SEC looking into James Simons' secrets

Last December, I wondered whether James Simons, who made $2.5 billion last year, could be the next Bernie Madoff. I came to the conclusion that it was not likely but that the little evidence available about how the secretive math maven makes money did raise some questions for me. But now Simons finds himself in a bit of hot water.

How so? The fund he manages for outside investors lost money in the first four months of 2009 while a fund he manages just for his employees made quite a lot of money. More specifically, the outside fund, Renaissance Institutional Equities Fund (RIEF) lost 17 percent this year through April, while the inside fund made 12 percent. Last year RIEF also lost money, while the internal fund jumped 80 percent.

Is Simons siphoning money from RIEF to pay his internal investors? No reason to think so. He claims that RIEF's bets on volatility did not pan out because the market rallied steadily. But those outside investors are pulling money out fast. In 2008, they withdrew $12 billion from the fund company; total assets have fallen to about $18 billion from a peak in mid-2007 of about $35 billion.

Simons' compensation derives from a very rich brew of fees. He takes home a management fee of five percent of assets under management (two percent is industry standard) as well as 36 percent of the profits (20 percent is the norm).

Meanwhile, one investment strategy employed by Simons involves collecting limit order books -- records of the price at which thousands of investors have asked their brokers to sell stocks. He can use this information to bet on a decline in a stock right before it hits that limit price -- which will predictably spur selling due to those limit orders. I am not sure if that's legal but it sounds close the edge.

The SEC is conducting a "routine" investigation of Simons. What do you think it will turn up?

Peter Cohan is president ofPeter S. Cohan & Associates. He also teaches management at Babson College. His eighth book isYou Can't Order Change: Lessons from Jim McNerney's Turnaround at Boeing.

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