Tag Archives: cayman hedge fund

Independent Directors for Failed Offshore Hedge Fund Found Personally Liable

Weavering Case Overview

An August 26, 2011 judgment of the Grand Court of the Cayman Islands, Financial Services Division, held two independent directors personally liable for “wilful neglect or default” in exercising their supervisory responsibilities as directors of the Weavering Macro Fixed Income Fund Limited (the “Fund”). The two independent directors were ordered to pay US $111 million plus costs.

The judgment is notable because it gives guidance for directors of Cayman Islands companies in discharging their “duty to exercise independent judgment, to exercise reasonable care, skill and diligence and to act in the interests of the [Fund].” The guidance is likely to impact the manner in which offshore directors supervise functions that are delegated to professional service providers, including investment managers and administrators. The court indicated that the exercise of the power of delegation “does not absolve [independent directors] from the duty to supervise the delegated functions.” “They are not entitled to assume the posture of automatons . . . without making enquiry . . . on the assumption that the other service providers have all performed their respective roles . . . .”

The following points made by the court in the opinion provide useful guidance for independent directors as well as the professional service providers in coordinating with and responding to the supervision of independent directors.

Supervision During Fund Establishment Phase

Directors should satisfy themselves that the overall structure of a fund is consistent with Cayman Island industry standards and that the terms in the service providers’ contracts are reasonable.
Directors should understand the nature and scope of work of each of the professional service providers and determine that the division or responsibilities between the service providers is appropriate.
Directors should satisfy themselves that the hedge fund offering documents comply with the requirements of Cayman Islands law (in particular section 4(6) of the Mutual Funds Law). The court suggests that this may be done by making inquiry of the lawyers who have coordinated the work of developing the offering documents.

Supervision During Ongoing Operations

Directors should convene board meetings to discuss matters of substance and not simply to rubber stamp routine matters raised by the investment manager. Generally, an agenda should be prepared in advance of the meeting and the substance of discussions should be maintained in the minutes at least to the extent that it is necessary to understand the basis upon which any decisions were made and any resolutions passed.
Directors should review a fund’s balance sheet and other financial reports so that they can understand the fund’s general financial/NAV position and satisfy themselves that a fund is trading in accordance with any investment restrictions.
If directors accept a responsibility for a fund’s financial statements, they must exercise independent judgment in satisfying themselves that the financial statement do present fairly the fund’s financial condition.
Directors must be cognizant of issues that are likely to arise from side letters and determine whether there could be an adverse impact on a fund before approving or signing the letters.

Conclusion

We have talked previously about some of the offshore hedge fund structural considerations and we have discussed the issues involved with establishing a Cayman hedge fund, but we have not specifically written a post about the obligations of directors of offshore hedge funds. Independent directors of offshore funds will need to be more cognizant about their duties going forward and the position needs to be taken seriously. As with other high profile hedge funds that have failed, certain service providers and directors are being taken to task for not properly doing what they were supposed to do. As more lawsuits go through the courts we are likely to see more lawsuits similar to this lawsuit.

The case can be found here: Weavering Judgement – Grand Court of the Cayman Islands

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Cole-Frieman & Mallon LLP provides legal services to domestic and offshore hedge funds. Bart Mallon can be reached directly at 415-868-5345. Karl Cole-Frieman can be reached at 415-352-2300.

Start a Hedge Fund in the Cayman Islands

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How to Set Up a Cayman Islands Hedge Fund

There are two main jurisdictions to establish an offshore hedge fund (either as a single hedge fund or as part of a master-feeder structure). The two jurisdictions are the BVI and the Cayman Islands. This article will discuss some of the features of Cayman Island based hedge fund structures.

Why the Cayman Islands?

Cayman has been the leading jurisdiction for fund formation with an estimated 80% of the world’s hedge funds domiciled there. As of December 2008, Cayman had over 10,000 hedge funds registered with the local regulatory authority: The Cayman Islands Monetary Authority (“CIMA”).

First and foremost: establishing a fund in the Cayman Islands is easy and efficient, offering managers many competitive advantages over other jurisdictions including:

Non-public funds can be registered in as little as 3-5 days with CIMA and the vehicle of choice for the fund can be registered within 1 day prior to filing, if necessary;
Flexible statutory regimes, with an absence of exchange control provisions, that are well-established and relatively low-cost;
There are no restrictions on: (i) investment policy (ii) issue of equity interests (iii) prime brokers or (iv) custodians;
The regulatory and legislative environment is continuously evolving to strengthen the jurisdiction’s appeal for hedge funds in response to ever changing market conditions;
Cayman is a tax neutral jurisdiction – there are no capital gains, income, profits, withholding or inheritance taxes attaching to investment funds established there, nor to investors in such investment funds;
Cayman is a British Overseas Territory and as such maintains all of the security and stability associated with the British flag. The UK remains responsible for the islands’ external affairs, defence and their legal system; and
The quality and expertise of the Cayman Islands local services, infrastructure and legal system is well above par.

Does Every Hedge Fund Have to be Registered with CIMA?

While most funds (90%) will be required by Cayman Islands law to register with CIMA, there are some funds that will not: those funds where the equity interests are not held by more than 15 investors who collectively have the power to appoint or remove the “operator” of the fund i.e. the director, trustee, or general partner, depending on the fund’s choice of vehicle. For example, a private fund or closely held funds such as partners’ funds or those in incubation “testing the waters” before launching into the registered world. These funds need not make filings or pay fees to CIMA.

All other funds must register with CIMA, pay annual fees and undergo annual auditing.

What are the CIMA Hedge Fund Registration Requirements?

