On January 18, 2013 the Cayman Islands Monetary Authority (CIMA) issued a consultation document to the local industry, directed at reviewing the regulatory framework surrounding corporate governance and the provision of independent directors in particular.
Over the years, Cayman has grown as the domicile of choice for international funds registration (including private equity and hedge funds) and is home to over 10,000 funds. As such, a wide number of sectors of the industry supporting these funds, including the provision of independent directors, has grown to sizeable proportions.
While there is no regulatory requirement to have a Cayman-based director on the board of Cayman-registered funds, many funds chose to do so for a wide variety of reasons, including tax and regulatory concerns in the home country of the manager or where they intend to distribute the fund.
Much of the recent focus on Cayman directorships has been driven by the Weavering case, in which a number of independent directors to a Cayman fund were accused, and initially found responsible, of the failing of the fund. However, it is worth noting those directors were not based in Cayman; they were nationals of and resident in Sweden, and as such, it is important to evaluate how any proposed new regulation will be implemented for resident and non-resident directors alike.
The robust decision on the Weavering case (it is on appeal at the time of writing in early May) did not create new law or impose new responsibility or liability on directors of Cayman funds. The court applied established law to a specific and extreme set of facts and, not surprisingly in the circumstances, found the two directors had failed to comply with their responsibilities and were liable for very significant losses.
There are two further important points that arise from Weavering when considering the proposals put forward by the regulator:
- Had it been a regulatory requirement that CIMA vets and approves the appointment of these directors, this approval would likely have been forthcoming, given the resumes and experience of these individuals.
- Had there been a numerical cap on the number of directorships these individuals could hold, it is also very likely they would both have been well within any such cap.
So these two key points, included as part of the consultation initiated by CIMA, would not, by themselves, have prevented this case from happening; the fact is that it is very difficult to stop misfeasance, intentional nonfeasance, or fraud by investment managers and service providers before it happens.
Consultation key points
The following section provides a description of the key issues included in the consultation initiated by CIMA. The Cayman Islands Directors Association (CIDA) has conducted a full survey of its members to gather the support to each of the proposals; included here, when relevant, are some of these results.
Limitation of the number of directorships per person
It has been reported in many media outlets what has been labelled the Jumbo Directors – individuals and companies that have adopted a model in which one person sits on a large number of boards, in some cases as many as multiple hundreds of boards. Many if not all of these directors delegate a significant amount of their day-to-day work supporting structures to allow them to service a large number of customers. However, it is clear that while they may rely on support structures, they cannot delegate many of the responsibilities. Without making a judgement, this model can be called the JD model.
In its consultation documents, CIMA stated: "Imposing a limit would be beneficial in pronouncing what the authority considers acceptable level of responsibility but it is challenging to design a limit that takes account the nature, size and complexity of the regulated entity."
It appears that most of the industry agrees with CIMA's view. A resounding 89 percent of the respondents to the survey conducted by CIDA believe there should not be a numerical limitation imposed. Probably most of the industry does not support the extent to which a few players have taken the JD model but recognise the difficulty in setting a number that regardless of what it is or for how long it is discussed, it will prove to be too big in some cases and too small in others.
As an extreme example, consider the time requirements of a director who sits on 20 boards of private equity funds managed by 20 different fund managers with different service providers versus the time requirements of a director who sits on 20 long-only equity funds managed by the same manager with slightly different strategies or sector focus and the same custodian and auditor. Attempting to create a model that considers all these variables would be a daunting task, and as such, if a number were to be set, it would have to be set at the high end of the spectrum, proving to be only a small part of the solution as it would affect only a limited number of providers.
If a number were to be considered, it would be better to consider imposing it on the number of 'relationships' instead of the number of funds. Even in this case such limit could only be part of the reform and not the main aspect of it.
According to the consultation documents: "The Authority has been considering the development of a public database, operated and controlled by the Authority for access by interested stakeholders. With the international call for heightened disclosure and transparency we believe that a public database will not only complement current due diligence processes but also enhance the reputation of its financial services industry."
The consultation documents go on to explain how the authority would fund this database and ask what other information should be included, plus how the database should be accessible.
