How Hedge Funds Hide

Illustrations by Jennifer Heuer.

Illustrations by Jennifer Heuer.

Seth Klarman’s Baupost Group buys distressed debt and goes to great lengths to hide it. Here’s why — and how — hedge funds such as his fight to keep secrets. Part 1 of a two-part series.

In Iceland, nothing captures the island nation’s psyche more than Thingvellir National Park, a geologic wonder of steep cliffs above a valley where streams spill into a wide lake, all carved from shifting tectonic plates. Iceland’s first general assembly was established on this soil in 930; almost 1,000 years later, in 1928, the area was proclaimed a “protected national shrine of all Icelanders.” Today a visitor might encounter a wedding ceremony in its rift valley.

But Thingvellir is not just Iceland’s greatest national treasure. It’s also the name of a shell company created by a U.S. hedge fund for the sole purpose of buying the country’s defaulted bank debt shortly after the 2008 financial crisis — a crisis that brought Iceland to the brink of ruin.

Thingvellir Fund, incorporated in Delaware, and Thingvellir SARL, based in Luxembourg, were the onshore and offshore names for two of several secretive funds created by Seth Klarman’s $30 billion Baupost Group and named after famous Icelandic towns and landmarks that disguised Baupost’s investment.

Operating through hard-to-trace shell companies — others included Gulfoss Partners, Geysir Advisors, and Grindavik Fund — Baupost became the hedge fund with the greatest dollar amount of claims on Iceland’s three major banks, totaling €3 billion ($3.7 billion). And while other hedge funds were stuck in Iceland for years as the country imposed capital controls, Baupost exited early and made what one analyst calculates was close to $1 billion. Outside of an obscure 2016 book written by Icelandic professors, and a corresponding blog, Baupost’s use of these shell companies has never been publicly revealed before. Neither has the hedge fund’s huge exposure, and corresponding windfall, in Icelandic debt.

More recent events have revealed that Baupost’s use of shell companies — or what hedge fund lawyers prefer to call “special purpose vehicles” — isn’t unique to Iceland.


The Boston-based hedge fund used a similar obfuscation strategy while investing in now-defaulted Puerto Rico debt. Through a series of shell companies — Decagon Holdings 1 through Decagon Holdings 10 — Baupost kept its holdings highly secret until last fall, when the strategy was exposed by the online media outlet The Intercept, a revelation that accompanied a string of protests pressing for cancellation of hurricane-ravaged Puerto Rico’s $74 billion in debt.

The Puerto Rico revelation brought Baupost’s strategy to the forefront of a raging debate over the morality of such investments, with the hedge fund’s secrecy a truncheon used by the activists seeking debt relief. But Klarman’s fund is hardly the only one that in dicey situations attempts to obscure its ownership, particularly when such investments might bring with them the label of vulture.

In another instance, in 2003, Paul Singer’s Elliott Management Corp. sued Argentina via a Cayman Islands holding company called NML Capital. Singer sought for years to keep his ownership of NML secret, but by 2012 his battle with Argentina had become front-page news.

Another is Davidson Kempner Capital Management, whose distressed investments following the financial crisis helped turn it into a $30 billion fund, and which has perhaps done the best job of camouflaging its interests. It was a co-plaintiff in NML Capital’s suit against Argentina, under the name Blue Angel Capital, and it was the third-biggest owner of Icelandic bank debt, using the shell company Burlington Loan Management, registered in Dublin, to buy distressed European assets after the financial crisis. That fund reportedly had another rationale: According to The Irish Times, it was structured precisely to avoid paying taxes. (Davidson Kempner declined to comment, except to say it has paid all the taxes it owes.)

Hedge funds are famous for their opacity, so their use of secret shell companies that are sometimes associated with tax avoidance or money laundering offers an added layer of intrigue. What will shock many not associated with this arcane area of finance is just how incredibly easy this stealth is accomplished.

“In the U.S. state of Delaware, for example, you need to provide more identification to obtain a library card than you do to create a company,” notes the Financial Transparency Coalition, a global group trying to curb illicit flows of money. “Being able to set up a company — which has the ability to move money, open subsidiaries, and act as a legal front — without providing any information about who ultimately owns it is a recipe for the perfect crime,” it explains on its website.

To be sure, most hedge funds aren’t engaged in criminal activity, and there may be legitimate reasons for hedge funds to hide what they own. Last year when Klarman spoke at the Robin Hood investment conference, he explained why Baupost likes to operate in stealth. “I don’t like to be attacked,” Klarman told the crowd, according to an audio recording of his off-the-record remarks obtained by Institutional Investor. The hedge fund titan also admitted that he “hid” his firm’s ownership of the Puerto Rico debt through Decagon because “the world tends to follow us and copycat us.”

