Geoff Roddick, International Management Services

Independent Directors: Considerations and Queries

Download the special report US Hedge Fund & Private Equity Services 2013
Download the special report Cayman Islands Hedge Fund Services 2014

Picking the right independent director is not as simple as you might think. Geoff Ruddick of International Management Services (pictured) takes a look at the key things to consider…

One of the first considerations when looking for an independent director is the underlying rationale behind your search. The main reason will of course be the desire for effective corporate governance. In today’s environment, corporate governance is no longer a luxury, but a requirement. Regulators and exchanges are increasing their scrutiny and investors are demanding it – so should everyone.

Aside from corporate governance, tax considerations are also important. Independent directors may be appointed in a tax-neutral jurisdiction to assist with the tax planning of the investment manager or to secure the fund’s offshore tax status by ensuring that the jurisdiction in which the mind, management and control of the fund is exercised, is clearly offshore.

Regardless of the reason, a qualified, experienced, independent director will assist in meeting these underlying requirements. The question remains, however, how do you go about selecting the right person for the job?

So, where do you start?

Investors, legal counsel, administrators, and other professional service providers are a good starting point and will have a shortlist of individuals with whom they are familiar and would recommend. Once you have their recommendations, you should make additional inquiries to find the individual who is right for the fund. Keep in mind that independent directors come with varying backgrounds, experience, qualifications, styles, interpersonal skills and corporate support—check around to compare and contrast.

The process of looking for an independent director is somewhat analogous to the search for a new employee. If you have been in the unfortunate position of hiring the wrong person for a job, you will understand the feeling of regret that comes upon you when it becomes evident you made the wrong choice. You now wish, with hindsight as your judge and jury, that you had performed more due diligence and asked more questions at the outset.

You will have some questions for the prospective director, and should expect that they will have some for you in return. Both parties need to be comfortable and confident with each other in order to have a conducive and effective working relationship.

Now, what should you be asking?

There are no hard and fast rules or an all-encompassing list of questions you should ask; however, some suggestions for consideration follow.

1) Independence – Ask!

Is the prospective director independent of the investment manager, administrator, legal counsel and all other service providers?

Independence is the ‘Holy Grail’ of effective corporate governance. If a director is not independent, conflicts of interest will inevitably arise and interfere with the director’s ability to act in the best interests of the fund.

2) Experience – Ask!

Does the individual have relevant industry experience and experience with the fund’s strategy?

You will get a good idea of their experience from their ‘bio’, which will eventually appear in the offering document of the fund. You will also want to ask if they have served on boards with similar strategies. Independent directors do not need to be experts; however, a general understanding of the fundamentals of the underlying strategy is essential.

3) Qualifications- Ask!

Does the individual have relevant professional qualifications?

You will possess academic credentials and qualifications of your own, and expect it of the people you employ. You should require it from an independent director as well. Remember, the directors are ultimately responsible for the oversight of the fund’s affairs.

A legal, accounting, compliance, investment or other relevant qualification, combined with experience, will provide a good indication of where their specific expertise lies and how they will add value.

4) Capacity – Ask!

Does the individual have ‘time’ to serve on the board?

Simply put, “Capacity = Time”.  There has been an extraordinary focus on ‘numbers’ and ‘caps’ in the last few years in reference to a director’s capacity. Everyone continues to want to know the magic number. In many respects, an arbitrary number or cap has been become analogous (and arguably the sole identifying factor) of determining the capacity of a director.  

Capacity does not, however, simplistically equate to some arbitrary number or cap. Unfortunately, there is no definitive number as every relationship will be different and have its own nuances and complexities.  Numbers will provide some insight, but it is only one of the many important questions to ask.  Keep in mind, however, that numbers, like all statistics, in isolation can also be misleading. 

The focal point should be ‘time’.   Figure out what they do day-in and day-out and where they spend their time.  Discuss the composition of the clients they serve; their role within their company; what other responsibilities they have beyond serving in a personal capacity on fund boards; their model , support infrastructure and their capacity constraints (which are critical, however, do not equate simply to an arbitrary number or cap).  Consider whether they have any excess capacity for those times of stress and perhaps most importantly determine how they personally view their role as a fiduciary. 

5) Back-up/Coverage – Ask!

Does the individual work for a director services company or are they a stand-alone operation?

Although most consideration should be given to the capabilities of the prospective director, there may be times when the individual may not be available. People take vacations, encounter emergencies, come and go from an organisation or jurisdiction, and start-up businesses often fail.

Confirm that the individual has a sufficient support infrastructure to cover these contingencies, and whether they have colleagues who can be appointed in their place should the need arise. Selecting a director from a director services company carries distinct advantages in such situations.

Furthermore, confirm how long the organisation has been in business, its reputation, whether it is licensed and regulated in relation to the services it provides, carries sufficient insurance, and is appropriately capitalised.

Conclusion

Any thorough ‘interview’ will end with the question of references.  You are half-way there if a reputable investor, lawyer, or other professional has recommended the candidate.  It would also be prudent to receive some positive feedback from clients who utilise the candidate’s services or serve on a board with the individual.  Ask for a couple of references.

Looking for an independent director does not have to be an arduous, time-consuming process; however, the decision should not be taken lightly. Remember, the directors are accountable for leading and directing the fund’s affairs. Effective corporate governance is imperative, and some of the issues, scenarios and outright collapses in recent news should highlight this point. As regulators and investors continuously increase their focus on corporate governance, the requirement for the appointment of experienced and qualified independent directors is essential. The days of directors with inherent conflicts of interest or passive (nominee) directors are over. It is an important decision, so take your time, be thorough and remember to Ask!  

Geoff Ruddick is part of the senior management team and heads up client and business development for the fund services division of International Management Services Ltd (IMS), a firm that specialises in fund governance and fiduciary services. Geoff serves as an independent director to investment funds and has extensive knowledge of the commercial side of fund management as well as with compliance, corporate recovery, and audit.   

Further reading


Download the special report US Hedge Fund & Private Equity Services 2013
Download the special report Cayman Islands Hedge Fund Services 2014


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