With the summer months now bearing down on the Cayman Islands, temperatures are rising for locals and visitors alike, and finding a cool spot to rest is a daily priority. The same can also be said of the environment inside the offices of the financial services professionals on island, who have been facing the heat of new legislative deadlines to meet, a swirl of new regulatory guidance with which to get to grips, and a suite of new judgments from the Grand Court to digest. If the old saying that “a change is as good as a rest” is true, the current industry climate should leave professionals feeling particularly refreshed.

Looming deadlines

The main area of industry change of late has been in respect of anti-money laundering initiatives. As has been made clear through dispatches from public and private bodies alike for many months now, all financial services providers are required to comply with the Proceeds of Crime Law (2018 Revision), the Anti-Money Laundering Regulations (2018 Revision) and the associated Guidance Notes (the “AML Requirements”). The most recent development in respect of this particular set of laws is that the list of activities falling within the definition of “Relevant Financial Business” has been extended to include “otherwise investing, administering or managing funds or money on behalf of other persons” and “underwriting and placement of life insurance and other investment related insurance.” Consequently, financial services providers carrying out such activities (which for the avoidance of doubt now includes closed ended funds), were required to have complied with the AML requirements by May 31, 2018.

However, a further deadline still looms. As part of the AML requirements, financial services providers are also now required to appoint suitably qualified management-level natural persons as anti-money laundering compliance officer, money laundering reporting officer and deputy money laundering reporting officer. Regulated funds are required to demonstrate to the Cayman Islands Monetary Authority their compliance with such requirements by submission of the requisite information via the REEFs portal on or before Sept. 30, 2018.

Financial services providers that are registering with CIMA as a regulated fund must now demonstrate compliance by the provision of the requisite information at the time of submission of the registration application via the REEFS portal.

Virtual currencies

Showing a general willingness to stay up to speed with global developments across the financial services industry, CIMA has also released a public advisory, dated April 23, regarding virtual currencies. The purpose of the advisory is to warn of the risks associated with investments in initial coin offerings (ICOs) and virtual currencies, and it sets out some of the red flags potential investors should look out for in order to help identify potentially fraudulent ICOs.

ICOs are often unregulated and involve new technologies and products that are highly technical and complex. However, should a regulatory body in the country where the ICO is based and/or issued consider the ICO token to be a security issued in breach of its securities laws, it could have a substantially negative effect on the company and the token’s value or usability. The advisory therefore recommends that investors protect themselves by undertaking thorough research before investing and to avoid ICOs where:

  • there are claims of endorsements by CIMA;
  • there is limited information provided (regarding the investment, the project, the development team and/ or vague technical information relating to the coin); or
  • the promoters are pushing for a quick decision or are otherwise marketing aggressively with promises of large or quick returns.

Other than to confirm that virtual currencies are not legal tender in the Cayman Islands, as is the case in most countries, no further guidance has been provided by CIMA regarding any substantive legal issues. However, as the Cayman Islands is an increasingly popular jurisdiction for ICOs, it is expected that CIMA will provide further guidance in respect of virtual currencies in due course, particularly in order to address anti-money laundering concerns.

Leveraging of investments

Investors will also be interested in the recent decision of the Privy Council in Al Sadik -v- Investcorp Bank BSC, which was released on June 18, 2018. Leveraging an investment is, of course, a common way to increase an investor’s potential returns. Instead of solely relying on the investor’s own funds, borrowed funds are also used to increase the size of investment and thereby increase the size of the potential return. However, any losses on the underlying investment will also be increased.

In this case, Al Sadik had invested around US$120 million with Investcorp in March 2008 pursuant to the terms of a share purchase agreement. The share purchase agreement authorized Investcorp Bank BSC and its related entities to leverage Al Sadik’s investments and take administrative steps in furtherance of that goal, including transferring Al Sadik’s funds to a special purpose vehicle, Blossom IAM Ltd. Those funds were leveraged through the use of the Blossom SPV. Ultimately, the leveraging increased the losses Al Sadik incurred on his investment in 2008/2009, one of the worst periods for hedge fund investors in history as the global financial crisis developed. When Al Sadik ultimately redeemed his investment in December 2009, he had lost over 40 percent of the initial amount invested.

