Weavering Macro v Peterson

• Jurisdiction: Cayman Islands
• Judge: (Jones, J.)
• Judgment Date: 26 August 2011
• Court: Grand Court (Cayman Islands)
• Date: 26 August 2011

Grand Court, Financial Services Division

(Jones, J.)

WEAVERING MACRO FIXED INCOME FUND LIMITED

and

PETERSON and EKSTROM

D. Lord, Q.C. and S. Folpp for the plaintiffs;

B. Valentin and Ms. K. Houghton for the defendants.

Cases cited:

(1) Barings PLC, Re, [1998] BCC 583, distinguished.

(2) Barings PLC (No. 5), Re, [1999] 1 BCLC 433, followed.

(3) City Equitable Fire Ins. Co. Ltd., In re, [1925] Ch. 407; [1924] All E.R. Rep. 485; [1925] B. & C.R. 109; (1925), 94 L.J. Ch. 445; 1333 L.T. 520; 40 T.L.R. 853, followed.

(4) Lexi Holdings plc v. Luqman, [2008] 2 BCLC 725, dicta of Briggs J. applied.

(5) Prospect Properties Ltd. v. McNeill, 1990–91 CILR 171, referred to.

(6) Westmid Packing Servs. Ltd., Re, [1998] 2 BCLC 646, followed.

Companies-directors-powers and duties-duty of directors, whether remunerated or not, to supervise investment companies with reasonable care, skill and diligence, and act in fund”s best interests-to act as objectively reasonable director and use subjective skills and abilities-may not delegate supervisory responsibility to professional service providers

Companies-directors-powers and duties-duties to assess financial position of company and supervise investments breached by, inter alia, failure to properly analyse financial statements and management accounts for compliance with investment restrictions, and failure to request further financial information from fund”s administrator

Official liquidators of an investment fund commenced an action for damages against its former directors.

Weavering Macro Fixed Income Fund Ltd. had been incorporated in the Cayman Islands, with shares listed on the Irish Stock Exchange. Mr. Magnus Peterson (‘the investment manager’) was its principal adviser, through his company, Weavering Capital (UK) Ltd. (‘WCUK’). The fund”s administrator was PNC Global Investment Servicing (Europe) Ltd. (‘PNC’), which was responsible for preparing monthly and annual financial statements with auditors, and quarterly management reports. Overall supervision of the fund was entrusted to the defendants, who were close relatives of the investment manager. PNC took no responsibility for the fund”s compliance with the investment restrictions set out in its offering memorandum, which included a limitation on the amount of gross assets exposed to the creditworthiness of any one counterparty to 20%, and

stipulated that over-the-counter interest rate swaps (‘IRSs’) only be transacted with a major bank as the counterparty. In breach of those restrictions, the investment manager, without the defendants” consent, completed 30 fraudulent over-the-counter IRSs with Weavering Capital Fund Ltd. (‘WCF’), a company believed by the defendants to be dormant, but in fact controlled by the investment manager. This dishonestly manipulated the fund”s net asset value, thereby exposing more than 60% of the fund”s gross assets to the creditworthiness of WCF.

The articles of association exempted the defendants from liability, unless loss was caused by their ‘wilful neglect or default.’ Over the course of the fund”s existence, they held infrequent board meetings, signed minutes of fictitious meetings, signed financial statements for audit purposes, and received quarterly management reports from PNC, without giving any detailed consideration to the financial position of the fund or its compliance with the investment restrictions. In particular, they did not appreciate the inflated NAV of the fund, or the existence of the fraudulent transactions, at the time of the PNC Quarterly Report for Q3 2008, the contents of which revealed the fraud. They instead relied upon PNC and the investment manager to ensure compliance and continued to pay share redemption requests based on the inflated NAV, until they discovered the fraud and liquidated the fund in 2009.

