Hedge Fund Fraud Case Study — Platinum

Photo: Business Insider

Abstract:

Platinum is a valuable precious metal, but it’s actually difficult to distinguish it from other materials, such as white gold and silver, by simply looking at them. However, platinum is harder to dent, not as soft as gold or silver, and weighs more than each of them. There is no bargain for platinum, either. With common sense and little knowledge, you can avoid buying fool’s platinum.

Platinum Partners is a New York-based hedge fund manager with more than a billion dollar assets under management — only a few people have heard of them and even fewer people enjoyed their stellar returns. Over the last 13 years of operations, its flagship Platinum Value Arbitrage fund generated 17% annualized return without having any negative year. However, Platinum Partners’ track record was nothing but fool’s platinum.

Case Profile:

Background

For years, a little-known New York hedge fund called Platinum Partners stood out for its stellar double-digit investment returns. Platinum Partners Value Arbitrage Fund, Platinum Partners’ flagship fund, generated 650%, or 17% p.a., over the 13 years since inception with only three months of greater than 2% loss. In sum, there was something uncomfortably consistent about their performance. It turned out that those returns were nothing but ‘fool’s platinum’.

Platinum Partners Value Arbitrage Fund

Source: The Corporate Prof

Mark Nordlicht (CIO) and Murray Huberfeld (President) co-founded Platinum Partners in 2001 and launched their flagship fund, Platinum Partners Value Arbitrage Fund (“PPVA”), in 2003. Their impeccable performance attracted money from investors and their assets under management stood $1.7 billion as of 2015, according to Platinum Partners’ last SEC filing. PPVA claimed a multistrategy investment approach which sought to generate consistent returns through several uncorrelated sub-strategies. According to the interview with Uri Landesmann in 2011, PPVA invested across seven strategies: Long Short Fundamental, Quantitative, Opportunistic/Macro, Energy Related Arbitrage, Asia Based Arbitrage, Event Driven and Asset Based Finance (Energy, General and Mining). In particular, the PPVA fund changed allocations among strategies dynamically over time based on the opportunity sets created by inefficiencies. The largest targeted allocation of the portfolio was Asset Based Finance, which represented 43% of PPVA’s net asset value.

Source: Risk.net

Nordlicht, 48, is a second-generation commodities-options trader. He started his career as a trader in the pits of the New York Cotton Exchange. In 1991, he founded Northern Lights Trading, a proprietary options firm based in New York. From 1997 to 2001, partially overlapping his time at Northern Lights, he was a founder and the managing partner of West End Capital, a New York-based money management firm that specialized in privately negotiated structured debt financing for small and mid-cap publicly traded companies. He also served as the Chairman and Director of Optionable Inc. from 2000 to 2007. Nordlicht earned a B.A. in Philosophy from Yeshiva University.

Huberfeld, the 55-year old son of a kosher restaurant owner in Brooklyn, traded penny stocks, and had a long history of legal troubles since 1992 according to court filings. Huberfeld took more of a back-seat role in the fund — connecting friends and community acquaintances, but was not the public face of the company.

In 2003, Huberfeld, David Bodner and their other friends helped Nordlicht to start Platinum Partners with $25 mm. Two years later, Huberfeld also started his own hedge fund called Centurion, whose name was later changed to Platinum Partners Credit Opportunities Master Fund.

Platinum Partners’ success made Nordlicht himself rich. According to the Form ADV filing with SEC, 23% of Platinum Partners’ total gross asset value, or $382 mm, belonged to the firm’s principals, majority of which was Nordlicht’s. Additionally, the most recent Department of Justice complaint against Platinum alleged that Platinum’s management had reaped over “$100 mm in fees alone” between 2011 to 2016 — the period in which the bulk of Platinum’s legal troubles stem from.

Source: SEC Form ADV

Problems

In June 2016, Huberfeld was arrested on charges of conspiracy and wire fraud. Prosecutors alleged he had bribed Norman Seabrook, the portfolio manager for a pension fund of a New York City correction officers’ union, with $60,000 — delivered “in a Salvatore Ferragamo bag” — in exchange for a $20 million investment in Platinum Partners’ hedge fund. Both Huberfeld and Seabrook pleaded not guilty to the scam, but in December, federal agents arrested Nordlicht and six others on counts related to a $1 billion “ponzi-like” scheme that started with over-inflating private assets, covering losses and eventually, covering redemptions with new inflows.

