* 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))