Independent directors and the capacity conundrum
The capacity conundrum continues to be one of debate and it has become increasingly apparent that it is not solved simply by the provision of an arbitrary headline number or cap. Geoff Ruddick (pictured) takes a look at the key things to consider when assessing the capacity of an independent director…
There has been an extraordinary focus on ‘numbers’ and ‘caps’ in the last few years in reference to a director’s ‘capacity’ to fulfill his or her fiduciary duties. In many respects, an arbitrary number or cap has become analogous, and arguably in some cases the sole identifying factor, of determining the capacity of a director. It is a controversial topic area and all industry stakeholders have become involved in the debate and have weighed in with their respective opinions - including investors, managers, directors, other service providers, and even more recently CIMA, Cayman’s regulator. Ultimately, the conundrum as to what the right or absolute number should be remains unsolved.
With that said, the numbers and caps fever as the sole focal point in assessing capacity is fading as stakeholders recognize and acknowledge that numbers are only one small part of the overall capacity equation. Numbers of directorships will provide some insight, but it is only one of the many important questions to ask a director when assessing their capacity to fulfill their fiduciary duties and provide effective oversight in order to protect underlying stakeholders’ interests.
With the above in mind what should you be asking when addressing the capacity conundrum?
How many client relationships do they have, how many entities do they serve on, etc?
Numbers are unquestionably relevant and therefore it is an important question to ask, however, if it is the only query raised in assessing a director’s capacity it will be of limited value. In fact, numbers in isolation, without context or completeness, can be incredibly misleading. As the objective of the numbers query is to obtain some perspective of what oversight responsibilities the respective director ultimately maintains, in order to assist in assessing their capacity, be thoughtful and keep this objective in mind when posing the question. CIMA’s proposed database initiative to disclose the number of Cayman registered funds associated with each director will provide some transparency, however, it will by its very nature be limited in scope in assessing a director’s appointments/numbers as it will only be applicable to CIMA registered funds (i.e. Cayman domiciled and registered funds). It is therefore important to ask yourself, and in turn the director, whether it be the number of client relationships, registered or total appointments, segregated portfolios & underlying cells, advisory committees, control boards, corporate appointments, trusteeships, trust oversight, etc. that you are trying to confirm and interpret.
Everyone wants to know, what is the magic number?
Unfortunately, there is no definitive number as every relationship and appointment will be different and have its own nuances and complexities. Some parties continue to focus on numbers and caps as the critical component in assessing capacity while others see them mainly as marketing pitches for those targeting only large fund groups or where the individual or director services provider is in the infancy stages of growing their client base. Some are adamant that hard caps are the key to controlling capacity and that the regulator should decide upon and enforce a hard cap. Others note that hard caps can arguably work against the principles of good corporate governance as some individuals once reaching a hard cap resign from their lowest fee-paying or profile client in order to take on the next higher-paying or profile client thus providing limited continuity on a board simply to adhere to an arbitrary number. Others simply break through the hard cap and move towards a soft cap instead after re-assessing the composition of their portfolio. Capacity constraints are critically important, however, do not simply equate to an arbitrary number or absolute cap.
So what else to you need do consider in ascertaining the capacity of a director?
Simply put, capacity is a function of ‘time’ and ‘ability’. It’s therefore imperative to determine whether the individual has the time and ability to apply their mind in order to discharge their duties.
Everyone asks the numbers question, however, rarely do they ask what those numbers represent. You need to know. It is important to ask what the composition of the individual’s portfolio consists of. Ask what types of strategies, structures, AUM, underlying investor bases, etc., these numbers represent. Are they stand-alone, single investor, internal capital only funds with a simple long-short equity strategy investing only in listed and liquid companies? Or are they a large global group with multiple funds, underlying SPV’s, focusing on complex credit or distressed situations, whereby the majority of investors are external all with differing interests and side letters? As one will appreciate the scenarios are endless and no two will be identical. This is a time consuming process in itself but spending the time is necessary to truly be able to assess the capacity of a director.
Their Role as a fiduciary
For some individuals serving as an independent director is a secondary career, for others only part of their role, some are full time fund directors with a director services provider and some are standalone operating from the comfort of their home. Get to know them and assess the stage of their career and role within their company as to whether they have an active management role in addition to their fiduciary role. Ask them where they spend their time and give you a break-down of their average day or week. Some people work thirty hour weeks and others work a steady sixty. Ask if they are on the conference circuit, marketing, writing articles, the frequency and geography of their travels, other outside interests and commitments, etc. You get the point, but your focus should be ‘time & ability’. Consider whether they have any excess capacity for those peak periods or times of stress based on their response. You need to be able to assess if they will be able to devote enough time to fulfil their duties and ultimately provide oversight in the best interests of the fund and its stakeholders. Perhaps the most important question of all is to ask the individual how they personally view their role as a fiduciary. The corresponding response will be very telling and provide great insight into how seriously an individual takes their responsibilities as a director.
Model, Support Infrastructure, Back-Up & Coverage
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, certain administrative or routine tasks can be appropriately delegated provided the director still ultimately retains oversight. Effective delegation of such tasks can free up time and increase a director’s capacity to address material issues. For instance, functions requiring judgment and an intimate knowledge of the funds affairs best remain with the director to perform. Enquire about their take-on and ongoing monitoring processes and whether there are any checks and balances in place. Ask for an overview of their support infrastructure and gain an understanding of what work they carry out directly versus delegating to support staff. Determine their support staff to director leverage ratio, number of layers of staff, and whether it is the director themselves that is the main point of contact.
Charges / Convictions / Investigations / Litigation / Claims.
Has the individual ever been charged or convicted of an offence or are they currently under investigation? Pick your choice of words, but this question needs to be asked. Adverse events such as fund blow-ups or fraud that generate negative publicity and ultimately lead to litigation do happen. By itself, it does not mean that a director named in an investigation or suit is incapable or guilty of any wrongdoing. In fact, as the common expression goes, ‘what doesn’t kill you makes you stronger’, and valuable experience can often be gained. The question, however, in relation to capacity is whether it is an ongoing issue as such matters can take up an immense amount of ‘time’.
If a director is not independent of the investment manager, administrator, legal counsel and all other service providers, conflicts of interest will inevitably arise and interfere with the director’s ability and capacity to act in the best interests of the fund. Managing conflicts can take up ‘time’ and therefore this should be a consideration.
Experience & Qualifications
These are important attributes to ensure the individual has the ‘ability’ to provide effective corporate governance. Ask how long they’ve been serving on boards and what experience and qualifications they have. A lot has transpired in the last few years. Ask them what they’ve seen and been through as this will help determine whether they will have the capacity to deal with difficult situations.
It is now being recognised that while numbers will provide some insight into a director’s capacity, it is only one of the many important questions to ask as numbers, like all statistics, in isolation can be misleading. The capacity conundrum is now being addressed whereby the primary focus is on a director’s ‘time’ and ‘ability’ to apply his or her mind to issues at hand. Queries now go beyond numbers and include the composition of the clients the director serves; their role within their company; what other responsibilities they have beyond serving in a personal capacity on fund boards; their company’s model, support infrastructure, back-up and coverage; and their capacity constraints. Other matters considered include whether the director has excess capacity for times of stress; independence; experience; qualifications; and perhaps most importantly determining how they personally view their role as a fiduciary. It is clearly evident that numbers and caps will continue to be a topical issue for the foreseeable future. Remember, the next time you are assessing a director’s ‘capacity’, go beyond the ‘numbers’ question and dig not a little, but a lot, deeper.