As part of a series of seminars for independent directors of Cayman Islands investment funds, the Cayman Chapter of the Alternative Investment Management Association (AIMA) invited three representatives of multi-billion dollar fiduciary investors to debate what Cayman can do to remain attractive to portfolio fund investors.
DMTC’s Gary Linford, who conceptualised the seminars and moderated the panel started off the debate by stating that during the fourth quarter of 2008 it became evident, that not only is the independent director market growing, but that the roles that independent directors play are increasing.
Greg Robbins of Mesirow Advanced Strategies, which invests into diffrent hedge fund manager companies both onshore and offshore, admitted that prior to late 2008 he had not spent a lot of time thinking about fund governance.
He blamed his personal prejudice in the sense that he believed that every hedge fund should be run like a Delaware LLP.
During 2008 Robbins found that some managers “were going off the rails in ways that were extremely unexpected to us”.
Litigation was not really an option as a fund of funds manager, he said. Instead he was looking for a court of appeal outside the public jurisdiction systems and specifically the directors as a resource.
“That at least was our hope. In some instances they were and in some instances they were not,” Robbins said.
He would like to see directors as business partners and neutral arbitraries in the dialogue between investors and investment managers and expects directors to be comfortable in this role and go beyond the duties that are set out by law, said Robbins.
Terry Raby of Universities Superannuation Scheme agreed that in addition to the formal responsibilities for directors, he was also looking for a more subjective input, for example in conflicts that arise between investors and managers and in conflicts between investors. This would require that directors have an insight into who the risk takers in the fund are, said Raby.
Raby added that before USS makes any fund investments he would speak with at least one of the independent directors. Although these conversations had on the whole been “extremely constructive and useful”, it was the first time for most directors in the history of their directorship that they had spoken to an investor, he said.
Eric Maidenhead of UBS Global Asset Management weighed in that a lot of the debate about transparency in the industry boiled down to the interaction between administrators, auditors and directors. He argued people should start to think much earlier, at the stage of formation, about how all these parties need to interact with each other.
“Investors will take a lot more comfort earlier on, if they understand how the service provider roles work together,” said Maidenhead.
In terms of the regulatory framework Maidenhead would like to see consistency in practices that are employed by directors residing in Cayman.
He suggested that it was “probably a better standard to have directors from different firms engaged on a particular board as opposed to having two directors from the same firm”.
Maidenhead quoted from personal experience cold-calling directors who were unable to answer his questions, referring him to the other director, as they had not been “as on it”.
“Those types of comments don’t satisfy an investor when calling and asking a very important question,” he said.
To appoint directors from different firms would not only avoid the internal passing of the review for a second signature, but also elevate standards across firms as experience is shared, he concluded.
No sanctioning mechanism for directors
Linford stated that one often heard remark is that there is no director disqualification regime in Cayman.
However, the Cayman Islands Directors Association, the group representing directors, has established a self-regulatory environment that would involve disciplinary procedures.
CIDA President Paul Harris said the organisation had 150 members which represented at least 80 per cent of fund directors in the Cayman Islands. CIDA is based on the Code of Professional Conduct for Chartered Directors issued by the Institute of Directors in the United Kingdom.
Greg Robbins remarked that having read CIDA’s code of conduct it was not immediately clear to him that the code had an enforcement mechanism.
Linford replied that CIDA’s name and shame process was probably sufficient and mentioned a similar approach by the Cayman Islands Monetary Authority.
The reason why something as simple as a director disqualification regime has not been introduced, he said, is based in the philosophy that the Cayman Islands has to be cost-effective.
A public notice approach is far cheaper than going through the courts, said Linford.
As the concept of independence of directors was not detailed by law, Linford asked how panellists would define independence.
Robbins believes independence is proven through actions, by asking the investment manager hard questions, getting actively involved and understanding how the business works.
Raby agreed that the demonstration of independence was the most important step. He also questioned whether directors who had taken on a large number of directorships were really able to form an independent judgement, particularly in a crisis situation.
Number of directors
How many directors the board of a fund would need was also debated.
Linford stated that the number of directors should not be rigid as it depended on a number of factors including infrastructure in terms of people around the director and their experience, the IT systems and the complexity of the investment strategy.
While acknowledging these factors, Maidenhead believes the number of directors could be higher. How much higher the number should be would also depend on the complexity of the engagements.
Most importantly he believes investors would be willing to pay for better standards. “We are certainly willing to agree to a higher remuneration for what would be a better overall standard. If it requires more infrastructure as an investor we are willing to pay more. My investor would probably be comfortable with the single digit basis points that it might amount to,” he said.
Fund formation – the issue of voting shares
As under the Cayman structure investors often hold non-voting shares, with all the voting shares being held by the investment manager, the ability of investors to take action tends to be restricted. Linford said that directors are in a position, where they can accept the commercial terms and allow institutional investors to vary those commercial terms through side letters or having the private placement memorandum rewritten at a later stage.
Alternatively the documents could be changed at the formation stage to incorporate the concerns and wishes of the investors.
“We don’t want to put our heads in the sand as a jurisdiction and simply say we take the documents as drafted; there is no need to change,” he said.
Robbins explained that the panel members do not invest in start-up managers and usually come to a fund once it has been in existence for three to five years and has $1 to $3 billion under management.
As a large fiduciary investor we cannot invest in certain structures anymore, such as a master fund where the investment manager is the general partner of the master, he said.
For many funds it is an evolution of the business to deal with investors that have the operational due diligence teams and research teams of large investors and they encounter investors that have problems with their fund structure for the first time, he explained.
The issue of the structure could either be addressed at formation or with a potentially much more difficult restructuring later on, Robbins said.
Raby said he would like to see that the formation documents grant investors the formal power of being consulted at strategic events in the life of a fund, such as winding up, appointing a manager, appointing directors and directors fees.
This could be arranged in an annual vote.
“We are possibly considering whether we should operate under managed accounts or under a fund structure and clearly the role of the director at the inception of the fund is very important,” said Raby.
Maidenhead agreed that the discussion around managed accounts is key, but while a lot of investors are pushing for it, he does not believe that as a platform it is the right solution.
“We don’t believe it is the right solution because it creates more operational risks to funds. It creates a greater degree of allocation policy issues and it is less transparent to the board functions,” he outlined.
The approach that has been built serves investors well as long as the independence and the governance functions are carried out, Maidenhead asserted.
Communication between investors and directors
Linford stated that most directors would be prepared to communicate with investors, but there was the issue of how to do that in a practical way?
“When you have got a database of 10 shareholders it is practically not that difficult, but if you have a list of 200 you cannot exactly hand your cell phone number out,” he said.
Another issue is that the contact information is not that transparent, said Maidenhead. But even if contact is made directors tend to ask for a question in writing and respond with a letter that has been scrutinised by an attorney, he said.
Diverging investor interests also complicate the ability of directors to communicate with investors. If the intention of the investors is not clear there are potential legal and other liability complexities that would not allow a board to speak to an individual investor, fund directors argued.
While it was generally not a question of a board not wanting to speak to an investor, the ability to communicate with investors depends to a large extent on what the conversation would be about, specifically in a crisis situation.
Robbins stated that he found it very troubling that at a time when investors needed directors the most, when things go bad, directors are not able to speak to shareholders.
While he can accept that administrators may regard themselves more closely aligned with the manager, the directors should have a duty to the shareholders.
“I do believe the directors have an obligation to us,” he said.
Raby concurred saying that “we expect them to work for ourselves”.
Robbins added that, for Cayman companies to pretend that the company has a purpose other than to serve its shareholders is a concept he is struggling with. He urged directors to let investors know whatever assurances they needed to be able to communicate with them.
I have personally signed letter confirming our firm would never front-run, would never hedge or would never use any information we get to trade on, he stated.
Linford admitted that there was no satisfactory answer although there was begrudging agreement by the fiduciary investors.
“We need to speak to all the investors and understand what their differences are. However, that is sometimes best achieved through a shareholder committee,” he said.
His experience during the fourth quarter 2008 was that everyone wanted the directors to follow their wishes, but there was great reluctance to form a shareholder committee or to be associated with the shareholder committee.
The issue what investors want and are prepared to do publicly became a fiduciary risk in itself, said Linford. He concluded that guidance on how fiduciary investors would like to see communication improving, whether through structured meetings or shareholder committees was very important.
With regard to documentation he stated that most documents have been drafted to protect the promoter and the service providers. Given time, he predicted, “we are going to have a little bit of equalisation in the approach to documentation, either through side letters, managed accounts or moving away from Cayman or the larger fiduciary investors telling Cayman that things have to change a little bit, [but] I don’t thing dramatically.”
We are going to see more activist fiduciary investors, said Linford. We can either ignore them or we can engage with them, understand what their issues are and agree or disagree with them on certain issues, he summarised the purpose of the debate. As a jurisdiction we have to accommodate what we believe is appropriate and push back what we feel is inappropriate, Linford concluded.