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Ghosts of Fairfax Financial: Now, Hedge Funds Scurry to Sever Ties with SAC Capital

By Judd Bagley, Published: December 23rd, 2009 12:44 PM CST

Investigative financial reporter Teri Buhl is reporting that hedge funds are scrambling to put as much distance as possible between themselves and the increasingly radioactive SAC Capital, which is rumored to be the next target of the FBI’s crackdown on insider trading. According to Buhl, this includes purging email exchanges with SAC.

Funds like Blue Ridge, Greenlight, Third Point, Glenview, and Maverick are cutting back on any contact with [SAC Capital's Steve Cohen]. When we asked major players such as [President of hedge fund Kynikos Associates] Jim Chanos and others if they’ve been pinging Stevie about a trade lately, you’ll get a very defensive ‘no.’

…Extra measures are being taken to hire data-miners to comb through any and all emails firms and their trading consultants ever sent to anyone at SAC in an attempt to erase them from internet memory.

If true, hedge funds Third Point and Kynikos will find it quite impossible to delete all their correspondence with SAC, given possesses several emails which, it just so happens, implicate all three funds in insider trading of a different sort; specifically, influencing and trading ahead of an analyst’s report. first reported on this situation nearly one year ago, but I feel it’s worth revisiting and updating this topic, given recent developments.

Here’s the short version: in late 2002, a group of short-selling hedge funds, led by Kynikos Associates, learned from a Morgan Keegan analyst that he was preparing to initiate very pessimistic coverage of Canadian insurance company Fairfax Financial (FFH) Holdings (NYSE:FFH). Kynikos promptly alerted SAC Capital and Third Point Partners about this prime shorting opportunity. In the days that followed, traders at Kynikos and SAC met with the analyst, reviewed and offered input on drafts of his forthcoming report, and, together with Third Point Partners, built up large short positions in Fairfax, which they very profitably covered following the report’s publication.

In one particularly telling email, a SAC trader sends an email to Steve Cohen himself, in which he explicitly states that SAC will cover their Fairfax short position following the Morgan Keegan report’s publication.

Here’s the long version: Fairfax Financial Holdings was first listed on the NYSE on December 20, 2002. During its first 15 trading days there, volume averaged well under 180,000 shares.

Then, on January 16, 2003 FFH volume exceeded 500,000 shares on an otherwise uneventful day in the life of a Canadian insurance company.

The next day, January 17, 2003 Morgan Keegan analyst John Gwynn initiated coverage of FFH with a scathing report and rating of “underperform”, making for one of the more eventful days in the lives of Fairfax shareholders, as their investments took heavy losses on extremely high volume.

Because information drives markets, one would expect to see extra activity in the wake of new information, such as that introduced by Gwynn on the 17th.

But what accounts for the unusually high volume observed the day before Gwynn’s report was published?

The answer to that question would come in October of 2008, when Morgan Keegan announced that Gwynn had been terminated for sharing his unpublished research on Fairfax with a small group of short-selling hedge funds.

Gwynn’s termination appears to be linked to the lawsuit Fairfax filed against several firms, including SAC, Third Point and Morgan Keegan, alleging racketeering.

Email and trading data obtained through discovery in that suit conform that hedge funds Kynikos Associates, Third Point Capital, and SAC Capital all traded ahead of this material, non-public information.

It all started on December 11, 2002 when Kynikos employee Mark Heiman alerted Chanos that he had just learned from an analyst at Ziff Brothers Investments that a Morgan Keegan analyst was about to publish a negative report on Fairfax.

From: Mark Heiman (Kynikos Analyst)
Sent: December 11, 2002 11:06 PM
To: James Chanos (Kynikos President), Douglas Millett (Kynikos COO)
Subject: Fairfax
I just got off the phone with ZBI’s insurance analyst, Michael Ting. He just talked to a new insurance analyst at Morgan Keegan, and apparently that analyst is about to initiate FFRX at “Underperform,” with the thesis being that they are extremely under-reserved into the $3-$5 BN area. Also, there may be an article in Forbes or Fortune soon that will be similarly critical.
Ting said he thought that analyst was one of the best P&C analysts he has talked to, and wanted to give us the heads-up, as well as hear how we’re coming at it.

The next day, Kynikos employee Matt Cantrell apparently contacted Gwynn, as he sent Ting several documents relating to Fairfax subsidiaries, with the comment, “John Gwynn believes these might be of interest to you.”

