The Cayman Islands Approach to the Regulation of Mutual Funds

Mutual Funds Law (1996 Revision)

The motivation behind the introduction of the Mutual Funds legislation in 1993 was to follow through the recommendations of the Gallagher Report which stated that the Cayman Islands were in the forefront of the regulation of their financial industry and the operation of mutual funds was an area that had not been subject to regulation by any suitable authority. Accordingly, in recognition of the need to ensure the measured supervision of mutual funds, it was appropriate to introduce legislation to provide a framework for the regulation of all mutual funds, unless specifically exempt, and mutual fund administrators. In July 1993 The Mutual Funds Law (1996 Revision) ("the Law") regulating mutual funds and mutual fund administrators came into force.

The Law strikes a balance between the acceptability of the major names in the industry, who are regulated by registration, and the obligations imposed upon the mutual fund administrators who provide services to the mutual funds which are managed in the Cayman Islands. The major part of the legislation is taken up with the supervision and enforcement provisions, which are to be the responsibility of the Inspector of Banks ("the Inspector").

A mutual fund is defined as a company, unit trust or partnership that pools the funds of investors who acquire equity interests in the mutual fund for the purpose of spreading the investment risk with a view to profit or gain arising from the acquisition, holding, management or disposal of investments. All the mutual funds are regulated by, or exempt from, the provisions of the law and, if regulated, will hold a licence issued by, or be registered with the Inspector. There are transitional provisions to enable existing mutual funds and mutual fund administrators to comply with the Law.

Licensed Mutual Funds
Unless it qualifies for exemption from the law or meets the requirements for registration only (see below) or a licensed mutual fund administrator is providing its principal office in the Islands, a Mutual Fund Licence must be obtained if a mutual fund is to carry on or attempt to carry on business from the Cayman Islands. A fund requiring to be licensed must also have its registered office in the Islands or, if it is a unit trust, a trustee licensed under the Banks and Trust Companies Law, 1989 and, unless the Inspector has granted an exemption, a current offering document must be filed containing a description of the equity interests to be acquired and such other information as would enable a prospective investor to make an informed decision whether or not to subscribe for or purchase the equity interests.

Registered Mutual Funds

If a mutual fund does not wish to apply for a licence and it has the following characteristics it need only register with the Inspector:-

The minimum equity interest is at least CI$40,000; or

The equity interests are listed on a stock exchange, including an over-the-counter market, specified by the Inspector by a notice in the Gazette.

The regulated mutual fund must file a synopsis of the mutual fund's offering document, register, and pay the prescribed annual registration fee to the Inspector.

Exempt Mutual Fund

It is not necessary for a mutual fund to apply for a licence or comply with the provisions applicable to a registered mutual fund before it can carry on or attempt to carry on its business, if it has fifteen or fewer investors, the majority of whom are able to appoint or remove the operator of the fund.

Even if a mutual fund satisfies the provisions providing for registered or exempt status, it may nevertheless still apply for a licence. The overall effect is that all mutual funds will be regulated apart from those covered by the exemption.

Application Procedures

An application for a Mutual Fund Licence must be made to the Inspector. The information to be contained in the application must be sufficient for the Inspector to be satisfied that all the requirements for a licence or for being treated as a registered mutual fund, or for treatment as an exempt mutual fund, have been supplied. A copy or draft of the offering document together with a synopsis must accompany the application. The Inspector cannot issue a Mutual Fund Licence unless satisfied that:-

-each promoter is of sound reputation; and

-the administration of the mutual fund will be undertaken by a person who has sufficient expertise and is also of sound reputation; and

-the business of the mutual fund and the offering of equity interests will be carried out in a proper manner.

The Mutual Fund Licence may be issued even though the relevant entity has not yet been formed and the Inspector may grant the licence to be effective from the date the relevant entity is incorporated or a trust established. The Inspector has wide discretions and may issue the licence subject to conditions which may then be varied or revoked from time to time.

In order to provide suitable financial information in respect of a regulated mutual fund, the accounts must be audited on an annual basis. The Inspector may extend the period within which they should be submitted.

The Mutual Fund Licence and registered mutual fund fee must be paid by 15th January in every year. If the fee remains unpaid then an additional fee equal to the licence or registration fee will be payable for each month that it is unpaid, although the Inspector has discretion to waive the additional fee.

If a mutual fund has a name which is identical with or resembles an existing name or is likely to suggest patronage or a special status, the Inspector may direct that the name be changed.

Mutual Fund Administration

The mutual fund administrators have a particular responsibility imposed upon them by the law, especially to ensure the promoters are of good standing and ability. If a mutual fund administrator receives his licence, then he has the obligation to know his client and thus ensure the effective "self-regulation" of the industry within the framework of the law; the potential maximum fine of CI$100,000.00 (US$120,000.00) in pertinent circumstances is acknowledgement of the pivotal role of the mutual fund administrators. In reality there is the delegation by the Inspector under the law through the licensing system. The over-regulation that thus exists in other jurisdictions has been avoided.

