The provision of directors for hedge funds is turning into a major business. The Cayman Islands leads not only in the number of experts on hand, but also in the multiplicity of models being used.

When the financial crisis hit, few would have thought one of the most lasting and far-reaching outcomes would be in the board room of hedge funds. The realisation by investors and investment managers that a board made up of independent directors was an essential hit home as gates, lock-ups and suspended redemptions became ever more common.

When times are tough for a hedge fund, it is also likely that emotions will run high, too. That means the board of directors needs to keep a cool head and a close eye on the interests of the shareholders (investors) rather than the investment manager.

If the portfolio manager or other senior figures making the investment decisions for the fund also compose the majority of the board seats, trouble is likely to follow when difficult decisions need to be made.

Those involved with the day-to-day operations and investments of the fund are unlikely to think first of shareholders. Their main interest will reside with the nitty gritty of the fund’s positions.

The personal involvement coupled with the emotional stress put on managers during a crisis does not always make them the most suitable people to make cool, objective decisions about the future of the fund and to put shareholder interests, rather than the fund’s, in first place.

This is when independent directors really started to have an impact on the hedge fund industry. In retrospect many investors, as well as investment managers, were grateful for the leadership taken by directors when presented with tough choices in an unprecedented situation.

The repercussions of this are still being felt and nowhere is this clearer than in the Cayman Islands. As one would expect from the number one hedge fund jurisdiction, hedge fund directors are thick on the ground. There is no doubt the island holds the largest concentration of directors for hedge funds than anywhere else. This is both a blessing and a potential curse.

The availability of highly experienced professionals with an unrivalled depth of knowledge about the intricacies of hedge funds has accelerated the growth of the industry in Cayman. No longer does retirement from legal and accounting firms, fund administration and other services mean long, lazy days on the beach. Instead many are opting for the potentially lucrative option of becoming a director. While this is certainly an attractive retirement option, it is also a job that many far from retirement age are also entering.

This gives the island an enviably large pool of talent from which to draw directors. It also has spurred controversy and intensive debate on a wide range of issues concerning directors.

The standard definition of a director’s duties comes from an English High Court case from 1925, City Equitable Fire Insurance Company. The judgments in this case are often cited as the foundations of a director’s role and responsibilities.

In the case Mr Justice Romer said a director “only need exercise the degree of skill that may reasonably be expected from a person with his knowledge and experience.”

Justice Romer laid down the duties of care and skill to be expected of a director. These included the ideas that a director does not need to show in the performance of his duties a greater degree of skill than can reasonably be expected from someone of his knowledge and experience.

Crucially he said a director is not bound to give continuous attention to the affairs of the company. Where duties may properly be left to some other official, a director is justified in trusting that official to perform his duties honestly.

How these guidelines and the discharge of fiduciary responsibility by a director are actually carried out has sparked debate in Cayman that could ultimately lead to best practice standards applied in other hedge funds jurisdictions.

The complexity and specialist elements of hedge funds mean directors need to have experience working within the industry. As Cayman has found this means the most likely candidates come from the accounting, legal and fund administration professions. All have intimate knowledge of the inner workings of a hedge fund.

Coupled with the ability to supply directors is also an increasing demand for these skilled professionals. While the majority of European-based hedge funds already had a majority of independent directors on their boards, their US counterparts were unlikely to have gone down this route.

Post crisis many are finding that investors are demanding a change in board structures. Start up funds and new launches are being asked to appoint boards where the majority or all are independent directors.

The discussion in Cayman is around just how many directorships is enough. The Cayman Islands Monetary Authority (CIMA) is looking at this issue.

Trying to find a solution that is both workable and relevant to the industry as well as embraced by the local directors’ association is not an easy task. For as many models of directorships, there are an equal number of opinions.

There is also no easy measure of capacity for a director. Merely choosing a number and saying that is the maximum number of directorships one person can hold is universally agreed to be a meaningless and unhelpful approach.

One idea is a register of directors. This idea has caused some uneasiness about what might be disclosed and how public its contents would be. CIMA is studying the sector and is working closely with the Cayman Islands Directors Association (CIDA) to address some of the concerns being raised. CIDA continues to use its own code of best practice, based on the UK Institute of Directors code, as the foundation of good corporate governance.

Meanwhile, the proliferation of companies offering director services continues. One of the most successful and controversial is DMS. It offers a range of services and a model based on accountancy firms. According to its marketing materials, the DMS approach is “the right people doing the right work”. For DMS this means a staff of around 40 supporting the efforts of nine directors, ensuring investors are protected by people who “have a deep understanding of hedge fund culture with the right experience, skills and personal attributes”.

