The kinds of secret offshore companies that have hidden political corruption and tax evasion around the world are often used by Wall Street’s biggest money makers — the $2 trillion hedge fund industry.
The now-famous Panama Papers leak offers rare insight into the workings of this exclusive investment club.
Hedge funds accept individual investors with net worths of $1 million or more and worker pension funds with $5 million or more. They and their investors often locate in tax havens such as the Cayman Islands or the British Virgin Islands.
The names found in the leaked files from the Panamanian law firm Mossack Fonseca include two now-imprisoned hedge fund managers, a major “feeder fund” that was part of the largest-ever Ponzi scheme run by Bernard Madoff and several anonymous investors whose offshore companies became tangled in the Madoff web.
“Most financial institutions do require considerable information on investors” today, said Robert Van Grover, an attorney with Seward & Kissel LLP in New York who thought the abuses found in the Panama Papers “would be very difficult in the United States” now.
But the hedge fund managers and their investors identified in the leaked documents by McClatchy and partners underscore what has been a weakness in oversight: They often used secret offshore companies, which hid investor fraud and potentially unsavory investors from U.S. regulators.
“In some jurisdictions it is absolutely a regulatory blind spot,” said a manager of a hedge fund that manages more than $200 million. He asked for anonymity in order to speak freely about competitors and added: “Definitely, there could be more transparency.”
Chetan Kapur, once a Wall Street whiz who lost millions in his investors’ money, employed Mossack Fonseca — now known for its exposure in a leak of 11.5 million documents — to set up offshore companies. He is jailed in Brooklyn on contempt charges, awaiting a hearing Thursday on accusations that he failed to disclose what’s in his offshore businesses.
The contempt hearing presents the first known legal development in the United States to come out of the Panama Papers.
Francisco Illarramendi, convicted in 2015 of wire fraud and other crimes, created offshore entities that were used to fleece investors and Venezuelan oil workers out of millions of dollars, federal prosecutors charged.
His two hedge funds, one registered in the United States and one unregistered, relied on a complex network of shell companies created through Mossack Fonseca.
Indeed, while federal prosecutors said he ran hedge funds, he was convicted for orchestrating a sophisticated Ponzi scheme that stole more than $50 million and, prosecutors said, caused five times that in losses.
Through the offshore companies that Illarramendi and Kapur set up, federal prosecutors allege, the two men represent an intersection between the secretive world of offshore companies and the opaque world of hedge funds.
Indeed, the two are among dozens of convicted or accused financial fraudsters found in the 2.6 terabyte archive from Mossack Fonseca that was analyzed by reporters working with the International Consortium of Investigative Journalists.
There are an estimated 10,000 hedge funds operating around the world, with more than $2 trillion in assets under management, according to the most recent estimate from the Hedge Funds Association.
Hedge funds engage in what’s called “alternative investing,” doing everything from betting on stocks to fall to buying distressed bonds at cents on the dollar or waging huge gambles on small price movements in oil.
About two-thirds of global hedge fund assets are from institutional investors such as pension funds and nonprofit endowments; the rest come from rich individuals, who have favored them for the chance at double-digit returns. Since 2009, hedge funds overall have trailed stock market returns, and they netted a loss last year.
Illarramendi and Kapur also highlight a regulatory weakness. The U.S. Treasury Department, concerned about criminals and corrupt foreign officials laundering illicit money, is trying to crack down on anonymous purchases of luxury homes in South Florida and New York through offshore companies. Yet hedge funds that are structured as offshore companies, or accept offshore companies as investors, receive less scrutiny.
Since 2011, there are more reporting requirements to regulators and the IRS, but offshore companies with fake directors or secretive ownership structures can still be used to invest in offshore hedge funds. And that raises questions about who is watching them.
“There’s room for improvement on how it’s handled, but I wouldn’t call it a systemic problem,” said Jason Scharfman, managing partner of Corgentum Consulting and the author of a book on hedge fund governance.
The Panama Papers show how some offshore companies were used by hedge funds and their customers to invest in so-called feeder funds that, in turn, directed the money into other investment funds. Some of these feeder funds are now locked in court battles over the billions in private investment they sent to Madoff, now serving 150 years for his Ponzi scam.
Hedge funds often disclose no information to the public about their investments and little more than a broad outline to regulators. The largest hedge funds, managing more than $150 million, must report on their auditors, bank partners and generic outlines of the types of assets in which they invest and the types of investors they attract.
In response to the financial crisis of 2008, hedge fund managers and advisers were required, beginning in 2011, to register with regulators if they manage more than $100 million.
But they are not regulated as banks are for financial safety and soundness, and until recently they didn’t report anything to regulators about their investors, which can be shell companies with the true owners’ identities hidden.
Hedge funds often incorporate outside the United States. They can accept foreign investors who may want to avoid the U.S. legal and tax system or Americans trying to limit tax liabilities. New IRS reporting rules, effective in 2014, require hedge funds to share some information about investors, but not foreign investors.
