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Breaking a long silence, Tom Steyer reveals the inner workings of Farallon Capital Management, the quietly successful hedge fund that student activists love to hate.

Day after day, month after month, for five long years, Thomas Steyer showed up at work wearing the same tie, a vibrant red plaid with navy, green and white stripes. His staff at Farallon Capital Management, the secretive San Francisco hedge fund, begged him to try another -- with no luck. Finally, one day in 1994, his assistant managed to swipe the tie and had it, stains and all, mounted like a deal trophy in a Lucite box.

Steyer's response? He simply went out and purchased several dozen more just like it. "I went to this place in London called the House of Scotland," he says. "I walked in and said, 'Bring me all your red plaid ties!' I bought every single one."

And he has worn one every day since.

Determination, willfulness and self-confidence are on full display in Steyer's approach to business as well. Since founding his multistrategy fund operation in 1986, after a stint in risk arbitrage at Goldman, Sachs & Co., Steyer has thumbed his nose at convention while aggressively pursuing investments across a wide sweep of markets in just about every corner of the world, tenaciously holding on to many positions for years. In investments, as in ties, Steyer stubbornly follows his own tastes.

This uncompromising approach has served him and his investors exceedingly well. Last year, say sources, Farallon Capital Partners, Steyer's flagship fund, earned 16 percent net of fees, or 20.8 percent gross; from inception Farallon has returned 16.7 percent annually net, or 21.9 percent gross, compared with just under 12 percent for the Standard & Poor's 500 index. Demonstrating remarkable consistency and a talent for managing risk, Steyer has never had a down year; Farallon Capital's worst performance came in the crash year of 1987, when it rose 3.2 percent. Steyer and other executives at Farallon declined to discuss its returns or specific investments.

As Steyer's reputation for investment acumen has grown, assets at Farallon have soared from $15 million to more than $12.5 billion, placing it among the biggest hedge funds in the world. It has attracted a roster of blue-chip clients that includes elite university endowments from Stanford University, where Steyer earned his MBA in 1983, to his undergraduate alma mater, Yale University, for which he manages hundreds of millions of dollars.

Along the way, Steyer, 47, a protégé of Robert Rubin's at Goldman Sachs in the early 1980s, has honed his connections to the uppermost echelons of political power and influence. Rubin, secretary of the Treasury from 1995 through 1999 in the Clinton administration and currently chairman of the executive committee of Citigroup, serves as an adviser to Farallon, consulting on general economic, business and strategic matters -- a role he has held since 2000.

Steyer has amassed his clout quietly. Unlike hedge fund grandee George Soros, for whom, seemingly, no thought goes unspoken or unpublished, Steyer has shunned publicity, seeking privacy for himself and for his firm as doggedly as he does undervalued assets. For a long while he managed to have it his way, even as he and his colleagues pursued a host of investments in such tricky markets and politically sensitive places as Argentina, Indonesia and Russia.

That all changed last year, when a coalition of student and labor union activists, fighting a long-running battle with Yale, decided to turn their focus -- and ire -- on Farallon. Their apparent objective: to embarrass the school by tainting Farallon, and other hedge funds generally, making them seem as objectionable as investments in South Africa in the 1980s.

"The purpose of this campaign is not to take down Farallon," says Rose Murphy, a former Yale graduate student in chemistry who now works as a senior research analyst for labor union Unite-Here, which represents several thousand Yale workers. "But I'd like to think that we're going to stabilize world markets with better regulation of hedge funds."

Last March, union organizers assembled a coalition of campus-based organizations and launched a Web site, Unfarallon.info, which combines information about Farallon with news about labor disputes and environmental concerns in the countries where the hedge fund has invested. They orchestrated a series of guerrilla theater actions; in one, a "transparency fairy" in a feathered mask waved her wand outside the Yale University Investments Office in a symbolic effort to make the endowment portfolio see-through. The group's biggest beef: a partnership Farallon formed in 1995 with Yale to invest in a water-development project on the 97,000-acre Baca Ranch in Colorado's San Luis Valley that was designed to supply the state's fast-growing Front Range cities, like Denver, Colorado Springs and Boulder. Activists denounced Farallon for promoting what they called an environmental disaster and demanded that Steyer meet with them to discuss "the ethics of Farallon's investment practices."

