This story was originally published in the March 2017 Princeton Echo.
Imagine for a second a roulette wheel marked not by numbers but by career opportunities available to the Class of 2017 at Princeton University. There would be hundreds of them. But if you knew just one simple fact about Bradley Snider, the senior who won a quarter of a million dollars in a poker tournament last summer, you could place your bets on just three spaces on the wheel and you could be pretty sure of winning.
What you need to know is that Snider is majoring in mathematics. And if you are a math major at Princeton it’s highly likely that after graduation you are moving on to 1.) graduate studies in math; 2.) software development; or 3.) financial investment analysis. That’s pretty much what happens to graduates of Princeton’s highly rated mathematics program.
It wasn’t always that way. The presence of mathematicians at Wall Street trading firms is a relatively recent phenomenon, and it can be traced back to single firm founded in 1969: Princeton Newport Partners. The spark came when a young man on Wall Street became interested in the work of a mathematician who had developed a system for beating blackjack and was using that system to pick stocks that would outperform the market averages. The mathematician is Ed Thorp, still active at age 84 and living in Newport, California. The Wall Street investor is Jay Regan, still active at age 74 and splitting his time between offices on Madison Avenue in Manhattan and Hulfish Street, overlooking the plaza in front of Mediterra in Princeton.
Princeton Newport Partners became the first quantitative hedge fund. Now there are hundreds of them, with computers armed to do split second research and execute lightning fast trades. It’s an amazing story, and a piece of history of which a bright and eager Princeton mathematics senior like Snider is totally unaware.
Thorp’s story, it turns out, makes the point that accepting the common wisdom is not always a good choice. Thorp lays out the lesson in great detail in his new book, “A Man for All Markets,” just published by Random House. In the preface Thorp writes how being largely self-taught led him to think differently:
“First, rather than subscribing to widely accepted views — such as you can’t beat the casinos — I checked for myself. Second, since I tested theories by inventing new experiments, I formed the habit of taking the result of pure thought — such as a formula for valuing warrants — and using it profitably.”
In addition, Thorp wrote, “I strove to be consistently rational, not just in a specialized area of science, but in dealing with all aspects of the world. I also learned the value of withholding judgement until I could make a decision based on evidence.”
That last lesson would come in handy for anyone getting to know James S. “Jay” Regan. Google his name and the first two words that might come up are “racketeering charges.” Gather just a little more evidence and you discover that in the late 1980s Regan and several colleagues had been convicted of 60-some counts of tax and securities fraud, each of which carried years of possible jail time and millions in possible fines. In fact he was sentenced to only six months, and even that sentence was later overturned when an appeals court judge called the entire episode a case of prosecutorial over-reach. The prosecutor, incidentally, was Rudolph Giuliani, even then politically ambitious.
For all that he and his family went through, Regan remains a bright and cheerful soul, and as enthusiastic about his work as he must have been when he first got involved on Wall Street a year or so after his graduation from Dartmouth in 1964.
The son of a pediatric surgeon in Buffalo, NY, Regan had “no bloody idea” what he would do with his college degree in philosophy. He moved to New York, where his sister and her husband were living. After tending bar for a while, dropping a keg on his foot, and collecting workers’ compensation for a few months, he decided to get more serious. His brother-in-law, who was in the investment business, suggested he try Wall Street. “I knew zilch,” says Regan, but he managed to get an interview with F.I. Dupont. The interviewer said, “Mr. Regan, what’s your view of the Dow Jones Industrial Average and where it might be in the next few months?” Regan literally did not know what the Dow Jones Average was. He never got a call back from that interview. His brother-in-law suggested he start reading the Wall Street Journal.
Eventually Regan got hired in the retail sales department at White Weld & Co., and then into the Institutional department at Kidder Peabody. “I wasn’t that good at retail sales,” he says. “I finally did reasonably well at institutional sales.” One of his bonuses paid for his honeymoon — he and his wife, Amy, had met in New York in 1966 at the wedding of a mutual friend.
