Hedge fund founder Mark Nordlicht was charged last December by both the US Department of Justice (DOJ) and the Securities and Exchange Commission (SEC) for taking part in a fraudulent scheme to inflate the fund’s asset values, conceal liquidity problems, make preferential redemptions, and divert proceeds from one of the fund’s oil investments to cover losses and cash flow problems. However, in the years prior to Nordlicht’s arrest for what the DOJ calls a “$1 billion investment fraud”, there were many reasons to suspect that he and his fund were involved in capital markets wrongdoing.

On December 19, 2016, the U.S. Attorney for the Eastern District of New York laid criminal charges against Nordlicht – the founder and Chief Investment Officer of hedge fund Platinum Partners L.P. (“Platinum”) – and six other individuals affiliated with Platinum for fraud and conspiracy. Specifically, charges were laid against:

  • Nordlicht and four other individual defendants for securities fraud, investment advisor fraud, securities fraud conspiracy, investment advisor fraud conspiracy, and wire fraud conspiracy, for defrauding investors through, among other things, overvaluing Platinum’s largest assets, concealing cash flow problems, and the preferential paying of redemption; and
  • Nordlicht and three other individuals for securities fraud, securities fraud conspiracy, and wire fraud conspiracy, for defrauding the bondholders of Black Elk Energy Offshore Operations, L.L.C. through a fraudulent offering document and diverting proceeds by falsely representing how much of the bonds were controlled by Platinum.

The same day that the criminal charges were filed, the SEC charged Nordlicht and the six other defendants with conducting a fraudulent scheme to defraud investors and bondholders. Nordlicht has pleaded not guilty to the criminal charges, and Platinum’s main fund has filed for bankruptcy and is currently being wound down.

From 2003 to 2015, Platinum had been posting unbelievably strong annual returns of 17%, with no down years (even during the Great Recession), which led some to question whether the fund’s purported returns were, in fact, believable. While Platinum’s returns alone should have given pause to U.S. authorities, the fund and Nordlicht had a conspicuous history of bad behaviour, including:

  • In 2007, accusations from a Canadian financial institution that Nordlicht had aided a “rogue” trader who had been covering up huge bets, many of them with Platinum, which had cost the institution approximately $500 million. The financial institution sued Nordlicht for allegedly being behind the trades. While Nordlicht denied any knowledge about the fraud and settled the lawsuit, the trades had helped Platinum post record returns.
  • In 2010, the discovery by the SEC while investigating a scheme to purchase annuities and profit from terminally ill patients’ deaths that Platinum had funded those annuities. When an enforcement action was finally announced in 2014, neither Nordlicht nor Platinum were named or accused of wrongdoing, and the SEC had only fined one of Platinum’s shell companies and the intermediaries running the scheme.
  • In 2011, testimony from a Florida lawyer who had confessed to orchestrating a $1.2 billion Ponzi scheme that Nordlicht, the scheme’s biggest funder, had lied in order to help lure in additional investors. Nordlicht had denied helping the lawyer, and was never charged in connection with the Ponzi scheme.

According to Bloomberg, the SEC did not conduct an examination of Platinum until 2015, despite the regulator stating that it conducts “risk-based examinations” of funds that have suspiciously smooth returns (the SEC declined comment on Bloomberg’s story).

The Nordlicht story also highlights the crucial role that internal and external gatekeepers must play in protecting against capital markets fraud. Platinum’s valuations consultant, for instance, did not verify the information it received regarding one of the fund’s largest assets, and noted that their valuation depended on information received from Platinum. While Platinum had touted its auditor and valuations consultant to investors, those gatekeepers had been reliant on information provided by the hedge fund. However, in its press release, the DOJ alleged that certain of Platinum’s employees “plotted ways to cover up their actions” and actively misled their advisors and investors, and underscored the importance of whistleblowers in reporting this kind of misconduct. As noted in the press release, an FBI representative stated that “The FBI and our law enforcement partners do all we can to stop these schemes and to keep fraudsters from stealing from investors, but we can’t do it alone. We need people to call us when they see things that don’t add up, or don’t make sense.”