"It is the Directors' duty to satisfy themselves that the overall structure...was consistent with Cayman Islands industry standards.." - Jones J in Weavering Macro Fixed Income Fund Limited (in Liquidation) v Stefan Peterson & Hans Ekstrom 2011
The reports in the press have covered the continual unravelling of the camera giant Olympus Corp., exposing what is alleged to be many years of misrepresentation, dishonesty and fiscal mismanagement. The recent admission that three of Olympus' top executives in Japan colluded to hide losses from investors, which has resulted in the firing of its Executive Vice President over his role in covering up the losses along with the company's former Chairman and with every indication that its auditor will also step down.
The press however, has taken particular issue that Cayman companies were utilised in the apparent well-orchestrated mismanagement and less than transparent actions of the Olympus' directors and officers. Perhaps forgetting that the role of the Cayman Islands companies in this saga, could easily have been filled by onshore companies in London or Delaware, with the same outcome. After all it is less about the company, which is nothing more than an inanimate vehicle, or its location, and more about the mind and management behind the company.
Cayman's renowned financial infrastructure for hosting international business has, in fact, never been better! Its ultimate vindication came in November, when the Financial Stability Board (a supranational body which includes amongst its membership the Organisation for Economic Cooperation and Development (OECD) and the Committee on the Global Financial System) made the finding that Cayman has 'sufficiently strong' regulatory and supervisory standards when it comes to cooperation and information exchange on the global stage1. Territories were assessed based on their frameworks for the implementation of:
- The Basel Committee on Banking Supervision's Core Principles for Effective Banking Supervision;
- The International Association of Insurance Supervisors Insurance Core Principles and Methodology; and,
- The International Organization of Securities Commission Objectives and Principles of Securities Regulation.
In that same month the G20 also cleared the Cayman Islands of the long standing myth of 'tax haven' status. In their recently published list of 'tax havens', Cayman was excluded, whilst jurisdictions such as Liechtenstein appeared on the list. This is an interesting and no doubt unwelcomed development for Liechtenstein, fighting to become a player in investment funds. Cayman also took the number one spot in The Banker's latest survey for the third year running as the leading specialist finance centre, by a wide margin. Additionally, Cayman has held its A3 rating by Moody's whilst competitor jurisdictions such as Guernsey have been downgraded and lost their A3 credit rating2. There is nothing to gloat about here as these are unprecedented times.
All that is needed to do legitimate business efficiently and effectively is available in the Cayman Islands and the Cayman Islands financial industry continues to rival those of its competing onshore jurisdictions and retains its edge.
Olympus' biggest shareholder demanded the resignation of the investor relations head, who allegedly assisted with the funneling of inflated advisory fees to the Cayman company and after his resignation, "the rest of the board must follow". The rationale for the shareholder's statement is logical, "Even if they didn't know how the specific details of where payments were going and exactly why, they knew that cash was going out the door and they also failed to raise their hands to ask questions3."
Although all the facts on Olympus have yet to be gleaned, the comment made by its main shareholder regarding the directors' obligation seems a valid comment. In this regard it is worth reflecting on the judgment in the recent case of Weavering Macro Fixed Income Fund Limited (In Liquidation) v Stefan Peterson & Hans Ekstrom, 2011 ('Weavering') which might seem to concur with the shareholder's statement.
The quandary of director's duties and responsibilities has been in some form or other addressed by the Cayman Islands Court over many years. It is well accepted in the global financial industry that part of Cayman's robust infrastructure is its judiciary and its court system, which is based on the British system. It has time and time again set recognized case law within the British Commonwealth.
Weavering however, was the first time that a Cayman court addressed directors' duties specifically with regard to an investment fund, but it was made clear the principles applicable to a company under common law were equally applicable to an investment fund. In so doing Jones J made a finding of [knowing] willful neglect or default and awarded a staggering US$111 million plus costs against the directors and it became the shot heard around the fund industry world. It is the first reported case in the Cayman Islands where the directors of a fund have been held accountable for the losses of a fund.
It is worth mentioning here that the circumstances of this particular case were particularly egregious and fall outside of the more routine disputes involving funds. In fact Jones J stated that the Weavering management structure was entirely conventional 'except in respect of the composition of its board of directors'.
In general, Jones J gave a useful summary (although not exhaustive) of the duties and responsibilities of the Board of directors, including those of non-executive directors, that will no doubt be relied upon to some extent by Courts in the future.
