Transcript: Inside a hedge fund disaster

This is an audio transcript of the Behind the Money podcast episode: ‘Inside a hedge fund disaster’

Michela Tindera
It’s pretty well known in finance that hedge funds can be among the most secretive types of investment firms. Behind that, there’s this idea that this secrecy and lack of transparency gives them an extra edge over their competitors. But there’s this one hedge fund manager who took a pretty unusual step within his industry. He listed his firm on the stock market.

Sujeet Indap
So if you’re a public company, obviously you report four times a year, you publish securities filings. That’s time consuming and onerous and you’re subject to SEC regulation.

Michela Tindera
That’s the FT’s Wall Street editor, Sujeet Indap. He says the one a hedge fund manager named Daniel Och decided to take his company public back in 2007, this was a surprising move.

Sujeet Indap
And just that kind of scrutiny is not something many hedge fund founders want who are often very secretive and already have stable investors who are loyal to them.

Michela Tindera
By taking his firm public in 2007, Dan Och made a bold bet on not only himself, but also the longevity of his hedge fund that — it would continue to operate long past his own career. But that move to go public also opened him and his company up to loads more scrutiny from investors, regulators and the media. And well, more than 15 years later, things haven’t turned out exactly the way he’d hoped.

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I’m Michela Tindera from the Financial Times. Today on Behind the Money, we’re going inside a messy Wall Street saga to see how a hedge funds plans to list on public markets years ago backfired and what that all says about how hedge funds fit into the public markets.

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This might sound obvious, but hedge funds are different beasts than your typical company. Here’s Sujeet again.

Sujeet Indap
Hedge funds ultimately are built around a very small group of very smart and very talented people. And the risk with that model is that they can leave at any point or they can lose their magic touch. And that’s just different than a typical big company.

Michela Tindera
In the case of the hedge fund Och-Ziff, that magic touch that Sujeet’s talking about was for a long time tied to its founder, Dan Och. Here’s the FT’s deputy corporate finance editor In the US, Ortenca Aliaj.

Ortenca Aliaj
Dan Och has managed to keep a pretty low profile. Not much is known about him other than he grew up in New Jersey. He went to Wharton. And he began his career at Goldman Sachs in 1982, spending quite a long time there to eventually become its co-head of proprietary equity trading.

Michela Tinder
In the mid-1990s, Och decides to branch out on his own and he launches a hedge fund called Och-Ziff Capital Management. And into the 2000s, Och-Ziff becomes quite successful. By 2007, the fund’s assets had grown to about $27bn.

Ortenca Aliaj
This is the sort of heyday of the hedge fund industry. It’s been through this period of enormous growth. And a lot of the hedge fund founders, including Dan Och himself, had started to think about how do we ensure the survival of these firms beyond us.

Michela Tindera
So Och’s thinking about how to make his fund last beyond his own individual career and how to turn his business into an institution. Now, this is something that a lot of Wall Street firms are thinking about around this time. That’s companies like the private equity firms Blackstone and Fortress Investment Group. So one way to achieve that goal is to take your company public.

Ortenca Aliaj
So when a firm goes public, that makes it an institution, right? So there is a board of directors that will have decision-making power, that gets to vote on things like pay and who runs the company and who they hire and who they fire. So it goes beyond just the founder himself.

Michela Tindera
Going public has a lot of benefits.

Ortenca Aliaj
One is that you get an immediate cash injection by raising money on the stock market.

Sujeet Indap
By having shares. It’s an avenue to keep growing the firm. You can use the shares to buy other asset managers or pay employees or pay new recruits, and it’s just an easier way to grow the business.

Ortenca Aliaj
And the other is that obviously, if the share price performs well, you become a billionaire.

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Michela Tindera
So the IPO for Och-Ziff is generally a success. The fund’s market cap debuts at around $12bn. And when the financial crisis hits, they managed to survive.

Ortenca Aliaj
Och-Ziff isn’t the sort of firm that is known for these outsized returns, but it’s known for consistency, and it delivers a fairly good performance.

Michela Tindera
In the aftermath of the financial crisis, a new star at the firm surfaces. His name is Jimmy Levin. Now, this is a name that you’ll want to remember.

