Jonathan Fitzgibbons and Simone Proctor comment on IOSCO’s report on suspension regulation and discuss a fund operator’s role when investment fund redemptions are on hold.
In the wake of global events which found some fund operators unable to meet the redemption requests of their investors, due largely to illiquidity in the market, the International Organization of Securities Commissions (IOSCO) has produced a report which aims to outline certain principles against which the practice of suspending redemptions can be assessed by regulatory supervisors and industry alike. While the report is not directly applicable to operators of hedge funds and other collective investment schemes, it provides food for thought as many funds remain suspended while their operators continue the often arduous task of unwinding positions.
The hedge fund industry is very well aware that suspensions, when imposed, have a negative impact on investor confidence in the operator and, unfortunately, that often triggers a chain reaction of further requests for redemptions. Years after the market crash, there are scores of unredeemed investors and unpaid redeemed investors, hoping, waiting and, in many cases, litigating their way back to what is left of their investment returns.
Ultimately, if suspensions are not managed appropriately, there is no doubt that the reputation of the operator can be put at serious risk. And in this industry, a great reputation takes years to establish but only a moment to lose.
So, what is the report saying, and should Cayman fund operators pay heed despite its not having direct applicability?
Six best practice principles are discussed and outlined, but there are two which we would like to highlight in this article, namely (i) disclosures to investors, and (ii) what steps operators should take during a suspension.
“There are scores of unredeemed investors and unpaid redeemed investors, hoping, waiting and, in many cases, litigating their way back to what is left of their investment returns.”
The mechanics of disclosures to investors are simple, and most jurisdictions currently require operators to disclose in the offering memorandum their ability to suspend redemptions to investors, before they invest. Indeed, it has long been the practice for Cayman fund operators to make these disclosures prominent. More importantly, the constitutional documents should provide that redemptions can be suspended and set out the possible reasons and criteria for the suspension. The recent landmark Privy Council decision definitively highlighted the importance of a fund’s constitutional documents in the suspension process. Principle 3 of the report emphasises this importance and also suggests that suspensions should be allowed to occur only in ‘exceptional circumstances’.
In jurisdictions such as the Cayman Islands, where the Mutual Funds Law or other applicable law does not contain a definition of ‘exceptional circumstances’, the report recommends the inclusion of ‘non-exhaustive’ examples of what might constitute ‘exceptional circumstances’, instead of the use of definitions. It was felt that as definitions in offering memoranda may in time become dated, or out of touch with market developments, or inadvertently exclude circumstances which could, in time, be considered ‘exceptional’, the better approach was to avoid definitions where possible.
Managing the suspension
No investor wants to hear that their fund is being suspended. But once the die is cast, the operators need to manage what unfolds very carefully until normal operations can resume if, indeed, they can resume. Taking a step back, it goes without saying that the suspension resolutions should cite the correct reasons for initiating the suspension, and the procedure should be carried out in accordance
with the fund documentation and constitutional documents. With increasing scrutiny of the role of independent directors of funds, and further pressures for reform in this arena, minds will no doubt be focused on ensuring that the processes comply with the requirements set out in a fund’s organisational documents. What an operator does not want to do is to provide an opportunity, or the grounds, for an investor to present a petition for the winding up of the fund, on ‘just and equitable’, or any other, grounds.
Where the suspension is ongoing, the decision to maintain the suspension should be regularly reviewed by the operators and, as Principle 8 in the report recommends, all necessary steps should be taken with regard to the best interests of the investors as a whole. Directors may therefore wish to consider whether seeking independent professional advice in respect of the valuation or potential for resale of the illiquid assets is appropriate. Until liquidity returns (for the fortunate ones) and the suspension is lifted, or the fund is ultimately wound up, the operators must keep investors informed of the decisions that are being taken.
Should operators be interested in the report? The short answer is ‘yes’. As we know, the Cayman Islands continues to lead as the domicile of choice for offshore funds and hedge funds, so it is certainly possible that the Cayman Islands Monetary Authority will, at some point, review, and even implement as appropriate, the principles and practical guidance contained in the report. It would be good for operators to be one step ahead of the game.
Jonathan Fitzgibbons is a partner in the corporate/commercial and funds group of Solomon Harris, a Cayman Islands law firm. He can be contacted at: firstname.lastname@example.org
Simone Proctor is a senior associate in the corporate/commercial and funds group of Solomon Harris, a Cayman Islands law firm. She can be contacted at: email@example.com
Jonathan Fitzgibbons has been in private practice for more than 10 years, with the last five years of his experience spent practising in the Cayman Islands. He specialises in corporate and commercial matters and investment funds.
Simone Proctor has more than eight years of corporate and investment funds practice in the UK. She specialises in corporate, investment funds and regulatory matters.