“Along the way someone gave me a copy of ‘Beat the Market,’” Regan says, referring to the book by Ed Thorp published in 1967, five years after he had published “Beat the Dealer,” about his successes at the Nevada blackjack tables. Regan was intrigued by Thorp’s strategy for hedging positions in a company’s warrants (convertible into stock), and the stock itself. “I read the book and said this is a shitload more fun than calling on institutions. I just picked up the phone and called him.” Regan’s question was simple: Was there some way they could turn the concept into a real business?
Thorp, as it turned out, knew no more about the stock market when he started than Regan did when he went on his first interview. What Thorp did know about was the blackjack scene.
On Thorp’s first visit to Las Vegas he was struck by the glitter of the strip, in sharp contrast to the homeless people in the parks. It was a place where “winners were celebrated as poster-people to draw more suckers while a great number, betting too much or too often, were impoverished and sometimes even ruined.”
A few years later Thorp played a bit of blackjack himself, losing $8.50 of a $10 stake, but coming out with a valuable nugget of knowledge. “The atmosphere of ignorance and superstition surrounding the blackjack table that day had convinced me that even good players didn’t understand the mathematics underlying the game. I returned home intending to find a way to win.”
Thorp, the skeptic, notes that “the belief that casinos must come out ahead in the long run was supported by conventional wisdom, which argued that if blackjack could be beaten, the casinos would have to either change the rules or drop the game. Neither had happened. But . . . I wasn’t willing to accept these claims about blackjack. I decided to check for myself if the player could systematically win.”
Thorp’s strategy is outlined in detail in his 1962 book, “Beat the Dealer,” and his new book, “A Man for All Markets” devotes several chapters to explaining it. In a nutshell Thorp devised a simple way of valuing cards as they flew out of the dealer’s hand, so that he could judge at any moment whether the cards remaining to be dealt would be more favorable to him or to the dealer. The trick was to bet more heavily when the deck was in Thorp’s favor, and bet only the minimum when it was not.
The system was good enough that Thorp found himself augmenting his salary as a mathematics professor. He decided to invest some of his money in the stock market. He bought $4,000 worth of stock in a manufacturer of car batteries. The business press was touting the company’s bright future, with promises of technological breakthroughs that would lead to increased sales. In two years the stock fell to half its original price. Thorp decided to educate himself about the stock market.
“Gambling is investing simplified,” Thorp writes in his new book. “The striking similarities between the two suggested to me that, just as some gambling games could be beaten, it might also be possible to do better than the market averages. Both can be analyzed using mathematics, statistics, and computers. Each requires money management, choosing the proper balance between risk and return. Betting too much, even though each individual bet is in your favor, can be ruinous . . . On the other hand, playing safe and betting too little means you leave money on the table. The psychological makeup to succeed at investing also has similarities to that for gambling. Great investors are often good at both.”
The first sweet spot Thorp discovered in the market was in warrants — a security issued by a company that gives the owner the right to purchase common stock at a specified price. Thorp discovered that the price of warrants generally moves in relation to the stock itself. But there were times when the values were mismatched. At that moment the savvy investor could buy the relatively undervalued securities and hold them in hopes of their value increasing and “sell short” the relatively overpriced one. (Selling short means the investor borrows the shares and then sells them, expecting it will be cheaper to buy back the shares when it comes time to return the borrowed shares.) In effect the investor is “hedging” his bet and will likely make money whether the stock price goes up or down.
The same strategy could be applied to convertible bonds, or convertible preferred stock, or options — financial instruments that would normally move in tandem to the stock with which they were associated but on occasion might be over-valued or under-valued.
Thorp set up a limited partnership through which he was able to manage investments for himself and some friends and colleagues. From the management fees for the partnership (20 percent of the profits) Thorp was making about as much money a year in the market as he was teaching college math.
In 1969 Thorp got a call from the young stockbroker who had read “Beat the Market” and wanted to see if they could do business together. Thorp invited Regan to visit him in his office at the University of California-Irvine. “Ten years younger than I and of medium height, the 27-year-old Regan had thinning, reddish hair, freckles, and the social skills of a promoter. A Dartmouth graduate in philosophy, he quickly took in the principles on which I based my investment methods.