Hedge funds are also sensitive to how such controversial investments might affect their clients. “It’s an issue with investors,” says Hans Humes, president and chief investment officer at Greylock Capital Management, which invests in distressed country debt, but does so in the open. “Bigger investors are going to be more sensitive to headline risk. The media attention in these cases can be very anti-creditor.

In the end, these are private companies that believe they are under no obligation to disclose their holdings to the public. Sean O’Shea, a former chief of the business securities fraud section of the United States Attorney’s Office for the Eastern District of New York who is now a white-collar criminal defense lawyer at Boies Schiller Flexner, says sometimes funds simply hide their investments because they think, “It’s none of your fucking business.”

Iceland was a newcomer to the rough-and-tumble world of international markets. Until the 1990s, it was an insular country whose economy was dominated by stalwart fishermen relying on the harsh Nordic seas for their livelihood. But in 1994, Iceland allowed its currency to float on the open markets. Later in the decade, it began to privatize its banks.

The type of financial liberalization so beloved by the global elite turned into a disaster. By the early 2000s, foreign capital began flooding Iceland — in part due to its relatively high interest rates, which made for a popular carry trade with the Japanese yen. With a population of under 350,000, Iceland quickly found that its bank assets dwarfed the real economy.

The financial crisis that followed was not kind to Iceland. What had become one of the globe’s richest countries became the face of hot money gone mad when its three major banks — Kaupthing, Glitnir, and Landsbanki — collapsed in October 2008 as the financial crisis that exploded with the bankruptcy of Lehman Brothers Holdings in the U.S. quickly spread. Iceland did not have the money to bail out its banks.

Klarman, whose investing strategy might often be described as “the best time to buy is when there’s blood in the streets,” sensed opportunity. But there was a problem: Iceland’s economy quickly sank into a severe depression, political unrest intensified, and foreigners who had arguably exacerbated its problems became easy scapegoats for its woes. But by creating shell companies with Icelandic names to buy defaulted Icelandic bank debt, Klarman’s Baupost engineered something of a coup: It was able to reap a windfall without public exposure as a foreign interloper, illustrating precisely why the tactic is so popular.

In Iceland, hedge funds were particularly despised. “Iceland had a bad experience with hedge funds prior to the crisis with people shorting the currency,” explains Hersir Sigurgeirsson, a finance professor at the University of Iceland and co-author (with fellow professor Asgeir Jonsson) of The Icelandic Financial Crisis: A Study Into the World ́s Smallest Currency Area and Its Recovery From Total Banking Collapse.

“They were betting against Iceland, which contributed to the feeling that foreigners were just here to seek profits by any means,” he adds.

Hugh Hendry, the founding partner at now-shuttered Eclectica Asset Management who had famously shorted Iceland’s krona and spoke publicly about it in the London media, found out exactly how upset Icelanders were. “In March of 2008, I was on a tugboat in the port of Santos in Brazil and my BlackBerry started going crazy,” he recalls. “I was getting death threats from Vikings — from guys in Iceland. The story had spread . . . . The interview I’d given in London had been picked up and put on the front page of Iceland’s newspapers.”

“How dare you try to destroy our country?” was the message Hendry says he got.

Baupost was not short Iceland’s currency, but it won’t say why it chose Icelandic names when it went in to buy the bank debt or otherwise comment on its Icelandic adventure. Given the anti-foreigner mood, however, it was “clever” to do so, says Sigurgeirsson: “Having Icelandic names just looks like someone in Iceland is buying claims.”

Thingvellir National Park, he notes, “is a very dear place” to Icelanders.

Baupost was one of the earliest foreign buyers of the bank debt, according to the professor, who believes the fund began buying at a CDS auction in London following the collapse of Iceland’s banks. At that time the bank claims were going for a song: The debt of Iceland’s biggest bank, Kaupthing, was sold for 6.63 percent of face value, debt on Glitnir went for 3 percent of face value, and debt of Landsbanki was sold for 1.25 percent of face value.

Some hedge fund ownership of the failed Icelandic bank debt came to light when the banks published claims directories in 2009 and 2010. A predictable furor erupted — but even then many true owners were still unknown.

Trying to track funds registered in Delaware would lead to a dead end. According to the Financial Transparency Coalition’s Andres Knobel, Delaware is “famous” for having the least transparent corporate records in the world. As a result, linking the various shell companies with Icelandic names back to Baupost wasn’t possible until 2011, when Luxembourg registries could finally be used to trace them.