Ronan Guilfoyle at DMS believes the database management system used is an innovation that provides technological support to directors. Through it a director can find exactly when his last meeting or phone conversation about a fund took place, the notes from the meeting, all supporting documentation as well as the entire history of contact with the fund from the beginning. The system stores documents, meeting notes and reminders. The system can be accessed from anywhere so directors can call up vital information and refresh their memories as soon as a call is put through to them.

For Guilfoyle and others at DMS this database has revolutionised the way directors are organised and helped improve efficiency and effectiveness.

While some criticise the model, David Bree says the system allows directors to focus totally on the fund or fund of hedge fund. He says the model is based on the same structures used by accountants and legal firms.

Roger Hanson points out that the system is an excellent way to keep on top of compliance obligations. “Corporate government is the beginning of a process and it’s not just about board meetings. There is a level of interaction that you can find in most emails and phone calls.

“Board meetings are sometimes retrospective because the business has already been dealt with,” says Hanson. With the underlying support staff, most of which are also highly qualified and the database archive, a director is able to deal effectively with issues, according to Hanson. For him, the model used by DMS works well. “Some people confuse the operating company with the hedge fund. The director’s role is linked to the fund, which delegates 100% of its activities to the investment manager, prime broker, fund administrator and others. There are no internal operations,” he says, adding, “Directors are not involved in the day-to-day operations.”

While DMS would not reveal the number of directorships each person holds, it did confirm the number is determined by how much actual work is generated by the fund. Some are routine but Hanson stresses that directors need to ensure they have the capacity to deal with issues when they arise. Directors need to be able to make decisions, sign off documents or give advice immediately.

“Sometimes it takes two years to work through an issue,” notes Bree. “Sometimes an issue results in bi-weekly investment meetings. If we are not available, the situation could deteriorate and result in liquidation. It is essential for the director to understand the detail,” he says.

“It comes down to a monitoring process and accessibility to shareholders and other board members. Directors need to respond in a timely manner. We expanded from only two people to 40 plus by adding talented members to the team. Nine people act as directors. This meant DMS could take on more clients and maintain the same response time,” explains Bree.

Like any professional services firm, there is a development mechanism to cope with capacity and share expertise in the organisation, says Bree. Time management is also important when dealing with funds in different time zones. The Dublin office of DMS is useful particularly in helping manage Far Eastern fund directorships.

Bree confirms that Asia is a growing area for DMS. “We are looking at different jurisdictions and how we could better serve clients in them. We are also expanding into new markets. Luxembourg may be a possibility. Dublin could expand. Wherever we operate, we bring the people here to train them and ensure they understand the culture of the company,” notes Bree.

Possibly the exact opposite model of DMS is ARC Directors run by Alan Tooker and Ramona Bowry.“We set up the rule before the business started that the only thing we would offer would be directorships. No secretarial services, no registered office. Nothing except directorships. And it would only be the two of us. When we reach capacity, we will stop. We will not try to expand,” declares Tooker.

Tooker’s strong views are at the centre of his business model. “We never worked out in advance the number of directorships we would each take on. There is a mix of business. Some are very complex products. Some are very large. They range from distressed securities to plain vanilla futures, from master/feeder structures to segregated portfolio companies to very complex platforms. Only as we take on the business will we know when it is significant and we have reached capacity,” he says.

Like others in Cayman, he has seen a growth in business over the past months. More investors are demanding independent boards while fund managers have seen the usefulness of a director during a crisis period. Tooker says a lot of clients return to ARC when they launch a new fund. They have also been asked by law firms on the island to stand in as directors on hedge funds that are in trouble and in need of expert directors to help steer them through restructuring or wind down.

Tooker also says a director needs to be available 24/7 as well as keeping up with reading. For Bowry and Tooker keeping up to date with regulatory changes, best practice and other related matters is also time consuming.

“We take our directorships seriously. We are aware of our fiduciary responsibility. We don’t take on someone and put them on the back burner. We need to be aware if anything goes wrong,” notes Tooker.

Tooker also raises one of the concerns about the provision of directors. He is adamant that some firms that have gone into providing directorships could face conflicts of interest. He is particularly concerned about legal firms offering directorship services.

One such operation is Walkers Fund Services. According to Scott Lennon, senior vice president, the model they use is “very basic”. The company offers seven directors with six based in Cayman and one in Dubai. There are also two administrative assistants. Lennon says there are also a couple of  “seasoned fund administrators” the company is training to become directors.

