Gary Linford didn’t get a lot of business two years ago when he co-founded DMTC Group, a Cayman Islands–based company (with offices in Luxembourg and Singapore) that provides hedge funds with independent directors. Most hedge fund managers he approached politely declined his pitch.
“‘We don’t need it,’ was the standard reply,” says Linford, a former head of the investment and securities division at the Cayman Islands Monetary Authority.
Today, Linford says, his phone is ringing off the hook, as hedge fund managers scramble to meet investors’ demands for boards of directors that are more accountable to investors than most seem to be.
And the demand for independent directors apparently exceeds the supply, mostly because managers are beefing up standards.
“The pool of available talent is smaller than the number of funds registered offshore,” notes Adrian Sales, head of operational due diligence at Albourne Partners, a London-based hedge fund consulting firm. Indeed, in the Cayman Islands alone, where about 65 percent of all offshore hedge funds are domiciled, 9,635 funds were registered with CIMA as of the end of March.
Qualification requirements to become a director are slim. The government in the Caymans does not mandate that directors have a degree or any particular certification. No test is required. Yet the breadth of duties ceded to hedge fund boards is substantial. Once a fund is established and a board selected, the directors’ first tasks are to hire service providers — attorneys, administrators, auditors and so forth — and to review and approve all of the fund’s incorporation documents.
Directors are also supposed to sign off on fund audits and are expected to review investment performance, valuation policy and net-asset-valuation calculations. In addition, they monitor funds to make sure that the manager is sticking to his advertised strategy. And they can exercise such discretionary powers as allowing participation below minimum-asset levels set in fund documents, providing redemptions on short notice and waiving early redemption fees.
Hedge fund boards of directors are responsible as well for things that make investors wince, like imposing redemption gates and reviewing and approving side letters, which protect and segregate some assets — all after a careful examination of the potential effects on investors, at least in theory. It’s small wonder, then, that until recently most managers filled their boards with friendly faces.
When Scott MacDonald, chief compliance and risk officer at $1.8 billion-in-assets HighVista Strategies went in search of two independent directors for the Boston-based endowment-style investment firm in 2005, he found that some candidates held so many directorships that they were reluctant to divulge the number. (The Alternative Investment Management Association, based in London, publishes a guide outlining board-of-directors best practices, in which it warns that it isn’t uncommon for hedge fund directors who work for professional-services firms to have “several hundred other directorships and very little time to devote to another directorship.”)
“It’s not easy finding truly independent directors with the experience and skill — and time — to attend to their duties,” MacDonald says.
Finding the right people typically involves a winnowing process. Hedge fund attorneys and executives recommend posing a slew of questions to potential directors. They say that interviewers should delve into whether an applicant has truly relevant experience and find out how many boards the candidate is on already. Managers should ask if — and why — a candidate has ever resigned from a hedge fund board.
The potential for conflicts of interest should also be explored. MacDonald, for instance, tried to avoid hiring directors who sat on the boards of the hedge funds in HighVista’s portfolio. Perhaps the chief qualification for a hedge fund director — in theory anyway — is an abiding interest in taking a watchdog stance.
“We are concerned when managers and directors fail to put the interests of investors first,” says Martin Kaplan, chief executive officer of Chicago-based Mesirow Advanced Strategies, which manages $9.7 billion in fund-of-hedge-funds assets.
“We’ve applied pressure to directors via our own relationships,” Kaplan says, “and we have called on other managers and investors to do the same.”
See related story, “Will the Directors Please Stand?”.
