Ponzi schemer Scott Rothstein lured supposedly smart money out of New York hedge funds. Why did they continue doing business with him?
Unlike Bernie Madoff or Allen Stanford, who mostly hurt individual investors, the 49-year-old Rothstein sucked in a billion dollars from sophisticated investors—including New York hedge funds that employed the well-known detective firm Kroll and an onsite inspector at Rothstein's Fort Lauderdale law firm, from which he sold discounted legal settlements with annualized returns as high as 437%. Sadly, the settlements didn't exist.
Two years after Rothstein's scam collapsed, the civil plaintiffs are just getting warmed up. The first jury trial to follow the mess awarded $67 million in January to a group of investors who sued TD Bank, claiming that its employees assisted Rothstein's scam. The U.S. unit of Toronto-Dominion Bank will appeal, but remains a deep-pocketed target for Rothstein victims. The Canadian parent recently set aside a litigation reserve of $255 million. On Thursday, it offered $170 million to settle claims with another group of Rothstein victims. The bank declined to comment on any aspect of this story.
The other deep pockets in the Rothstein lawsuits are the New York hedge funds. Sharing offices on the 54th floor of a tower above Carnegie Hall, the funds—Platinum Partners Value Arbitrage Fund, Centurion Structured Growth and Level 3 Capital Fund—advanced about $440 million to Rothstein, starting in early 2008, and got all but $19 million back before the lawyer fled in a private jet to Morocco in October 2009. After returning, Rothstein pled guilty to racketeering, fraud and money laundering.
Sentenced to 50 years and the forfeiture of $1.2 billion, he began cooperating with federal prosecutors and the trustee in his law firm's bankruptcy. In a December 2011 deposition, Rothstein said he had compromised some hedge-fund employees with cash, strip-club outings and escort services. He also claimed that, to get their money out, the hedge funds helped him attract new investors, after they suspected fraud and realized that Rothstein would need fresh money. The bankruptcy trustee is seeking $423 million from the three hedge funds and another $20 million directly from their principals.
The hedge funds say they were unsuspecting victims of Rothstein and didn't recommend him to others after he missed scheduled payments. In court filings and in statements to Barron's, they say they invested in good faith on the strength of due-diligence visits with Rothstein, TD bankers and lawyers—who, they claim, falsely told the funds that Rothstein had the settlement money. "What was unique about Rothstein," said Platinum's boss Mark Nordlicht in an e-mail to Barron's, "was his ability to enlist so many others to assist him in his deceptions."
ROTHSTEIN'S DECEPTIONS consisted of offering investments that were too good to be true. He told investors they could have a piece of confidential settlements that plaintiffs were willing to trade for sharply discounted lump sums. The settlement funds were safely escrowed in trust accounts. Rothstein instead used the cash to enjoy a rock-star lifestyle.
As the nearby chart shows, Rothstein's scheme had netted about $25 million by April 2008 when he started to tap into the New York hedge funds. The first was Centurion, a secured-lending fund that Murray Huberfeld launched in 2005 after a career that can fairly be described as picaresque. With longtime partner David Bodner, he got booted from the brokerage industry following their 1990 arrests for sending imposters to take their broker-license exams. They disgorged $4.6 million in 1998 to settle a fraud case brought by the Securities and Exchange Commission, without admitting guilt. Still, Huberfeld had his fans. By 2008, Centurion had a couple of hundred million under management and a high ranking among fixed-income hedge funds in the Barclay Managed Funds Report. For its part, Platinum Partners Value Arbitrage Fund ranked No. 56 on Barron's annual hedge-fund performance survey for 2010 and No. 16 for 2009. It reported a three-year compound annual return of 14.58% through 2010.
Centurion didn't lend directly to Rothstein but to a feeder fund called Banyon established by a Florida entrepreneur named George Levin. Banyon used Centurion's money to purchase what it thought were settlements from Rothstein. Huberfeld insisted that the settlement funds go into trust accounts at a bank of his choosing, Commerce Bank, which later became part of TD Bank. Platinum and a related fund, Level 3, joined shortly thereafter.
The hedge funds did their due diligence jointly. Although the Kroll investigators didn't notice that Levin's Banyon manager, Frank Preve, had a felony conviction for bank fraud, they did warn that Rothstein didn't seem to have access to hundreds of millions of dollars worth of settlements. (A subsequent Platinum negligence complaint against Kroll was thrown out by a judge.) The hedge funds hired Michael Szafranski, a Miami accountant who knew an executive at Platinum, to verify Rothstein's paperwork and bank accounts. Centurion portfolio manager Jack Simony came to Florida to inspect the TD Bank accounts, while Centurion counsel Brian Jedwab met with four lawyers who said their firms were financing settlements through Rothstein. The hedge-fund employees say they were convinced.
But in Rothstein's December deposition, he said he'd bribed the four lawyers to say they supplied him with settlements. He also claimed he paid a $50,000 bribe to TD Bank's regional vice president at the time, Frank Spinosa, to falsify bank records and persuade Szafranski, Simony and others that Rothstein had hundreds of millions locked up in accounts for the benefit of investors. Spinosa hasn't been charged by prosecutors, and his attorney, Samuel J. Rabin, says the former banker never lied or took a bribe.
The hedge funds' verifier, Szafranski, "wasn't very inquisitive," said Rothstein at deposition. Szafranski met a purported TD banker called "Ricardo Mejia" who was actually Steve Caputi, the manager of Rothstein's nightclub Café Iguana. Rothstein testified that, strangely, Szafranski later socialized with Caputi—as Caputi—at the cafe and at a strip club called Solid Gold. Szafranski's attorney didn't respond to inquiries. Rothstein claimed in his deposition that he'd also paid prostitutes to service Centurion's Simony and a Platinum employee named Ari Glass—allegations that both Glass and Simony deny.
In court, the hedge funds have steadfastly said they were fooled by Rothstein until he missed payments in April 2009. An accounting analysis filed by the Rothstein bankruptcy trustee in his case against the funds–the basis for our chart–shows that the hedge funds' aggregate outstanding investment with Rothstein peaked at $183 million before that, on Jan. 2, 2009. Their net investment then declined as more money was paid out. By the time the scheme collapsed, they had a net investment of just $19 million. As their money left, a net $179 million came into Rothstein's scheme from investors like Florida billionaire Doug Von Allmen and money manager A.J. Discala.
In two separate proceedings that seek $20 million from Huberfeld, Bodner, Nordlicht and their wives, the Rothstein bankruptcy trustee alleges that the hedge-fund principals cut side deals with Rothstein. In January 2009, when the funds were already reducing their investments, the principals supplied $11 million through an entity owned by their wives called Regent Capital Partners, on which Rothstein promised to return $22 million over six months.
"When you're running a Ponzi of this magnitude," Rothstein testified, "you want to reward the people that are taking care of you and helping you sustain the Ponzi scheme."
In an e-mail, Nordlicht says the Regent deals with Rothstein were a way to use their own money to test the potential for a fund that would directly invest with Rothstein.
By BILL ALPERT - barrons.com