Directors owe fiduciary duties to their companies to act bona fide in the best interests of the company Accordingly they must exercise their powers for the purposes for which they are conferred and not to place themselves in a position where there is a conflict between their personal interest and their duty to the company.
A Director must exercise his powers independently, without subordinating those powers to the will of others, except to the extent that they have properly delegated their powers.
Specific to funds, it is conventional that the investment management, administration and accounting functions will be delegated to external entities or service providers and a company's independent non-executive directors will exercise a high level supervisory role. In this regard the Judge referred to Jonathan Parker J in Re Barings PLC, Secretary of State for Trade and Industry v Baker (No 54) and, adopting it as constituting Cayman Islands law, stated:
- Directors have both collectively and individually, a continuing duty to acquire and maintain a sufficient knowledge and understanding of the company's business to enable them properly to discharge their duties as directors.
- Whilst directors are entitled (subject to the articles of association of the company) to delegate particular functions to those below them in the management chain, and to trust their competence and integrity to a reasonable extent , the exercise of the power of delegation does not absolve a director from the duty to supervise the discharge of the delegated functions.
- No rule of universal application can be formulated as to the duty referred to in (ii) above. The extent of the duty, and the question whether it has been discharged, must depend on the facts of each particular case including the directors' role in the management of the company."
The Directors' duty to exercise reasonable care, skill and diligence
The Judge noted here that the duty to exercise reasonable care, skill and diligence comprises both an objective and a subjective element. From an objective element he noted:
"Directors must exercise the care, skill and diligence that would be exercised by a reasonably diligent person having the general knowledge, skill and experience reasonably to be expected of a person acting as an independent non-executive director of an open ended investment fund incorporated in this jurisdiction. They are expected to perform a high level supervisory role. They are expected to act in a professional, businesslike manner....Whilst independent non-executive directors rarely have the technical expertise and experience to be able to monitor sophisticated investment strategies and trading techniques in a direct hands-on manner, they are expected to satisfy themselves (on a continuing basis) that the investment manager's strategy is fairly described in the offering document and that the investment manager is complying with whatever investment criteria and restrictions have been adopted by the fund."
The subjective element of their duty of skill and care requires the exercise of knowledge, skill and experience which they actually possess. The professional qualifications and business experience of the directors of a fund is material information which needs to be disclosed in its offering document. Any conflicts of interest or other relevant information that would ensure that such disclosed information in the offering document is accurate and not misleading, is necessary to be included in the offering document.
The Directors duty to exercise an independent judgment
Here the Judge referred to Re Westmid Packing Services Ltd 5 which was examined in the judgment, noting, 'delegation of responsibility is permissible, and often necessary, but total abrogation of responsibility is not. A board of directors must not permit one individual to dominate them and use them... '. Whilst the delegation of functions of investment management, administration and accounting functions are commonly delegated to contracted service providers, directors remain obligated to high level supervision of these functions and to exercise independent judgment in this regard.
In analyzing the directors' duties, it was also helpful that the Judge broke it down into three phases during the life span of the fund:-
- Phase One – The Establishment of the Fund –
At this stage the directors should have made sufficient enquiries to ensure that they properly understood the nature and scope of the work each of the service providers were proposing to do and that there was a proper division of responsibility.
The scope of their own work as Directors was to be determined after a clear review of the work to be undertaken by the other service providers and understanding the contracts to be entered into by the service providers.
It is also interesting to note that the Judge found that the lawyers engaged to conduct the legal work on behalf of the fund do so in the best interest of their client i.e. the investment manager (who traditionally puts the fund together and engages the counsel to establish the fund) and not in the overall best interest of the fund. This might be somewhat of a surprising finding for some of us in the industry as we take the view that we represent the fund i.e. the company and in the event of a dispute the parties including the investment manager must seek separate counsel.
The Judge took the view that the directors could not rely on the lawyers to fulfil the directors' duties with regard to the offering document and retained their obligation of independent judgment.
The Judge also required the directors to satisfy themselves that the offering document contains all information necessary to enable a prospective investor to make an informed decision as to whether or not to subscribe for or purchase shares in the fund. The Judge made a further comment that, at the very least, the directors will need to make enquiries of the lawyers who have coordinated the work so as to gain a proper understanding of what has been done and with what result.
