FBI Target Diamondback Returned Three Times the Average for Fund Category

Diamondback Capital Management LLC, one of three hedge funds raided by Federal Bureau of Investigation agents, returned three times as much as peers since being founded in 2005, according to an investor letter.

Diamondback gained 73 percent from mid-2005 through July this year, compared with 22 percent for funds with a similar approach, as tracked by Chicago-based Hedge Fund Research Inc. The fund beat so-called multistrategy funds in 2006, 2007 and 2008, when it skirted losses from the credit crisis. It has lagged behind the group average since then.

Diamondback, along with Level Global Investors LP and Loch Capital Management, had its offices searched yesterday in connection with insider trading investigations by the office of Manhattan U.S. Attorney Preet Bharara, said a person briefed on the probes. The raids came less than three weeks after Bharara charged a French doctor with leaking proprietary information to a hedge fund run by FrontPoint Partners LLC in 2007 and 2008.

Diamondback, which manages about $5.8 billion, has returned about 6.3 percent this year and 23 percent last year, compared with gains of 12 percent and 25 percent, respectively, for multistrategy funds. In 2008, when peers on average lost 20 percent, Diamondback was flat. In 2007, it rose 19 percent, compared with 1.8 percent on average for the strategy, according to Hedge Fund Research.

SAC Alumni

FBI agents took trading files from Diamondback’s offices and asked general questions about their business, according to people familiar with the fund. The agents told the firm to continue to operate as usual, the people said.

Steve Bruce, a spokesman for Diamondback, declined to comment.

The firm, based in Stamford, Connecticut, was founded in 2005 by Chad Loweth, Rich Schimel and Lawrence Sapanski, 51, who all previously worked at billionaire Steven A. Cohen’s hedge fund, SAC Capital Advisors LP. Schimel, 42, is Cohen’s brother- in-law. Loweth left Diamondback earlier this year.

John Hagarty, Diamondback’s chief operating officer, was previously COO at FrontPoint, according to Diamondback’s marketing documents dated June.

SAC Capital got a government request for documents, said a person familiar with the firm today, as the U.S. widened the insider trading probe. Mutual fund managers Wellington Management Co. and Janus Capital Group Inc. also received requests.

‘Silo Structure’

Diamondback has a similar structure to SAC Capital, in that the hedge fund employs traders to run their own portfolios, while Sapanski and Schimel oversee a so-called center book that invests in trades believed to have the best potential for success, according to the investor letter.

At SAC Capital, a team runs a portfolio, previously known as the “Cohen Account,” that utilizes the best ideas from other traders and analysts, according to the firm’s marketing documents.

“Since Diamondback has this silo structure, it could be just down to one bad apple,” Tammer Kamel, president of Toronto-based Iluka Consulting Group Ltd., which advises clients on investing in hedge funds, said referring to managers who run their own portfolios. “I don’t see this as being systemic.”

Diamondback charges clients fees of as much as 30 percent of profits, according to the investor letter. Most managers charge 20 percent.

FrontPoint

Neither SAC Capital nor Cohen have investments in Level Global and Diamondback, said a person familiar with the firm who asked not to be named because the funds are private.

Schimel and Sapanski didn’t return phone messages seeking comment. Hagarty didn’t reply to a phone message and an e-mail seeking comment. Jonathan Gasthalter, a spokesman for Stamford- based SAC, declined to comment.

FrontPoint, which wasn’t accused of any wrongdoing, decided to close down the $1.5 billion health-care hedge funds after a portfolio manager allegedly received tips about the results of Human Genome Sciences Inc. trials for the drug Albuferon, according to a person briefed on the firm’s plans.

The firm, which managed about $7 billion, had placed Dr. Chip Skowron, a co-portfolio manager at the health-care funds, on leave pending the outcome of the probe. Before joining FrontPoint, Skowron was an analyst at hedge funds Millennium Partners LLC in New York and SAC Capital.

Level Global

Level Global, too, was founded by a former SAC trader, David Ganek, 47. The firm, which invests in technology and financial stocks, won a $100 million commitment from New York State Common Retirement Fund in November last year, according to a monthly report from the pension plan.

Dennis Tompkins, a spokesman for New York State Comptroller Thomas DiNapoli, the sole trustee of the $132.8 billion New York State Common Retirement Fund, said the fund also invested $225 million with Diamondback. He said the comptroller monitoring the situation closely and are in contact with both funds.

“It concerns us, obviously,” Tompkins said. “We’re going to do whatever we can to protect the assets of the fund and protect our investments.”

Level Global told clients in April that it had sold a minority stake to a leveraged-buyout firm run by Goldman Sachs Group Inc., Petershill Fund Offshore LP.

Andrea Raphael, a spokeswoman for New York-based Goldman Sachs, declined to comment.

‘Bottom-Up’ Approach

Level Global, with offices in New York and Greenwich, owned U.S.-listed shares of 77 companies valued at $3.08 billion at the end of the third quarter, with 34 percent of that in consumer discretionary stocks and 31 percent in information technology companies, according to data compiled by Bloomberg.

Diamondback had invested in 706 U.S.-listed companies as of Sept. 30, with a market value of $4.13 billion, the largest portions in energy and financial services, according to regulatory filings.

Diamondback had about 215 employees as of August, according to the letter. The firm said its portfolio managers “use bottom-up fundamental ideas as provided by research analysts, and integrate these ideas with macro and technical analysis to complete investment perspectives.”

Diamondback last year agreed to return $94,014 in profits, plus pay interest of $21,154 and a civil penalty of $47,007, to settle allegations by the U.S. Securities and Exchange Commission that the firm violated trading regulations for stock offerings by public companies. The company neither admitted nor denied guilt in settling the allegations.

SEC Settlement

The SEC alleged that Diamondback in 2005 sold securities short within five days of the pricing of a stock sale, and then covered the short sale with shares it purchased in the offering. The stock sales were by several Bermuda-based reinsurance companies, including IPC Holdings Ltd., Axis Capital Holdings Ltd., Endurance Specialty Holdings Ltd., and Everest Re Group Ltd.

In determining whether to accept Diamondback’s settlement offer, the SEC took into account “remedial actions promptly undertaken” by Diamondback and cooperation afforded to the agency’s staff, according to a copy of the administrative order filed with the SEC.

Agents also executed a search warrant at the offices of Loch Capital Management, a Boston-based hedge fund run by twin brothers Timothy and Todd McSweeney.

The McSweeneys had close personal connections with Steven Fortuna, a hedge-fund manager who pleaded guilty in the insider- trading probe that stemmed from Galleon Group LLC, according to Reuters.

Timothy McSweeney didn’t respond to a phone message seeking comment. Leonard Pierce, a lawyer for Loch Capital, didn’t return phone calls and an e-mail seeking comment.

To contact the reporter on this story: Saijel Kishan in New York at skishan@bloomberg.net

To contact the editor responsible for this story: Christian Baumgaertel at cbaumgaertel@bloomberg.net

Press spacebar to pause and continue. Press esc to stop.

Bloomberg reserves the right to remove comments but is under no obligation to do so, or to explain individual moderation decisions.

Please enable JavaScript to view the comments powered by Disqus.