Investment managers - a stark reminder of your liabilities and duties

12 February 2015


In a judgment dealing with the collapse of the Arch Cru Funds (the Funds), the High Court has re-examined and clarified the law applying to investment managers.

In awarding over £22 million in damages against the investment manager and its Chief Executive in SPL Private Finance (PF1) IC Ltd and others v Arch Financial Products LLP and others, the court found that the investment manager acted in breach of fiduciary duty, in breach of contract and in breach of its duty to act with reasonable skill and care in managing assets for the Funds.

Although fact specific, the case acts as a useful reminder to investment managers of the duties they owe and the circumstances in which they can be held liable for the management of a client's investment portfolio.

The facts

Arch Financial Products LLP was the investment manager (the Investment Manager) for the Funds, which constituted a number of Guernsey incorporated companies (the Investors). Each of the Investors had entered into investment management agreements (IMAs) on the same terms with the Investment Manager. A number of the Investors subsequently brought claims against the Investment Manager arising out of real estate investments made on their behalf.

The claims concerned investments made in a student housing business called Club Easy. The basis of the allegations made was that the acquisitions made by the Investment Manager:

"…were driven by [the Investment Manager's] financial interest in obtaining illegitimate payments rather than proper consideration of the investments' merits and the interests of the [Investors], and that in this regard [the Investment Manager] acted in breach of fiduciary duty, in breach of contract and negligently".

The Investment Manager arranged the purchase of a student housing business in the sum of £13 million, in return for which it received "structuring fees" of £3 million, which the Investment Manager claimed had been agreed with the Funds. The initial investment was then followed by a further injection of additional sums to cover operating costs of the business.

Only two years after making the investment, the value of the investment was written down to zero.

The judgment

Mr Justice Walker found that the Investment Manager and its Chief Executive Officer, Robin Farrell, had hatched a plan to purchase the student housing business as a way of extracting money from the Investors. The so called "structuring fees" did not in fact in any way pay for the mechanics of the acquisition, nor were they found to have been agreed to by the Funds as the Investment Manager had claimed.

The relationship between the Investors and the Investment Manager gave rise to fiduciary duties which should have fairly managed any potential conflict between the interests of the Investors and the Investment Manager. Instead, the Investment Manager breached its fiduciary duties in advising upon an investment which was not in the best interests of the Investors.

The Investment Manager negligently relied upon property valuations based on the premise that the student housing business was a viable investment, whereas it should have taken into account the need for ongoing substantial capital investment. In not conducting a risk/reward analysis of the merits of the investment, which were plainly unjustifiable on the facts, the Investment Manager was found to have been negligent.

The Investment Manager's Chief Executive Officer was also found liable to pay compensation for dishonestly assisting the Investment Manager in its breach of fiduciary duty.

Comment

The case acts as a stark reminder of the duties of an investment manager, which the court will uphold. The key principles for investment managers to bear in mind are:

  • A fiduciary duty arises from the relationship of trust and confidence between the investor(s) and the investment manager.
  • There is a duty upon the investment manager to put the interests of the investor(s) ahead of its own financial and commercial interests.
  • An investment manager must always be transparent with investors about the fees it proposes to charge on an acquisition and is under a duty not to make a secret profit from arranging a transaction.
  • The acts of an individual, in this case the Chief Executive Officer of the Investment Manager, can result in a liability for the individual if he/she is found to have induced a breach of contract or a breach of fiduciary duty on the part of the investment manager.

Wragge Lawrence Graham & Co LLP's Investment Funds team is a specialist team comprising tax, corporate, finance, regulatory and dispute resolution experts advising on every aspect of a funds lifecycle. The team is involved in a mix of domestic and international fund structures. It provides advice to fund and investment managers, the fund vehicles, sponsors and operators and investors (including pension schemes).


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