The plaintiffs sought US$111m. in damages, submitting that (a) directors of investment funds, whether remunerated or not, had supervisory duties to act independently, reasonably, and in the fund”s interests, and could not delegate their supervisory responsibilities to service providers; (b) the exemption clause did not assist the defendants because they had acted wilfully in failing to make any, or any serious, attempt to fulfil their supervisory responsibilities; (c) the defendants had breached their supervisory duties in respect of the fund by failing to consider the compliance of their agreements with industry standards, failing to supervise auditing arrangements properly, and failing to assess the legality of the offering documents, having either ignored such matters or improperly assumed that lawyers, service providers, and the investment manager would comply with their obligations; (d) this improper approach continued and critically impaired the defendants” ongoing supervision of the fund, its financial position, and its investments. They approved quarterly management reports and audits quickly and without any proper review or investigation, did not request any further information, ‘noted’ compliance with investment restrictions without exercising any independent judgment, and performed their functions nominally as a favour to the investment manager, rather than exercising any real supervisory role; (e) their execution of a sham management agreement and side letters without proper enquiry further evidenced their general failure to comply with their supervisory duties; and (f) the defendants should have become aware of the fraudulent IRSs upon receipt of the PNC Quarterly Report for Q3, and immediately put the fund into liquidation. Their failure to do so had caused the fund

losses of US$111m. in making irrecoverable redemption payments after this time based on an inflated net asset value.

The defendants submitted in reply that (a) the scope of the supervisory duties of directors of investment funds was narrower if, as in the present case, they were not being remunerated; (b) the exemption clause assisted them because any default on their part was not wilful or intentional; (c) they had properly considered that their lawyers, service providers, and the investment manager would comply with their obligations, on which they had been entitled to rely; (d) they had exercised a real supervisory role and had not been required to enquire beyond the quarterly reports and financial audits in assessing the financial condition and investments of the fund; (e) the execution of the management agreement and side letters had not misled anyone or caused the losses claimed; and (f) although the defendants did not notice details of the PNC Quarterly Report for Q3, and had not immediately put the fund into liquidation, PNC had known about the IRSs at that time, and the defendants had been entitled to rely upon them to act in accordance with their contractual obligations.

Held, awarding damages to the plaintiffs:

(1) Directors of investment funds, whether remunerated or not, owed supervisory duties to exercise independent judgment, to act with reasonable care, skill, and diligence, and to act in what they considered to be in the fund”s interests. This included acting as an objectively reasonable director in addition to subjectively applying the abilities and expertise they possessed. Delegating power to service providers could not absolve directors from their duty to acquire information about the fund”s financial affairs or exercise supervisory responsibility for the fund (paras. 8–13).

(2) Exclusions of liability for directors except for ‘wilful neglect or default,’ would protect directors who carelessly or negligently attempted to perform their duties, but not those who, as in the present case, knowingly, intentionally, or recklessly failed to make any, or any serious, attempt to fulfil their supervisory responsibilities (paras. 14–17).

(3) The defendants had breached their supervisory duties when establishing the fund. They had failed to consider whether the fund”s articles of association and professional service contracts complied with industry standards, and had not properly considered how those services would be performed. They had failed to satisfy themselves that the auditor was approved by the CIMA, or that the auditor had issued the ‘letter of consent’ required for its name to appear on the offering documents. Nor had they considered the terms on which the auditor would be appointed. They had failed to satisfy themselves that the fund”s offering documents complied with the Mutual Funds Law (2009 Revision), s.4(6) in giving all necessary information for prospective investors to make informed decisions before subscribing for shares. The defendants had breached their supervisory duties by failing to consider issues or by assuming that

lawyers, service providers, and the investment manager, would comply with such obligations (paras. 18–23).

(4) This improper approach had continued and critically impaired the defendants” ongoing supervision of the fund. In breach of duty, they had approved quarterly management accounts, financial statements for audit accounts, and the plans of the investment manager, without any proper review or analysis. They attended board meetings only to approve the quarterly management reports prepared by PNC without giving them any serious attention. The minutes of board meetings had been made on a template that merely ‘noted’ compliance with investment restrictions without any further analysis or investigation and some minutes were signed when the meeting had not taken place. No monthly reports or further information were ever considered, or requested from the fund”s administrator, and the defendants could not have acquired a proper understanding of the fund”s financial condition, or of its compliance with the investment restrictions, from the quarterly reports alone. When signing the financial statements, they had not taken the time to satisfy themselves that it was appropriate to do so...