Inside the fall of a famed hedge fund

On Aug. 3, 2009, a single-engine Cessna 206 float plane took off from Ontario’s Lake Muskoka, the epicentre of Toronto’s prestige cottage country. It rose erratically before shaving tree tops, flipping, and bursting into flames. The two passengers—pilot Jack Lawrence and his companion, Carol Richardson, were killed instantly. News of the crash reverberated through the Canadian business old guard. Lawrence, a vital 75-year-old, was one of those Runyonesque Bay Street legends, the type not seen so much since the banks began buying up brokerages. Lawrence had made his name as an aggressive bond trader, then as the architect who built tiny broker Burns & Co. into power player Burns Fry; as its chairman, he sold the firm to the Bank of Montreal in 1994 for $400 million plus. Lawrence lingered at BMO as an éminence grise for a time but his competitive, combative nature wasn’t suited to the corporate corral. In 1996, he founded Lawrence & Company Inc., an investment and venture capital firm.

As the polite tributes poured in honouring Lawrence’s legacy—as a mentor to many, as the co-founder of Toronto’s Cambridge Club and an outspoken voice on national issues—more vitriolic murmurs were being vented in the salons and squash courts frequented by Toronto society. The topic: the fallout from Lawrence’s ill-fated hedge fund, Lawrence Partners, run by Lawrence & Co. subsidiary Lawrence Asset Management, or LAM. The fund, which went public in 2005 with a $25,000 investment minimum, attracted more than 1,000 investors, among them many prominent Canadians.

What drew them was the prospect of running with the big dogs, the notion of benefiting from Lawrence’s street cred, the lure of being on the inside. That, and the fund’s unbelievable returns—75 per cent in 2006, 21 per cent in 2007—finessed by thirtysomething manager Ravi Sood, a Lawrence protege who was hyped as the next big thing. One investor recalls Sood being touted as “the next Eric Sprott,” a reference to the Toronto fund manager known for stellar long-term returns. Monty Gordon, a Bay Street veteran, was an investor and rainmaker, bringing friends into the fold, for a commission. Robin Korthals, a former CEO of the Toronto-Dominion Bank, bought shares. So did the author (and former Maclean’s editor-in-chief) Peter C. Newman.

Then came September 2008; investors watched in horror as 81 per cent of the fund’s value evaporated in weeks. Their anger mounted when redemptions were frozen in November, pending restructuring. One investor recalls trying to get out earlier: “I didn’t like what was going on and tried to redeem, only to have the door slammed in my face,” he says. Tales of ruination made the rounds: one man reportedly lost $13 million, a widow of a well-known businessman was said to be destitute.

“I consider myself lucky because I didn’t have the kitchen sink in there,” says Nicholas Sayce, a Toronto investor relations consultant. “I would have been better giving it to a homeless person, the way things ended up.” So acute was the bitterness that some conjectured the gas tank of Lawrence’s Cessna had been sugared, and even more wildly, that the experienced pilot had staged his own death. “A lot of people, good people, lost a lot of money and they won’t say anything,” says Newman. “It’s so damned Canadian.”

Newman isn’t one to be quiet. He came to the fund flush with the first real money he says he ever amassed, the royalties from his Mulroney biography and his own autobiography. A neighbour who’d invested talked it up. Newman knew Lawrence and called him. “He told me he was in it too, and that if there were any problems, he’d help me out, whatever that meant,” he says. Newman’s wife, Alvy, says that when they met with Sood and Lawrence, she pressed for assurances that their principal was safe. “[Lawrence] said, ‘If the market goes down, that’s when we’ll really sing.’ ”

That was the extent of their due diligence. Newman says he took “hedge fund” literally: “My understanding of hedge was the name—you’re protected going up or going down,” he says. It’s a surprising mistake given the number of high-profile hedge fund scandals and implosions in the past decade. As it happens, “hedge” is just another of those semantical stock market prevarications, along with the upbeat “correction,” which means “decline,” and the responsible-sounding “leverage,” rich-person-speak for assuming massive debt. Hedge funds don’t file prospectuses with securities regulators; instead, investors must sign an “accredited investor exemption,” which declares they meet certain financial requirements. These vary, but a net worth of $1 million or a $300,000 income for two years will usually get you in the door. Hedge fund managers are also given more freedom in accounting, and have more tools and strategies in their arsenal, which usually feature high-risk derivatives, short selling, and buying stock on margin. Looser rules, obviously, have at times provided ripe petri dishes for fraud (see Bernie Madoff). Hedge funds were once like cosmetic surgery: exclusive to the rich, requiring at least $1 million to invest. Now, owning a house in Toronto makes most people eligible as “accredited investors.”

Still, seasoned investors like Korthals, once a commissioner with the Ontario Securities Commission, see hedge funds as legitimate investment tools—and the quickest route to wealth. He lost money in the Lawrence Partners fund, but maintains that a diversified hedge fund portfolio provides higher returns than mutual funds over the long haul. “A lot of the best analysts have gone into hedge funds,” he says. “So if you want to have them manage your money, you have to do that.”

Michael Decter, president and CEO of Lawrence Decter Investment Counsel, who went into partnership with Lawrence in 1998 but untangled his interest five years ago, is more wary. Like many, he says the fact the riskiest part of the market is unregulated by provincial securities commissions is “ridiculous and mystifying,” particularly after the 2008 crash exposed the devastating perils of leverage. Decter is also critical of hedge fund managers’ high fees, typically a two per cent “management” fee that is calculated based on the fund’s net asset value and a 20 per cent “performance” fee based on the fund’s profits, which is where managers make their real money. It also gives managers a huge incentive to make high-risk/reward speculative bets, he says: “It’s a slippery slope because it isn’t always allied with investors’ needs.”

