Regulation in the fund industry is alive and well and while things look much rosier in the regulatory garden than ever before – regulation is not going to deliver the panacea that some investors hope for. This is not a new view – whether it is a focus on AIFMD, capital adequacy, UCITS IV or Dodd Frank reforms – none deliver an alternative to detailed investor due diligence or even to vastly improved governance standards in the industry. This can only be done by greater investor involvement.
Good governance is an essential add on to proper due diligence when investors make investment decisions and should be viewed as something to be looked at together with the due diligence process as no amount of due diligence can deal with the pressures of ongoing decision making which need to be made with the interests of the investors at the forefront and which can only be delivered through good governance structures which are independent of the investment managers.
But even good governance structures need checks and balances and members need to take care about the slow but relentless erosion of their ability to have a say in matters relating to their money particularly where the board is not independent and investors have a limited say in who can be appointed as directors to their funds. When things are going well – this is never an issue – but investors do need their own people when things go wrong and backs are against a wall.
Investors who have done their due diligence will be aware that they already have very little say in the governance of the funds that house their money once they have invested unless there are suitably written material adverse change clauses in the articles of association of their fund that protect them from changes when the fund is under stress. Non voting preference shares (the normal way investors hold their interests in funds) mean that control on fund matters is essentially a matter for investment manager nominees appointed as directors.
What little rights that did exist continue to potentially be eroded further and members of funds that hold such shares need to beware and ensure that directors do act in their interests. The Cayman Islands have recently published the Companies (Amendment) Law 2011 to modernise and clarify certain aspects of Cayman Company law – but with it have come potential dangers for members who have not done their homework properly and where directors may have to deal with the pressures of conflicts of interests and where independence may take on greater significance.
An example of this is in section 8 (b) which adds a paragraph (da) to the principal Law in relation to the provisions for redemption and repurchase of shares – on the face of it just a simplification. Previously how shares were redeemed needed to be authorised by the company’s articles of association or approved by shareholder resolution (s 37 (3)(d) of the Companies Law (2010 Revision). It is true that the way this was set out was not always ideal or clear, but the Companies (Amendment) Law 2011 (8)(b) now allows the articles of association or a resolution of the company to delegate to the directors of the company authority to determine the manner or any of the terms of any such redemption and repurchase – thereby cutting out the shareholders involvement. In such a scenario the existence of a well drafted material adverse change clause in the articles of association becomes even more important than ever before. But it is not enough to take comfort that such a clause exists. It is important to understand how polls can be demanded at the meeting, what constitutes a quorum for such a meeting and what the mechanics of instituting the change would be and that the investors are comfortable with the directors making these decisions and are able to have a say in who they are.
I have pointed out previously that investors themselves are not blameless for the current position as managers and fund administrators often struggle to get investors involved properly in fund governance issues when changes are required and so expediency does drive them to ensure that things can be done by the directors without having to rely on investor involvement – but as directors are given greater powers, the need for investors to determine who their fund directors are becomes ever more important.
So whilst the regulatory environment grows for funds, investors still need to beware of relying too much on the regulatory environment protecting them from some of the risks that may arise such as from potential conflicts of interest.
©Jaitly LLP