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The Principal Point of Contact: A Quiet but Critical Role

Why the PPoC function has become one of the most important administrative appointments a Cayman Islands fund will make, and what directors and managers should look for when making it.

The Principal Point of Contact (PPoC) is, on the face of it, a simple administrative appointment. The role exists so that the Cayman Islands Tax Information Authority (TIA) has a single, named individual through whom it can correspond with a Reporting Financial Institution in respect of its obligations under the Common Reporting Standard (CRS) and the United States Foreign Account Tax Compliance Act (FATCA). In practice, however, the PPoC has become considerably more than a mailbox.

Since CRS and FATCA were first implemented in the Cayman Islands the regulatory expectations placed on the PPoC have evolved significantly. The Department for International Tax Cooperation (DITC) Portal is now the single channel through which a Cayman fund manages its FATCA Returns, CRS Returns, Compliance Forms, Filing Declarations and PPoC change notifications. The PPoC is the person whose access governs each of those submissions, and the person to whom the TIA will direct any query, deficiency notice or enforcement correspondence. A poorly managed PPoC function is therefore not a back-office inconvenience: it is an open exposure to the fund and its directors.

Why the PPoC matters

The PPoC sits at the intersection of three obligations that are easy to confuse but should be kept distinct. First, the fund's CRS and FATCA classification and reporting obligations under the Tax Information Authority (International Tax Compliance) (Common Reporting Standard) Regulations and the equivalent FATCA Regulations. Second, the operational obligation to file accurate returns on the DITC Portal within the prescribed deadlines. Third, the governance obligation on the directors to ensure that the fund is, and remains, compliant. The PPoC is the operational link between the second and third of these obligations and, in many cases, is also the practical custodian of the first.

For most hedge funds the day-to-day reporting work is performed by the administrator. That arrangement remains entirely appropriate and is one I would generally encourage. However, the appointment of the PPoC is a separate matter. The PPoC is named on the DITC Portal, receives all official communications from the TIA and is the only person who can authorise certain Portal-level actions, including the addition or removal of secondary users, changes to the Authorising Person and the submission of certain declarations. Where the administrator is not the PPoC, a clear delineation of responsibilities is essential, and the PPoC must remain sufficiently engaged to discharge his or her statutory function.

Who should hold the role

There is no single correct answer to the question of who should act as PPoC, but there are some clear indicators of suitability. The PPoC should be someone who has a working understanding of the fund's CRS and FATCA classification, who is familiar with the operation of the DITC Portal, and who has the time and standing to respond to TIA correspondence on a timely basis. The role calls for continuity. A PPoC who changes frequently, or who cannot be contacted when correspondence arrives, creates real regulatory risk for the fund.

It is permissible for a director to act as PPoC. There is nothing to prevent a director from doing so, and in some structures it makes good sense. However, depending on the complexity of the reporting and the size of the investor base, it can be preferable for the administrator or manager, or a service provider with dedicated regulatory capacity, to discharge the function so that submissions on the Portal can be made without delay. What matters is that the appointment is deliberate, that the appointee has capacity to perform the role, and that the directors are kept informed.

The MG Management PPoC service

At MG Management Ltd. we have provided CRS and FATCA reporting services since the inception of those regimes in the Cayman Islands and have followed each iteration of the rules as they have developed. That continuity, in our view, is the single most valuable thing a service provider can offer in this area. The CRS and FATCA frameworks are not static; the schemas, the validation rules, the Compliance Form requirements and the TIA's expectations have all changed materially since 2014, and they will continue to do so.

