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This second issue in the series of Hedge Fund Governance Briefings focuses on the role of hedge fund directors.
According to research conducted by Carne in 20111, 87% of allocators to hedge funds would like to see the majority of hedge fund boards' membership held by independent directors. The difficult task that faces many hedge fund sponsors is finding the right people to sit on a hedge fund board and being clear about what is expected of them, not just as individuals but also acting collectively as an effective board of directors.
Director Role and Responsibilities
Director responsibilities are typically defined by a combination of common law, statute, regulatory provision, precedent and a hedge fund's constitutive documents. Common law provides a good framework to outline director fiduciary responsibilities and duty to act with due care and skill.
Director fiduciary responsibilities:
- to exercise powers independently, acting in good faith in what the director believes to be in the best interests of the fund
- to exercise powers in the fund's interests and only for the purpose that the powers were given
- not to misuse company property
- not to act in such a way as to create a conflict between the director's duty to the company and his or her personal interests
- not to restrain or restrict directors' future discretion
Director duty of due care and skill:
- to be attentive to the affairs of the fund
- to obtain and retain sufficient information about the affairs of the fund to enable proper discharge of their responsibilities
- not to act in a manner that conflicts with the interests of the fund
Independence and Acting Independently
It is clear from the Carne research mentioned above that investors expect a majority of hedge fund directors to be independent. For directors that are not independent, there remains the dilemma of continually being vigilant to identify and deal with any conflicts that may arise. So what is an independent director?
A director will be considered to be independent if he or she does not have any commercial, economic or personal links with any of the parties, or personnel connected with those parties, with whom the hedge fund enters into a material contract.
Independent directors must also act independently. They are required to exercise whatever skill they possess with reasonable care and whilst they are entitled to rely upon fellow directors, they do have to apply their minds to what they are doing and not merely rely on the explanations of others.
Director Skills and Experience
In the Carne research study conducted in 2011, it was reported that 70% of hedge fund allocators expected a senior member from the investment advisor to be on the board. Whilst that person is not independent—since the hedge fund contracts with and pays fees to the investment advisor—that director brings to the board important information regarding the hedge fund's portfolio and the operational activities within the investment advisor's business.
Hedge fund directors do not have to be experts in every field. It is therefore best practice to ensure that the board of a hedge fund is comprised of directors with relevant and complementary skills, knowledge, expertise and experience.
A hedge fund board should ideally comprise a minimum of three directors. In addition to a senior member from the investment advisor, the other directors should possess skills gained from working in a relevant field, such as legal, regulatory, administration, audit or accountancy. Directors should have gained sufficient time and experience to obtain the substantial amount of knowledge that is required of the role and their activities should be performed in a professional and business-like manner.
Hedge fund directors should ensure that they have sufficient time and capacity to properly discharge their fiduciary responsibilities and to perform their duty of due care and skill. Accordingly, in the selection and appointment process for hedge fund directors, consideration should be given to what other commitments each director has, and whether those commitments are personal or professional. The basic math is as follows: out of 365 days in each year, after weekends, public holidays and vacation, there are approximately 230 working days per annum. If a hedge fund board is meeting on a quarterly basis and directors are travelling to attend meetings once a year or more, there are only a limited number of appointments a director can accommodate. There will be further commentary on this point in Issue 3: Board Meetings. Those responsible for putting together a hedge fund board of directors should take this into account and make appropriate enquiries of potential director appointees.
Hedge fund directors act in a non-executive capacity. This means that they do not perform the day-to-day operations of the fund, but they are obliged to inform themselves about such activities and ensure that there is an effective system whereby the board can perform a management oversight role. The directors are responsible for the performance of service providers, since these parties are acting under delegated authority from directors. Therefore, it is incumbent upon directors to monitor, supervise, and ensure that delegates are acting in compliance with their appointment, the hedge fund's offering memorandum and the constitutive documents.
1. Corporate Governance In Hedge Funds: Investor Survey 2011 (Carne Global Financial Services)
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.