THE CRISIS IN CAYMAN

October-November 2009

 

This tiny island territory has made itself one of the world's biggest financial centers, but now it's coming under attack from politicians on both sides of the Atlantic. Can the Cayman Islands survive the storm?

“Welcome to another day in paradise,” the customs official at Grand Cayman’s Owen Roberts Airport tells me. He sounds unconvinced, as you might expect from someone who says “welcome to another day in paradise” every two minutes or so. The man stamps my passport, and I walk past a sign denoting a long list of acts banned in the Caymans—“riotous behavior” and “looking disrespectfully at a woman” among them—into a paradise more troubled than its sundrenched surface would suggest.

I am here for work, though Grand Cayman—one of three Cayman islands along with the sparsely populated Little Cayman and Cayman Brac—seems too idyllic a place for that. Cayman, as locals call the three, has pristine beaches, crystal-clear waters and close-to-shore reefs that make it one of the Caribbean’s most popular dive sites. About 150 miles south of Cuba, Grand Cayman is a 60-minute flight from Miami, and cruise ships carrying 1.5 million passengers a year moor a few hundred yards off George Town, Grand Cayman’s cozy capital. During the day, thousands of hungry Americans bum-rush the streets of George Town, impatient to throw dollars at t-shirts and trinkets.

The tourists amble past nondescript office buildings that house Cayman’s other big business:money. Some 9,000 hedge funds, reportedly half the hedge funds in theworld, are based in George Town.There are almost 300 banks here which, before the global downturn, contained some $2 trillion in assets. (The numbers now are uncertain but surely smaller.) There are also billion dollar businesses in reinsurance, captive insurance and ship registration. Cayman constitutes about 100 square miles and has a citizenry of some 25,000 people—non-citizen residents make up another 25,000—but this small island territory is one of the world’s financial powerhouses.

Why? Cayman, a British crown colony whose governor is appointed by the queen, has a stable legal system rooted in British common law, a sophisticated regulatory framework, strong (some say too strong) confidentiality laws, trained financial professionals and a passionately probusiness government.

But the lynchpin of Cayman’s success is what Cayman doesn’t have: taxes. Imported goods are slapped with a duty, usually 20 percent of their cost, and the government collects licensing and transaction fees. That, however, is it. There is no income tax, no capital gains tax, no inheritance tax, no tax on corporate profits …. As a result, Cayman has proved irresistible to individuals and corporations around the globe looking to avoid taxes in their home country. “The Caymans have historically been a clearinghouse for people who want to hide things,” one financial investigator told me. “The Russian Mafia, the Italian Mafia, the Triad, crooked business people ….” In years past travelers of ill repute would land at Owen Roberts lugging suitcases filled with cash.

Caymanians and their defenders insist that such skullduggery was an unfortunate consequence of a young industry’s growing pains. “There is no dividend you can reap as a banker now that will be worth what will happen to you if you get caught” laundering money, argues Chris Mathers, author of Crime School: Money Laundering. “The Caymans are an extraordinarily well-run marketplace,” adds Steve Crosby, co-author of a 2009 global wealth survey published by PricewaterhouseCoopers, which has a branch in Cayman. “There will always be a need for offshore financial institutions. There are people in marketplaces that they deem unstable, and they want to manage their wealth in another jurisdiction.”

But the practice that really infuriates many Cayman critics ismore systemic: the creation by foreign firms of Cayman-based corporations in order to avoid taxes on overseas revenue. The Cayman corporations are little more than computer files. One innocuous George Town building, known as Ugland House, home of the law firm Maples and Calder, is the registered office of about 19,000 of them, including roughly 1,000 owned by American firms. At UglandHouse, the companies receive mail, maintain records and file forms—and that’s all they have to do. As a 2008 report by the U.S. General Accounting Office put it, “Cayman Islands law does not require or presume that any other business activity of the corporation occurs at the registered office.”

 In recent months, foreign politicians have begun fiercely criticizing Cayman. Their intention? To level the regulatory playing field and reduce domestic deficits. During his 2008 campaign, Barack Obama blasted Ugland House as “the biggest tax scam on record,” and his 2010 budget calls for raising $210 billion from offshore tax havens. Michigan senator Carl Levin is pushing the “Stop Tax Haven Abuse Act,”mandating that any American who transferred an asset to Cayman would be presumed not to have reported it to the IRS. The law, which also stipulates that the United States could tax Cayman-based corporations with U.S. owners, would devastate Cayman. (Montana’s Max Baucus has proposed a milder alternative requiring IRS notification upon transfer of assets to Cayman.) Meanwhile, the global financial crisis has hit Cayman so hard that some British politicians are saying it’s time for the territory to impose taxes.

Anxious Caymanians are fighting back. “It is a cheap political shot to say how much better the world would be if offshore ‘havens’ were outlawed,” argues Anthony Travers, chair of the Cayman Islands Financial Services Association, a trade group. CIFSA has hired Washington lobbying firm Quinn Gillespie & Associates to make Caymans’ case on Capitol Hill. “President Obama has his facts wrong,” says firm head Jack Quinn. “That there are many businesses registered in a single place has nothing to do with whether they are paying their fair share of taxes.”