We provide the services of an experienced employee as the named PPoC for our clients. The appointment covers the full operational scope contemplated by the CRS Regulations and the FATCA Regulations, including:

• Acting as the primary contact for FATCA and CRS compliance on the DITC Portal
• Receiving all regulatory communications from the Tax Information Authority and routing them appropriately within the fund's service provider network
• Managing user access on the Portal, including the addition and removal of secondary users and the maintenance of the Authorising Person details
• Facilitating the submission of FATCA Returns, CRS Returns, Compliance Forms and Filing Declarations within the prescribed deadlines
• Processing and notifying any change of PPoC details required under the Regulations
• Providing general support for CRS and FATCA compliance in accordance with the Tax Information Authority (International Tax Compliance) (Common Reporting Standard) Regulations, as amended

In each engagement we work alongside the fund's administrator, manager and other service providers. The PPoC role is not a substitute for the administrator's reporting work; rather, it is the regulatory interface that ensures that work is properly received, acknowledged and, where necessary, defended before the TIA.

Practical considerations for directors

Directors should treat the PPoC appointment as a substantive board decision, not as an administrative box-tick. In my experience the questions worth asking at the point of appointment are the same questions that should be asked periodically thereafter. Is the PPoC sufficiently familiar with our fund's classification and reporting profile? Has the PPoC raised any portal communications or deficiencies that the board should be aware of? Are submissions being made within the prescribed deadlines? Has the PPoC's contact information on the Portal been kept current?

Directors should also be alive to the consequences of getting the appointment wrong. Failures in CRS and FATCA reporting can attract administrative penalties under the relevant Regulations and, in more serious cases, can expose the fund and its officers to enforcement action. The TIA has been increasingly active in pursuing late or deficient filings, and Compliance Form review has become a recognised supervisory tool rather than a procedural formality. A board that has appointed a PPoC and then left the role unmonitored is in a weaker position than one that has appointed a competent service provider and receives regular reporting on the Portal status of the fund.

A maturing regime

When CRS and FATCA were first introduced there was a degree of latitude granted to funds that were finding their way through unfamiliar reporting obligations. That latitude has narrowed. The DITC has, in recent years, refined its guidance, tightened its validation checks and made clear that the Compliance Form is to be treated as a substantive self-assessment rather than a formality. The role of the PPoC has matured in step with that development. What was once a notification function has become, in effect, a continuous compliance interface.

For Cayman funds and their boards, the PPoC is therefore worth more deliberate attention than it has historically been given. The right appointment will not, on its own, make a fund compliant: that remains a matter for the directors, the manager and the administrator working together. But the right appointment will give the board confidence that nothing is falling between the cracks, that correspondence from the TIA is being received and acted upon, and that filings are being made on time and in the proper form. In a regulatory environment that continues to demand more, not less, of fund directors, that confidence is not a small thing.

Hedge Fund Side Letters: A Director's Perspective

In crafting a side letter that is in the best interest of the fund, there is a difficult balancing act that managers must perform. As a professional director, here is the view from the boardroom.

Most hedge funds are asked at one time or another by certain investors to provide side letters agreeing to preferential dealing, investment or other strategic terms. As a professional director with more than ten years of hedge fund industry experience, I have seen a broad cross section of side letters. There are clear cases where a side letter would not be acceptable, e.g., it contains plainly egregious terms; has no legitimate purpose; or is clearly contrary to what the hedge fund or hedge fund manager is doing in practice. In most circumstances, however, there is no black and white answer as to what constitutes an acceptable side letter term or where the line should be drawn.

In crafting a side letter term that is in the best interest of the hedge fund (and in particular, other investors in the fund), there is a difficult balancing act that managers must perform. On the one hand, the side letter can be used to facilitate a large investment that attracts other strategic investors, which could benefit the fund and the execution of its investment strategy. On the other hand, side letters generally raise various fiduciary and other concerns that must be addressed.

Side letter disclosure

Hedge fund directors must ensure that a manager's authority to enter into side letters and any required disclosures related to side letter terms or information rights are disclosed to investors. A hedge fund manager that wishes to enter into side letters should ensure that it has the authority to do so pursuant to the fund's governing documents.

Such authority, in addition to the fact that the manager may enter into side letters, should be disclosed in the risk factors section or other relevant section of the fund's offering memorandum. Different jurisdictions have varying expectations with respect to the disclosure of side letter terms in fund governing documents. U.K. fund managers are expected to disclose all material terms of their side letters to their investors. The material terms include, among other things, preferential redemption and preferential transparency terms. The non-material terms not requiring disclosure can include provisions addressing fee rebates and most favored nation provisions.