Much of the protesters' characterization of Farallon was over the top, and some was misleading: Steyer was already in the process of selling the ranch to the Nature Conservancy when news of the investment broke at Yale. And while Farallon, with its billions of dollars, makes an easy mark, it's arguable that the organizers' real target was, and continues to be, Yale's president, Richard Levin, who leads the university's negotiations with its unions.

Still, the outcry came as a rude awakening for Steyer, who never expected to be demonized by a gaggle of former graduate students with time to burn and a proclivity for building Web sites. The protests spread beyond Yale as activists on college campuses tried to turn Farallon into the symbol of what they saw as the depredations of unfettered global capital. Last May, Steyer was accosted on Stanford's Palo Alto campus by students complaining about the treatment of workers at an Australian lead and zinc production company in which Farallon held a small stake.

The protests hurt on a personal level. A voluble Democrat and a key fundraiser for John Kerry's presidential campaign, Steyer sees himself as aligned with student protesters, not capitalist oppressors. His wife, Kathryn, is an avid environmentalist. And, at least in his own mind, the Baca Ranch development easily passed the no-harm environmental litmus test.

Steyer decided that the only way to deal with public vilification was to abandon his own penchant for privacy and open up. Last spring he wrote a lengthy letter to the protesters defending his record. This fall he spoke to Institutional Investor at length about his approach to investing, his management style and some of the mistakes he has made since founding Farallon.

"We spent a ton of time looking at the environmental issues and trying to convince people we were right," Steyer says of the Baca Ranch investment. "Eventually, we got it through our thick skulls that we were not going to convince anyone. Were we dumb? Yes, very! But we weren't irresponsible or wicked."

Certainly his investors don't think so. "In an era of corporate and personal corruption, Tom is just off the other end of the scale -- he has tremendous integrity," says F. Warren Hellman, former president of Lehman Brothers and co-founder of private equity firm Hellman & Friedman. Hellman invested $4 million of his own money to launch Steyer's inaugural fund, HFS Partners (shorthand for Hellman, Friedman, Steyer), which was renamed Farallon in 1990. "He's the last person I would describe as an ugly capitalist."

But partnering with Farallon now means having to run a political gauntlet, one risk Steyer never anticipated his investors would face. It's a risk that other hedge funds must increasingly contend with as intense scrutiny from many quarters begins to reshape a once-cloistered business. Regulators, led by the Securities and Exchange Commission, are taking a closer look; so too is a growing cadre of environmentalists, labor organizers and student activists keen to uncover the workings of these firms. Their inquiries, ironically, have been made possible in good part by the flood of money coming to hedge funds from institutions like public pension funds and university endowments, which are far more susceptible to political pressure than the wealthy individuals who once dominated the ranks of hedge fund investors.

Steyer is all too aware of the new political complexities of managing money for big institutions, but he isn't about to back down from his tough-minded investing discipline. Nor is he about to alter his strategy -- he's just as determined as ever to scour the world for value-oriented opportunities.

"We haven't changed what we're trying to do, in terms of approach or outcome," Steyer says. "But we may not get there the way we did before. Our investors have got to recognize that it's a risky world, and it's getting riskier."

Farallon Capital takes its name from an archipelago of rocky islands 27 miles west of San Francisco's Golden Gate Bridge. Named Los Farallones, or "the rocky promontories," by Spanish explorer Sebastian Viscaino in 1603, the deserted, windswept islands retain an aura of danger: After a series of great white shark attacks on scuba divers over the past 20 years, few venture into the water. The sharks hunt undisturbed.

Steyer may wish he were that lucky. As the number of hedge funds has grown exponentially in the past decade, investment opportunities have become harder to find. Farallon has diversified both strategically and geographically. From its start as a multistrategy arbitrage operation, the firm rapidly expanded beyond traditional merger arbitrage into other opportunities, largely event-related. Farallon has since added distressed debt, corporate restructurings and value investments (both long and short), real estate­ related transactions and direct investments in operating companies.

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