By Ingrid Pierce, Daniel Wood, Denise Wong, Anne Forbes-Harper and Thomas Granger From Walkers Cayman Islands

Introduction

The Mutual Funds Law was introduced to the Cayman Islands on 26 July 1993 and has been consolidated and revised in the Mutual Funds Law (2013 Revision) (“MFL”). The MFL regulates all hedge funds falling within the definition of a “mutual fund” (as defined below as supplemented by the Mutual Funds (Amendment) Law, 2011) established in or operating from the Cayman Islands, and those who administer mutual funds in or from the Cayman Islands. Furthermore, the MFL regulates certain ‘master funds’ which are also mutual funds established in or operating from the Cayman Islands, with at least two investors, at least one of which is a regulated mutual fund.

With one exception, the MFL requires all mutual funds (note that this term does not include closed ended funds) to be regulated.

The exception is for a mutual fund in which the equity interests are held by not more than fifteen investors, the majority of whom are capable of appointing or removing the operator of the fund (eg the Directors in the case of a corporate mutual fund) (the “Exception”). A mutual fund of this type escapes regulation altogether. The Exception does not apply to master funds, which, typically have one or more ‘Feeder Funds’ as investors.

Amendments

The MFL was amended in November 2006, April 2008 and December 2011. These amendments are incorporated in the memo where applicable but, by way of summary, the main changes were:

increasing the minimum subscription for Section 4(3) funds from US$50,000 to US$100,000;

removing the requirement that foreign funds domiciled in a country approved by the Cayman Islands’ Monetary Authority (“CIMA”) and administered in Cayman need to be registered with CIMA or with the Registrar of Companies;

enhancement of CIMA’s powers with regard to the power to cancel registrations and investigate or gather information to ensure compliance with the MFL;

increasing the obligations auditors owe to CIMA;

introducing a system for filing audited accounts with CIMA electronically;

the re-definition of the term “equity interest”;

the prohibition on licensed mutual fund administrators from providing mutual fund administration to a mutual fund unless satisfied that:

in instances where a mutual fund is administered in the Islands, the business of the fund will be carried out in a proper way; and

the fund is otherwise regulated by CIMA if it is not incorporated or established in the Islands or in a country or territory approved by CIMA; and

bringing master funds (as described above) within the scope of the MFL, for reasons including the fact that regulated mutual funds are often feeder funds into master funds, which are the principal trading vehicles.

What is a “mutual fund”?

This is defined in section 2 of the MFL as a company, unit trust or partnership that issues equity interests, the purpose or effect of which is the pooling of investor funds with the aim of spreading investment risks and enabling investors in the mutual fund to receive profits or gains from the acquisition, holding, management or disposal of investments but does not include a person licensed under the Banks and Trust Companies Law or the Insurance Law, or a person registered under the Building Societies Law or the Friendly Societies Law.

Exemptions

Exemptions exist for licensed banks and trust companies and licensed insurance companies.

Equity interests

The reference to “equity interests” is critical. Under section 2 of the MFL “equity interests” are defined as a share, trust unit or partnership interest that carries an entitlement to participate in the profits or gains of the company, unit trust or partnership and that is redeemable or repurchasable at the option of the investor, but does not include debt or alternative financial instruments as prescribed under the Banks and Trust Companies Law (2013 Revision).

Closed ended funds

The MFL does not cover closed ended funds in which investors do not have the right to redeem or require repurchase of their interest – many trusts and exempted limited partnerships are not covered by the MFL for this reason.

Master Funds

The MFL covers master funds, which are themselves mutual funds as described above, and which have one or more investors, at least one of which is a regulated mutual funds registered with CIMA (conducting more than 51% of its investing through that master fund). The Exception does not apply to regulated master funds which otherwise fall within this definition.

Other relevant definitions

“Investments” is not specifically defined and will take its normal English language meaning.

“Investor” in respect of a mutual fund means the legal holder of record of an equity interest in a mutual fund but does not include a promoter or operator.

“Operator” in respect of a mutual fund means:

where the mutual fund is a unit trust, a trustee of that trust;

where the mutual fund is partnership, a general partner in that partnership; or

where the mutual fund is a company, a director of a company (note that from June 2014 The Directors Registration and Licensing Law, 2014 (the “DRL Law”) requires that each director of a mutual fund registered with CIMA is either registered or licensed in accordance with the DRL Law. There is an annual fee to be paid to CIMA).

It follows that the term “Operator” does not include a manager operating under a contractual arrangement with the mutual fund.

