With regulatory and compliance requirements on Cayman ever more stringent and the regulator now issuing fines, a diligent and experienced independent director can now be critical. Geoff Ruddick, partner at Paradigm Governance Partners, lists 11 things you should always ask during the selection process that will separate the wheat from the chaff.
One of the first considerations when looking for an independent director is the underlying reason behind your search. Given some of the spectacular hedge fund and corporate collapses in years gone by you may be seeking an extra layer of corporate governance and reassurance.
But equally, in today’s environment, corporate governance is no longer a luxury, but a necessity, and often a requirement. Regulators and exchanges are increasing their scrutiny and investors are demanding it—so should you.
On top of that, a raft of new requirements around regulations and compliance mean that keeping track with filing dates and various deadlines can be a tricky task in itself. And with CIMA, the regulator, wielding the power to impose fines for a variety of indiscretions including missed deadlines, a diligent and experienced independent director can help save both money and reputation.
Another reason for using a good independent director is tax-related. 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 company is exercised, is clearly offshore.
Regardless of the reason, the question remains: how do you go about the selection process and determine who is the right person for the job?
In terms of building shortlists, your legal counsel and administrator are a good starting point and will have a shortlist of individuals they recommend. Once you have their recommendations, you should make additional inquiries to find the individual who is right for the fund. Investigate your options and don’t limit your search to the first name on the list. 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 and corresponding interview. 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.
To help avoid such scenarios and ensure you always get the right person for the job, below are a list of questions, we suggest you ask – always. Some of them may make the candidate uncomfortable but asking these will go a long way towards helping make the right decision.
Are they truly independent?
Is the prospective director independent of the investment manager, administrator, legal counsel and all other service providers? Check. Grill them on this if needed. It should be a key prequalification for the role.
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.
Consider the nuance of split boards
The subject of ‘split boards’—engaging independent directors from different fiduciary firms—continues to be a topic of debate when considering board composition. It is certainly worth considering this one carefully – in principle, engaging independent directors from different firms looks like a good thing.
But the reality can be a lot more nuanced than this. While there is certainly an argument that it can be a positive, it is also an overly simplistic definition and assessment of how to recruit and construct an effective and diverse board. In some respects, there is merit and in other respects it is simply a sales pitch.
How experienced are they – really?
Spend some time during the process checking and asking if the individual has relevant industry experience and, importantly, experience with the fund’s strategy specifically.
You will get a good idea of their experience from their biography or CV but dig deeper by looking on their LinkedIn profile or simply doing a Google search. You will also want to ask if they have sat 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.
What qualifications do they have?
Don’t assume ask – and ask for certification. You need to be certain that the individual has relevant professional qualifications – so ask and ask again.
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.
Capacity – do they really have the time?
Make sure you ask this: how many boards does the director currently sit on and how many manager relationships do they service?
Everyone wants to know the magic number. Unfortunately, there is no definitive number as every relationship will be different and have its own nuances and complexities. If you receive a vague response or, worse yet, they just don’t know the answer, it will be an indication of the level of responsiveness you can expect to receive from them. Directors should know exactly how many relationships and corresponding fund boards they serve on at any given time. You need to be able to assess if they will be able to devote enough time to fulfil their duties.
A related question is whether the director has the ability to remain in direct contact with the affairs of the fund from formation onwards. Each director must personally be aware of the fund’s affairs, and having an adequate support infrastructure to gather information can facilitate this. Confirm with the candidate how they, or their company, are structured and operate in this regard.
What is their backup plan if incapacitated?
Another potentially critical point is whether the individual works for a director services company or if they are a stand-alone operation.
Although most consideration should be given to the capabilities of the prospective director, there may be times when the actual person you have selected may not be available. People take vacations, encounter emergencies, come and go from an organisation or jurisdiction, and start-up businesses often fail.
Confirm whether your director has a support organisation of long standing, with sufficient support infrastructure to cover these contingencies, and if they have colleagues who can be appointed in their place should the need arise. Selecting your director from a director services company can carry distinct advantages in such situations.
Factors to consider when selecting a director services company are: how long it has been in business, its reputation, whether it is licensed and regulated in relation to the fund services it provides, is it sufficiently capitalised, and can the company supply more than one director if required.
Last, but not least—‘what if’? Those of us who live and work in the Cayman Islands, or other disaster-prone geographies, know that ‘what ifs’ do happen. Hurricanes constantly remind us all of the importance of disaster recovery plans. Ascertain whether a director, or directorship services company, has a formal and documented disaster recovery plan in place. Confirm if it has ever been put to the test and whether it was a success. The reality is that ‘what ifs’ do happen, and it is critical to know that a director will be able to continue to serve the fund.
Do they have regulatory approval?
Has the individual, or entity by which they are employed, been approved or refused by a regulatory body?
An individual, or entity, who is approved and subject to a regulatory body’s ongoing scrutiny can offer the reassurance and credibility that they are not only fit and proper, but also familiar with the jurisdiction’s legal and regulatory regime.
Any other skeletons in the closet?
Don’t be shy – it is better to ask now than find out when it is too late. 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 do happen. By itself, it does not mean that a director implicated is incapable or guilty of any wrongdoing. The question is whether it is in the fund’s best interests to be associated with any potential headline risk and corresponding reputational risk.
Confirm if the candidate has ever been censured, disciplined or criticised by any professional bodies. If so, ascertain the underlying reasons and confirm whether there was a satisfactory resolution.
Are they insured?
Another one that is easy to overlook but so important if things go wrong. Does the director require the fund to hold directors’ and officers’ liability insurance or does the director carry adequate insurance?
Directors’ and officers’ liability insurance is becoming increasingly necessary given today’s litigious environment. Depending on the individual candidate and the specifics of the fund, some directors will require insurance to be provided by the fund. Others will maintain their own policy or have one provided by their company. Still, some will ‘roll the dice’ and not have coverage at all. Confirmation that insurance coverage is maintained will provide an indication of the financial standing of the individual and organisation, as well as provide comfort that they have an understanding of the litigation risks prevalent in today’s environment.
How much will they charge?
Now that the right individual has been found they must be compensated fairly. Remember, the directors oversee the affairs of the fund, and time and effort is required to effectively fulfil their duties. Directors have personal liability, and the penalties associated with a failure in fulfilling their duties will far exceed the fees received from their post.
The remuneration of a director needs to be sufficient to attract and equitably compensate high-quality individuals. Remuneration may comprise an annual fee and compensation for time spent, or it may be a fixed annual charge. Out-of-pocket expenses will also be incurred, which may include standard administrative expenses in addition to travel, lodging and other expenses properly incurred attending meetings or in connection with the business of the fund. Whatever the arrangement, be sure to compensate directors fairly. As the saying goes, “you get what you pay for”.
References—get them prior to offer
Who will vouch for them? Any thorough ‘interview’ will end with the question of references. You are halfway there if your lawyer or administrator has put in a good word for the candidate. It would, however, be prudent to receive some positive feedback from clients who utilise the candidate’s services or who serve on the board with the individual. Ask for a couple of references and follow through with these.