Litigation avoidance

What are the main legal risks a fund administrator faces?


As the complexity of funds and the difficulty of validating some valuations become more difficult, administrators may be running the risk of litigation by irate or disgruntled investors. Most administrators believe it is best to avoid a court appearance as it could damage a company’s reputation.

If an administrator is grossly negligent in its duties resulting in the fund becoming insolvent, then the administrator will bear the financial liability and will need to compensate the fund and the investors, warns Akshaya Bhargava at Butterfield Fulcrum. Such a loss could be significant and could lead to lawsuits and other litigation, he notes.

For Dermot Butler at Custom House, one of the main legal risks for administrators is spurious claims against it by dissatisfied investors. “The cost of defending a trivial case can be huge,” says Butler.

A manager could exceed its authority and the investor sue the administrator, even though the administrator does not have a contractual responsibility to the investor but to the fund. “This fine legal point doesn’t deter attacks against what are perceived to be deep pockets,” notes Butler. “Often these ‘frivolous’ cases end up in settlement, in order to reduce the potential for huge legal bills that may exceed insurance cover,” he adds.

For Stephen Castree at Equinoxe the main risk lies in pricing errors and missed subscriptions or redemptions.

Kleinwort Benson’s Joseph Truelove believes losing the company’s regulatory licence in its home jurisdiction is the key legal risk. “Guernsey and Jersey both have very robust inspection programmes and monitor fund administrators very closely. Neither regulator is afraid to step in and place restriction on licensees. This is why we place so much reliance on complying with regulations,” says Truelove.

The key risks facing administrators are risk of error or a fraudulent manager, according to Hughes at Apex. “You focus on designing all your processes and procedures to mitigate as far as possible,” he advises.

Liam McNiffe at Bank of Ireland Securities Services says a solid administration agreement should protect an administrator against most legal risks outside of its own negligence. “However, a legal action successfully defended can lead to the risk of loss of reputation – guilty by association,” says McNiffe.

Trinity’s John McCann believes the main legal risk centres on mispricing. “Currently, for reasons of reputation as well as legal liability, the vast majority of administrators will steer clear of the actual calculation of valuations of instruments themselves,” notes McCann.

“Many administrators instead opt for the more modest task of validating prices recommended by external specialists such as prime brokers, exchanges or other external specialist firms. There is the risk of potential lawsuits, as derivative pricing is more art than science,” he concludes.

Richard Ernesti at Citi says administrators must ensure robust and scalable processes and controls in order to mitigate risks effectively. “In this manner potential legal risks arising from, for example, incorrect valuation calculation or incorrect processing of investor dealing activity can be negated,” he says.

The risk, according to Martin Tolcher at Legis Fund Services, focuses on valuations including inaccuracies and wrong net asset value, leading to erroneous dealing. He is also concerned about preparation of financial statements and the inability to meet statutory and regulatory deadlines, as well as acting as company secretary where there is a possibility of a failure to report corporate governance issues.

For Jonathan White at Viteos Fund Services the risk is litigation “due to perceived operational negligence. 2009 has seen that suing fund administrators has become a sport.”

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