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

Diamondback’s assets shrank to $1.5 billion 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.

“We especially appreciate your patience and support during the last two difficult years during which we reached closure of the government’s investigation,” they said in the letter, a copy of which was obtained by Bloomberg. Steve Bruce, a spokesman for the firm, declined to comment beyond the letter.

SEC Settlement

Diamondback 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.

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.

Yahoo, AIG

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 Cohen’s brother-in-law.

Level Global, founded by former SAC employees David Ganek and Anthony Chiasson, 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.