The disclosure can be general in nature and simply reference the material terms themselves rather than going into detail as to what the terms are. The U.K. and U.S. regulatory views are generally aligned with respect to what terms constitute material terms. Additionally, the U.S. Securities and Exchange Commission, during its on-site inspections of fund managers, may review side letters of registered hedge fund managers. In implementing the reforms introduced by the Dodd-Frank Wall Street Reform and Consumer Protection Act, side letters were specifically added to the list of books and records to be maintained by registered investment advisers.

Whether or not a hedge fund manager wishes to share side letter terms with other investors (even on an anonymous basis) will depend on various factors, including contractual obligations, favorability of terms, confidentiality and commercial sensitivity. Notwithstanding a fund manager's election not to affirmatively disclose side letter terms to investors, investors can request to see the side letters and make an investment decision based on the fund manager's willingness to produce them or, if produced, on their terms.

To ensure that a hedge fund manager can share the terms of a side letter with other investors, a standard provision should be included in all side letters authorizing the fund and the manager to disclose the general terms of the side letter to all investors.

ERISA considerations

The effect of side letters on ERISA investors can sometimes be overlooked and should be one of the key priorities to consider when a hedge fund contemplates entering into a side letter.

Where a fund wishes to accept an investment from an ERISA plan investor, it must be mindful of the effect on the hedge fund of the terms of the side letter. If the terms of the side letter are material, the side letter beneficiary's investment may be deemed to constitute a separate class of shares for that investor. The creation of a new class of shares may cause the hedge fund to become a "plan assets" fund if the ERISA plan investor's investment constitutes 25% or more of the total assets of that class of shares of the hedge fund. A hedge fund that is a "plan assets" fund is subject to the fiduciary duty, prohibited transaction and various other provisions of ERISA.

Unsavoury terms

Proposed side letters sometimes contain terms that should at least be questioned, and sometimes should be rejected outright. A term that may usurp the constitutive documents, such as the Memorandum & Articles of Association, should be carefully evaluated. At a minimum, such an evaluation can put the directors on notice that they may be agreeing to a course of action that offends the constitutive documents. However, even a term that does not contravene the constitutive documents may do so in the future, and directors should consider such terms over time. For example, a term may be or become ultra vires, that is, may commit the directors to a course of action that exceeds the powers and purposes set forth in the fund's constituent documents.

Preferential liquidity terms allowing for a shorter redemption notice period and other preferential redemption rights are often problematic. The hedge fund should consider whether the investor being granted preferential redemption rights can evaluate its redemption decision on information not made available to other investors. If the answer to this is yes, then the fund should not agree to the granting of such terms without at least disclosing the terms of such side letter to other investors. The granting of the right for an investor to redeem an investment immediately from a fund upon the occurrence of certain events can be problematic, and the manager will need to consider each situation to determine whether it is appropriate to grant such a right to an investor.

For example, if an ERISA investor wishes to redeem an investment as soon as possible in the event that the hedge fund is near the 25% benefit plan investor ownership threshold that would cause the fund to become a "plan assets" fund subject to ERISA, the fund can consider granting such redemption rights because the operation of the fund would change in that circumstance. However, granting redemption rights to an investor upon a key man event can be inequitable to the other investors, and the directors should have very good reasons in determining to grant such a right, of course with proper disclosure to all investors.

Another problematic area is the granting of preferable transparency rights, such as the dissemination of estimated mid-month fund net asset value (NAV) to the holder of the side letter before the official NAV is released at the end of the month to other investors. Such rights should not be granted in side letters if the investor has the right to redeem an investment prior to the dissemination of the end-of-month NAV to all investors. The risk is that the preferential transparency rightholder is privy to information otherwise not made available to other investors, thus allowing it to mitigate or avoid losses where the other investors do not have the opportunity to do so.

Best practices for directors' review

Directors are bound to perform their duties to Cayman Islands companies with a duty of care, in good faith and in the best interests of the company. Fund managers should provide directors with as much time as possible to review the side letter and to provide their input. Side letters should not be presented to the directors on the evening of signing once all of the terms have already been thoroughly negotiated.

A first review of the side letter by directors will reveal any unsavoury terms as well as any obligations upon the fund that will require review by the funds' service providers. A typical review and confirmation is required on the monitoring of ERISA investors by the administrator, where the fund obliges itself to inform the party to the side letter should a class of the fund near the 25% benefit plan investor investment limit, consequently allowing the side letter investor to redeem a portion of its investment.

Where the side letter provides the rightholder with preferential transparency rights, directors would ordinarily request a confirmation that all investors will at least be granted access to such information either by an update to the offering documents or a notification in the general investor letter from the manager.

In situations where there is a fee reduction granted to an investor through a side letter, it is often overlooked that the fund is legally obliged to pay delineated fees to the manager pursuant to the investment management agreement between the fund and the manager. Therefore, only the manager (and not the fund) can waive the right to receipt of the full payment of its management and incentive fees. This can be addressed either by making the manager party to the side letter or obtaining a separate written waiver from the manager to the investment management agreement.

The Vital Role of Directors

Directors play a central role in every stage of the life cycle of a hedge fund. This examines every aspect of the relationship between directors and their funds.

The board of directors plays a central role in any offshore hedge fund. The directors are involved at every stage of the life cycle of a hedge fund. The life cycle can roughly be determined as the fund formation stage, the post-launch operation and then the wind-down. Hedge funds have evolved into very sophisticated investment vehicles, no two hedge funds being the same. The role of director cannot therefore be defined within narrow parameters. However, there are common issues that arise and can be addressed competently by an experienced hedge fund director.

Composition of the board

During the fund formation and planning stage the composition of the board of directors is one decision that the promoters/manager of a new hedge fund must make. It is common for the manager to speak with a number of directors in order to assess their suitability for their particular fund.

Experience

One of the issues that was central to the widely reported Weavering case in the Cayman Islands was whether the directors possessed sufficient experience. There were also other issues, including the relationships with the manager. When selecting a hedge fund director experience is vital to ensuring that proper oversight is achieved, whether this be directors from different firms with complementary professional backgrounds or people from the same firm with different experience.

If the director has no relevant industry experience, this can be a red flag to investors and regulators that there is no proper oversight. Evidence of professional qualifications and experience should be sought from directors (such as being a qualified accountant or lawyer).

Directors should be asked if they are willing to show independent thought and that they fully understand directors' duties, including the interests of investors and be able to manage conflicts. The directors should also have a good working knowledge of corporate law and the mutual fund laws and regulations of the jurisdictions the hedge fund operates in, as well as a good grasp of international issues affecting hedge funds.

The hedge fund industry works on the basis of disclosure to investors to make informed choices, even though investors in these vehicles must be sophisticated. Careful consideration is required to ensure the offering documents are consistent with the constitutional documents and reflect the operation and investment strategy of the fund.

Information exchange — FATCA & CRS

The US Foreign Account Tax Compliance Act (FATCA) and Common Reporting Standard (CRS) reporting has now bedded down. Most service providers are aware of the annual requirements to make the filings on the Cayman Islands Tax Information Authority's Automatic Exchange of Information (AEOI) portal.

Directors of hedge funds are charged with the responsibility to ensure that the relevant information is gathered from the shareholders and filed on the portal. Sometimes the directors themselves act as the principal points of contact (PPoCs) for the authority. There is nothing to prevent a director acting as a PPoC, but depending on the complexity of the required reporting and the investor base, it is usually preferable that the administrator or manager can upload the required reports directly.

Beneficial ownership reporting

All hedge funds are required to document how and whether they are exempt from reporting their beneficial owners to the secure Cayman Islands government platform. Most funds rely on the exemptions provided for by their Cayman Islands Monetary Authority (CIMA) mutual fund registration and their regulated service providers. This is normally addressed in the first board meeting and recorded at the registered office. The directors must ensure that the correct exemption has been selected and is appropriate for their fund.