In particular, Platinum relied on capital from a network of wealthy Orthodox Jewish investors — including the Gindi family, owners of the Century 21 department-store chain, and real estate moguls Ruby Schron and Abraham Fruchthandler. As such, the collapse of Platinum Partners was a shock to the wealthy Jewish community in New York and Florida, which has not completely recovered from the damages stemming from the Madoff scandal less than a decade ago.

The problems of Platinum Partners emerged as early as 2012. On November 6th of that year in an email entitled “Current Redemptions Nov 5, 2012” regarding a $27 mm redemption, Nordlicht had stated that “If we don’t exceed this in subs from dec 1 and jan 1 we are probably going to have to put black elk in side pocket. i also need to pay back [loan from an individual] and an additional 4 million oct 31 and nov 30 so we are talking 40”. Replying, President of Platinum Uri Landesman said “we could sweep the table here, so far, think jan 1st is a possible for some, if not all”. In response, Nordlicht writes “it’s just very daunting. It seems like we make some progress and then reds are relentless almost. It’s tough to get ahead in subs if u have to replace 150–200 a year”. Landesman ended the email chain expressing “Didn’t take it as complaining, it is my job. Redemptions very daunting”.

Later on April 29,2014, Nordlicht sent an email to CFO Joseph SanFilippo stating: “Start paying down reds [redemptions] as u can. Between Blake and ppbe (additional 10million), should have decent short term infusion. Hopefully some may 1 subs [subscriptions] show up as well. Have a few more outflows to discuss but this is obviously the priority.” Things seemed to reach a crisis point in June 2014 when Nordlicht wrote “It can’t go on like this or practically we will need to wind down….this is code red,” Yet investors remained in the dark about the firm’s precarious liquidity position — even as the firm claimed quarterly liquidity with 90% of capital being able to be returned “in the first 30 days”. A month later, when an investor emailed to ask about the reliability of Platinum’s reported performance figures, Landesman wrote back, “The numbers are all kosher, they have had verbal input every month.”

A June 3, 2014 email from a Platinum employee to Nordlicht and others entitled “Cash Sheet” listed cash on hand of $96,000; “Pending Inflows” totaling $20,000,000; “Pending Outflows” totaling $16.75 mm and Redemptions of $500,000 for May and $9.5 mm for June, which thus resulted in a “Projected Cash” of negative $6.14 mm. Nordlicht forwarded this message to another staff member asking him to: “Take June reds off the list,” inferring that Platinum was unable to meet its June redemptions of $9.5 mm.

Platinum Partners’ hunt for cash eventually led to Norman Seabrook. Seabrook was a Portfolio Manager for the pension fund of the Correction Officers’ Benevolent Association (“COBA”), the largest NYC corrections officers’ union. Seabrook was noted in filings to be “frustrated with working hard to invest the pension money and receiving no reward”. In late December 2013, Platinum Partners formerly arranged for a meeting between New York’s Correction Officers’ Benevolent Association (COBA) and Platinum Partners. By January 2014, Seabrook was able to convince his Annuity Fund Board to invest in Platinum Partners. The first investment was made in March 2014 when COBA made an initial $10 mm subscription. In June another $5 mm was added. In return, Seabrook ended up taking $60,000 in payment. A further $10,000 was donated to charity Seabrook was involved and was honored at.

Platinum Partners was involved with several suspicious transactions, which probably caused significant losses over the history of the firm. However, the biggest problem was the mismatch of liquidity and the lack of oversight for independent valuation of assets. While Platinum Partners promised investors that they could redeem their investments every month with 60 or 90 days’ notice and receive payment of 90% of their redemption request within 30 days thereafter, they started investing a significant amount of assets in illiquid investments — namely Asset Based Finance. As discussed previously, almost 43% of the PPVA’s portfolio was invested in this illiquid investment opportunities. The most notable illiquid investments were (1) Golden Gate Oil LLC, valued at around $170 mm, or 19% of PPVA’s total assets at the end of 2013, and (2) Black Elk Energy Offshore Operations LLC, representing 24% of PPVA’s total assets at the end of 2012. These two assets represented at least 20–30% of the portfolio between 2012 and 2014. At the end of 2014, almost 80% of fund assets at the end of 2014 was classified as “Level 3” assets. In late November 2015, Platinum Partners placed a majority of PPVA’s assets, all highly illiquid, in a “side pocket”, from which no redemptions were possible for three years.