“We seemed to make a natural team. I would generate most of the ideas but he would bring suggestions and trading possibilities from ‘the Street.’ I would do the analysis and compute orders for him to execute through various brokers. He was to handle taxes, accounting, and most of the legal and regulatory paperwork, things I wished to avoid . . .”
The basic deal came together in a single day, sealed with a simple handshake. Thorp proposed that they form a business with each of them having equal ownership. “Ed probably could have taken more than 50 percent, but he didn’t,” Regan says today.
First known as Convertible Hedge Associates and later renamed Princeton Newport Partners (PNP), the firm’s operation “was a revolutionary idea,” writes Thorp. “Hedging risk was not new but we took it to an extreme never before tried. This nearly total reliance on quantitative measures was unique, making us the earliest of a new breed of investors who would later be called quants, and who would radically transform Wall Street.”
Notwithstanding the technical and analytical underpinnings, the firm needed some old-fashioned shoe leather to help round up investors. Regan and Thorp both put up $25,000 or so ‑— “not much money even in those dollars,” Regan says. “We needed to figure out ways to raise more money.” There were already a few hedge funds in operation, but not very many. Regan reasoned that investors in those would be good prospects for him and Thorp. “It turned out you could go into the County Clerk’s office and get the names of investors in those funds.”
So he did just that, jotting down the names, and then looking up the phone numbers. “I was able to spend 15 minutes with Larry Tisch,” says Regan. “He owned a big part of New York.”
He got two meetings with Charles Evans, a businessman and brother of Robert Evans, the movie producer. “On the second meeting he told me he’d give us $100,000 but we’d have to have our office in his building at Fifth Avenue and 57th Street. I think he wanted to keep an eye on me,” says Regan with a smile.
Eventually the firm earned the confidence of a critical mass of investors and started off in 1969 with $1.4 million in capital. Regan and his wife had the first of their three children and concluded Manhattan was not the place to raise them. But the Regans knew people living in Princeton. So the family and the business made the move.
From 1969 to the end of 1987 the amount invested rose from $1.4 million to $273 million. Its limited partners saw their wealth grow at 18.2 percent annualized after fees. PNP had no losing years — and not even a losing quarter.
The beginning of the end of PNP could be traced to a single day: Thursday, December 17, 1987. That’s when armed federal marshals pulled up to the corner of Witherspoon and Spring streets and entered the third floor offices, presenting a search warrant to the startled receptionist. Regan was in a back room, talking with some of his traders. Someone came in and said “Jay, there are three or four guys here who claim they have a search warrant.” Regan thought it was a joke. “I figured it was a couple of my college buddies playing a trick on me.”
But it was for real. At the end of the day every nook and cranny of the office had been searched. Some 60 boxes of records were removed. Women’s purses were inspected. The resulting charges were related to trades that PNP had made to create losses that would offset corresponding gains that arose during the firm’s hedging maneuvers.
But most knowledgeable observers believed that the charges — filed under the Racketeer Influenced and Corrupt Organizations (RICO) Act — were also intended to get the Princeton Newport principals to testify against Michael Milken, the controversial “junk bond” trader who had upended Wall Street conventions and who had dealings with PNP. Regan and his fellow defendants refused to cooperate. The Princeton Newport attorney, Theodore Wells, a Harvard Law and Harvard Business School alumnus known for high-profile white collar criminal defense, argued that the trades were allowed under IRS regulations. They even had a former IRS commissioner, Donald Alexander, prepared to testify in their defense. The judge would not permit it.
The complicated trial took more than a month during the summer of 1989. Figuring that this was a way to show his kids how the real world worked, Regan had the entire family go to court whenever they could. His older son had just completed his freshman year at college. His daughter worked as an unpaid assistant to the defense team.
In the end the jury, led by a bus driver from the Bronx, was apparently moved by the prosecution’s down-to-earth summation: “You don’t need a fancy tax law expert because common sense tells you it’s fraudulent. It’s phony.”
But not everyone thought the case was so simple. A reporter from the Wall Street Journal, L. Gordon Crovitz, who would later become the newspaper’s publisher, asked Regan if he would sit for a follow-up interview after the verdict was returned. The resulting article, highly critical of the prosecution’s case, was, says Regan, lifting his arms toward the sky, “my salvation.”
