role of a hedge fund director (intro)By: Alric Lindsay, Cayman Director, Cayman Counsel

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Summary www.cidirector.com DISCUSSION POINTS

Typical (Offshore) Hedge Fund Structure

Reasons for Cayman as a Domicile

Failure to Monitor/Supervise Delegates

Q & A

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(Offshore) Director’s Role Generally and Delegation of Responsibilities

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This chart illustrates a commonmaster-feeder structure.

As the chart shows, a US entity maybe set up to take in US taxableinvestors. A Cayman offshore fund isformed to take in Non-US investorsand US Tax Exempt Investors. Bothentities then invest in a Caymanmaster fund, which makes theactual investments for thestructure.

Typical (Offshore) Hedge Fund Structure Master-Feeder Structure

•US Domestic Feeder which accepts subscriptions from US taxable investors

•Typically, a Delaware entity is used for this purpose

Onshore Feeder

•Cayman Offshore feeder which accepts subscriptions from US tax exempt investors (usually, pension plans) and Non-US investors

Offshore Feeder

•Cayman Offshore master fund into which both feeders invest

Offshore Master

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• No Direct Income or Corporate Tax or Tax on Capital Gains or Other Income

• Stable Government and Close Ties To United Kingdom

• Proximity to North America and Other Financial Centres

• Available Pool of Professionals With Hedge Fund and Financial Services Experience

• Good Legal System Based On English Law

• Excellent Infrastructure

Reasons for Choosing Cayman(THE WORLD’S #1 DOMICILE)

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60%

otherother

other

Pre-Financial Crisis, Cayman wassaid to be the jurisdiction of choicefor a large percentage of hedgefunds

Reasons for Choosing Cayman (THE WORLD’S #1 DOMICILE)

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• Overall responsibility for fund lies with board of directors

• Board may delegate responsibilities to service providers below

• However, Board remains ultimately responsible for monitoring andsupervision of delegates

Director

• Board delegates calculation of fund’s NAV to administrator

• Administrator processes subscriptions, redemptions and transfers ofshares/units/interests in the fund

• Administrator may maintain the register of shareholders of the fund

Administrator

•Board delegates daily investment decision-making to the investment manager

•Manager may earn a management and/or performance fee

Investment Management Entity

•Other service providers include bankers, custodians, prime brokers

Other Service Providers

As a director cannot usually perform all

aspects of the hedge fund’s business

alone, for example, the completion of

accounting and fund administration,

auditing at year-end and daily trading and

decision-making, a director will cause the

hedge fund to enter into various contracts

with service providers. The terms of such

agreements will specify the responsibilities

that a director delegates to such service

providers, including administrators and

investment managers. Any person that is

appointed as director must be intimate

with the roles of these parties.

(Offshore) Director’s Role Generally

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• A Director Can Take a “Hands-Off” Approach: WRONG. THEBOARD MUST HOLD SUCH MEETINGS AS REQUIRED FOR THEPARTICULAR FUND AND ENSURE THAT THE ADMINISTRATOR,INVESTMENT ADVISER AND OTHER SERVICE PROVIDERSREPORT TO THE BOARD ON A PERIODIC BASIS

• Delegation Removes A Director’s Liability: WRONG.ULTIMATELY ACCOUNTABILITY AND RESPONSIBILITY LIESWITH THE BOARD. A DIRECTOR MAY BE FOUND LIABLE FORPROVEN BREACHES OF HIS DUTIES

(Offshore) Director’s Role Generally Delegation (continued): Common Misconceptions

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(Offshore) Director’s Role Generally Delegation (Continued): Proper Understanding of Functions

• Misconceptions held by funddirectors may lead to issues.

• In order to minimize theoccurrence of problems, a directormust ensure that he understandsthe terms of each agreement that afund enters into with a serviceprovider, including the specificresponsibilities that are beingdelegated. He must also ensurethat service providers are properlycarrying out their duties bymonitoring and supervision asdiscussed above.

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Example 1:

• Fund’s offering document states that the fundmay not invest more than 5% of the fund’sassets in real estate.

• Director fails to complete a timely review ofperiodic accounts or net asset value reportsissued by the investment manager oradministrator.

• Due to this omission, it goes unnoticed that50% of the fund’s assets are actually investedin real estate.

• Value of real estate investment falls to zero.Fund incurs significant losses of assets.

• A prudent director would have noticed thebreach of investment restrictions, drawn it tothe attention of the investment manager andensured that the manager corrected theposition.

Failure To Supervise DelegatesIssues that may arise www.cidirector.com

Example 2:

• Investment manager claims to be investing theassets of the fund, but over several fiscalperiods, he fails to invest any assets of thefund. Falsified statements are sent to investors,supporting the manager’s false claims

• Directors fail to do a periodic check with theindependent custodian of the fund’s assets todetermine if such investments actually exist.