PPVA’s Estimated Exposures to Golden Gate and Black Elk

Source: SEC v. Platinum Management (NY) LLC, et al

In addition to these two investments, Platinum Partners most likely experienced significant losses from exotic investments in so-called life insurance settlements, medical receivable financing and litigation financing. This is not completely confirmed as there is no overwhelmingly clear evidence in the public domain

  • Life insurance settlement: BDL Group, subsidiary of Platinum Partners was accused by SEC in 2014 for collecting personal information of terminally ill patients to benefit from investing in variable annuities. BDL raised approximately $56 mm for the scheme. It is not clear whether Platinum Partners lost money from this investment.

Platinum Partners increased its valuation of Golden Gate sharply while in actuality, the company’s performance was falling far below initial projections, with deeply disappointing oil production figures and heavy operating losses. On a process level, the company’s first development stage involved the drilling of seven wells, but such efforts bore heavy cost overruns and led the firm to consume the $18 million borrowed from Platinum Partners by the end of 2013. Golden Gate also faced heavy delays in obtaining needed permits — worsening problems further. Moreover, of the wells that were producing, such produced mostly water and many were shut down. The only consistently-producing well provided revenue representing less than 10% of initial projections. Resultantly, far from producing projected millions, Golden Gate netted $6 million losses in 2013.

Platinum Partners even tried to have Black Elk to purchase their stake in Golden Gate, but this potential transaction created a problem as Black Elk’s engineers who appraised Golden Gate’s oil reserves said preliminary estimates of Golden Gate’s reserve was merely 10% of Platinum’s prior valuation. In Sep 2014, Platinum Partners paid $3.2 million for the remaining 52% stake in the company and valued the entire stake in the company at $140 million. This transaction instantly generated $134 million paper profit, or a 16% return (in 2014, PPVA was up 10%).

Valuation of Golden Gate

Source: SEC v. Platinum Management (NY) LLC, et al

The relationship between Platinum Partners and Black Elk was even murkier and complicated, but Platinum Partners essentially controlled Black Elk and used it to manage its liquidity and inflated asset values. While holding substantial amount in Black Elk-related assets, Platinum Partners unlawfully extracted nearly $100 million out of Black Elk after Back Elk sold some of its core assets.

So murky was the relationship that a separate law-suit, a civil one, is also underway between third-party Black Elk bondholders and Platinum Partners. In this, creditors accuse Platinum Partners of using a “Trojan Horse” associated entity to bypass fair treatment of bondholder rules (that excuses Platinum from voting as a bondholder) to save Platinum’s preferred shares positioning and subordinate more senior, secured debt.

***

Formed in November 2007 as a limited liability company, Black Elk was an oil and gas company headquartered in Houston with all its producing assets located offshore in US federal, Louisiana and Texas state waters in the Gulf of Mexico. John Hoffman was Black Elk’s founder and CEO.

In 2009, Platinum invested in Black Elk across the capital structure through Series E Preferred shares, vote holding equity rights, and secured notes.

That investment initially seemed successful. In 2011, the Wall Street Journal reported that, helped in part by the ban on drilling in the Gulf of Mexico after the BP Macondo explosion and oil spill, Platinum’s Black Elk investment “was Platinum’s most successful last year, having contributed a significant portion of its high-teens return.”

From 2008 to 2011, Black Elk employed a buy-and-build strategy to develop its business.

To finance this, Black Elk issued $150 mm of senior secured notes on November 23, 2010. Simultaneously, the company entered into a Security Agreement in favor of The Bank of New York Mellon Trust Company, N.A. (“BNY”) as Trustee and Collateral Agent for the 13.75% Coupon Senior Secured Notes. Pursuant to such an agreement, the Senior Secured Noteholders were granted a first priority lien on substantially all of Black Elk’s assets.

At its peak of operations, Black Elk had approximately 457,065 gross (223,852 net) acres under lease in the Gulf of Mexico, 935 gross (444 net) wells and 58 production platforms.

