Fairfax the Latest to Join Fight on Hedge Funds

Lawsuit is the latest salvo in a years-long feud that has escalated into a declaration of war

By Sinclair Stewart and Paul Waldie
The Globe & Mail
July 28, 2006


One day last fall, in early November, a strange package arrived at the doors of St. Paul's Anglican Church in downtown Toronto. The cover letter, signed by a P. Fate from a Roman Catholic cathedral in New York, was personally addressed to Reverend Dr. Parker, and purportedly sought to warn him about his church's finances.

The source of concern, Mr. Fate wrote, centred on the church's investment committee chairman, Prem Watsa, the reclusive founder and chief executive officer of Canadian insurer Fairfax Financial Holdings Ltd. The letter compared Mr. Watsa's facial features to those of convicted U.S. fraudster Martin Frankel, and then took a stab at equating their business methods as well, saying their "pattern of activities" was far too similar to be overlooked.

"Be aware, father, be skeptical and ask Mr. Watsa to make confession," the letter concluded. "God bless. P Fate."

For good measure, the package included a 30-page document, titled "Marty Frankel: Sex, Greed, and $200 million fraud," which described his money-laundering schemes along with lurid descriptions of group sex and other "sensational activities."

Dr. Barry Parker could not be reached for comment yesterday, but details of the package were included in a $6-billion (U.S.) lawsuit filed by Fairfax this week against a research analyst, several high-powered hedge funds, and two so-called fund "operatives," one of which allegedly wrote the letter.

None of the allegations have been proved. According to the lawsuit, this was a turning point in Mr. Watsa's long-running and increasingly bizarre fight with short sellers, a group of investors he has accused of trying to drive the value of his company into the ground through a well-orchestrated campaign of rumour-mongering and harassment.

That feud erupted in late 2002, when Fairfax listed its stock on the New York Stock Exchange. Within weeks, two million shares were sold short, a practice of borrowing shares and agreeing to replace them later, in hopes the stock price will dive. Around the same time, an analyst named John Gwynn issued a critical report on the company, one that Mr. Watsa and his company alleged was not only dead wrong, but "incredible, materially misleading."

Fairfax's stock plunged more than 30 per cent, and continued to slide in the lead-up to the company's annual investor meeting in April, 2003. It prompted Mr. Watsa, who has typically shunned any kind of spotlight, to do something uncharacteristic: He showed shareholders a picture of a U.S. tank hauling down a statue of Saddam Hussein, but with his own face pasted over the Iraqi dictator's. The caption underneath was a declaration of war: "The shorts."

For more than 2 years, the battle raged on, largely unnoticed, of course, given the secretive nature of both combatants. Mr. Watsa and his defenders blamed hedge funds for spreading negative rumours about the company in a bid to drive its stock down; detractors, however, insisted Fairfax was a financial basket case, one burdened by non-communicative management and an overly complex structure that was almost impossible for investors to understand.

Bitter though the fighting may have been, it was not wholly unusual. At least, not until Mr. Watsa's pastor received his package. It was at this point, according to Fairfax's lawsuit, that the company and its executives began to face much more personal attacks: And the culprits, it alleges, are some of the same hedge funds and analysts it had been wrestling with since 2002.

These are not bush-league investment firms, either. One of the defendants, Steven Cohen, is regarded as perhaps the most aggressive -- and successful -- hedge fund manager in the world. He is also a controversial art collector, and paid $8-million last year for an installation piece by contemporary artist Damien Hirst that consisted of a rotting shark in a tank. He can afford it: His firm, SAC Capital Management LLC, controls $7-billion in assets and accounts for a reported 3 per cent of the New York Stock Exchange's trading volume.

In a statement yesterday, SAC flatly denied the accusations.

"This is another baseless lawsuit by a company attempting to shift the blame for its fundamental business problems," the hedge fund stated. "We are confident that we will prevail."

Another defendant, Adam Sender, worked for Mr. Cohen before founding his own firm several years ago, and eventually renaming it Exis Capital Management.

Mr. Sender, 37, was a star trader for Mr. Cohen at SAC before striking out on his own in 1998. According to court filings, his new hedge fund, Exis Capital, grew to about $1.5-billion in assets by 2003 and produced annual returns of about 30 per cent. Like Mr. Cohen and other hedge fund managers, Mr. Sender took up to 50 per cent of all profit. And, like his former boss, he had a passionate and sometimes peculiar interest in art. He spent $44,000 on a photograph of a crucifix immersed in urine.

According to court filings, Exis ran into trouble in late 2003 after taking a short position on Research In Motion Ltd. The fund allegedly lost a fortune when RIM's share price increased, and Exis's overall assets were cut in half. That debacle prompted Mr. Sender to become involved in the plot against Fairfax, documents allege.

An official at Exis said the firm would not comment on the matter, and Mr. Sender did not return an e-mail.

Part of Fairfax's suit deals with allegations that these and other powerful hedge funds used their influence to spread falsehoods and prod analysts into writing negative reports on the company, resulting in substantial financial damage.

By the fall of 2005, however, shortly after Fairfax received a U.S. regulatory subpoena as part of an industry-wide probe, the company claims that its opponents adopted more guerrilla-style tactics, and allegedly began harassing executives and their families.

Fairfax alleges that Exis employed Max Bernstein and Spyro Contogouris as "operatives" to help manipulate the price of Fairfax's stock.

