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In good times and in bad: The importance of effective directors for troubled funds

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With the global financial crisis of 2008 now a decade in the past, much has changed in terms of how offshore private funds are governed and monitored. The highly publicised Weavering case in 2009 brought the role of fund directorships into sharp focus, specifically the lack of robust independent oversight. 

With the global financial crisis of 2008 now a decade in the past, much has changed in terms of how offshore private funds are governed and monitored. The highly publicised Weavering case in 2009 brought the role of fund directorships into sharp focus, specifically the lack of robust independent oversight. 

Both the financial crisis and the Weavering case highlighted significant deficiencies in the way some fund managers approached the role of appointing directors to the board resulting in more independent non-executive board members now being appointed. 

Moreover, as part of Cayman’s drive to enhance its corporate governance environment, the Directors Registration and Licensing Law (2014) was introduced. Whilst section 30(3) (c) of the Mutual Funds Law gives CIMA the power to require the substitution of any director of a regulated fund, the DRLL goes further and provides CIMA additional powers including, the effective disqualification of hedge fund directors through Section 25(2). 

The overall quality and scope of directorship services work in the Cayman Islands continues to be enhanced with professional director firms such as Maples Fiduciary establishing the highest possible standards. 

Maples Fiduciary, a division of MaplesFS, offers a number of qualified, seasoned professionals to act on fund boards, distinguishing itself by the quality of its professional staff, considerable experience and expertise across a broad range of structures and investment strategies. This, coupled with robust policies and procedures, internal systems and a dedicated team of operational, information technology, internal audit and compliance professionals, ensures that Maples Fiduciary directors are well equipped to provide effective and efficient governance services.

“When considering a board appointment, we review all of the relevant fund documents to ensure that the documentation is in line with best practices and that the documents provide appropriate transparency to investors,” explains Tammy Jennissen, Senior Vice President, Maples Fiduciary. 

“Once the fund is launched, we have monthly or quarterly information provided to us by the relevant service providers, which we review to obtain an overview of the activities and performance of the fund and market as a whole.”

As part of exercising fiduciary oversight, directors at Maples Fiduciary actively participate in board meetings for the investment funds they represent. During each board meeting, directors discuss various topics with service provers to ensure they are operating within the parameters stipulated in the fund documents. Part of this discussion involves reviewing the investment portfolio so that a director can better assess portfolio composition with a view to mitigate potential risks, for example, looking at whether the portfolio is heavily weighted towards illiquid securities.

While high quality, engaged independent directors add value throughout the life of a fund, these individuals play an especially critical role when a fund is facing challenges. 

There are a number of issues that can arise with troubled funds, says Abali Hoilett, Senior Vice President, Maples Fiduciary. “When that happens, we provide guidance on what the fund should consider when seeking to resolve issues in the most effective and compliant manner, at all times ensuring that investors are being treated fairly.”

While there are basic best practices that directors should be well versed in, dealing with issues affecting troubled funds largely depends on the specific considerations of each situation. 

In some instances there may be valuation issues that require the fund director to engage external valuation agents. In addition, there may be concerns regarding side letters, or indeed management issues. “There are myriad issues that we have to deal with when funds encounter difficulties. The process in some situations can be fairly straightforward, and others, not so straightforward. The key in these situations is to effectively apply our knowledge and experience to the issues at hand, seeking appropriate advice, where required, to determine the best solution for the specific situation,” explains Jennissen.  

If a manager proposes a side letter that violates the terms of the funds constituent documents, a director would be expected to step in, often getting fund counsel involved to make sure that the letter does not get signed before the issues are resolved. However, in some instances, managers may execute side letters without bringing the letter to the attention of the full board and that is typically when issues can arise. 

“If during the course of a board meeting, we determine that a side letter has been executed without our knowledge, we would immediately get involved. Depending on the terms agreed in the letter, we would typically not ratify the execution of the letter until we were comfortable that the letter did not favour certain investors unfairly. In a worst case scenario, the board may have to ask that the letter be re-issued to fix specific terms agreed, which is never a good situation,” adds Jennissen. 

Other areas that require fund directors’ involvement include the emergence of non-standard capital activity within a fund, as well as dispute resolution.

Hoilett explains that non-standard capital activity can relate to anything that is raised or requested outside of the terms of the current offering. 

“Non-standard capital activity may include, though not be limited to, extra redemption or subscription dates, in-kind subscriptions and capital activity where a security is impaired. We would initiate a fact gathering exercise, making sure all the information is available and then would then give due consideration to the fund to make decisions within the bounds of the legal documents,” he says. 

Dispute issues can arise for various reasons. It may originate from a disagreement between the partners or principals of the management company and, depending on the severity of the dispute, the director would need to think about what recourse to take and reach out to fund counsel to ensure that investors are being treated fairly. 

Equally, it may originate with a disgruntled investor that may not be happy with the fund’s activities or the performance of the portfolio manager. 

In such a situation, says Jennissen, “The board would want to determine what, if anything they think the investment manager did wrong. If the issue was regulatory, we would query what had been done and whether the alleged breach impacted the fund. As long as there is consistent and transparent dialogue between the directors and the investment manager appropriate disclosure and action can be taken to ensure the interests of the investors are safeguarded.”  

Directors can also play an active role in the winding down of a fund. If the fund’s performance has been poor for a considerable period of time and redemption activity is increasing, it is often not a surprise to investors that directors might consider, with the manager, an orderly wind down of the fund. 

“At this point, the board of directors and the investment manager would consider the redemption activity, assess the potential for future redemptions and compare that with the liquidity profile of the remaining assets.  At some point a decision may need to be made to wind down the fund by either moving straight to cash and mandatorily redeem all investors or whether the directors need to invoke fund gates or a full suspension of redemptions is required to ensure that remaining investors who had not yet submitted redemption requests are not left with a basket of illiquid investments. 

“Following a decision to terminate a fund, a notice would be sent out to investors stating that all external capital will be returned on a specified date, which is typically the next month if it is a fully liquid portfolio. If it is more illiquid, it might require a longer wind-up process. For the most liquid part of the portfolio, the aim would be to return this capital to investors as soon as possible. Over time, the fund would try to unwind the illiquid positions as quickly as is practicable, but in a way that ensures investors are getting the best return possible given the illiquid positions,” explains Jennissen.   

Being able to avoid a fire sale is a key part of the director’s role when handling a troubled fund.

“With a troubled fund in full wind down mode, there is a risk that an investment manager may disengage but it is the responsibility of the directors to ensure that the investment manager stays engaged and properly manages the remaining assets for ultimate sale for maximum value. If the board feels that the investment manager is not doing its job, either because he is preoccupied with a regulatory or criminal investigation or its staff are leaving to seek new positions elsewhere, one remedy, albeit drastic, is to terminate the investment manager and engage a liquidator to complete the liquidation of the portfolio. This will be subject to the terms of the investment management agreement and is never a decision that is taken lightly” says Hoilett. 

Despite the measures that have been put in place and the way the industry has evolved with respect to corporate governance, challenges still abound for funds. Engaged, proactive directors bring a level of technical expertise, experience and overall perspective and insight that can play a critical role in supporting a fund in both times of prosperity and distress.

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