Corporate governance on offshore funds is worth re-examining as investors continue their search for reliable investment structures.
It has always been the case that the investment manager as the sponsor of a fund has determined whom to appoint as the service providers to the fund, the level of charges and the terms of appointment. Fund directors are no different in the manner in which they are appointed.
Shareholders are normally unable to vote a director off a fund board as they generally hold non voting shares to avoid issues of control and either the investment manager or a trust managed by the fund administrator will hold the voting or management shares.
Investors can, of course influence those decisions and often do – either through quiet diplomacy or by voting with their feet. The directors have fiduciary responsibilities to discharge in relation to the fund regardless of whom they are appointed by, but the perceptions at least, do linger that they are in effect the investment manager’s men (and women) given the provenance of their appointment and who would generally control their removal.
Perhaps this perception is also fuelled by the limited involvement of the director because of the non executive nature of the appointment or perhaps it is because there is a significant expectation gap between the duties investors expect to see performed by such directors and those actually seen to be performed. There are of course many excellent fund directors who do all that might be expected of them and more but because investors often know little about these activities – the perceptions remain. There are also others who fuel these perceptions by doing very little! Investor due diligence is increasingly being directed towards directors because of this and that has helped shed some light on what they do.
The slight unease with which the offshore fund directors role is viewed by some investors suggests that it is time for greater clarity on all sides on what can reasonably be expected of a director in a non executive role.
Investors themselves are not entirely guiltless; I have often heard investment managers complain about the difficulties of getting investor responses to corporate actions on the funds. Which is the reason given for investors being required to give an automatic proxy to the administrator in subscription documents so that fund administration and corporate actions can remain uncomplicated by a typical lack of investor response. The accepted view is that if investors are getting ‘reasonable performance’ they don’t want to be bothered by administrative matters.
A starting point might be greater engagement with investors on the potential appointments to the board (these without doubt already take place at an informal level and should be part of an investor’s due diligence process through which indirect approval is, in any event, given) It is however rare for directors to proactively engage with investors in a fund even though there are a few good exceptions.
The private equity industry has for sometime nominated their own directors on the boards of investments. Their reasons for doing so may be worth examination as hedge fund investments do share similarities.
What are the potential pitfalls of such appointments? To start with it would require the buy in of the investment manager. That will never be a done deal – whether on grounds of cost, confidentiality, objections from other investors or differences in view of what is required of the role. The residence status of a wider universe of directors also has the potential to impact the fund’s tax status. Clarification would be required on the role of an investor nominated director and in what respect it might differ from other directors on the fund. In theory of course there should be no difference whatsoever but investors may require greater engagement with them to be kept informed of developments on the fund. Conflicts of interests between investors themselves could also be a significant consideration. Investors often underestimate co-investor risk which can be significant to the health of a fund.
An investor nominated director that was subject to a service agreement that specified say a requirement to review fund documentation, to visit the fund managers operations, participate in fund board activities, engage with investors on fund related matters and meet the service providers of the fund would set a minimum standard of corporate governance. Good directors in the industry may already perform many of these functions and more as part of their roles but there are also many who do not.
Of course a list of activities such as this begs the question as to whether this can be done for the usual standard cost of an offshore director – which may explain why there can be a gap between between investors expectations and what actually happens. To some extent investors get what they pay for, in some cases they get great value for money where there is a good director who will do it all for the standard fee, but if greater engagement with them is something the investor seeks then there will be a cost attached to it.
Perhaps investor nominated director appointments with service agreements are worth consideration as a way to at least narrow and manage the perception gap that currently exists.
©Jaitly LLP