THFJ: Is this ruling welcome from your perspective? What is your reaction to it?
DJ: From a director perspective, everybody realises that this is a particularly egregious case. Clearly the Weavering directors were negligent and breached their duty to exercise reasonable skill and care in their supervisory duties, and this was confirmed by both the lower court and the Court of Appeal. The question at hand was, however, a very specific legal question, being the following: did the conduct of the directors amount to wilful neglect or default, thereby preventing the directors from relying on the exculpation and indemnity provisions set out in the articles of association of the fund? The relevant legal test for wilful neglect or default is generally accepted. However, there was a difference of opinion between the lower court and the Court of Appeal as to whether the conduct of the directors met the requirements of the test. So I am not sure there is a huge amount of significance from a legal point of view, as there has been no change to the standard of conduct expected of directors.
I think the industry has moved on quite dramatically from 2008 in terms of what is expected of non-executive, independent directors. Post-Weavering, the Cayman Islands has enacted a raft of regulatory measures to enhance corporate governance standards and the regulatory oversight of directors in the Cayman Islands, including the CIMA Statement of Guidance (SOG) on the Corporate Governance of Regulated Mutual Funds, which sets out CIMA’s minimum expectations for the sound and prudent governance of a regulated mutual fund, as well as the recent Director Registration and Licensing Law (DRLL). The SOG contains many requirements that were set out by the lower court as to what a non-executive, independent director should be doing in order to meet his or her responsibilities to the fund.
So I think that there have been significant developments in the area of corporate governance post-Weavering. I do not have an issue with the fact that the case has been overturned, as this is based on the specific evidence of the case and the differing interpretations by the lower court and the Court of Appeal. It is difficult to prove wilful neglect or default, because it involves establishing subjective conscious intention or knowledge of a breach of duty, and the decision, in my view, simply acts to reaffirm this.
THFJ: Do you think this case clarifies the position of directors in the Cayman Islands?
DJ: In my view it is fairly defunct in the sense that it is just a question of the different view of the evidence. The broader question has become: is wilful neglect or default the appropriate standard, or is there a higher standard expected which would require that conduct of a director amounting to some form of negligence also excludes reliance by such director on the exclusion and indemnity provisions in the articles of association of a fund? Using wilful neglect or default as the standard means that a director will be entitled to avail himself of the exclusion and indemnity provisions in the articles and therefore escape liability if he merely does his “incompetent best” even where such conduct is clearly negligent.
Most people in the industry have, I think, accepted that this is not an adequate standard, and that the test should involve a more objective negligence element.
THFJ: Do you think it will impact the wording of those clauses?
DJ: It will definitely have an impact in terms of people reviewing the wording more carefully. However, there has been a significant shift in terms of focus on the articles and the terms of the exclusion and indemnity, even prior to the decision. Historically in many instances standard boilerplate language provided that only conduct rising to the level of wilful neglect or default would result in the loss by a director of an ability to rely on the exclusion and indemnity provisions in the articles. Now it has been expanded quite significantly to include – at least in my experience in most cases – gross negligence, which is a significant shift.
In addition, there is also more focus on the exclusion and indemnity provisions in the contractual arrangements of other service providers to a fund, including auditors and administrators.
THFJ: So do you think that investors will be perturbed by the ruling, or do you think that all it will do is become a spur for those higher standards in the articles?
DJ: If you examine the decision in detail, I do not think that there is a significant cause for concern. The decision further raises the discussion of what is an acceptable standard of conduct for directors. Most in the industry would, I think, agree that the “incompetent best” standard, as reflected by wilful neglect or default, is not acceptable and that a more objective negligence standard should be used.
THFJ: Right. Do you think that investors will seek redress more widely in the future or do you think that this really is a case of badly worded articles? For instance, would auditors be dragged in if something similar were to happen again in the future?
DJ: Yes, I think so. I think that is already happening and also occurred in the case of Weavering where the auditor and the administrator were sued. Once a potential loss arises, claimants are looking to all the service providers and their respective roles and responsibilities, and whether the relevant standards set out in their service agreements with the fund have been met. So all service providers to a fund, including the auditor and the administrator, are going to be scrutinised and potentially joined to litigation, this being consistent with the view that all service providers to a fund have their specific role to play in ensuring good corporate governance.
THFJ: Will this case have any implications wider than Cayman?
DJ: Yes, given the pre-eminence of the Cayman Islands as the jurisdiction of choice for hedge funds, the original case has had a broad impact across all jurisdictions in terms of highlighting the importance of corporate governance and further what should considered as best practice in the industry from a corporate governance perspective. The most recent decision is likely to further enhance focus on this area.
THFJ: What implications more broadly and not necessarily in the short term do you think these kinds of movements will have on your industry, the director’s industry? For instance, do you think fees will go up?
DJ: The hedge fund industry has moved from cottage industry to become more institutionalised as a result of the significant inflow of institutional investors. In order to meet the increasing demands of institutional investors in the area of corporate governance, the director service industry has similarly been evolving from a cottage industry to become a lot more institutionalised.
Institutional investors now conduct significant due diligence in the area of corporate governance, and their expectations extend beyond the skill set and experience of the director, to include factors such as whether the director forms part of a regulated firm, the reputation and regulatory status of that firm, whether the firm provides sufficient support to the director in terms of IT and other infrastructure, the current capacity of the director based on his or her existing portfolio of funds and, further, what role the director practically performs on the board. The expectation of the level of involvement of the director in the fulfilment of his or her supervisory duties over operations of the fund has also increased significantly amongst investors as well as regulators.
Given these increased expectations, it has become difficult for someone who purports to be involved full-time in the provision of directorship services to maintain credibility unless he or she can meet these institutional standards.
In terms of fees, most in the industry have accepted that the increasingly demanding nature of the role requires that directorship fees increase accordingly. However, this has been tempered by the significant cost pressures and declining assets experienced by many investment managers over the course of the last few years.
THFJ: Do you think a ruling like this negatively impacts the Cayman brand?
DJ: I don’t think so. Initially, I would expect some headlines expressing outrage that the Weavering directors have escaped liability, and arguments that this is indicative of deficiencies in the standards and regulation of directors in the Cayman Islands.
The Cayman Islands has, in my opinion, responded effectively to concerns in this area by increasing the standards of corporate governance and regulation of directors, this being reflected in the SOG as well as the DRLL.
Ultimately investors have sufficient traction to demand from investment managers whatever information they deem appropriate on directors and their related firms as well as the implementation of corporate governance standards that meet industry best practice.
THFJ: How mature do you think the industry is in this regard, and how much further down the institutionalisation road do you think it has to go?
DJ: I think it differs depending on jurisdiction. Broadly speaking, in Europe and especially the UK there is a fairly developed awareness of the importance of corporate governance, and it is developing rapidly in the US.
The appreciation and awareness of most investment managers on this issue has been driven by institutional investors effectively saying, “We’re not going to allocate funds to your fund unless we are comfortable with a number of areas, including your corporate governance.”
So I think generally the industry is moving towards best practice in the area of corporate governance, but jurisdictions are at different points of development. However, awareness is certainly accelerating, and it seems to me that in all jurisdictions there’s definitely an awareness of this issue; it’s just a question of how far advanced that is, and further whether investors are actually making a point of it to investment managers as part of their conditions to allocate money.