The Fairfax Chronicles Part 1 - Exposing SAC's Alleged Market Manipulation And Insider Trading Schemes

by Tyler Durden
03/12/2011 15:10 -0500

The story of Fairfax Financial vs almost every single US-based hedge fund is nothing new. The company has long been embroiled in litigation against a bevy of hedge funds, including SAC Capital, Exis Capital, Third Point, Kynikos, and Institutional Credit Partners, contending that ever since the start of 2002 it was the repeated target of bear raids, which involved not just a cabal of bearish hedge fund managers who would allegedly (although we now have evidence) spread rumors, innuendos, and outright lies about the company in the hope of bringing the price down (whether through naked shorts or otherwise is irrelevant), but also sellside research analysts, and of course media lackeys, willing to pander to the hedge fund "masters of the universe" in hopes of the occasional bone thrown their way. The reason Zero Hedge had largely ignored this story over the years is that its narrative truly reads like something out of a conspiracy theorist's wet dream: the allegations previously presented by the mainstream media implied such a level of collective deviousness and manipulation, that it would bring about the immediate ridicule of anyone who dared to bring them up in polite society. This is no longer case.

On Friday, Reuters' Matt Goldstein brought our attention to a just declassified document in the case (Superior Court of New Jersey, MRS-L-2032-08 ) from April 1, 2008 which until very recently existed in the void only under seal with confidentiality provisions due to some very unflattering exposures regarding the behavior and/or maturity level and language of key defendants (primarily Dan Loeb and Adam Sender). Goldstein's report on some of the florid language presented in the 800 page "Plaintiff's Memorandum in Opposition to Defendants' Motions for Partial Summary Judgment and to Determine Choice-of-Law" can be found here. Yet going through this filing, which incidentally reads like a Grade-A thriller, highlights much, much more than just some crude language. With extensive proof courtesy of e-mails, instant message transcripts and notes, we find that the "conspiracy" case brought by Fairfax (which incidentally) recently traded near decade highs. In fact, previous disclosures in the case already led to the ignoble termination of one sellsider involved: John Gwynn, who would fabricate reports based on hedge fund solicitation, advise hedge fund clients of report issuance dates, and send his non-public research days in advance to the defendants, in exchange for receiving trading commissions. And while reading bits and pieces of the filing is informative, it is not until one has read it in its entirety does one realize why hedge fund managers believe they are untouchable: after all the accusation presented herein, and validated through subpoenaed evidence, is nothing short of one of the biggest conspiracy theories ever presented to the public. Whether it is proven true remains to be seen: the case is still ongoing. In the meantime, we will provide our readers with as much of the plaintiff's case as possible. But before we get into the meat of the matter, today we wish to present the accusations levelled against one SAC Capital, in what is possibly the most controversial if, some would say, realistic description ever proffered to the public of this secretive hedge fund which controls up to 3% of the NYSE daily volume.

When one speaks of Stevie Cohen, it is usually with unbridled fawning, in hopes of extracting extrernalities, particularly by members of the media or blogosphere, with admiration, in hopes of getting a job there, particularly by employees of other hedge funds, biotech companies, investment bankers or the SEC (naturally), or, one just doesn't speak at all: after all, SAC, which no longer is as prominently in the public's eye as it was in the mid/late 2000 period, is well known as one of the most ruthless hedge funds - both internally and externally. After all who in their right mind would consider crossing a man who is known to (allegedly) sexually "assault" his male traders, offer on site psychological counselling, and who also just happens to be a billionaire thus having unlimited access to any resource... and recourse.

Not us.

We leave that to our far braver and wealthier peers at mainstream media organizations like Bloomberg, Reuters and the New York Times, but certainly not Barron's, or NYPost, as they were all in on the scheme as will soon be revealed.

Which is why we will let the lawsuit filed against SAC among others do the talking. Naturally, this is just one side of the story. Yet we are confident that readers will certainly enjoy that surprisingly coherent narrative which perhaps the SEC should consider reading. After all, it is hardly a secret that the person at the center of the recent "expert trading" network crack down is none other than the man who formerly had an ice rink in his own back yard.

This is the first post in a series exposing the true inner working of the hedge fund world. This following exposition on SAC Capital is merely the appetizer.

From Docket No. MRS-L-2032-06, Fairfax Financial Holdings Limited v S.A.C. Capital Management LLC et al (pp 192-197)

The S.A.C. Defendants

The S.A.C. hedge funds derive their names from the initials of their founder and leader Steven A. Cohen. Cohen is known in the industry as the "most powerful trader on Wall Street you've never heard of" because of the "highly secretive and stupendously successful S.A.C. funds he controls." Defendant Cohen began his hedge fund through major ill-gotten gains from a substantial trade that he executed based on material inside information about a merger transaction and about which he asserted the Fifth Amendment when he was questioned by regulators.