Ortenca Aliaj
There’s a very famous story about how Levin and Och first met, which is that Levin in the 90s was working at a summer camp attended by Och’s son, and he was teaching his son how to water ski. So that was the first introduction between the two.

Michela Tindera
And flash forward several years into the future, Levin’s gone to university. He started his career in finance. And now he’s working at Och-Ziff.

Ortenca Aliaj
So it turns out that Levin has this really good talent in the credit business. And as we were over the financial crisis in 2008, the housing market is at bottom and things are sort of starting to climb up again, levin makes this big outsized bets on structured credit, and this really puts his name up in lights within Och-Ziff.

Michela Tindera
Now, this is a big deal. Remember, at a hedge fund, the whole business is only as valuable as the people inside of it. So it’s massive for the firm to have this young trader winning these kinds of bets.

Ortenca Aliaj
Immediately, he is seen as a star trader and he becomes Och’s protégé. He gets paid a lot of money and he becomes a really, really important part of the business because the investors who are putting money into Och-Ziff see him as sort of the talent.

Michela Tindera
Levin’s big credit bet pays off in 2012. He ends up making about $2bn from it. But within just a few years, things take a turn for the worse.

Ortenca Aliaj
Federal prosecutors file this claim, alleging that Och-Ziff spent tens of millions of dollars bribing officials in countries such as Libya and the Democratic Republic of Congo.

Michela Tindera
In short, the firms accused of paying bribes in at least five countries in Africa to win business. In 2016, the firm pays US authorities more than $400mn to settle the criminal and civil charges against it. It’s one of the largest penalties ever levied against a hedge fund.

Ortenca Aliaj
I think at the time, the only thing that Och really said was that it was a quote unquote, deeply disappointing episode for the hedge fund.

Michela Tindera
The fund tries to put all this behind them, but that doesn’t really work.

Ortenca Aliaj
Clients are obviously really spooked. And this whole drive to institutionalise the hedge fund world and get endowments and pension funds to become your main investors, well, those places are also much more susceptible to reputational risk. So if you have something like a bribery scandal in Africa, they are going to struggle to stay as investors, right? Now if Och-Ziff had been a private hedge fund, yes, they probably would have seen these investors redeem their cash, but that would have been the extent of the damage because there was a public hedge fund. What happened was that investors saw the impact that this fine was having and they sold out of the shares. So all the sudden you go from your shares peaking at something like $300 and now they’ve tanked to $20.

Michela Tindera
Lots of investors are pulling their money out of Och-Ziff. But inside the firm, some people, like Dan Ochs protégé Jimmy Levin, see this chaos as an opportunity for leverage.

Ortenca Aliaj
He’s had this really successful run at the company. They are fearful that they’re going to lose some of their top talent, and they understand that a lot of the investors who stick with Och-Ziff are loyal to these traders.

Michela Tindera
In an effort to keep Levin with Och-Ziff, the firm gives Levin this massive pay package worth about $280mn. Dan Och even takes about $100mn worth of his own personal company’s shares and gives them to Levin. And Och picks Levin to be the firm’s co-chief investment officer. Ortenca tells me that these are pretty clear signals. The combination of the pay package, the new title, plus the success he’d already had at the firm, made it look like he was going to be the company’s next CEO. In the years ahead, things don’t go the way that Och probably planned when he took his firm public in 2007. His efforts years earlier to turn his company into an institution seem to be working against him. After the bribery scandal, the fund struggles to move forward and it fails to perform as well as its peers. In 2018, Dan Och officially leaves his job as CEO. And many people thought Levin would be the guy to take over for him. But that’s not exactly what happens. Instead, a banker from Credit Suisse comes in to lead the firm.

Ortenca Aliaj
This is a huge shock to most people who know the firm. You don’t hand someone a $280mn pay package if they’re not going to take over the firm.

