When Hedge Funds Hide

Illustrations by Jennifer Heuer.

Illustrations by Jennifer Heuer.

Did hedge fund Baupost set up opaque investment vehicles to shield its prestigious clients from headline risk? Part 2 of a two-part series.

More than 20 years ago, Paul Singer, who ran what was then a little-known New York–based hedge fund, stunned a federal courtroom with his brash admission.

Read Part 1 of the series

Singer’s Elliott Associates had gone to Manhattan federal court to sue the country of Peru for the $20 million in government-backed bank debt the hedge fund owned. The South American country was sinking under the weight of its debt, but troubled countries cannot go bankrupt and start over again like companies and individuals can, so Peru — along with other struggling nations — was part of the U.S.-led Brady Plan that devised restructuring plans to forgive some of what it owed.

Singer would have none of it.

“Peru would either . . . pay us in full or be sued,” he told the court in a deposition, which was revealed under Singer’s cross-examination by Peru’s attorney, Mark Cymrot. The statement was such a bold acknowledgment of Singer’s bare-knuckled tactics that U.S. federal district Judge Robert Sweet focused on it in a lengthy opinion in which he ruled against the hedge fund in 1998, claiming Elliott had violated a New York state law that forbade buying debt with the express purpose of bringing a lawsuit.


Singer’s comment stunned some market players. “It was mind-blowing that his testimony was saying, ‘We’re not here to negotiate,’” says Hans Humes, president and chief investment officer at Greylock Capital Management, which also invests in distressed country debt. “I think that was really critical to them losing the case — though they appealed and won.” (Sweet’s ruling was overturned on appeal in 2000, and Singer ended up victorious, with a $58 million payday on debt it bought for $11.4 million.)

Despite the eventual win, Singer decided to go undercover with his next, much bigger, haul in the debt of Argentina.

As that country was heading toward what seemed an inevitable default on some $82 billion in sovereign debt in 2000, Singer created a Cayman Islands company, NML Capital, that would buy the bonds as they collapsed in value. After their default in 2001, the majority of bondholders quickly agreed to a draconian haircut to restructure the debt, but Singer wouldn’t go along. He dismissed the settlement as a puny one being crammed down investors’ throats, say people familiar with his thinking, and in 2003 NML sued Argentina to be repaid in full.

Further Reading: Paul Singer Is the Last Hedge Fund Pitbull

Singer’s choice to use a shell company was not, as some have speculated, to avoid paying taxes via an offshore vehicle, or as a structure to divvy payments among the principals. After all, the ultimate owners of NML’s Argentina debt were Elliott Associates, Singer’s oldest fund, which pays U.S. taxes, and Elliott International, his offshore vehicle geared toward foreign investors and pension funds that don’t pay U.S. taxes anyway.

“The idea was to take hedge fund politics out of the equation so that the focus was on the legal merits of the case and not on the identity of the hedge fund,” says a person familiar with Singer’s thinking.

Elliott and Singer declined to comment, but that explanation may be the most transparent answer ever given for a hedge fund’s subterfuge, given the delicate political and moral issues surrounding these investments.

Yet NML was all for naught. Elliott’s ownership eventually came out in court; politics could not be avoided. What instead happened was a 13-year drama played on the international stage, with its protagonists a right-wing American über capitalist (Singer) and a left-wing authoritarian Peronist (Argentina’s then-president Cristina Fernández de Kirchner), extensive congressional lobbying on Singer’s behalf, and a trip to the U.S. Supreme Court, which eventually ruled in Elliott’s favor.

The only default that threatens to rival the politics of the Argentine drama is the ongoing fracas over $74 billion in defaulted Puerto Rico debt that began to take shape in 2015, when then-governor Alejandro García Padilla boldly proclaimed, “The debt is not payable.”

Hedge funds, it turned out, had gobbled up Puerto Rico debt assuming it was a sure thing. Their reasoning was that, unlike other issuers of municipal debt, under U.S. law Puerto Rico couldn’t file for bankruptcy. DCI Group, the same lobbying group that had worked for Singer and other Argentina bondholders, fought hard to keep it that way.

But Puerto Rico is not like Argentina in one critical way: Its residents are also U.S. citizens.

In 2016 the U.S. Congress finally enabled the island commonwealth to declare bankruptcy. Puerto Rico did just that. Now payments of debt and principal have ceased as lawsuits with several groups of competing bondholders are winding their way through the courts even as the island struggles to recover from the devastation of Hurricane Maria.

In both of these highly charged cases, powerful hedge funds — Singer’s Elliott in Argentina and Seth Klarman’s Baupost Group in Puerto Rico — tried to hide their ownership of the beleaguered debt and their attempt to wrest payment from desperate creditors. The stories behind their efforts at secrecy shed more light on why such opacity is prized by the hedge funds, equally abhorred by their opponents, and often ultimately unsuccessful in shielding funds from public censure.

In fact, sometimes the attempt to hide only makes things worse.

Elliott’s lawsuit against Peru, including Singer’s stunning comment, has largely been forgotten. But the details revealed in that case show precisely why a hedge fund would prefer to be secretive in a high-profile lawsuit against a debtor — particularly in a case where an entire country’s future is at stake.