Data protection

The Cayman Islands has implemented its own Data Protection Laws which are very similar to the EU General Data Protection Regulation (GDPR). A director's consideration for GDPR is whether the fund has any EU individual shareholders and whether there has been relevant notice provided to those shareholders on how their data will be handled. Quite often for a new fund this can be addressed through amendment to the subscription document and disclosure in the offering document. Fund documents will have to be reviewed and updated for the Cayman Islands' new data protection rules.

Anti-money laundering officers

There have been significant enhancements to the existing Anti-Money Laundering (AML) Cayman Islands Guidance Notes. Fund directors are responsible for ensuring: (1) the suitability of the AML officers and making appointments; (2) that the fund complies with the updates to AML laws and regulations; (3) that an AML compliance programme is established; and (4) that the AML officers and all service providers are adhering to the regulatory AML requirements.

AML officers are responsible for periodically reporting to the funds directors on the implementation of the fund's AML procedures and report the results of any testing. Therefore, it is perhaps not advisable that fund directors themselves fulfil the AML officer role as they would essentially be reporting to themselves. The Guidance Notes envisage that the directors will have oversight and receive reporting from the AML officers of their fund.

Master-feeder redemption terms

A master fund ordinarily would be established with identical articles of association to the feeder fund and this is especially important for redemption terms. It was assumed in the Cayman Islands that there was an automatic back-to-back redemption process as between feeder and master funds. However, the recent Cayman Islands case of Arden Maroon decided that a redemption notice from the feeder permitted the administrator to process the redemption from the master fund notwithstanding a failure of the feeder fund to provide an actual redemption notice.

The impact of this decision is that existing funds should enter into a written agreement between the feeder fund and master fund outlining the mechanism used to process redemption from the master fund. For newly established funds, they should embed in their constitutional documents as to how the redemptions will be made from the master fund so that there is a written process in place. This is one of the key areas that directors should assess for existing and new funds.

Operation of the fund

One of the most-asked questions is about how often board meetings should be held and if any should be held in person. In forming an opinion on frequency and format for the meetings there are a number of considerations, including how active the fund is, whether there are special issues needing oversight and the requirements of investors and other stakeholders. Board meetings will be held to approve audited financial statements and for most hedge funds quarterly or even more frequent meetings may be appropriate.

Any professional hedge fund director who is properly experienced, and has sufficient time to devote to his or her appointment, will make sure that board meetings are comprehensive and substantive and not merely "going through the motions". Hedge fund directors need to be able to weigh up legal advice, and the commercial aspects of a transaction and situation, and balance this with their duties to the hedge fund and investors. This may mean challenging advice or recommendations they do not agree with.

Directors should also request to see copies of any investor letters or complaints. As was shown in the Weavering case, the directors received the reports but failed to duly consider or question them.

Side letters

The majority of hedge funds will be asked to enter into a side letter. The side letter can be used to facilitate a large investment or to attract a strategic investor. Entering into a side letter will raise various fiduciary and other concerns that must be addressed by the director. A director should not be afraid to raise questions when a side letter term is clearly incompatible with the fund's articles or the rights of the investors.

Investor protection

Since the global financial crisis most hedge fund investors are conducting due diligence on the manager and its principals. The independence and quality of the directors should also be carefully evaluated as part of that process. In particular investors will want to ensure that the director is sufficiently competent and experienced so that if they have to make difficult decisions they will do so independently in the best interests of all the investors, and not favour one group of investors over another.

Liquidation

A decision to liquidate the fund may be taken at some point. The directors will execute the declaration of solvency to commence the process in the most common winding-up: a voluntary liquidation (a solvent liquidation). The directors will need to be satisfied as at that date that the fund is solvent for a certain period (usually 12 months). The directors will take personal liability in the event such declarations prove to be untrue so they should undertake to receive proper information from the administrator, manager and, in some cases, the auditor.