Hedge Fund, Under Fire, Braces for Withdrawals

The embattled hedge fund SAC Capital Advisors is bracing for investors to pull out as much as several billion dollars by a Monday deadline. Withdrawals have stepped up as a separate deadline looms for law enforcement officials investigating the firm.

Over the next several weeks, the authorities must decide whether to bring a criminal case against SAC related to suspicious trading in two drug stocks. The government has already brought charges against a former SAC employee connected to those trades, which involved the fund’s billionaire founder, Steven A. Cohen. Authorities have explored new avenues on how they might bring a criminal case against the firm and possibly a civil action against Mr. Cohen, people briefed on the case said.

The escalated investigative activity has caused SAC investors to grow increasingly worried about the fund’s future. Already this year, investors have pulled $1.7 billion from the $15 billion fund, or about a quarter of the outside money managed by SAC. (Mr. Cohen’s fortune and employee money accounts for about $9 billion of the fund.)

Depending on the total amount of withdrawals on Monday, a scheduled quarterly deadline, SAC, which is based in Stamford, Conn., could shut its door to outside investors and manage only internal funds.

But the ultimate fate of the fund may be determined this summer, as the government’s investigation enters the final stages. Prosecutors expect four senior SAC executives who received subpoenas last month to testify before a grand jury, according to the people briefed on the case. The executives include the firm’s chief compliance officer and head trader, and they are expected to field questions about trading and compliance practices, these people said.

Mr. Cohen has also received a grand jury subpoena, but he is expected to assert his constitutional right against self-incrimination rather than subject himself to unlimited questioning, the people briefed on the case said. He has already provided testimony to securities regulators in a parallel civil inquiry. Neither Mr. Cohen nor the firm has been accused of criminal wrongdoing.

Though SAC has been a focus of investigators since at least 2006, the firm came under heightened scrutiny in November. Prosecutors accused Mathew Martoma, a former SAC employee, of obtaining secret data about clinical trials being done by the drug companies Elan and Wyeth, and using the information both to earn trading profits and avoid losses, a total of $276 million. For the first time in the inquiry, the government said that Mr. Cohen authorized the trades. Prosecutors have not claimed that Mr. Cohen knew about the confidential information that Mr. Martoma is accused of obtaining.

Mr. Martoma is fighting the charges against him and has rejected overtures to cooperate and testify against Mr. Cohen.

Because the Elan and Wyeth trades occurred in mid-July 2008, the government is running up against a five-year deadline to bring charges related to them. Prosecutors also face an August deadline to file charges related to trading in Dell shares, a case that has resulted in two indictments of former SAC employees, one of whom pleaded guilty.

As these deadlines approach, clients are fleeing. At least three have indicated they are withdrawing money, according to people briefed on the matter. Blackstone Group, SAC’s largest outside client, is expected to redeem more than half of roughly $500 million. Magnitude Capital, a New York-based firm that invests client money in hedge funds, has asked for its money, though how much is unclear.

A third investor, Ironwood Capital Management, has also put in a withdrawal request. Ironwood, a San Francisco-based fund, decided to pull its money after SAC said last month that it was no longer cooperating “unconditionally” with the government or providing investors with updates about the investigation.

Based on these withdrawals, SAC may decide to return money to all outside investors and become a “family office,” managing only Mr. Cohen’s wealth.

The investor retreat comes after Mr. Cohen and his legal team thought that they had resolved most of SAC’s legal problems. In March, it agreed to pay $616 million to settle two civil cases brought by the Securities and Exchange Commission related to the Elan, Wyeth and Dell trades.

But despite the record fine, the S.E.C. is still contemplating a civil action against Mr. Cohen, according to the people briefed on the case. The agency is considering a number of possible claims against him, including insider trading related to the drug-stock trades. Another option is a lawsuit accusing Mr. Cohen of failing to supervise his employees.

The S.E.C., which could assess a fine and seek to ban Mr. Cohen from the securities industry, has a lower threshold for proving its case than criminal authorities do. Prosecutors need to prove their case beyond a reasonable doubt, but the S.E.C. would have to prove its case by a preponderance of the evidence.

The criminal authorities also continue to press their case. In recent weeks, by serving new subpoenas on SAC executives, they have made it clear that they are still trying to build evidence against the fund, and perhaps Mr. Cohen. Prosecutors often hesitate to indict companies, fearing job losses and the threat to the economy. Often they file a so-called deferred prosecution agreement, suspending charges as long as the company begins reforms. But prosecutors are not considering such an agreement with SAC, say people briefed on the investigation.

