Sales between funds, Sartor and Continuation Fund case (III): exegesis of article 22, letter g), of the Chilean funds law

Rule

The rule we are analyzing tells us that, without prejudice to other prohibitions contained in other laws, the following acts or omissions carried out by the administrators and, as applicable in each case, by the persons who participate in the fund’s investment decisions or who, by reason of their office or position, have access to information about the fund’s investments, are contrary to the Single Funds Law (LUF). The rule then lists such prohibitions, among them paragraph g), which states that the acquisition or disposal of assets on behalf of the fund in which the administrator or a private fund under its administration, or a company related to it, acts as seller or buyer, is prohibited.

We will now analyze what we should understand by “the persons who participate in the fund’s investment decisions or who, by reason of their office or position, have access to information about the fund’s investments.”

Offending subjects: managers

In principle, for the sole purpose of the paragraphs of article 22 the law distinguishes between, on the one hand, those who make investment decisions and, on the other, those who have information about the investments by reason of their office or position. This distinction is relevant with respect to prohibitions that can only be committed by the manager.

We believe the latter must be interpreted strictly. When the law states “as applicable in each case,” we must understand that the prohibition may be infringed either only by the manager, or only by the person who has information about the investments. This is relevant because, in each case, it will not be possible to bring charges, or to sue civilly as appropriate, against multiple persons under all the foregoing grounds (manager and holder of information).

On this point, paragraph a) of the rule we comment on gives us an example. It prohibits carrying out transactions with the fund’s assets to obtain undue benefit. Thus, this rule can only be infringed by a manager. But it is possible to interpret that someone with information, other than the manager (the other possible infringer), trades with the fund’s assets to obtain benefits. That would be to interpret that the law uses the concept of “the fund’s assets” in a generic sense. Such an interpretation could conclude, which we believe would be erroneous, that someone with information trades with the same assets that they own and that the fund also holds, thereby infringing this paragraph. That would be a mistake, without prejudice to the fact that another paragraph prohibits the latter hypothesis.

All of the above has a technical basis, namely that when the law seeks to separate the manager from the person who has relevant information, it is thinking for the latter of those infringements related to information proper (insider information, front running, abstention, confidentiality, blocking, false information, failure to disclose, manipulation, among others), separating them from other infringements distinct from the use of information, such as accounting manipulation, misuse, conflict of interest, etc. Moreover, concluding otherwise would unduly broaden, to the point of distorting the different hypotheses, each prohibition. It would be enough to trade with the same assets of the fund to risk breaching such a rule.

Therefore, the prohibitions of article 22 may be violated by the manager and/or the administrator (the other possible subject to infringe these rules), or by the holder of valuable information and/or the administrator. But never by both a manager and an information holder together.

This, in any case, does not prevent understanding that the manager may indeed be one of those who have valuable information and be an infringer. But in that case, the same person simply acquires the other status, without being the manager as the proper holder of the infringement title.

From the list in article 22, paragraph a) can only be committed by the person who carries out transactions with the affected fund’s assets (to obtain an undue return). The same applies to paragraph b) regarding charging the fund for services without authorization. The same applies to paragraph c), similar to case b), but in this case for services with related parties.

In the case of those who, by reason of their office or position, have access to information about the fund’s investments, they may infringe paragraph d), which refers to insider information.

Now, paragraph e) may cause greater confusion. As we know, among the possible infringers are the administrators. But this paragraph establishes the hypothesis in which the administrator acquires for itself an asset disposed of by the affected fund (carried out obviously by the same administrator). Here we believe the legislature merely repeats “the administrator” to make clear who performs the transaction, but there is no doubt, properly interpreted, that the infringement can only be committed by the manager of the affected fund (from the first part of the wording of the paragraph) and the administrator. The possibility of interpreting that the rule is infringed by the manager, or any other subject, who acquires the assets in favor of the administrator must be closed. Therefore, in this paragraph the infringement can only be committed by the manager of the affected fund.

Exactly the same, mutatis mutandis, must be concluded about paragraph f). The infringer will be the manager of the harmed fund or its administrator.

In the case of paragraphs h) and i), the manager will be responsible in case of infringement. Only add that, in paragraph h), the manager who may infringe the rule is that of the fund referred to in the first part of the paragraph, but not the other managers who participate on the opposite side in favor of the administrator’s related parties, in the managerial structure of the funds administered by it or the related companies, without prejudice to the fact that those latter managers may, in turn, be infringers with respect to their own fund.

In the case of the paragraph we analyze, the possible infringer is the manager of the fund mentioned in the first part of the paragraph, following the same logic already explained for paragraph h). Therefore, in paragraph g) there is no hypothesis of infringement by a person who, by reason of their office or position, has access to information about the fund’s investments. It can only be infringed by “the persons who participate in the fund’s investment decisions […]”.

As we have already stated, in Chile the law is aware of the material difference between the “administrator” and the person who decides the investments. The former is responsible for what we call the administrative control of the fund, such as listing it, calling meetings of the shareholders where applicable, accounting control, verifying regulatory compliance, monitoring investments, recording transactions, among other duties. The latter, using U.S. nomenclature, we could describe as an investment manager: any person (i) that is not a natural person who invests or buys and sells securities for its own account, and (ii) any person (legal or natural) who exercises investment discretion with respect to the account of any other person.

The administrator is in charge of control, and the manager of investing when full discretion exists. The caveat, which can confuse matters, is that the administrator is always responsible, whether it manages or not. Thus article 15 LUF. The latter, at least for sanctioning purposes, concerns infringing liability. Now, those who propose to modify this, in the sense of separating the liability of both to effectively separate both activities completely, may be considering something different. Although we believe the separation of those responsibilities should be discussed, it is not entirely certain that it would change things much. Indeed, civil rules should suffice to seek the responsible party for gross breaches, such as failing to invest in accordance with the fund’s rules. Think of joint and several obligations, as well as any other institution included in the fund’s bylaws (as in any other contract). This could also lead to holding the administrator liable for lack of control, even if the manager is ultimately responsible. The lack of management may be due to lack of control. And, in the event that the administrator is equally liable to the contributors, without there being a control failure, one could in turn pursue liability against the external manager.

This last matter only becomes complicated if the management is carried out by the contributors themselves, since that can indeed complicate things somewhat, but we believe that issue relates to the fund’s own bylaws that must be agreed by the administrator. In that hypothesis it could be useful for the law to detail this matter. But, in any case, under the current regime, if the contributors are ultimately responsible for management while the administration is duly agreed in the bylaws, there could be no basis to demand the obligation. No one may profit from their own negligence.

All the same, we must remember that investments are obligations of means, which in the industry are not usually breached, since financial results are never certain. It is difficult to imagine, absent gross breach, liability in this area.

Finally, the manager and the administrator may coincide in two cases: when (i) the manager is part of the administrator, or (ii) the administrator as a legal person is the one that decides the investments (this is especially relevant now that there may be hypotheses where a robot decides, without a natural person).