1. Incorporation/Formation of the fund vehicle. The fund must be in the form of one of three vehicles: i) a Cayman Islands Exempted Company (most common); ii) a Unit Trust; or iii) an Exempted Limited Partnership. (The latter is popular with US investors as the Cayman Islands Exempted Limited Partnership Law follows the equivalent legislation in Delaware.) There must be a minimum of two (2) directors appointed to the fund – corporate or individuals. The directors need not be local.

2. Preparation of the fund’s Offering Document.

3. Preparation of the fund’s constitutional documents (i.e. Memorandum and Articles of Association) to reflect the terms of the Offering Document. This is usually done by way of amending and restating the constitutional documents after the vehicle for the fund has been properly formed (see 1 above).

4. Preparation of the service agreements i.e. administration agreement/investment management agreement/advisory agreement etc.

5. Preparation of the form of subscription agreement to be executed by the investors of the fund.

6. Resolutions must be passed approving: the Offering Document, service agreements and the issue of equity interests by the fund.

7. All of the following documents must then be submitted to CIMA:

i)    A certified copy of the fund’s certificate of incorporation (or otherwise, depending on the vehicle used);
ii)    Fund’s Offering Document;
iii)    Application Form (“Form MF1”);
iv)    Auditor’s letter of consent; (A local auditor must be appointed. Such auditor must also sign off on the fund’s audited financial statements which are to be submitted annually to CIMA.)
v)    Administrator’s letter of consent (no requirement for local administrator);
vi)    Registration fee (approximately US$3,000 (subject to change))

What Are the Costs for CIMA Registered Funds?

The total approximate costs of setting up a Cayman Islands Hedge Fund will include: the incorporation/formation costs of the vehicle required plus the ongoing annual fee (for exempted companies); the annual administrator’s fee; the annual auditor’s fee; the initial registration fee of the fund with CIMA and an annual fee to maintain the fund’s registration, and any legal fees associated therewith.

Quotes for incorporation etc. and estimates for services may be obtained from service providers and legal counsel directly, as these will likely vary. Legal counsel may provide recommendations for service providers upon request.

Article Written by Michelle Richie

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Please contact us if you have any questions or would like to start a hedge fund. Other related hedge fund law articles include:

Bart Mallon, Esq. has written most all of the articles which appear on the Hedge Fund Law Blog. Mr. Mallon’s legal practice, Cole-Frieman & Mallon LLP, is devoted to helping emerging and start up hedge fund managers successfully launch a hedge fund. If you are a hedge fund manager who is looking to start a hedge fund, or if you have questions about investment adviser registration with the SEC or state securities commission, please call Mr. Mallon directly at 415-296-8510.

Hedge Fund Auditors | Thought Piece From Castle Hall Alternatives

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The following article is by Christopher Addy, President and CEO of Castle Hall Alternatives, a hedge fund due diligence firm. We have published a number of pieces by Mr. Addy in the past (please see Hedge Fund Fees, Hedge Fund Due Diligence Issues, Issues for Hedge Fund Administrators to Consider and ERISA vs. the Hedge Fund Industry). The following post can be found here.

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And the auditors work for….

Audit opinions of a hedge fund’s financial statements are unlikely to make the New York Times bestseller list. As a result, we can certainly understand if the auditor’s fine print is not exactly top of the list for investor attention. However, not all audit opinions are the same and, over time, it seems that different audit firms are quietly introducing different standards of care and attention – and, of course, liability, which is always the 800 pound gorilla.

The issue is the addressee of the audit report – or, put more simply, who the auditor works for. In a public company, the auditors report to both the shareholders and the Board of Directors. A quick web search gives us a couple of examples – GE and Goldman Sachs (don’t laugh at the Level III assets, by the way).

In a hedge fund, however, sometimes the audit report mentions the shareholders, but sometimes it does not. What seems to be a fine difference is actually very profound – exactly why would a hedge fund auditor report only to the Board of Directors and deliberately fail to address their report to the shareholders? Adding insult to injury, of course, is the reality that the average Board of Caymanian rent-a-directors hardly acts with the same vigor and intervention as the non execs on the boards of GE and Goldman.

In our experience, certain audit firms appear to have taken a deliberate decision to direct their audit opinions, wherever possible, only to the directors. This is a difference which applies across both US GAAP reports as well as audits completed under International Financial Reporting Standards. Check 10 audit reports from different firms, and see what we mean.

The underlying issue – of course – is the lack of investor control. Investors, if asked, would very likely have an opinion on this issue: but, needless to say, they are not asked. Audit engagement letters are signed under cloak and dagger secrecy (usually because they include ever more expansive terms seeking to limit auditor liability under Caymanian law). Thereafter, as investors and due diligence practitioners know to their ongoing annoyance, it proves incredibly difficult and pointlessly time consuming to get some auditors even to confirm that they are the auditor of record for the hedge fund in question.

In the short term, one answer would be for offshore jurisdictions such as the Cayman Islands to mandate that all audit reports filed for Caymanian hedge funds be addressed to the shareholders rather than just the Board. If it’s good enough for GE, it should be good enough for any hedge fund.

In the bigger picture, however, this is just one question within the broad construct of Hedge Funds 2.0 post Madoff. Unfortunately, it is only investor pressure which can enforce any change so that service providers – auditors, administrators, lawyers et al – take responsibility and recognize that their primary duty of care is to the investors that pay them. Without that pressure, hedge funds will continue to be the asset class where everyone wants to get paid, but no-one wants to take responsibility.

www.castlehallalternatives.com
Hedge Fund Operational Due Diligence

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Other related hedge fund law and start up articles include: