Grand Court judgment ‘wake up call’ for fund directors

The Grand Court of the Cayman Islands has found two directors of a Cayman-registered fund guilty of wilful neglect or default in the discharge of their duties and fined each of the defendants US$111 million.

Ogier Cayman brought the proceedings against the directors on behalf of the joint official liquidators of the failed Weavering Macro Fixed Income Fund.

The Cayman fund was listed on the Irish Stock Exchange and the fund’s investment manager, Weavering Capital (UK) Ltd, was incorporated and based in England and controlled by Magnus Peterson.

Typically directors of Cayman Islands investment funds are afforded indemnity covering all losses under the terms of the fund’s constitutional documents, except for losses caused by wilful negligence or default in the exercise of their duties.

The liquidators, David Walker and Ian Stokoe of PwC, sought damages against each director for their failure to take any role in the business of the fund.

The court found that the directors had signed documents that were put before them by the investment manager “without applying their minds to their content”. Although the directors acknowledged that they had a high level supervisory duty, Justice Andrew Jones wrote in his judgment, “They never once, in six years, asked any of those they were supposedly supervising to give them a written report or attend a board meeting to provide them with an oral report”.

‘Their behaviour was wrong’

In addition the court found that the directors Stefan Peterson and Hans Ekstrom, who are the brother and stepfather of the investment manager, “consistently signed financial statements, management representation letters, side letters and other documents without making any enquiry whatsoever”.

The fact that the directors had signed the minutes of two board meetings that never took place “leads unequivocally to the conclusion that they knew perfectly well that their behaviour was wrong”, Justice Jones wrote in his judgment.

The plaintiff claimed that if the directors had not acted wilfully negligent or in default of their duties, they would have discovered that the fund’s transactions involving interest rate swaps violated the fund’s investment guidelines and this would have led much earlier to the discovery that those transactions were in fact fictitious.

The court concluded that the directors’ conduct fell well below what was required of them, and that they were guilty of wilful neglect or default “because they consciously chose not to perform their duties to the fund, or at least not in a meaningful way”.

Ogier noted that although Cayman Islands investment funds may be structured differently than traditional corporate entities, in particular by the appointment of and delegation of powers to services providers, such as an investment manager, the fundamental duties owed by a director of a Cayman Islands investment fund are the same as those duties owed by a director of any other corporate entity.

“The case shows that directors of Cayman Islands investment funds cannot sit idly by, leaving the management and control of the fund to its service providers. A director’s duty to supervise the affairs of the company, and to exercise reasonable care, skill and diligence is non-delegable,” said Shaun Folpp, managing associate at Ogier Cayman who, together with Will Jones, associate, acted for the plaintiff, led by David Lord QC.

“Directors of Cayman Islands investment funds can no longer live under the misconception that they are immune from liability for a company’s losses if they do not themselves take an active role in the company’s business,” added Mr. Folpp.

‘Long time coming’
Former CIMA Chairman Tim Ridley said, “This has been a long time coming and should be a real and final wake up call to those few remaining people, and their insurers, who still think ‘just tell me where to sign’ is good enough.”

Chris Johnson, of business recovery and insolvency firm Chris Johnson & Associates, comes to the same conclusion. “This is a welcome decision and a wake-up call to those in the Cayman Islands that provide directors as a career.”

While Mr. Johnson contends that the legal content of the judge’s decision offers very little new, he says the verdict does serve as a reminder that the onus of responsibility is placed on the shoulders of those who are the guardian’s of investors’ monies.

“During the past few years there have been numerous lawsuits, largely brought in the United States courts, rather than the Cayman court, that have illustrated the recklessness of certain directors, several being local residents, in their governance of hedge funds,” Mr. Johnson said. “This is not only bad publicity for the incumbents, but it reflects poorly on the level of expertise that Cayman prides itself in providing to the funds.

“For those professionals providing directorships to hundreds of companies this is a warning that there may be more bad news to come,” he added.

In a commentary on the judgment, Don Seymour, managing director of fund governance firm dms Management, noted it is the first time the court has dealt with a case specifically involving directors’ duties to a hedge fund, and particularly the blockbuster award of US$111 million in damages “should send a strong message to all recalcitrant directors to either perform their duties and responsibilities properly, or pay a heavy price”.

Mr. Seymour argued that although the verdict will not end the debate, it favours professional over amateur fund governance. “[T]he Court did repeatedly confirm its view that independent directors should perform a “high level supervisory role” in a “professional, businesslike manner”, he said.
 

Folpp

Mr. Folpp
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1 COMMENT

  1. This Is a welcome and overdue development that will do much to allay fears that the Cayman is a flag of convenience only for many funds.

    The Cayman regulators could be more proactive and also require that the register of attendance of board members be submitted regularly and that the minutes of these meetings be available on demand.

    Those funds that do not hold board meetings at least twice a year, which fail to produce board minutes, or those directors who miss more than one board meeting should be named and shamed and or fined.

    This might help to indicate which funds are being adequately supervised and potentially help identify problem funds before they go into liquidation by which time it is generally too late for investors.

    Other initiatives such as the mandatory reporting of any changes in service providers ( lawyers, auditors, custodians, prime brokers etc ) should also be instituted. Too often these service providers quietly
    slip out the door and resign from funds when they see potential trouble brewing rather than blowing the whistle and risking any litigation. Audit reports are these days so qualified in mealy mouthed legalese ( essentially saying we stand by nothing in this report ) as to be virtually useless in identifying problems until it is far too late. It is sad to see how far the once proud auditing profession has sunk in the post Enron / Arthur Andersen world and the extent to which
    accountability is dead.

    The Cayman could provide employment opportunities for suitably qualified people by requiring a minimum of one or two Cayman nationals / residents to be on the board of every Cayman registered company as some other countries have done. In this instance care should be taken that these people do not become rubber stamps and the number of boards upon which they can serve should be strictly limited to no more than 20 or so and ideally even fewer.

    These sorts of further steps would do much to enhance the status and reputation of the Cayman Is. Nonetheless the Cayman courts and Ogier Cayman are to be congratulated on this important first step.

    Kind regards,

    Peter Urbani
    Hedge Fund Professional

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