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Weavering Macro Fixed Income Fund Limited (in liquidation) v Peterson and Ekstrom: Hedge Fund Directors Are Told to Jump, But How High?
Jeremy Walton, Partner, Appleby (Cayman) Ltd, Grand Cayman, Cayman IslandsThe Financial Services Division of the Grand Court has just delivered what is already being hailed as a seminal judgment on the subject of directors’ duties in the context of offshore hedge funds.
In Weavering Macro Fixed Income Fund Limited (In liquidation) v Peterson and Ekstrom, after a full trial the Court found a fund’s independent directors guilty of wilful default in the discharge of their duties, and ordered them to pay damages to the fund’s liquidators in the sum of USD 111 million, representing the losses suffered by the fund which were caused by their default.
The findings recorded in the judgment suggest it was a case of extreme facts: the fund’s investment manager arranged the appointment of two relatives to serve as the fund’s directors on a gratuitous basis. This was purportedly done in order to meet certain minimum legal requirements. For the next 6 years, the fund directors allegedly did not actively discharge their functions as directors beyond signing documents at the manager’s request. The Court found that the lack of apparent oversight allowed the fund’s NAV to be inflated to disguise substantial losses which the fund was suffering [Note:1]. By the time this was discovered and the fund was put into insolvent liquidation, it was said that over USD 141 million had been wrongly paid out to investors by way of redemptions based on NAVs which were found to be inflated to the tune of USD 111 million in aggregate. In these circumstances, the Court found the directors guilty of wilful default – an essential finding, since it disqualified them from relying on an indemnity from the fund which would otherwise have blocked the liquidators’ claim.
Directors’ duties defined
These facts also made a convenient platform for the trial judge to make a series of stern statements of principle about the duties of hedge fund directors. These statements are important because the Court took long-standing principles concerning the duties of nonexecutive directors in a conventional company structure and adapted them for the unique structure of a hedge fund – with its array of professionals independently performing various critical functions in support of management. The key statements are as follows:
The Cayman Islands investment fund industry works on the basis that investment management, administration and accounting functions will be delegated to professional service providers and a company’s independent non-executive directors will exercise a 'high level supervisory role'. They must also make sure that the scope of their own supervisory role is clearly understood by all concerned.
Directors must satisfy themselves that the overall structure of a fund is consistent with industry standards; that the offering document complies with Cayman Islands law; and that the terms of the service providers’ contracts are reasonable and consistent with industry standards.
Whilst independent 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 fund is complying with investment restrictions set out in the offering documents and to acquire a proper understanding of the financial results of the investment and trading activity, without which they would not be in a position to perform an overall supervisory role.
It is their duty to satisfy themselves that there is an appropriate division of function and responsibility between the investment manager and administrator. They need to satisfy themselves, on a continuing basis, that the various service providers are performing their functions in accordance with the terms of their respective contracts and that no managerial and/or administrative functions which ought to be performed are left undone.
Independent directors must do more than simply react to whatever problems may be brought to their attention by the other professional service providers. They must apply their minds and exercise an independent judgment in respect of all matters falling within the scope of their supervisory responsibilities.
Reviews of financial accounts must be conducted in an inquisitorial manner, the directors making appropriate enquiries of the administrator and auditor.
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