$111 million. It really is a lot of money. It is also the value of the personal liability awarded against the two directors of the Weavering Macro Fixed Income Fund Limited by the Grand Court of the Cayman Islands in late summer last year.
The decision brought into sharp focus an issue that has been growing in significance for a number of years. This issue is the standards of governance of investment funds. The Weavering case is an extreme example, but all participants exposed to investment funds business should take it as a salutary lesson and familiarise themselves with the principles identified by the court regarding fund governance.
The issue of governance has been growing in importance since the credit crunch of 2007 and the collapse of Lehman's in 2008. Investors in openended funds discovered, in some cases, that the approach of the directors in responding to liquidity or other difficulties that arose appeared to favour not the investors but the investment managers (and some investors also felt that the investment managers were putting their own interests ahead of investors'). As a consequence, investors' due diligence practice when making an investment decision about a new fund investment has developed, and investors increasingly want to be sure that fund directors are demonstrably independent of the investment manager and have as a body the skills and acumen to exercise that independence in the interests of the investor body as a whole.
In the Weavering case the facts found by the court are such that it was easy for the court to conclude that the two directors of the fund had been guilty of wilful neglect or default in their duties as directors. Broadly speaking the court found that they had never truly put their mind to their role and obligations, relying entirely upon others without enquiry or examination. As a consequence of the finding that they were guilty of willful default or neglect any insurance that was carried for the benefit of the directors was likely to be void and so this truly is a personal liability.
Whilst the decision of the court did not create new law in relation to directors' duties or responsibilities, the application of existing law in the context of investment fund structures and the summary of applicable law provides a useful analysis. The court did make some recommendations as to how directors should address some issues that might surprise some practitioners in the industry and perhaps do not sit easily with common market practice. The consequence may be a modification of market practice to address these issues and directors would be wise to have them to mind.
The court recognised that as an investment manager is usually the driving force behind the establishment of a fund, it is often the case that the support team (investment manager, administrator, custodian/prime broker, legal advisers, auditors etc) is informally put in place for the fund before the directors first come together. A consequence of this is that in the early stages of the life of the fund the board must carefully consider the relationships between the fund and those service providers and satisfy itself that, where there are any gaps or limitations in the contractual services to be provided, the fund itself can fill those gaps or address those limitations. It may therefore be an onerous task for a director to carefully consider all facets of the fund before accepting his appointment to the new vehicle, and the directors (or the board as a whole) may wish to consider whether separate support or advice should be taken.
The comments of the court would suggest that once the fund is established it is important that the board regularly reviews the performance not only of the fund but of the service providers; for every service provider that has a contractual relationship with the fund vehicle, the board should receive input and examine and assess their performance and how they contribute to the success of the fund. As noted, this is no more than a reiteration of established law on directors' duties albeit in the specific context of investment fund directors. The court noted the particular nature of investment funds and the fact that save for the board, the fund's functionality will be wholly reliant on delegates.
Perhaps the key point to draw from both the court's decision in Weavering and from the greater attention to this area being paid by investors is for directors to understand that they can no longer fulfil their role in a relatively passive manner but must in fact take an active approach ensuring not only that they make enquiry and consider the input of the various service providers, but also that those steps that are taken are fully recorded.
As originally appeared in Business Brief, Issue 278 – February 2012
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