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, Weavering Macro Fixed Income Fund Limited, had acted in willful neglect or default of their duties as directors. As a result of this judgment, the defendant directors were found personally liable for losses of US$111 million sustained by the fund.
This judgment has served an important purpose in that it piqued broader interest in the subject of corporate governance in the investment funds context, and increased the focus on the importance of fund directors properly fulfilling their high-level supervisory role in the professional and business-like manner that is required.
This has led to increased discussion over the last year regarding possible regulation of the types of persons who may act as directors of Cayman Islands’ domiciled investment funds and the manner in which such directors fulfil their duties.
The role of directors
Under Cayman Islands’ law, the board of directors is the most important decision-making body within the company structure1.
There is no requirement that a director of a Cayman Islands’ exempted company, or even any one director on the board of directors, be domiciled in the Cayman Islands. Accordingly, many directors of Cayman Islands’ funds are not domiciled in the Cayman Islands. It is likely that many have never been to the Cayman Islands.
Notwithstanding this, all such directors are required to understand Cayman Islands’ law in so far as it imposes duties upon them personally.
Whilst a full discussion of directors’ duties is beyond the scope of this article, when we speak of directors’ duties we are broadly referring to the following requirements:
- The directors have a duty to act bona fide in the interests of the company.
- The directors must use their powers for the purposes for which they were conferred and not for a collateral purpose.
- The directors have control of the company’s property and are treated as if they were trustees in their dealings with the company’s property.
- Directors should not put themselves in a position where their interests and those of the company conflict.
- A director owes a personal duty to inform himself about the affairs of the company and to join with his co-directors in supervising and controlling its affairs.
- A director is entitled to delegate tasks and functions to the extent permitted by the articles of association of the company. However, where a task has been delegated, the director remains under a continuing obligation to supervise and control the person to whom that task has been delegated.
Current regulation by the Cayman Islands’ Monetary Authority makes some efforts to ensure that people acting as directors of licensed Cayman Islands domiciled investment funds are fit and proper persons.
In order to ensure that directors of a range of licensed entities including not only mutual funds but also banks, trust companies, securities investment managers and others are fit and proper persons, CIMA requires a completed personal questionnaire, two character references, one financial reference and a police clearance certificate for the individual seeking to be appointed.
However, recent statistics from the CIMA website indicate that there were only 120 active mutual funds licensed by CIMA operating in 2011.
By way of comparison, recent statistics from the CIMA website indicate that there were 8,714 registered funds and 424 administered funds operating in 2011, to which none of the above obligations for a questionnaire or references apply.
In addition, the above statistics only reflect open-ended funds. Beyond the above statistics, there are closed-ended funds (and funds operating under the “15 investor exemption”) for which no statistics are available. The number of such funds is considerable, but, as these funds are not required to register with CIMA, none of the above obligations for a questionnaire or references apply to closed-ended funds.
Accordingly, for the vast majority of Cayman Islands’ domiciled funds, being closed-ended funds or open-ended registered funds, there is currently no pre-appointment “director vetting” process2.
Is this enough?
It could be argued that the vast majority of these registered and administered fund structures are institutional investment products designed for high net worth and sophisticated investors, who should be quite capable of forming their own view as to whether the directors of the fund they are investing in are adequately sophisticated to understand their directors’ duties and to properly fulfil their obligations as directors.
Further, the directors of any investment fund that has retained competent Cayman Islands’ legal counsel should be receiving advice from such counsel, and it could be argued that this is really the most appropriate means to ensure that the directors properly understand, and act in accordance with, their duties and obligations under Cayman Islands’ law.
Indeed, the whole premise of allowing funds that maintain the current US$100,000 minimum subscription threshold to operate as a registered fund without a full mutual fund license is that the high net worth and sophisticated investors who invest in these funds should be capable of protecting their own interests and accordingly, regulation should be “light touch”.
It could be seen as inconsistent then to impose a heavy regulatory regime in respect of the directors to be appointed to those categories of funds.
In addition, one of the great competitive advantages of the Cayman Islands, in respect of attracting investment funds’ business, is the speed and flexibility with which funds can be established and launched. Caution should be exercised prior to implementing more extensive formal regulation measures that would detrimentally affect this speed or flexibility.
CIMA has made some comment that this is an area of possible regulation that they are investigating. In particular, there has been some discussion of whether the number of fund boards on which any particular director can be appointed should be limited.
This seems a rather arbitrary means of determining whether a director is assuming an excessive oversight role, with which they are likely unable to comply. There are certainly arguments both for and against reliance on this number. This has led to some vigorous debate of whether this is an appropriate means of regulation and, if so, what this number should be.
Given that the Cayman Islands is generally modelled on the disclosure principle, perhaps any regulation of this specific issue should be limited to a requirement for all directors to disclose the number of fund boards on which they act.
In any event, we would hope that any reform would continue to accommodate investment manager representation on the board of directors in a straightforward manner and would continue to facilitate fund launches in an expedited manner.
One alternative to greater government regulation in this area is the growing movement in the self-regulation of directors, in the manner of a profession.
The Cayman Islands’ Directors’ Association is a self-regulating association of Cayman Islands’ resident directors. All CIDA members must comply with a code of conduct that was adopted by CIDA in October 2008, and which is based on the “Code of Professional Conduct” adopted by the UK Institute of Directors in August 2008.
It remains to be seen whether a growing body of institutional investors will require directors to maintain such professional affiliations – and undertakings to act in accordance with relevant code of conduct requirements – as a requirement of their investment. Alternatively, it is possible that some equivalent of the code of conduct approach to maintaining the standards of directors could be adopted by CIMA as a formal requirement for regulated fund directors.
The manner in which regulation of the persons who may act as directors of Cayman Islands’ domiciled investment funds, and the manner in which such directors fulfil their duties, is ultimately addressed may significantly affect the fund industry in the Cayman Islands and is worthy of consideration and input from all interested parties.
This will ultimately promote best practice, further strengthen investor confidence in the Cayman Islands, and ensure that the Cayman Islands remain as the global offshore fund jurisdiction of choice.
- The voting shareholders, at a general meeting of such shareholders, generally control the composition of the board of directors by virtue of their power to appoint and remove directors by ordinary resolution. Accordingly, a majority of such shareholders controls the company. However, the shareholders do not retain day to day decision-making responsibilities.
- However, there is a degree of CIMA oversight of the ongoing conduct of those directors once appointed. For example, CIMA may at any time ask the directors of a registered or administered fund to give them such information or such explanation in respect of the fund as CIMA may reasonably require to enable CIMA to carry out its duty under the law. The directors must give CIMA access to or provide at any reasonable time all records relating to the registered or administered fund and CIMA may copy or take an extract of a record to which it is given access.