Lennon stresses that although Walkers Fund Services is owned by partners at Walkers law firm, there is a strict division between them.

Walkers Fund Services would not provide directors if there was a chance of conflict.

He says the directors come from a mixture of professions including accountants, back office administrators and others. The person named as a director is responsible for the work, he confirms. In his opinion it is not possible to delegate fiduciary responsibilities to someone else. For him it is important that a director understands how all the parts of a fund fit together so that when they review documents they can get a clear view on how the operations are structured as well as the legal structure.

When asked how he determines when a director has reached capacity he, too, responds that it is not about numbers. The nature of the fund structure as well as its strategy are factors to be considered. However, he believes the 80/20 rule applies to directors as much as to other service providers: 20% of clients take up 80% of time.

Lennon admits the company rejects around half or more of the funds it sees. Start up managers do not usually have the requisite experience or background for Lennon. He also thinks they are generally under pressure to cut costs and may not have the best service providers or opt for things like net asset value (NAV) light alternatives.

Regarding risk
For Walkers Fund Services to accept a fund, the director needs to understand the structure and the risk properly and be satisfied with the offering documents and contractual arrangements.

Like the majority of independent directors, they encourage face-to-face board meetings at least once a year. The cost for such meetings, however, can be substantial for the larger institutions. Nevertheless, Lennon is insistent this is necessary to maintain good corporate governance of the fund.

Peter Heaps, managing director at Carne, agrees with this attitude. He sees a “heightened awareness” about what good corporate governance is about. For Heaps an independent director should “go back to the fundamental role.

He is responsible for the fiduciary oversight and the actions of the company of which he is director. There is a financial duty of care to the company and a fiduciary responsibility to the shareholders. Directors should look after the shareholders.

That is paramount,” says Heaps.He disagrees with some of the business models in Cayman that are designed to support significant numbers of appointments. He believes directors must have enough time to do their job. “You can’t play the numbers game, but if you have 600 directorships then you only have two hours a year for each company. That is ludicrous,” notes Heaps.

John Lewis joined DMTC Group in 2008 as a partner. His primary focus is DMTC’s Cayman subsidiary, DirectorsPlus. Like others he agrees there is no “magic number” for determining how many directorships one person should hold. He agrees with Tooker that the strategy run by the fund can be a determining factor. “Ten long/short equity funds may not mean less work than two or three distressed funds. To me the constraint is on the person’s time. It is not hard to decide when you have reached capacity,” says Lewis.

He has also seen a change in attitude by fund managers who before the financial crisis were less likely to use independent directors. “Managers are open to discuss this,” he confirms, adding that even the smaller sized funds running between $100 and $500 million are seeking out independent directors, not just the larger institutional funds with $1 billion or more. Quite simply, notes Lewis, the world changed after 2008. “Investors say independent directors are needed now. They are much more aware of a potential conflict if the fund manager and others involved in the fund sit on the board.”

He, too, is selective in the funds he agrees to take on. “We typically only work with funds that are audited by the Big Four or specialist auditors like Kinetic. We also like funds using bigger administrators and bigger law firms,” he says. “You’ve got to be comfortable with the services providers. There should be no ‘personal’ flags with the manager.”

Harbour Trust Company spun out of the trust and corporate governance services offered by Deloitte in 2004. Five of the six directors have a background with Deloitte. According to Alan Milgate, Harbour is content to grow “very conservatively”. If and when more directors are added, they will need to be a good fit, he says.

“We are approached by many people who would like to join but we were not interested in them. A lot are under-qualified. This is not a job where you can give someone a training book,” he says.

He believes Harbour offers a good business model, coming from a trust and corporate service provider company which also provided some fund administration.

Milgate emphasises the risk standards he believe are core to the director’s functions. “Directors need to make informed decisions. Have they done enough to be informed on industry issues? What are the best practices applicable to a particular situation? The decisions of the board should be based on these. I don’t think there is a higher standard than that: to be well informed in good faith,” he says. Controlling risk, says Milgate, is at the heart of the Harbour model.

The client range is mixed. These include large funds as well as start ups. Like others, Harbour has a minimum number of board meetings it thinks should be held yearly. In addition there are regular meetings with the managers and service providers. These he thinks are essential if a director is to be kept informed of the fund’s activities and aware of any issues that may be brewing.

Another model that also exists in Cayman is the one-man director. Alric Lindsay, a consultant working at Intertrust which provides a range of corporate, private wealth and specialised services is sceptical about the delegation of work by a director to others. “The main reason I question this system is on the effective discharge of duty,” he says. “So I only take on a limited number of directorships,” he concludes.