Hedgies About to Get Trimmed?

The Journal and Bloomberg have very interesting stories on the legal battle between Fairfax Financial Holdings and the short-sellers it says conspired against it.

Fairfax’s attorneys uncovered emails that show a stock analyst gave several hedge funds, including SAC and a Jim Chanos firm, a head’s up that he was about to release a very negative report. The WSJ scoops that the SEC is now investigating the hedge funds.

The investigation comes amid a civil-court case brought by the insurer, Fairfax Financial Holdings Ltd. That case, filed in a New Jersey state court in 2006, unearthed documents indicating that executives at the hedge funds discussed the coming report of the analyst and made bets that the company’s stock would decline.

This looks very bad for the hedgies and for the analyst who allegedly tipped them off:

On Dec. 11, 2002, a Kynikos Associates executive wrote the hedge fund’s founder, James Chanos, saying he had heard from another hedge fund that Mr. Gwynn was going to issue a research report rating Fairfax stock “underperform” and warning about a reserves deficiency, according to a court exhibit.

A week later, Mr. Chanos forwarded an email to Jeffrey Perry at SAC Capital Advisors, a New York hedge fund founded by Steven Cohen. The email, written by another Kynikos employee who said he had talked to Mr. Gwynn, said the analyst “was more critical of [Fairfax] than I’ve ever heard a sell side analyst … everything from underwriting to accounting to honesty,” according to a court exhibit.

On Jan. 16, 2003, a Kynikos executive wrote Mr. Chanos, saying he had just talked with Mr. Gwynn. “[H]is piece that rips FFH [Fairfax] apart is supposed to be published tomorrow. Should be interesting to see how the street reacts,” he wrote, according to a court exhibit. The report was issued the next day.

Trading records obtained by Fairfax through discovery in the lawsuit show that Kynikos put on a $5 million “short” position, or a bet against Fairfax shares, in the month after Mr. Chanos learned of Mr. Gwynn’s report, including $2.5 million the day before the report came out, a Fairfax attorney, Michael Bowe, said during a September court hearing.

The hedge funds, of course, deny any wrongdoing.

This is one to watch.

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Ryan Chittum is a former Wall Street Journal reporter, and deputy editor of The Audit, CJR's business section. If you see notable business journalism, give him a heads-up at rc2538@columbia.edu. Follow him on Twitter at @ryanchittum.