The development of the offshore hedge fund industry is increasingly driven by institutional investors, including large allocators (particularly North American pension funds), wealth management offices and sovereign wealth funds. Such investors extend their due diligence to all aspects of the management and control of offshore hedge fund vehicles. Included in their due diligence procedures is the corporate governance of a hedge fund, and in particular the fiduciary responsibilities of the directors of the fund and the directors’ available time and ability to fulfill those responsibilities.
The Cayman Islands, home to the bulk of the world’s offshore hedge funds, is in the throes of consulting with the private sector on corporate governance via its regulator, the Cayman Islands Monetary Authority. Aparticular issue in the survey that has attracted comment is directorship capacity. In crude terms, capacity is seen as a function of the number of directorships held by an individual working as a full-time independent non-executive director. It is of interest because there is a belief, depicted in headlines in the international press over the past year, that many Cayman Islands resident directors are taking on more directorships than they can handle from the perspective of good corporate governance. My concern is that the focus on the number of directorships is too much of a blunt instrument. There are a number of other factors that interested parties would be well advised to take into consideration when looking at capacity.
Let us consider three hypothetical (and somewhat esoteric) examples to highlight the drawback of simply defining capacity by numbers of directorships:
Example 1: Director A has 120 directorships, all of which are for stand-alone fund companies, each one of which is advised by a different investment adviser.
Example 2: Director B has 120 directorships, all of which are for master/feeder fund companies (i.e. 60 economic units), which are split equally across 10 investment advisers, each of which pursues a single investment strategy across the six feeder funds he advises.
Example 3: Director C has 120 directorships, 80 of which are for master/feeder fund companies and 40 of which are for special purpose vehicles each of which has been established to house illiquid assets that were originally in the master fund investment portfolios (i.e. there are 40 economic units). Assume also that the economic units are split equally across eight investment advisers, each of which pursues a single investment strategy for the five feeder funds he advises.
For those who believe in the value of quarterly board meetings, we see that Director A would need to set aside sufficient time in his calendar for 480 appointments to attend board meetings over the course of a year. I make no comment on how practical this is – I will leave it to the reader to judge.
In the second example, Director B needs to set aside sufficient time for 60 annual appointments, sub-divided into 6 meetings per appointment (assuming the feeder and master company meetings are held concurrently for each of the economic units). But even this sub-division needs to be carefully examined from a “time spent” perspective. If the funds advised by the same investment adviser not only have the same strategy, but also have the same service providers, then many of the issues for discussion and consideration will be common to all of the funds advised by the investment adviser. Director B will need to pay attention to specific issues such as the investment advisers’ procedures for allocating investments equitably across the various funds. (It should be noted in passing that this may well be an issue for Director A as well if, for example, the investment advisers advising the funds he is a director of also advise managed accounts or fund company vehicles established by funds of funds or institutional investors with allocations to the investment advisers.) And there are without doubt economies of scale across elements, such as a complete understanding of the investment strategy, consideration of the fund administrators’ competence to prepare NAVs for the funds, etc.
In the third example, Director C needs to set aside sufficient time for just 32 annual appointments, sub-divided into 5 meetings per appointment (assuming the feeder, master and special purpose vehicle company meetings are held concurrently for each of the economic units). Special purpose vehicles are quite likely to take up quite a bit of a director’s time and attention at the time they are established, both in the structuring and in the consideration of their suitability from the perspective of the investors in the relevant feeder fund (generally speaking, the side pocketing of illiquid investments in special purpose vehicles enables investors to redeem when they wish to do so without disadvantaging the remaining investors). But once established, the investments in the special purpose vehicles can be considered at the same time as the investments in the master fund are considered.
It is abundantly clear that Director B is in a far better position to allocate sufficient time to his fiduciary responsibilities than Director A, and that Director C is in the best position of all in terms of having sufficient time available to attend to the affairs of the 120 companies he is a director of.
As already pointed out, the three examples above are somewhat contrived. But they serve to highlight one very important point. As important as the absolute number of directorships may be, the number of investment adviser relationships that an independent director is party to is of even greater significance when considering capacity.
There are, of course, other factors which need to be considered by an investor when performing due diligence. A key factor is the infrastructure and resources an independent director has available to him. Does he have the resources, independent of the investment adviser, to perform his own due diligence on counterparties? Has the director ascertained that the appointed fund administrators have the suitability and competence to perform the services set out in the fund administration agreements? And in particular, does the independent director have the time available for site visits to the investment adviser? Such site visits, at least annual, are invaluable in enabling the independent director to spot changes in the nature and scope of the investment adviser’s operations, and the extent to which such changes may impact on the service provided by the investment adviser to the relevant hedge fund companies.
Finally, apart from playing the numbers game when considering capacity, how much consideration do investors give to the background and experience of the director? Does the director have commercial nous? The independent directorships profession is one where grey hair and battle scars may be of considerable advantage (I write as one with a head full of grey hair, if not visible battle scars). There is nothing like relevant experience to enable a director to help a fund through a time of crisis, provided that the director has sufficient time and the willingness to attend to the crisis.
My conclusion regarding the question of capacity, based on my own experience? In the real world, it is perfectly feasible for an independent non-executive director to have 25–35 manager relationships and in excess of 100 directorships and still have sufficient time available to exercise his fiduciary responsibilities to a very high standard.
Alan Tooker is Managing Director of A.R.C. Directors Ltd, a provider of independent directorships to the offshore hedge fund industry. He has well over 30 years’ experience of the financial services industry. Prior to his move to the Cayman Islands in 2005 to establish A.R.C., Mr Tooker served as Finance Director and Chief Operating Officer of various financial services businesses in London, including two hedge fund manager businesses.