Cayman directors: 'next big scandal' for hedge funds - FT

The Financial Times has an important article looking at a subject we have written about many times in the past.

A small group of Cayman Islands “jumbo directors” are sitting on the boards of hundreds of hedge funds.

A Financial Times investigation reveals that at least four individuals hold more than 100 non-executive directorships each, and 14 have more than 70 – each worth as much as $30,000 a year. One has been listed as on the boards of 567 Cayman entities, almost all of which are hedge funds.

How on earth can such people exercise judgement and oversight when they look after so many companies?

This is indeed a scandal from top to bottom - and reflects the deep corruption at the heart of the laissez-faire 'who cares how this affects countries elsewhere' model of Cayman and many other jurisdictions where this happens. The FT continues:

"It is the “Walmart model” of governance, said Kevin Ryan, former head of hedge fund research for ABN Amro, and will be the next big scandal to hit the industry. “We have specialist directorship firms building obscenely large portfolios of directorships without even earning a rebuke from the Cayman’s regulator.” The numbers will invite comparisons to the US mutual fund scandal last decade and the UK’s “Sark lark” in the late 1990s, where individuals were criticised for taking dozens of appointments.

More detail is provided in a perceptive 2009 speech by Tim Ridley, a well known Cayman operator, foreseeing just the sort of article the FT has just written:

"The individual employee who serves as a director will be paid a salary (and bonus perhaps) by the service provider for whom he or she works. The directors’ fees will typically not go to the director but to the service provider.
. . .
the service provider is typically not liable for the acts or defaults of the employee as a director of a client company. Good for the service company and its owners; not so good for the client or even the employee. Little wonder that the offshore director is looked upon with derision as a man of straw by outsiders (and maybe by insiders too). As an employee, he is unlikely to have significant assets so there is no point in suing him for breach of duty, negligence etc. And the service company that put him forward and collected the fees cannot be successfully sued under the Paget Brown principle. In the context of the offshore financial business, this has many scratching their heads."

The whole speech is well worth reading, and contains several other warnings, e.g.There are also questions of conflicts of interest that may seem academic at the outset, yet which are anything but when things go wrong. A good example is where a law firm acts as legal counsel to a fund and the service company owned by that same law firm provides the directors of the fund. These directors then approve the various agreements and transactions on behalf of the fund. The directors can scarcely be considered truly independent (if that is one of the reasons for their appointment). And taking waivers from all and sundry at the outset when all appears rosy, is a fig leaf and no proper solution. If the deal falls apart and/or questions are raised about the legal advice or the transactions, it will quickly become apparent why the model is flawed. The law firm may well head for the hills, ironically now pleading conflicts of interest and suggesting new legal counsel be retained by all parties and possibly that new directors be appointed. The directors under fire will also likely have to retain their own legal counsel. Pontius Pilate could hardly have done better. Well done the FT for doing the legwork on this one. And this is the tip of a larger iceberg. There are plenty of other examples, some perhaps nastier, from around the world, such as here. Treasure Islands, looking at nominee directors (and other company positions,) notes that Delaware Limited Liability Companies, for instance:

"might offer certified copies of the passports of that company’s directors. That looks reassuring, but even with genuine passport copies you are no closer to knowing who really owns the company or its assets. These directors are probably professional nominees who work for hundreds of such corporations. Typically a nominee director will route all queries via a company attorney who has contact with the real people – and when crime fighters come looking, the attorney will hide behind attorney–client privilege and claim they cannot reveal the information."

The comments underneath are interesting, ranging from the "who cares?" to the more thoughtful:

"I do not want to invest in a fund with an assembly line management structure. I do not currently have any funds so managed and from now on Cayman Islands is a red flag to me."

Well, that's good to hear. And there are a few other jurisdictions you might be interested in looking at.

More on this here.