Caymanian Leaders Excel at Pimping out Their Country

WILLIAM E. GRAYSON, the president of EGM Capital, a hedge fund firm in San Francisco, has never set foot on the Cayman Islands, but he knows that sun-baked Caribbean haven quite well. That’s because he set up one of his funds in the Caymans, where lucrative tax breaks and fabled financial secrecy have made this British territory a magnet for hedge fund managers.

“All of the offshore jurisdictions are competing against each other to provide the most hospitable regulatory landscape, and the Caymans are really coming on strong,” Mr. Grayson says. “As a hedge fund manager, you just might be deciding whether you want to golf or scuba-dive more.”

In as little as two weeks, and for about $35,000 in fees, hedge funds can set up shop in the Caymans — just a fraction of the time and up to one-tenth the price of incorporating a fund in drearier climes like Delaware.

While speed and bargain prices are big attractions, the real draw, say analysts and Congressional investigators, are perfectly legal Caymans-based corporations and partnerships that allow major investors to avoid taxes of up to 35 percent that the Internal Revenue Service levies on unearned business income. Cayman tax laws also help American fund managers legally defer domestic taxes on their personal profits by channeling them offshore through their funds.

The biggest of the three islands that make up the Caymans, Grand Cayman, is only 22 miles long and, at its widest, 8 miles across. But the territory’s tax advantages have turned it into one of the linchpins of the estimated $1.5 trillion global hedge fund business.

“So many of the best money managers have set up in the Cayman Islands,” says Kurt N. Schacht, managing director of the CFA Centre for Financial Market Integrity, a nonprofit research organization in Charlottesville, Va. “It has become the place to go.”

As recently as a decade ago, regulators and law enforcement officials regarded the Caymans, an outpost 480 miles south of Miami that once served as a shelter for pirates like Blackbeard, as a hotbed for money laundering and other dubious financial schemes. Today, it is the corporate home for what the Cayman Islands Monetary Authority estimates to be three out of every four of the world’s hedge funds — more than anywhere else — thanks to its friendly tax and regulatory regimes, as well as an army of foreign bankers, tax lawyers, accountants and fund administrators who make it all work.

“With some of the other jurisdictions, there’s an island mentality,” says Michelle Kline, a principal at Genesee Investments, a hedge fund based in Bellevue, Wash. “The thing that’s different about Cayman is that the regulators realize that hedge funds are a business, rather than just something to regulate.”

For their part, Cayman officials, regulators and private-sector lawyers, bankers and accountants say that there is nothing illegitimate about how the territory supports offshore finance, and that it is a system that is unfairly tarred and much misunderstood by its critics.

True, “we’re not a widows-and-orphans jurisdiction,” says Ted Bravakis, the director of public relations in the Portfolio of Finance and Economics, a Cayman government agency that helps to oversee financial services there. But, he adds, “the Cayman Islands sees the use of our jurisdiction and service providers by U.S. entities and individuals to avoid their tax responsibilities as abusive — we feel equally abused because our regime is not intended to be used in that way.”

The Caymans’ ascent as a hedge fund haven coincides with recent calls by American legislators for greater oversight and taxation of hedge funds — lightly regulated, secretive investment pools for wealthy individuals and institutions — as well as greater scrutiny of the tax status of private equity firms.

As legislators like Senators Carl M. Levin, Democrat of Michigan, Charles E. Grassley, Republican of Iowa, and Max S. Baucus, Democrat of Montana, also make renewed calls for a broader crackdown on financial abuses in offshore tax havens, the Cayman government has continued spending heavily on high-profile lobbyists, public relations firms and well-connected lawyers to persuade the world’s senior financial officials and regulators that the Caymans has outgrown its past as a center of financial high jinks.

During the spring, Cayman representatives lobbied the Securities and Exchange Commission, aides and members of the Senate Banking Committee, tax policy officials of the Treasury Department, and the office of Vice President Dick Cheney in an effort to foster the impression that the island territory has remade itself into a law-abiding, smoothly run financial supermarket.