Steyer Power

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,, 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.

Steyer has sustained this diversification by hiring -- and hanging on to -- talent. In 2003, Farallon added four partners and four managing directors; on January 1, 2005, it added five new managing directors. The firm now employs 81 people at its headquarters on the 13th floor of One Maritime Plaza in San Francisco and an additional 23 elsewhere around the world. It has 15 partners, whose average tenure with Farallon is 10.5 years.

Even when partners leave, they don’t go far: Meridee Moore, who spent a decade focusing on credit investments, private placements and restructurings for Farallon, runs her investment firm, Watershed Asset Management, from the 15th floor of the One Maritime building. Katie Hall, who worked with Steyer in the 1980s, is now co-CEO of Offit Hall Capital Management, an ultrahigh-net-worth investment advisory business, on the fifth floor. Hellman & Friedman’s headquarters are on the 12th floor.

“Tom surrounds himself with people who are very smart and productive,” Moore says. “He has a way of making you feel empowered, and he’s a terrific mentor. People want to be around him -- and they want to stay around him.”

Proximity has practical advantages, too. In addition to running Farallon, Steyer is a managing director at Hellman & Friedman -- a relationship that allows him to consider private equity deals alongside his former mentor. Warren Hellman’s patient approach to investing is evident in Steyer’s efforts: Steyer sees himself as a research-oriented fundamental investor, not a trader. Farallon typically holds investments anywhere from two to five years; the oldest position in its portfolio, a stake in City Investing Co. Liquidating Trust, dates back to 1987.

Steyer currently oversees 11 funds and accounts at Farallon. Three are large, representative funds: Farallon Capital Partners, the flagship fund created for individual investors and for-profit institutions; Farallon Capital Institutional Partners, designed for not-for-profit investors, such as foundations and endowments; and Farallon Capital Offshore Fund. (The remaining eight are special accounts designed for particular investors.) Steyer manages all of the firm’s capital with a consistent overarching strategy, making value-oriented investments in businesses undergoing significant upheaval or transformation.

As of November 30, 2004, only 9 percent of Farallon’s assets were invested in traditional merger arbitrage. The largest allocations were to restructurings and value, at 40 percent of the portfolio; credit investments and liquidations, at 22 percent; and real estate, at 11 percent. Direct investments accounted for 7 percent, and a surprisingly big chunk, 11 percent, was held in cash and other small, miscellaneous investments.

Steyer’s long experience managing both public and private investments sets him apart from his peers. In 2004, 80 percent of the firm’s assets under management were held in fairly liquid funds; redemptions are possible only at year-end and require 45 days’ written notice. The remaining 20 percent of assets were allocated to what the firm calls side pockets, special-situation accounts with longer lockup periods designed to take advantage of opportunities in private equity, real estate and other types of illiquid investments. Steyer does not discriminate among his investors; all who are eligible at any given moment are also invested in the side pockets.

Farallon requires a minimum investment of $5 million, subject to Steyer’s discretion. But his rates are surprisingly modest compared with those of his peers: Farallon charges a 20 percent incentive fee and a 1 percent management fee. For investors with $30 million to $50 million under management, the management fee is 0.75 percent; for those with more than $50 million, it’s 0.50 percent.

Unlike many managers, Steyer doesn’t demand a long lockup period for new investors: He insists on one year for U.S. limited partners and three months for investors in the offshore fund. Currently, endowments and foundations contribute about 40 percent of Farallon’s assets, individual investors account for some 30 percent, and an assortment of funds of hedge funds and banks’ private clients groups are responsible for the remainder.

Farallon’s explosive growth has complicated operations. Rather than risk expanding further under the single-manager model, Steyer -- who hired a CFO, Greg Swart, from Goldman Sachs in 2002 -- is now decentralizing his operation to be able to invest more nimbly on a global basis and to delegate some decision making. Currently, there are four operating groups within Farallon: credit and liquidations, headed by William Mellin, Derek Schrier and Rajiv Patel; arbitrage, run by Chun Ding; real estate, managed by Stephen Millham and Richard Fried; and restructuring and value, overseen by William Duhamel.

