Plain truth at Plainfield

By Britt Erica Tunick
Photographs by Mike McGregor

Stepping into the Stamford, Conn., office of Plainfield Asset Management, one would never know it was once the disaster recovery site for a $5 billion hedge fund firm. Sailboats drift by the window of Plainfield founder Max Holmes's office, which is adorned with vintage art deco travel posters promoting such European destinations as London and the city where Holmes was born while his parents were college students there—Cologne, Germany. But the vacation mood belies that Plainfield's office has become the headquarters for hard work—and a different kind of disaster recovery these days.

The 50-year-old Holmes, who started Plainfield in 2005 after leaving then-$11.4 billion D.E. Shaw, is fighting for his firm's survival following what he terms a smear campaign from two dodgy companies Plainfield lent money to before the financial crisis hit. After Plainfield foreclosed on these companies' loans, the borrowers accused Plainfield of using predatory lending practices to force them into default and hired a well-connected private investigator with ties to the Manhattan district attorney's office to argue their case.

"This is a tale straight out of Kafka—there but for the grace of God go quite a few people," says Holmes, whose boyish looks and tousled hair disguise the stress he has been under for months. Plainfield's story is something of a morality tale for other hedge funds. "If I had gone to my partners two years ago and said, 'Here's our big risk: there's the potential that two defaulted borrowers will find each other, get the regulators and prosecutors interested in their allegations and then publicize the whole thing,' they would have said, 'You're watching too many episodes of '24.' '?"

It isn't what Holmes, who'd developed a solid reputation for distressed investing in recent years, expected. By early 2008 he'd gathered about $5 billion in assets for a fund that was only three years old and thought he was well positioned for the credit crisis he'd warned investors of two years earlier. But instead of capitalizing on the environment, as so many other distressed firms are doing, Plainfield, which was named after Holmes's hometown in New Jersey, remains under investigation by Manhattan's district attorney's office, the case against it having been highlighted in Fortune magazine.

Plainfield recently received some vindication in the form of two separate legal rulings that not only discredit the accusations but paint the accusers as dishonest instead. Still, the victory is bittersweet. Following a 21.5% loss in 2008, investors had already started fleeing. As a result, Plainfield, which was down 9.8% in 2009, has had to significantly downsize its operations and recently left behind its pricey Greenwich headquarters for the disaster site in Stamford. Just over $500 million of the firm's current $3 billion in assets under management is likely to remain once assets that were side-pocketed in the portfolio are released, and even Holmes's defenders believe the firm's days are numbered.

"Never has a guy called so many things right in the market, but gotten it so wrong to the point where he's ended up turning a $5 billion hedge fund business into a very small fund," says one of Plainfield's largest institutional investors. "It's a wind-down story at this point. Effectively, they don't have a future as a hedge fund manager." But he says it would also not be surprising to see Holmes wind down Plainfield, only to relaunch a new firm after a short while—particularly since Holmes is widely respected for having been straightforward with his investors and treating them fairly when his portfolio got into trouble.

How did it all go wrong?

Max Holmes is one of the very few hedge fund managers who saw the credit crisis coming for one special reason—he'd been through it before. Holmes's initiation came in 1984, when he began his legal career in Texas just as oil prices were falling through the floor. The Columbia University graduate in law and business had a crash course in bankruptcies, which led him into investment banking. In early 1986 he took a job as a corporate finance generalist at Drexel Burnham Lambert—and was the last person hired by the firm before Ivan Boesky's arrest for insider trading. Following his arrest, Boesky went on to provide the Securities and Exchange Commission with detailed information on his dealings with Drexel junk kingpin Michael Milken that led to his indictment and the firm's eventual downfall.

At first Holmes tried to launch a company of his own specializing in leveraged buyouts, but that market died with the crash of 1987 and the Drexel scandals, so in 1991 he went to work as a corporate bond trader for Salomon Brothers, right after an investment from Berkshire Hathaway stabilized the firm and Warren Buffett took over as its chairman.

By 2002 Holmes was able to parlay his experience with high-yield bonds, distressed investments and bankruptcy transactions into a position at D.E. Shaw, where he led the firm's blockbuster entrée into distressed investing and generated returns of 40.6% in 2003, during his first year at the helm of Shaw's Laminar Portfolios fund.

Three years later Holmes decided to go out on his own. In 2005, at the height of the new hedge fund boom, he launched Plainfield with 12 employees and $150 million in assets under management—some of it from a few of his Shaw investors.