Industry seems to be much more divided on this issue. According to the CIDA survey, the majority of respondents (76 percent) believe it is desirable for CIMA to maintain a database of directors. If such a database is maintained, the majority of respondents (83 percent) believe the information should be limited to details of directors of regulated companies only. The respondents are divided about whether the number of directorships a director has should be disclosed – 45 percent in favour and 55 percent against. The majority of respondents (74 percent) believe the names of the companies the director is a director of should not be disclosed. Whether the database should be open to inspection, the respondents are again divided – 47 percent for inspection and 53 percent against. However, if the database is to be open for inspection, the majority of respondents (88 percent) believe it should not be open to the general public but should be restricted to specific interested parties such as investors or shareholders. If the database is to be open for inspection the majority of respondents (78 percent) believe it should be searchable only by reference to individual companies and should not have further search capabilities.
It seems overall industry favours enhanced transparency to allow investors to make better informed decisions in a way that is simpler and that does not expose them to have to directly ask the director. Although this was not part of the consultation, based on informal feedback the industry seems to support some kind of mandate to ensure the director has to disclose the current number of directorships held to the manager and to prospect investors referred by the manager, we believe this is common practice but may not be the case across the industry.
While transparency is supported and industry appreciates the need to facilitate this information to the investors, there are some concerns about the way a completely open database may be used by other parties and, in particular, how that information may be interpreted in conjunction with some of the other proposals discussed below.
To express this in other words, there seems to be support to increase transparency of the industry but a concern about reacting to comments from third-parties that have no real interest in the funds and end up with solutions that may unnecessarily erode the legitimate right to confidentiality between commercial parties.
In the writer's opinion, it would be useful to consider a staged approach where once the other proposals are implemented, including clarification of responsibilities and functions that can and can not be delegated, together with an obligation to disclose directorships held on request to the manager and potential investors, the openness of the database held by CIMA can be reviewed after a predefined period of time.
Statement of Guidance regarding the responsibilities of Independent Directors
CIMA is proposing to extend the Statement of Guidance on Corporate Governance (SOG) application to all registered entities and is proposing amendments to "make the SOG more generic and suitable for cross-sectoral application" and "explicitly outlining in the SOG key management oversight and corporate governance principles and the primary duties of the board of directors".
In response to the questions asked in this section, the results obtained by the survey conducted by CIDA show that 75 percent of respondents favour sectorspecific guidance. It is thought more detail is desirable regarding best practice and the expectations by the regulator.
Registration of directors
In regards to the registration of directors, the results of the survey show that 92 percent of respondents believe all directors of regulated companies should register with CIMA. A total of 75 percent of respondents believe any mandatory registration should apply equally to non-resident directors as well as Cayman resident directors. However, industry seems to be much more divided in regard to the costs associated with this registration. While there is support for a fee to cover the cost of this process, there is resistance to a higher fee imposed in this process as a way for government to collect additional revenue, based mainly on the premise that at least part of that cost will be passed to the company, increasing the overall cost to the end-customer.
So what is the problem and can these proposals resolve it?
The Cayman director class has not helped its cause as some (but by no means all) of its members resist exercising self restrain, do not limit the number of directorships they take on (regardless of the business model they have implemented), and become rather defensive and secretive when asked about the number of directorships they hold. So Cayman is now faced with incredulous comments like: how can a single person be a director of 500 companies and properly meet his obligations to all those companies?
This has put Cayman on the back foot, and a great deal of effort is now required to explain the existing regime that already imposes a 'fit and proper' requirement under the Mutual Funds Law on those who serve as fund directors and to give CIMA the power to require their replacement if it is determined they are not fit and proper. CIMA has issued detailed guidance on the fit and proper requirements together with the Statement of Guidance on Corporate Governance that is now being expanded in its content and application.
Each company and directorship has to be individually assessed to see what is required, how much time it is likely to take, and what support services and functions the director has in place that enable him to perform properly. It is also necessary to restate it is ultimately up to the investors (the great majority of whom are very sophisticated and can find out how many directorships a person holds – they simply have to ask the investment manager/promoter as part of their due diligence) to decide whether to invest in a fund that has directors holding a big number of offices or if this information is denied to them. As stated above, a requirement to the director to regularly disclose this number to the managers would be supported.
The real underlying issue is of the board's performance. A properly performing and effective fund board is not dependent on size or on the nationality or residence of its directors or where they meet. A large and expensive board may fail to perform, and this has been proven during the recent financial crisis. Relatively small boards with well-qualified, experienced and active directors will usually perform well. It is simply not possible to regulate to secure good performance. Again, investors and the market are best placed to drive the composition of the board. And the courts are more than able to decide ex post facto if the performance of the directors or other service providers was below the required legal standard.
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