The recent English case Weavering Capital (UK) Ltd (In Liquidation) v Peterson [2012] EWHC 1480 (Ch) is a wake-up call for directors and senior employees not exercising due diligence in their roles.

Background

This case arose from the collapse of Weavering Capital (UK) Ltd (“WCUK”), a U.K.-based hedge fund that was founded by its chief director Magnus Peterson (the “chief director”), a Swedish banker. Both Weavering Macro Fixed Income Fund (“Macro”) and Weavering Capital Fund Limited (“WCF”) were funds under WCUK’s management and financial advice. In fact, both WCF and Macro were controlled by the chief director and/or his associates.

WCUK’s collapse

Under WCUK’s management, Macro first appeared to perform well with its assets once reported as over US$500m. However, the truth is the chief director had been causing Macro to enter into a series of over-the-counter (“OTC”) transactions with WCF, a type of trades which Macro was not supposed to engage in. Initially, such transactions had allowed the chief director to manipulate the net asset value of Macro and thus convert Macro’s tremendous loss into profit on record. Later, however, Lehman Brothers collapsed and Macro experienced very high volume of redemption requests which it failed to meet. As a result, Macro went into liquidation with losses of over US$500m. WCUK also went into liquidation soon afterwards. Macro submitted a proof of debt to WCUK’s liquidators asserting a primary claim of US$536.1m for breaches of the Investment Advisory Agreement, breaches of fiduciary duty, negligence, conspiracy, and fraudulent/negligent misstatement in WCUK's purported performance of its duties as Macro’s investment adviser.

The SFO’s investigation

In view of the fraud (largest hedge fund fraud in British history) and losses alleged to be involved in WCUK’s collapse, the Serious Fraud Office (the “SFO”) put up a criminal inquiry into the case but gave up after initial investigation on the ground that there was “no reasonable prospect of conviction”. Such decision was reversed after the judgment in this case and now the chief director is charged with fraud.

Claims against chief director

In gist, the liquidators alleged that (1) the chief director perpetrated a fraud by the OTC transactions and representations (which were false and misleading) made to Macro’s investors, as the OTC transactions were not honest trades but merely shams, and (2) other directors were negligent in permitting the fraud to happen. The above allegations were upheld by the court which held that the chief director was liable for fraud and breach of fiduciary duties.

Negligence claims against fellow directors

Other directors’ of WCUK were also liable for negligence with regard to the chief director’s breach of fiduciary duties.

First, the chief director’s wife, Amanda Dawn Peterson (the “wife”), who joined WCUK as Head of Trading Execution and became a director in 2000, was alleged to have negligently permitted the fraud to happen. The court rejected the wife’s defence that she had limited and confined role at WCUK and was not responsible for investment management strategy, and that she assumed the other directors were managing Macro properly. Instead, the court looked at whether the wife’s conduct was that of a reasonable director of a hedge fund management company in her position who had her experience, actual knowledge and intelligence, and whether she had acquired sufficient knowledge of WCUK’s business to discharge her duties. On this basis, the court found that the wife indeed had specific knowledge of the OTC transactions, such as the investment restrictions in relation to OTC transactions. She also knew the facts that showed the significant undertakings and counter-party risks involved in the OTC transactions. As a highly paid director, not only did she fail to ask questions about the transactions, but also positively approve the OTC transactions. Had she exercised reasonable care, she could not have approved the transactions. Therefore, she was held liable for negligence.

Another over-promoted director, Charanpreet Dabhia, who took up his directorship within less than a year of joining WCUK at the age of 27, was also held liable for negligence. His duties include attending meetings with investors and prospective investors to discuss Macro's strategy, holdings and performance, sending out marketing materials and due diligence questionnaires of Macro and dealing with queries from investors. As a director of WCUK which managed Macro, Mr. Dabhia was held to have (1) negligently made false and misleading representations to the investors about the OTC transactions and (2) failed to acquire sufficient knowledge and understanding of WCUK’s business and thus the details and propriety of the OTC transactions.

Negligence claim against senior employee

Apart from the directors, an over-paid and promoted employee of WCUK, Edward Platt, who was regarded as the chief director’s right-hand man and always followed the chief director’s instructions, was also held liable for negligence. He had regular meetings with the chief director in an office with the door closed that Proudman J inferred the subject of discussion was fraud and the swaps. In relation to the OTC transactions, he sent the trade tickets to Macro’s Administrator for calculation of its net asset values which were manipulated by the chief director, and circulated untrue NAV estimates to the investors. Besides, his bookkeeping for the OTC transactions was flawed and involved backdating, forging of documents and irregularities in documentation for the OTC transactions.

Even though he was not a director and regarded his role as confined to options and futures trading, his duties to WCUK were held to be fiduciary in nature: he was highly paid and was entrusted to safeguard the cash and investments under WCUK’s management. Therefore, he owed a duty to conduct WCUK’s business with due care, skill and diligence. In blindly following the chief director’s instructions in operating the OTC transactions without questions, he was held to be negligent.

Conclusion

As a result of this judgment, the liquidators obtained an award of US$450m from the directors and other defendants in this case. This had also encouraged the SFO to re-open its investigation in July 2012 which led to the chief director’s criminal charge in December 2012.

This case is an apt illustration of how negligence claims could be deployed by liquidators to recoup losses not only from the directors in breach of fiduciary duties, but also his fellow directors who turned a blind eye to or were incompetent to be aware of any irregularities of the business. In Hong Kong, the new Companies Ordinance coming into effect in 2014 will further codify directors’ duty of care, skill and diligence along the line of English case law. The principles in this case are largely applicable in Hong Kong.