Are Independent Fund Directors An Unnecessary Evil?

Apr 21 2014 | 1:24pm ET

By Alric Lindsay
Managing Director, Lindsay Fiduciary Services

Having served as an independent director on the boards of offshore investment funds for many years, I have come across the viewpoint held by some parties that independent directors are not really necessary. The rational for this position is that the investment manager does all of the groundwork. This leaves all of the fund’s directors, including any independent directors, with bystander or spectator roles.
 
In order to understand the basis for this notion, take a closer look at the activities of the investment manager of a typical stand-alone Cayman Islands corporate fund. The investment manager secures the seed money, establishes an initial track record for the offshore investment fund and sacrifices time and money to locate new investors to bolster the offshore investment fund’s assets under management. In addition, the investment manager carries out the day-to-day investments on behalf of the investment fund. Investors receive monthly reports. Once everyone is happy with their returns, there would be no need to look into the activities of the investment manager because a board of directors selected by the investment manager would ratify (without question) all of the actions of the investment manager.

Such a “no questions asked” model, however, leaves investors in a precarious state. In fact, the dangers have been underlined in several cases, including the Madoff scandal. Investors in an offshore investment fund would therefore query:

  •  the lack of independent verification of the existence of investments;
  • the degree of compliance by the investment manager with the offshore investment fund’s investment policy; and
  • the accuracy of asset valuations and legitimacy of non-independent, unchecked valuations

A flaw or misleading statement in any one of these areas could lead to massive investment losses. Therefore, it is important that an independent person sit on the board of directors of an offshore investment fund – one who has more than a perfunctory role and who can mitigate the risks associated with a “no questions asked” model. 

Jurisdictional Requirements

As a jurisdiction, the Cayman Islands do not require the appointment of an independent person to serve on the boards of Cayman Islands based corporate investment funds. Notwithstanding this, the “no questions asked” model makes evident that the appointment of independent directors to the boards of directors of offshore funds in a real role is necessary for the protection of offshore fund investors.

Best Practices

It is easy to argue away the need for independent directors; the expenses of the fund increase and some decision making may be delayed due to the time spent by independent directors to scrutinize certain fund transactions. However, without the checks and balances brought to the table by independent directors, ‎the risks of fraud and of being lured into a Ponzi scheme are staggering.

As a best practice therefore, initial seed investors and new investors should demand that one or more independent persons be appointed to the board of directors of an offshore investment fund. However, these independent persons must be "real" directors and not persons with a simple mechanical or unthinking role.

Alric Lindsay is an independent director to Cayman Islands based investment funds. He is approved and regulated by the Cayman Islands Monetary Authority. He can be contacted at alric@lindsay.ky


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