At least nine current or former SAC employees have been tied to insider trading while at the fund; four have pleaded guilty.

In late April, SAC’s lawyers called a meeting to lay out their defense to possible charges, according to people briefed on the investigation. They were taken aback when 17 government officials â€" prosecutors, S.E.C. lawyers, F.B.I. agents and postal inspectors â€" attended the meeting at the United States attorney’s office in Manhattan.

Underscoring the importance of the SAC case, Richard B. Zabel, the deputy United States attorney in Manhattan, and Lorin L. Reisner, the head of the office’s criminal division, helped lead the meeting and have taken an active role in the investigation. Lawyers from Willkie Farr & Gallagher and Paul, Weiss, Rifkind, Wharton & Garrison are defending SAC.

A few weeks after the meeting, the authorities issued the grand jury subpoenas to the SAC executives, including one to Mr. Cohen. That day, the firm told investors it was no longer fully cooperating, a sign that Mr. Cohen will decline to testify. The other subpoenaed executives are Thomas Conheeney, the firm’s president; Solomon Kumin, chief operating officer; Steven Kessler, chief compliance officer; and Phillipp Villhauer, head of trading.

None have been accused of any wrongdoing.

Mr. Cohen’s lieutenants are expected to testify, but if they refuse, the government could compel testimony with a grant of immunity. One risk is that the executives could tell the grand jury they have no knowledge that Mr. Cohen ever violated securities laws.

Some government officials hold out hope that the two former SAC employees under indictment will turn against Mr. Cohen. If convicted, Mr. Martoma, 38, married with three young children, faces up to 25 years in prison. Much of the case rests on what was said during a 20-minute call between Mr. Martoma and Mr. Cohen the night before SAC began executing the trades.

Another of Mr. Cohen’s former employees, Michael S. Steinberg, 41, also married with a young family, is also staring at possible prison time for his involvement in the Dell trade. The authorities sought the cooperation of Mr. Steinberg, one of SAC’s longest-serving employees and a friend of Mr. Cohen. But he, too, has denied the charges.

Jon Horvath, a former SAC analyst, pleaded guilty to trading Dell shares illegally, and said he passed inside tips to Mr. Steinberg. He is expected to be the government’s main witness at Mr. Steinberg’s trial, set for Nov. 18. SAC is paying for the legal bills of both Mr. Martoma and Mr. Steinberg.

Bank of Ireland Bond Sale Confirms a Credit Boom

Investors’ appetite for Bank of Ireland bonds has changed a lot in the last four years.

In September 2009, the Irish lender, which received a 4.8 billion euro ($6.2 billion) bailout during the financial crisis, was forced to offer investors a return of around 4.6 percent to sell $1.3 billion of three-and-a-half year bonds.

Yet when the bank returned to the European corporate bond market last week, the yield, or interest rate, had almost halved, to 2.75 percent, on its $650 million of unsecured three-year bonds.

More important, the issuance was almost three times oversubscribed, as investors clamored to secure access to the relatively risky bonds.

“Ireland has recovered strongly in the past couple of years,” said Christopher Whitman, global head of risk syndicate at Deutsche Bank in London, which helped sell the bonds to investors. “Many credit investors are now comfortable with Ireland, as well as with the Bank of Ireland.”

The demand for the Bank of Ireland’s bonds is the latest example of the credit boom that is gripping Europe.

Despite concerns about the Continent’s wider economy, companies including global giants like Siemens and Barclays as well as smaller local firms have issued more than $430 billion of bonds this year, according to the credit ratings agency Standard & Poor’s. In contrast, companies in the United States have pocketed around $380 billion.

The bonanza has eased the short-term financing troubles for many of Europe’s struggling companies.

With banks cutting back on lending to meet more stringent capital requirements, the debt markets have provided companies an opportunity to refinance maturing loans, often at reduced interest rates. The new financing has also helped offset the impact of dwindling sales caused by the financial crisis.

Even in debt-ridden southern European countries like Greece and Portugal, companies have found willing bondholders to back new issuances.

The Greek oil-refining company Hellenic Petroleum, for example, raised $650 million in four-year bonds on April 30, after it offered investors an annual return of 8 percent. Portucel, a Portuguese paper manufacturer, also won backing in mid-May for its seven-year bonds worth a combined $455 million. The company had offered investors a return of 5.4 percent.

In total, European companies have issued $64.1 billion of high-yield bonds this year, almost double the amount compared with the same period in 2012, according to the data provider Dealogic.

Europe’s banking sector has also gotten into the financing act.

Faced with regulatory demands to increase their financing reserves, a number of large European financial institutions, including UBS of Switzerland and BBVA of Spain, have issued so-called contingent capital, or CoCos, to fill the void.

These complex financial instruments offer bondlike returns to investors, but convert to equity â€" or, in some cases, wipe out bondholders’ investments altogether â€" if a bank’s capital falls below a certain threshold. European banks have raised almost $5 billion through these products this year, and analysts expect more issuances by the end of the year.

“CoCos are an attractive option for some of Europe’s largest banks,” said James Longsdon, a managing director at the credit ratings agency Fitch Ratings.

While Europe’s corporate and financial sectors have benefited from the near record amount of bond issuances so far this year, analysts worry that investors may be setting themselves up for trouble.

As demand for new corporate bonds has outstripped supply, many investors are now looking to buy debt from noninvestment grade companies in the so-called high yield market.

These companies once had to guarantee double-digit returns to entice investors to part with their money. Now, the average coupon, or return, on offer in the European high-yield market has fallen to around 6 percent, almost an all-time low.

For some, that still represents a healthy return.

But other investors fret that the falling yields do not compensate for the dangers associated with backing these somewhat risky companies. The returns have plunged in the last 12 months because more investors are fighting for access to the bonds, which allows companies to reduce the interest rate payments that they offer to bondholders.

For analysts, the concern is that investors may face major losses if companies cannot repay the borrowed money when interest rates start to rise.

“Investors will get absolutely shellacked,” said Robin Doumar, managing partner of Park Square Capital, a company based in London that invests in debt financing. “As rates rise, investors will get savaged by both interest rate and credit risk. This will end in tears.”

In China, Concern of a Chill on Foreign Investments

China was booming, and Nina Wang, a Hong Kong billionaire, wanted a piece of the action.
It was 1995, and a group of investors was setting up the first nationwide joint-stock bank of the Communist era to be primarily owned by nongovernment companies.

But Ms. Wang, considered to be the richest woman in Asia and a flamboyant figure who wore her hair in pigtails well into her 60s, faced an obstacle: Foreigners were barred from holding stakes in Chinese financial institutions.

To this day, it remains a hurdle in China, where swaths of the economy can be off limits to foreign investments, including areas like education, finance, media and technology.

To get around the problem, Ms. Wang became a pioneer in the use of regulatory loopholes to control restricted assets in China. The practice has since been refined by Chinese companies that have raised billions of dollars on stock markets in the United States and Hong Kong and also by some multinational corporations with onshore business in China.

Ms. Wang’s Hong Kong company, Chinachem Financial Services, used a series of contracts to effectively gain economic control over a mainland Chinese firm, which in turn acted as proxy to buy and hold the stake in the new bank, China Minsheng Banking.

Chinachem soon had a falling out with the Chinese holding company over the ownership and dividends from the bank shares. The dispute ended up in mainland courts for 12 years â€" until a little-noticed ruling in October by the Supreme People’s Court, the top judicial body in China.

In what appears to be the first time that high-ranking Chinese authorities have weighed in on the issue of foreign control agreements, the court ruled that the contracts Ms. Wang had signed were invalid. The court said the shares in the bank â€" by then worth about $700 million, compared with Ms. Wang’s original investment of $11 million â€" belonged to the Chinese holding company.

Moreover, the court, in a 16-page judgment, ruled the contractual agreements between the Hong Kong and mainland companies had clearly been intended to circumvent China’s restrictions on foreign investment, and amounted to “concealing illegal intentions with a lawful form.”

The ruling was the latest indication that Beijing’s long-assumed tolerance of overseas capital finding its way into the economy’s restricted sectors may be waning, a development that could have far-reaching implications for investors and the companies they support.

“This case shows that contracts used to get around China’s foreign investment restrictions can be struck down by the courts,’’ said Paul Boltz, a partner at the law firm Ropes & Gray in Hong Kong. Until then, many observers had come to regard the general absence of an official backlash as a sign of tacit approval â€" an acknowledgment that such investment can help build corporate champions and create jobs.

“‘While this situation is fundamentally different” than how such contracts are now drafted and put in place, he said, the ruling “‘does raise the possibility that a Chinese court could take a similar position on other contracts.”

The loopholes used by foreign investors in China, and by Chinese companies seeking to list on overseas stock markets, have become more sophisticated since Ms. Wang made her play for the stake in Minsheng bank.