That wasn’t the case at Lawrence, says Sood. He and Lawrence’s estate remain the fund’s biggest investors, he reports; all of their management fees were reinvested in the fund. “We deserved to suffer along with our shareholders,” he adds earnestly. Sood’s rise was one of those “whiz kid” trajectories abetted by the business press. Born in Toronto, he graduated high school at age 16, then earned an honours B.A. in mathematics from the University of Waterloo. Just turned 22, he went to work for Lawrence & Co. in the summer of 1998. Lawrence saw promise in the bright, ambitious young man; in 2001, the two founded LAM, of which Sood is now CEO. “A gunslinger” is how a Partners fund investor describes him. A former LAM salesman says Sood had what matters most in rising markets—connections: “He had a great network and access to deal flow necessary to that type of fund—small cap resources and private equity placements.”

And that’s what the fund focused on, buying short and on margin, in the go-go bull markets of the mid-2000s. But it also left the fund vulnerable. So when a nervous BMO Nesbitt Burns and CIBC World Markets called their loans in September 2008, everything had to be sold off, even takeover targets Fording Canadian Coal Trust and BCE Inc. For the first time, investors started looking at what the fund held. What they saw were a lot of illiquid investments one investor calls “really weird, weird stuff”—a potash company in the Republic of Congo slated for development in 2011, high-interest loans in Russian oil and gas lease companies, shares in Russo-Forest Corp., formed to exploit timber leases in Russia. Some of the companies were also in the portfolio of TriNorth Inc., a LAM-owned company whose assets are managed by LAM. TriNorth suffered its own tribulations last year, losing 90 per cent of its value, weathering an unsuccessful shareholders’ bid to unseat the board, which includes Sood, and being delisted from the TSE and put on the ventures index. Newman says he confronted Lawrence, who was seen to take an increasingly hands-off role in the business, about the devastating losses. “He told me: ‘You can sue me, and you’ll win. But you’ll never collect.’ ”

Sood was only one of many hedge fund managers caught in the liquidity crunch. Toronto-based Epic Capital Management Inc. closed its flagship hedge fund in October 2008 after assets sank to $200 million from $300 million. “We wanted to do it while we could and didn’t have a gun to our head,” Epic CEO David Fawcett said at the time. The Lawrence Partners fund, which saw assets plummet from $202.5 million at year-end 2007 to $43 million by the end of 2008, took another approach, one that would buy them more time—a restructuring that forced investors to chose between “wind-up” shares to be eventually paid out in cash or “reinvest shares” locked in until March 2011 subject to stricter disciplines: no leverage, and only high cap, publicly traded Canadian stocks. The management fee was cut to one per cent on the existing portfolio, 1.5 per cent on reinvested capital. The performance fee was waived.

A composed Sood faced shareholders at the Toronto offices of law firm McCarthy Tétrault in February 2009, the same month Gordon McMillan, a veteran Toronto asset manager, acquired a significant minority equity interest in LAM. Neither Lawrence nor Monty Gordon were present, much to some investors’ chagrin. Sood sees the fact that more than two-thirds chose to reinvest shares as “a real vote of confidence; it gave us a chance to claw our way back.” An investor sees it otherwise: “We felt filleted.” Sayce, who opted for wind-up shares, is furious he has to pay even a one per cent fee and that his wind-up shares were down 10 per cent in December. “These people have totally mismanaged the fund,” he says.

Gordon, for one, still has faith in Sood: “I believe, give him time if the world holds together and recovers, he will likely do okay and we will likely make money out of this fund.” Sood says he wants to put it all behind him. He says the fund’s remaining illiquid investment should be sold for “a reasonable value” in the coming months and that it is paying out disbursements to investors ahead of schedule. Still, he admits, “it’s going to take a long time to regain that position.” The fund reported a nine per cent gain in 2009, a year the TSE rose 31 per cent.

As for lessons learned, Sood says the 2008 melt-down was too singular to derive any. “It exceeded the crash of 1929 so it’s hard to draw a parallel to anything,” he says, seemingly unbowed by the experience: “You can’t operate your fund or your business assuming everything is going to grind to a complete halt, no credit will be extended and everything will drop 30, 40 per cent in a day. Otherwise you won’t do anything.”

Sood’s purported magic touch appears to have remained intact. In mid- January, he surfaced on the Globe and Mail’s investor forum website to take questions about investing in agriculture. In the sort of ­“insider-y” discussion investors love to be part of, Sood pronounced himself bullish about potash and called Saskatchewan farmland “seriously undervalued.” Nowhere was there a disclaimer that LAM associate company TriNorth holds Wild Horse Group, a private venture with plans to be “one of Canada’s largest owners of irrigated farmland” in the province. When questioned about the Lawrence Partners fund’s performance by a Globe reporter, Sood blamed “the worst sell-off in the history of markets,” then boasted that the fund “has outperformed its key benchmarks since inception due to its strong performance in previous years.” That’s of little solace to one investor who bought in just months before the crash; his most recent statement dated Nov. 30, 2009, shows his initial investment is down 78 per cent: “But it doesn’t mean anything because you can’t take it out,” he says, still stunned by events. “I don’t know where all that money went.

Millions and millions and millions just vanished.” As for the mystery of Jack Lawrence’s last flight, that too remains unsolved.

The Transportation Safety Board is still investigating.