Multibillion-dollar hedge funds run by billionaires know they do not make for sympathetic plaintiffs. Yet seldom have their tactics been attacked as bluntly as by the federal judge who ruled against Elliott in that case.

Judge Sweet based his Peru decision on a New York law that outlawed claims by those who’ve bought the debt for the express purpose of bringing a lawsuit — a practice called “champerty” that dates to medieval English common law. It was the crux of Peru’s defense.

The judge laid out the past of Elliott portfolio manager Jay Newman, who had convinced Singer to take on Peru. Newman had a long history of trading sovereign debt, refusing to go along with any restructurings, and suing to collect, Sweet detailed in his opinion. After stints on Wall Street trading floors, Newman had run an offshore company named Water Street Bank & Trust, which bought the sovereign debt of Poland, Ecuador, Ivory Coast, Panama, and Congo and filed lawsuits against each of those sovereigns seeking full payment. But when the judge in the Panama case demanded the names of Water Street’s investors, they balked, Water Street closed up shop, and in 1995 Newman went to work with Singer.

“Jay felt he had to associate with someone who was not going to be embarrassed by this kind of activity, and Singer said, ‘I’m not embarrassed,’” says Lee Buchheit, a partner at Cleary Gottlieb Steen & Hamilton who has represented several countries, including Iceland and Greece, in their debt restructuring negotiations with bondholders.

The judge detected a pattern. “Elliott purchased the Peruvian debt with the intent and purpose to sue,” Sweet concluded. “This purpose and intent can be determined from Elliott’s investment strategy, the resumes of the individuals assembled for the Peruvian debt project . . . the absence of credibility to Elliott’s alternatives, and Elliott’s conduct subsequent to the purchases.”

While Elliott’s case against Peru was pending, the firm was busy lobbying the New York state legislature to change the champerty law, according to Peru’s lawyer Cymrot, who says the effort fell short when it was pointed out that the anti-champerty lobbying was designed to win a hedge fund’s lawsuit.

But then an appeals court tossed out the Peru case, stating that champerty did not apply because “the accused party’s ‘primary goal’ is found to be satisfaction of a valid debt and its intent is only to sue absent full performance.” (In 2004 the state legislature finally amended the champerty statute so it would only apply to cases under $500,000. Never again would Singer have to worry about that law.)

The battle with Peru weighed heavily on Singer’s mind when he began to buy up Argentina debt. “Because of Peru, it would be potentially problematic for the government of Argentina to sit down with Elliott Associates,” says an individual familiar with the firm’s thinking. He says Elliott hoped to work out a deal behind the scenes. “NML doesn’t make any headlines in Argentina.”

For a time the NML camouflage worked well. “No one knew who they were; the name was not familiar,” says one attorney close to the case. “For at least a year and a half they were completely incognito.”

But by 2005, Argentina’s attorneys suspected Elliott was behind the lawsuit, given the use of legal arguments similar to those used in the Peru case. As the Elliott connection was unveiled through discovery, the hedge fund’s lawyers insisted the information be kept under seal. In one hearing, Jonathan Blackman, the Cleary Gottlieb partner representing Argentina, let Elliott’s name slip in open court. The hedge fund’s lawyers were furious: It was clear that Argentina had no interest in protecting Elliott’s privacy, and it would go on to use its name, and Singer’s, to rail against the “vultures.”

The lawsuit against Argentina shut out its access to the capital markets and eventually led to another Argentina default. Finally, in 2016, after Argentina had elected a new government, the two sides reached a settlement. Singer and the hedge fund “holdouts” that joined him, including Aurelius Capital Management and Davidson Kempner Capital Management (via a fund called Blue Angel Capital), won big, getting 79 percent of the total claim, which included principal, interest, and penalties. Though the investment took more than 15 years to pay off and likely cost hundreds of millions of dollars in legal fees for the hedge fund, Elliott earned $2.4 billion. The bonds had an estimated face value of more than $600 million, which Elliott had purchased for an estimated 20 to 25 cents on the dollar.

Newman retired, and Elliott appears to have lost its appetite for sovereign debt battles, but Singer’s reputation only grew: He was, all at once, possibly the most hated man in Argentina and admired as the most ferocious of global hedge fund managers, giving him an edge as he moved into other investment arenas, especially shareholder activism. Elliott Management Corp. now has $35 billion under management to make it one of the most powerful funds in the world.


Paul Singer.

While a tough-guy image might help Singer, it isn’t one that would likely benefit Baupost’s Seth Klarman, which makes the exposure of his investment in beleaguered Puerto Rico debt something of a millstone. It is also unclear whether Klarman will make the type of mouthwatering returns that Singer earned in Argentina. Last year, Baupost’s Puerto Rico investment dragged down its returns, which were between 5 and 6 percent as Hurricane Maria pummeled the bonds’ prices.

A big problem for Klarman is that Baupost’s investors are quite different from Elliott’s.

