Oceanic Bank and Trust Ltd v M J Select Global Ltd; M J Select Global Ltd v Oceanic Bank and Trust Ltd et Al

• Jurisdiction: Bahamas
• Judge: Lyons, J.
• Judgment Date: 02 December 2005
• Court: Supreme Court (Bahamas)
• Docket Number: 180 of 2005
• Date: 02 December 2005

Supreme Court

Lyons, J.

180 of 2005

Oceanic Bank and Trust Limited

and

M J Select Global Limited

M J Select Global Limited

and

Oceanic Bank and Trust Limited et al

Appearances:

Ms. B. Dohmann, Q.C. with Mr. M. Barnett for the plaintiff.

Mr. S. Hofmeyr, Q.C. with Mr. E. Knowles for the defendant (plaintiff by counterclaim).

Mr. A. Malek, Q.C. with Mr. H. Tynes, Q.C., and Ms. N. Tynes for the defendant by counterclaim.

Company law - Liquidation — Mutual investment fund — Whether directors failed to maintain adequate control over the fund — Collapse of the fund — Whether directors' negligence caused the collapse.

1 (1) Lyons, J. This case concerns issues of diligence, vigilance, honesty, integrity, a responsibility to the maintaining of the rule of law and the pursuit of truth.

2 (2) The plaintiff (“Oceanic”) is an offshore bank and trust company situated in the Bahamas. It was incorporated pursuant to the prevailing Banks and Trust Companies Regulation Act (1965) (“B&TC Act”) on 15 March 1982. It remains so incorporated under the present B&TC Act 2000 (Ch. 316).

3 (3) In February 1994, Michael Coglianese (Coglianese) instructed David Lunn of Rawson Trust Company Limited, (Rawson Trust) to form an international business company (IBC), MJ Select Global Limited (“The Fund”). (Rawson Trust subsequently became New World Bahamas Trustees Limited, (“NWBTL”), which subsequently became Oceanic Bank and Trust Limited. (“Oceanic”).

4 (4) Rawson Trust was a registered Trust Company situate in the Bahamas. Lunn was its senior officer. Coglianese was an accountant from Illinois, U.S.A. He had previous dealings with Rawson Trust and was known to them. For his Bahamian business, Coglianese operated through Commodity Compliance Services Inc, (CCSI) a Bahamian IBC.

5 (5) Lunn was instructed to provide directors for the Fund and open a bank account at Barclays Bank.

6 (6) By 7 February 1994, the Fund was incorporated. Its authorised share capital was 5000 shares set at par value $1 (U.S.) per share. Some 30,000 or more shares were actually issued. The initial subscribers were two Rawson Trust controlled companies (Rawson Nominees Limited and Dahlia Nominees Limited). Two other Rawson Trust controlled companies Pantilles SA and Falkirk SA (“Pantilles” and “Falkirk”) were appointed directors with Pantilles being appointed corporate secretary.

7 (7) The bank account was opened with Barclays as instructed. The authorised signatories to that account were employees of Rawson Trust.

8 (8) By virtue of their prior business dealing with Coglianese, it must have been obvious to Rawson Trust, that the Fund was to be an investment fund, promoted by Coglianese and his affiliates, designed to attract investors from U.S., Europe and elsewhere, and using the jurisdiction of the Bahamas so as to benefit from certain income tax advantages.

9 (9) And so it was.

10 (10) By late November (the 24) 1994, the Offering Memorandum (“OM”) of the Fund was produced. Copies were forwarded to Rawson Trust.

11 (11) As best as I understand it, the OM was produced by Coglianese or his affiliates. Rawson Trust did not have a hand in its production.

12 (12) By virtue of the OM, the Fund sought subscriptions in the sum of $100,000 (US$) or greater (subsequently increased to $500,000 or greater). It was to invest in high risk, highly leveraged securities and other financial instruments using “a market neutral trading approach that utilises arbitrage trading strategies”.

13 (13) Mr. David Croft (a financial markets expert called by the Fund) explained this strategy as follows.

“…

Market neutral trading strategies are essentially the taking simultaneously of a long and short position in a security or combination of securities which when revalued or realized for cash will result in a net profit, the amount of which is not sensitive to the movements up or down in the price of the security. Hence the term and the description “no directional risk”. In general, the return relies on the existence of a spread, i.e. a small difference in the price of two securities. The prices of the securities need to be highly correlated, i.e. their prices move together. In a sophisticated from it may involve a portfolio of long positions hedged with a portfolio of short positions, which together have only small net risk to normal moves in overall price level of the market. No one pair of securities would hedge each other.