- Phase two –Ordinary Course of Business
The Judge observed that one would ordinarily expect an agenda to
be prepared and circulated in advance of each meeting, reflecting
input from the investment manager, the administrator and the
directors themselves. The agenda should specify the matters for
discussion, the reports to be presented and the investment manager
and administrator should be invited to participate, either in
person or by telephone. In fact the Judge went further to state,
"I would expect the agenda to provide for a representative
of PNC [the administrator] to attend (at least
occasionally) for the purpose of reviewing the funds monthly or
quarterly management accounts with the Directors'.
A great deal of emphasis was placed by the Judge, on the need to have the investment manager and the administrator in attendance at meetings to provide guidance through their reports as was the requirement, for the directors to satisfy themselves that the fund was complying with the investment restrictions 'in an ordinary businesslike manner'. Whilst the Judge did not choose to address the issue of whether or not directors of an investment fund can properly delegate all their functions in respect of the financial statements, the Judge did state that independent directors of investments funds are 'expected to be able to read a balance sheet and have a basic understanding of the audit process.'
- Phase Three – Crisis/Liquidation
Jones J did not outline any general duties and obligations that arose specific to this stage but rather detailed the continued failures of the directors in performing their general duties and obligations outlined in phases one and two which should have rightfully endured during this phase. The Judge did observe that the directors in this instance continued to fail to make the necessary enquiries or to fully understand the investment fund's financial condition, particularly in the context of the then, serious global financial crisis. In his view, an emergency meeting of the directors would have and should have been convened, at which all relevant representatives from the investment manager and administrator and possibly others, would have been required to attend.
The Specifics of Weavering
The board of directors in this particular case was made up solely of close family relatives of the principal investment manager, Mr. Magnus Peterson, i.e. his younger brother and his elderly stepfather (who was 85 years old by the time he gave evidence to the Court). Both of the directors however had the appropriate professional credentials and met the requirements for the fund to be listed on the Irish Stock Exchange. Jones J's comment, that Mr. Magnus chose to appoint his relatives rather than a 'real board of directors who could be expected to perform their supervisory role in an ordinary businesslike manner,' is key to his verdict.
The evidence that unfolded during the trial showed that the directors signed whatever documents were put in front of them by Mr. Magnus Peterson as the investment manager without making enquiry or applying their minds to the issues at hand, including proforma minutes that were pre-drafted and presented by the investment manager for signature by the directors. At some point in the early stages of the fund the directors signed resolutions appointing PricewaterhouseCoopers and learned after the event that Ernst & Young had been appointed instead as auditors.
In this case, the directors acted gratuitously without remuneration for their services as directors. The Judge determined that, this does not suggest that the scope of their duties were reduced and that they were not expected to perform duties normally performed by that of an independent non-executive director. Instead the nonpayment of the directors became evidence that they never intended to function properly as directors, but rather as a favour to their relative, Mr. Peterson. At this point Jones J distinguished Barings Plc6 and comments made by Sir Richard Scott V-C in that case that the level of a director's reward may be a factor in determining the scope of his responsibility. In the Weavering case the Judge took the view that in Barings Plc, the comments by Sir Richard Scott were an observation made in the context of a disqualification proceeding against a highly paid executive director, unlike Weavering, where they were independent non executive directors. Nonetheless this nonpayment did not reduce their duties and obligations as independent non-executive directors of an investment fund.
Amongst the evidence found against the directors, and perhaps most damning, were minutes that were created of meetings that never took place and backdated. And to further demonstrate the unusual egregiousness of this particular case, there was the issue of forged documents to which the investment manager admits, but suggests that he was authorized to put the signature of the directors to the document.
Whilst Cayman companies were utilized in the structure of this fund, it is interesting to note that none of the directors or any of the other officers in this saga were based in the Cayman Islands, prompting the Cayman Islands Directors Association to promptly issue a statement contrasting the actions of the directors in Weavering to the conduct set out in its Cayman Islands Directors Association Code of Conduct and citing their actions as 'abhorrent to the independent director profession'.
At the time of writing this article the Directors of Weavering are appealing both on facts and on law and the liquidators of Weavering have also filed an appeal.
In October 2011 Solomon Harris hosted a Webinar presentation: Directors' Duties After The Weavering Decision. A link to the Firm's slide presentation follows.
1. Tax-News – Global Tax News 14th November 2011
2. Telegraph 15th November 2011
3. Bloomberg 9th November 2011
4. 1999, 1 BCLC 433 at p. 489
5. 2 BCLC 646 at p. 653b-c
6. Re Barings Plc, Secretary of State v Baker  BCC 583 at p 586