By Frances Denmark
In 2009 investors in the London hedge fund firm Weavering Capital got a very unpleasant surprise. When they tried to cash out of the Weavering Macro Fixed Income Fund, domiciled in the Cayman Islands, they found out that their money simply wasn’t there. Instead, Weavering’s assets were tied up in swap transactions with an entity that turned out to be controlled by firm founder Magnus Peterson.
The swaps ultimately proved worthless — with a London judge later declaring that they were “sham” transactions set up to inflate the fund’s net asset value — and investors lost more than $530 million when the fund collapsed. The fund’s board of directors included none other than a brother and the stepfather of Peterson; they were found guilty by the Cayman Grand Court and each fined $111 million in August 2011.
That scandal threw into sharp relief the behavior of directors who sit on hedge fund boards. Since then, the Cayman Islands Monetary Authority, which oversees some 12,000 hedge funds registered there, has grappled with the question of whether hedge fund directors provide adequate oversight to fund management firms. But the Caribbean-based regulatory agency has been slow to act — until recently.
CIMA has finally responded to continued complaints from investors and requests for stronger regulations when it comes to governing funds by commissioning a survey of fund managers, directors, service providers and a handful of investors, released at the end of June. This year CIMA also published two consultation papers — or comment letters, as they are known in the U.S. — about corporate governance practices. Separately, Deutsche Bank released its own survey on operational due diligence at hedge funds, examining a broad spectrum of hedge fund operations that includes investors’ views on governance issues.
Investor complaints about board composition led to the creation of a new Cayman industry: providers of independent directors who have no personal affiliations with the managers of a firm’s funds. But the largest such firms began to draw complaints of their own when hedge fund investors discovered that some directors were overseeing hundreds of hedge funds.
Since those practices came under scrutiny in the wake of the 2008 financial crisis, investors have begun to insist on better oversight of the funds in which they are invested. The fact that more and more public pension plans are investing in hedge funds has lent new urgency to the calls for better governance, as these pensions are investing on behalf of mom-and-pop investors.
“Paid very little to do very little”
“Institutional investors are demanding more than they ever have been,” says Yolanda McCoy, head of CIMA’s investments and securities division. Among those demands, she notes, are requests for greater fund transparency, a CIMA-managed database of directors, a limit to the number of fund relationships a director can hold, and assurance that directors have enough time to apply themselves to every board position they hold.
In the past, directors were “paid very little to do very little,” says Adrian Sales, head of operational due diligence at pension consultant Albourne Partners in Norwalk, Connecticut. After the crisis, “many investors woke up to the fact that [directors] weren’t doing what they were supposed to be doing and were too closely aligned to the manager,” he adds.
The CIMA consultation paper found “a consistent call for directors’ duties to be detailed as some respondents confirmed that there is an inconsistency in the industry on what directors’ duties were.” These conclusions, coupled with pressure from international securities organizations calling for greater fund regulation, have led CIMA to consider revising its governance standards.
“The work now truly begins as a result of the information we garnered from the industry, both locally and globally,” says McCoy. To continue its information gathering and aid in the regulatory decision-making process, CIMA posted a second consultation paper on its website with a call for comments and a closing date of August 16.
But not everyone is happy with CIMA’s call for better scrutiny of board directorships. This spring, DMS Offshore Investment Services, a Cayman-based provider of independent board directors, went to court to prevent CIMA from moving ahead with its plan to enhance regulations. DMS has long been criticized for assigning one director to hundreds of hedge funds.
Don Seymour, DMS founder and former CIMA head, has countered that his firm operates with a big stable of analysts and other staff that support a smaller number of directors. Other directorships, such as Carne Global Financial Services, maintain a limit of 30 or fewer relationships with hedge fund managers. The lawsuit has not been resolved, and both parties could not comment.
Larger managers slow to embrace change
Not every fund has gotten religion when it comes to better governance. While smaller and newer hedge funds have begun to comply with investor demand for increased scrutiny, the largest hedge funds have lagged in this department, observes Michael Levin, associate director of operational due diligence at Pacific Alternative Asset Management Co., a fund of funds in Irvine, California.
“Large institutional managers generally don’t have independent directors appointed to the funds they manage. They will tend to provide their own directors,” confirms Ian Gobin, head of funds and investment services at Cayman-based law firm Appleby Global. “It’s the midlevel managers and start-up managers where you’ll find independent directors being appointed, generally at the insistence of institutional investors.”
That may be changing, however. “Today there is more appetite for the top 200 hedge fund managers to look at their boards and come to a firm like ours to discuss independent directors,” says John Ackerley, an independent director at Carne, which published its own governance survey in late 2011. “There has been a lot more focus from operational due diligence teams.”
For Deutsche Bank’s part, its survey found that a majority of respondents felt boards should meet at least four times a year, including at least one in-person meeting. The poll covered 68 institutional investor entities globally, with more than $2.13 trillion in total assets including a hedge fund allocation in excess of $724 billion.
Now, says Sales, fund governance is but one in a long list of operations issues that investors are checking off. Still, increasing demand for more independent directors continues to be a large source of new employment in the Cayman Islands for retired accountants, lawyers and analysts fleeing hedge funds of funds. Says Sales, “We are seeing more independent directors setting up and existing independent shops adding people.”