Al Sadik made a number of claims against Investcorp in respect of the losses he incurred before the Grand Court and, subsequently, the Court of Appeal. On further appeal, the Privy Council was asked to consider whether the transfer of Al Sadik’s funds to Blossom SPV was permitted under the SPA and whether the leveraging of Al Sadik’s funds was a breach of the share purchase agreement.

The Privy Council noted that the Court of Appeal had properly considered the factual background, and that the relevant investment proposal had suggested leveraged investments in hedge funds to Al Sadik. Accordingly, the Privy Council found that the share purchase agreement needed to be construed to permit this type of investing of Al Sadik’s funds.
Counsel for the investor asserted that a distinction should have been made between the different methods by which the investment could be leveraged and that the transfer of funds to the Blossom SPV was not a permitted method of leveraging under the share purchase agreement. However, the Privy Council was not attracted to this submission. The Privy Council found that the Court of Appeal and Grand Court were both correct in concluding that, upon its true construction, the share purchase agreement authorized the leverage and payment to (or purchase of shares in) Blossom SPV, which was an authorized administrative step, rather than an investment, for the achievement of the leveraging purpose.

Given the common use of generally drafted clauses in commercial investment agreements, the Privy Council decision will be welcomed by the investment community. Nevertheless, the decision is a reminder to managers to ensure that the terms of investment agreements are fit for purpose in order to mitigate the risk of future misunderstandings or disputes between managers and investors.

Attacks on trust assets

Finally, a dispute over rights to distributions from a Cayman Islands trust was the subject of a recent judgment of the Grand Court. In the matter of Y v R (unreported, Jan. 9, 2018), a Cayman Islands discretionary trust established by M, the late father of R, was the target of enforcement proceedings in the Grand Court. The plaintiff, Y, was a professional law corporation, and the defendant, R, was a former client of Y who had engaged the firm to act for him in relation to certain matters concerning M’s estate, including the trust. A dispute had arisen between Y and R regarding payment of Y’s legal fees and, as a result, Y commenced arbitration proceedings against R outside the Cayman Islands for recovery of the fees. The foreign arbitral tribunal ultimately issued an award in favor of Y for approximately $2 million and a judgment was subsequently entered by the Grand Court in the same terms as the award.

Y then issued a summons seeking, among other things, an order from the Grand Court for the appointment of receivers by way of equitable execution to receive all distributions to or for the benefit of R from the Trust. Y argued that the Grand Court had jurisdiction to appoint a receiver over future distributions from a discretionary trust in circumstances where it was likely that the trustee would apply its discretion in favor of the judgment debtor. Y’s argument was that, at the exact point when the trustee makes the decision to apply its discretion in favor of a beneficiary, the trustee holds the intended distribution as a bare trustee or agent for the beneficiary and the asset is therefore one that is amenable to equitable execution. However, Justice Ingrid Mangatal held that to grant the relief sought in the summons would amount to a “radical, impermissible extension of the law.” The judge confirmed the longstanding position with respect to discretionary trusts, which is that a beneficiary holds neither a legal nor a beneficial interest in the trust assets, but merely a right to require the trustee from time to time to consider whether to apply the whole or some part of the trust fund for his benefit. In those circumstances, there was no available asset that could be viewed as the beneficiary’s asset in equity, and as such there was nothing over which to appoint a receiver.

The Grand Court also noted that there was nothing to suggest that the Trust was anything other than a true discretionary trust: There was no evidence of a sham, or that R had the right to call for any part of, or had de facto control over, the trust assets, or that the trustee did not have a genuine discretion with respect to the trust assets. Further, there were other adequate remedies available to Y, namely that R had other foreign assets that were amendable to execution, and even if R was found to have assets within the Cayman Islands it would not have been just and convenient to appoint a receiver in the circumstances of the case.

In keeping with the hot pace at which our jurisdiction continues to evolve and modernize, further judicial guidance, regulatory change, and legislative initiatives are expected as the summer rumbles on.