Liquidators attempting to ‘claw back’ Ponzi scheme payments

Repercussions of the 2008 financial crisis are still being dealt with by the Cayman Islands judicial system, with the London-based Judicial Committee of the Privy Council hearing a case last week involving liquidators attempting to “claw back” payments made by a feeder fund to investors in early 2009, when the fund was already insolvent.

The case stems from the collapse of the Cayman-registered DD Growth Premium Master Fund, which was controlled by Italian hedge fund manager Alberto Micalizzi. DD Growth suffered losses in excess of $150 million due to the collapse of the derivatives market, which was triggered by the failure of Lehman Brothers in 2008, according to an initial 2011 Grand Court judgment on the case.

Mr. Micalizzi tried to prop up the investment scheme by overvaluing bond purchases he made in 2008, court documents state. He was fined £3 million by the U.K. Financial Services Authority in May 2012 for concealing losses and was barred from the securities industry.

But before that alleged wrongdoing came to light, investors in 2X Fund, a feeder fund for the DD Growth Premium Master Fund, redeemed some US$23 million in shares. After the 2X Fund was placed in liquidation in May 2009, liquidators from Grant Thornton sued the investors in Grand Court.

The liquidators argued that Mr. Micalizzi gave the investors “fraudulent preference,” claiming that investors who received payments were unfairly preferred over ones who did not. Liquidators also argued that Cayman’s Companies Law prohibits share payments being made from a fund’s capital after the fund is insolvent.

Though he acknowledged that 2X Fund had become a “Ponzi scheme” before the investors redeemed their shares, Chief Justice Anthony Smellie rejected both arguments.

Rather than Mr. Micalizzi engaging in fraudulent preference for the paid shareholders, he likely made payments because they threatened to sue him, wrote Mr. Smellie in his Nov. 2014 judgment. And while the Companies Law prohibits a fund from making payments from its capital after the fund is insolvent, the shareholders were not paid from the 2X Fund’s capital, but from its share premium fund – an account in which the premiums of sold shares are held.

The liquidators appealed Mr. Smellie’s judgment on the grounds that share premiums should be classified as capital for a fund. However, the Cayman Islands Court of Appeal upheld the chief justice’s judgment.

The liquidators appealed that decision to the Privy Council, and arguments were made in London last week. A judgment has not yet been rendered.

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