20/07/2011 Author: Tony Griffiths

The HFMWeek Big Debate: Corporate Governance

In an effort to explore the thorny issue of corporate governance, and in particular the role of hedge fund directors, HFMWeek’s inaugural Big Debate assembled a panel drawn from the hedge fund manager and investor communities to engage in some healthy discussion

Corporate governance. Capped directorships. Increased disclosure. Criticism of hedge fund boards has been following the industry around for several years, an unease in no small amount magnified by a financial crisis teeming with gates, lock-ups and suspensions. Critics have been champing at the bit and a growing number of investors have been registering their own discomfort.

As one of the hottest topics on the industry debating table, HFMWeek has decided to give corporate governance a platform of its own, in this, the magazine’s first ‘Big Debate’. “The financial crisis opened the eyes of investors to the fact that a lot of directors weren’t actually at the wheel and weren’t as independent from managers as they should have been,” says Kevin Ryan, founder of independent director provider HedgeDirector.

Our first participant, Ryan is joined around a virtual roundtable by: Don Seymour, president of Cayman-based dms Management, one of industry’s largest director services firms; Greg Robbins, general counsel at $14bn fund of hedge funds (FoHF) Mesirow Advanced Strategies and an outspoken advocate of increased director disclosure; and Stephen Foster, head of single manager and FoHFs at Credit Suisse, himself a director on hedge fund boards.     

Moderating the conference call, HFMWeek first wanted to know what changes have been forthcoming.
Seymour and the debate’s investor representative, Robbins, began proceedings.

Don Seymour (DS): The key thing for us is engagement with investors. During the crisis it was necessary for directors to make some very difficult decisions. I liken it to going to court. Irrespective to what happens when you go to court, there’s going to be one party that leaves the courtroom feeling aggrieved. What we tried to do during the crisis, and continue to do to this day, is engage investors in the process.

Greg Robbins (GR): One of the main things we’re looking for directors to do is what Don is talking about – get people in a room together. I think the main thing that investors are looking for are directors who are actively involved with the manager, who understand what the manager is trading, who the manager’s investors are and the kind of liquidity mismatches that can derive from that.

One of the most contentious issues surrounding hedge fund boards has been whether it is necessary to cap the number of directorships an individual holds. Tales of directors with hundreds of directorships regularly do the rounds, prompting suggestions that a regulatory cap could be useful. HedgeDirector is one of the few to employ such measures – restricting each member of its team to a maximum of 15 fund relationships.

HFM: Let’s discuss individual directorships then. Do you think there should be a cap?

Kevin Ryan (KR): I do. In my opinion it’s common sense. Investors are looking for directors who are capable, competent and have the time and resources to devote to each fund. You simply can’t do that if you are sat on a large number of boards. I think to be a reliable and credible director it’s important that you have sufficient time to get to know the portfolio manager and the dynamics of the  management firm. If you’re on the boards of large numbers of funds you simply can’t do that. You need to be devoting a couple of hours a week to each fund, which caps the number of fund relationships to 20, maybe 30.

DS: Well, of course we believe that there are capacity restraints on any one individual. If you take my firm for example, it started with myself, and today we have over 60 people. We have 60 because we feel there’s a need to build capacity so that you can deliver on your obligations. That goes without saying. What we don’t believe is that there is a magic number and that there’s a set limit. Whether you are one person or a firm of 60, you need the capacity to deliver an institutional-quality service.

HFM: Does this idea of a ‘magic number’ hold any water or is it going down the wrong path?

Stephen Foster (SF): I think it’s going down the wrong path. It’s not about the number, it’s about the value-add that those directors can bring to the board. They need to have an understanding of the strategy, they need to be able to spend the time on it, and that will be different for each individual. Someone that’s a full-time director can clearly take on a lot more roles than someone that has a day job, for instance. A lot of it comes down to common sense. If you’ve got someone who’s a director of hundreds of funds, clearly they cannot be putting the sufficient time into all of those roles. What investors should be looking at is the number of other directorships those directors have – they can form a sensible decision themselves. You can come up with a number – 15-20 may be a good number – but I’m not sure that a magic number is the right way to look at it.    