Since that time, however, Cohen has grown his funds so that today Cohen controls no less than $12 billion and regularly accounts for 3% of the NYSE daily volume and 1% of the NASDAQ daily volume. These investment dollars are channeled through several different companies or feeder funds -- including a core fund, a global diversified fund, a health-care fund, and Defendant Sigma fund (comprised of Cohen's personal monies), all of which Cohen manages in a highly integrated and hands-on fashion without regard to appropriate formalities and for the purpose of disguising his participation in fraudulent and other illegal trading activities.

Cohen's market influence extends much further than the S.A.C. funds he directly controls. In addition to the billions he controls directly through those funds, he has also invested billions more in non-S.A.C. funds, including funds formed by former S.A.C. managers who are required to agree as a condition of S.A.C. employment to permit Cohen to hold up to a 50% interest in any hedge funds they form after leaving S A.C. Through such S.A.C. satellite" or related fund investments, Cohen is better able to mask his trading and investment strategies and the frequent market manipulation employed in executing those strategies. Cohen likewise is very closely involved in the management and decisions at these satellite funds, and communicates constantly with the managers there to ascertain market intelligence and coordinate his investment strategy. In addition, S.A.C. regularly communicates with other market participants, including putative competitors, at specially scheduled "idea meetings" for the purpose of collaborating with and among such putative competitors. Consequently, Cohen personally has one of the most, if not the most, powerful market-Moving capabilities on Wall Street.

In the first 12 years since he formed S.A.C. Capital Advisors, Cohen had regularly generated incredible returns in the range of 40% per annum. Reflecting this extraordinary performance, investors pay him a 50% success fee, far above the 20% industry standard. As a result, Cohen's annual S.A.C. management fee regularly has exceeded $400 million, which is in addition to profit he earns on his own monies invested in Sigma and other S.A.C. and non-S.A.C. funds. Cohen himself reportedly earned $550 million in 2005, and $1 billion in 2006.

Unlike most hedge funds, S.A.C. seeks no volume discount on its enormous trading costs and commissions, and consequently pays over $150 million in annual commissions -- making it one of Wall Street's top ten trading customers. In addition, S.A.C. frequently purchases secondary offerings that include substantial built-in brokerage commissions for banks, and thereby further increases S.A.C.'s already substantial financial leverage and influence. Cohen uses this enormous financial leverage to support S.A.C.'s trading strategies by demanding access to material non-public information from financial institutions with whom S.A.C. does business, including non-public inside information concerning public companies and other clients to whom those institutions owe fiduciary and other duties of non-disclosure, and the substance and timing of reports and recommendations being issued by analysts for those institutions. Financial institutions and their employees understand -- because S.A.C. has told them and made it clear in practice -- that by providing S.A.C. with privileged access to material non-public information, they will be rewarded with business from S.A.C. and its related funds and the failure to do so would result in the inability to secure such lucrative business.

S.A.C. uses its enormous financial leverage not only to extract and trade on material non-public information but also to actually dictate the substance and timing of certain material information being disseminated to the market. For example, S.A.C. regularly uses its substantial financial leverage to direct and influence the analysis and recommendations of purportedly independent stock analysts and the time such analysis and recommendations are issued to the market, without any disclosure of the material conflict of interest reflected by its leverage and influence. Like S.A.C.'s demand for material non-public information, it is now simply understood in the industry that failing to provide S.A.C. with influence and control over the substance and timing of analyst reports will result in the loss of S.A.C.'s substantial business.

Those who fail to produce at S.A.C. or its related funds are quickly terminated or lose their S.A.C. investment funds: "At S.A.C., you either perform or you're dead," according to one public report by an insider. Such policies ensure that those who remain at S.A.C. are willing and capable of doing whatever it takes to secure the extraordinary performance Steven Cohen demands. The enormous pressure to perform at S.A.C. was particularly acute in 2003 after Cohen had experienced what insiders called "quite a disappointing year" of 14% returns and $100 million in management fees in 2002.

In addition to trading on material non-public information, the S.A.C. Defendants and their related funds orchestrate short-selling "bear attacks" on publicly traded companies where they need a "catalyst" to move the stock price in line with their investment needs. They prosecuted these attacks on Fairfax and other targeted companies by, among other things, paying, pressuring, and otherwise influencing purportedly independent analysts and others working with S.A.C, including over the years Defendants [John Gwynn, a then sellside analyst at Morgan Keegan] and [Spyro] Contogouris, to disseminate materially false and misleading information about the business, accounting, and corporate governance of those targeted for Bear Raids and securing material non-public information.