Types of funds

Mutual funds break down into essentially four types as set out below.

Licensed funds

These are funds holding a licence under the law, which must have either a registered office in the Islands or, if a unit trust, a trustee which is licensed under the Banks and Trust Companies Law (2013 Revision).

Licensed mutual fund administrator in the Cayman Islands

The second type are mutual funds which have a licensed mutual fund administrator providing its principal office in the Cayman Islands.

Minimum equity interest or listed on approved exchange

The third type are mutual funds where either:

the minimum equity interest purchasable by a prospective investor is US$100,000 or equivalent (please note that funds already registered under s4(3) of the MFL prior to 14 November 2006, including existing funds which issue new classes of shares after 14 November 2006, may continue to accept minimum subscriptions of US$50,000); or

equity interests are listed on an approved stock exchange or over-the-counter market.

Regulation in the third tier is generally designed for more sophisticated investors such as those having at least US$100,000 to invest and who are therefore assumed to be better able to afford professional advice in the management of their affairs.

Master Fund

The fourth type are master funds.   See above.

Requirements for application for mutual funds regulation

Tier 1 – licensed mutual fund

Application for a licence for a licensed mutual fund is made to CIMA in an approved form, accompanied by the prescribed application fee and the following:

the current offering document (or the latest draft);

a synopsis of the offering document;

details of its registered office (or, if a unit trust, its trustee);

details of the mutual fund administrator (if any) providing its principal office in the Cayman Islands;

sufficient evidence to satisfy CIMA:

as to the sound reputation of each promoter;

as to the sound reputation and expertise of each person undertaking the administration of the mutual fund; and

that the business of the mutual fund and any offering of equity interests will be carried out in a proper way;

a letter from the mutual fund’s administrator confirming its consent to act; and

a letter from the mutual fund’s auditors confirming their consent to act. Local auditors must at a minimum sign off on the mutual fund’s accounts annually.

Tier 2 – mutual funds with a licensed mutual fund administrator

Mutual funds which are represented by a licensed mutual fund administrator are not required to obtain a licence but the licensed mutual fund administrator is required to satisfy itself:

as to the sound reputation of the promoter;

as to the sound reputation and expertise of the person undertaking the administration of the mutual fund; and

that the business of the mutual fund and any offering of equity interests will be carried out in a proper way and it must give details of each mutual fund which it represents and pay the prescribed fee for each mutual fund.

Tier 3 – regulated mutual funds

Mutual funds where either:

the minimum aggregate equity interest purchasable by a prospective investor is US$100,000 or equivalent; or

equity interests are listed on an approved stock exchange or over-the-counter market;

are not required to obtain a licence nor to be represented by a licensed mutual fund administrator but are regulated.

Master Funds

Mutual Funds which are master funds for the purposes of the MFL are not required to obtain a licence nor to be represented by a mutual fund administrator, but are regulated in a similar way to tier 3 regulated mutual funds (save that if the master fund does not have an offering document (which is typical), no such document need by filed with CIMA).

Provisions common to all mutual funds

All regulated mutual funds are required to:

at launch, provide CIMA with letters of consent to act from the fund’s administrator and local auditor;

submit to CIMA, and keep current, a copy of its most recent offering document (save that this requirement does not apply to regulated master funds that do not have an offering document);

provide CIMA with audited annual accounts (see below); and

pay an annual fee of approximately US$4,268 (or US$3,048 for master funds).

Offering documents must describe the equity interests in all material respects and contain such other information as is necessary to enable a prospective investor to make an informed decision as to whether or not to invest.

Regulated mutual funds which are required to be licensed or to employ a licensed mutual fund administrator are only to be administered by persons with sufficient expertise and of sound reputation and either CIMA or the licensed mutual fund administrator will have to be satisfied that the business of the mutual fund and any offering which it makes is to be carried out in a proper way.

The MFL also contains enforcement provisions allowing CIMA to inspect books and records, call for accounting and to take action to protect investors where appropriate. The penalties imposed by the MFL for breach of any statutory requirement are relatively stringent.

Local audit sign off

Since 1 July 2002, CIMA has required local audit sign-off on all mutual funds and mutual fund administrators regulated by CIMA. Only auditors with a physical presence in the Cayman Islands are approved as auditors of record for locally incorporated or established mutual funds and other entities subject to regulation by CIMA (see list below). This policy does not, however, require that all of the audit work is carried out locally in the Cayman Islands or carried out solely by the approved auditor of record. The audit can be performed wherever the principal books and records of the entity are maintained provided that a Cayman auditor is included in the process. Please note that this policy does not apply to branches of international companies licensed in the Cayman Islands and foreign domiciled funds that are administered in the Cayman Islands but not otherwise registered as foreign companies doing business in the Cayman Islands.