This past spring David Cohen, a partner since 1992, and Andrew Spokes, head of Farallon’s London office, banded together to launch Noonday Global Management. Named for one of the Farallon islands, Noonday essentially functions as a fifth operating team within Farallon: It won’t raise any capital beyond what is allocated to it by Farallon, nor will its performance record be disclosed to Farallon’s investors. But Cohen and Spokes will have their own separate management company and research staff, all of which will give them considerable independence in the marketplace.

“The nature of the business is changing quite dramatically,” Cohen says. “It’s getting very crowded. We decided that we either needed to systematize operations or decentralize. We opted for the latter.”

Cohen’s team, based in Charlotte, North Carolina, will focus on specific industries; Spokes’ operation in London will specialize in particular countries. The pair will work independently of each other, but when they need to combine forces for maximum impact they will match an industry specialist with a country specialist. Noonday’s structure will allow its teams to undertake complex international investments -- an area that has always held tremendous appeal for Steyer, who is keen to move away from the crowd into areas that are perceived to be dangerous or opaque or to entail higher political risk.

“Globalization is happening so quickly,” Steyer says. “We have to be able to get out there. I’ve never wanted Farallon to be the biggest hedge fund in the world, but we need to reflect the world.”

STEYER HIMSELF GREW UP IN A TIGHTLY KNIT world bounded by wealth and privilege. His father, Roy, was a lawyer at white-shoe Wall Street firm Sullivan & Cromwell. His mother, Marnie, worked for CBS News before marrying and having children (Steyer has two older brothers, Hume and James).

Tom Steyer was by all accounts an exemplary student at the Buckley School, an exclusive all-boys private school on Manhattan’s Upper East Side. He then attended Phillips Exeter Academy, the elite boarding school in New Hampshire. After graduating in 1975, he enrolled at Yale, where he majored in economics and political science. An avid soccer player, he made Yale’s varsity team his junior year as a wingback and was named captain his senior year. Steyer met his best friend on the field: Matthew Barger, a forward, who -- a decade later -- introduced Steyer to Hellman (Barger is currently deputy chairman of Hellman & Friedman).

As an undergraduate, Steyer developed a deep love of the West. Between his freshman and sophomore years, he worked on a ranch in Smith Valley, Nevada, living in a house without electricity or running water. The following summer he picked fruit in Oregon.

But as much as he loved the outdoors, Steyer also wanted to earn more cash. After graduating from Yale in 1979, he entered the two-year analyst training program at Morgan Stanley, working in mergers and acquisitions. It was classic investment bank boot camp, but the job had its benefits: Steyer met his close friend, Katie Hall, at Morgan. She remembers Steyer as “a clear star,” who could hardly bring himself to dress the part of the young, ambitious Wall Street lion.

“Fashion is just not his thing,” Hall says. “He wore what were possibly the ugliest suits of anyone I have ever known.”

Before his two years were up, Steyer decided to go to the Stanford University Graduate School of Business. Barger and Hall soon joined him. In the summer after his first year at Stanford, Steyer worked at General Atlantic Partners, the Greenwich, Connecticutbased private equity firm funded by Charles Feeney, one of the founders of the DFS Group (Duty Free Shoppers). As graduation neared, Steyer got a tip that would send him back to New York: A friend who had found summer work at Goldman Sachs returned to Stanford with glowing reports of a brilliant man named Robert Rubin, who was then running the risk arbitrage department.

Goldman had a team-oriented environment, and Rubin attracted some of the best and brightest players, among them such future hedge fund luminaries as Richard Perry of Perry Capital, Daniel Och of Och-Ziff Capital Management Group and Edward Lampert of ESL Investments. Steyer’s star rose quickly at Goldman. Within two and a half years, Steyer, still an associate (reporting directly to a senior partner), had gained primary operating responsibility for all of Goldman’s small but growing international arbitrage business.

Still, he had a problem: His girlfriend didn’t want to live in New York. Kathryn Taylor, a Californian he had met at Stanford while she was in the JD-MBA program, was from San Mateo. Steyer didn’t hold out much hope for his chances of marrying her and starting a family if he chose to remain at Goldman.