PPVA was Black Elk’s principal lender and considered its position as one of its most profitable. At the end of 2012, Black Elk represented 24% of PPVA’s total assets. However, On November 16, 2012, though, an explosion occurred on an offshore Black Elk platform — killing three workers. The explosion caused huge legal headaches, which eventually led to spiraling legal costs, and suspensions of operations.

Black Elk was effectively insolvent by early 2014 — some trade creditors were paid, if at all, more than a year past their due dates.

Also by early 2014, Nordlicht and his associates dominated Black Elk’s management as its majority largest investor. The firm controlled its credit facility, controlling the majority of the Senior Secured Notes and also junior Series E preferred equity, and appointing and controlling the Black Elk Board and CFO. In early 2014, Platinum confronted the prospect of losing more than $100 mm if the company could not meet its debt schedule. In response, Platinum Partners looked towards selling of Black Elk’s assets and returning to the proceeds to itself, and not its senior noteholders.

This came about through the sale of Black Elk’s prime assets to Renaissance Offshore, LLC. Proceeds from that sale was to Platinum by redeeming its junior Series E preferred equity instead of the Senior Secured Notes, including those held by Platinum, which were in fact entitled to first call on those proceeds.

Thus, as Black Elk negotiated the sale of its prime assets to Renaissance, Platinum devised a method to seek noteholder approval to waive their rights to the sale through an amendment to the indenture. Understanding that it would be difficult to persuade truly unaffiliated and disinterested Secured Senior Note Holders to renounce their rights and that Platinum itself as an equity holder of Black Elk could not use its noteholder votes, Platinum had to find a way to rig the vote.

Taking into account Platinum’s ownership of most of the $150 mm in notes, $37 mm of said notes comprised a majority needed to waive the rights of the indenture.

As Platinum controlled Black Elk, this statement meant that the sum of all Notes held by Platinum, Platinum-affiliated entities and entities controlled by Platinum were to be subtracted from the $150 million Notes entitled to vote. Of the remainder, a majority had to consent.

Since it was blatantly obvious that truly unaffiliated and disinterested Senior Secured Note Holders would consent to writing-off their secured notes, Platinum this created a Trojan horse “friendly” consenter: secure the votes of a company or companies holding a substantial number of Notes that looked independent, but were in fact controlled by Platinum.

The ‘Trojan Horse’ was a group of Beechwood entities named in filings as B Asset Manager Fund and B Asset Manager Fund II. In addition to 68.9% ownership, Platinum assigned a number of Platinum employees to Beechwood, and installled a Platinum executive, David Levy, as the Chief Investment Officer of B Asset Manager. Levy still continued to use his Platinum Partners email address while “CIO” of Beachwood. Levy soon thereafter directed the Beechwood entities in early 2014 to purchase $37 mm of the Black Elk Senior Secured Notes. The Beachwood entities thus then voted to consent their Notes in favor of the Platinum proposal.

Only a few weeks after Beechwood’s vote, Levy left his position at Beechwood, and returned full time to Platinum. This manipulation of the Indenture vote secured $98 mm of the proceeds of the Renaissance sale to Platinum Partners.

Platinum’s approach was not entirely opaque. Black Elk Chief Executive Officer John Hoffman emailed Black Elk’s General Counsel and one of its retained counsel on June 26, 2014 that described his take on what was unfolding:

I apologize for this note out of the blue but I need your guidance. Platinum (PPVA) is planning to create many new companies and place the acquisitions [including Northstar] that Black Elk recently technically worked up, bid and won into those new entities. Many if not all of existing equity holders would be left in the cold with no equity in the new companies. Further, they plan to isolate Black Elk, pay themselves back ([Series E] preferred equity) ahead of so called friendly bond holders [the Beechwood entities] and lay off most people. I believe that the ultimate plan is to bankrupt the company.

John Hoffman and the General Counsel eventually jumped ship from the company in August 2014.

Hoffman was also right about Black Elk’s eventual plan. In August 2015, Black Elks creditors had placed the company into involuntary Chapter 7 bankruptcy. The company had 20 days to respond, and it was successful in its motion to convert the case to a voluntary Chapter 11 case, according to court documents.

Later on in the year, the offshore energy driller filed for Chapter 11 bankruptcy.

