Investors flee fund with ties to Galleon witness

BOSTON Thu Jan 21, 2010 3:17am EST

BOSTON (Reuters) - The tight-knit Boston hedge fund community has been rattled by a guilty plea in the biggest insider trading prosecution in two decades.

Loch Capital Management, a technology-oriented hedge fund that once boasted over $2 billion (1.2 billion pounds) in assets, has been hit hard by redemptions because of close personal ties between its founders -- twin brothers Timothy and Todd McSweeney -- and a key witness in the still-unfolding Galleon investigation.

The reason? Federal prosecutors revealed that Steven Fortuna, a co-founder of hedge fund S2 Capital Management, had pleaded guilty in the ongoing insider trading investigation and was cooperating with federal authorities, said at least three people familiar with Loch Capital.

Neither McSweeney has been implicated by name in any court filing that federal prosecutors or securities regulators have made public about the investigation.

Still, speculation has swirled around their firm as a result of the brothers' friendship with Fortuna, which prompted a string of clients to demand their money from the fund.

Fortuna and the McSweeneys were born in Massachusetts and still live there.

Some of Loch Capital Management's more than 100 investors as well as people familiar with the hedge fund said the relationships were behind many of the redemption requests.

The decision by some Loch Capital investors to cash-out may be nothing more than an overreaction based on speculation. Or the redemption requests could be an indication of just how nervous hedge fund investors remain a year after the Bernard Madoff scandal left a lot of investors looking foolish.

Spooked by the industry's 19 percent plunge in performance in 2008, investors are more likely to ask for their money back rather than give managers the benefit of the doubt.

It is not clear how much money investors in Loch Capital have withdrawn since Fortuna's name surfaced in the insider trading investigation that first made headlines when Galleon Group co-founder Raj Rajaratnam was arrested and stayed in the news when charges were filed against 20 others.

But people familiar with Loch Capital said investors have either pulled or sought to redeem a substantial sum of money, well in excess of $200 million. This comes at a time many other hedge funds have reported taking in new money.

NO-GO ZONE FOR REPORTERS

Loch Capital Management and the firm's Boston-based lawyer, Leonard Pierce, did not respond to a number of telephone calls and email messages requesting information about the redemptions and the brothers' friendship with Fortuna.

A security guard at Loch's offices in the city's financial district said he had been instructed to turn away any reporter.

He even had photographs of the two authors of this story at his kiosk with instructions not to let them enter under any circumstances.

People familiar with the situation said some Loch Capital investors became skittish when Fortuna pleaded guilty to conspiring with the manager of an unnamed Boston hedge fund to exchange insider information about Dell Computer Inc DELL.O.

Federal prosecutors did not identity the manager with whom Fortuna had shared insider information, but a court filing said Fortuna and the unidentified manager were friends.

Other investors who yanked money were also concerned that Loch Capital, whose assets peaked at $2.4 billion in early 2008, was sitting on too much cash, said people familiar with the situation.

Hedge fund investors who had met with the brothers said the McSweeneys were used to making big bets. "If it is tech and liquid they trade it," said one person who invests billions in hedge funds and had considered putting money with Loch.

Investors' concern about the McSweeneys' ties to Fortuna coincides with the conclusion of a rather lackluster year for Loch Capital. Through the end of November, its two main funds were down about 1.5 percent, according to performance tracking service Hedgefund.net.

Like many hedge funds, Loch Capital can bet that a stock will fall and investors who know the firm said the brothers made more of those bets last year, which left them with anemic returns when the market rallied.

By contrast the average hedge fund returned 20 percent last year, marking their best returns in a decade.

Returns at Loch Capital's flagship fund have trailed off in recent years. In 2006, the fund registered a 19 percent return-its best year ever.

In 2006, the Dundonald Fund, the McSweeneys' other main investment vehicle, debuted with a 43 percent annual return. But the Dundonald fund also has seen its returns come back to earth of late.

The funds, which have never employed much more than a dozen people, have let go of several employees in recent months. The fund's website is no longer operational and oddly brings up an ad for the consumer electronics chain PC Richards.

Loch Capital is one of Boston's bigger hedge funds, and over the years it has attracted money from investment funds run by Citigroup and Credit Suisse. Another big investor includes the hedge fund management arm of American International Group.

Yet despite managing to attract money from some big players, the McSweeneys aren't particularly well-known outside of the world of technology investors.

People who know them around Boston call them family men who prefer to keep a low profile in an industry where some managers make headlines with multi-million dollar charity donations or owning parts of local sports teams.

Todd McSweeney and his wife, Jeanette Hsu, were photographed last year at a fundraiser gala for the Isabella Steward Gardner Museum, one of the cities more established social events.

Both brothers, who grew-up in Lexington, a tony Boston suburb, graduated from Clark University in Worcester and earned business degrees from Northeastern.

Fortuna, meanwhile, is one of five people known to be cooperating with the ongoing Galleon investigation. He co-founded S2 Capital in 2008 with Seth Buchalter.

The two men started S2 after leaving Stratix Asset Management, a hedge fund that closed in 2007.

Buchalter hasn't been charged in the case. Bernard Cooney, a lawyer for Buchalter, declined to comment.

Court filings show that Fortuna began cooperating with federal authorities in April 2009, after being approached by an agent from the Federal Bureau of Investigation.

Federal prosecutors have alleged that Fortuna exchanged insider trading information with Danielle Chiesi, a former manager with New Castle Partners, a one-time $1 billion hedge fund originally set-up by Bear Stearns.

Chiesi, who comes across on government wiretaps as a person quick to use profanity to make a point, has pleaded not guilty to the charges against her, just like Rajaratnam. Prosecutors have alleged that Chiesi and Rajaratnam also shared insider tips.

There is nothing in the court filings that suggest that Chiesi and the McSweeneys shared any information.

(Reporting by Matthew Goldstein and Svea Herbst-Bayliss; editing by Jim Impoco and Ted Kerr)

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