Fairfax’s Once-Sprawling Racketeering Suit Shrinks as Hedge Funds Drop Out

Fairfax Financial Holdings Ltd. (FFH), with seven of eight hedge funds it accused of spreading false rumors out of a lawsuit, may see the $24 billion case shrink again with a judge poised to rule whether racketeering counts allowing triple damages should be tossed.

Three of the funds that won dismissal in the case, including billionaire Steven A. Cohen’s SAC Capital Advisors LP, have a total $29 billion in assets under management. The two main defendants remaining are a New York hedge fund with less than $100 million and a Memphis, Tennessee, brokerage recently sold for $930 million.

Fairfax, in the suit filed in New Jersey state court in 2006, accused the funds of trying to drive down its stock as they bet against it in a so-called bear raid. The remaining defendants seek to block Toronto-based Fairfax from tripling its $8 billion claim, as allowed under the state’s anti-racketeering law. The case can be viewed as an example of civil racketeering suits moving into the realm of hedge funds, one legal expert said.

“If they win that, that could be the nail in the coffin,” Jonathan W. Wolfe, a lawyer who represented a fund released from the litigation, said of the defendants’ effort. “I think you will continue to see this case get smaller and smaller.”

Trial Date

New Jersey Superior Court Judge Stephan C. Hansbury in Morristown is considering whether Fairfax can invoke the state’s anti-racketeering statute. The defendants, arguing at a Jan. 6 hearing that Canadian or New York law applies, said the case doesn’t have enough connection to New Jersey to allow the counts to go forward. They called the racketeering claims “a manipulative public relations sham.”

Hansbury, who scheduled a March 16 hearing on other motions, said he wants to set a trial date as early as May.

Fairfax, which owns stakes in Canadian and U.S. insurers, said in its complaint that the hedge funds coordinated with stock analysts to spread false rumors about it so the funds could profit through short sales, borrowing shares in anticipation of making money by replacing them with cheaper shares later after the price dropped.

The company’s $8 billion damage claim is based on allegations the hedge funds’ actions depressed Fairfax’s credit ratings, diminished its ability to make acquisitions and reduced the amount it could raise in debt and equity offerings, according to court papers.

‘Robust Remedy’

New Jersey’s Racketeer Influenced and Corrupt Organizations law, unlike anti-racketeering laws in New York and Canada, allows private parties to sue and seek triple damages. The New Jersey law covers conduct outside the state, said Michael Bowe, a lawyer for Fairfax, at the January hearing. “It is a unique and very powerful, robust remedy,” he said.

Fairfax’s Crum & Forster Holdings unit, a plaintiff in the case, is located in Morristown and provides one of the bases for suing under New Jersey law.

“The only reason they brought this case in New Jersey was to try to take advantage of the New Jersey RICO statute,” Bruce Collins, a lawyer for the Memphis brokerage Morgan Keegan, told Hansbury in January. “If the New York law applies, as we urge, then the New Jersey RICO claims must be dismissed.”

‘New Intersection’

The case could be viewed as an example of the expansion of civil RICO suits, usually brought in other commercial and financial contexts, into the realm of hedge funds, said Kristin N. Johnson, a law professor at Seton Hall University School of Law in Newark, New Jersey.

“This is a new intersection in terms of efforts to assert civil-liability claims against players engaged in complex transactions, including short selling,” Johnson said.

Biovail, once Canada’s largest publicly traded drugmaker, sued SAC Capital over racketeering claims in New Jersey state court six months before the Fairfax suit. Biovail, which used the same law firm and public-relations firm as Fairfax, accused the hedge fund of plotting to drive down its share price. As in the Fairfax case, the Canadian parent was a plaintiff with a New Jersey subsidiary.

The Biovail judge dismissed the case in 2009, finding that New York, not New Jersey, law applied. SAC Capital sued the company, now part of Mississauga, Ontario-based Valeant Pharmaceuticals International Inc., for “vexatious litigation.” In 2010, Valeant settled for $10 million, saying Biovail’s suit was “regrettable.”

Fairfax Trading

In September, Cohen, 55, and Stamford, Connecticut-based SAC Capital, with $14 billion under management, won dismissal from the Fairfax case. Hansbury said the evidence didn’t show they were part of a conspiracy to bring down Fairfax.

“The deficiencies of plaintiffs’ case are particularly glaring as to Steven A. Cohen and SAC Capital,” Hansbury wrote in his summary of SAC Capital’s argument. “Cohen never participated in an enterprise to injure Fairfax.”

Cohen was almost totally uninvolved in SAC Capital’s Fairfax trading, the judge wrote.

