The Bear Stearns saga isn't over yet

Nov 19, 2007

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Did you think the Bear Stearns hedge fund drama of the summer was over? We may see a low-budget sequel.

The Financial Times reports that aggrieved shareholders of one of the failed Bear funds, High-Grade Structured Credit Strategies Enhanced Leverage (Overseas), have assumed control. US based investors get to vote on Friday (no guess as to outcome, but the success in London would seem to bode well for the US owners). The Wall Street Journal discusses in more detail the lawsuit filed by the Massachusetts securities regulator alleging improper trading and conflicts of interest, charges which apparently resemble the ones made by the London shareholders.

This gets fun because the shareholders are 'seeking recovery' which is code for 'out to find a basis for suing Bear.' It's easier and cheaper for them to investigate what happened if they posses the books and records than if they have to go through the costly and often imperfect process of discovery and document requests.

Note that Bear was sloppy in how it administered the funds, which has already worked to its disadvantage. Bear had set the funds up in the Cayman Islands, and sought to have them liquidated there, and simultaneously filed in the US for protection under Chapter 15, which shields foreign companies from US creditors. The US judge denied the request and Bear is appealing.

The problem is that Bear did not take the steps to have its Caymans domicile stick. I'm no expert, but having sat in on a few presentations, minimum steps include keeping your books and records in the jurisdiction, having a local attorney and local administrators for the fund, holding annual meetings in person (how awful can it be to be required to go to the Caymans once a year?). But Bear apparently couldn't be bothered to do that.

Similarly, according to the Massachusetts filing, Bear also couldn't be bothered to follow its own requirements, which required that its two independent directors sign off on any trades made between Bear and the funds to assure that the funds were getting good prices. (And I hate to be cynical, but how could directors in the Caymans have verified the prices were good anyhow? This appears to have been a matter of form with almost-certain-to-be-compliant directors.)

Rest assured that sharp-eyed attorneys will be looking to turn any other procedural sloppiness to their advantage. However, note that the suit has not indicated damages, and until the shareholders or the State of Massachusetts can establish that these failings actually hurt the funds' investors, these moves are more heat than light.

Posted by Yves Smith on Naked Capitalism, Thursday November 15th

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