UPDATE 1-Hedge fund Diamondback closing after clients pull out
* Assets dwindled to $1.45 bln
* Former Diamondback trader on trial on insider charges
* Redemption notices swamped firm's expectations
* Diamondback was up 7 percent in mid November
BOSTON, Dec 6 (Reuters) - Hedge fund Diamondback Capital Management, one of a handful of firms embroiled in the government's insider trading probe, told investors that it will close down after nervous clients pulled out more than half a billion dollars in assets.
Richard Schimel and Larry Sapanski, the firm's co-heads, broke the news to clients in a letter on Thursday only three weeks after investors asked Diamondback to return $520 million, five times the amount top executives had expected. Reuters obtained a copy of the letter.
As assets dwindled to $1.45 billion from roughly $5 billion only two years ago, the firm's business model was in jeopardy and executives had to decide between closing the firm down or trying to engineer a second big restructuring within 18 months, two people familiar with the move said.
So nearly exactly two years after federal agents raided the Stamford, Connecticut-based firm and as Todd Newman, a former portfolio manager, stands trial on insider trading charges, the firm began selling assets and moving into cash in order to return the bulk of client money by mid-January.
Yahoo! Inc, Capital One Financial Corp and American International Group Inc were among the firm's biggest holdings at the end of the third quarter, according to securities filings. Diamondback expects to lay off nearly all 133 employees. A small number will stay to manage the final liquidation, the people familiar with the matter said.
"It is with deep regret that we inform you that Diamondback Capital Management LLC has made the difficult decision to recommend the commencement of an orderly wind down and termination of the funds under its management," Schimel and Sapanski wrote.
CLOSING THE LOOP
Diamondback's liquidation now closes the last chapter of four firms surprised by FBI raids in November 2010 when the government's investigation into how some hedge funds might be relying on illegal tips to make money was picking up speed.
The other firms - Level Global Investors, Loch Capital Management and Barai Capital - unraveled quickly. Diamondback limped along because the firm had not been accused of wrongdoing and some powerful institutional investors like Blackstone Group had been vocal supporters.
But by Nov. 15, the date for investors to decide whether they would stay or go, there was a tough decision to be made.
While Diamondback was delivering respectable returns of 7 percent after having returned an average of 9 percent a year since its founding in 2005, Newman's trial was playing out in a Manhattan court room.
Even though Diamondback's founders would not be prosecuted in the matter, many investors were clearly getting nervous. The firm had already agreed to pay $9 million to settle civil charges that Newman, who handled technology investments from Boston, and Jesse Tortora, a former Diamondback analyst, were making illegal trades.
Diamondback's founders got their start at Steven A. Cohen's SAC Capital, one of the industry's most admired traders who has posted average annual returns of 30 percent over the last two decades. Schimel's ties to Cohen are especially close as he is married to Cohen's sister.
But SAC too has moved closer into the government's crosshairs and told its own clients last week that it would likely face civil securities fraud charges. So far, four former SAC employees have been arrested and charged with having traded on illegally obtained information while working for Cohen. And a handful of others who had previously worked for Cohen have been charged with insider trading while working at other firms.