Holmes set out to replicate his success at the legendary multistrategy firm, and at first he appeared to have managed to do exactly that. By 2008 he'd hired a staff of 150, gathered an investor base of 160—nearly 75% of which were funds of funds, with the remainder made up of institutions and a few wealthy individuals—and was positioning his portfolio for what he expected would be the investment opportunity of a lifetime.

In a November 2006 speech at a Bear Stearns conference in London, Holmes warned investors of a coming crisis in CDOs and CLOs, which he argued were way too leveraged. "By the time we got to late 2006 and early 2007, the liquid syndicated-loan market had gone crazy, spreads were way too tight and loans were Libor plus 250," says Holmes, adding that it was clear the markets were mispricing the loans.

Convinced that a crisis in CDOs and LBOs was simply a matter of time, Holmes began deleveraging his firm's portfolio so that he would have cash when the buying opportunities that recessions offer for distressed investors appeared.

But he made what in hindsight was a miscalculation. Holmes needed to continue generating returns in the interim, so he decided to follow in the footsteps of hedge fund firms such as Cerberus Capital Management and his alma mater D.E. Shaw by moving into direct lending.

With desperate borrowers taking on egregious terms, lenders willing to make such loans were positioned to profit handsomely. "Our theory was that if we did our own homegrown, self-originated loans we could do Libor plus 750 with lower leverage, better covenants and equity kickers. So, we viewed that as a better risk reward than just buying syndicated loans," says Holmes. At the time, he believed middle-market loans would outperform high-yield bonds or syndicated loans because of their lower leverage levels and better covenants, as well as higher yields and equity kickers used to offset risk. But Holmes did not foresee how dramatic the recession would be, and he failed to account for unexpected events such as the collapse of Bear Stearns and Lehman Brothers. As a result, Plainfield's middle-market loans were hit with a higher default rate than expected and have been slow to recover.

Though Holmes took several actions —such as reducing his portfolio's overall leverage, reducing equity risk and adding a wider variety of hedges—his efforts were unable to compensate for the large number of illiquid investments Plainfield held. The liquid portion of Plainfield's portfolio held up, but Holmes was forced to sell much of it off in order to meet redemption requests.

Holmes's market foresight also didn't extend to Plainfield's ability to identify the best loan candidates for its foray into distressed lending. Holmes and his colleagues overlooked just how desperate some of these borrowers were to hold onto their businesses at any cost.

The business plans of RHS Ventures and Children's Legal Services couldn't be any further apart—both figuratively and geographically. RHS Ventures, a Miami operation run by Roger Stein, was a major investor in a 383-acre development project in the Bahamas that included plans for hotels, private residences, a golf course boasting Professional Golfers' Association champion Greg Norman as its designer, and the last of only three casino licenses on the island.

Michigan's CLS, run by Kenneth Stern, identifies cases it believes to be worthy of prosecution and refers them to a network of partner law firms with which it shares fees. But it is unclear how the duo came together. Despite their differences, Stern and Stein joined forces against Plainfield after their businesses both experienced financial troubles and were unable to stick to the payment plans they had agreed to under the loan agreements they entered into with Plainfield.

When CLS defaulted in October 2007, Plainfield agreed to restructure the loan, lending additional money instead of simply instituting foreclosure proceedings. Though CLS continued to miss its loan payments only two months after the restructuring, Plainfield continued efforts to work with the company. It modified the loan agreement six times before finally pushing the company to restructure. Stern threatened to file suit if Plainfield refused further funding, and in late November 2008 the hedge fund firm finally took legal action seeking enforcement of its loan agreement. Stern responded by filing a counterclaim alleging that Plainfield had made an oral promise to lend the company additional funds.

The court finally granted Plainfield's attorneys the right to dig through CLS's finances, at which point they discovered Stern had ignored a requirement that any of the company's proceeds be deposited in a "lockbox" account and that he had hidden $3.4 million in proceeds. In an April 28 ruling, Nancy Edmunds, a U.S. district court judge for the eastern district of Michigan, instituted an injunction against CLS that prohibited the company from removing funds from any of its accounts and appointing a custodian to oversee its operations.

Similarly, RHS Ventures defaulted less than a year after taking a loan from Plainfield. The company also failed to secure senior debt financing for its construction project from outside sources, and Plainfield's requests for information detailing how money for the project had been spent were met with resistance by Stein. After an initial audit of RHS's finances found inconsistencies, in late October 2008 Plainfield took immediate legal actions to remove RHS Ventures as a general partner from the project—an effort vehemently fought by Stein.

As court proceedings against RHS Ventures moved forward, court documents show that Plainfield eventually discovered that Stein had used millions of dollars from the partnership on personal expenses for everything from his purchase of a yacht to overseas vacations for himself and his family members, bribes paid to members of the Bahamian government, his personal wine collection and even the buyout of his partner from the project.