Indeed, as set forth in detail below, Gwynn issued his initial report on Fairfax at a time when S.A.C. had a substantial short position in Fairfax, was actively searching for a catalyst to move the stock price down, and was communicating regularly with other short-sellers such as defendants Chanos, Kynikos, and Lone Pine, and others, including those with contacts to Gwynn, such as Lone Pine. As part of this effort to find a catalyst, in late 2002, S.A.C. lobbied research and ratings analysts to issue negative reports or downgrades on Fairfax and discussed the same with other short sellers, including defendant Lone Pine. As part of that effort, S.A.C. communicated with CIBC research analyst Quentin Broad in or about November 2002 about initiating coverage on Fairfax and understood from those conversations that Broad would initiate such coverage on Fairfax by the end of 2002. However, in December 2002, S.A.C. learned from Broad that he would not be able to initiate coverage by year end or by any definite time in 2003, and S.A.C. used this material non-public information to adjust its investment decisions

And as set forth in detail below, Morgan Keegan and Gwynn then agreed to initiate negative coverage on Fairfax in and around late November/early December 2005 after consultation between and among Defendants and Enterprise Members, including Lone Pine, which was also communicating with S.A.C. about their respective substantial short positions in Fairfax and the need for a catalyst. S.A.C. was then tipped off by Chanos of Defendant Kynikos that Gwynn would be issuing a negative report on Fairfax. Gwynn provided S.A.C. with the actual research that would be published by Gwynn and informed them when it would be published, S.A.C. used that material non-public information in its investment decisions, and S.A.C. thereafter sent business to Morgan Keegan as a quid pro quo for Gwynn's assistance.

In addition, as also set forth in detail below, Contogouris got his "start" in the securities industry by working with Mr. Cohen, his general counsel Peter Nussbaum, and S.A.C. manager Jeff Perry. Initially, Contogouris was an insider at Hanover Compressor and provided material non-public information about that company to Cohen, who then took a short position in advance of Contogouris instigating an SEC investigation out of the SEC Forth Worth, Texas office and a class action lawsuit. Based on Contogouris' actions, Cohen profited and he paid Contogouris for his services. Contogouris then continued to work as one of many "outside consultants" working with Perry and others at S.A.C.

Contogouris was thereafter considered for employment at S.A.C., but after S.A.C. reviewed a background check on Contogouris, it determined that formal employment was not appropriate. Instead, Contogouris began working for various S.A.C.-spin-offs or affiliates, including Exis and certain of its subsidiaries, as well as with Perry, and kept in regular communication with Cohen up until the filing of the complaint in this action. One of those funds was S.A.C. spin-off Exis, in which S.A.C. was a central investor and with which Cohen maintained frequent contact with Sender concerning Exis' investment of S.A.C.'s money. As a result of these communications, Cohen was aware of Exis' strategy and methods for investing his money and its use of Contogouris to generate a profit on these positions.

Indeed, in 2005, when Contogouris began his work on Fairfax in earnest, he was working for three S.A.C.-related funds -- Exis, Bridger, and Prentice Capital -- each of which had major investment relationships with S.A.C. and at least two of which had major short positions in Fairfax. In this regard, Cohen not only maintained regular communications with these funds but also with Contogouris, whose employment he approved of, despite the fact that he was aware that Contogouris was not a real research analyst but an operative used to manufacture "catalysts" to move stock prices, and was also aware of Contogouris' fraudulent background. Nevertheless, Cohen at no time objected to or insisted any of the funds in which he was invested, and which were shorting Fairfax, stop utilizing Contogouris because Cohen understood and approved of Contogouris' role just as he had when he worked for Cohen directly in 2001 and 2002.

Throughout the period in question, and in particular while he was engaged in the conduct related to Fairfax that is the subject of the TAC, Contogouris continued to communicate on a regular basis with Cohen and kept him regularly informed about all material market information he possessed as did Sender and Contogouris' boss at Bridger, Roberto Mignone. And through these communications and those with Sender and Mignone, Cohen was aware of and approved of the their efforts to secure substantial profitable returns from massive short positions these S.A.C.-related funds had assumed in Fairfax and for which they were using Contogouris. And based on this information, various accounts at S.A.C. engaged in shorting and short-related trading parallel to that of Exis and others working on the Fairfax short during the time alleged in the TAC.

In order to ensure there are no records of his and his funds activities, Cohen insists that all electronic and other communications be destroyed and not stored.

Much more to come ... ading-sche

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