Michela Tindera
The next year in 2019, the company goes through a rebrand in an effort to further distance itself from the scandal. It changes its name from Och-Ziff to Sculptor Capital Management. Even with the new name Sculptor, the firm continues to struggle. The other CEO leaves, and in 2020, the board does finally appoint Jimmy Levin to take over the company. But here’s where things get interesting. While Och left his job as CEO, that doesn’t mean he’s disappeared from the picture.

Ortenca Aliaj
When the firm IPO’d, Och was very smart about it, right. He didn’t want to lose control of the farm. So actually Och is still its largest shareholder. And through the structure that they used, it meant that Och could effectively still control the firm. He has this power as a large shareholder to express his dissatisfaction, to vote against certain proposals, and he wields it.

Michela Tindera
In 2021, Och files a legal claim against Sculptor. He says he wants to view the company’s books because he thinks that Jimmy Levin, whose 2019 pay package had been about $130mn, was being paid too much money.

Ortenca Aliaj
So in these legal filings, Och compares Levin’s salary to that of JPMorgan CEO Jamie Dimon and Goldman Sachs CEO David Solomon. The irony being that this all began with Och, himself. And he basically accuses the board of not having appropriate oversight on this and being too much in Levin’s pocket, which they deny.

Michela Tindera
There are a flurry of accusations and court filings, and all of this is problematic for Sculptor’s business.

Ortenca Aliaj
So, again, it affects the share price. But also now investors are having just stomached this bribery scandal, the change in leadership, are now sort of having to come to terms, the fact that Och is fighting Levin and the board.

Michela Tindera
Ortenca, can you help me out here? Why is there this bad blood between Dan Och and Jimmy Levin? I mean, I don’t really understand how they went from this protégé-mentor relationship to apparently in this big feud.

Ortenca Aliaj
So unless there is a personal matter which has not come into the public domain, I think it’s largely because Och felt like he was giving Jimmy all of these things and Jimmy kept saying, well, I want more. And that’s understandable. The hedge fund industry runs on its talent, on the people who are making money. And Levin is a star trader who’s able to command his price. So Och ends up giving him what he wants. But once Och has left the business, the gloves are off. He doesn’t feel like he has to acquiesce to Levin’s demands anymore. And now he takes the other side and says, actually, this guy’s being paid too much money.

Michela Tindera
All of these events are tough on the hedge fund. It’s not a good position for investors and there’s a lack of stability.

Ortenca Aliaj
And so the fund and the board are incentivised to find a way to resolve this. And the way that they decide to do that is to form this special committee where they can sell Sculptor.

Michela Tindera
And now that future that Dan Och likely envisioned for his hedge fund beyond his own career looks like it might be slipping away. In July this year, it’s announced that a buyer has been found. It’s an investment firm called Rhythm Capital. They’re going to purchase Sculptor for around $640mn. Now, remember this company IPO’d in 2007 at a $12bn valuation. That means the firm’s shareholders have lost more than $10bn. And Sujeet says that this is pretty remarkable.

Sujeet Indap
You don’t see companies that have lost 95 per cent of their value. That’s highly unusual, particularly one with this kind of famed founders and one-time place in Wall Street.

Michela Tindera
But this isn’t the end of the story. The deal doesn’t go through immediately. Remember, we know that Dan Och still has this big stake in the company and the deal needs to be approved by the shareholders.

Ortenca Aliaj
Dan Och comes back out and says, no, I don’t accept this deal. It’s a really bad deal for shareholders. It undervalues the company. And, you know, the board is breaching its fiduciary duty again and is not getting the best deal for shareholders.

Michela Tindera
But there’s also something else to keep in mind.

Sujeet Indap
Och, as the founder of the firm happens to have something that ordinary shareholders of the public Sculptor do not. And what that is is called a tax receivable agreement, which just think of it really as a pile of money or the right to a pile of money. And that figure is almost $200mn. And that pile of money, which is supposed to be paid by Sculptor for several years in the context of a buyout or a merger, the acquirer has to decide what they want to do with that. And so that pile of money, the tax receivable agreement, how that is negotiated for ultimately becomes a sticking point in how art views the rhythm deal.

Michela Tindera
So over the next couple of months, there’s this big back and forth. Another bidder comes in, but the Sculptor board declines their offer. Then Rhythm comes back and raises their offer. Then they raise it again in October to an amount that the board and Dan Och finally agreed to, $720mn.