Stein went to extreme lengths to try to hide this information. After an arbitration panel dismissed his claims that he could not provide documentation of RHS's finances because the information was too closely intermingled with his personal financial records, he was ordered to turn over his computer records. But before doing so, Stein installed a software program to wipe all records from his personal computer and created false accounting records on a second laptop, which he then tried to pass off as his own.

Following months of legal arguments, an April 8 ruling by an arbitration panel denounced Stein's claims that he was the victim of loan-to-own practices and that Plainfield had used unethical tactics to force his company into bankruptcy so it could take over the assets. Instead, the court granted the hedge fund firm's request that Stein and his company be removed from the Bahamas venture and awarded damages and court costs of $3 million to Plainfield. As part of the ruling, in assessing Stein's demeanor and credibility, the tribunal said: "He was evasive and unwilling to respond to direct questions forthrightly. He repeatedly stated that he did not know or could not remember basic facts... his testimony was not substantiated by the record and was not credible." A July 1 hearing has been scheduled in New York to determine whether the arbitration panel decision will be enforced.

Before these recent court rulings, Stein and Stern had dragged Plainfield's name through the mud. Apparently desperate to save their businesses and cover up their own transgressions, the duo turned to Watts Guerra Craft, a Texas law firm known for its aggressive practices, and enlisted Robert Seiden, a private investigator with close ties to Manhattan's district attorney's office, in their fight. Seiden and his clients started an aggressive media campaign accusing Plainfield of using loan-to-own tactics as part of its business strategy. After the trio successfully pitched their accusations to several publications, including Fortune, in late January news broke that the New York County District Attorney's Office was investigating Plainfield's lending practices. Connecticut's attorney general is also said to have launched an investigation.

Despite both rulings in Plainfield's favor, Stein and Stern have yet to let up on their accusations. So far neither the Manhattan DA or Connecticut's attorney general have abandoned their investigations. Queries with Connecticticut's office went unanswered, and a spokeswoman for the Manhattan DA declined to comment.

Seiden, a former prosecutor for the Manhattan district attorney's office, has admitted on multiple occasions that he was hired by Stein and Stern and that he is the individual who brought Plainfield to the attention of authorities. But when specifically asked about his clients, he declined to reveal their identities. He says at this point he is pursuing the matter somewhat on his own, saying that he has identified a "pattern involving what appears to be fraud on the part of Plainfield," which he claims to have uncovered through a series of about 30 interviews with Plainfield borrowers across the country eager to tell their stories.

When asked for names and contact details for some of these individuals, however, Seiden failed to provide the information. Meanwhile, he says the recent rulings in Plainfield's favor will likely be overturned—a sentiment shared by Edward Allred, an attorney with Watts Guerra Craft who represented Stein in his loan-to-own claims against Plainfield.

"The other shoe might not have dropped yet," says Allred. "I understand the hurdle and that very few arbitration hurdles are overcome, but if there is one that should be, I think you're looking at it," says Allred, referencing the recent arbitration ruling against Stein. Watts Guerra Craft, which was recently singled out by Texas Monthly for its ties to Mauricio Celis, a Texas con man known for drumming up lawsuits that he passed on to other firms, is allegedly also planning a class action suit against Plainfield. Allred would not comment on the matter and says he is no longer the attorney at his firm who is handling the case.

Howard J. Kaplan, a partner with law firm Arkin Kaplan Rice, who has been defending Plainfield, calls such claims ludicrous, saying there is no basis for overturning the ruling against Stein. "They could only appeal this decision if they establish that there was fraud on the arbitration panel, or that one of the arbitrators is suffering from bias that influenced the panel," says Kaplan, adding that he believes any such finding to be highly unlikely since Stein and his attorneys were actually involved in selecting the three members of the arbitration panel.

For many of Plainfield's clients and former employees, the allegations against the firm seem unbelievable. Jeff Gural, chairman of real estate development company Newmark Knight Frank, turned to Plainfield for a loan after two racetracks his company purchased began losing significant amounts of money and two of his partners in the deal refused to continue funding the project and dropped out. "Plainfield could have made my life miserable if they wanted, but they've let me run it. When we were losing money they were right there funding their share of the losses along with myself," says Gural, adding that he wouldn't hesitate to work with Plainfield again.

