High-flying fund manager under SEC scrutiny
Hedge fund Third Point Management faces an investigation into its outspoken manager's conversations with other hedge funds.
NEW YORK (Fortune) -- Third Point Management, a New York hedge fund run by one of the country's most outspoken and controversial investors, has come under investigation from the Securities and Exchange Commission.
The $5.6 billion fund, whose founder Daniel Loeb is well known for his pointed regulatory filings targeting chief executives he deems underperforming, informed investors in a letter last month that it has been notified that the SEC has commenced a formal investigation into its communications with other hedge funds.
The SEC's investigation into Third Point comes at a time when hedge funds are being criticized for playing a key role in the trading of various companies as well as in the continuing financial crisis. The SEC is investigating the actions of up to 50 hedge funds in the collapse of Bear Stearns and in the continuing troubles of Lehman Brothers (LEH, Fortune 500) and mortgage guarantors Fannie Mae (FNM, Fortune 500) and Freddie Mac (FRE, Fortune 500). According to reports, the SEC is investigating whether hedge funds knowingly and intentionally spread falsehoods about the financial strength of these - and other - brokers and banks. According to Institutional Investor magazine, which broke the Third Point story Tuesday, Loeb told investors that the communications were uncovered during the course of a routine audit last year after Third Point became a registered investment adviser.
"During the course of the audit, the examination staff noted that we regularly communicate with portfolio managers at other hedge funds about investment and trading ideas," wrote Loeb. "The SEC later informed us that it had commenced a formal investigation of Third Point primarily relating to these types of communications."
Unlike many hedge fund managers who are secretive about their investments, Loeb and several of his key portfolio managers and analysts have at times been willing to discuss potential or current trades. Loeb reasons that these communications with other managers provide valuable insight into the worth of trade ideas, and help glean important market intelligence.
Loeb, in his letter to investors, stated that Third Point's outside attorneys had signed off on the fund's communications with other managers and analysts as within the bounds and scope of securities laws.
The SEC's probe into short-sellers isn't the only case in which hedge funds are being closely scrutinized. For instance, lawsuits allege that conspiracies between hedge funds and analysts are responsible for steep share-price declines at Biovail (BVF), Overstock (OSTK) and Fairfax Financial (FFH) - even as skeptics of those companies attribute the declines to business and balance sheet problems. Loeb noted in his letter that "a chorus of 'blame the shorts' is generally an excellent indicator of significant underlying problems."
Even former Bear Stearns CEO Jimmy Cayne is claiming the shorts are behind his problems. He recently told Fortune that the so-called run on Bear last March was largely brought about by a slew of hedge funds that conspired to sow doubts about the company's health. Hedge funds, it seems, are becoming public enemy No. 1.
Third Point, at least, had nothing to do with Bear's demise. The fund put on a large short bet on Bear Stearns in the summer of 2007 - when the stock was in the triple-digits - and even reduced its prime brokerage exposure to the firm. But after making a nice profit, Third Point covered its Bear trade later that year, before the collapse that saw shareholders get just $10 a share for a stock that a year earlier was fetching $170.
Loeb didn't return a call seeking comment. But he reportedly has told colleagues and investors that he sees the SEC investigation as "a badge of honor." 
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