Wednesday, 29 March 2017
Last updated 57 min ago
Feb 24 2017 | 8:59pm ET
By Lawrence Delevingne (Reuters) - Criminal charges against top executives of Platinum Partners for running the $1.4 billion hedge fund firm “like a Ponzi scheme” have revived an old question for investors: Where was the board?
The literal answer is the Cayman Islands. As is common in the hedge fund world, New York-based Platinum drew five of its six independent directors from firms in the tax-friendly British overseas territory nestled in the Caribbean to comply with a local requirement for external oversight.
What is less clear is whether those directors could have prevented Platinum’s decline.
Donald Seymour and David Bree of Cayman-based DMS Governance were directors for Platinum’s troubled Value Arbitrage Fund. They are among the most prominent practitioners of what critics call the “jumbo” model – where professional directors sometimes sit on hundreds of boards at once.
After U.S. authorities arrested Platinum executives in December and charged them with running a $1 billion fraud scheme, some investors asked DMS founder Seymour what happened, people familiar with the situation told Reuters.
In response, Seymour sent a mass email to investors and consultants in January saying the firm was “very proud” of its Platinum work, according to a copy seen by Reuters. He said DMS was not the subject of any related litigation or government investigations and had in fact helped the U.S. Securities and Exchange Commission (SEC) in its probe of Platinum.
Spokesmen for the SEC and Platinum, whose executives pleaded not guilty, declined to comment.
Still, some hedge fund investors who spoke to Reuters in recent weeks remain wary of directors serving too many clients.
“As a director serves more and more funds it's no longer about governance and quality," said Jacob Walthour, chief executive of Blueprint Capital Advisors. "It is about scaling their business and revenues and not about protecting investor interest.”
Independent directors usually meet at least twice a year with hedge fund personnel and service providers to review operations. While they have the mandate to ask hard questions, they still face serious constraints.
For one thing, they often oversee feeder funds, which ultimately invest assets into a master fund that is responsible for making portfolio investments and trading. That gives them limited insight and little power to effect change because master fund managers can simply ignore their suggestions.
Hedge funds are not always candid about those constraints.
Platinum, for example, said in marketing materials that directors signed off on an annual certification of compliance, part of its commitment to “secure third-party controls” and “the highest legal and ethical standards in the industry.”
Prosecutors say the reality at Platinum was far different. DMS directors worked for feeder funds and were not aware of all Platinum is accused of doing, including illegally transferring money between funds, dramatically over-valuing assets and cashing out some investors ahead of others, according to a person familiar with the situation.
DMS did push Platinum to provide more information and questioned some of its decisions, such as changing its auditor, the person said. When Platinum did not comply, DMS resigned and reported the firm to the Cayman Islands Monetary Authority, which in turn contacted the SEC, all months before any charges.
A similar scenario played out with three directors from Cayman-based HF Fund Services, another firm that provides independent directors for hedge funds and other financial companies. The men, Brian Burkholder, Patrick Harrigan and Richard Coles, worked for feeder funds of Platinum’s Credit Opportunities Master Fund, which is expected to recover much of its assets.
The trio resigned last summer after a longtime Platinum associate was arrested in connection with a political bribery scandal, a person familiar with the matter said, but they had no knowledge of Platinum’s alleged fraud.
HF Fund Services, whose directors work with about 30 clients each, said in an emailed statement that it had no relationship with Platinum’s now-bankrupt Value Arbitrage Fund. The issues of control between feeder and master funds amount to a “governance gap” and should be addressed through alternative structures, HF said.
"When shopping for directors, it's still buyer beware," said Greg Robbins, chief operating officer for Mesirow Advanced Strategies, which helps institutions invest in hedge funds. "Don’t simply assume you’ll get strong shareholder advocacy."
Defenders of firms like DMS compare the model to being an experienced doctor at a major hospital with a large roster of patients. They also argue that a director can sit on many boards of small, simple funds and do as much work as another who sits on one board of a big, complex client.
“Obviously no one likes to see a fraud,” said Ronan Guilfoyle, who co-founded Cayman-based director boutique Calderwood in 2016 after a decade at DMS. “But there’s still great value for many funds in working with experienced directors like DMS who serve many clients at once.”
Although DMS faces fresh competition, it remains a dominant force in the independent director business.
The 225-person firm says it works with about 900 fund managers, representing more than $330 billion in assets and 60 percent of the world’s top hedge funds. It charges about $10,000 a year for each master-feeder fund pair, roughly one-third of what others cost.
The number of funds its directors work with is secret, but clients have included prominent firms Bridgewater Associates, Elliott Management Corp, Apollo Global Management's credit investing unit, and JANA Partners, according to SEC filings. Asked to comment, representatives of those firms either declined or did not respond.
Seymour at DMS now works with about 90 firms and hundreds of their funds, a person familiar with the situation said.
By comparison, the vast majority of U.S. mutual fund directors work with just one company, according to the Mutual Fund Directors Forum. Corporate directors serve on an average of 1.5 company boards at once, according to the National Association of Corporate Directors.
The so-called jumbo model came under scrutiny following the 2008 financial crisis, when investors in troubled funds questioned whether the directors they paid for truly worked on their behalf.
Cayman authorities issued a non-binding “statement of guidance” in 2013 for its more than 10,000 funds, and required directors to register in a private database.
But it remains difficult to hold Cayman directors responsible for hedge fund collapses. Indemnity clauses in their contracts usually require investors to prove they acted with “gross negligence."
“There’s a very high hurdle to get damages from directors,” said Jeremy Walton, a Cayman-based partner with law firm Appleby who heads its fund disputes team.