Mushrooming scandals at Cambridge Analytica, the embattled quantitatively driven consulting firm accused of misappropriating data and possible violations of U.S. election laws, are inexorably pushing pensions and other investors toward a decision: whether to pull their money from Renaissance Technologies, arguably the world's most successful hedge fund firm.
Cambridge Analytica is largely bankrolled by Robert Mercer, a backer of Breitbart News and other ventures, who stepped down on January 1 as co-CEO of Renaissance following public criticism of his political activism. Mercer continues as a top researcher and part owner at Renaissance.
The specific hot-button issue for Renaissance investors: Cambridge Analytica's focus on psychographic modeling — using machine-based learning to sort through myriad data points as a way of determining how a person is likely to vote. The techniques are strikingly similar to those Renaissance researchers have harnessed for years, according to quantitative scientists and other experts.
"The math used in machine learning for the purpose of affecting the election is the same math used in the world of quantitative investing," says Peter Carr, chair of the Finance and Risk Engineering Department at New York University's Tandon School of Engineering. "I believe Renaissance has a fairly deep knowledge of human behavior. Whether [Mercer] passed that on I wouldn't know."
That raises the question of whether safeguards or policies exist to prevent that from happening. "If proprietary algorithms that were developed at Renaissance were used for other purposes, that would be a concern for partners and investors," says Charles Lee, a former managing director and global head of equity research and co-head of North America active equities at rival Barclays Global Investors, now part of BlackRock.
No one to date has publicly accused Mercer of any misuse of Renaissance information. But investors should be raising the question, says Lee, currently an accounting professor at the Stanford Graduate School of Business.
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On March 17, The New York Times and London's Observer newspaper reported, among other things, that Cambridge Analytica had utilized information gleaned from the accounts of tens of millions of unknowing Facebook users in its work on Donald Trump's 2016 presidential campaign. The Times further reported that the firm may have violated U.S. election laws by using foreigners in its campaign work. Facebook CEO Mark Zuckerberg is slated to testify before both the Senate and House this week, where he is expected to address how the company allowed Cambridge Analytica to allegedly misappropriate Facebook user data.
Mercer's move to relinquish his co-CEO post followed an October decision by the $2.77 billion Baltimore City Fire and Police Employees' Retirement System to redeem its $25 million investment in the Renaissance Institutional Equities Fund, or RIEF.
"We had some concerns about [Mercer's] outside activities," says Anthony Calhoun, executive director of the retirement system, noting that Mercer announced he was stepping down as co-CEO shortly after the pension fund decided to withdraw its money.
Mercer's handling of company information speaks to the scientist's fiduciary obligation to Renaissance and the funds it manages, according to experts. "An informal transfer of intellectual property from Renaissance to Cambridge could amount to a misappropriation of Renaissance's property," says John Coffee, a professor at Columbia Law School, in an email.
Even if any such transfer of intellectual property was approved by senior Renaissance management, Coffee says that sidesteps the question of whether the hedge fund firm received fair market value for the property. "If not, this could be seen as self-dealing and amount to a fiduciary breach," he says.
And even if there is no fiduciary breach, that wouldn't necessarily let Mercer off the hook. Without knowing specifics of the situation, Ron Geffner, who oversees the financial services group at New York law firm Sadis & Goldberg, says that if Mercer did use Renaissance information at Cambridge Analytica, the concern would be whether it violates his employment contract, rather than fiduciary obligations. "If there are assets that are developed, [they] can't be taken willy-nilly," he says.
Cambridge Analytica did not respond to emails and phone calls seeking comment. Jonathan Gasthalter, a spokesman for Renaissance, declined to comment.
Lee says big investors often ask that top money managers limit outside activities. On occasion, in side letters to their investments, they will require that managers disclose such activities in a timely manner.
At the very least Mercer's activities raise the question of how his outside interests may affect the execution of his responsibilities at Renaissance, where he is still engaged in research at a senior level. "It certainly seems to me as if there is a key-man issue," says Ted Aronson, managing principal at AJO Partners, a quantitative equity investment firm with $25.4 billion in assets.
