09/02/2011 Author: Tony Griffiths

Know your board

The make-up of hedge fund boards of directors has been overshadowed by more pressing regulatory concerns of late, but with reviews of the process of monitoring directorships underway in both Cayman and Ireland, the topic is set for fresh scrutiny from investors and regulators in the coming year

Rarely far from the industry’s debating tables as it is, corporate governance has felt the heat of the spotlight a little more intensely in recent months. Having been sidelined by grander regulatory efforts for much of 2010, the topic looks to have finally been given the attention many feel it deserves, with policy reviews in Cayman and Ireland – fast becoming a premier hub for funds – reportedly in full flow.   
    
Murmurings of discomfort with corporate governance were covered by HFMWeek early last year. Back then, the topic of directors and the boards on which they sit was one which most agreed required further attention, particularly in regards to US funds, where the wider culture for independent directors was yet to settle.  

Matters have since progressed. In Cayman, the Cayman Islands Monetary Authority (Cima) has been doing an in-depth review of the corporate governance framework for all regulated sectors, including hedge funds. The initiative is widely believed to be the result of a letter-writing campaign on behalf of institutional investors and asset allocators, started in June by US-based Mesirow Advanced Strategies, a fund of hedge funds (FoHF) firm with $14bn in AuM.  

Over in Ireland, the Central Bank – handed the reins to fund regulation in October – is undertaking a similar review. Originally focused on the banking sector, with corporate governance having been identified as a potential weakness during Ireland’s banking crisis, the appraisal was extended to funds in the middle of last year. A working group dedicated to funds is expected to publish its findings in March.     

Reassuringly, the focus of both reviews is the same. “Issues being examined include, but are not limited to, composition of boards, fitness and propriety, and transparency,” a Cima spokesperson told HFMWeek. “As part of this process, we have been in dialogue with stakeholders on various aspects of the issue. This dialogue will continue,” they added.
 
Granular detail on the respective processes is currently hard to come by. Either way, said developments show that corporate governance is an issue with which the hedge fund industry still has unfinished business.

“While the industry within Cayman continues to talk about this transparency initiative, certain fiduciary investors are not as patient with the lack of progress and are now asking far more intrusive questions on corporate governance,” says Gary Linford, managing director at HighWater, a Cayman-based company specialising in governance services. “There is definitely a more activist approach taking hold and I would suggest this will continue, and will be significantly aided if Cima proceeds with the transparency initiative.”  

Greg Robbins, general counsel at Mesirow Advanced Strategies, is the author of the original June letter to Cima, credited by many as prompting the recent review. He spoke to HFMWeek about his objectives from the firm’s Chicago base. “Our focus is on two forms – MF1 and the Far (Fund Annual Return) form,” he explains. “These two forms contain a lot of information about funds and in particular fund service providers, and if Cima talks to the manager community and the manager community agrees there’s no harm in providing that service provider information then we think it would be valuable to be shared with the hedge fund community as a whole.

“I think what we should focus on is the relationship with the manager level, because it’s really important for the director to understand the manager’s business. I also think it’s a function of what type of strategy the manager trades, so if it is a simple hedge equity strategy, that’s very liquid and doesn’t present valuation problems, as a director you require less involvement in a fund that’s got that type of strategy.”
He adds: “We find independent directors more valuable on funds that have less liquidity and harsher deal terms
because it’s nice to have somebody there looking over everyone’s shoulder in those contexts.”

The school of thought that US and European funds differ on this issue is one to which Robbins gives credence. “I don’t think that European managers or non-US-based managers are any more conscientious than US managers but I do think that there’s a habit that’s been formed due to the location of having an independent board involved, and I think it’s easier to engage with those managers because of it.”

Clearly voicing a view shared by many, Robbins has since watched his request for more transparency “take on a life of its own”. Having informed a number of investors and asset allocators of his intentions in June, his letter has seen a steady flow of follow-ups arrive at Cima’s door. In fact, as recently as a couple of weeks ago he was approached firsthand by other asset allocators who had seen the original letter and wanted to add their support.

