July 12, 2020

Cayman corporate governance reforms face legal challenge


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CIMA-logoKris Devasabai, from Risk.net

Efforts to enhance the corporate governance framework for hedge funds in the Cayman Islands have run into opposition from local fund directors, who take issue with the regulator’s plans to create a public directors’ database

Fund directors in the Cayman Islands are pushing back against an initiative to improve corporate governance standards in the jurisdiction, even though the proposals have garnered widespread support from investors.

An affiliate of DMS Management, the largest provider of fiduciary services to hedge funds in the Cayman Islands, is seeking a judicial review of the Cayman Islands Monetary Authority’s (Cima) proposed corporate governance reforms.

Don Seymour

Don Seymour

The company, which provides directors for scores of Cayman-registered hedge funds, claims Cima’s proposals will harm its competitiveness and negatively impact the jurisdiction.

DMS wants an injunction from the courts preventing Cima from taking any actions based on its recent consultation on corporate governance.

Don Seymour, founder of DMS, declined to comment on the proceedings.

DMS is not alone in opposing the reforms tabled by the regulator.

At the GaimOps conference in Cayman, Scott Lennon, managing director and principal of 19 Degrees North Fund Services, another fiduciary services provider, declared he is “not thrilled” about Cima’s plans to create a public database of hedge fund directors.

In January, Cima published a consultation paper on enhancing the corporate governance regime for hedge funds registered in the offshore jurisdiction. The reforms include a registration regime for professional fund directors and the creation of a searchable public database of directors to assist investors with due diligence.

The regulator also wants to clarify the legislative duties and obligations of fund directors and extend its existing ‘statement of guidance’ on corporate governance to Cayman-registered funds.

The proposals aim to address some of the corporate governance issues that came to the fore in the aftermath of the 2008 financial crisis when fund directors were criticised for failing to spot risky investments and allowing managers to gate and suspend redemptions.

The pressure for reform intensified after the collapse of Weavering Capital’s Cayman-registered Macro Fixed Income Fund in 2009. The UK and Cayman courts found the directors of the $600 million fund – the younger brother and elderly stepfather of Weavering founder Magnus Peterson – guilty of wilful negligence or default in failing to perform their duties to supervise the manager.

James Newman, a director at Barclays Wealth and Investment Management, says investor concerns around corporate governance need to be addressed. “This is a confidence and perception issue for Cayman.” He made his comments speaking on a panel at the GaimOps conference.

Newman supports Cima’s proposals for a ‘statement of guidance’ outlining the duties and responsibilities of fund directors, which he says should be applied on a ‘comply or explain’ basis.

For instance, the regulator should clarify directors’ responsibilities with respect to gating funds and suspending redemptions, he says. “If the director delegates responsibility for certain actions to the investment manager, there has to be a clear communication to the investor.”

Cima’s initiative has been broadly welcomed by institutional investors. Barclays’ Newman was part of a delegation of investors that met with the regulator earlier this year to discuss the issue. “I think everyone is on the same page in terms of where we want to go with this,” he says.

The investor community would like to see a principles-based corporate governance framework that includes regulatory approval of corporate fund directors, increased transparency and clearly defined standards.

Fiduciary service providers in Cayman are not entirely opposed to reform. DMS favours a registration or licensing regime for professional fund directors similar to the requirements for auditors and fund administrators in the jurisdiction. It also supports clearer guidance on the duties and responsibilities of fund directors.

The main sticking point seems to be Cima’s plans to create a searchable, public database of locally registered funds, which would include the names of the directors.

Investors believe such a database would allow them to identify the funds each director oversees and spot potential conflicts of interests, thereby improving the due diligence process. “If we can get easily accessible, consolidated information on directorships from Cima, that will help us as an institutional investor,” says Barclays’ Newman.

However, many Cayman-based fund directors feel the proposed rules will effectively force them to reveal their confidential client lists, which could be used by competitors to poach business.

Lennon says sophisticated investors are capable of conducting effective due diligence without the need for a public database. “Cayman is a professional investor jurisdiction and some people are looking for a retail level of protection, which I don’t think is appropriate,” he says. “It doesn’t make sense to make information about professional funds available to everyone.”

In any case he reckons the debate over the number of directorships is misguided. “Directors that sit on a lot of boards are being negatively perceived without good reason,” he says. Investors should consider the director’s policies, procedures and experience when deciding whether they are the right person to sit on the fund’s board, rather than focusing on the number of directorships, according to Lennon.

The biggest threat to the largest fiduciary service providers in Cayman is a potential regulatory limit on the number of boards an individual director can sit on. This would directly impact DMS, which provides directors to hundreds of funds. The company operates like an audit or law firm, with directors working with teams of associates and support staff to discharge their duties.

Cima has not ruled out a cap on the number of directorships, although the idea has received a mixed reaction from investors who favour increased transparency over prescriptive limits.

In its lawsuit DMS affiliate Cayman Private Manager II argues Cima’s consultation on corporate governance was “deeply flawed” and questions the regulator’s reasons for pursuing the reforms. The application also challenges Cima’s decision to hire Ernst & Young to perform a survey on corporate governance, citing prior links between the audit firm and senior staff at the regulator.

The consultation period ended on March 18 and Ernst & Young’s survey has also been completed.

DMS’s legal challenge, which was filed on April 2, has prevented the regulator from moving ahead with the reforms.

Cima has not commented on the application for a judicial review, although sources in the jurisdiction say the regulator is likely to press ahead with its reforms.

The Grand Court has not yet ruled whether to grant the application for a judicial review.

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