Judge blasts SEC on Caledonian case

A U.S. District Court judge has described the $76 million freezing order against Caledonian Bank, which directly resulted in a run on the bank and its ultimate bankruptcy, as “incredible government overreach.” 

Judge William H. Pauley III, who signed the temporary injunction against Caledonian, questioned U.S. Securities and Exchange Commission lawyers at a pre-trial hearing in the Southern District of New York on May 21. He asked whether the SEC had been aware when it made the application that the bank had net equity of only $25 million, and that any amount exceeding that would represent depositor funds. 

SEC attorney Richard Simpson said the SEC learned about the bank’s finances a couple of days after the application had been granted, but it did not bring that to the court’s attention nor did it seek a reduction of the frozen assets. 

“We were negotiating with Caledonian and I believe they requested a reduction in the freeze amount. We took that to a very high level within the commission and decided that we were not going to agree to that,” Mr. Simpson said. 

The judge asked the SEC lawyer how the commission could think that it was “entitled” to freeze money that belongs to the bank’s depositors and was told that the issue was not discussed. 

“The bank collapsed because of your actions, didn’t it?’ Judge Pauley asked. 

“Yes, your Honor,” Mr. Simpson responded. 

“It’s stunning. It’s incredible government overreach,” the judge concluded. 

A spokesperson for Caledonian’s former management said: “We are pleased to see that some of the truth is starting to be revealed. Unfortunately, it does not look like justice will ever truly be served in this case. Our business has been destroyed and the careers and lives of the people that made Caledonian great have been forever changed. In time, it will be shown that the allegations against Caledonian are without merit.” 

The judge also apportioned blame to Caledonian’s lawyers, asking why they had agreed to the asset freeze if it exceeded their clients’ net equity. 

Margaret Dale, an attorney for Caledonian, responded: “Your Honor, we were in a bad place on Friday afternoon the 6th of February. The court had entered a restraining order that actually restrained all of Caledonian Bank’s assets in the United States. When we got knowledge of that order late in the afternoon on the 6th, we contacted the SEC to begin to negotiate a reduction, fearing exactly what transpired, which was [that] there would be a run on the bank.” 

On the following Sunday, Caledonian negotiated a reduction of the asset freeze to $76 million, which represented double the amount that was passed through Caledonian’s omnibus account for trades in four securities. 

The SEC alleges that Caledonian Bank and Caledonian Securities and three offshore brokers in Belize and Panama sold unregistered, restricted shares to the public and that those shares were part of a sham stock offering and penny stock pump-and dump-fraud. 

Asked again by the court how the lawyer could “conceivably agree to an asset freeze of $76 million when you knew that your clients’ net equity was $25 million,” Ms. Dale responded: “We weren’t necessarily in the driver’s seat on that negotiation. We were constrained by time.” 

The lawyer acknowledged that the legal team was aware that “every dollar above 25 million belonged to someone else, [the] depositors” but it had hoped the matter could be resolved within a few days without a run on the bank. 

“It’s stunning. It’s really stunning,” Judge Pauley said. “You bear as much responsibility for what happened as the SEC did in this foolhardy exercise.” 

The district judge signed the temporary injunction against Caledonian after what appeared to be a casual hearing on Feb. 6. In an initial meeting that was brief because the judge had to attend another court hearing, he asked for a “Readers Digest tease” and brief summary. 

Neither the financial situation of Caledonian Bank nor the adequacy of the size of the temporary injunction was discussed in the initial meeting or in the subsequent hearing. 

Caledonian depositors tried to withdraw US$68 million in the week after the SEC accused the bank and its broker affiliate Caledonian Securities of violating U.S. securities law. At the time, the consolidated financial statements for Caledonian Bank showed total assets of US$618 million, total liabilities of US$593 million and a shareholders’ equity of $25 million.  

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Caledonian House on Dr. Roy’s Drive, George Town. – PHOTO: TANEOS RAMSAY
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  1. CIMA is just as responsible for the Caledonian collapse as the SEC. CIMA”s ultimate responsibility as regulator is to protect Cayman”s financial industry. CIMA should have played a more substantial role and guided the investigation earlier on, in an effort to avoid a run on the bank and to minimize reputational damage to the industry as a whole. Instead, CIMA just relented to the SEC”s every whim, and let the SEC dictate the inevitable outcome. Shame on CIMA for letting a paltry $76 million dollar sham result in the closing of a major financial institution, Caymanians losing their jobs and the Cayman financial industry taking a reputational hit it couldn”t afford. Ridiculous.

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  2. It”s been publicly stated that CIMA had been working with the SEC for 18 months prior to when these allegations were brought.
    Given that the SEC didn”t even understand the capital base of the bank, it increasingly obvious that CIMA”s stated involvement was minimal or non-existant.
    Given that, what was basis used by CIMA to place Caledonian into controllership?

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