Market neutral strategies are just one of 12 or so categories of techniques employed by hedge funds. Market neutral strategies are sometimes further separated into market neutral –arbitrage and market neutral-hedging. The former attempts to hedge out most market risk by taking offsetting positions, often in different securities of the same issuer. The latter generally invests equally in long and short equity portfolios often in the same sectors of the market and stock picking is essential in achieving meaningful returns. For both the benchmark for the returns is usually treasury bills, Market neutral returns are expected to have low correlation with the returns from equity or bond markets and show low variability in their returns.

It is the case that the high returns with low volatility, uncorrelated with the equity markets attracted many investors and encouraged the launch of many hundreds of hedge funds labeled and packaged as market neutral funds. Within the universe of these lightly regulated funds there has always been a wide variety of risk control, management equality and integrity, and performance.

As prices change and time passes, constant adjustments and rebalancing are required to maintain the overall directional risk at a low level. It is nearly always based on securities or derivative instruments which are liquid, easily transferable, inexpensively bought and sold, and for which the market price is easily observed. This last point enables frequent revaluations to market to be done which enable the calculation of adjustments to the hedge to be made, although nothing is ever perfectly hedged – there is always some degree of residual risk tolerated for a variety of reasons, not least being the practical costs of constantly buying and selling and the approximations involved in the mathematical models used to calculate prices, risk and hedges. How much unhedged exposure is acceptable in part is a function of how closely a fund manages to whatever risk tolerance is implicit or explicit in the investor mandate and objectives it has committed to. Constant minor judgments are needed in the daily execution of the trading positions and hedges required to maintain market neutrality in the targeted range. In my experience there is also a temptation on the part of traders to seek extra return (for which they are rewarded financially) by allowing risks to increase from market neutral levels unless well monitored and controlled by management.”

14 (14) Specific strategies to be used were described in the OM as:

“The Advisor will trade International and U.S. securities, security options, bonds, mutual funds and other related investments following a “market neutral” trading approach utilising arbitrage trading strategies. The Advisor may hire traders directly or participate in their programs through a Fund. Following is a description of the trading strategies and how they will be used.

1) Fixed-Income Securities Arbitrage

The Advisor will trade both U.S. and International fixed-income securities and Eurodollar dollar deposits. The Advisor will trade “spreads” between two or more fixed-income securities of different maturities in order to take advantage of a perceived distortion in the yield curve. The Advisor generally seeks to establish positions that will profit from a favorable change in the price relationships between the corresponding long and short positions, rather than from an outright move in any one position.

2) Synthetic Stock Market Hedge Yielding Program

This program is aimed at participating in the profits to be expected from an increase or decrease in volatility in any stock market (U.S. or International) while hedging against a decrease to the principal investment. The program is structured to yield a return close to or exceeding the risk-free rate of the underlying stock market economy if there is no significant change in volatility. For example, if the program is applied to the U.S. stock market, and volatility does not change, the Advisor expects to earn a rate of return at least equivalent to the U.S. Treasury Bill rate of return. If the Japanese stock market is utilised, and volatility does not change, then the Advisor expects to earn at least the equivalent of the Japanese Euro-Yen market rate of return.

…

With an increase in volatility, and no change in the price of the stock, the Advisor would expect to profit from increasing warrant prices and time decay from the short put options. If the stock price increases, the short stock losses would be covered by appreciating warrants and the collection of put option premium (plus time decay) on the short put options. A falling stock price will yield profit from the short sale of stock and the collection of put option premium. Eventually these gains would be offset by the rising premium of the short put options.

3) Volatility Arbitrage

The Advisor may engage in equity derivatives arbitrage such as a “volatility arbitrage” between international equity warrants and their short-term options listed on foreign markets. The objective is to capture the excess premiums that exist in the call options at times of high volatility expectations. The Advisor will attempt to collect the “overpriced” option premium while at the same time being hedged against market direction risk.

The Advisor will attempt to hedge its investments in securities denominated in currencies other than U.S. dollar through the use of forward contracts and...