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Selecting independent hedge fund directors

In today’s environment, corporate governance is no longer a luxury but a necessity, and often a requirement.

In today’s environment, corporate governance is no longer a luxury but a necessity, and often a requirement. As regulators and investors increase their focus on corporate governance, the requirement for an independent director is more essential. A qualified and experienced independent director will assist in meeting the underlying requirements, but how do you go about the selection process and determine who is the right person for the job?

Independence is the holy grail of effective corporate governance. The interests of the fund may differ from those of its service providers, putting a director provided by, say, the fund’s administrator in a position in which they have a conflict of interest whether at establishment, during ongoing operations, or in the case of extreme events.

As has recently transpired, the valuation and liquidity of certain securities can be difficult or even impossible to determine, and the resulting effects have created situations in which an independent director’s involvement has been critical. An independent director can assist in making an unbiased determination in the best interests of the fund, its investors, and creditors during these times.

Suitable directors should be experienced – they need not be experts, but should have relevant industry experience and a reasonable understanding of the fund’s strategy. They should also be qualified; a designation such as an accounting, compliance, investment or legal qualification will provide an indication of where their expertise lies and how they will add value.

Equal importance should be placed on enquiring about how many boards the director currently sits on, and how many manager relationships they service. The question of capacity is imperative to ensure that a director will be able to devote enough time to fulfil their duties. Consideration should also be given as to whether a director will require the fund to hold directors’ and officers’ liability insurance or whether the director carries adequate insurance individually.

Ask if the individual, or the entity by which they are employed, have been approved or refused by a regulatory body. Similarly, enquire whether there are any investigations, charges or convictions. Adverse events such as fund blow-ups or fraud can generate negative publicity, so confirm whether there is any potential headline risk and corresponding reputational risk.

And, of course, the questions of references and remuneration should not be overlooked. Directors have personal liability, they are responsible for overseeing the affairs of the fund, and, as such, they should have reputable references and should be compensated fairly – as the saying goes, ‘you get what you pay for’.

Looking for an independent director should not be an arduous process, but the decision should not be taken lightly. The objective is to find a competent individual with a commercial mindset, who will be responsive to the fund’s affairs. A reasonable degree of due diligence should be conducted to find an independent director who holds the knowledge, skills, qualifications, experience and time to make a positive contribution to the board.

Remember, the directors are collectively responsible for the success of the fund by leading and directing its affairs. Effective corporate governance is imperative, and some of the recent problems and outright collapses experienced by funds recently highlight this point. The days of directors with inherent conflicts of interest and of passive (nominee) directors are effectively over.

Geoff Ruddick is a senior company manager with International Management Services

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