“I think her desire to have a family in New York could best be described as nonexistent,” says Steyer, now the father of four (three boys and a girl, who range in age from 11 to 16). “She’s from out here, and no matter what, I knew we were going to end up back west of the Mississippi.”

The turning point came when Rubin stopped running the risk arbitrage department on a day-to-day basis in 1985 and began to take on more firmwide operational responsibilities. “Bob was just a fantastic person to work for,” Steyer says. “He’s extremely clear. He’s really supportive. And even though he’s a pretty quiet guy, he’s very charismatic -- I felt a ton of loyalty to him.”

Meanwhile, Barger had moved to San Francisco, landing a job at Hellman & Friedman. He knew his friend wanted to break away from Goldman and offered to enlist the partners’ help in gathering capital for Steyer’s own shop. Steyer met Tully Friedman and Warren Hellman over Thanksgiving weekend in New York in 1985, and he and Hellman took to each other immediately.

“I’m a very average investor,” Hellman says. “But I think I’m good at being able to sense whether someone has extraordinary talent. There was just something about Tom that made me think he was unique.”

Steyer moved out to San Francisco and launched HFS Partners -- the precursor to Farallon -- in March 1986. He married Taylor that August, with Barger as his best man and Katie Hall as one of his groomsmen, wearing a black cocktail dress instead of a tuxedo. (“My wife’s mother was appalled!” says Steyer gleefully.)

Steyer began with $15 million: $4 million from Hellman and the rest from family, friends and some of Hellman & Friedman’s clients.

“I was concerned that it wouldn’t be enough,” Hellman says. “I said, ‘Tom, this isn’t very much money.’ But he just said, ‘No, no, that’s fine. It’s enough to get started.’”

STARTING WITH SUCH A MODEST SUM MAY HAVE been a good thing: Steyer didn’t really know how to run an investment business. Now he oversees billions spread across hundreds of positions on a daily basis. Since launching Farallon, Steyer has largely eschewed the use of leverage, preferring to take risks that he can control rather than ones he can’t. At most, he says, he’s 125 percent invested, using one part debt to four parts equity.

“There are two ways that financial businesses blow up,” he says. “One is by being highly leveraged, and the other is by being dishonest. Those two things are consistent, and you can track them over time.”

Steyer’s disciplined approach was shaped by his first experience with market shock. Eight months after launching HFS Partners, Steyer convinced Hall, then at Morgan Stanley in New York, to join him. The two friends did a little bit of everything: arbitrage, valuation, liquidation. Markets were volatile, but nothing prepared them for Monday, October 19, 1987, when the Dow Jones industrial average plunged 22 percent.

HFS Partners owned a sizable stake in Allegis Corp., which was being broken apart for its components: United Airlines, Hertz Corp., Westin Hotels and Resorts and Hilton International Hotels. Allegis stock, Steyer ruefully recalls, had been described in one Wall Street research report as “safer than cash,” and the 30-year-old Steyer watched in dismay as the share price dropped from $93.88 to $66. That one stock cost Steyer 3 percent of his capital -- still the worst loss (on a percentage basis) the fund has ever sustained on a single position.

Black Monday’s events helped change Steyer’s approach to investing. For a start, he stopped relying too heavily on anyone else’s research. He also got serious about risk. Steyer worries constantly about correlations and unintended, industry-specific concentrations and demands that his team do the same. Each operational group has its own customized risk management system, which combines proprietary and off-the-shelf tools. In the restructuring and value group, for example, partner William Duhamel can view his positions through almost every imaginable lens: country, industry, sector, liquidity, volatility, price target, potential loss, potential gain, value-at-risk, beta measurements and more. As his operating group partners keep track of investments and risk assessment at the micro level, Steyer oversees firmwide risk management. His desk sits in the middle of the open floor and he circulates constantly, interrogating the partners about position sizing relative to potential losses, given what he sees across their portfolios.

“Computer modeling is a very orderly way to think about the world and quantify things and examine your assumptions, but it is not the world,” Steyer says. “The world is a nasty, bloody place where things can go really, really wrong. And if you want to survive in it, you have to think in a much more primitive way.”

