Due Diligence on Board of Directors of Offshore Hedge Funds and Private Equity Funds Recent surveys suggest that hedge fund investors are not happy with the Cayman Islands. Specifically, the issue relates to governance. Many so-called, "offshore" hedge funds and private equity funds are domiciled in tax advantaged jurisdictions such as the Cayman Islands. As a result a cottage industry has developed in the Cayman Islands, and many other offshore jurisdictions, supporting the investment community surrounding those funds. These service providers include law firms, administrators, accountants and most notably directorship services. Offshore funds typically have a Board of Directors which for the purposes of this discussion can be effectively equated to the General Partner in most domestic or onshore funds. The role of the Board of Directors of offshore hedge funds and private equity funds has been a hotly debated issue among both hedge fund / private equity managers and investors. As investors have increased the scope of due diligence reviews on hedge funds and private equity, the role of the Board of Directors has become increasingly highlighted. Industry groups such as the Alternative Investment Management Association ("AIMA") have recognized this and are reportedly developing a due diligence questionnaire aimed at helping investors evaluate the role of directors. While investors should be skeptical of boiling the due diligence process down to a questionnaire, the role of the Board of Directors is one which should be focused on. As their due diligence efforts have increased, many hedge fund and private equity investors have been surprised to learn that the director's, which typically work for professional board management companies which provide director's on demand, serve on multiple boards. Indeed when many investors begin to look at the issue more closely they may even discover that the same individual(s) serve on the boards of multiple funds in which they are invested. When a director is effectively a professional full-time director and nothing else investor's may begin to question how much time and attention a director is devoting to any one fund. On the other hand, Caymanian director's (the majority of which are not from the Cayman Islands but instead British or Irish imports) may also raise several compelling arguments. The first of which might be that the Cayman Islands is no Sark Lark and the Cayman Islands does have in place a regulatory framework as overseen by the Cayman Islands Monetary Authority. There are also industry groups in the Cayman Islands which foster director practices such as the Cayman Islands Directors Association. Another point worth considering, and one which many hedge fund and private equity managers may raise when questioned about this, is that local professional Cayman based directors are familiar with the local law and filing requirements. Furthermore, many professional directors may have insurance coverage which it could be argued would lighten the burden on the fund itself to obtain coverage such as Director's & Officers coverage however, from the perspective of many investors any such coverage a director may have most likely does not obviate a preference for a hedge fund or private equity manager themselves to maintain such coverage.
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While both sides present interesting arguments and different investors may have their own particular opinions in this regards, at a minimum it is important for investors to incorporate a review of the role of the Board of Directors into the operational due diligence process. To start off the discussion some common questions investors may consider asking include: • • • • • • •
How many directors serve on the board? Is it an odd or even number? Has the composition of the board been the same since inception? Are any of the board members affiliated with the hedge fund / private equity manager? What fees are paid to directors? What are the qualifications of the directors? Have any of these director's ever resigned from a fund board before?
Indeed, in light of a recent landmark decision by the Grand Court of the Cayman Islands to find two former directors of the failed Weavering Macro hedge fund guilty of willful neglect or default in the discharge of their duties. When investors begin to conduct such reviews of a hedge fund or private equity firm's Board of Directors they may often be surprised at the useful additional operational insights which may be obtained. Originally posted on the Corgentum Consulting blog at www.Corgentum.com/blog
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© 2011 Corgentum Consulting, LLC
Originally posted at the hedge fund operational due diligence blog www.Corgentum.com/blog an overview of due diligence on offshore board of...