“From a global standpoint, this is a larger question of how countries can collect information from companies outside their regulatory reach,” said Steve Rosenthal, a tax expert at the Urban Institute, a centrist research group in Washington.
Are his offshores empty?
Kapur, a 42-year-old Indian national with a U.S. work visa and an upscale New York address, established ThinkStrategy Capital Management in 2002. Through it, he managed ThinkStrategy Capital Fund, which invested in stocks, and the larger TS Multi-Strategy Fund, which took stakes in multiple hedge funds.
The SEC brought a civil action in November 2011 that alleged that, over a period of seven years, Kapur misrepresented to investors everything from his performance and credentials to the experience of his management team. At its peak, the SEC said, Kapur’s TS Multi-Strategy Fund managed $520 million for 90 investors.
Kapur consented on Nov. 30, 2011, to an SEC order without admitting or denying guilt that he would be barred from associating with most parts of the U.S. financial market. The Justice Department filed criminal securities-fraud charges in July 2012, but nearly 13 months later, a judge effectively dismissed the charges by sentencing Kapur to time served in jail after finding he’d lost money alongside his investors.
Kapur was also ordered to pay a $1 million penalty and return another $3.98 million to investors. And that’s where his offshore companies eventually became his current legal issue.
Companies he created in Panama with the help of Mossack Fonseca are now at the center of efforts to recover money that the government alleges belongs to investors.
U.S. District Judge Paul A. Engelmayer scheduled a July 7 hearing in New York on attempts to recover money from Swiss bank accounts that the Panama Papers show were linked to shell companies Kapur created. The jailed Kapur insists he does not have the money.
A transcript of an April 15 teleconference between the judge and lawyers showed that the SEC is trying to freeze $2.3 million in Swiss banks tied to Kapur’s offshore entities.
“Because of the (Panama) papers, it has generated quite a bit more interest. The information that is provided (in the papers) caused us to seek relief before the court,” SEC Attorney Michael Roessner said, asking the judge for support in getting the help of governments abroad.
Large parts of the transcript are redacted, apparently covering details of the SEC’s international division seeking help from either a foreign government or company. Panamanian authorities, which seized records from Mossack Fonseca, told McClatchy that as of June 23 they had not received any requests for help. The SEC and the law firm declined to comment.
Kapur’s ties to Mossack Fonseca and offshore entities were partly revealed in early April by McClatchy’s Indian reporting partners. One was a Panamanian offshore company called Opler Company Consulting Corp., created in December 2007.
In May 2010, Kapur opened a foundation in Panama called Family and Children Charitable Foundation that held as its assets 100 percent of the shares of Opler Company Consulting.
‘Asset protection’ sought
A contract with Mossack Fonseca found in the leaked files shows bearer shares, the most secretive type of ownership, for Opler Company Consulting and that the company paid Mossack Fonseca to provide the names of the law firm’s employees as founders and officers of Opler. Asked his purpose for the foundation, Kapur responded “asset protection,” according to the law firm’s records.
There was another request, in a May 10, 2010, email. Kapur asked whether he could buy a shelf company, one that’s already established and has the appearance of longtime activity.
“On the shelf corporations, do you have names with INC, LTD, CORP and with incorporation dates going further back?” Kapur asked.
Both Panamanian entities were linked in the documents with Swiss bank accounts at Bank Vontobel and Bank J. Safra Sarasin.
“I currently have a wealth management/bank account at Bank Sarasin (in Geneva, Switzerland), and was looking to transfer the assets to the Foundation structure with Bank Vontobel,” Kapur wrote on May 6, 2010 — an email that appears to link both bank accounts to his offshore companies.
An end-of-year statement from Bank Vontobel found in the leaked files shows Kapur had a balance of $2.087 million on Dec. 31, 2011.
The foundation’s structure made the true owners very difficult to determine from the outside.
On Sept. 24, 2012, months after criminal charges against Kapur were public, in his capacity as head of the foundation he authorized the Panamanian law firm to make his older brother Kabir the beneficiary of the foundation and its assets and their godmother Rina Bai a substitute beneficiary. Earlier that year, the foundation began making loans to Bai.
When Kapur set up the foundation, Mossack Fonseca was aware of an investor lawsuit against him but still did business with him.
“We have to be very careful with people who manage money for third persons, they might want to escape with the $ of their constituents and use us as their refuge,” partner Ramon Fonseca warned in a June 24, 2010, email with colleagues discussing Kapur.
The law firm limited the funds transferred to the Kapur accounts, and “if millions start to arrive, it should sound all our alarms,” Fonseca wrote.
Days before Kapur was to report to jail for contempt on July 7, 2015, his brother Kabir wrote to Edison Teano, a lawyer with the Panamanian law firm. He needed two letters saying his brother had never been the beneficial, or true, owner of the foundation’s assets at Bank Vontobel nor of assets at Bank Sarasin.
“This has become complicated and I don’t see how we can certify that,” Teano wrote in an in-house discussion about the request.