Christopher Columbus discovered Cayman on May 10, 1503, on his fourth and final voyage to the New World. His son Ferdinand, a crew member, remarked that so many turtles swam about them, the sea “seemed to be full of little rocks.” Columbus dubbed the islands “Las Tortugas”—the name didn’t stick— and kept sailing. The first European probably didn’t land in Cayman till Sir Francis Drake stepped ashore in 1586. In 1655 England seized Jamaica from Spain and, for good measure, claimed Cayman as well.

Truth be told, the islands weren’t very inviting. Little Cayman and Cayman Brac were too small to support much life, and Grand Cayman wasn’t exactly the Garden of Eden. Then as now, the island—as opposed to the sea around it—lacked natural riches or beauty. It is flat. It has no fresh water other than rain. Little can grow in its shallow soil. Today its main product is rum cake, peddled to tourists in George Town.

For most of the past four centuries, Caymanians eked out a living from turtles, shipwrecks, rope making and a little shipbuilding. Cayman men began enlisting in the U.S. merchant marine during World War II, sending remittances home. But as late as the 1960s, Cayman was not exactly thriving.

Between around 1960 and now, however, Cayman left behind centuries of hardscrabble existence to become an economic miracle: It has the highest standard of living in the Caribbean. As a practical matter, unemployment doesn’t exist; the islands have more jobs than citizens. “If you’re a college-educated Caymanian and you want to work in the finance industry, you pretty much have a job for life,” one American businessman living in Cayman told me.

For 300 years the residents of Cayman had survived by living off what the wind and the currents brought them, yet the islands had remained poor. What changed? Cayman learned how to exploit a different current: the globalization of finance.

To understand just how Cayman did that, I visited James Bergstrom, managing partner at a law firm simply called Ogier. Located in the new development of Camana Bay, the firm also has branches in Bahrain, the British Virgin Islands and Jersey, among other tax-friendly sites. Its motto: “Excellence. Offshore.”

Bergstrom had just wrapped up a deal involving companies from Chile, Germany and the U.S. None of the parties wanted to sign “in someone else’s home port,” Bergstrom said, fearing that the laws of a home country would create an unfair advantage. “So they do it offshore,” he said. “And if they’re going to do it offshore, they’re going to do it in Cayman.”

Bergstrom, 41, was born in George Town, but his father, Eric, hailed from Wisconsin. Eric Bergstrom left the States for Cayman in the early 1960s and opened a 14-room resort called the Tortuga Club before founding the department of tourism. “The island was fairly basic then,” Bergstrom recalled. “The roads would flood during the rainy season, and the school system wasn’t so great.” Most important, “there was a constant struggle to find a source of income for the island.”

Inspiration came from neighbors Bermuda and the Bahamas, already hanging out shingles as safe places for foreign money. Cayman, which didn’t even have a bank until Barclays opened a George Town branch in 1953, followed suit, creating regulatory authorities and a depositor friendly legal structure. Over the years, Cayman had competitive advantages. It didn’t go independent, like the Bahamas, making investors nervous. It was less restrictive than Bermuda. And it wasn’t plagued with corruption, like Jamaica.

True, there were those suitcases. “In the late ’60s, early ’70s, much of Caymans’ reputation was deserved,” Bergstrom said. But in 1986, Cayman entered into a mutual assistance treaty with the U.S., “and slightly nefarious activities were just eradicated eradicated.” Now, “there’s no objection to providing the IRS with any information it needs to nab tax cheats, but I don’t think they’re going to find anything here.”

There’s evidence to back up at least some of that statement: The GAO report concluded that “U.S. officials consistently report that cooperation by the Cayman Islands in enforcement matters has been good.” This summer the Organisation for Economic Cooperation and Development, a powerful international group, removed Cayman from its “grey list” of tax havens due to its willingness to cooperate with international tax authorities.

So why is Cayman still associated with bad behavior? I asked Bergstrom. “John Grisham,” he said. It’s a response I heard repeatedly: Grisham’s The Firm, and Sydney Pollack’s 1993 film, portrayed Cayman as a haven of Mob money where a naïve Tom Cruise was seduced on Seven Mile Beach, then blackmailed. “They want to kill John Grisham here,” investigator Chris Mathers told me. “There was a stage where every spy novel featured a reference to the Caymans,” a frustrated Bergstrom added. If so it isn’t over yet: Cayman plays an unscrupulous part in Stieg Larsson’s new bestseller, The Girl with the Dragon Tattoo.

Still, Bergstrom said, the real threat to Cayman isn’t pop culture or toughtalking politicians. “The real risk to our A couple of days after returning to New York, I went to see Bergstrom again. He was giving a talk at the London Hotel on West 54th Street. His subject: “The Evolution of Offshore Investment Funds.” About 75 people—lawyers, mostly—were on hand. “What is a tax haven?” Bergstrom asked. He listed some characteristics—no exchange of information with regulatory bodies, a lack of transparency. Cayman, he insisted, did not fit the bill.

In a couple of hours, Bergstrom would be on a British Airways jet to the real London to deliver the same message. Paradise, it seemed, requires a lot of work.

 By Richard Bradley