The two men used such pseudonyms as "Dick Tracey," "MI4 Reconnaissance," "Monty Gardener," and "P. Fate," the last of which is the fictitious name Mr. Bernstein adopted when he sent the letter to Mr. Watsa's pastor, according to the suit. Neither could be reached for comment.

Throughout last fall, Fairfax claims the defendants stepped up their attacks on the company with the help of these men. Not long after the letter to the pastor, two people linked to the defendants allegedly showed up at Mr. Watsa's house and inquired of his whereabouts in a "threatening manner." Two days later, another person allegedly dropped off a package at Mr. Watsa's office and began taking pictures of the waiting room.

Mr. Watsa claims he was followed by men associated with the defendants, and the company alleges his secretary received a pair of e-mails from "Dick Tracey," warning her about the consequences of being involved in criminal behaviour.

Similar allegations are littered throughout Fairfax's 89-page complaint filed in a New Jersey state court.

There are alleged cyberattacks on the company website; an alleged legal threat from Mr. Bernstein to the company's auditors; and an "eerie" e-mail to a Fairfax lawyer, remarking on a photograph of her, the suit claims.

Mr. Watsa, who is known for his reserve, initially dismissed these alleged incidents as "silly," according to lawyers working on the case. But when rumours circulated that Mr. Watsa had fled the country with company money and was being pursued by the RCMP -- rumours that the suit claims incited panicked phone calls from bankers -- Fairfax decided to press forward with legal action.

"I think that he views these attacks as outrageous," said Marc Kasowitz, a lawyer at the New York law firm of Kasowitz Benson Torres & Friedman.

Mr. Kasowitz filed a suit on behalf of Canadian drug maker Biovail Corp. earlier this year, which included similar allegations against some of the same defendants, including SAC. A spokesman for Fairfax said the Biovail suit played a "considerable" role in the company's decision to retain Mr. Kasowitz's firm.

Plaintiff: Prem Watsa

Publicity-shy founder of Fairfax Financial, which has sued SAC Capital and several other hedge funds for $6-billion (U.S.). The suit is the third in the past year to target hedge funds for allegedly colluding behind the scenes to manipulate stock prices. Fairfax's suit contains the most bizarre allegations of the three. Fairfax claims the funds used "shadowy operatives" to harass Mr. Watsa's business colleagues, family members and even his pastor. SAC called the suit "baseless."

Plaintiff: Eugene Melnyk

Chairman of Biovail Corp. and a sports club owner, Mr. Melnyk has sued SAC Capital Management and research firm Gradient Analytics for $4.6-billion (U.S.), making similar allegations as Fairfax. Mr. Melnyk has also publicly gone after hedge funds in an appearance on a segment of CBS's 60 Minutes titled "Betting on a fall." Biovail's lawsuit claims to have eyewitness accounts of Gradient's strategy of producing "hatchet jobs" on companies on behalf of short sellers.

Plaintiff: Patrick Byrne

Founder of Utah-based on-line retailer Overstock.com, Mr. Byrne sued hedge fund Copper River Partners and Gradient last year, alleging they conspired to crush his company's share price. He's since gone on a campaign against funds, calling them "lickspittle," "condoms," "jackanapes" and "tools of Satan." He once wrote to a hedge fund manager: "I don't like people like you. I think you are dishonest and slimy…I don't like you." The hedge funds have rejected his allegations.

The lawyer

A high-profile New York lawyer known for aggressive tactics, Marc Kasowitz, is leading Eugene Melnyk's and Prem Watsa's case and his team has worked with lawyers involved in Patrick Byrne's case. Best known for launching a $5-billion libel lawsuit on behalf of Donald Trump against a prominent business author.

The strategy

All three lawsuits allege that powerful hedge funds work together to attack companies, short their stocks and spread false information to drive down share prices. The hedge funds deny the allegations and claim the companies are just trying to deflect attention from their own ineptness.

The mug slinging

Patrick Byrne has alleged some hedge funds worked under the direction of an unnamed "Sith Lord" to destroy Overstock's share price. Prem Watsa has alleged hedge fund operatives spread bizarre information about sadomasochistic sex in order to destroy his reputation. David Rocker, who runs Copper River, has shot back saying Mr. Byrne is conducting a "theatre of the absurd" to intimidate him and others into silence.

The hedge funds


SAC Capital Management: A $7-billion fund headed by Steven Cohen, 49, famous for his take-no-prisoners approach to investing. Mr. Cohen earned an estimated $550-million last year. He has called the lawsuits "baseless" and attempts by these companies to shift the blame for their problems.

Exis Capital Management: Run by Adam Sender, 37, who left Mr. Cohen's fund in 1998. Mr. Sender's fund has around $1-billion in assets. He has run into controversy over his taste in art, buying a photograph of a crucifix immersed in urine, and his alleged ties to Anthony Pellicano, a notorious Hollywood private detective who faces charges of wiretapping and conspiracy.

Third Point LLC: Run by Daniel Loeb, 44, a colourful investment guru known for his scathing letters such as this one to the head of Star Gas: "A review of your record reveals years of value destruction and strategic blunders which have led us to dub you one of the most dangerous and incompetent executives in America." Mr. Loeb paid $45-million for a penthouse apartment in Manhattan last year.

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