According to HighWater’s Linford, himself a director of one of Mesirow’s vehicles, the original letter has since produced up to eight follow-ups from large fiduciary investors, each backing the same calls for greater transparency. The total number of follow-ups is rumoured to be much higher.

A professional independent director, Linford currently has 46 relationships as a director, 27 of which are with hedge funds. He considers himself at or very near full capacity. As for the Cayman average, he estimates that the typical range for a Cayman director is 25-75 directorships, but admits the overall range is “huge”.

“It’s a monkey on Cima’s back,” he says. “The industry is growing and with certain hedge funds having had run-ins with other regulators or with disgruntled investors, Cima will continue to be criticised for not addressing the issue of excessive directorships with that section of the industry that equates a high number with problem issues.

“I think the issue of excessive directorships is overplayed and in my opinion the term ‘excessive’ will eventually only apply to small number of individuals, perhaps less than five,” he adds. “That said, the term ‘excessive’ is subjective and if someone deems the right number to be ten, then you will find many people fall within the definition.”

Back across the pond, Ireland’s current review is expected to spawn what will be the jurisdiction’s first
official code of governance. Speculation has turned to potential details, with many people suggesting that the regulator will cap the number of directorships at 30.

“That seems to be the magic number,” admits Karen Malone, founder and managing director of Centaur Fund Services, an Ireland-based fund administrator. “But what does it actually mean? Is that directorships of 30 individual funds or does an umbrella structure count as one? Besides, it’s not just about the numbers of directorships, but the actual experience of the directors themselves.”

“The Central Bank is looking for a balance,” adds Donnacha O’Connor, a partner at Ireland-based law firm Dillon Eustace. “They are likely to look for at least one director from or representing the investment manager of the fund and a number of independent directors – a balance between the two.”  

Robbins, however, is keen that Cima avoids introducing fresh legislation. “We’re not really interested, and frankly we’re opposed, to any type of regulation in this area. For us, the goal is just to make the information available and then let the market decide what the value of that information is.

“Let’s be clear, 80 managers [directorships] would be too many, but if somebody is in the realm of, say, 30 or so managers and could present us with an explanation as to why that’s appropriate – that’s fine, but we need some place to start the conversation.”

Don Seymour is the managing director at DMS Management, a Cayman-based director services firm. He admits that following the finical crisis of 2008, “questions are now being raised about director capacity,” but believes those queries have been answered by the event itself. “If Cayman directors were truly over-capacity from serving on hundreds of funds, their  failures would have been exposed during the crisis,” he says.  

Two local directors had actively solicited support from a few FoHFs to advocate for the implementation of a public hedge fund database in Cayman, but, according to Seymour, faced a muted response. “It was widely accepted that disclosing private fund or personal information to the public served no value and merely exposed the fund and its associated individuals to unnecessary risks such as fraud.”

There is no guarantee that increased disclosure would unearth, “anything inappropriate going on in terms of the number of directorships,” Robbins is happy to admit, neither does he have any qualms with the current approach – which largely consists of collating a list of the directors of a board, phoning them and asking direct questions. However, sensitive questions relating to existing, dissatisfied investors and the reasons for their dissatisfaction have, in the past, led to stand-offs.   

“There’s nothing wrong with that approach,” Robbins says, “but at the same time a handful of these directors have just been unwilling to answer these types of questions, which to us is pretty shocking in the context. It makes you wonder to who the directors’ duties are owed.”

Linford believes that the topic of transparency still divides the Islands. In July 2009, he recalls, the industry within Cayman could not find consensus on a policy initiative on transparency as it related to disclosing the number of directorships. “While there now seems to be a growing agreement that more transparency is needed, there is no agreement on the level of such transparency.”  

Whether in Cayman or Ireland, a corner now seems to have been turned. Reports suggest Ireland will make
the first move, potentially within the next month, while Cayman is rumoured to be readying its own solution for publication by the end of the year. It’s been a long time coming, but 2011 looks likely to be the year corporate governance is finally addressed in the manner the investor community expects.