By placing its holdings in a number of different secret vehicles, Baupost was able to operate under the radar. “People didn’t know how much Baupost had,” says Alexander Freyr Einarsson, an MIT graduate student whose thesis on hedge funds’ involvement in Iceland post-crisis formed part of the Icelandic professors’ book. (At the time of his research, Einarsson was a student at the University of Iceland.) He reckons that having so many different names may have allowed the hedge fund to sell off its claims more easily. By the second half of 2013, according to the bank registries, Baupost was almost entirely out. In the end it made about $880 million, for a 51.3 percent internal rate of return, he estimates. “Those who managed to buy the debt at this CDS auction were the guys who ended up making the most money, as the value started rising pretty fast,” he adds.

Baupost’s early entrance and exit allowed it to escape the fate that befell most hedge funds in Iceland, according to the University of Iceland professors. Hedge funds had been exempted from capital controls imposed in the wake of the crisis, but political turmoil ushered in a new government. In 2012 it revoked the funds’ special status, and negotiations to allow the funds to take their money out of the country dragged on for years.

“Massive profits were possible for those that chose to exit their position early enough. Others spent up to three more years stuck behind capital controls, while prices stayed the same, and suffered substantial opportunity costs,” the professors write in their book.

Baupost’s stunning success in Iceland helped it turn in strong returns in the years just following the financial crash, gaining 20 percent in 2009 and another 13.4 percent in 2010. Moreover, Klarman’s investors are primarily endowments and charities, including Ivy League universities that abhor being dragged into international crises. Klarman was able to make such lofty returns for these investors without a hint of controversy, keeping the stellar reputation that has endeared him to them.

“Klarman has cultivated an image as a moral and principled person, which is appealing to those who are more socially responsible investors,” notes Stephen Lerner, a labor strategist and fellow at Georgetown University’s Kalmanovitz Initiative for Labor and the Working Poor who is working with activists seeking to cancel Puerto Rico’s debt. But Lerner isn’t convinced. “It’s disgusting that people like Seth Klarman can hide how they are pillaging countries around the world, taking advantage of people — and it’s even worse when they try to come off as good guys.”


Seth Klarman.

While its secrecy worked wonders in Iceland, the Boston-based hedge fund did not fare so well in another of its efforts.

Two years after the 2008 market crash, Baupost was wrangling with Bank of New York Mellon, the trustee for Countrywide’s soured mortgage-backed securities. Baupost wanted to get Countrywide — by then part of Bank of America — to buy back some $1 billion in bonds the hedge fund had purchased, according to Reuters. But as the talks faltered and Baupost planned to take the matter to court, the hedge fund created a legal entity called Walnut Place to hold those bonds, bringing the lawsuit in its name. A Bank of New York Mellon attorney described Walnut Place as a “made-for-litigation” name, Reuters reported.

BofA was also negotiating with major institutional investors like BlackRock, MetLife, and PIMCO over their losses, and in June 2011 reached a settlement worth $8.5 billion. Walnut Place refused to go along, however, arguing that the sum was inadequate.

The parties headed to court, where later that year Theodore Mirvis, BofA’s attorney, revealed the true owner.

“Walnut Place is actually a made-up name,” Mirvis, a partner at Wachtell, Lipton, Rosen & Katz, said at a hearing in New York State Supreme Court. The real firm, Mirvis said, was Baupost — “known as a distressed-debt or sometimes a vulture fund.”

Unlike the institutional investors that had purchased the mortgage-backed securities before the housing crisis pummeled their prices, Baupost had bought the bonds on the cheap. “I didn’t want the judge to think the plaintiff was a mom-and-pop investor,” Mirvis says. Walnut Place certainly didn’t have the ring of a so-called vulture fund. “Walnut Place sounds friendly. It has the name of a tree in it.”

The day after Baupost’s ownership was divulged in the media, Klarman sent a letter to his investors admitting that Walnut Place was indeed Baupost (and denying rumors it had disguised its ownership because it had shorted BofA stock). But Baupost’s attempt to throw out the settlement by moving the case to federal court eventually failed. Baupost declined to comment.

“Where does one half-truth end and another begin?” asks former hedge fund manager Hendry. “When you’re taking risks with other people’s money, I think you should never be in denial. I don’t like secrets. Once you begin to have secrets with other people, you have them with yourself, and therein lies the road to ruin.”

Hedge fund secrecy in both Argentina and Puerto Rico would test that view.

Read Part 2 of the series.