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July 15, 2008

E&Y Cayman Islands cleared of wrongdoing in hedge fund case

A New York State Supreme Court judge has dismissed claims brought against Ernst & Young Cayman Islands (E&Y) by the liquidators of a defunct hedge fund that “imploded” in 2002.

The liquidators claimed the Big Four firm performed a deficient audit and was negligent in failing to detect the investment managers’ fraudulent valuation and alert the directors, thereby causing the fund’s losses.

The hedge fund, Beacon Hill Master, lost nearly half its net asset value in the collapse which resulted in a Cayman Islands court appointing Theo Bullmore and Phillip Stenger as liquidators in 2004.

In 2002, the US Securities and Exchange Commission (SEC) commenced an action against the investment managers for securities fraud. In March 2005, the liquidators launched a motion against the investment managers, E&Y and the fund’s administrator ATC Fund Services (Cayman) Limited. All of the defendants settled with Bullmore and Stenger with the exception of E&Y.

E&Y conducted the fund’s only audit, based upon a three-month period between 2 January and 31 March 2002. E&Y issued a “clean audit report”.

In a court document, E&Y contended, among other things, the “joint official liquidators failed to demonstrate E&Y proximately caused the losses, because the ill-fated act that ultimately caused the fund to implode was a poorly-timed bet on the direction of interest rates by the investment managers, made after E&Y issued its report”.

Judge Charles Ramos dismissed the proceedings against E&Y on 24 June.

In his ruling, Ramos noted the undisputed evidentiary record demonstrated the directors ceded control of the fund to the investment managers and permitted them to operate the fund with impunity until they were removed by the SEC. Ramos said that the directors appeared to have ignored their own responsibilities to the fund by failing to review the financial statements, despite attesting to their accuracy in the representation letter.

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