A Mutual Fund Administrators Licence is required if the following matters are dealt with:-

- the management or administration of the mutual fund, which includes the control of all or substantially all the assets; or

- the provision of the principal office in the Cayman Islands; or

- the provision of an operator;

A restricted Mutual Fund Administrators licence will mention the specific funds to be administered.

The Inspector must give written approval of any director, similar senior officer or a general partner, as the circumstances warrant, although exemption from this requirement may be granted. A company that is a Mutual Fund Administrator must have at least two (2) directors.

No Mutual Fund Administrators Licence is required if all that is being provided is a principal office for a registered mutual fund, and a registered office where corporate secretarial and related services are provided or the maintenance of any register of equity interests or the filing and payment of fees in respect of a company, Partnership or Limited Partnership or Trustee.

The application for the Mutual Fund Administrators Licence must be made to the Clerk of the Executive Council and it will not be granted unless conditions, similar to those that apply to the application for a Mutual Fund Licence are satisfied. There is a net worth requirement of CI$400,000.00 (US$480,000.00) for a Mutual Fund Administrators Licence. Although such a requirement must be considered by the Executive Council, and the Executive Council may waive compliance with the CI$400,000.00 net worth requirement if they are otherwise satisfied as to the financial viability of the mutual fund administrator, the Inspector, for reasonable cause, or if the net worth is less than the amount prescribed, may ask for guarantees or other financial support or direct the mutual fund administrator to increase its net worth to an amount the Inspector considers appropriate. The mutual fund administrator would normally be expected to have a place which will be its principal office in the Cayman Islands and two individuals, who may act jointly or separately, or a body corporate resident or incorporated in the Cayman Islands, as its agent or representative, unless the Executive Council has waived a need for compliance with the provisions. A restricted mutual fund administrator must have a registered office in the Cayman Islands.

If there are any changes to the principal office or the individuals or corporate entity acting for the mutual fund then the Inspector must be advised of the changes. The Executive Council may impose any conditions that it considers appropriate.

If any of the information is supplied in circumstances that the applicant knows, or reasonably knows, that it is false or misleading at the time and subsequently, then the conditions upon which the licence was issued are not satisfied and significant fines may be imposed. The most severe aspects which must be brought to the attention of the Inspector are if the mutual fund is:-

- or is likely to become, unable to meet its obligations as they fall due;

- carrying on business otherwise than in accordance with the normal tenets of the mutual funds law or any other Laws of the Cayman Islands;

- carrying on business in a manner that is or likely to be prejudicial to investors or creditors of the mutual fund.

The notification to the Inspector must be in writing and set out the reasons for the Administrators knowledge or belief.

In order to ensure suitable control of the mutual fund administrators the Inspector must be advised, so approval can be obtained, of any issue, transfer, disposal or dealing in the shares of the mutual fund administrator, unless the Inspector has waived a need to comply with the relevant provisions. Further, as an important element of the supervision, the mutual fund administrator must have annual audited accounts and submit them to the Inspector no later than six months after the end of the financial year. The Inspector may grant an extension but in view of the overall thrust of the legislation it is likely that such a power will be exercised sparingly and only in extenuating circumstances.

Supervision and Enforcement - Powers and Duties of the Inspector

The cornerstone of this mutual fund law is the protection of the unsuspecting and unsophisticated investor. The reasons for this approach do not have to be explained because of all the developments of an adverse nature that have been experienced in the area of mutual funds over the past few years. It does not mean that through regulation there will never be a problem, but the objective is to ensure the regulated environment provides a suitable framework of protection at an acceptable cost to the mutual funds and the Mutual Fund Administrators.

The first requirement enables the Inspector to instruct a regulated mutual fund and a mutual fund administrator to have its accounts audited within a specified time. It is this supervisory power, together with the obligations imposed upon auditors, that provides the level of control over the mutual funds and the mutual fund administrator that should protect investors. The auditor, quite independently of the Inspector, must notify the Inspector in writing if the mutual fund is unable to meet its obligations as they fall due, is not carrying on business in accordance with the mutual fund law or any other law, or is carrying on business in a manner prejudicial to the investors. A comparable responsibility is imposed upon the auditor in relation to a mutual fund administrator. The responsibility of the auditor is particularly pertinent if he has resigned or his audit activities have been terminated.

It is in the area of enforcement that there is the clear indication that the Cayman Islands is serious concerning the protection of investors. The level of fines that are imposed for infringements of the mutual fund legislation are more realistic and provide a structure and level that should assist in deterring those who undertake obligations to investors either as promoters or operators, as well as mutual fund administrators, yet do not reach the level of professionalism, despite meeting the initial requirements of the mutual funds law, that is demanded by the law. The responsibility imposed upon the Inspector, as well as all who are involved in the mutual fund industry in the context of the Cayman Islands, is to know those with whom one is dealing so that there will be no need for the Inspector to invoke any of the powers available.