With rare exceptions, Steyer does not allow any position to exceed 10 percent of the value of the portfolio. At Farallon’s present size that rule gives him a ceiling of about $1.25 billion, which is hardly a constraint. Typically, his bets are numerous and fairly small. At any given time, Farallon may have as many as 300 to 500 positions. Monica Landry, Farallon’s head trader, says that she executes only 40 to 50 trades a day, and actual position turnover is slight.

After the 1987 crash, Steyer directed his staff to specialize in narrower disciplines. In the spring of 1989, he asked Fleur Fairman, a friend from Morgan Stanley, to take over risk arbitrage; he began focusing on credit risk. Both agreed that the highly leveraged deals that were being struck right and left in the LBO frenzy would not hold up -- interest rates were too high. Steyer anticipated a credit crunch, and he and his team trained for it nonstop. Six months later, he says, it came like rolling thunder.

On October 13, 1989, bank lenders revolted against the $6.8 billion attempted leveraged buyout of United Airlines, and the stock market suffered a minicollapse. The junk bond market went into a tailspin, and Wall Street’s arbitrageurs hemorrhaged money. Farallon escaped the bloodletting. Although the fund was down 2 percent that month, Steyer felt confident, not shaken. “I still tell people that October 1989 was best month we ever had,” he says.

By 1990 the S&L industry was in chaos, and Drexel Burnham Lambert Group, prime purveyor of junk bonds, declared bankruptcy. Steyer and his team went to work picking diamonds out of the dust and ended up holding 20 percent of the bankrupt Drexel’s restructured debt. Meridee Moore, who researched claims against Drexel exhaustively, kept encouraging Steyer to up the ante. In 1993 their bet paid off: Farallon’s stake in DBL Trust, which liquidated Drexel, helped boost the portfolio to a gross return of 34.8 percent. William Mellin, who joined Farallon in 1987, remembers those days fondly. “Some of us are still wistful for a return to the early ‘90s,” he says. “We had so much to look at in terms of possible deals.”

The real estate bust of the early ‘90s piqued Steyer’s interest in bankrupt companies’ assets. He hired Stephen Millham from JMB Realty Corp., a major U.S. real estate investment firm, in 1993, to evaluate commercial properties. Steyer -- ever smitten with the West -- also took a look at unusual development projects. That interest led him directly into Farallon’s most notorious undertaking, the Baca Ranch.

In 1994, Steyer was approached by Gary Boyce, a rancher in Colorado’s San Luis Valley, who knew of Farallon through wealthy connections in San Francisco. Boyce wanted Steyer to help him buy the ranch and lay claim to the deep aquifer beneath it. His goal was to export the water directly to Colorado’s rapidly developing Front Range cities.

But claiming the water rights was no easy feat. Unlike with other natural resources, water rights are not necessarily associated with physical property; certain users are vested with rights by federal land grants that date back to the settling of the West in the 1800s.

Boyce wasn’t the first to try to tap this aquifer. Eight years earlier, American Water Development, led by Maurice Strong, a multimillionaire Canadian businessman who then owned the ranch, had submitted a claim to pump water from the aquifer. That application sparked a lengthy court battle, which was resolved only when the Colorado Supreme Court denied American Water’s claim in 1994. The company then entered into negotiations to sell the property for a reported $15 million to the Nature Conservancy, which wanted to annex the land to the Great Sand Dunes National Monument and create a new national park.

The deal never closed. Boyce, armed with Farallon’s money, stepped in and superseded the Nature Conservancy’s bid. Farallon created Vaca Partners to help fund the purchase. Structured as a 50-50 partnership between Farallon and Yale, Vaca Partners was in turn the financial sponsor of Cabeza de Vaca, which owned Baca Ranch. Cabeza de Vaca was also owned in part by Stockman’s Water Co., headed by Boyce.

Farallon began researching to ascertain how much water could be drawn from the aquifer without causing environmental degradation -- and whether farmers in the valley were already overdrafting. In 1998, Boyce succeeded in getting two initiatives on the state ballot concerning water usage in the San Luis Valley: One would have demanded payment from the Rio Grande Water Conservation District for irrigators’ use of water pumped from beneath state trust lands; the other required that certain agricultural, industrial and municipal users in the valley install water flow meters at their own expense.