KR: I think what’s happened in the industry is we’ve evolved a situation where the directors have become perceived as a service provider; the same as the auditor, accountants and administrators. But they’re not the same, they’re different things. Directors aren’t there to provide a service that’s measured by its efficiency. It’s not about the number of roles they hold and how quickly they can get jobs done. It’s about having someone – an experienced, trustworthy person – looking out for investors’ interests. It’s not the same as an administrator who can automate a process and take up hundreds of roles. Directorship is not an automated process – it’s case by case oversight, bringing individual expertise to bear on a wide range of situations.

GR: I agree. Even though there may not be a magic number, there is a limit. Whether it’s 15 or 20 individual funds may not be the right answer, but we know it’s not, in my view, 30 manager relationships. It could never be that high. I think you’re right about taking a common-sense approach to it, but you know there’s a limit as far as I’m concerned.

In June 2010, Mesirow Advanced Strategies sent a letter, penned by Robbins, to Cima, the Cayman regulator, outlining improvements it would like to see in regards to the jurisdiction’s corporate governance regulation. For Robbins the key is transparency – increasing the amount of information available to investors to allow for better decision making. Many other investors have since echoed these sentiments.  

GR: We’d like to know if directors have been involved in fund suspensions before, and what the reasons for those suspensions were. It would be nice to know if a director sits on, not just the board of the hedge fund, but also of the manager itself, which we think presents the opportunity for conflicts. We would like to know the directors’ view of its obligation towards the fund and towards the shareholders. But we think that one of the important factors that really gives insight into the director’s mindset in regards to its obligations, is the number of directorships, and we do think that information should be made publically available.      

KR: I don’t see any reason why people shouldn’t be 100% open with all of the roles they hold. I think investors have a right to know this information.

HFM: Is there any information that could be seen as detrimental if a director was forced to give that out?

SF: I can’t think of anything. If you’re just saying you’re a director of another fund, and you’re not disclosing confidential information about that fund, then I think it’s right and proper that investors should be aware of the role you have.

DS: Of course we support transparency and disclosure – I guess the question is ‘to whom?’. We don’t support it to the general public, we don’t see how that makes sense, but we certainly do privately disclose and give any stakeholder in a private fund the transparency they require.

GR: In our ideal world, there would be more disclosure about directors, their view of their duties towards shareholders and their history in terms to acting on those duties. That would give all the investors a better guidepost by which to make decisions and to initiate conversations with directors.

DS: But disclosure to whom?

GR: Public disclosure. I don’t know why we wouldn’t want public disclosure. One of the main problems the hedge fund industry has is that it’s viewed as a secretive, non-transparent business, and that allows it to be attacked from a lot of different sides, including director firms being unfairly attacked. The more disclosure out there the better and it also allows people to educate themselves about the industry.

If there is a crux to the discussion, it centres on board impartiality – or lack of it. Who the directors represent, what their backgrounds are and where their loyalties lie. The classic board, made up of family and friends of the manager – a scenario particularly common in the US – has, in some ways, become the topic’s critical totem.  

HFM: Have we seen the end of the days where a board is just made up of family and friends, there to rubber stamp on the manager’s behalf?

SF: Yes, we are definitely moving away from that. Will you find the odd one out there? I’m sure you will, but the industry as a whole has come a long way, driven by the events of 2008. Certainly during my first directorship roles I had very little, if any, interaction with investors. It’s still not a lot if I’m honest, but it’s happening a lot more and I think people are realising there’s an important role for directors to play and investors are speaking to them directly.

KR: I think an important point to make is that we’ve arrived at a catch-22 situation, where for a long time investors’ perceptions have been that the directors are not independent; they’ve been in the pockets of the managers and, therefore, contacting them hasn’t been worthwhile. It’s been a relatively recent development that administrators have stopped being the sole providers of directors. I think only now we’re arriving at a stage where investors are saying, ‘we want our directors to be real people with more responsibility to protect our interests’. Things are changing, but it’s a slow process.       

HFM: Should all directors be paid the same?

KR: In my opinion, a director’s role is like any other role: you pay the market rate of the individuals you find and the responsibilities and risks they take on. It’s a question of paying the appropriate rate to attract the calibre of people that you want for the job.

GR: Directors who have proven themselves valuable can demand more and we’re happy to pay more as an investor. I do think that one of the things you’re likely to see are white-lists of approved directors firms, just as we have approved service providers across the industry.

HFM: This idea of a white-list is interesting. Blacklists have also been mooted – is this something that you have seen?

GR: Institutional investors share information and when we find a director we like we’re happy to pass on information about that director, and when we find directors we don’t like we obviously talk about that as well. We’d rather not focus on blacklists – we like to focus on the directors we’ve approved. We’re happy to put them on lists that we recommend to fund managers who are both starting up and looking to make changes in their director make-up.

HFM: In terms of the make-up of the board, are we heading towards a standardised structure with a certain number of independent directors or is that a bit of a misnomer?

SF: I think that’s a bit of a misnomer. I think, what you want to see, in my personal view, is a majority of independents and a representative from the manager. And then really it’s about the quality of those individuals. As has been previously said, this is still a relatively small industry. People talk. I’m sure there’s not black or white lists as such, but certain people will recommend people, or say ‘this guy has rolled over and let the manager have his way’, so they’re there if not as exact lists. But I don’t think there’s a cookie-cutter solution of what the board should look like.

KR: To my mind, there should be a range of skill sets across the board. What’s often been lacking in the past  is a sufficient range of different skills and backgrounds. You’ve seen boards almost exclusively with backgrounds as fund administrators, custodians and possibly lawyers, but very little with fund management experience. As a consequence, investors’ interests are being compromised by boards who don’t understand the investment strategy.

GR: The boards we like the most are the ones that have some diversity of background – you don’t have directors that have the exact same resume and you do have people that are subject matter experts. For instance, someone with an accounting background and someone with a legal background. An investing background is great too.

DS: I think the ideal board make-up is the one that Stephen suggested, which is independent, but includes a representative of the manager, because I think that adds real value to the board. Beyond that, having representatives of administrators and law firms is more questionable because of the independence concerns, although they can, in certain situations, add some value.

As the debate progressed, a subtle, but key, point of difference reared its head. The issue centred on the nature of the service offered by directors to larger hedge funds compared to that at smaller funds. Tailoring the service – a typical approach for the traditional director services provider – is something Seymour felt passionately about. 

DS: We have to understand that the majority of funds are actually $100m and less. Sometimes what gets lost in this debate is that we’re thinking about the governance requirements of $4bn-$5bn funds and doing all of the same things. The point that I’m making is that there’s no overall, one-size-fits-all solution. The way that you would price a board for a $100m and under fund compared to the governance responsibilities of someone running a $5bn fund, where there is a lot more interaction from the board, are two different types of situations.

KR: I would disagree with that. I would say that the investors in a $100m fund deserve the same protection as the investors in a $5bn fund.

DS: But in the $100m fund it’s the mother, the father, the friends and family.

KR: In my experience that’s not true. At that size, a fund is typically managing external capital.

DS: Most funds are small, certainly, and the risk profile is much different. If you’re saying that you’re going to approach a less than $100m fund – friends and family money, liquid strategy, no external money – in the same way as a $5bn fund running endowments for Harvard and Yale – complex strategies – that doesn’t make sense to me.

HFM: Is there anything to be said for a variation of approach?

GR: We all recognise that managers who are starting out tend to engage cheaper service providers. But, at the same time, minimum standards have to be maintained. I think Don makes a good point, that a highly liquid strategy, where someone is invested with a trusted relative, is probably not expecting the same level of protection. But I don’t think that excuses directors from providing the highest level of protection that they can, and if they don’t feel they can provide it at the price point that they’re charging the manager then they shouldn’t be serving on that fund. I think everyone’s entitled to the same level of protection.

DS: That goes without saying. What I’m saying is that some institutional investors suggest you should spend 200 hours a year on a fund. Now, even for a fund that’s $5bn, I think you’re going to be hard pressed to find any director that feels they can effectively spend 200 hours on any fund. I’m not saying you shouldn’t do anything for a friends and families fund, I’m saying that the expectations are not the same. Of course there are minimum standards of governance though.

GR: I guess the flip of that is that as hedge fund managers tend to upgrade their service providers as they get larger, I think we would expect them to upgrade their directors as well, or at least expect the directors to upgrade the services they’re providing.