They are largely endowments and charities, including Ivy League universities like Harvard and Yale. With that investor profile, Klarman is loath to go on the attack in such controversial situations. Of all the foreign hedge funds, Baupost owned the most defaulted bank debt in Iceland, purchased through a number of secret funds. But it never was involved in the country’s negotiations with the banks’ hedge fund creditors. (For more, see Part 1.)

Something similar happened in Puerto Rico, where Baupost took a nearly $1 billion stake, via ten shell companies named Decagon Holdings 1 through 10, to become the second-largest bondholder and party to one of the most contentious lawsuits swirling around the bankruptcy. But Baupost was not on the bondholder group’s steering committee, and when the attorney for the group testified before the House Committee on Natural Resources in April 2016 — before Puerto Rico filed for bankruptcy — he named only four hedge funds as clients, none of them Baupost, notes Kevin Connor, co-director of the Public Accountability Initiative, a nonprofit research organization focused on corporate and government accountability.

“Baupost and Klarman were perhaps seeking to hide their involvement from the rest of the market and avoid the reputational damage associated with aggressively trying to extract bond payments from Puerto Rico,” reckons Connor.

Connor, who helped track down the Decagon/Baupost connection, says a 2017 court filing finally revealed that ten parties to the litigation called Decagon — the name for a ten-sided polygon — were heavy investors in Puerto Rico debt. “But it was a complete mystery as to who was behind them,” he says. A Delaware LLC filing indicated the ten funds were all created the same day: August 4, 2015.

That was long before the bankruptcy filing and the hurricane. But the island’s finances were already sinking, and so were the bonds. The governor had just indicated that a default was looming, and the type of bonds Baupost had bought, called Cofinas, were securitizations of a slice of the island’s tax revenues that were controversial even when they were created. Other Puerto Rico bondholders would soon claim they were illegal.

The Delaware Decagon filing gave no indication as to the real owner, and by the time online media outlet The Intercept broke the news of Baupost’s ownership in October 2017, Hurricane Maria had so devastated the island that activists in Puerto Rico and the mainland U.S. were calling for the cancellation of the debt. Soon after the report came out, Klarman sent an email to Baupost investors acknowledging the investment and insisting that canceling the debt was not an option.

“Expunging the debt would almost certainly eliminate any ability the commonwealth would have to borrow money in the future at reasonable rates, which will be critical to the island’s rebuilding efforts,” Klarman wrote.

Since then activists have raised a ruckus, and the secrecy Baupost hoped would protect its investment has been used as a truncheon against the $30 billion hedge fund.

A letter signed by 25 organizations, led by the Hedge Clippers community and labor activist group, was sent to 18 university endowments that are Baupost investors, claiming that “Seth Klarman is a particularly egregious actor in the Puerto Rican economic crisis due to his decision to use an elaborate network of shell companies in order to keep the public, and presumably investors, from knowing about his dealings on the island . . . the company’s extreme opacity with respect to these investments is unacceptable.”

Baupost’s focus on endowments as clients has given the activists an opening.

University endowments aren’t entirely bound by the profit motive, and their higher moral purpose has enabled them to lead the way in divestiture campaigns in everything from South Africa and private prisons to tobacco and fossil fuels. As a result, Puerto Rico activists are finding a sympathetic ear among students as protests at Harvard, Yale, and Cornell have targeted Baupost’s investment.

Students at Yale, which has about $835 million in Baupost, have been particularly responsive.

“There’s been an appetite on campus for a long time for holding Yale accountable on what it is doing with its investments,” says Charles Decker, a political science Ph.D. candidate and vice president of research for Unite Here Local 33, Yale’s graduate employee union. With the level of human suffering in Puerto Rico, it would be unconscionable for “elite universities” to profit rather than take up the challenge to help, says Decker.

Baupost is one of Yale’s top asset managers by allocation, and Yale’s famous CIO, David Swensen, sits on Baupost’s advisory board. “Given that relationship, Swensen is in a position to tell his managers to cancel the debt,” argues Decker.

Swensen did not respond to a request for comment. But Jonathan Macey, a Yale law professor who heads Yale’s Advisory Committee on Investor Responsibility, which looks into questions of social responsibility in the university’s investments, brushed aside the concerns, saying the matter is being appropriately handled through the bankruptcy court. “It’s not within Yale’s power to cause Baupost to decline to accept interest and principal payments.”

For his part, Klarman has tried to strike a conciliatory tone, acknowledging that the debt is likely to get a bigger write-down than initially expected. (Baupost is not demanding to be paid in full, as some of the protesters have inaccurately claimed.) Through a spokeswoman, Klarman says Baupost is “committed to being a constructive partner in a restructuring that results in a fair outcome for all parties, including the people of Puerto Rico.”

That isn’t stopping the activists intent on pulling back the curtain they believe has been used to shield Yale — among other universities — from uncomfortable questions about how it is investing alumni money.

“The question is not whether they are hiding any investments from Yale, but whether they are hiding them for Yale,” says Decker. “Did Baupost set up opaque investment vehicles to shield its limited partners from headline risk?”

The answer to that question is no doubt another secret Baupost would like to keep.