Another of its borrowers, Tim Needham, chairman of paper company SMART Papers, acknowledges that Plainfield's loan terms are aggressive but points out that the firm does not charge hefty monthly management fees as do many of its competitors. "I'd rather get my money from more traditional sources, but in all my dealings they've been extremely professional, and they've been very clear to me on what our agreements are," says Needham. "Never once did they come back to us and say, 'You need to do this, or else that.' So when I hear all these things I sit back and scratch my head and think, 'Is this the same company they're talking about?'?"

But with investors so easily spooked after the events of 2008, Plainfield is well aware it has an uphill battle to regain investors' confidence. To allay investors' concerns, Holmes has made sure to provide full transparency about everything going on with the firm and he has owned up to its mistakes.

The firm admits that it dropped the ball on some of its due diligence and should not have continued lending some of its clients money after things became questionable. But it is also quick to note that there was no systematic failure of due diligence, and that only a handful of the loans the firm has made in the nearly five years since its launch have been problematic. And though both Stein's and Stern's fraudulent activities seem glaringly egregious in the legal documents detailing them, both men came up clean when Plainfield ran background checks on them with the highly regarded investigators at Kroll before ever agreeing to lend them money.

Still, Plainfield is getting out of the direct lending business—a sentiment Holmes expresses by joking that he is prepared to take a blood oath that he will not go near such financings again.

But Plainfield's troubles are not limited to the headline risk surrounding its DA investigation or its legal battles with Stein and Stern. Like many of its peers, when the bankruptcy of Lehman Brothers sent the markets into full crisis mode, Plainfield was immediately hit with redemption requests from a group of investors desperate to pull capital from wherever they could. At that time, the firm had only a one-year lockup on its fund, and after that, investors were able to make quarterly redemption requests with 60 days' notice. Though Holmes tried to convince investors that the market chaos actually presented an attractive buying opportunity and that they should double down, worried investors kept their gaze fixed on the exit. Plainfield's fund-level gate didn't help matters either.

Nor did the losses incurred in 2008. An initial wave of redemption requests had a reverberating effect as many of the firm's other investors followed suit by placing requests of their own in order to avoid being last in line for the exit. "Even if you're the happiest investor out there, if you hear that everyone else is redeeming, you don't really have a choice," says a senior executive at Plainfield, noting that the firm has since switched to an investor-level gate so that each investor can take out only a percentage of its capital at any given time.

By the end of October 2008, just a month and a half after Lehman filed for bankruptcy, Plainfield, which had $5 billion in assets under management at the time, was hit with $1.6 billion in year-end redemption requests, an amount that well exceeded the firm's 8.3% fund-level gate. Instead of closing the fund's gate, however, Holmes froze assets in the flagship fund and told investors he had decided to restructure, and he created a liquidation share class for investors set on exiting the fund.

The firm worked with investors desperate for quick cash by helping arrange sales of their holdings on the secondary market. The remainder of investors who sought redemptions were given the choice to move their investments into a new fund or join a liquidating share class with reduced fees. As was the case in many hedge fund restructurings, though some investors chose to roll their money into the Plainfield Special Situation Fund II, the majority chose the latter. Plainfield has already paid out about 30% of the assets in its liquidating share class, and though the firm initially told investors that it expected total liquidation to take three years, that time frame is now expected to be shorter because of improved market conditions. Plainfield was down 1% in May, according to investors.

In the meantime, Plainfield has been trimming the fat anywhere and everywhere it can. It is saddled with a $7.3 million annual lease it took for its Greenwich headquarters at the height of the market, a decision Holmes says seemed okay at that time because the amount then represented only 7% of the firm's revenues. Now Planfield is trying to sublet those offices.

In April the firm relocated to its nearby Stamford site, which it initially took on as a backup loction after the small hedge fund that formerly occupied the offices went under. The new space, located on Stamford's picturesque waterfront, houses two small trading floors and a slew of sunny offices adorned with the travel posters that Holmes has collected over the years. (His wife won't allow him to hang more than one of them at home.) Holmes's taste is also on display in the form of a framed, temperature-controlled guitar that was owned by Elvis Presley during his Las Vegas era.

Plainfield has also been forced to drastically reduce the size of its staff, with the head count now down to 67. On top of cuts Holmes has been forced to make because of the firm's depleted assets under management, Plainfield recently lost founding partner Niv Harizman, a longtime friend of Holmes who headed up corporate finance. With Plainfield now distancing itself from direct loans, Harizman and former Plainfield managing director Gregg Bresner decided to set out to launch a venture of their own, Tyto Capital Partners, which will specialize in illiquid investments. But while Harizman has been reported to be trying to buy some of Plainfield's illiquid investments, the firm is aware of the risk that it could be perceived to be giving preferential treatment and says that a sale to Harizman's firm would take place only if it puts in the best offer for Plainfield investors' interests.

