In this article we look at the role an independent and appropriately comprised board can play in evidencing that such structures operate in an environment that seeks to ensure that the various parties to the fund are carrying out their roles effectively, operating within expected parameters and engaged with the governing body of the fund, the board of directors.
At the end of last month, Mrs Justice Proudman in the High Court found Magnus Peterson, founder of Weavering Capital, along with his wife and two colleagues, jointly and severally liable for a breach of fiduciary duties. The court awarded damages of $450 million against the four. Peterson maintains his innocence. It should be noted that the Serious Fraud Office has recently reopened the investigation of the fund and its founders after having decided in 2011 to drop proceedings – a decision that was met with disbelief by many in the investor community.
The UK ruling follows a ruling in the Cayman Islands Grand Court last year where Mr Justice Jones delivered a judgement against the directors of the Weavering Macro Fixed Income Fund, for $111 million for wilful neglect and default.
Poor governance introduces risk
Both cases illustrate that poor governance can represent a substantial risk for all the parties to the fund, including the investment manager, investors, directors, and also potentially service providers. In the case in question the directors of the fund, which was listed on the Irish Stock Exchange and thus required to have two ‘independent’ directors, failed to monitor the operations of the service providers to the fund adequately, if at all, and in failing to do so could not discharge their fiduciary duties.
There was no new law or statute involved: instead the Cayman court went to great lengths in a 37 page judgement outlining what Justice Jones considered to be minimum expectations regarding fund directors’ responsibilities and levels of responsible corporate governance in investment funds.
Justice Jones stated that “directors owe fiduciary duties to their companies to act bona fide in what they consider to be the best interests of the company…and not to place themselves in a position where there is a conflict between their personal interests and their duty to the company.”
Directors, he explained, “have a duty to exercise an independent judgement in what they consider to be the best interests of the company.”
By both of these standards the directors of Weavering, who despite being accepted by the Irish stock Exchange as independent, were in fact related to Magnus Peterson, would appear to have consistently failed.
So how then could a robust board, operating in best practice mode and comprised of experienced and truly independent directors have produced a different result in a case such as Weavering?
Board meetings: forum for discussion
As borne out in a recent survey of allocators by Carne, best practice for board meetings is to convene quarterly to discuss the business of the fund. These meetings should be more than a perfunctory review of the papers allowing for detailed discussions of the operations of the fund and the performance of key service providers and should be supported by a comprehensive board pack that has been tailored by the directors over time to the particular circumstances of the individual fund.
This pack, provided in advance, allows directors to be fully apprised as to the operations of the fund through detailed reporting from the Investment Manager, the Administrator and various other service providers as may be appropriate from time to time and provides a platform for discussion.
Unlike in Weavering, where the Administrator appears to have provided reporting to directors that was simply not reviewed, a properly operating board will insist upon representatives of the Administrator attending meetings and presenting their report to the board. This at once allows the directors the opportunity to query the report and the Administrator an opportunity to not only present their report in a manner that will be evidenced, but also to raise any concerns they may have. In the case of Weavering one can only assume that the Administrator would have taken the opportunity to raise concerns around the continual irregular unwinding of positions and the concentration of risk with a related counterparty.
The same principle will apply to various members of the Investment Manager’s senior team such as the Chief Investment Officer, who will typically provide detailed information on the implementation of the strategy and, key in the Weavering case, any departures therefrom. ‘Style Drift’ and the breaking of key trading parameters such as concentration limits are both areas where strong independent boards focus their minds in such discussions. Additionally it is common for the Chief Compliance Officer to be called to present reports to the board and to air any concerns in connection with the trading or other activities of the Fund or the personnel supporting it.
Finally it is worth noting that best practice would also require that the Auditors to the fund attend at least one board meeting per year to finalise the annual audit. For timing purposes this is frequently a fifth meeting of the board that will usually focus exclusively on the audited financial statements.
Generally both the Investment Manager and the Administrator will also attend to both hear the presentation of the Auditors and to provide representations to the board of directors – who are ultimately responsible for the completeness and accuracy of the audited financial statements – that they are not aware of any issue surrounding the accounts as presented by the Auditors.
In the case of Weavering it appears that the directors did not take their responsibility for the financial statements seriously, as evidenced by the approvals procured from the directors a few short hours after they’d been initially presented with the statements by fax and seemingly without any enquiry being made of the auditors, the investment manager or the administrator prior to approval.
Accordingly we believe it is reasonable to assume that a process of holding regular meetings designed to allow constructive and inquisitive debate amongst the various parties surrounding a fund can add assurance that issues such as those in Weavering may be discovered at an earlier juncture to the benefit not only of investors but also the service providers.
Minutes: more than record of resolutions
In his original Cayman Islands ruling, Mr Justice Jones stated that “minutes be taken of the meeting which fairly and accurately records the matters which were considered and the decisions which were made.” The board must do the right thing, be seen to do the right thing, and be able to prove they did so. And any concerns raised by the service providers should be properly recorded in the minutes of the board meeting.
Directors were further instructed that agendas and board packs must be prepared and minutes be taken of meetings that would allow a “future reader to understand the basis upon which decisions were made” and how the fund was supervised.
In the Weavering case, Justice Jones said there was “no documentary evidence reflecting that these Directors ever sought to discuss or enquire about any subject at all.” Minutes were designed to give the impression that the directors were functioning as a properly constituted board, but in reality they had made no attempt to understand the fund’s condition.
Again, it is reasonable to assume then that the appointment of a competent Corporate Secretary charged with overseeing the compilation and distribution of board packs in advance of the meeting, and the recording of the substance of discussions comprising the meeting through the production of comprehensive minutes afterwards, is a positive step forward in evidencing not only the board’s discharge of its duties but also the satisfactory performance of each of the service providers.
Minutes should not be a simple and formulaic record of the resolutions passed at a meeting; rather they should provide context and a rationale to the discussions around the decisions made. At Carne we believe that the role of the Corporate Secretary has long been undervalued and that appointing such a service provider can greatly enhance the governance framework of the fund.
In a poll of major allocators to hedge funds in 2011, Carne found that over 70% of investors would like to see a minimum of two truly independent directors on a fund board. Investors also raised the skills and experience of the directors as key concerns in constituting an effective board.
Although Weavering is illustrative of an extreme case where the directors of the fund were both conflicted and ineffective, and with the clear caveat that there will never be a board of any entity constituted that can guarantee that any and all nefarious activity will be identified, the appointment of a strong, engaged and proactive board who operate with authority in monitoring the operations of all of the service providers to a fund can do nothing other than add valuable assurance to investors, service providers and managers that someone is looking out for them.
John Ackerley is a Director with Carne in the Cayman Islands. Carne is a multi-national advisory business focused on the provision of a broad spectrum of corporate governance services to the alternative investment funds industry.