* Fairfax lawsuit dogs Cohen's SAC, Chanos' Kynikos
* Funds' executives and traders to be deposed
* SEC launched own probe into Fairfax allegations
* SEC served subpoena on Fairfax seeking fund reports
* For Cohen, probe comes at awkward time, given Galleon
By Matthew Goldstein and Svea Herbst-Bayliss
NEW YORK/BOSTON, Nov 23 (Reuters) - When Fairfax Financial
Holdings Ltd FFH.TO sued a group of hedge funds in 2006
claiming they conspired to drive down the price of the
company's shares, many viewed the litigation as a cynical
attempt by the Canadian insurer to silence its critics.
Some skeptics predicted the lawsuit filed with a New Jersey
state court would be quickly dismissed and forgotten. But three
years later, the lawsuit against Steven Cohen's SAC Capital
Advisors, James Chanos' Kynikos Associates and others is going
strong and creating headaches for two of the best-known U.S.
hedge fund managers.
Fairfax's lawyers are expected to start taking depositions
of some of the hedge funds' executives and traders soon.
The Securities and Exchange Commission, now prominently
pursuing an insider-trading case against New York-based hedge
fund firm Galleon Group, has taken notice of some of the
allegations raised in the Fairfax lawsuit, launching its own
investigation last year, said people familiar with the case.
This spring the SEC served a subpoena on Fairfax's lawyers,
seeking copies of all emails and trading reports the hedge
funds had turned over to the insurer during the initial
discovery process in the litigation.
The subpoena specifically requested information concerning
any trading activity "that gave SAC a financial interest in the
rise or fall" of Fairfax's share price, according to a copy of
the document.
SAC, which is said to account routinely for 3 percent of
the average daily trading on the New York Stock Exchange, ranks
as one of the biggest and most consistently profitable U.S.
hedge funds, whose trading secrets are highly regarded but
often generate envy and questions on Wall Street.
Representatives for SAC and Kynikos, for their part,
declined to comment on the SEC investigation. An SEC lawyer in
New York assigned to the investigation also would not comment.
Securities regulators are trying to determine whether
Cohen's SAC, Chanos' Kynikos and the other hedge funds received
advance notice that a research analyst at Morgan Keegan Inc
would issue a negative research report on Fairfax and then
sought to profit from that information by betting against the
insurer's stock through short sales or other trading
strategies.
For Cohen, the regulatory focus on his $12 billion hedge
fund firm in connection with the Fairfax litigation comes at an
awkward time.
Richard Choo-Beng Lee, a cooperating witness in the insider
trading case brought by federal prosecutors against Galleon
founder Raj Rajaratnam and 18 others, is prepared to tell
authorities of any insider trading he may have done while
working as a technology analyst at SAC from 1994 to 2004.
Besides Lee, federal prosecutors are taking a close look at
several other former SAC traders and analysts to see if they
may have violated any securities laws while working at the
Stamford, Connecticut-based fund, said people familiar with the
insider trading probe.
But so far, prosecutors have not charged anyone with
breaking any laws while working at SAC.
And certainly, the allegations in the Fairfax litigation
are a far cry from the kind of aggressive horse-trading and
paying for top-secret corporate intelligence that prosecutors
allege they have found in their investigation into insider
trading at Galleon and a handful of smaller hedge funds.
As for the Fairfax matter, the SEC opened its regulatory
inquiry in the fall of 2008 after the Memphis, Tennessee-based
investment firm fired analyst John Gwynn, claiming he violated
firm policy by discussing the research report and its findings
with several hedge fund managers before its release, said
people familiar with the investigation.
Regulators issued the subpoena after the hedge funds
produced emails showing that some of their employees had been
talking and emailing with Gwynn about his forthcoming report --
in some instances nearly a month before the negative report on
Fairfax was published on Jan. 17, 2003.
The emails, now part of the court record, reveal that
Chanos, who famously forsaw the collapse of Enron Corp and bet
against its stock, may have been aware of Gwynn's upcoming
report as early as Dec. 11, 2002, and that Chanos may have
subsequently shared that information with a trader at SAC.
Another former SAC employee, Forrest Fontana, also had
frequent contact with Gwynn in the days leading up to the
report's release, according to court filings.
Fontana left Connecticut-based SAC to return to Boston
where he had previously worked at powerhouses Putnam
Investments and Fidelity Investments to set up his own hedge
fund, Fontana Capital, in 2005.
With an initial $50 million investment from his former
employer, Steve Cohen, Fontana grew his own fund to $325
million by Nov. 1, 2006, according to documents he sent to
potential investors.
In late 2006, a few months after Fairfax filed its lawsuit,
SAC withdrew all its money from Fontana Capital, said several
people familiar with the situation.
A few weeks ago, Fairfax lawyers notified Fontana Capital
that the fund firm will have to begin turning over documents
and emails as part of the discovery process.
Despite the fund's strong performance over the years, it
seems to have fallen on hard times.
Fairfax attorney Michael Bowe would not comment on what
information he hopes to obtain from Fontana Capital, but he
confirmed asking the hedge fund to begin turning over the
requested documents. He said the allegations in his client's
lawsuit offer a "blueprint for how hedge funds operate and
interact with each other."
But in earlier court filings in the Fairfax litigation, all
the defendants have argued they have done nothing wrong and
were not involved in helping to spread false rumors in the
market about Fairfax as the insurer claims they did. A
spokesman for Morgan Keegan, a division of Regions Financial
Corp RF.N, declined to comment.
Gwynn, meanwhile, died of natural causes earlier this year
-- before Fairfax's attorneys could interview him. It is not
known whether lawyers for the SEC spoke to Gwynn before he
died.
Some trading records already obtained by Fairfax's lawyers
purport to show that Chanos' hedge fund increased its short
position in Fairfax shares by several million dollars after
learning that Gwynn's negative report was in the works.
Lawyers for SAC long have maintained the fund's trading
records, which have yet to be made public, will show that
Cohen's enterprise was actually accumulating Fairfax shares in
the days before Gwynn's report was released.
(Reporting by Matthew Goldstein and Svea Herbst-Bayliss;
Editing by Martin Howell and Matthew Lewis)
((Matthew.Goldstein@ThomsonReuters.com; +1 617 856 4331;
Svea.Herbst@ThomsonReuters.com; + 1 617 856 4331))