For Holmes, who has traditionally steered clear of media attention and keeps an antique harpoon hanging over his office window as a reminder that, as he says, "the spouting whale gets harpooned," the events of the past year are mind-boggling. But he has managed to keep his sense of humor about it all and remains optimistic that Plainfield still has a future and that the DA's investigation will come to an end in time for him to raise fresh capital and position himself for the next market downturn.

"I happen to be in the camp that the financial markets have moved too fast and too furious, based on the Fed buying $1.2 trillion of mortgages," says Holmes. "I'd like to be in position for the next recession. I'm only 50 years old, so there's going to be another one in my lifetime. I would like to participate either by reviving Plainfield, which will take time, or perhaps merging with a larger organization. In the meantime, I tell our investors I'm chained to the mast," he says, referring to his focus on the $2.5 billion Plainfield has left to liquidate.

In the absence of a strong rebound in the firm's portfolios, investors remain skeptical that Holmes will be able to turn things around. "It's not as if Plainfield was regaining a lot of traction and all of the sudden this lawsuit popped up and stopped them in their tracks. But it kind of looks to me as if they were dying a slow death and the lawsuit maybe accelerated that a bit," says one institutional investor in Plainfield who asked to remain anonymous. "We don't dislike Plainfield, but the problem they have at this point is stabilizing the business, and the tail they have on a lot of things is extremely long," he says. Plainfield's large number of illiquid holdings will make it extremely difficult for the firm to dig itself out, he says.

Plainfield's situation is something of a cautionary tale: The events that have played out against the firm could just as easily have happened to any of the numerous other companies or hedge fund firms that got into the direct lending game.

"I have seen this sort of attack before, but I think this one is a little unique. The populist rage against hedge funds and the financial markets in general, and the failure to discover schemes like Madoff, allows people like Stein to get much more traction than they would otherwise," says Kaplan, who believes Watts Guerra Craft's involvement in the case is responsible for the predatory lending claims against Plainfield. Though Stein initially claimed that Plainfield had agreed to put money into his company as equity instead of loans, Kaplan says those allegations changed to loan-to-own almost the second Watts Guerra Craft got involved with the case.

The recent Fortune article on Plainfield highlighted a handful of the firm's troubled deals and noted that nine companies that took loans from the firm have filed charges. But Holmes says litigation is a routine business risk for anyone who ventures into the lending arena. Of the 812 investments Plainfield has made since its launch, the firm has been involved with a total of 24 lawsuits.

He also breaks down the 24 lawsuits. In five of the cases filed against Plainfield, the firm was part of a group seeking damages and ultimately prevailed. Four instances where the firm was sued were settled for nuisance money or the charges were outright dropped. Another three cases against the firm were secured by real estate that Plainfield foreclosed on and is now marketing, while Plainfield was the sole lender for three other distressed or bankrupt companies that were ultimately sold to third parties. Of the remaining cases against the firm, four were restructuring proceedings, two were against borrowers who defaulted but whom Plainfield stopped chasing when it was clear they had no assets. In one case Plainfield was part of a large group of owners of bank debt that have won their case, but the defendant is now on its fifth appeal.

CLS and RHS Ventures mark the firm's final two suits—cases where Plainfield was the sole lender and eventually instituted foreclosure proceedings after the borrowers defaulted. Plainfield was awarded $3 million in damages in the case of RHS, and Holmes says the firm is still trying to work out a settlement with CLS.

"Lawsuits are not unusual in this business," says Holmes, adding that he'd rather have zero suits to deal with. "What is unusual is that it appears [Stern and Stein] found each other through public search records, hired Seiden, and then they found a contingency law firm in Texas to take their case," he says. "The bottom line is that we haven't lost any of these decisions, so not only have our actions been vindicated, but they've been vindicated big-time." His sentiment is one shared by some of Plainfield's investors. Says Plainfield's large institutional investor: "Anyone who does direct lending is going to end up at some point with people who don't want to pay you back. But I think it's pretty random that it happened to them, as opposed to someone else."

Holmes remains optimistic that many of his investors will ultimately stand by him. "What these people wanted was that they would torture us so that we would either give up and give them their assets back, or pay them the money to go away. You can go to some borrower and say, 'I'm paying you $1 million to go away,' and that will solve the problem, but it's not consistent with our fiduciary duty," says Holmes. "Our investors know that we have some litigation and that that's not in our character... we are a heavily compliance-minded organization."

Max Holmes may not be able to salvage Plainfield, but it appears his reputation has remained intact.