Beginning in 2000, when Nasdaq listed the Internet company Sina.com, most Chinese companies in restricted sectors have relied on complex investment vehicles known as variable interest entities, or V.I.E., as a way to sell shares to foreigners and get around China’s laws on outside investment.

About half of the more than 200 Chinese companies listed on the New York and Nasdaq stock exchanges rely on the investment vehicles to control onshore assets in China, according to research by Paul Gillis, an accounting professor at Peking University’s Guanghua School of Management, and Fredrik Öqvist, an independent financial analyst.

The structure has also been used in Hong Kong listings, like that of Tencent Holdings, China’s biggest publicly traded Internet company, with a market value of more than $70 billion.

While variable interest entities in such cases are technically owned by the Chinese, foreign-owned corporations maintain de facto control through a series of contracts that can involve equity pledges, profit assignments, purchase options and service or consulting agreements.

The complexity of the agreements, and the fact that they have not often been tested in court, has created some high-profile challenges for foreign investors.

In 2011, Yahoo shareholders were caught by surprise when the Chinese Internet giant Alibaba, in which Yahoo held a 40 percent stake, announced that it had transferred the assets of its online payment unit, Alipay, to a variable interest entity controlled by Jack Ma, Alibaba’s chief executive.

A large online video company, Tudou Holdings, delayed its initial public offering on Nasdaq in 2010 after the former wife of the company’s founder filed a lawsuit in a Shanghai court seeking control of the investment vehicle that held Tudou’s operating licenses, claiming it was common property from her marriage.

The matter was settled by the court in June 2011, and Tudou successfully listed two months later. (Tudou merged with a rival Internet video company, Youku, last year.)

In the Chinachem case, Ms. Wang signed several lending and trust contracts in late 1995 with the mainland Chinese firm that was to hold the bank stake, China Small and Medium Enterprise Investment Development, or China S.M.E.

Chinachem then transferred $11 million to a mainland bank account owned by China S.M.E., which in turn acquired a board seat and a 6.5 percent stake in Minsheng bank. China S.M.E. was to use its board seat to vote in accord with Chinachem’s wishes, and to transfer dividends to the Hong Kong company.

Problems became apparent in 1997, when the mainland firm did not respond to Chinachem’s requests for information about the bank’s finances. The next year, Chinachem sought to enforce its contracts and lay claim to the bank shares. China S.M.E. responded that it was the shares’ rightful owner.

Chinachem eventually sued in Beijing, seeking ownership of the Minsheng shares. The court ruled against the Hong Kong firm in 2001, but ordered China S.M.E. to pay Chinachem about $15 million in compensation.

Chinachem appealed the case to the high court in 2002, and Ms. Wang died in Hong Kong five years later, before the court ruled.

It is unclear why it took a decade to issue the ruling, which confirmed a lower court’s decision that Chinachem had no right to the bank stake. It did, however, increase the compensation payable by the mainland firm to more than $300 million.

Today, Minsheng bank is traded in both Shanghai and Hong Kong and has a market value of around $45 billion. China S.M.E. retains a stake worth $1.26 billion based on the stock’s current valuation.

China’s courts are not independent, and rulings do not have the same precedent-setting effect that they do in the United States.

Still, other foreign-control contracts have come under official scrutiny in recent years. In August, China’s Ministry of Commerce attached a notable condition in allowing Wal-Mart Stores to bolster its stake in one of China’s biggest e-commerce companies, Yihaodian.
The ministry, which enforces China’s antimonopoly legislation, said Wal-Mart could lift its shareholding in the online retailer to a controlling stake. But it expressly forbid the American company from using a variable interest entity to operate an Internet trading platform that Yihaodian had hosted for other online retailers and consumers.

Since 2010, Shanghai’s arbitration board has invalidated two variable interest entities that had been used by foreign companies to control onshore businesses. In one case involving an online gaming firm, the panel applied China’s contract law to reach the same conclusion as the supreme court in the Chinachem case â€" saying that the variable-interest entities were “concealing illegal intentions with a lawful form.”

“I think what you are looking at here is that China is attacking these V.I.E. structures and the other ways that people have used legal form to get around the substance of what Chinese law says you can’t do,” said Mr. Gillis, of Peking University, who also serves as a member of the standing advisory group of the Public Company Accounting Oversight Board in the United States.

“Of course, people have been doing that as long as there has been foreign investment in China,” he said.