* Assets dwindled to $1.45 bln from $5 bln two years ago
* Former Diamondback trader on trial on insider charges
* Redemption notices swamped firm's expectations
* Diamondback was up 7 percent in mid November
By Svea Herbst-Bayliss
BOSTON, Dec 6 Hedge fund Diamondback Capital
Management, one of a handful of firms embroiled in a government
insider trading investigation, told investors it would close
down after nervous clients demanded the return of more than a
quarter of its assets.
Richard Schimel and Larry Sapanski, the firm's co-heads,
broke the news to clients in a letter Thursday just three weeks
after investors asked Diamondback to return $520 million, five
times the amount top executives had expected.
As assets dwindled to $1.45 billion from about $5 billion
two years ago, the firm's business model was in jeopardy and
executives had to decide between closing the firm down or trying
to engineer a second big restructuring within 18 months.
"Rather than continue to manage investor capital while
undertaking to restructure the firm to manage this reduced level
of assets, we have decided that the most prudent course is to
wind down and terminate the funds and return investor capital,"
the two men wrote in the letter, a copy of which was obtained by
Diamondback expects to lay off nearly all 133 employees. A
small number will stay to manage the final liquidation, the
people familiar with the matter said.
Founded by Schimel, Sapanski and a third partner, Chad
Loweth, in 2005, Diamondback had been an industry darling.
Its three founders had all worked at Steven A. Cohen's
successful SAC Capital Advisors, giving them the kind of
pedigree that attracted some $6 billion of assets from marquee
clients like the New Mexico's pension fund and Blackstone
Group's powerful fund-of-funds unit.
BUCKING THE TREND
The fund's returns were strong with an average annual return
of 9 percent since 2005, boasting gains even during the
financial crisis when many hedge funds were in the red. There
was only one down year - 2011.
But two years ago, the firm's fortunes plunged when federal
agents raided its Stamford, Connecticut-based headquarters,
shepherding employees into a conference room, taking their cell
phones, and spending hours boxing up documents.
With Diamondback swept up in the government's fast-moving
insider trading probe into how managers might be using illegally
obtained tips to make million-dollar trades, many investors got
cold feet and ran for the exits.
The probe had already led to the arrest of Galleon Group
founder, Raj Rajaratnam, in 2009 and would later lead agents to
Cohen's SAC, where seven former SAC Capital employees have now
been implicated or charged. Last week, SAC told its clients it
would likely face civil securities fraud charges.
Diamondback's founders and the firm were never accused of
any wrongdoing, but many clients left, and the company gradually
In January, when Todd Newman, a former Diamondback portfolio
manager, was arrested in Boston, the news turned worse for the
firm. Although executives promptly fired him after he came under
a cloud and cooperated with the government investigation, the
fact that Newman's trial coincided with investor redemption
notices that were due hurt the firm, a person familiar with the
So managers began selling assets and moving into cash in
order to return the bulk of client money by mid-January.
Yahoo! Inc, Capital One Financial Corp and
American International Group Inc were among the firm's
biggest holdings at the end of the third quarter, according to
CLOSING THE LOOP
Diamondback's liquidation now closes the last chapter of
four firms that were surprised by FBI raids in November 2010,
when the government's probe picked up speed.
The other firms - Level Global Investors, Loch Capital
Management and Barai Capital - unraveled quickly. Diamondback,
however, vowed to stay in business, helped by powerful investors
like Blackstone Group's ongoing support.
But by Nov. 15, the date for investors to decide whether
they would stay or go, there was a tough decision to be made.
While Diamondback was delivering respectable returns of 7
percent after having returned an average of 9 percent a year
since its founding in 2005, Newman's trial was playing out in a
Manhattan court room.
Even though Diamondback's founders would not be prosecuted
in the matter, there was a lot of headline risk. The firm had
agreed to pay $9 million to settle civil charges that Newman,
who made technology investments from Boston, and Jesse Tortora,
a former Diamondback analyst, were making illegal trades.
Diamondback joins a large number of funds that have recently
decided to get out of the business for a variety of reasons.
John Kleinheinz is shutting Kleinheinz Capital because, he said,
he wasn't having fun running the fund anymore, and Pierre-Henri
Flamand, who set up Edoma Partners after leaving Goldman Sachs,
said he could not make money in the current tough market
At the same time, tougher regulations have also put a crimp
in some traders' operations, industry experts said. And the
government's insider trading case is expected to continue for
some time at least.