Sujeet Indap
And if you read the fine print in the securities filings, in fact, the company had made some concessions to them, economic ones. It paid $5.5mn in transaction and legal expenses from his involvement and the kind of fighting over this transaction over the last year.

Michela Tindera
And in the firm’s last dying breath, Och secures an additional concession from Rhythm Capital. That special pot of money Sujeet mentioned — the tax receivable agreement — Och gets Rhythm to increase that value from $170mn up to almost $300mn.

Sujeet Indap
And that is enough for him to finally come around and drop his litigation and support the transaction.

Michela Tindera
Finally, earlier this month in November, shareholders, including Dan Och, have a vote to approve the $720mn sale to Rhythm Capital. It passes.

Sujeet Indap
So it means that Sculptor is no longer going to be publicly traded. It will be now a subsidiary of Rhythm Capital. Sculptor manages roughly $30bn. That now will be a part of Rhythm. It’ll be its own unit. And the company in many, many senses will be the same one. It just won’t be publicly traded. It’ll be owned by this other company and all the public shareholders will be bought out at $12.70 per share.

Michela Tindera
So Och is officially done with the hedge fund he started nearly 30 years ago. And the hedge fund doesn’t exist as an independent entity anymore. And Jimmy Levin is now an employee of Rhythm Capital.

Sujeet Indap
He has been awarded pay and compensation in the tens of millions of dollars, too, to stay and be incentivised, to continue to generate returns. And that is, I think, one of the reasons Rhythm bought this company. They bought it for obviously the Sculptor name and its funds, but obviously the investors were on top of that, starting with Jimmy Levin.

Michela Tindera
So Ortenca. So what can we learn from this whole saga?

Ortenca Aliaj
So very often when these hedge funds were being created at a time when the industry was flourishing, they became associated with their founders. So for every hedge fund, in Och-Ziff’s case, it was Dan Och. But for every hedge fund, there was the founder who sort of embodied the firm. And that has proven to be a very difficult thing to move away from. So much so that a lot of hedge funds are no longer looking at picking one successor. But they haven’t had quite the same success at moving on beyond the founder that private equity firms, for example, have had.

Michela Tindera
Sujeet, you’ve reported on some of these private equity firms that Ortenca is talking about for a while now. What have you seen in that area?

Sujeet Indap
A good contrast with Och-Ziff is Blackstone, which also went public in 2007, around the same time as Och-Ziff did. They were both pioneers in taking public companies that were traditional private investing partnerships. And in fact, there are fortunes of completely diverged Blackstone. Its leadership has gone well beyond the founders, and it expects to be a prominent institution for generations to come and in some sense is the model of what Dan Och wanted to do, but ultimately fell short.

Michela Tindera
Yeah, that’s true. Blackstone even passed the mark of $1tn in assets under management this year. So why do you think that is? That these two businesses went in such different directions?

Sujeet Indap
Hedge funds and private equity ultimately have proven to be very different businesses. The capital that private equity firms raise has proved to be much more a durable and long lasting hedge funds are much more erratic and volatile. So there’s a macro trend, but there’s also a story about the nuts and bolts of building businesses, which is a very different thing than being good at picking investments and something Blackstone has mastered in a way Och-Ziff just wasn’t able to.

Ortenca Aliaj
I mean, I guess this is the irony of it, is that the IPO was supposed to solve the succession issue, which is a huge problem in the hedge fund industry and arguably in private equity as well. But although all of these famous, quote unquote, you know, masters of the universe, who are these big personalities that really dominate their firms, well, they won’t live forever. And so there needs to be plans in place about ensuring the continuity of the business when this founder retires, leaves, dies. And that’s something that the hedge fund industry has really struggled with.

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Michela Tindera
Behind the Money is hosted by me Michela Tindera. Saffeya Ahmed is our producer. Topher Forhecz and Manuela Saragosa are our executive producers. Sound design and mixing by Sam Giovinco and Breen Turner. Cheryl Brumley is the global head of audio. Thanks for listening. See you next week.