“In a nutshell, the ballot initiatives were basically designed to bankrupt the valley,” says Christine Canaly, a former engineer for NBC News in New York who lives in the area and helped raise $1 million to combat the initiatives. (She is now executive director of the San Luis Valley Ecosystem Council, a local public lands advocacy organization.) “Fortunately, people here in Colorado saw through them.”

The initiatives were rejected by a 3-1 margin. Shortly afterward, Colorado Senator Wayne Allard, then-senator Ben Nighthorse Campbell and U.S. Representative Scott McInnis began working with thensecretary of the Interior Bruce Babbitt to create a piece of legislation to transform the Great Sand Dunes National Monument into a national park. In 2000, fed up with the political fray, Farallon began quietly exploring a possible sale of the land to the Nature Conservancy -- for $31.3 million.

Farallon had a hard time finding its exit. Boyce refused to accept that the project was dead and fought to keep it going. When Farallon refused, Boyce and his partner, Peter Hornick, sued to prevent the firm from selling to the Nature Conservancy.

Word of Yale’s involvement first made news in January 2002. The timing was hardly coincidental: Yale’s contract with some 4,000 of its unionized workers had expired at the end of 2001, and negotiations were protracted and bitter; union organizers, as well as graduate students looking to unionize, were searching for anything they could use for leverage. They uncovered Yale’s investment in Baca and turned a fading battle into a political tinderbox: Senator Allard demanded that Yale lower the sale price of the ranch or donate its profits from the sale to the Nature Conservancy.

Yale President Levin agreed, but how much the university should pay was challenged by protesters. Yale’s union activists insist that the university’s anticipated profit was close to $4 million, but at best that was an estimated gross total -- to which Yale was entitled to only about half. In January 2004, Yale announced it would donate $1.5 million to the Nature Conservancy. The business was finally resolved in September 2004, when the sale to the organization closed.

“Was it a failed deal?” Steyer asks rhetorically. “Duh! But we thought we were doing the right thing, all along the way.”

COLORADO NOTWITHSTANDING, STEYER’S GROWING interest in real estate and private equity investments helped spark growth and diversification at Farallon. He and his team began fashioning the side-pocket structure of separate accounts to enhance the firm’s ability to invest in less liquid securities with longer lockups. Although the structure was initially a tough sell to Farallon’s limited partners, the added diversification -- coupled with strong performance -- gave the firm quite a boost. From $935 million under management and 24 employees at year-end 1994, Farallon tripled in size, to $2.8 billion and 35 employees, in 1997. It has continued to grow rapidly, adding more than $1 billion in assets per year, much of it money pouring in from institutional investors attracted to Farallon’s returns and record for risk management.

In the mid-1990s, Steyer intensified Farallon’s overseas push. International assets quadrupled between 1994 and 1997, the year he hired Andrew Spokes, a former Goldman Sachs investment banker with expertise in Europe and Asia, to further advance the expansion. That year, too, Farallon struck the first of two sale-leaseback deals with Singapore Airlines with typical ingenuity. Farallon agreed to pay $20 million for two Boeing 747-400s and to assume $220 million in additional debt in return for long-term lease payments that have given the hedge fund a handsome revenue stream.

Spokes, who was initially based in San Francisco, moved to London to open Farallon’s first overseas office in 1998. In 2000 the firm hired Raymond Zage, another former Goldman Sachs banker, who opened Farallon’s first Asia office, in Singapore, in 2003.

The Teva-shod, T-shirted masses from New Haven to Palo Alto were becoming keenly aware of globalization and the role of hedge funds in it. And in truth, many of Farallon’s biggest investments during the 1990s can be traced to major political and economic upheavals: the LBO crisis in the U.S. in 1989'90, the fall of Communism and the dissolution of the Soviet Union in 1991, the real estate bust in 1993, the Mexican peso devaluation in 1994 and the Thai baht crisis in 1997, which precipitated the Asian economic crisis.