That same month, Judge Engelmayer held Chetan Kapur in contempt after he skipped a required hearing, claiming he was too sick to travel from India. He was in New York, and was later jailed.
13-year fraud sentence
Francisco Illarramendi worked out of the Connecticut financial center of Stamford, favored by many hedge funds and other investment firms as a wealthy and distant suburb of New York. His two hedge funds, one registered in the United States and one unregistered, relied on a complex network of shell companies created through Mossack Fonseca.
Illarramendi was sentenced on Jan. 29, 2015, to 13 years in prison for securities and investment adviser fraud. Through an official from his Fairton, New Jersey, prison, he declined to be interviewed.
As described by prosecutors, Illarramendi’s scheme sucked in the pension fund of one of the world’s largest oil companies, Petróleos de Venezuela S.A., and another one of his businesses was indirectly linked to prohibited deals with Iran.
Illarramendi ran Michael Kenwood Capital Management and Highview Point Partners. His hedge fund activities centered on bond trading and complex trading of derivatives, which involve bets on bond returns.
Federal prosecutors alleged that the Ponzi scheme began with attempts to cover a $5 million loss and then blossomed into a complex fraud exceeding $700 million.
Before Illarramendi pleaded guilty in 2011, U.S. prosecutors said he’d paid a $3.4 million bribe to get a $10 million investment from the pension fund of Venezuela’s state oil company.
Through offshore companies in the British Virgin Islands, established with Mossack Fonseca, Illarramendi and partners took on new investors to pay past ones and pocketed large sums, prosecutors said.
In January 2013, nearly two years after his plea, Illarramendi’s bond was revoked and he was held until sentencing because he’d failed to disclose that he had received and spent a $637,576 state tax refund. lllarramendi built a $5 million home in upscale Greenwich, Connecticut. Court documents listed another property on the 36th floor of 845 United Nations Plaza in New York. That address is the Trump World Tower, a luxury high-rise across from the U.N. headquarters.
John J. Carney, the receiver in charge of unwinding Illarramendi’s companies, said in late 2014 that he would pay claims on at least 92 percent of investor losses. Carney declined to be interviewed on the role of the offshore companies.
The most famous scam
Madoff, now imprisoned in Butner, North Carolina, carried out the largest financial fraud in U.S. history, cheating investors out of about $17 billion.
Money flowed to Bernard L. Madoff Securities LLC through private-investment vehicles called feeder funds. Structures often used by hedge funds, they involve a number of funds that all feed into a master fund. Think of them as umbrellas over trading and investment activities.
One of the Madoff feeder funds found in the Panama Papers was Plaza Investments International, which was established in 1996 and, at the time of the collapse of Madoff’s scheme, used Mossack Fonseca as its registered agent in the British Virgin Islands. Plaza was run by the wealth management fund Notz, Stucki Management (Bermuda) Ltd.
Research by McClatchy found that investors in Plaza and other feeder funds, such as Fairfield Sentry Limited, Harley International Limited and Thema Fund Coral USA, appear in the Panama Papers. These investors used offshore companies to invest in Madoff feeder funds, documents show.
Irving Picard, the trustee who is seeking to reclaim money for Madoff’s investors, has tried to claw back money from investors and funds that cashed out before the Madoff empire collapsed.
Picard battled Plaza Investments in court, and a June 2015 settlement required Plaza Investments International to pay $140 million to those harmed by Madoff. In exchange, it got to keep about $405 million in its claim against Madoff’s company.
A key decision on offshore companies, however, remains. The courts are weighing Picard’s argument that he has the right to force foreigners who had been paid off by feeder funds, such as Plaza, to return Madoff’s ill-gotten gains.
U.S. investors are vulnerable to a claw-back, but Picard wants extraterritorial rights that would affect foreign nationals or Americans who created offshore companies to avoid U.S. law.
There are several offshore companies found in the Panama Papers that received notification through Mossack Fonseca that they could be involved in litigation over Madoff.
Even if U.S. courts support Picard, the identities of some offshore company owners may prove tough to find.
Take Obelisk Holdings International Inc., a Panamanian offshore company created for an owner who uses bearer shares. Their use has been banned by most countries, but Panama only recently began phasing them out.
“Unfortunately, it appears that you are one of the unnamed beneficial owners that the Fairfield Funds are asserting claims against,” said a letter from Banque Safra-Luxembourg S.A. to Obelisk, which was administered by Mossack Fonseca. It had no identifiable owner in the Panama Papers.
McClatchy reviewed documents pertaining to Obelisk Holdings International, finding it had invested in Madoff through the feeder fund Fairfield Sentry Limited.
But the documents refer only to Marcelo Moseinco. He’s an executive in Luxembourg for Safra. Obelisk was registered in November 2009 by the Luxembourg office of Mossack Fonseca, and in a section for special instructions it says in capital letters, in Spanish, “REDOMICILE.”
It did not indicate where it might be moved, or whether it happened.
Kevin G. Hall: 202-383-6038; @kevinghall; email@example.com