Pensions and endowments aren't talking on the record. Those that own RIEF or one of its siblings, such as the Renaissance Institutional Diversified Alpha Fund, or RIDAF, either did not return phone calls or declined to comment on the record about whether they are considering redemptions or communicating with Renaissance about Cambridge Analytica.
Big-ticket Renaissance fund investors identified in public documents include the Public School and Education Employee Retirement Systems of Missouri, the Employee Retirement System of the City of Providence, the Los Angeles Water and Power Employees' Retirement Plan, the William Penn Foundation, the American Physical Society, the Robert Wood Johnson Foundation, Tufts Medical Center, the National Academy of Sciences, and Furman University. Officials either declined to comment or did not return phone calls or emails.
Such investors may be reluctant to part ways with Renaissance, and for good reason. RIEF and RIDAF have generated stable, positive returns in each of the past four years — always in the double digits — beating the HFRI Fund Weighted Composite Index every year.
Last year, RIEF's Class B shares returned 14.47 percent, RIDAF Class A shares returned 11.15 percent, and the HFRI Index rose 8.58 percent. The Standard & Poor's 500 Index returned 21.80 percent.
Indeed, a person familiar with the matter says Renaissance overall had net inflows in 2017 of more than $9 billion, a pace that is accelerating this year. Renaissance has about $58 billion in assets under management.
In the past, Renaissance aggressively pursued former employees over alleged purloined intellectual property. In December 2003, the firm sued two former employees, Alexander Belopolsky and Pavel Volfbeyn, accusing them of misappropriating Renaissance trade secrets by taking them to another firm, then known as Millennium Partners.
Renaissance and Millennium settled that suit in 2007, with the latter agreeing to terminate Belopolsky and Volfbeyn. Millennium founder Israel Englander said at the time that his firm had not had access to Renaissance computer code and would not have used it if it had. Media reports said Millennium also agreed to pay Renaissance $20 million.
In 2008, Renaissance entered into a confidential settlement with Belopolsky and Volfbeyn. A spokesman for Millennium declined to comment.
Such legal wrangling belies an unappreciated truth of quantitative investing: the math underlying it is relatively simple in most cases, experts say. "The secret sauce of Renaissance is not the math — the math is well known," says Carr. "It's making decisions that matter — what variables to include, what variables not to include."
That could muddy definitions of what constitutes the firm's intellectual property.
Still, investigators would likely have plenty of avenues to explore whether any fiduciary obligations or contracts had been breached. "Conceivably, proof could be found if emails between Mercer, [Renaissance], and Cambridge were subpoenaed," says Coffee.
On March 19, the U.K.'s Channel 4 News broadcast video of Cambridge Analytica CEO Alexander Nix suggesting to what appears to be a potential client — actually an incognito reporter — that the firm would be willing to snare a political rival in a bribery or sexual entrapment scheme. Cambridge Analytica's board then suspended Nix.
In the Channel 4 News report, a Cambridge Analytica executive says the firm communicates using ProtonMail, a Switzerland-based encrypted email service in which messages can be set to self-destruct after a short period of time, like those on Snapchat.
As for Cambridge Analytica, the firm can be surprisingly open about the psychographic modeling it did on behalf of the Trump 2016 election campaign. In a document submitted to the Advertising Research Foundation, or ARF, a prominent industry think tank, in support of its nomination for a prestigious David Ogilvy Award for big data usage in 2017, Cambridge Analytica described how it was able to identify populations that could be persuaded to vote for Trump:
"This was accomplished by first collecting surveys from thousands of voters. Using advanced machine learning algorithms and our internal database with thousands of data points per person (including voter history, demographic information, and commercial data), survey responses were then modeled for the millions of other voters in our target states."
Now we know that at least some of this data is alleged by Facebook to have been improperly harvested by Cambridge Analytica. The firm in a statement said the data used in providing services to the Trump campaign did not come from Facebook.
Cambridge Analytica won its prestigious advertising award in March 2017. Last month, ARF said it was "investigating the conditions surrounding the recognition that we bestowed upon Cambridge Analytica" and reserves the right to rescind the award.