Not all of these ventures were successful. For example, Farallon’s activities in Russia during the early days of economic reform have come back to haunt it. In 1994, Farallon entered into a joint venture to create Farallon Fixed Income Associates with Nancy Zimmerman, then a vice president in fixed-income arbitrage at Goldman Sachs. FFIA intended to invest in Russia, where the fall of Communism was precipitating major changes in the country’s capital structure.

Zimmerman’s husband, Andrei Shleifer, a well-known professor of economics at Harvard University, was deeply involved in the transformation of the Russian economy. In 1992 the U.S. Agency for International Development had awarded him an initial $2.1 million as the project director of Harvard’s Institute for International Development to act in an advisory capacity to Russian market reformers. Shleifer, in turn, signed on Jonathan Hay, a Russian-speaking Rhodes Scholar then about to graduate from Harvard Law School.

The U.S. government allocated $57 million for the project, but in 1997, AID pulled the plug, charging Shleifer and Hay with conflict-of-interest violations. In 2000 the U.S. government brought a civil suit against Harvard, Shleifer, Zimmerman, Hay and his wife, Elizabeth Hebert; it charged that the two couples had defrauded the government “and abused their positions as high-level and trusted advisors to and on behalf of the United States in Russia.”

In one instance, according to the government’s initial complaint, Shleifer and Zimmerman invested $200,000 in 1994 through a company called Renova-Invest in various Russian companies, including those being privatized under Shleifer’s guidance. Shleifer advised Farallon on investing in Russian oil stocks, agreeing to co-invest with the hedge fund firm. Farallon lost a significant sum of money on these oil stock investments.

Last summer a federal judge ruled that Harvard was in breach of its contract and that Shleifer and Hay had conspired to defraud the government; neither admits any wrongdoing. Zimmerman and Hebert were dropped from the case in 2001. Zimmerman and Farallon parted company in 1998, and Zimmerman started Bracebridge Capital in Boston; Bracebridge was renamed FFIA in 2001. FFIA paid $1.5 million to settle separate civil claims last July, denying any misconduct.

Farallon itself was never charged with any wrongdoing, and Steyer is reluctant to discuss the episode. “Things come up sometimes that you don’t expect,” he says. “We work with a lot of people, so we make a lot of investments. Sometimes they don’t work out. But we try really hard, when we discover we’ve made a mistake, to correct it and not cover it up.”

Farallon’s experience has been happier in Indonesia, where Steyer’s mentor, Rubin, worked with the International Monetary Fund to stabilize the economy following the 1997'98 Asian crisis, when many of the country’s banks were near collapse because of bad loans. By 2000, after the departure of president Suharto, Indonesia was freer than it had been in decades, but it was financially destitute. The IMF began to pressure the Indonesian government to sell Bank Central Asia, one of the country’s biggest banks, as a good-faith show of financial reform.

Farallon entered the bidding for BCA in 2002, putting together a partnership, Mauritius-registered FarIndo Investments -- whose largest co-investor is Indonesia’s biggest cigarette maker, PT Djarum -- to make a bid for the bank. FarIndo retained Deutsche Bank as an adviser; Hubert Neiss, the chairman of Deutsche Bank Asia, had been director of the IMF’s Asia and Pacific department during the 1998 crisis and supported FarIndo’s bid. Although Farallon had no experience running a bank, FarIndo won the auction, besting the U.K.'s Standard Chartered Bank.

For Farallon, BCA, which has about $10 billion in assets and 6.7 million deposit accounts, has been a spectacular success. FarIndo paid about $541 million for a 51 percent stake in BCA, whose share price has more than doubled since the acquisition, making FarIndo’s investment worth more than $1 billion.

The way the Yale protesters see it, Indonesia is now making interest payments to wealthy U.S. stakeholders to pay off the bad debt of Suharto cronies. Within Indonesia academics and some government officials questioned the sale of such a critical state asset to foreign investors.

“There are two competing methods of global investing,” says union activist Rose Murphy. “There is one in which investors actually invest in and build the economies of developing nations, and one in which investors take resources out of distressed communities as a return on their investments. Yale should pursue the former strategy; Farallon’s purchase of BCA was an example of the latter.”

Steyer argues that he is, in fact, helping Indonesia. “This is a key institution for a huge developing country,” he says. “And we are not going to go to this country to take advantage of anyone. We need to leave them with an important institution in better shape than it was before.”

