| Platinum Partners president Uri Landesman |
It’s a lawsuit wrapped in a lawsuit, a twist on a strategy that has become fairly widespread among hedge funds. The world is so rife with litigation that many hedge funds have made money buying legal claims or funding legal proceedings in return for collecting the settlement money or a portion of it. At the bottom of the claims are corporations or ordinary citizens hoping to collect on some kind of loss. Maybe they had a dispute with a supplier, or trusted their assets to Bernie Madoff, or have reason to believe an employer wronged them. The claimant gets financial compensation without having to wait for the case to go through court. When the judge finally reaches a verdict, it’s the hedge fund manager who collects the recovery money.
D.E. Shaw and Fortress are among the large funds that have invested in legal receivables, according to people familiar with the strategy. There are are also a number of funds that specialize in this asset clas, including Giltspur Capita, Harbour Litigation Funding, Juridica Investments, Calunius Fund and Burford Capital.
But last week a court awarded New York-based hedge fund firm Platinum Partners $70 million in losses in its own lawsuit against TD Bank and the trustee for a collection of legal receivables on sexual harassment suits. The receivable claims turned out to be non-existent; the deal was a Ponzi scheme in its own right. The experience has been a cautionary tale in due diligence for all hedge funds getting into the legal receivables game.
“You won’t see us funding legal receivables again any time soon,” says Uri Landesman, president of $1.25 billion Platinum Partners. Since the firm’s inception in 2003, Platinum has made its money in investments that often fall into the category of eclectic, with somewhat over half of the firm’s assets going into direct lending. As noted in a previous Alpha profile, the firm has lent money to explore distressed oil and gas wells and invested in small businesses including one with a plan to open convenience stores in Chinese post offices. Such deals have served the firm well; the flagship Value Arbitrage Fund has never had a negative year. The fund was up 4.89 percent year-to-date through April and 12.13 percent for 2012, according to Hedge Fund Intelligence.
In 2008 Platinum became one of three hedge fund firms (the others were Centurion Credit and Level 3 Capital) to put money into legal receivables that sprang from the Florida law firm Rothstein Rosenfeldt Adler, which is now defunct. The firm’s chairman and CEO, Scott Rothstein, turned out to be selling non-existent claims that financed a lavish lifestyle, at least for a while. He was able to bilk just over $1 billion in total from hedge funds and other sophisticated investors before he turned himself in to authorities on December 1, 2009. Platinum invested a total of $440 million in the deal but was able to recover all of that except the $70 million it will get back through the court settlement.
Landesman did not join Platinum until 2010, just in time to pick up the pieces. Like most investors in the Rothstein scheme, Platinum went through a middleman, George Levin, who ran a Florida firm called Banyan Investments and issued a guaranty on his and his wife’s personal assets. According to accounts of the case, by mid-2009 Rothstein was falling behind in scheduled payments to Banyan, and Levin reported Rothstein to the U.S. Attorney’s office for suspicious activity. Levin himself has declared bankruptcy.
In retrospect, perhaps Rothstein’s two Bugattis, each worth $1.6 million, and his propensity for entertaining at a strip club he owned — details chronicled in a book that came out earlier this year, “The Ultimate Ponzi: The Scott Rothstein Story” by Chuck Malkus — should have raised red flags to participating parties. More to the point, however, Landesman says an investor in legal receivables should demand to see detailed proof of the volume of receivables.
And that is where the greatest problem lies. Even in a perfectly above-board situation it is difficult to perform due diligence on bundled claims, says Jeremy Walton, a Cayman Islands-based partner in the litigation and insolvency practice at the international law firm Appleby and head of the firm’s fund disputes team. Walton, who frequently advises hedge funds on litigation, insolvency and restructuring deals, was not involved with the Rothstein case and didn’t see the marketing materials, but he says than in general bundled legal claims can be as chancy as, to take a not-so-random example, bundled sub-prime mortgages. “Most likely,” he says, “each claim is not worth very much, so bundling them together makes them look more attractive.”
Walton says hedge funds are in a much better position to manage the risks when they invest in individual claims of higher value. Each claim will still require extensive due diligence that can go on for months. The investor has to assess the legal merits of the claim, the costs of bringing the claim to fruition, the likelihood of a recovery, and the resources of your own legal team to monetize the claim.
In the case of bundled claims is it next to impossible for a hedge fund to perform this kind of analysis, at least in a timely and cost-effective way. “You’re reliant on the seller to tell you how much of the package is recoverable, and you have no way to verify it,” says Walton. “So it becomes completely speculative.”