At sentencing the judge gave the defendants minimum terms. On appeal virtually all charges were dropped.
But Princeton Newport Partners was out of business. Several of the traders at the firm who had not been charged scooped up many of the limited partners and created their own hedge firm, which to this day operates from the former Princeton Newport space on Witherspoon Street, with a computer operation based in California. That firm is called TGS, named after founders C. Frederick Taylor, a Haverford alumnus; David Gelbaum, a mathematics major from University of California-Irvine; and Andrew Shechtel, who had been a trader in the Princeton office when the raid occurred.
A Johns Hopkins alumnus who earned his degree in math and political economy at the age of 19, Shechtel had attended Harvard Business School and worked on Wall Street before joining Princeton Newport Partners in the mid 1980s. TGS made national news in 2014, when Bloomberg BusinessWeek tracked down the source of hundreds of millions of dollars in donations to researchers investigating possible cures for Huntington’s disease.
The secretive donor was Andrew Shechtel. One Princeton link: CHDI, a research organization that was originally called the “Cure Huntington’s Disease Initiative,” is based at Princeton Forrestal Village and headed by Robi Blumenstein, identified by Bloomberg as the man Shechtel hired to oversee what had become a $100 million a year research effort.
Shechtel can afford it — his net worth has been estimated in the billions. Ed Thorp, who was not greatly affected by the criminal charges, was able to restart his hedge fund activity. In 2012 Thorp’s net worth was estimated at $800 million.
The Princeton Newport case lasted from December of 1987 until September of 1992, when the last of the charges were vacated by a federal judge. Regan had spent an estimated $5 million in the defense of himself and the others. In a recent list of the 50 wealthiest New Jerseyans published in NJBiz, Regan was not mentioned. “I don’t go around talking about myself too much,” he says.
Even in the darkest days Regan maintained his sense of humor, even if it had a certain gallows cast to it. At one meeting with a federal prosecutor he showed up wearing a cap that said “Shit Happens.”
After the trial and appeal he was able to rebound in the business world. He and one of the attorneys working on the defense team, David Mills, went into business together. At the time the savings and loan industry was in crisis and the Resolution Trust Corporation was selling off troubled assets. Regan and Mills saw an opportunity to bid on some undervalued assets. “Here we were, recently convicted on racketeering counts and asking for credit,” Regan recalls. “The banks were resistant at first. But then we sent them the Wall Street Journal article.”
Today Regan has about 20 people working with him managing Harbourton Enterprises, a private investment firm, and the Harbourton Foundation, founded in 1985 by him and his wife. His older son Jason, based on the West Coast, is involved in the family investment business. His daughter and younger son, also based on the West Coast, work part-time for the philanthropic foundation.
Regan, who donated enough money to the Hillary Clinton campaign to be invited to lunch with her, and his wife are both oriented toward progressive causes. As the mission statement for the Harbourton Foundation says, “it was established with the intention to help individuals and communities in need. We fund organizations that promote healthy individuals, healthy communities, and a healthy planet . . . The foundation’s areas of interest are human rights, health, and the environment.”
Amy Regan is also a director of the Woods Hole Research Center (not to be confused with the oceanographic institute), which is one of the leading climate change think tanks.
Among their other beneficiaries are the Nichols School in Buffalo, Regan’s alma mater, which received a seven-figure donation to offer scholarships to students in need; and Operation Smile to create the Regan Resident Leadership Program for plastic surgery residents to attend an Operation Smile medical mission to perfect their surgical skills while also working with a global patient population. This program is named in honor of Regan’s father, known for his excellence in cleft lip and cleft palate reconstructive surgery.
Regan discovered another worthy non-profit shortly after his racketeering conviction was overturned. He was at a memorial service for a friend, and one of the speakers was Jim McCloskey, the founder of Centurion Ministries, the Princeton-based organization that works to free wrongly convicted prisoners. “He was unbelievable,” says Regan.
Regan ended up on the organization’s board of trustees, serving for many years as president. To say that he is sympathetic to the cause is an understatement. Says Regan: “There but for the grace of God go I.”