Diamondback Capital Management LLC, among the hedge funds raided by the FBI two years ago in the U.S. investigation of insider trading on Wall Street, is liquidating after an exodus of clients.

The fund received requests from investors to withdraw about $520 million, or 26 percent of its assets, for the end of the year, co-founders Richard Schimel and Lawrence Sapanski said today in a client letter. The Stamford, Connecticut-based firm, which has 133 employees, plans to return most of clients’ cash next month.

The redemptions left Diamondback with $1.5 billion assets, down from from $5.8 billion in November 2010, when its offices were searched by the Federal Bureau of Investigation. Three other hedge funds that were also raided at the time, including Level Global Investors LP, have shuttered. Former Diamondback portfolio manager Todd Newman is on trial in Manhattan on charges that he was part of a “criminal club” of friends and co-workers who made trades based on illegal tips.

“It’s difficult for anyone to survive once they’re connected with the insider-trading probe,” said Ronen Schwartzman, founder of Ten Capital Advisors LLC, a New York- based firm that advises clients on investing in hedge funds.

Steve Bruce, a spokesman for Diamondback, declined to comment beyond the letter.

SEC Settlement

Diamondback, which has 22 investment teams, agreed earlier this year to pay more than $9 million to resolve a Securities and Exchange Commission lawsuit over trades made in 2008 and 2009 by Newman and Jesse Tortora, a former analyst who worked with Newman. Tortora has pleaded guilty to securities fraud and is cooperating with the government.

The office of Manhattan U.S. Attorney Preet Bharara agreed not to prosecute Diamondback for the actions of the Newman and Tortora and said the co-founders weren’t aware of their misconduct.

A third Diamondback employee, portfolio manager Anthony Scolaro, pleaded guilty to conspiracy and securities fraud in November 2010. His cooperation with the government’s insider- trading probe led to the raid on Diamondback.

“We especially appreciate your patience and support during the last two difficult years during which we reached closure of the government’s investigation,” Schimel and Sapanski said in the letter, a copy of which was obtained by Bloomberg.

Largest Holdings

Diamondback returned about 6 percent this year through yesterday and an annualized 9.1 percent since its June 2005 inception, according to a person with knowledge of the returns who asked not to be named because the information is private.

Hedge funds gained an average 1.8 percent this year through November, according to data compiled by Bloomberg. The Standard & Poor’s 500 Index returned 15 percent in the period.

Diamondback held about 2 percent of US Airways Group and Take-Two Interactive Software Inc. as of Sept. 30, according to regulatory filings. Its largest U.S. stock holdings were Yahoo! Inc., Capital One Financial Corp. and American International Group Inc.

The hedge fund has already started selling its investments, according to the letter.

Schimel and Sapanski started Diamondback with Chad Loweth, who left the fund in 2010. They all previously worked at billionaire Steven A. Cohen’s hedge fund, SAC Capital Advisors LP. Schimel is married to Cohen sister.

Cohen’s SAC

Cohen was last month linked for the first time to transactions at the center of an insider trading case when prosecutors said he sold shares in two drug companies based on the advice of Mathew Martoma. Martoma, a former portfolio manager at a unit of SAC, was arrested Nov. 20 in what court documents described as the “most lucrative” insider-trading case ever uncovered.

Cohen hasn’t been accused of wrongdoing. His spokesman, Jonathan Gasthalter, said last month that Cohen and SAC are confident they acted appropriately and will continue to cooperate with the government’s inquiry. Charles Stillman, a lawyer for Martoma, said last month he expects his client to be fully exonerated.

The U.S. Securities and Exchange Commission told SAC, which manages $14 billion, that it is considering pursuing civil fraud claims against the fund related to the alleged insider trading, three people with knowledge of the matter said last week.

Lyxor Pulls

Following the news last month, Citigroup Inc.’s private bank is advising clients not to add money to SAC, two people with knowledge of the matter said yesterday. Societe Generale SA’s Lyxor Asset Management unit has asked to withdraw its clients’ funds from SAC, a person with knowledge of the situation said this week. Lyxor’s investments in the hedge fund are very limited, the person said.

Blackstone Group LP is monitoring how the government proceeds with respect to SAC and will make a decision accordingly, J. Tomilson Hill, who oversees the New York-based firm’s $46.2 billion hedge fund investments, told Bloomberg Television yesterday.

Level Global, founded by former SAC employees David Ganek and Anthony Chiasson in New York, shuttered in February last year. Chiasson is on trial with Newman. Barai Capital Management LP, which was run by Samir Barai in New York, also closed last year, while Loch Capital Management LLC told clients at the end of 2010 that it was liquidating.