Bitter Medicine for Whiz Kid Sacane - TheStreet

Scott Sacane, the 37-year-old scientist-turned-money runner, is probably in regulators' crosshairs by now. His bizarre trading in a pair of tiny medical companies raised allegations of market manipulation, and he could even owe money to the companies in questions.

But the emerging picture of Sacane is at odds with recent images of hedge fund rogues like Ron Baron and Michael Lauer. Sacane is described by associates as an extremely intelligent former top-ranked health care analyst who got into the rough and tumble of money-running at a time when the temptation to cut corners in the name of performance was never greater.

Federal filings also show the onetime whiz kid ran into his first rough patch at the beginning of this year.

Securities experts said regulators almost certainly are looking into Sacane's belated disclosure last week that his Durus Capital Management hedge fund "inadvertently" purchased huge stakes in two small health care companies:

Aksys

(AKSY)

and

Esperion

(ESPR) - Get Report

.

The disclosures prompted selloffs in both companies' shares. The plunge continued in Esperion, which fell $2.18, or 12.5%, to $15.20 on Wednesday. But four days of selling finally abated in Aksys, with the shares climbing 86 cents, or 10%, to $9.35 on Wednesday.

The

Securities and Exchange Commission

, as is customary, declined to comment on the matter. Sacane and his lawyer, William Natbony, continue to turn away telephone calls from the press.

The problem for Sacane, who launched his $400 million fund two years ago, is that his explanation for how he acquired a 77% ownership stake in Aksys and a 33% equity stake in Esperion aren't cutting it.

No securities lawyer or hedge fund manager interviewed for this story had ever heard of anyone "inadvertently" accumulating so many shares in a company without a warning bell sounding at the firm. Adding to Wall Street's incredulity is that the buying went on for several months before Norwalk, Conn.-based Durus finally disclosed it last week.

In the view of many observers, Sacane's fund must be guilty of either gross incompetence or an attempt to manipulate stock prices and boost the performance of his Durus Life Sciences Fund.

The trouble at Durus comes at a time when securities regulators are taking a closer look at the hedge fund industry -- a $500 billion business that caters to the wealthy and famous. The SEC has been concerned about how these loosely regulated funds value their assets and report their returns to investors.

Plagued Funds

In recent months, several high-profile hedge funds -- Lancer Partners, Lipper Convertible Bond Funds, Beacon Hill Asset Management and Gotham Partners -- have been forced to close amid allegations that the managers misrepresented their returns to investors. While it's too soon to say whether a similar story is unfolding at Durus, the early signs aren't encouraging.

"It could be a sign of an operational concern," said Ron Geffner, a lawyer with Sadis & Goldberg, a New York firm that represents a number of hedge funds. "If this happened inadvertently, who is minding the store?"

Geffner added that many hedge funds have charters that prohibit them from taking large positions in a company or a particular sector.

For Sacane, a defense of incompetence or negligence is clearly best. A worse possibility is that the University of Colorado graduate was trying to bolster his performance by cornering the market of two thinly traded stocks.

Industry sources said Sacane's fund had been reporting stellar returns the past few months. Before the controversy broke, the fund was up about 50% for the year, and up 20% in June alone -- a month during which Durus was "inadvertently" buying large blocks of shares in both stocks, according to Durus' recent disclosure statements.

The Nasdaq Biotech Index is up 48% for the year, essentially matching the gains posted by Durus, which invested heavily in biotech and other small-cap health care stocks. But in June, the biotech index fell 1% -- quite a difference from the big gains registered by Durus in that month.

The Payback

Meanwhile, shares of Aksys and Esperion more than doubled during the period Durus was accumulating their shares.

Durus wasn't just buying stocks during that time. It was also selling shares -- sometimes on the same day it made large purchases. And securities experts say that could create another problem for Sacane: He may owe money to Aksys and Esperion.

Federal securities laws require any 10% owner in a stock to return to the company any profits made on a short-term purchase and sale of that stock. Peter Ingerman, a partner in the New York law firm Chadbourne & Parke, said the rule presumes that a big stockholder making short-term trades may have access to inside information at the company.

Although a violation of the rule doesn't constitute illegal insider trading, it is the kind of prohibition that most money managers know to steer clear of.

"Most sophisticated people are aware of it and don't run afoul of it," he said.

Good Guy

The irony is that up until this week, most people on Wall Street had only good things to say about Sacane and his fund, which employs several doctors and scientists to do research on the companies it invests in. Sacane himself has a science background, working at two Boston-area biotech companies before landing a job on the Street as a health care analyst in 1993.

As an analyst, Sacane earned high marks for his stock-picking prowess as he moved from the defunct

Robertson Stephens

to

Furman Selz

to

Nationsbanc Montgomery Securities

, now part of

Bank of America

(BAC) - Get Report

.

In 1995,

Bloomberg

, the business news service, named Sacane its top brokerage analyst, based on the performance of his biotech stock picks.

One money manager called Sacane a "really smart, great guy" and the sentiment was echoed by several others.

Ater just a few years as an analyst, Sacane was looking to move onto something even more challenging -- managing money for wealthy investors. He got a job as a portfolio manager for

Perseus Soros Biopharmaceutical Fund

, a $400 million fund that's affiliated with Soros Fund Management.

For a while, Sacane was managing both the Perseus fund and his own hedge fund, which he started in November 2001, originally under the name Highline Management (a fund unrelated to New York-based Highline Capital Management, another hedge fund). A spokeswoman for Perseus declined to comment.

It's not known how many investors are in Durus. One of them is the

Excelsior Hedge Fund of Funds

, a $135 million investment vehicle operated by

U.S. Trust

, a division of

Charles Schwab

( SCH). The Excelsior fund sunk $3.5 million into the Durus fund and as of March 31, that investment was valued at $3.79 million -- an 8% gain. A U.S. Trust spokeswoman could not be reached for comment.

Danger Signs

For those paying attention to other disclosure filings by Sacane and Durus, there are some hints that all might not be well.

In May, Durus reported that its stock investment at the end of March totaled $245 million, down 6% from the end of last year, when it reported that its holdings were worth $260 million. The disclosures are contained in the fund's quarterly 13-F filings, which must be filed with the SEC by any fund with more than $100 million in assets.

The decline in the value of Durus' stock portfolio wasn't large. It was, however, the first reported decline in the portfolio's value since December 2001, when it reported owning $97 million in stock.

One possible explanation is a drop in the price of the shares owned, the other is investor withdrawals. Neither is good news for a relatively new money runner.