At about the same time as creditors filed to put Black Elk in bankruptcy, federal prosecutors filed criminal charges against Black Elk related to a 2012 rig explosion in the Gulf of Mexico. The charges stemmed from an investigation conducted by the Bureau of Safety and Environmental Enforcement which ended with 41 citations relating to the fatal explosion. A year after the explosion, Black Elk had spent $12.4 mm trying to clear up the remains and deal with the blast’s legal aftermath.

The Black Elk senior debt in question in the Schmidt vs. Platinum October 2016 case. Source: Bloomberg

But the $98 mm transfer was not enough. Indeed, taking into account Platinum’s own bondholding position in Black Elk totaling $111 mm at face value, with $74 mm held by Platinum, and another $37 mm held through the Beachwood Entities — it is clear that even Platinum lost out from its own transfers. While perhaps the scheme with Black Elk helped shoulder losses and pass them disproportionately to bondholders, Platinum nonetheless suffered a great deal.

***

Platinum Partners’ external auditor, BDO, in early 2015 reported to it that “a material weakness exists in the Master Fund’s investment valuation process related to its Level 3 investments.” But, Platinum Partners did not disclose to its investors this important information. The auditor also identified a “very material” misstatement that required a large markdown of the valuation of one large, illiquid position, triggering a restatement of the fund’s year-end 2013 AUM. Platinum Partners, however, terminated that auditor. Still, the replacement auditor, CohnReznick, included in its 2014 opinion, which it did not issue until September 2015, an “emphasis-of-matter” stating that management’s estimated values for investment representing over $800 million rested on unobservable inputs, and that the amounts that might be realized in the near-term could differ materially from management’s valuations.

Platinum Partners used at least three valuation agents: Alvarez & Marsal Valuation Services, LLC, Sterling Valuation Group Inc. and DeGolyer and MacNaughton. There valuation agents were chosen by Platinum Partners and provided their valuation assessments based on the data provided by Platinum Partners. For example, they did not conduct onsite checks on the assets held by Golden Gate and Black Elk as they were not commissioned to do so.

SS&C Technologies, Inc. was a fund administrator for all three funds managed by Platinum Partners. For a portfolio of highly illiquid investments, a fund administrator’s ability to evaluate the value of the portfolio is limited since they rely on the inputs from the auditor and valuation agents.

It is difficult to conclude whether Platinum Partners started as an outright fraud from the very beginning, however, they could not keep up with their promises to investors and covered up problems with lies after lies. The scheme’s collapse was triggered by the bribery case, but Platinum Partners would eventually run out of cash.

Recommendation

Do Not Believe in the Unusually Stable Returns

It is almost impossible to run a hedge fund for over a decade without having a substantial draw-down. All investors should know this simple fact and avoid investing in any investment scheme showing a straight line. Platinum Partners’ investment scheme was also heavily involved with the energy-related investments and the falling oil price should have had material impact on the underlying investments even though they were structured as a secured lending. Instead, the fund only had superficial down periods lasting no more than two months. Indeed, out of 155 months of operation, only three months endured a loss of more than 2%,

Source: The Corporate Prof., Bloomberg

Be aware of risks involved with hard-to-value assets

Secured lending and private equity investments can deliver “stable” returns if operated properly, but the return stream is stable only on the surface. The lack of a market price makes it very difficult for an auditor and an administrator to assess valuation of a portfolio. Investors are exposed to this unobservable risk.

Be extra careful when auditors change

According to the interview with Uri Landesman, President of Platinum Partners, in 2011 on Risk.net, BDO Tortuga was listed as the auditor of Platinum Partners Value Arbitrage Fund. However, the latest SEC Form ADV filing of Platinum in 2015 shows the change of auditor to CohnReznic LLC. The Dec 2016 claim filed by SEC indicated that the previous auditor was fired after the disagreement with Platinum Partners’ management. All investors should be warned of the change.

Speak to an auditor

Investors should have taken a step to speak with both previous and existing auditors. Due to the confidentiality requirement, the ability of auditor to speak about their clients (i.e. Platinum Partners) was probably limited. However, the previous auditor might have been able to tell you why they decided to resign or were fired.