Four days later, Heiman spoke to Gwynn personally, having a conversation which he summarized in the following report to Chanos:

From: Mark Heiman (Kynikos Analyst)
Sent: December 16, 2002 4:46 PM
James Chanos (Kynikos President), Douglas Millett (Kynikos COO), Charles Hobbs (Kynikos Managing Partner)
Subject: Fairfax
Just spoke to John Gwinn at Morgan Keegan, and he was more critical of FFRX than I’ve ever heard a sell side analyst. It looks like his criticisms of from the top to the bottom–everything from underwriting to accounting to dishonesty. He gave me his basics, as he is somewhat restricted because he hasn’t officially launched. It will be interesting to see how much of this the people who run the research department there will let him publish!

On December 18, 2002, Chanos forwarded Heiman’s email to Jeff Perry, then a senior portfolio manager at SAC Capital.

The day after Fairfax began trading on the NYSE, Gwynn’s revelations became much more explicit as he shared with Kynikos employee Heiman portions of his forthcoming report on Fairfax.

From: Mark Heiman (Kynikos Analyst)
Sent: December 21, 2002 6:03 PM
To: James Chanos (Kynikos President), Douglas Millett (Kynikos COO), Charles Hobbs (Kynikos Managing Partner)
Subject: Fairfax
Last night John Gwinn at Morgan Keegan faxed over to me an outline detailing the issues at FFH, basically those he will be publishing on. He has been a huge help and even offered to talk to me from his home today. We can look at these and talk to him next week–I just wanted to come in today and take a look at what he sent to get a head start on what he sent.

In the days to follow, Gwynn and SAC Capital Portfolio Manager Forrest Fontana held a face to face meeting where they discussed Fairfax.

Fontana followed up on that meeting via email to Gwynn:

From: Forrest Fontana (SAC Portfolio Manager)
Sent: January 06, 2003 8:57 AM
To: John Gwynn (Morgan Keegan Analyst)
Subject: RE: hope you had a nice holiday!

you available to touch-base on Fairfax sometime this week?

Followed by Gwynn’s prompt and eager reply:

From: John Gwynn (Morgan Keegan Analyst)
Sent: January 06, 2003 9:01 AM
Forrest Fontana (SAC Portfolio Manager)
Subject: RE: hope you had a nice holiday!
Name the time.

Fontana proposed a conversation the following day and requested a spreadsheet summarizing Gwynn’s analysis on Fairfax, which Gwynn promised to send.

On January 13, 2003 Fontana sent his boss, Steven A. Cohen himself, a summary of his planned activities for the week, which included:

Tuesday 1/14: Morgan Keegan expected to launch on Fairfax with sell rating – we will be covering into this.

As it turns out, Gwynn’s report was published on the 17th of January, not the 14th as Fontana expected. Still, it’s clear that SAC Capital was formally planning to trade ahead of the information received by Gwynn.

Trading records produced by Kynikos and Third Point all tell the same story: heavy short selling in anticipation of Gwynn’s report, and highly profitable short covering in the days that followed.

What did John Gwynn get out of all this? That’s unclear, though upon his firing, Morgan Keegan went to great lengths to say that Gwynn’s opinions were his own and not influenced by the hedge funds that profited from advance knowledge of them. We’ll likely never know more than that, as Gwynn reportedly passed away earlier this year.

The next question is: did Morgan Keegan get anything out of this arrangement?

The answer is yes: On December 21, 2002, the day after Kynikos received Gwynn’s unpublished analysis, Kynikos COO Douglas Millett declared his intention to begin sending business to Morgan Keegan.

Apparently, that’s how big hedge funds like Kynikos operate, which makes Chanos, who is also head of the Coalition of Private Investment Companies,  the logical person to lobby Congress as that body considers long-overdue reforms.

A few weeks after these emails were initially published here on, the Wall Street Journal reported “The Securities and Exchange Commission is investigating whether several hedge funds traded improperly after being given advance notice by a research analyst of his negative report on a prominent insurer.”

At the time, I made it clear that if anything became of that investigation, I would publicly eat my hat…not because of a lack of evidence of wrongdoing on the part of these hedge funds, but because — consistent with its captured state — it goes against the SEC’s culture to take action against big players.

Had these been small hedge funds acting illegally, the SEC’s version of civil justice would have most certainly been both swift and sternly-worded.

Related: FFH

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