Historically, independent directors of offshore hedge funds and managers were often appointed with the sole intention of fulfilling a limited but important function in relation to UK tax planning - to maintain the offshore tax status of the fund and its manager. The calibre and experience of the directors was often of limited concern. The annual cost usually was. However, recent hedge fund litigation, the issue of SEC guidelines on independent directors for US mutual funds, the recent UK Inland Revenue initiatives and corporate scandals in Houston and Parma have led to a new focus on the issue of corporate governance.
A fund director's role in a well structured fund is usually to (1) keep the business and performance of the fund under review, and (2) deal with issues that fall outside the fund's operating guidelines. For example, approving special arrangements with key investors relating to liquidity and fees or approving variations to investment strategies and restrictions, and reviewing the performance of service providers.
To discharge their obligations properly, directors should understand the fund's investment strategies, for example, how frequently it trades, the risk profile of the margin, and the nature of the underlying investments, including their risk profile and liquidity. Directors should also be aware of the logistical issues facing the fund's administrator in dealing with subscriptions and redemptions and calculating net asset value, and be familiar with the laws and regulations affecting the fund.
Cayman law imposes the English law standard of care, diligence and skill by a director in the performance of his duties. It also follows English law in imposing the fiduciary duties upon directors: a duty to act honestly and in good faith in the interests of the company; a duty to act for a proper purpose; a duty not to fetter their discretion and a duty not to put themselves in a position where there is a conflict between their duty to the company and their personal interests or duties to others. These duties are owed to the company and not to any individual shareholder or service provider.
The possibility of a conflict of interest for directors often arises because in practice they owe their appointment to the promoter (usually the investment manager) of a fund. An individual may also serve as a director for a number of other funds promoted by the same manager, or may be an employee of the fund's administrator.
One way of dealing with potential conflicts of interest is to include a full disclosure in the offering documents. However, disclosure will not assist in avoiding conflicts of interests that may subsequently arise and are different from those envisaged in the original disclosure.
It is in the interests of all parties involved with a fund for it to have independent directors on its board with the appropriate skills and experience to manage these issues when they arise. Such directors provide comfort to the investors and service providers of the fund, integrity to the fund's structure and reduce the risk of mismanagement and consequent litigation. Without that integrity, the director may incur personal liability and the tax structuring may fail.