14/09/2011 Author: Will Wainewright

A warning sign

The $111m fine meted out last month to two directors of failed Cayman-based hedge fund Weavering Capital, which collapsed in 2009 after failing to meet redemption requests, was striking in scale. The Cayman Grand Court’s unprecedented ruling punished Stefan Peterson and Hans Ekstrom, directors at Weavering Macro Fixed Income Fund, for “wilful neglect or default in the discharge of their duties” – in short, for not paying enough attention as a $637m swap agreement with a linked company led to the fund’s demise.

The scale of the losses faced by investors was vast, but the directors’ punishment still surprised some. It appeared to be a clear message that board members must take responsibility and play an active role – unlike Peterson and Ekstrom – and prepare to face the consequences if they don’t. Coming in a year which has seen hedge fund boards and the role of directors put under the spotlight, the verdict was timely.

But the exceptional details of the Weavering case must be noted. The guilty directors are the investment manager’s younger brother and stepfather and worked for free, hardly a shining example of independence. The Cayman industry is understandably quick to stress the verdict is purely a judgement on conduct at Weavering, and does not reflect wider practice in the domicile.

“Director services provided from the Cayman Islands are already at a high standard and the judgement only confirms that the standards we are applying are the correct ones,” says Paul Harris, a director at IMS Fund Services, which provides directors to Cayman funds. “If anything the judgement is probably a strong warning to directors outside of the Cayman Islands that they are to apply the same standards as those providing services from within the Cayman Islands or bear the consequences.”

The case was straightforward enough for Cayman’s High Court, with the directors signing off paperwork without reading it on a serial basis. But though the circumstances of the case seem extreme, will the verdict cause other funds to monitor their approach to directorships? Julian Korek, founding member at Kinetic Partners, thinks so. “It was a specific case, but having said that, it is a warning shot to directors that they need to fulfil their duties,” he says.
Robert Duggan, partner at Cayman law firm Mourant Ozannes, believes hedge funds and their investors will continue to demand better, more rigorous hedge fund boards as a result of the verdict. “Perhaps the greatest impact of the Weavering case will be felt among those fund managers who have tended to favour ineffective and malleable boards, as this approach will cease to be tolerated by the breadth of the hedge funds industry.”

The verdict was welcomed by Kevin Ryan, founder of HedgeDirector. He told HFMWeek: “The enormous fines imposed on the Weavering directors should help dissuade individuals who consider directorships as a hands-off or ‘trophy’ role, and also put pressure on the large service providers to reduce their directors’ portfolios to a realistic size.” HedgeDirector limits the number of directorships any one person can hold to 15, although an industry culture exists which sees many hold considerably more, a fact many see as a problem.

Ryan hopes the verdict will lead to a tougher era of regulation, but what form would it take? “It will be interesting to see how this unfolds in regulatory terms,” says Korek of Kinetic. “We could have a situation where different non-exec board members have different fixed roles: one for mandates, one for valuations and so on. Investors may push for this.”

The Cayman Islands Monetary Authority (Cima) will undoubtedly play a role in this. The case comes during their corporate governance review, which is considering options including fit and proper person tests for directors and disclosure on number of directorships held. Kevin Ryan thinks the verdict makes the issue even more pressing. “This case puts even greater pressure on Cima to start regulating directors more actively and providing more information to investors about directors and the roles that they take on.”

The organisation told HFMWeek that a number of the issues highlighted in the judgement are relevant to its ongoing review and will be taken into account. A Cima spokesperson said: “The Grand Court judgement underscores the personal accountability of fund directors under Cayman law. It should cause fund operators to be more extensive in assessing how they exercise their responsibilities and take the necessary steps to correct any shortcomings.” It is a message all funds, offshore or not, will have heard loud and clear, given the severity of the verdict.