SEC probing alleged improper trades by hedge funds

[February 14, 2009]  WASHINGTON (AP) -- Federal regulators are investigating allegations by a large insurer that several hedge funds conspired to drive down its stock price by using advance notice of an analyst's negative report about the company.

The Securities and Exchange Commission is examining the situation involving insurer Fairfax Financial Holdings Ltd., a person familiar with the inquiry said Friday. The person spoke on condition of anonymity because the investigation has not been made public.

Fairfax Financial, a Canadian property and casualty insurer, brought the allegations in a lawsuit filed in July 2006 in state court in New Jersey. Documents submitted in the ongoing case indicate that executives of the hedge funds discussed the upcoming report of the analyst, John Gwynn of Morgan Keegan Inc., who was fired by the brokerage firm in August 2008.

The hedge funds - SAC Capital Advisors, Third Point LLC and Kynikos Associates - used knowledge of Gwynn's report before its public release to bet against Fairfax Financial's stock by short-selling it, the insurer alleges. Short sellers borrow a company's shares, sell them, and then buy them when the stock falls and return them to the lender, pocketing the difference.

Short-selling is legal and widely used on Wall Street, but trading on significant information about companies that was obtained ahead of the general public is a violation of securities laws.

Fairfax Financial shares dropped 13 percent to $65.10 on Jan. 17, 2003, when Gwynn's report was released saying the insurer's reserves against potential losses on claims were $5 billion short. On the next trading day, the stock closed at $59.30.

As the financial crisis spiraled last fall, regulators said aggressive short-selling worsened the downturn, contributed to the plunging values of bank stocks and the collapses of big investment firms Lehman Brothers and Bear Stearns. The SEC has been investigating the actions of hedge funds in the crisis.

The agency's inquiry regarding Fairfax Financial was reported in Friday's editions of The Wall Street Journal.

SEC spokesman John Nester declined to comment Friday.

Toronto-based Fairfax Financial alleged that the hedge funds paid Gwynn and Morgan Keegan to disseminate false, damaging information about the company from 2003 through 2007.

"We've just been trying to set the record straight" through the court case, Paul Rivett, vice president and chief legal officer at Fairfax Financial, said Friday. He declined to comment further.

The funds - SAC Capital Advisors, Third Point LLC and Kynikos Associates - have denied wrongdoing in the court proceeding.

Stamford, Conn.-based SAC Capital has maintained in court that trading documents show the hedge firm was actually buying Fairfax Financial stock - not selling it as a negative move - in the period before Gwynn's report was made public.

Jonathan Gasthalter, a spokesman for SAC Capital, declined to comment Friday.

Spokesmen for Third Point and Kynikos, both based in New York, didn't immediately return telephone calls seeking comment.

Memphis-based Morgan Keegan, a subsidiary of Regions Financial Corp., said Gwynn was fired for violating the firm's policy prohibiting advance disclosure of the publication date and recommendations of analyst research reports.

"The timing of the report's release, which is the reason for Mr. Gwynn's discharge, has no bearing on the content or accuracy of the report," the firm said in an e-mailed statement. "The central issue of the lawsuit is whether Mr. Gwynn was bribed to spread false information about Fairfax. We continue to believe that the lawsuit is completely without merit. In fact, the evidence shows that Mr. Gwynn strongly believed in the accuracy of the facts in his report."

Fairfax Financial shares rose $7.70, or 2.4 percent, to $325.81 Friday.

[Associated Press; By MARCY GORDON]

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