Speak to valuation agents

Platinum Partners relied on the valuation reports from the third party valuation agents for valuing the portfolio. The names of the valuation agents were disclosed to investors and investors should have contacted valuation agents to understand the scope of their responsibilities. If asked properly, the valuations agents could have told investors that they were not required to conduct onsite visits to evaluate the assets. Investors could also request a copy of the valuation reports.

Carefully analyze portfolio’s concentration

Regarding Golden Gate and Black Elk investments, there were many publicly filed documents (especially for Black Elk). Platinum Partners was seemingly open to tell the funds’ exposures to these investments although they kept the valuation of these businesses very high. Despite the detailed financial information, investors should have known that the portfolio carried a significant concentration risk on two energy companies while the energy price was falling precipitously. Investors should have asked themselves whether this is the risk they want to face. They should have also assessed whether Platinum Partners’ steady returns make sense given the exposure.

Conduct a background checks on all key personnel

Murray Huberfeld’s identify was carefully concealed from the public filing although he appeared frequently to meet with investors and presented himself as an owner of Platinum Partners. The firm’s SEC Form ADV has no trace of Murray Huberfeld and he was not even listed as an owner of the business. It was probably because of Huberfeld murky background as a penny stock broker in mid-90s. in 1996, FINRA fined him together with Broad Capital Associates, Inc (their relationship is unknown) $426,790 and he agreed to pay without admitting the FINRA’s finding. This is a considerably large sum for a seemingly minor violation, indicating Huberfeld might have been involved with other problems. This information is readily available on FINRA’s BrokerCheck website.

Source: FINRA BrokerCheck

Carefully analyze past legal issues

Nordlicht was non-executive chairman of Optionable, Inc, which Platinum Partners had control and used to benefit from natural gas trading. In 2007, Bank of Montreal discovered that a natural gas trader had been covering up huge bets, many of them with the hedge fund. The bank was forced to liquidate the trades, resulting in big gains for Platinum, among others, according to Vince Lanci, who handled some of the bets as an independent trader and managed money for the fund. Bank of Montreal sued Optionable, saying the company helped devise the trades. Nordlicht denied knowing anything about the fraud, and the case was settled out of court. The FBI investigated, arrested the rogue trader and charged the chief executive officer of Optionable with aiding the scheme. Both men pleaded guilty. Nordlicht wasn’t accused of wrongdoing by the government. When the Optionable CEO was released from prison in 2014, he went to work for a company controlled by Platinum. Although the trades with Bank of Montreal helped Platinum record a 53 percent gain in 2007, the way Optionable and Platinum Partners profited from the trade needs to be carefully assessed.

Timeline

Source: various news articles

Source:

Court Documents

United States of America v. Norman Seabrook and Murray Huberfeld, June 2016

Richard Schmidt, Litigation Trustee v. PPVA, PPCO, PPLO, and PPVA Black Elk, Oct 2016

SEC v. Platinum Management (NY) LLC, et al, Dec 2016

News Articles (chronological order)

“Platinum Partners Value Arbitrage Fund: Platinum Partners. Platinum proves its value in turbulent markets”, risk.net, February 1, 2011

“Fraud Probe Ricochets Through Platinum Partners, a Hedge Fund With Ties to Jewish Community”, Wall Street Journal, July 25, 2016

“No Blow Up is Big Enough to Tarnish Platinum Partners’ Returns”, Bloomberg, October 21, 2015

“Appointment of Cayman liquidator adds pressure on Platinum Partners”, Reuters, August 24, 2016

“Seven Hedge-Fund Execs Arrested in Madoff-Like “Ponzi Scheme”, Vanity Fair, December 19, 2016

“Authorities Allege $1 Billion Fraud at Platinum Partners”, Wall Street Journal, December 19, 2016

“U.S. charges Platinum Partners execs with $1 billion fraud,” Reuters, December 19, 2016

“Platinum Partners: hedge fund execs charged with $1B in fraud case”, The Corporate Prof., December 22, 2016

“Platinum Partners arrests are scant consolation for alleged victims”, Reuters, December 24, 2016

“Platinum Partners arrests are scant consolation for alleged victims”, Reuters, December 27, 2016

“Ex-CEO of Platinum-linked energy company convicted of tax evasion”, Reuters, January 4, 2017

“No One Connected Dots as Platinum Reported Madoff-Like Returns”, Bloomberg, January 5, 2017

Shinya Deguchi @ Star Magnolia Capital

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