Platinum Partners: How a Wall Street darling over-valued assets on its signature USD 1 Billion Fund
- AVN
- Jul 3, 2019
- 4 min read
Updated: Aug 19, 2019
For the majority of its 13-year life span, Platinum Partners was well-known on Wall Street for its average annual returns of over 17% per annum across 13 years. It came as a surprise to many when US authorities charged Platinum Partners founding partner Mark Nordlicht with allegations of fraud.
According to prosecutors, Platinum Partners overvalued private equity assets held by their signature Platinum Partners Value Arbitrage Fund LP (PPVA), allowing them to post excellent returns even as their investments tanked. For reference, this is a diagram from Reuters illustrating the percentage increase comparative to several indexes from 2003 to 2015.
Deriving illegal proceeds from Black Elk
One of the key allegations surrounding Platinum Partners involved its share in Black Elk, a huge illiquid investment in an oil company accounting for 24% of PPVA assets in 2012.
In November 2012, a Black Elk Oil rig exploded, killing three workers and spilling oil into the Gulf of Mexico. The legal fallout and following implosion of oil prices in 2014 would subsequently force Black Elk into bankruptcy proceedings by August 2015.
In 2014, Renaissance Offshore, a Houston-based production company, purchased Black Elk Oil fields for USD 170 Million. PPVA allegedly secretly orchestrated a bondholder’s vote to approve an indenture agreement to convert their bonds to preferred shares. Black Elk then issued a Form 8-K authorizing the repurchase of those preferred shares. Prosecutors say that this was done through affiliated entities who held a total of USD 93 Million in Black Elk Bonds, generating hefty USD 95 Million in proceeds and defrauding other bondholders of USD 50 Million. Platinum Partners maintained that it only held a USD 18.3 Million stake and was not allowed to vote in the process.
Over-valuation of Golden Gate Oil
Another company which heavily featured in the allegations against Platinum Partners’ consistent returns via high valuations is Golden Gate Oil Investments, an oil driller in which Platinum Partners had played a key role in setting up. By the tail-end of 2013, Golden Gate Oil’s valuation had doubled to USD 173 Million from USD 78 Million just a year before.
The high valuation of Golden Gate was backed by an independent valuation expert, who produced quarterly reports overstating oil production, due to inaccurate data supplied by Platinum Partners.
On the ground, Golden Gate Oil ran into massive cost overruns when it began oil extraction on a series of 7 wells, which produced mostly water instead of oil. This came at the cost of USD 18 Million on loan from PPVA, resulting in many of the wells being shut-in due to cost overruns. As a result, it lost over USD 6 Million across 2013.
More tellingly, PPVA granted a purchase option to purchase one of Golden Gate’s key oil fields for USD 6.2 Million, a mere one-tenth of the amount publicized by Golden Gate. In November 2013, the Black Elk reported in a filing that it had received an option to purchase the entirety of Golden gate for USD 60 Million, a drastic change from the USD 173 Million Valuation at the end of 2013. On hindsight, the warning signs were abundant, as Platinum Partners did not grant bonuses to the portfolio managers overseeing Golden Gate, despite its purported valuation.
Amongst growing skepticism, investors started raising questions. In response, Platinum Partners’ investor relations produced a report stating Q1 revenues of USD 4.6 Million, despite internal indications placing the actual value at USD 229,000, a mere 5%. In that very same report, the probable reserve level was at 16 Million barrels, as compared to the 6 Million barrels of probable reserves estimated by an independent engineering firm.
Change of Auditors
Platinum Partners’ external auditor, BDO LLP reported in early 2015 that “a material weakness exists in the Master Fund's investment valuation process related to its Level 3 investments”. It also issued an opinion that there was a “very material” misstatement which warranted an extensive markdown regarding on of PPVA’s large illiquid positions, which would have resulted in a restatement of its 2013 year-end AUM. Platinum Partners terminated its contract with BDO LLP that year.
Even so, Platinum’s replacement auditor issued a statement that the fund’s valuations for positions representing an estimated USD 800 Million were predicated on opaque inputs, and that investments realized within the short-term could differ materially from this valuation figures.
Warning Signs
On hindsight, we could observe various warning signs:
Suspiciously stable returns
Over the 13 years since inception, Platinum Partners had generated over 17% per annum on average, with only three months where the losses amounted to more than 2%. Such a record should have triggered some warnings, especially in light of several events that might have affected its fund returns. This included:
An investment in a medical accounts receivable Ponzi scheme carried out by International Portfolio Inc (IPI) and Account Receivable Services, LLC (ARS), which took place from 2008 to 2010.
A stake in Banyon Capital, a litigation financing Ponzi scheme which took place from from 2009 to 2011.
Termination of its auditor
While the act of dismissing its auditor may not have been representative of the ongoing issue with the fund, the subsequent opinions issued by its replacement is a collective indicator of an ongoing malaise.
Large Illiquid Positions
A large percentage of PPVA’s AUM was sunk into illiquid positions within the commodities sector, which belied its representations to investors that they were a diversified fund.
Reduced Purchase Options
The numerous purchase options floated to related entities, hinting at a tendency to overvalue its underlying assets.
The benefit of hindsight
Despite these apparent warning signs, there is no doubt that Platinum Partners represents a case where there were deliberate and intricate attempts to mislead investors. This is exemplified by its usage of at least three valuation agents to back up its internal valuations - Alvarez & Marsal Valuation Services LLC, Sterling Valuation Group Inc. and DeGolyer & MacNaughton. These agents conducted valuations based on false data provided by Platinum but were never commissioned to conduct on-site checks which would have revealed the dire state the underlying assets were in.
To unsuspecting investors, PPVA was a rockstar with over 10 years of stable returns involving a diversified strategy. Without native industry experience and a concerted effort to closely monitor and question third parties, it can be next to impossible to uncover the true extent of fraud perpetrated in today’s increasingly complex hedge fund landscape.
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