Welcome to the Caymans, Where the Enemy is Your Friend

In the debate over the liquidation of two failed Bear Stearns hedge funds, where are the investors? Booking their tickets to the Cayman Islands, no doubt.

Last week, federal bankruptcy Judge Burton Lifland denied the Bear Stearns funds' requests to file bankruptcy under Chapter 15 and liquidate in the Cayman Islands, where they are registered. The arrangement would have protected their assets from investor lawsuits here in the U.S., and all distributions to creditors would have been handled by the Cayman court system, which many lawyers believe is less transparent and more favorable to management than U.S. courts.

Judge Lifland's ruling was important, because it will likely set a precedent for other bankrupt hedge funds registered in the Cayman Islands. It's estimated that three out of every four new funds registers there.

One would think that Judge Lifland heard both sides of the argument in court proceedings, by both the petitioners (Bear Stearns) and by its creditors objecting to the request.

But what actually unfolded was that the Judge denied the request without a single objection recorded. Not a peep from Bear Stearns investors, who were told earlier in the summer that the fund managers' bad bets had managed to wipe away their balances. The only creditor who showed up at the third and final hearing regarding the matter was Merrill Lynch, and the vague wording its lawyer used actually made it sound as if it supports the Chapter 15 filing.

According to a transcript from the final hearing last week, a Bear Stearns lawyer acknowledged that "several important creditors" appeared at the first hearing on August 1. But by August 27, there were no objections filed.

What gives? Were the "important creditors" too busy sipping pina coladas to object to fighting in the Caymans? Is the $75 million the two funds have left in the bank too paltry a sum to even bother with?

Lifland includes a footnote that likely explains it all. In the text of his ruling, he wrote: "The Petitioners basically argue that because no objections have been filed and the Funds' registered offices are in the Cayman Islands, this Court should recognize the Foreign Proceedings as main proceedings. In other words, the Petitioners contend that this Court should accept the proposition that the Foreign Proceedings are main proceedings because the Petitioners say so and because no else says they aren't."

In a footnote to that statement, he writes: "There may be many reasons for the lack of objections including the fact that many members of the financial communities have their own similar relationships with offshore jurisdictions."

Bingo.

Many of the institutional investors that lost money on Bear Stearns have their own Cayman-based operations that could also wind up in court someday. Lawyers for funds of funds and other investment banks with hedge fund subsidiaries would all also argue that their businesses operate in the Caymans. So Bear Stearns, instead of being the enemy, is actually their comrade in arms.

They probably even have post office boxes at the same Cayman mail stations.

by Megan Barnett