In April, a judge in the Cayman Islands ordered the liquidation of a hedge fund managed by Fletcher Asset Management at the behest of three Louisiana pension funds seeking to withdraw their investments. The petition from Louisiana Firefighters' Retirement System, Municipal Employees' Retirement System of Louisiana and the New Orleans Firefighters' Pension and Relief Fund claimed that Fletcher had not filed audited financial statements since 2008, and that it appeared to have no directors on its board between Nov. 21, 2011, and Jan. 24, 2012. Such a situation is disturbing for investors — and deeply troubling as well to the many industry participants striving for integrity, transparency and the highest standards of fund governance.
As a former regulator of the Cayman Islands Monetary Authority and the architect of its regulatory oversight of hedge funds, I hope this recent decision acts as a galvanizing force for all hedge fund managers and investors in offshore funds to demand professional, regulated fund governance services.
The hedge fund industry is growing up fast. The Securities and Exchange Commission is implementing key regulatory overhauls for hedge funds, even as investors are refining their due diligence processes and expectations. As we complete our transformation into an institutional community, industry leaders must advocate for best practices and encourage industrywide acceptance of the new realities of a global marketplace.
Fund governance touches every aspect of a hedge fund's operations — valuation, custody, expenses, conflicts of interest and style drift — and has rightfully become an object of rigorous scrutiny by industry regulators. A consensus is finally emerging that existing fund governance standards have become inadequate because of obsolete metrics and other factors. Effective fund governance provides a system of checks and balances to support the four pillars of investor protection promulgated by the SEC: guarantees that investments are managed in accordance with the fund's investment objectives; insurance that investors' assets will be kept safe; security that when investors redeem they will get their pro-rata share of the fund's assets; and credible assurances that the fund will be managed for the benefit of investors, not the fund's service providers.
A professional fund governance model is vastly more productive than the amateur model. Well-regulated, institutional fund governance programs instill more confidence in the industry, which in turn promotes robust but intelligent growth. Such governance models should always include appropriate evaluation systems, net capital requirements, D&O insurance, whistle-blowing reporting and annual audit requirements. In addition, these models must support the SEC's recommendation to hire staff with the appropriate skills to assist independent directors in fulfilling their fiduciary responsibilities.
Finally, we must remain aware that what regulators, investors and stakeholders define as appropriate standards today will not necessarily be effective tomorrow. The call to innovate and refine outmoded standards must be seized on as an opportunity to further excel — rather than as an obstacle to “getting the deal done.” To all those who are reluctant to set sail for the “new world” of fund governance standards, it's worth bearing in mind that an amateur, unregulated environment is a thing of the past. Let's work together to turn apprehensions about the future regulatory climate into a renewed commitment to sustainable industry growth.
Don Seymour is the founder of DMS Offshore Investment Services and a former head and director of the Cayman Islands Monetary Authority.