List of auditors approved by CIMA

Anchin, Block & Anchin (Cayman)

Grant Thornton

Paul Harris & Company

Altschuler, Melvoin and Glasser (Cayman)

Goldstein Golub Kessler International Cayman

PKF (Cayman)

Arthur F. Bell & Associates (Cayman)

Harb Levy & Weiland LLP

PricewaterhouseCoopers

Baker Tilly Cayman

J. H. Cohn (Cayman)

Rankin Berkower (Cayman) Ltd

BBD (Cayman)

KPMG

Rothstein Kass & Company (Cayman)

BDO (Cayman)

Kinetic Partners Cayman LLP

RSM Cayman Islands

BDO

Kaufman, Rossin & Co Cayman

Russell Bedford (Cayman)

Berdon Cayman

Moore Stephens (Cayman Islands) Ltd

Sandler & Co (Cayman)

Citrin Cooperman (Cayman)

Moores Rowland (Cayman Islands)

Stout, Causey & Horning (Cayman)

Doran and Associates (Cayman)

McGladrey & Pullen, Cayman

Spicer Jeffries (Cayman)

Deloitte & Touche

Marcum (Cayman)

Squar Milner (Cayman)

Ernst & Young Ltd

Margolin, Winer & Evens (Cayman)

Untracht Early (Cayman)

EisnerAmper (Cayman) Ltd.

Marks, Paneth & Shron (Cayman)

Weiser Cayman

Fulvio & Associates (Cayman) Ltd

O’Connor Davies (Cayman)

Walsh, Jastrem & Browne (Cayman)

Mutual fund structures

Corporate mutual funds

Corporate mutual funds are usually established in one of two ways:

single or multiple classes of shares: redeemable shares which are issued to investors, all shareholders having the right to participate in general meetings of the Company; or

voting and non-voting multiple classes of shares: a small class of par value voting shares having control of all aspects of general meetings of the company and one or more classes of non-voting redeemable preference shares offered for sale to investors at an initial subscription price and thereafter at net asset value.

A voting and non-voting multiple class structure has the advantage for the promoter or investment manager of allowing minor changes to be made to the operating structure of the mutual fund (ie to the Articles of Association), without the need to call a meeting   of   the   investors   in   circumstances   where   shares   may   be   widely held. Disenfranchised shareholders retain the right to vote on matters affecting the rights attaching to their shares or by voting “with their feet” by redeeming their shares if dissatisfied with the management of the mutual fund.

Even where investors of a mutual fund have no voting rights, it does not mean that the voting shareholders have the right to vary the class rights of the non-voting shareholders. For example, the voting shareholders could not call a meeting of the small class of voting shares to cancel rights of redemption attached to shares held by the main body of investors.

Exempted limited partnerships

An exempted limited partnership may be registered as a mutual fund. Under the terms of the Exempted Limited Partnerships Law (as amended) in order to be a limited partnership, the partnership must be registered as an exempted limited partnership in the Cayman Islands and the general partner must be either a Cayman company, a foreign company registered in the Cayman Islands under Part IX the Companies Law (2013 Revision) or another exempted limited partnership.

Unit trusts

A unit trust may be registered as a mutual fund if the trust units are redeemable at the option of the investor. Units trusts may also be registered as exempted trusts under the provisions of the Trusts Law (2011 Revision) provided that none of the investors are, or are likely to be, resident or domiciled in the Cayman Islands. As an exempted trust, a unit trust can apply for a 50 year tax exemption undertaking from the Cayman Islands Government.

Anti-money laundering regulations

Mutual funds need to comply with the anti-money laundering regulations of the Cayman Islands as set out in the Proceeds of Crime Law, 2008 and the Money Laundering Regulations (2010 Revision) (as amended)(the “Regulations”).

Compliance with the Regulations is the ultimate responsibility of the fund and the fund’s Board of Directors (or the general partner if the mutual fund is a partnership or trustee if the mutual fund is a trust). This includes designating an employee at managerial level to be a Compliance Officer, having in place procedures for identifying and reporting suspicious activity and identifying an appropriate person to receive internal suspicion reports (usually called a Money Laundering Reporting Officer or “MLRO”).

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