SAC Capital’s biggest position in Fairfax was in 2004 when it owned as many as 100,000 shares, and that for most of the period the lawsuit covers, the hedge fund’s economic interests were aligned with Fairfax’s, Hansbury wrote.

“I’m in the lawsuit because of marquee value,” Cohen said in a February 2011 pretrial, sworn interview in the case. “Meaning that, you know, I’m a well-known guy and -- on Wall Street.”

‘Waste of Time’

In December, Hansbury ruled that Daniel Loeb, 50, and his Third Point LLC, with $8.8 billion, and James Chanos, 54, and his $6 billion Kynikos Associates LP couldn’t be sued in New Jersey. The judge also dropped Institutional Credit Partners LLC, or ICP, a fixed-income fund, and William Gahan, who was a trader there and is now with P E Capital Markets LLC in New York. Third Point, Kynikos and ICP are also based in New York.

“We are gratified that the judge has put an end to this colossal waste of time and resources,” Third Point said in a statement after Hansbury’s ruling.

Of the four other hedge funds sued by Fairfax, David Rocker and his former fund company, New Jersey-based Copper River Management LLC, formerly Rocker Partners LP, won dismissal in 2008.

Fairfax had said in its complaint that David Rocker was “a key architect and manager” of the scheme. The previous judge in the case, Deanne Wilson, ruled there wasn’t enough evidence linking Rocker to a conspiracy.

Fairfax voluntarily dropped two other funds from the suit. They were Greenwich, Connecticut-based Lone Pine Capital LLC and Trinity Capital of Jacksonville Inc. in Jacksonville, Florida.

Battle Continues

The legal battle continues between Fairfax and hedge fund Exis Capital Management Inc. and Morgan Keegan & Co. (3543Q), the Memphis-based brokerage that St. Petersburg, Florida-based Raymond James Financial Corp. agreed to buy in January. The seller, Birmingham, Alabama-based Regions Financial Corp. (RF), is indemnifying Raymond James for litigation brought prior to the sale.

Exis is one of the defendants seeking dismissal of Fairfax’s racketeering claims. Morgan Keegan has said in court filings that it, too, should be dropped from the case.

The remaining defendants include Exis Chief Executive Officer Adam Sender, 43, and Chief Operating Officer Andrew Heller, 40; Christopher Brett Lawless, a former analyst at Fitch Group Inc.; and Spiro Contogouris, an outside analyst who Fairfax said the funds hired to spread misinformation. Contogouris’s companies, including MI4 Investors LLC, and associate Max Bernstein, are also defendants.

Pursuing Claims

Hansbury’s ruling dismissing SAC Capital and the two other hedge funds was a “clear error,” Bowe, the Fairfax lawyer, said in an e-mail. Fairfax intends to get judgments against Morgan Keegan and Exis this year, and then continue pursuing the claims against the other defendants on appeal immediately after, he said.

Dismissal of the racketeering claims, which would eliminate the possibility of triple damages, wouldn’t affect other claims or limit the billions of dollars in damages that Fairfax is seeking, Bowe said in an e-mail last month.

The Fairfax complaint includes allegations of commercial disparagement, tortuous interference with contractual relationships, tortuous interference with prospective economic advantage and civil conspiracy.

Weaker Underwriting

On Feb. 16, Fairfax reported net income of $45.1 million for last year, compared with $335.8 million in 2010. It said the drop was due to weaker underwriting results from large catastrophe claims worldwide. Since July 2006 when the suit was filed, Fairfax’s U.S. market capitalization has increased almost four-fold to $8.06 billion from $2.16 billion.

Fairfax fell 1.5 percent to C$403, after dropping as much as 2.3 percent, in Toronto today, the biggest one-day drop since Feb. 22.

One of Fairfax’s main accusations centers on Contogouris and another on a former Morgan Keegan analyst.

Fairfax said in the complaint that, as part of the funds’ bear raid, Contogouris began a dirty-tricks campaign in November 2005, when Bernstein, who worked with him, sent a letter under the name P. Fate to Rev. Barry Parker at St. Paul’s Anglican Church in Toronto. Fairfax founder Prem Watsa served as chairman of the church’s investment committee. Watsa was bilking Fairfax shareholders, according to the letter cited in the complaint.

Watsa, 61, who founded Fairfax in 1985, modeling its management style after Warren Buffett’s Berkshire Hathaway Inc., received the same package via e-mail with computer code at the bottom showing P. Fate was Bernstein, according to the complaint.

