Set Adrift - Navigating the Weavering Ruling

CAYMAN COURT CONFIRMS PROPER CORPORATE GOVERNANCE REQUIREMENT

On 26 August 2011 the Financial Services Division of the Grand Court of the Cayman Islands found that two former directors of a Cayman Islands’ registered fund, the Weavering Macro Fixed Income Fund Limited (the “Fund”), had acted in wilful neglect or default of their duties as directors and as a result were ordered to pay US$111m in damages to the liquidators of the Fund. A copy of the full judgment is attached for your reference.

This judgment is of key importance for all hedge fund industry participants given the organisational structure adopted by the Fund was considered to be quite standard for an open ended Cayman Islands investment fund, with the exception of the fact that the directors were held out to be independent non-executive directors despite the fact that they were relatives of the investment manager. The judge reached the conclusion that both of the non-executive directors were guilty of “wilful neglect or default” as the presented evidence indicated that they consciously chose not to perform their duties in any meaningful way. This was evidenced by the fact that they apparently signed documents that were put in front of them, including standard form minutes of meetings, financial statements, management representation letters, side letters and other documents, without any enquiry or proper consideration.

This highlights an issue that we at Harbour have noted for some time, namely that strong and effective corporate governance is of great importance. Investors, regulators and creditors are ever more demanding the presence of an active and independent board of directors to oversee fund activities and protect their interests. Of course having a high standard of corporate governance also benefits investment managers, as a board consisting of experienced industry professionals familiar with current issues can skillfully guide a fund’s team of service providers through matters that arise.  

While the judgment leaves certain important questions unanswered, in particular with regard to the duty of care owed by service providers, we do believe it provides valuable insight and that anyone serving as a director of a Cayman Islands fund, or managing such a fund, should make themselves aware of the details of the ruling. In particular, we have summarised below some of the specific responsibilities the judge identified as being required in order for a director to discharge their mandated supervisory role.

Director Responsibilities

The Cayman Islands investment fund industry operates on the basis that a fund itself does not have any employees and therefore the investment management, administration, and accounting functions are delegated to professional service providers.  As such, a fund’s directors exercise a supervisory role, which should include:

  1. Satisfying themselves that the fund’s offering document is accurate and complete, and complies with the requirements of the Mutual Funds Law, including a proper description of the rights of participating shares as well as including all other relevant information necessary to enable a prospective investor to make an informed decision on investing.  
  2. Satisfying themselves that the overall structure of the fund is consistent with Cayman Islands industry standards and that the terms of the service providers’ contracts are similarly reasonable and consistent with industry standards and the planned operations of the fund. 
  3. Ensuring that the investment manager is complying with the investment criteria and restrictions disclosed by the fund.
  4. Acquiring an understanding of the investment and trading activity.
  5. Satisfying themselves that the service providers are performing their functions in accordance with the terms of their respective agreements and that all necessary functions are being carried out.

The judge also noted that where board meetings are used as a means of discharging supervisory obligations, they need to go well beyond simply signing standard form minutes without appropriate consideration. Specifically, the following points were considered essential:  

  1. That an agenda detailing matters for discussion be prepared and circulated in advance of each meeting, which includes input from the investment manager, other service providers and the directors themselves. 
  2. That the directors review recent financial reports at each meeting and that the administrator participates (at least  occasionally) to answer questions that arise.
  3. That directors obtain comfort that the investment manager has met the investment criteria and restrictions detailed in the offering memorandum. Directors may rely on the investment manager in this regard, so long as this function has been delegated to someone who understands the criteria and is performing the appropriate analysis. 
  4. Minutes should be taken that fairly and accurately record the matters considered and the decisions made.  
  5. Once finalised the minutes should be signed and filed in the fund’s minute book.

The ruling further noted that if the directors of a fund accept responsibility for its financial statements, evidenced by signing the financial statements and corresponding management representation letter, then they also need to:

  1. Read and review the financial statements and have a basic understanding of the audit process.
  2. Satisfy themselves that the financial statements present fairly the fund’s financial condition by way of conversations with and obtaining information from the investment manager and administrator. 
  3. Query the auditors about any issues which may have arisen during the course of the audit and the way in which they were resolved. 

Finally, the ruling noted that directors should pay particular attention to items such as side letters, which can potentially provide certain investors more favorable terms, as well as consider the impact of significant external events, such as the 2008 financial crisis, and provide additional oversight as necessary.

The Weavering Judgment provides us with useful guidance on what the courts view as proper discharge of directors’ duties.  We at Harbour continually assess and develop our policies and procedures in order to comply with relevant legal standards and industry best practice.  If you have any questions or comments about any of the above we would be more than pleased to discuss with you at your convenience.

pdf Click here to download the Weavering Ruling