The Inspector can have access to information and all the records relating to a mutual fund. The Inspector has in support, where there are reasonable grounds to suspect an offence under the mutual fund law has been committed in certain premises or where access has not been accorded, power to apply to a magistrate for a search warrant. The Inspector can apply to the Grand Court to preserve the assets of the mutual fund if the mutual fund is in breach of any of the provisions forming the basis of the issue of its license.

Sanctions and Fines

The Inspector has extensive powers to alter the conditions under which a licensee can operate, enquire into the reasons for non- compliance with any direction and call for information from the promoter or operator. The Inspector may revoke a licence, impose conditions, require the substitution of the promoter or operator, appoint a person to advise on the proper conduct of the affairs of a mutual fund and appoint a person to assume control of the affairs of a mutual fund. The Inspector may take further action which will require application to the Grand Court to protect the interests of the investors or creditors of the mutual fund. There is an obligation on the Inspector to inform the investors if it is practicable to do so. There is also an overriding power with the Inspector to revoke a Mutual Fund Licence if the holder of the licence has ceased to carry on the business as a mutual fund or is being wound-up or has been dissolved. If the Inspector is hindered in any way in the exercise of his powers a fine not exceeding CI$200,000.00 (US$280,000.00) may be imposed.

If a mutual fund is in breach of the conditions of its licence then a fine not exceeding CI$100,000.00 (US$120,000.00) may be imposed. If a mutual fund that is not licensed, registered or exempt represents that it is carrying on or attempting to carry on business in or from the Cayman Islands then it may be fined a sum not exceeding CI$100,000.00 (US$120,000.00). If false or misleading information is provided to the Executive Council the fine may not exceed CI$100,000.00 (US$120,000.00). If the mutual fund administrator is not authorized to carry on business as such then a fine not exceeding CI$100,000.00 (US$120,000.00) may be imposed. If a mutual fund administrator knows or has reason to believe that the mutual fund is unlikely to meet its obligations as they fall due, is carrying on business contrary to the law or in a manner that is prejudicial to the interests of the investors or creditors, the fine is CI$200,000.00 (US$240,000.00).

If an operator of a mutual fund or the mutual fund administrator does not provide audited accounts within the time specified then the fine is CI$10,000.00 plus CI$500.00 per diem during the period of the failure to comply. Failure to comply with requirements of the Inspector can lead to a fine not exceeding CI$100,000.00 (US$120,000.00). The fine that can be imposed upon auditors for not disclosing material information to the Inspector is not to exceed CI$20,000.00 (US$24,000.00); such a sum is also applicable to matters concerning audited accounts, the appointment of directors, issue or transfer of shares, and failure to increase capital or provide a guarantee. If a name has to be changed on the direction of the Inspector and it is not complied with, then the fine may not exceed CI$2,000.00 plus CI$100.00 per diem for the period there was failure to comply with the direction.

Privacy

The confidentiality of the affairs of those using the Cayman Islands has been well respected over the years. In the mutual fund context it has resulted in very little information being available on the extent to which the Cayman Islands has been used for the establishment of mutual funds and the administration of funds in the Cayman Islands. It is known that the Cayman Islands has been used extensively, but the identity of many of the funds is unknown to the authorities. The mutual fund law, whilst continuing to maintain the non-disclosable nature of the information contained in the application for a licence, the affairs of the mutual fund and that of the mutual fund administrators, does enable the Inspector to collate statistical information, which will be invaluable for the future quantification of the size of the industry and the assistance of the Inspector in the exercise of responsibilities within the mutual fund law. In particular, the information may be used by the Inspector for the effective regulation of a mutual fund, when lawfully allowed or required to be disclosed by a court or under the provision of any other law. Further, as long as the identity of the investors is not disclosed, general information of a statistical nature relating to a mutual fund or a mutual fund administrator may be advised to a mutual fund regulatory authority outside the Cayman Islands. If the Inspector abuses his position and discloses information in a manner outside the law, he can be subject to a fine not exceeding CI$50,000.00 (US$60,975.00).

Appeals

The appeal possibilities cover any situation where a person is aggrieved by any action taken by the Inspector. An appeal must be filed within sixty (60) days of the written notification of the Inspector's action. The written notice of the appeal must be submitted to the Clerk of the Council setting out the grounds. The result of an appeal may be to uphold the Inspector's action or direct the Inspector to take no action or some other action.

Transitional Provisions

It is crucial on the introduction of new legislation to ensure that the existing business which will now become regulated is not disrupted. It is therefore provided that mutual funds which were in existence at the time of the commencement of the licensing provisions have six months from then to continue to carry on their business without having to become immediately a regulated mutual fund complying with the law. In addition, if a person was carrying on the business that would make him a mutual fund administrator, or an exemption was held under the Companies Management Law, 1984, then a Mutual Fund Administrators Licence does not have to be obtained for six months after the commencement of the law.