Harassing Messages

The same day Watsa got the e-mail, someone phoned Fairfax and left a message. “Tell Watsa that when he goes to jail next year we will visit him and bring him some treats,” the caller said, according to Fairfax’s complaint.

Contogouris and Bernstein sent other harassing messages to Fairfax executives and false documents that put the company in a negative light to analysts and shareholders, Fairfax said in its complaint.

Michael Critchley, a lawyer for Contogouris, Bernstein and MI4 at Critchley, Kinum & Vazquez LLC in Roseland, New Jersey, didn’t return two calls seeking comment on the litigation.

The originating phone number for the November 2005 call to Fairfax was listed to Exis, and the materials were sent to Fairfax and Watsa from Exis’s New York office, the insurer said. Contogouris worked out of Exis’s office.

Where the messages came from is irrelevant, Exis COO Heller said in a phone interview.

“It doesn’t answer allegations of conspiracy and spreading false and misleading statements,” Heller said. “You can’t have a conspiracy if there’s no conspiracy.”

‘Publicity Stunt’

Exis acquired a short Fairfax position in 2005 that peaked in July 2006 at 230,000 shares, according to Hansbury’s September ruling.

“This Fairfax lawsuit has caused our firm immense damage and has prevented us from raising money despite great performance over the last five years,” Exis CEO Sender said in a phone interview. “The lawsuit is completely frivolous and without any merit whatsoever.”

Bowe disagreed.

“If plaintiffs’ claims were meritless or a publicity stunt, Contogouris, Exis, and the other defendants paying and working with Contogouris would have moved years ago to be dismissed because there was no evidence they did what they are accused of,” Bowe said in an e-mail. “They never made that argument because they can’t. The evidence is overwhelming.”

Negative Reports

Fairfax also said the hedge funds coaxed John Gwynn, a former insurance analyst at Morgan Keegan, into giving them his negative Fairfax reports before they were published. Morgan Keegan fired Gwynn in 2008 for disclosing research on Fairfax to selected clients before publication, the brokerage said at the time. He has since died.

Fairfax said Gwynn misrepresented the company’s finances in his reports, including its reserves for claims.

On Jan. 17, Morgan Keegan asked Hansbury to drop the case against it because Gwynn’s opinions were speech protected by the U.S. Constitution’s First Amendment. Kathy Ridley, a Morgan Keegan spokeswoman, declined to comment on the litigation.

On Feb. 3, Lawless, the former Fitch analyst who worked at Exis for two months in 2006, also moved to be dismissed on First Amendment grounds. In November, Hansbury declined to drop Lawless, who in that motion argued the evidence didn’t connect him to any conspiracy. Hansbury ruled there were enough facts in dispute to present to a jury.

Kevin S. Reed, a lawyer for Lawless at Quinn Emanuel Urquhart & Sullivan LLP in New York, declined to comment on the litigation.

Ethical Rules

Last year, the defendants tried to persuade Hansbury to have Bowe’s law firm, New York-based Kasowitz Benson Torres & Friedman LLP, removed from the case.

The defendants accused the law firm’s investigators of posing as managing directors of a sham hedge fund and contacting Gwynn even after the suit was filed in 2006 and they knew he had a lawyer, which the defendants said violated ethical rules.

“Balanced against the interests of the plaintiff in maintaining counsel it wishes, I can’t remove the firm and I won’t,” Hansbury said at an Oct. 6 hearing. “It’s clear the purpose of these motions is to get rid of plaintiffs’ counsel to disadvantage plaintiff.”

Elicit Information

Hansbury said the investigators engaged in “a deception” on Gwynn that was “orchestrated by counsel. These people told lies in order to elicit information.” The judge said the defendants could bring their allegations to the court’s ethics committee.

Bowe denied his firm broke ethics rules.

“Moving to disqualify opposing counsel after six years of litigation for something you have known about for five years is a classic litigation tactic when you have little else to defend your case,” he said in an e-mail.

“People spread lies about Fairfax,” he said. “Fairfax sued. People who spread lies are sued all the time.”

The Fairfax complaint revealed the funds’ bear raid on the company, Bowe said.

“The suit exposed that attack, restored billions in market cap within months, and will provide damages for the substantial business harm suffered,” he said.

The case is Fairfax Financial Holdings Ltd. v. SAC Capital Management LLC, L-2032-06, Superior Court of New Jersey, Morris County (Morristown).

To contact the reporter on this story: Thom Weidlich in Brooklyn, New York, at tweidlich@bloomberg.net

To contact the editor responsible for this story: Michael Hytha at mhytha@bloomberg.net.

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