ONE BALMY EVENING IN PALO ALTO LAST MAY, Steyer was on his way to a meeting of the Stanford Business School Advisory Council when a group of student protesters recognized him. Another person in his position might have rushed past them, but Steyer lingered outside to talk for nearly an hour, eager to defend his investments against their barbed commentary, which ranged from matters of disclosure to accusations about Farallon’s supposedly having poorly treated workers at an Australian lead and zinc production company.

“We owned about 10 percent of the bank debt of Pasminco, which -- as a result of bankruptcy -- had to renegotiate its labor contracts, which is pretty normal. We weren’t even the controlling company, but these kids were up in arms about it,” Steyer explains. “I said, ‘Look, you guys are concerned about workers, and that’s great. Totally sensible. But the labor dispute has been resolved now, and if there was something wrong done, we didn’t do it. We don’t even know about it.’”

His answers, and his willingness to engage, impressed some of the students, but they have, in the argot of another era, had their consciousness raised, and they’re angling for bigger game -- the global activities of all hedge funds, which they see as operating without any social or environmental accountability. Thanks to the Yale imbroglio, Farallon is, for now, the easiest and most accessible target.

“Most of the people in our group at Stanford feel that he’s almost on our side,” recalls junior Derek Kilner, a coordinator for the Stanford Community for Peace and Justice. “He agrees with us on a lot of issues, and he’s even advocating for greater control of hedge funds. But he has to be competitive and remain profitable. If Farallon changes its approach and makes big ethical improvements, then what happens? Some other hedge fund will just take its place. We’ve got to get the universities to change.”

Kilner may have sounded an ominous note for university endowments and their overseers, but Steyer believes wholeheartedly that he is doing the right thing: making money for Stanford and his other limited partners the best way he knows how.

That -- not dealing with campus protestors -- is Steyer’s most daunting challenge: how to keep turning up good deals in ever-more-congested (and theoretically more efficient) global markets. For every successful position that Farallon closes, it must turn right around and put the profits to work someplace else.

And despite the contretemps, Steyer’s investors are deeply supportive. “Tom is a brilliant investor,” says Yale president Levin, who was one of his undergraduate economics professors. “He has been remarkably innovative and creative in his investment strategies over a long period of time. It’s a privilege to be associated with him.”

How will Steyer maintain his edge as his firm continues the rapid growth that has proved the bane of other hedge funds? Beyond diversifying geographically, he is keen to forge sustainable partnerships. One such long-term relationship brought the firm its biggest single gain in 2003 through the IPO of CapitalSource, a start-up finance company designed to provide loans of $5 million to $250 million to midsize businesses. Entrepreneur John Delaney, who has known Steyer since 1994, saw an opportunity to provide loans to small, solid companies with good credit -- a client group being neglected in the wake of numerous massive bank mergers.

Farallon made an initial investment of about $190 million in 2000. CapitalSource also raised some $118 million from Madison Dearborn Parters, a Chicago-based private equity fund, and smaller amounts from other hedge funds, including Highfields Capital Management and Och-Ziff Capital Management.

In August 2003, Delaney took CapitalSource public at $14.50 per share. Farallon sold 2.15 million shares into the IPO and another 6.8 million shares in January 2004, grossing $177.4 million. With the shares trading at $26 in early January 2005, Farallon’s remaining 23 million shares were worth $598 million.

“One of the things we want is for people to understand that we are incredibly serious about relationships with companies and investors,” Steyer says. “We’re not traders. We’re not hostile. In order to get these kinds of returns, we think people have to want you to be their partner.”

Partnering with Steyer has become a more complex proposition. Farallon can no longer operate so unobtrusively. Given a choice, Steyer would clearly prefer to step out of the spotlight, continue to build and diversify his business and not have to answer questions.

But he is a pragmatist, and ultimately adaptable. Political risk is now just one more factor he worries about. This fall, after taking a pounding on the Internet, Farallon launched its own Web site. It doesn’t reveal much, to be sure, but it’s a sign that when pressed, Steyer will make changes.

Just don’t ask him to give up the tie.