SEC: Boston hedge fund Fontana Capital broke rule

BOSTON (Reuters) - U.S. financial regulators on Friday charged a former Boston-based hedge fund manager with illegally earning more than $1 million by violating a short-selling rule involving three financial stocks.

Forrest Fontana, who started Fontana Capital LLC after having worked at industry powerhouse SAC Capital Advisors, violated Rule 105 of Regulation M, the U.S. Securities and Exchange Commission said in an order instituting administrative cease and desist proceedings.

The rule prohibits investors from participating in public offerings after having shorted the same securities.

According to the government, Fontana, who traded mainly in financial stocks, violated the rule on three occasions, helping his investors earn unlawful profits of about $1,101,000.

Fontana’s lawyer, Lisa Wood, said the matter is not a fraud case and relates to “isolated, inadvertent, technical violations of Rule 105.” “We disagree over the measure of damages,” Wood said.

For the last year these types of cases have become a priority for the SEC. But they’ve been overshadowed by the government’s more prominent and growing investigation of insider trading at hedge funds.

Fontana set up his own fund in 2005 with $50 million in start-up capital from his former SAC boss, Steven Cohen, and he quickly generated buzz in the local investment community.

But by 2010, he was effectively out of business, managing no funds for clients and concentrating on his work as one of five selectmen in the town of Winchester, north of Boston.

In 2008, more than three years after his launch of his fund, Fontana violated the SEC rule, the government said. He shorted 60,000 shares of XL Capital (which changed its name to XL Group last year) and shorted 40,000 shares of Bank of America’s Merrill Lynch on July 25, 2008.

Four days later, the regulators said, Fontana purchased 50,000 shares of XL Capital and 200,000 shares of Merrill Lynch in secondary offerings. Fontana earned $792,000 on his Merrill Lynch and $149,000 on his XL Capital bets, the SEC said.

A few months later on November 6, 2008, during the height of the financial crisis, Fontana shorted 100,000 Wells Fargo shares and then purchased the same amount one day later, realizing a profit of about $160,000, the SEC said.

Merrill Lynch was acquired by Bank of America in 2008.

The matter will now move to a hearing and Fontana could be ordered to pay back all or some of the gains and he might face certain penalties, the SEC said.

For Fontana this may mark a low point in a storied career that took him from Boston’s famed mutual fund houses Fidelity Investments and Putnam Investments to SAC, one of the world’s most prominent hedge funds. Thanks to Cohen’s backing, Fontana quickly expanded his firm to about $325 million by November 2006. But in 2007 Cohen pulled his money out and after suffering through the financial crisis, Fontana managed only $16.1 million in early 2009. He moved out of his Boston offices early in 2010.

This is not the first time Fontana has been embroiled in a regulatory issue. While at SAC, he had frequent contact with a research analyst at Morgan Keegan Inc before the firm issued a negative research report on Fairfax Financial Holdings Ltd. Fairfax promptly sued a group of hedge funds, including SAC, claiming they conspired to drive down the company shares.

Additional reporting by Matthew Goldstein; Editing by Steve Orlofsky