• Fraud goes undetected and manager depletesthe fund’s entire assets

• A prudent director would complete a randomor periodic check with the fund’s custodian

• Waiting for this to be caught by the auditorsduring the annual audit of the fund is too lateto discover that the no investments exist andthat the entire structure was a ponzi scheme

Failure To Supervise DelegatesIssues that may arise

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Q: How Should A Director Manage Strategy “Drift” ? (investors are chasing increasing returns, manager feels pressure to produce alpha and goes outside the fund’s investment objective and strategy to achieve investor’s wishes)

Questions & Answers1

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• A: “Strategy Drift” may occur from time to time. Although it may seem that the manager is outside the investment objective & strategy (i) the offering document may contain a disclosure that it is not an exhaustive list of strategies and/or (ii) the manager may actually be acting within a discretion contained in the terms of the fund documentation. Therefore, a strategy drift may not be a drift at all.

• The fund’s director or lawyer must review the fund documentation to determine if the perceived departure from the strategy or discretion is an actual departure. Investors should be given anopportunity to redeem in cases of actual breach.

Questions & Answers1

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• Q: Are All Hedge Funds Required To Have Directors?

Questions & Answers2

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• A: Due to various hedge fund scandals and for other reasons, a need has arisen for independent parties in a hedge fund structure. Therefore, the need for an independent Cayman director on the boards of Cayman hedge funds. If there were no independent parties and board members were all representatives of the investment manager, then the manager would be left to do as he pleases (which may not be in line with the wishes of investors). Independent directors must therefore be appointed to act as watchdogs for investors. At least one director is required for a Cayman fund which is not registered with the regulator. A

registered fund requires two directors.

Questions & Answers2

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• Q: Do Directors Have Their Own Stake/Investment In The Fund Or Are They Completely Third Parties And Have No Ties To The Fund?

Questions & Answers3

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• A: By way of background, from a Cayman point of view, there is no legal requirement for a director to make any investment in a fund. However, where a director is also a representative of the investment manager, that director may decide to invest in the fund. In return, such director is typically issued shares with special terms (e.g. no performance fee or management fee is applicable to such shares)

Questions & Answers3

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• Q: It Is Understood That A Director Must Supervise All of The Relevant Parties, But How Much Contact Must A Director Have With Service Providers In Order To Monitor And Supervise These Parties?

Questions & Answers4

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• A: The amount of time that a director spends on any particular fund depends upon (among other things) how much activity the fund has (monthly vs. quarterly NAV, frequency of board meetings, etc) and the particular director’s model. One suggestion is for a director to link the amount of contact to the frequency of the NAV calculation. For example, if the fund is subject to a monthly NAV, then the director should contact the administrator or the investment manager at that time to discuss the reasons for any unusual changes in NAV and to confirm whether such changes are due to a departure from strategy or performance of the market.

Questions & Answers4

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• Q: What Are The Advantages For A Start-Up Hedge Fund To Domicile Somewhere Other Than The Caymans?

Questions & Answers5

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• A: Choice of a hedge fund domicile is usually influenced by the jurisdiction that a client is coming from. Cayman is preferred due to better regulation, infrastructure and the good attitude towards the protection of investors’ interests.

• Cayman also offers products for start-up managers. For example, start-up platforms are available whereby a new manager would be responsible for running a portfolio of an existing segregated portfolio company structure. The manager uses this portfolio to build a track record and build capital. At the relevant time, he exits the platform and, hopefully, starts his own stand-alone fund.

Questions & Answers5

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Q: Does Jersey, Luxembourg, Or Mauritius Have A Strategic Advantage Or A Niche For A Certain Type Of Manager?

Questions & Answers6

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A: Many of the so-called strategic advantages of using jurisdictions outside Cayman are simply clever “marketing” and based on misleading “perceptions”.One misleading perception is that Cayman does not have proper legislation and laws. However, the fact is that the Cayman Islands has had to implement strict laws and regulations in response to pressure from international bodies and large countries. As a result, the Cayman Islands has higher standards than many other countries, especially in the area of anti-money laundering.Some parties may select a European domicile because managers who want to market to European investors feel forced by the EU Directive to domicile in Europe (there is no particular value added by this choice and a domicile in Europe may not necessarily result in better protection for investors or better performance)

• As a result of the foregoing, it is important that stakeholders distinguish between “perceived” advantages and “actual” advantages.

• Obviously, bigger countries market “perceived” advantages in order to attract new capital following the global financial crisis and as a tactic to keep existing capital within their jurisdiction.

• Upon researching the facts, investors will see that Cayman is a better , non-misleading choice.

Questions & Answers6

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End of PresentationBy: Alric Lindsayalric.lindsay@cidirector.comwww.cidirector.comTwitter: CaymanFundGuy