The fundraising endeavour took place on January 27th, and participating companies, in addition to DMS, included KPMG, Deloitte, and Conyers Dill & Pearman. Each company invited employees to show support by making a donation to participate in the dress down day.

The Joanna Clarke Scholarship Fund was introduced in 2010 as an expansion to its already well-established Joanna Clarke Excellence in Education Award (JCA). The scholarship fund grants financial support to an aspiring or existing educator looking to further his/her education or wishing to further expand on his/her professional development. The JCA is celebrating its sixth year, whereby DMS grants up to $12,000 KYD annually to a worthy education initiative (s), thereby both efforts serve to publicly acknowledge the efforts of all persons and organizations that contribute to education in the Cayman Islands.

Commented DMS employee, and the DMS Gives Back Committee Chairperson, Mindy Kimball, “We were really pleased with our employees’ willingness to put their hands in their pockets for a good cause, and we are further delighted by the support the Joanna Clark Scholarship fund received from other local companies. We hope to build on this support each year, and we always encourage the business community to join in our effort to support those who champion education, thereby ensuring the future of the Cayman Islands. It has always been our belief that, ‘together we make a difference’.”

For the past two years the scholarship fund recipient was Krishan Welcome, an established lawyer in the Cayman Islands, who redirected her talents and energy from a career in law and is pursuing a teaching degree to fulfill her passion to influence young minds. Ms. Krishan obtained a 4.0 GPA during her fall semester at Catawba College and has continued these outstanding results thus far in her second semester.Ms. Welcome will return to the Cayman Islands in June 2012 to embark upon a teaching career and to further impact the lives of Cayman’s youth.

Commented Ms. Krista Pell, DMS Vice  President and a Joanna Clarke committee member, “We recognize the incredible role that educators play in the lives of our children, and consider this to be of paramount importance for the growth of the Cayman Islands. We fully support the teaching profession and encourage all development of the educators in our community.”

For further information on the Joanna Clarke Excellence in Education Award or Scholarship Fund, visit www.joannaclarkeaward.ky.

DMS and its subsidiary companies all participated by dressing down in cupid’s colors, purchasing raffle tickets and delivering friendly cards to co-workers and friends. In total, the DMS Group raised eight hundred and fifty dollars by the red and white affair.

Mindy Kimball, DMS Gives Back Chairperson commented on behalf of the DMS Gives Back Team, Social Committee and participating staff members:  “At DMS, we are committed to giving back to the community through various efforts for charity, it was a pleasure to assist the Cayman Islands Red Cross in their aims to protect human dignity by helping vulnerable people in crisis, and what better way to do this than to share the love on Valentine's Day!"

Commented Jondo Malafa Obi, Director for the Cayman Islands Red Cross: “The Red Cross appreciates the efforts made by the DMS Gives Back committee of DMS. As the largest volunteer organization worldwide, we always commend members of the public that take such initiatives to raise funds for our community.”
           

“Our New York office aims to fortify our existing relationships with US stakeholders, many of whom are based in New York, and to facilitate our ongoing face-to-face interactions,” said Ms. Celoria.  “It will help make our governance work more accessible and transparent to the funds we serve and their investors.” 

The New York office will also serve the increasing demand for institutional fund governance for onshore funds.  Already the industry leader in fund governance, DMS now aims to leverage its governance expertise and market experience to serve onshore funds and their stakeholders. As part of this effort, DMS has been consulting regularly with major institutional investors since the 2008 financial crisis.  

“The simple truth for these investors is that many of the real life governance failures they suffered during the financial crisis were attributed to offshore funds feeding into onshore funds without proper governance. They’re now focused, correctly we believe, on a results-driven governance approach to avoid a repeat of those experiences” said Don Seymour, DMS Managing Director.

The insights that DMS gained from these regular investor conversations have helped them achieve breakthroughs in stakeholder reporting like the annual Fund Governance Report, which makes transparent a fund’s governance process, in a specific and measurable manner, and have also shaped the development of strict standards like DMS’s forensic governance techniques, which add to the existing operational risk controls within the hedge fund control structure.

“We’ve been on a mission to improve fund governance for the last decade and we’re as passionate as ever about further collaborating with industry stakeholders and advancing fund governance,” said Mr. Seymour. “We believe that 2012 will be a pivotal year for fund governance with SEC fund governance standards likely dominating the agenda.  We want to do everything we can to advance effective fund governance standards and our New York office is an integral part of our commitment.”

In May 2011, DMS presented cheques totaling $12,000 KYD to help fund these initiatives, and as part of the award follow up, the JCA Committee and DMS ensure that the grants are in action and learn firsthand how these initiatives are advancing.  In October and November site visits were conducted with the two 2011 award recipients, Catch Up Literacy Catch Up Cayman programme and The Speech and Language Therapy Department programme “Making Hanen Happen”.

Catch Up Literacy “Catch Up Cayman” programme seeks to address the problem of underachievement that is often rooted in literacy and numeracy challenges, and supports the sustainable use and embedding of the Catch Up Cayman intervention for ‘at risk’ students across Cayman’s public schools.

Committee Members Tanya Samuels and Mark Ray visited Sir John A. Cumber Primary School to check-in on the Catch Up Literacy program.  Ms. Tanya Samuels commented on the site visit saying “I am pleased to report that the visit went well and I am impressed with the caliber of the support staff that has been selected to implement the program. The support teachers were well-informed about the program and eager to improve on their assessment and instruction methods from last year. Generally, the team seemed focused, well-organized well-trained, and motivated to make the program a success. This was a great visit!”

JCA committee member Mark Ray also visited The Lighthouse School in East End to see the Speech and Language Therapy Department programme “Making Hanen Happen”.  The programme received funding to set up a training assistance which is intended to train and support parents and caregivers of children with language delays to understand how they can assist with language development.

Ms. Clarke has been an iconic educator in the community, impacting students for more than 40 years. DMS launched this cornerstone education initiative to recognize the efforts of all persons and organizations that contribute to education in the Cayman Islands.

In the latest edition of HFMWeek, Derek Delaney, a Director of dms Management (Ireland) Ltd., joined with fellow industry experts to discuss why Ireland continues to be a strong candidate for onshore domicile of choice.

The common tax optimization structure for Swiss based investment managers includes a Cayman Islands based management company contracted to manage the applicable offshore funds.  It is clear that the Swiss tax authorities, while encouraging the migration of UK investment managers to the jurisdiction, are more closely examining the extent of operations that are provided by any Cayman Islands based management company. 

Frequently, Swiss managers have Cayman Islands based management companies that, in an effort to reduce the costs of operation or to simplify communication, may not be operated as envisaged by the tax optimization plan established at launch.  Worse yet, the operation of the investment management company may have evolved over the years such that the daily operations, documentation and correspondence actually undermines the planned structure rather than support it.

It is important for the shareholders to review the efficacy of their offshore investment management operations and consider if the type, scope, and substance of the duties being performed in the Cayman Islands are adequate and, where concerns are identified, have them addressed.  

While the specific tax considerations will vary based upon the specific facts and circumstances of the investment management company shareholder/sponsor and the tax legislation in the relevant onshore jurisdiction, there are common processes and best practices that should be implemented by most offshore investment managers.  

The primary concern is that management and control of the investment management company can be demonstrated to actually occur in the Cayman Islands.  This is typically achieved by:

• Engaging directors domiciled in the Cayman Islands
• Conducting all board meetings from the Cayman Islands
• Having directors domiciled in taxable jurisdictions travel to a tax neutral jurisdictions for purpose of participating (even if by phone) in board meetings
• Holding regular board meetings, evidenced by minutes, to demonstrate active control of the company by the offshore directors
• Ensuring that the agenda of the board meetings address appropriate topics including strategic considerations and oversight of delegates and service providers
• Using different directors on the investment manager and the fund where possible
• Ensuring fund and management company service providers respond to and send correspondence directly to Cayman Islands directors

The control of the operation can be better demonstrated, and possible transfer pricing questions minimized, by enhancing the scope of investment management operations occurring offshore by making certain investment decisions, establishing an office, performing certain administrative services, and performing marketing or investor communication in/from the Cayman Islands.
Making actual investment decisions offshore generally works best for Private Equity or Fund of Fund investing where traders do not need to make immediate decisions.  That being said, it is possible, even for an active trader, to initiate certain fund treasury decisions offshore to enhance the scope of offshore responsibility and activity.

Establishing an office for the company in the Cayman Islands, including a dedicated phone line answered by seconded staff lends additional support to the offshore operations.  The office may be further substantiated by housing a computer server within it, and developing offshore Cayman website and email addresses.  Often, the Cayman Islands office may be supplemented by the staff of the onshore advisor outside of Cayman business hours.   In addition, the email addresses and Cayman Islands based server can be used to communicate with investors and other service providers. 
It is generally straightforward to have the administrative duties of the investment manager, such as approval of invoices, authorization of bank transactions, and preparation of periodic accounts for the investment manager performed in the Cayman Islands.  
 
The offshore presence of the investment manager can be further strengthened by having some or all of the duties outlined above performed by an employee physically domiciled in the Cayman Islands.  While some investment managers transfer a senior employee from their onshore office, other investment managers will engage a part time employee to perform specific duties.  Although there are issues specific to employing staff in the Cayman Islands, such as health insurance/work permits/pension requirements, having services performed by an actual offshore employee is a key component of a sound tax optimizing structure. 

Lastly there are a number of ancillary matters that, while not individually significant, can contribute further evidence to the offshore presence including:

• Establishing an offshore bank account and ensuring that all management company transactions are processed through the offshore account
• Ensuring signing authorities are, as much as possible, located in the Cayman Islands
• All relevant agreements, such as the investment management agreement, should note that the law and jurisdiction to be applied are those of the Cayman Islands
• Emails and correspondence (especially those requiring decisions) should be drafted to demonstrate that control of the company resides in the Cayman Islands

It is worth noting that many of the issues identified above are matters of operational rigour and would not necessarily cause the offshore investment manager to incur more fees or overhead costs.  Furthermore, even steps that will result in increased fees, such as establishing an office or hiring an employee in the Cayman Islands, can be achieved in a cost efficient nature.  Certainly any additional cost is mitigated by the potential tax or regulatory consequences if Cayman is not seen as the center of main interest of the Company.

As the largest service provider in the Cayman Islands focused on the unique needs of investment managers, Offshore Business Solutions is well positioned to provide many of the services that should be performed by the offshore management company, at fees that are much lower than many investment managers expect and most importantly, lower than the possible tax consequences that might accrue from not fully supporting the planned structure. 

The success of the Cayman Islands has always been predicated on continuous improvement, so now is as opportune a time, as any, to consider ways in which our regulatory framework can be further enhanced. It is also clear that none of the problems of the global financial crisis can be attributed to any failure of the regulatory policies of the Cayman Islands despite the fierce rhetoric of the lame Cayman pundits, including those in our midst, to scapegoat our regime.

The recent CNBC House of Cards programme should be mandatory watching for these pundits. CNBC expertly researched and traced the beginning of the crisis back to 11 September, 2001, and identified several causes, none involving the Cayman Islands. The fact that some entities were incorporated in the Cayman Islands is inconsequential. Cayman companies were minor irrelevances in this show with its international cast of unscrupulous lenders, buyers and sellers as the main actors. All were unregulated but operating in regulated jurisdictions. This was not lightly regulated nor internationally applied regulation, similar to that in the Cayman Islands, but entities that were not subject to any regulation whatsoever. It sounds like a recipe for disaster and it certainly was.

Nonetheless, I also agree that the lame Cayman pundits will never allow the facts to get in the way of their own biases, so the Cayman Islands need to stay at the forefront of regulatory change for its economic survival. This article explores the challenges and opportunities presented by the global financial crisis to the Cayman Islands regulatory framework.

The role of regulation
Historically, the Cayman Islands has always viewed effective regulation as promoting market confidence in its financial products and services. Acting in the best economic interests of the islands was paramount. It was considered nonsensical to implement regulatory policies that were counterproductive to maintaining the competitive position of the islands, otherwise soon regulators would have nothing to regulate. These principles are enshrined in the Monetary Authority Law and to date CIMA has excelled in achieving these objectives as have other local regulators with similar objectives. There is no reason to believe this excellence will not continue throughout these challenging times.

However, it is critical that the pendulum does not swing too far in the opposite direction as when some suggest implementing regulatory solutions to problems that don’t exist in Cayman Islands, or that are inappropriate to Cayman, simply because they are being applied elsewhere. Some argue that such policies are necessary to be internationally compliant when no such standard really exists. Every regulator adopts standards that are appropriate to the challenges in their jurisdictions. The Cayman Islands is no different. There is no one-size-fits-all regulatory solution. Notwithstanding, it can be instructive to consider best practices internationally and adapt these ideas locally insofar as they are relevant and appropriate to the circumstances of the Islands. Indeed, CIMA is bound by the MAL to achieve this goal. Since only the Legislature of the Cayman Islands can change the MAL, stakeholders should rest assured that the parameters for implementing regulatory initiatives are clear and well established.

Act in the best economic interests of the islands
This has never been more important considering the poor global economic climate. Our local financial industry is at its tipping point and what regulators do next will determine the fate of the jurisdiction for many years to come. While it is common for regulators to ratchet up the pressure during a crisis, especially when spectacular frauds are being revealed in other jurisdictions, Cayman regulators should remain focused on promoting sound industry compliance and competition. I strongly believe in vigorous enforcement of regulatory violators, but witch hunts, fishing expeditions and trivial gotcha pursuits will do little to inspire compliance.

At a recent conference, it was terrifying to hear a Cayman regulator announces that the new approach would be first to freeze your assets, arrest you, then talk to you. This is a great example of the crisis causing regulators to behave irrationally, panicking to the extent where they abandon core principles like the presumption of innocence. Calm, rational thinking is critical in times of great stress. We all acknowledge that, if our building is engulfed by fire, our chances of survival are exponentially greater if we react calmly rather than rushing for the fire exits all at once. Criminalising our financial industry based on a few bad actors in overseas jurisdictions is an improper and disproportionate response. Internationally, the success of the Cayman Islands is still coveted by many challengers and such capricious actions would be devastating to the best economic interests of the islands.

Uphold transparency and fairness
Regulatory leadership and innovation are needed now more than ever. The best way for regulators to promote transparency is to practice it. Regulatory solutions should not be developed in a black box by a few in the know. Regulators should get out and engage stakeholders in frequent and intense dialogue. Do a listening tour and get into learning mode as the best ideas may lie outside government. Uncertainty is anathema to growing markets so this is a time for regulators to be more candid and transparent about regulatory initiatives. Regulators should seek to eliminate excitement and drama from the regulatory process. Be staid and predictable. This is not the time for grandstanding, informal rule-making and inconsistent interpretation. Regulatory rhetoric needs to be tight and thoughtful because of its enormous potential to disrupt business flow.

Increase resources
Industry expertise is essential for regulatory success. Regulation works best when regulators are experienced in the various industries they regulate. During the boom times, it was difficult for regulators to attract staff with deep industry experience, but the economic downturn now offers regulators good opportunities to reload their depleted staff ranks with top talent that would not otherwise be available. Like all regulators globally, Cayman regulators will be significantly challenged to do more with less resources. This will necessitate employing more sophisticated enhancements to their risk-based supervision approaches to deploy their limited resources more effectively.

Facilitate innovation
Change is inevitable and continuous improvement is always desirable, but regulators should have the courage to stay committed to the core principles that have proven successful, not dismantle and rebuild what is otherwise effective. Regulation can expand, yet stay true to its core principles, not merely imitate our less successful competitors.

Regulatory enhancements should maintain the principles-based framework that has served the jurisdiction well. Prescriptive ideas such as arbitrarily limiting service-provider capacity are a radical departure down the slippery slope of decline that will create unintended consequences for regulators. Such policies reward weak service providers that are unable to compete under free-market conditions at the expense of strong service providers; creating disincentive for the strong service providers to continue to invest in our jurisdiction, derailing innovation and wrecking competitiveness. Also, regulators should seek to regulate, not allocate, the market – this would be a step too far.

Obviously, regulators must remain concerned with whether service providers are fit and proper and capacity is important to this assessment. However, prescriptive regulatory measures would likely violate the precepts of the MAL, drawing the ire of disaffected service providers and unleashing a firestorm of litigation that would only serve to squander the precious resources of stakeholders during a critical time when they are needed most.

Rather than prescriptive measures, strict and meaningful enforcement of the existing financial regulatory laws to disqualify recalcitrant service providers, will do far more to enhance regulatory compliance than fluff prescriptive policies that simply create a false sense of effective regulatory change.

In the end, there is a fine line between stimulating and stifling regulation. The burden can be heavy or light. Regulators have the unenviable task of deciding where to draw this line and how brightly to illuminate it. These choices are not free. Regulators determine the cost of these choices and our economy pays the price.

Bio: At a Glance
Don Seymour was the first Head of Investment Services Division and a former director of the Cayman Islands Monetary Authority. He is credited with establishing its market friendly and responsive framework for regulating hedge funds that propelled the Cayman Islands to the most successful hedge fund jurisdiction in the world. He is the founder of dms Management Ltd., the largest company management firm in the Cayman Islands focused on serving the hedge fund industry.

Everybody likes one-man bands. You see them busking in the streets and tube stations with their big base drums, cymbals, guitars, harmonicas and even perhaps penny whistles. Children find it fascinating to see one person doing so many things at one time. However, I am not aware of any one-man band who is a renowned drummer or guitar player, or who is generally respected for the quality of their music, but they are a source of general amusement, which essentially is their purpose in life.

These one-man bands turning their hands to all these separate instruments simultaneously—yet mastering none—can now be found in the hedge fund world. They are not, I believe, generally musically inclined but can be found in the guise of the one- and two-man ‘professional director shops’.

These one-man bands spend their days picking up the mail, preparing FedEx packages, filing, scanning, faxing and photocopying. Like the street buskers, these one-man band directors have all their parts moving in different directions, and simultaneously review, consider and sign documentation critical to the well-being of the hedge fund and the investors whose interests they are serving and protecting. Hopefully, they can manage a four-four beat whilst strumming C sharp.

But the concept that ‘small is beautiful’ simply does not fit into the hedge fund world. The concept is great for cell phones, laptops and governments—but not for the very serious and responsible business of investing and safeguarding other people’s money. Investors need to ensure that all their service providers are best of breed, and an investor’s search and due diligence selection procedures for directors should be no different to those they employ when evaluating the investment manager, auditor, prime broker or administrator.

If there is one overriding characteristic that these firms have, it could be described as ‘operational substance’. The prudent investor is not going to entrust their money to two or three guys with desks, telephones and a nice potted plant—no matter how well qualified or brilliant they are personally.

The growth in independent professional firms now providing operational due diligence to investment managers, administrators and directors highlights the importance of selecting a firm with theability, substance, capacity and infrastructure to meet an investor’s expectations. It is the people and the systems that directly or indirectly support the investment manager, auditor or the director that make an entity a professional services firm, rather than a co-operative.

A professional services firm will provide a hedge fund with not only an individual director or directors, but with a whole corporate governance team: the director, the manager, the paralegals and the administrators will all be involved in the corporate governance process, providing the fund with a team of people knowledgeable about its business and particular modus operandi.

The team approach to corporate governance, as in an audit or legalfirm, brings the benefits of knowledge-sharing, continuity, and the ability to train and develop the directors of tomorrow, for the particular fund and the firm in general. Whilst many may be entering the world of directorships, albeit with relevant industry experience, none have the depth and breadth of actual directorship experience that exists within the professional corporate governance firm.

Whilst the corporate governance firm supports the director in the performance of his duties, the corporate governance firm also supports the fund in its interaction with the investors, the auditors, the prime brokers, the administrators, the regulators and, of course, the investment manager. This requires a full documentary workflow system and processes way beyond  those that a director would have been expected to have just a few years ago.

Additionally, as the governance sub-specialisms of audit administration, regulation and compliance become ever more complex and specialised, it is the firm that can provide a team of individuals with varying relevant and specific expertise that is best situated to serve its clients and add the greatest value. Indeed, today, many clients are seeking a team with specific investment sector knowledge.

The larger professional services firms are able to construct a team with the specific varying experiences that a client may require. With such a firm, the sharing of knowledge and experiences between directors, managers and administrators provides a client with a depth and breadth of knowledge that a smaller co-operative simply cannot hope to provide. There is now much evidence that boards of directors contribute to the success of a company in many ways through their varying interactions, and this can only be achieved where the board has a combination of skills and sufficient support.

The combination of skills and institutional knowledge within the professional services firm inherently provides each director with this combination and a fund thereby indirectly benefits from the whole infrastructure and skill set within the professional services firm. It is not limited to the knowledge and skills of one particular director, no matter how impressive his individual resume may be.

As the corporate governance team is supporting the director, it is itself being supported by the operational infrastructure of the firm: departments and professionals dedicated to information technology, human resources, accounting and compliance, ensuring robust support and maximisation of efficiency and capacity for the client services team, whilst also ensuring disaster recovery and continuity planning.

In performing due diligence, investors should also be looking to select directors with some longevity and experience, perhaps sporting a few battle scars to prove that they have been stress tested and have passed. As Albert Einstein said: “The only source of knowledge is experience.” It is one thing to have been involved in hedge fund businesses in a senior executive position such as an administrator, lawyer or regulator, but how many years of actual directorship experience and corporate governance work does the director bring into the boardroom? Investors may therefore be interested in hearing examples of how directors have resolved conflicts with investment managers, administrators and investors (particularly litigious ones).

Equally, an investment manager will want to get a sense from his potential director as to when and where the director will draw the line in the sand, and how much oversight and control the director intends to exert over the manager. Being a director to a hedge fund is an art, not a science. As such, different directors will have different approaches and experiences, and the investment manager and investors need to know that they can have a satisfactory working relationship.

From an industry that has grown from around 140 hedge funds in 1968 to more than 10,000 today, the fund structures and the values involved, the instruments traded and the sophistication of investors have evolved substantially. A similar evolution has occurred in the role of the independent director and the support systems the independent director requires in order to keep pace and meet investor, investment manager, auditor and regulator expectations.

It would be naive to believe that the methodology by which those ultimately charged with the overall supervision and governance of the funds deliver their services could have remained stationary. The professional corporate governance firm is the modern, sophisticated, intelligent answer for the provision of director services to the hedge fund industry. Visit your directors, view their websites, quiz them, examine their infrastructure, and make the right choice.

Roger H. Hanson is a director at dms Management Ltd. He can be contacted at: rhanson@dms.com.ky on tel: + 1 345 749 2587

“The independence of hedge fund boards has been questioned recently as funds became distressed under adverse economic conditions and directors implemented various mechanisms to manage fund liquidity,” says Don Seymour, managing director of Cayman-based director placement firm dms Management (sic), and director of a number of Cayman funds. “I’ve seen several situations where views were narrowly split and board actions were questioned because of the lack of a clear consensus.”

According to Paddy Dowdall, investment manager with the Merseyside Pension Fund, investor-led changes at hedge fund boards is a likely next step for the industry. “I wouldn’t be surprised to see some bigger investors with more resources demanding seats on these boards – it makes a lot of sense,” he said.

“Directors are looking at what we are doing and feel we have to be closer to the shareholders,” admits Peter Niven, chief executive of GuernseyFinance. Niven sits on the boards of six investment vehicles, including listed fund of hedge funds (FoHF) Dexion Trading.

“It’s especially important in times like these, when an awful lot of FoHFs are going into continuation votes,” he added.
“There’s a lot more communication.”

However, despite the noises made by investors, and the readiness of directors to heed the call, efforts being made to implement industry-wide changes to boards are finding differing standards of governance an obstacle to international accord.

As stakeholders began to recognise the importance of competent, independent corporate governance, particularly in the hedge fund industry, the old retiree model was replaced with specialist professional firms providing comprehensive fund governance services. These firms, whether truly standalone and independent or associated with a large law firm, had the resources and infrastructure needed to deal with the complexities and demands of the offshore industry in the 21st century. Ironically, the success of these firms in providing exceptional service and raising the standards of fund governance for offshore entities is now perhaps indirectly responsible for a worrying phenomena developing with the supply of offshore hedge fund directors.

Having witnessed the success of these large professional services firms, bankers and accountants (and now fund administrators and lawyers) have decided that being an independent director is a sinecure. With no barriers to entry, they are deciding to retire earlier and, with a couple of their buddies, set up shop and provide independent fund governance services. Sadly for the industry, these directors are merely reinventing the retiree model, albeit at a younger age. These firms do not have the resources of the professional services firms and are not well equipped to deal with the demands of today’s complex hedge fund world. There is no organisational infrastructure, or in some cases not even any physical infrastructure, with some working from their kitchen table or converted garage. For those who have rented a small office space, the question is; where is their IT infrastructure (owning a Blackberry does not count)? What are their back-up facilities and disaster recovery plans? Where are their accounting department, HR, training, compliance, and general administrative support? It is not realistic that the single mind of any one director can truly comprehend the full range of risks in today’s highly-sophisticated hedge fund environment. Today’s fund governance requires dedicated organisations providing operational, technical, compliance and administrative support for the funds’ directors.

As a general rule, the world and commerce move forward. There is one notable exception; the retirement of Concorde. The end to transatlantic flights at supersonic speed, as opposed to the eight hours travelers endure with regular commercial airlines, albeit for lower fees, was a step backward. The new breed of standalone, independent directors are bringing about a similar change in the fund governance market and reintroducing the retired director business model. With the exception of Madoff, no hedge fund, (I realize Madoff was not a hedge fund, but it has been portrayed as such in the press), would dream of appointing a two-man audit firm. Even if they tried, investors would not accept it. Yet, multi-million and billion dollar funds are appointing directors with no organisational support or infrastructure. The professional directorship firms have taken fund governance to new levels of competence and built robust, thorough, professional organisations with operational, risk and compliance systems modeled after other professional services firms. These firms now see the emergence of the one-man (and his buddy) directorship shops, which have the possibility of taking fund governance back 10 years. No internal or external infrastructure, no systems, no processes, no controls, no risk management, no succession planning - just one man, semi-retired and serving as a director.

Hopefully, the market will soon differentiate between the new retirees and the professional fund governance firms and select to travel by Concorde.

These agreements mark a further significant step forward in international efforts to implement standards of transparency and exchange of information in tax matters developed by OECD’s Global Forum on Taxation.

They bring to eight the number of such agreements entered into by the Cayman Islands, as it already has a tax information exchange agreement with the United States.

In addition to these TIEAs, the Cayman Islands has also enacted legislation that allows it to exchange information unilaterally with countries that it chooses to identify. A number of OECD countries have now been identified that could benefit from this new provision.

Jeffrey Owens, Director of the OECD’s Centre for Tax Policy and Administration, welcomed these developments. “The Cayman Islands was one of the first jurisdictions to commit to the new standard in May 2000,” he said. “I welcome the fact that this commitment is now being implemented by the latest TIEAs. Their new legislation is innovative and could speed up the process of implementing the standard.”

Since it committed to the standards, the Cayman Islands has worked with OECD member countries to further develop and implement the principles of transparency and exchange of information. It was one of 11 jurisdictions that contributed to the development of the Model Agreement on Exchange of Information in Tax Matters, on which the bilateral agreements with the Nordic economies are based. The Cayman Islands has also been an active participant in the Global Forum’s Sub-Group on Level Playing Field Issues.

OECD’s work in this area is focused on the development and implementation of high standards of transparency and exchange of information designed to enable countries to fully and fairly enforce their tax laws. The OECD has welcomed a number of announcements in recent weeks supporting this work and providing specific timelines for implementation.

Mr. Owens stated, “I am very pleased to see the pace of implementation now being accelerated and I appreciate the fact the Cayman Islands has sought to simplify the means by which to broaden its information exchange relationships The Cayman Islands is setting a good example.”

For further information journalists are invited to contact in the Cayman Islands, Ted Bravakis (tel +3452 442 266) for the Nordic economies, Per Olav Gjesti (tel + 47-22 24 44 72) or Torsten Fensby (tel: +33 6 78 25 12 89) or in France, the OECD’s Media Division (tel: + 33 1 452 4 97 00). For more information visit the OECD's website on tax.

The global financial crisis and its tremendous impact on the hedge fund industry continue to bring the issue of director independence and effective board performance sharply into focus. As directors exercise their vast powers to impose various forms of liquidity management mechanisms and valuation methodologies on the problems created by the crisis, some investors have questioned and challenged director responses, or the lack thereof, and the degree of their loyalty to investors. An independent director should be free of biased loyalties that could adversely affect his professional judgement and ability to discharge his fiduciary duties in an impartial, objective and unbiased manner.

Independence is fundamentally important and necessary, because independent directors play a vital role in resolving conflicts of interest between a fund and its service providers. There have been numerous instances in dms’ history where investors would have suffered significant losses had we, as independent directors, not taken appropriate action—the most common circumstances being improper treatment of expenses, charging the cost of service provider errors to the fund, and improper or fraudulent valuation of investments.

Independent directors should prove their worth in a crisis. Like firefighters, independent directors should be running in when others are running out. To date, dms has actively led the fight to protect and promote the interests of investors and creditors in some of the major and most high-profile hedge fund crises.

Independent directors are not involved in the day-to-day operations of the fund, and it is unrealistic to expect any single director to truly and independently understand and monitor the full range of risks and complexities in today’s highly sophisticated hedge fund. They do not, nor should they be expected to, interfere or dabble with the orderly operations of the other service providers. Some argue that they should. In my opinion, this argument is specious and ultra vires of directors’ powers. Directors are ultimately responsible for the fund, but not the operations of the various service providers. Those day-to-day operations are rightfully the responsibility of the governing body of the respective service provider, and directors should only get involved in those operations where a conflict or other dysfunction has arisen.

An independent director cannot effectively provide oversight without the conscientious performance of the service providers and vice versa. Effective fund governance depends entirely on the effective interdependence of all the service providers.

The best guidance on fund director independence is promulgated by the United States Securities and Exchange Commission (SEC) in The Role of Independent Directors of Investment Companies (Release Nos. 33-7932; 34-43786; IC-24816). Although these rules have been designed for the mutual fund industry, the offshore hedge fund industry and the mutual fund industry share the same fundamental goal of sound investor protection; so there are several pragmatic principles among these rules that may be instructive to offshore hedge funds—especially those already being managed by an SEC-registered investment adviser. Sound principles for any fund board to consider include that: fund boards should be majority independent; the chairman of the board should be an independent director; and independent directors should be affirmatively authorised to hire their own staff, including independent legal counsel who are “free from conflicting loyalties”.

To achieve sound fund governance, offshore fund boards must adhere to the fundamental philosophy of investor protection and its four pillars. Investors expect that: their investments will be managed in accordance with the fund’s investment objectives; the assets of the fund will be kept safe; when they redeem, they will get their pro rata share of the fund’s assets; and the fund will be managed for their benefit, and not that of the service providers.

Regulation v. governance
The key role of a regulator and an independent director are the same— effective oversight. As the first head of investment services at the Cayman Islands Monetary Authority (CIMA) in 1998, I established the Investment Services Division (ISD), and developed and implemented its key regulatory policies and strategies. In 1998, the Cayman Islands was far from the dominant jurisdiction it is today, and this was a challenging opportunity. I listened carefully to and worked closely with market participants to develop and implement regulatory principles and policies that were both effective and market-friendly. During that period, gaining agreement on good ideas that maximised investor value was paramount, and this approach worked well as the Cayman Islands transformed into the world’s number one hedge fund jurisdiction.

It was also important to learn when to say ‘no’. During my tenure, the first enforcement cases were brought against hedge funds in the Cayman Islands. In these cases, the service providers were diligent in detecting and reporting the abuses, but the directors did not act appropriately on the information. The Cayman Islands has always had high-quality talent in the legal, audit and administration professions, but in that era, inaction or abandonment from directors was frequent. Many didn’t reside in the Cayman Islands and could not be found, or lacked the ability or willingness to act to protect investors’ interests.

If those failures had been allowed to fester, they would have undermined the credibility of the entire regulatory regime. To prosper, the Cayman Islands needed to have first-class fund governance to complement the other first-class professionals in its industry. These enforcement initiatives took courage, because the decision to prosecute is frequently unclear, often controversial, and involves considerable judgement. However, vigorous enforcement was vital to send a clear signal to the marketplace that the Cayman Islands would not tolerate any form of investor abuse. The support I received and the lessons I learned equipped me with the skills to make hard decisions and to lead in difficult situations.

It is not coincidental that as the quality of fund governance increased in the Cayman Islands, the number of enforcement cases brought by the CIMA significantly reduced, even as the industry grew enormously.

New developments
One important development that has emerged to shape the future of the independent director industry is the newly formed Cayman Islands Directors Association (CIDA), of which I am proud to serve as vice president. The CIDA was established to respond to the professional needs of directors in the Cayman Islands and has recently issued its Code of Conduct based on the code used by the UK Institute of Directors. As the director industry grew in importance, the development of the CIDA to focus on the unique needs of Cayman Islands directors was a necessary and natural evolution.

Prior to the CIDA, there was no professional association representing the interests of Cayman Islands directors. Various   guidelines and views had been promulgated by others, but these were developed without any involvement from any actual or experienced Cayman Islands directors, and therefore were of limited value from a Cayman Islands perspective.

The CIDA now has more than 120 members representing the vast majority of Cayman Islands professional directors and all of its leading professional director firms. It has received the support of the CIMA and the Cayman Islands government, and is now the most authoritative source on the director industry in the Cayman Islands. dms is proud to be a founding member and is committed to contributing to its continued development.

Other emerging ideas, such as additional director regulation, are not as market-friendly, as they could increase costs significantly without any demonstrable benefit over the existing framework of directors’ duties long established in jurisprudence. Proponents of this idea would be wise to spend more time identifying and defining the nature and extent of the problem that this additional regulation is supposed to solve.

As I travel around the world talking with users of Cayman Islands financial services, the issue of rising prices is frequently mentioned as a concern. These users perceive that as the industry transformed from high net worth to institutional users, service providers grew less concerned about competitive pricing; yet ironically, institutional users are more likely to be price-sensitive because of the need to be transparent and the pressure to increase profitability to drive share prices.

Further moves by service providers to increase profits under the guise of ‘regulation’ may push our users past the tipping point and create opportunities for our competitors in ways never previously imagined. Business history is littered with examples of the hubris of promoters that overestimated the price elasticity of demand for their otherwise excellent products. This fragile balance is very easy to destroy.

Every profession needs to renew itself. We are continually doing this at dms—adapting, learning and growing. The independent director profession has transformed from a cottage industry to a bona fide profession that is now too important to be considered simply ancillary to providing administration, legal or investment management services. All can flourish in these challenging times, but it does take the right ideas and the right motivation

Don Seymour is a managing director of dms Management Ltd. He can be contacted at: dmseymour@dms.com.ky.

One pundit imputed the responsibility for the global financial crisis on local directors. Another implied that the directors of the Bear Stearns funds were responsible for the funds’ demise. Yet another has conjectured that directors’ indemnities lead to risky behaviour – ignoring the established market practice of all service providers to use indemnities that contain appropriate exculpation clauses. The circus of bad ideas is performing live in George Town. To pass these extraordinary judgments, without extraordinary evidence, is deplorable and demonstrates fundamental ignorance of corporate governance and a director’s role. To find culprits one should follow the money to determine who profited, but this is an inconvenient truth to the pundit parade. The pièce de résistance of the pundits’ campaign is to limit directorships and CIMA has recently confirmed that it is examining the issue.

The rush to regulate can be destructive. Sarbanes Oxley (SOX) is a case in point. SOX was implemented in 2002 in great haste to react to the crises of Enron, WorldCom et al. Hailed as “the most far-reaching reforms of American business practices”, it was intended to avoid any further financial crises. Evidentially a great idea at the time (US Senate passed the legislation 99-0), the financial meltdown of the past year has proven SOX to be a colossal failure. That is the power of a bad idea in a crisis. I am absolutely a fan of regulation, provided it is necessary, sensible and efficient. If regulation is deemed necessary, principles-based regulation is far more effective. Even the SEC recently announced that it would move away from the more prescriptive US GAAP towards the principles-based IFRS for its registrants. Why anyone believes that corporate governance can be improved by implementing prescriptive measures such as limiting directorships and mandating board meetings is mystifying. The Board of Lehman Brothers is a case in point. The WSJ recently reported that Lehman directors met 25 times during 2008 alone to discuss ‘risk’ – yet this company failed spectacularly.

Ultimately, corporate governance is a system, not a person. If the system fails the test is simple – did the director observe his duties and fulfill his responsibilities or not? It is irrelevant to this question whether the director spent his other time serving on other boards or playing golf. It is indefensible to say a director failed to fulfill his responsibilities, but because he only serves on a limited number of boards he gets a pass. This is an illogical idea. Effective regulation needs to focus on results. Whether the director or a member of staff performs the task is also irrelevant. What simply matters is that the task is accomplished – correctly – and the system works. Today, the leverage and scalability inherent within the professional firm model renders the calculus of number of directorships per person obsolete. The new paradigm is that of a professional firm sustaining business growth within a market economy by continually building its intellectual capital and leveraging technology.

The growth of any professional firm will be continually challenged, not only in the Cayman Islands, but worldwide because of the global talent shortage. This is a truism, yet critics of the Cayman Islands still question whether Cayman hedge fund professionals have sufficient capacity. Due to the enormous success of the Cayman Islands in developing a large hedge fund industry, relative to our population, and perhaps more importantly, relative to our competitors; our critics have falsely attributed our success to lax professional standards rather than competence and market preference. This belief is, of course, naïve and ignores the sophistication of market participants. If we are fooling people, we are sure fooling many very smart people around the world!

For example, critics question whether CIMA has sufficient capacity to regulate over 10,000 funds with its current staff level, or whether the relatively limited number of local audit partners can effectively issue over 10,000 audit opinions, or whether local directors have the capacity to serve on hundreds of boards.

The elimination of risk is not a pragmatic goal for any regulator, and when you carefully examine these assertions against the extraordinarily successful regulatory track record of the Cayman Islands, it is clear that these assertions are baseless and no serious capacity constraints exist. Ultimately, the proof is in how a service provider performs in the market. Some pundits argue that other marginal, less successful jurisdictions have limited directorships. As the industry pioneer and established market leader, it would not behoove the Cayman Islands to now begin emulating the practices of its less successful competitors. Misery loves company but our jurisdiction need not join the club. Regarding directorships, first, it is important to recognize that local directors are not mandated so the reality of local directors serving on many boards is clearly a consequence of market preference.

Second, the idea of limiting directorships for hedge funds is derived from the public company model so it is critical to understand the fundamental difference between the control structure of a public company and a hedge fund – and why it is incorrect to equate these director responsibilities. A public company control structure typically has many employees ultimately reporting to one governing body (board). A fund typically does not have any employees and delegates management functions to various service providers, each with its own governing body. Director responsibilities are not transferred by delegation, only the fulfillment of those responsibilities. Consequently, within a typical fund control structure there are several governing bodies with fiduciary duties to the fund.

Therefore, a director is no more or less important in the fund control structure than any other service provider such as an auditor, administrator, investment manager, attorney or even regulator. For the fund control structure to work effectively, these services must function interdependently and be delivered by competent professionals under the oversight of their own governing body, independent of the fund. It is destructive to regulate the capacity of any service provider within a free market and infeasible to try to allocate a number of directorships per individual – especially in the context of the professional firm model. Independent directors range from retired individuals accessible part-time to professional directors accessible 24/7. There are simply too many variables for a one-size-fits-all solution. Unfortunately, the motivation for this misguided idea comes from the few pundits who are more interested in limiting competition and redistributing the market, rather than solving genuine investor concerns.

Finally, there is also the obvious question of what problem would limiting directorships solve? I have worked in the industry for over 17 years as an auditor, regulator and director, and have been directly involved in successfully resolving many high-profile hedge fund failures. I am not aware of any problem that could have been avoided or solved if directorships had been limited. Limiting directorships is a contrived issue and a solution in search of a problem – a red herring indeed.

These are truly interesting times for fund directors, and it seems like everyone is weighing in. Recent court rulings and press reports in the wake of the Bear Stearns hedge fund case, among others, brings the issue of director independence sharply into focus and raises serious questions about the efficacy and suitability of affiliated directors to offshore hedge funds, especially those managed within a hedge fund complex regulated by the United States SEC.

An independent director should mean that a board member is free of conflicting loyalties that would adversely affect his professional judgment and ability to discharge his fiduciary duties in an impartial, objective and unbiased manner. For example, the SEC staff has continually emphasized that fund directors have access to legal counsel that is “free from conflicting loyalties”. The best guidance on fund director independence promulgated by SEC fund governance rules that address the independence of fund directors can be found in Role of Independent Directors of Investment Companies (Release Nos. 33-7932; 34-43786; IC-24816).

Although offshore funds are not directly subject to SEC rules, many investment managers of offshore funds remain registered with the SEC, so dms Management Ltd. (dms) continues to recommend that, for the avoidance of any doubt, SEC-registered investment advisers adopt the SEC fund governance rules, as applicable, for their offshore hedge funds as best practice.

Independence is fundamentally important and necessary because independent directors play a vital role in resolving conflicts of interest between a fund and its service providers, and also in approving principal and agency cross trades like those now under investigation in the Bear Stearns funds. These transactions attract a high degree of scrutiny from regulators and it is critical that true independence be evident and demonstrated.

There have been numerous instances in dms’ history where investors would have suffered significant losses if we had not taken appropriate action as independent directors, the most common circumstances being improper treatment of expenses, charging the cost of service provider errors to the fund and, of  course, improper or fraudulent valuation of investments.

A challenging opportunity
As the first head of investment services of the Cayman Islands Monetary Authority (CIMA) in 1998, I was responsible for establishing the Investment Services Division (ISD) and developing and implementing the key regulatory policies and strategies for the ISD. In 1998, Cayman was far from the dominant jurisdiction it is today and this was a challenging opportunity. I listened carefully to and worked closely with market participants to develop and implement regulatory principles, policies and procedures that were both effective and market friendly. Then and now, getting to ‘yes’ on good ideas that maximised investor value was paramount.

It was also important to learn when to say ‘no’.  During my tenure, I brought the first enforcement cases against hedge funds in the Cayman Islands. In these cases, the service providers did excellent work detecting and reporting the abuses, but the directors did not act appropriately on the information. We have   always had first-class talent in the legal, audit and administration professions, but in that era, inaction or abandonment from directors was frequent. Many did not reside in Cayman and could not be found, or lacked the ability or willingness to act to protect investor interests. For any fund control structure to work effectively, true collaboration needs to be achieved with all service providers and corporate governance was then the missing link. A clog in any artery will make the whole body sick so if those failures were allowed to fester, it would have undermined the credibility of the entire regulatory regime. To prosper, the Cayman Islands needed to have firstclass corporate governance service providers to complement the other first-class professionals in the industry.

These enforcement initiatives took courage because the decision to prosecute is frequently unclear, often controversial, and involves significant judgment. However, I felt strongly that vigorous enforcement would send a clear signal to the marketplace that the Cayman Islands would not tolerate any form of investor   abuse. The support I received and the lessons learned made me more courageous and smarter about making hard decisions and how to lead in difficult situations. The mind-set of a regulator and an independent director is the same – effective oversight. Independent directors are the referees in the game, we do not interfere in the play, we do not take sides, but we call the fouls according to the rules.

Independent directors should prove their worth in a crisis. Like a firefighter, independent directors should be running in when others are running out. Today, dms has actively lead the fight to protect and maximise the interests of investors and creditors in some of the most major, high-profile hedge fund blow-ups, winning the praise of renowned publications like the Wall Street Journal.

Independent directors are not involved in the day-to-day operations of the fund, and it is not realistic that the single mind of any director can truly independently understand and monitor the full range of risks and complexities in today’s highly sophisticated hedge fund. They do not, nor should be expected to, interfere or dabble with the orderly operations of the other service providers. Some argue that they should. This  argument is specious and ultra vires of director powers. Directors are ultimately responsible for the fund, but not the operations of the various service providers. Those operations are rightfully the responsibility of the governing body of the respective service provider. An independent director cannot succeed without the support of the service providers and – vice versa – mutual success depends on the effective interdependence of the various service providers.

Effective regulation
It is not coincidental that as the quality of corporate governance has increased, the number of enforcement cases brought by the CIMA today has been significantly reduced even as the industry has grown.  Additionally, this is a testament to the increasing effectiveness of private sector regulation. Self or private sector regulation can be highly effective, as evidenced by SROs such as FINRA and the NFA among others.

As the independent director profession develops, ideas are emerging to shape the future of the industry.
One good idea was the development of a SRO to work in true collaboration with other industry    constituencies. The newly formed Cayman Islands Directors Association (CIDA), of which I am proud to serve as vice president, has answered that call and will be an important force in galvanising the positive voices for continued improvement in corporate governance.

Some of the other ideas emerging are not so market friendly, as they would increase costs significantly without any demonstrable benefit. As I travel around the world talking with users of Cayman Islands financial   services, the issue of rising prices is frequently mentioned as a concern.

These users perceive that as the industry transformed from HNWI to institutional users, service providers grew less concerned about competitive pricing, yet ironically institutional users are more likely to be price sensitive because of public accountability and tremendous pressure to increase profitability to drive share prices.

Further moves by service providers to increase profits under the guise of ‘regulation’ may push our users past the tipping point and create opportunities for our competitors in ways never previously imagined. Business history is littered with examples of the hubris of promoters who overestimated the price elasticity of demand for their otherwise excellent products. This fragile balance is very easy to destroy.

Every profession needs to renew itself. We are continually doing this at dms – adapting, learning and growing. The independent director profession is transforming from a cottage industry to a bona fide profession – from the kitchen table to the boardroom – into a profession now too important to be considered simply ancillary to providing administration, legal or investment management services. All can flourish in these changing times, but it does take the right ideas and the right motivation.

Hedge fund failures as a result of sub-prime bets or credit crunch-related losses have increased the need for independent directors at hedge funds. "Historically, corporate governance was viewed as inconsequential in the hedge fund industry, but the recent hedge fund failures have demonstrated the enormous value of an effective independent board capable of protecting and maximizing the interests of investors," says Don Seymour, managing director at dms Management, a service provider and adviser to hedge funds. Independent directors are responsible for looking out for issues that arise within the fund, and addressing problems such as regulatory investigations.

However, it is not that simple to find independent directors. Whether retired individuals or professional firms of several staff, Seymour says the key is to find directors with the ability "to understand and adapt to investor expectations as outlined in the fund documents and not arbitrary policies conceived in the director's mind. The potential negative effects of style drift of the investment manager are well understood in the industry but this also applies to directors, who can destroy investor value by imposing their will in a manner inconsistent with investor expectations."

Seymour says that independent director services have moved beyond part-time practice to a full-time boardroom role. Indeed, firms offering new directorship services, such as dms Management, are becoming increasingly popular. It is important, however, that the directors have skin in the game, say hedge fund industry participants. "It is a role of responsibility and directors need to be on the hook for that responsibility, otherwise there is no incentive to act in a fiduciary manner," says Gavin Gray, managing director of Phoenix Fund Services, a hedge fund administrator headquartered in Ireland. He questions firms that do not make sure their directors have some degree of liability. The fiduciary role of an independent director is shared with other service providers to the hedge fund and the management itself. "It is not reasonable that any director can truly independently understand and monitor the full range of risks and complexities in today's highly sophisticated hedge fund. For the fund control structure to work effectively, these services must function interdependently and be delivered by competent professionals under the oversight of their own governing body, independent of the fund," says Seymour.

Fee inflation likely

Being personally liable for problems that might arise at the fund, directors must be certain that the fund is properly structured and transparent, and is legally compliant. It's a burden that some independent directors feel requires greater compensation than in the past. Gray agrees and says that there is likely to be pressure on fees as independent directors become more sought after. At the moment the role of independent director can pay as little as $7,500 a year. Seymour agrees that fees are likely to rise, adding that any increased regulatory responsibilities will also add upward pressure.

The role is tougher than it used to be, given that the industry is under more scrutiny, especially from institutional investors. “Clients are demanding a high caliber of director,” says Mark Lewis, an attorney at law firm Walkers Group in the Cayman Islands and deputy chairman of the AIMA. Duties include attending three or four meetings a year and deciding when to put up withdrawal gates or close a fund.

“Historically, they’ve been directors for hire,” says Matt Auriemma, head of operational due diligence for Barclays Global Investors’ fund of hedge funds in New York. Auriemma says only 20 percent of hedge fund firms meet Barclays’s standards for a well-structured board. He recommends that investors include in their due diligence finding out whether directors are any good.

In the meantime, in at least two offshore locales —  the Cayman Islands and Dublin — hedge fund directorships have become a cottage industry. In the Caymans, Don Seymour — who runs a firm called dms Management that has more than 30 staff members who review fund documents — says there can be unexpected duties.

“I’ve actually been in situations as an independent director where I had to sit for several days on the trading floor making trading decisions because of the catastrophic failure of an investment manager,” says Seymour, who has a bachelor’s degree in accounting from the University of Texas, Austin, and is a certified public accountant in Illinois.

Neither dms nor Dublin-based Carne Global Financial Services, two of the biggest contract providers of directors, would divulge how many hedge funds a typical director is assigned. But Lewis says he knows of 26 directors who sit on more than 100 Cayman-registered hedge funds each.

The Ten Commandments, or Income Tax Regulations section 1.864-2(c)(2)(iii) as they were more formally called, were the rules that determined whether or not certain foreign corporations and partnerships trading in stocks or securities, were engaged in a U.S. trade or business. The objective for the foreign (offshore) entity was to establish that its principal office was located outside the United States. The relevant regulation very helpfully set out the activities, the majority of which should be performed outside the United States, if the offshore entity did not want to be considered as having its principal office within that jurisdiction and thereby subject itself to U.S. taxation.

1. All communication with shareholders, including provision of monthly statements of accounts, investment reports, annual financial statements and all other reports, financial or otherwise;
2. Communicatig with the general public;
3. Soliciting sales of shares of or subscriptions into the fund;
4. Accepting and processing subscriptions from shareholders;
5. Maintaining both the corporate records and books of account of the fund;
6. Auditing the fund's books of account;
7. Distributing payment of dividends, fees and expenses, including legal, accounting management and investment advisory fees, as well as payment of salaries and other expenses of the fund;
8. Publishing the fund's share prices, whether at the net asset value per share, or the bid (redemption) and offer (subscription) prices;
9. Holding board (directors) and shareholders' (members) meetings;
10. Accepting redemption notices from shareholders and effecting the redemption of the Fund's shares for such shareholders.

Lawyers, accountants, administrators, managers and directors were all extremely conscious of these requirements and undertook great measures, not only to make sure that the majority of these activities were performed outside the United States, but performed all activities outside the United States for the avoidance of doubt. Indeed, it was standard for an offering memorandum of an offshore entity to specifically state “the Fund’s sole activities in the United States are effecting transactions in stocks or securities, the Fund is not a dealer, and its principal office will not be in the United States (in accordance with Treas. Reg. § 1.864-2(c)(2)(iii))).”

Then on August 5, 1997, President Clinton signed the Taxpayer Relief Act of 1997 which removed the requirement for a foreign entity trading in stocks or securities to have its principal office outside the United States. The rationale behind this decision was job creation. There was a perception that the offshore jurisdictions were ‘taking jobs’ that rightly belonged in the United States and, in this respect, the legislation was successful as many of the previously prohibited activities began to be performed within the United States.

The first activity to be performed onshore was the “soliciting sales of shares of or subscriptions into the Fund.” It was no longer necessary for marketing documentation, subscription documents and shareholder reports to be sent from a location outside of the United States. This was shortly followed by the traditional offshore administrators such as CITCO and Bank of Bermuda (now HSBC) moving onshore to the United States to perform their administration services. Eventually, this repeal leads to perhaps as many as nine of the Ten Commandment activities being performed in the United States. Today, any administrator of offshore funds that wants to be considered ‘a player’ has to have a U.S. presence. The Bear Stearns funds, Bear Stearns High-Grade Structured Credit Strategies Master Fund and Bear Stearns High-Grade Structured Credit Strategies Enhanced Leveraged Master Fund, both had a U.S. based fund administrator and investment manager.

This general trend of moving various activities related to the ongoing operation of an offshore fund to the United States has now had the unforeseen consequence and, for Bear Stearns investors and its creditors, the unwanted consequence of not being able to take advantage of Chapter 15.

In simple terms, Chapter 15 is a new chapter added to the Bankruptcy Code by the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005. The purpose of the act is to:

1. Promote cooperation between the U.S. courts and parties in interest and the courts and other competent authorities of foreign countries involved in cross-border insolvency cases;
2. Establish greater legal certainty for trade and investment;
3. