Comment: Independent value - maximising the benefit of independent offshore directors
Scott Lennon, a senior vice-president at Walkers Fund Services in the Cayman Islands, examines the impact of the credit crisis on the role of independent offshore directors.
Independent directors are appointed to offshore structures to undertake two equally compelling, and at times competing, functions. First, the independent director must exercise effective oversight of actions taken by investment managers. Second, and arguably the more critical function, the independent director must ensure that all decisions are made based upon the best interests of investors, and in some circumstances, potential creditors.
Inherent in the independent director's responsibility to the investor is the need to exercise heightened scrutiny of the fund at critical times. To ensure that the responsibilities owed to the investor are fully satisfied, the director must be vigilant in overseeing the fund's operations while ensuring proper reporting to investors in accordance with the offering documents.
It is imperative to acknowledge that while a fund's constitutive documents may well give the investment manager the discretion to impose certain measures including, for example, the power to suspend redemptions, the managers must consult and work with the directors to achieve a decision that lies in the best interests of the investors as a whole.
Consistent with the need to employ best practice, independent directors must be aware, as well as anticipate any conflicts that could arise and potentially compromise the structure. The expertise of the director extends to identifying issues and, at times, making critical decisions that could impact the very existence of the fund. In such exigent circumstances, directors need to consider whether or not to seek independent legal counsel separate and apart from the counsel of the investment fund.
A prime example of an issue that merits the exercise of the independent director's action occurs when the investment manager proposes a workout of a distressed situation that clearly prejudices one group of investors over another. This creates a very high-risk situation for the board, and therefore prudence dictates that the independent director seeks independent counsel.
The risks faced by independent directors are numerous and real. Uncertainty and unprecedented losses in the industry have magnified the threat of litigation. More than ever, the same scrutiny exercised by directors is also borne by the directors themselves. Today, directors are forced to justify and undergo rigorous examination of every decision that they make. They are expected to demonstrate precisely how each decision was taken with the best interest of the fund, its investors and potential creditors in mind.
However, investors and investment managers critical of decisions made by directors need to be mindful that the role of the director is wholly independent. Accordingly, decisions made by the director are intended to benefit all interested parties. The director is not commissioned to advocate the position or interests of one party, such as the fund manager, to the exclusion of the investor. The director must strike the right balance of making appropriate decisions for the fund while safeguarding the interests of shareholders.
The growth of the professional director services sector, coupled with the unprecedented upheavals in the banking and credit sectors over the past year and a half, have presented the industry with a new wave of challenges.
At the micro level, the appropriate number of directorships assumed by an individual or organisation has become a hotly debated topic. However, efforts to regulate the number of directorships lack any level of practicality and should be rejected. Instead, given the uniqueness of each fund it is incumbent upon the director to identify and satisfy the requirements of that particular fund. Indeed, the director is in the best position to properly manage the number of relationships while acting in the best interests of investors.
Proponents of enforcement of a hard cap on the number of directorships neglect the fundamental premise that different relationships require varying needs. For instance, it may require less time and resources to oversee a number of institutional funds that may share service providers or strategy, compared with oversight of a large number of single manager funds. However, there may come a point when the independent director no longer has the resources to accept new appointments given the responsibilities of his existing portfolio.
Ultimately, the individual director bears the responsibility of determining whether he has the capacity to assume the directorship in conjunction with exercising the requisite due diligence prior to joining a board.
Upon completion of a thorough risk assessment, and based upon a wealth of experience, the director must determine whether he can properly fulfil his fiduciary duties. It is equally important for the investment managers and investors to gain assurance from the director that expectations regarding service levels and operations will be satisfied.
The bedrock of the relationship between the independent director, fund managers, and investors is confidence. Especially in such trying times, where investors are grappling with their investments in distressed funds, the independent director together with the board of directors must assume a leading role in assuaging the concerns of anxious shareholders.
In the face of developing challenges in the marketplace, the industry is anticipating a new wave of onshore-led regulatory directives in 2009. Where offshore funds are concerned, any changes are likely to be focused on issues relating to transparency and disclosure, as well as more oversight of funds marketed to retail investors.
In response, all service providers, particularly the independent director, will need to ensure that transparency is at the forefront of any relationship going forward. Turning to onshore investment managers, a new, more comprehensive system of registration appears to be a likely implementation.
The credit crisis has forced the industry to scrutinise and consider readdressing its regulation, but the role of the independent director remains a constant. The director's duty is to act in good faith in the best interests of the fund's investors while overseeing the fund's operations. The independent director is in a position to contribute experience and direction to a fund during difficult times, the benefits of which are ultimately reaped by investors.
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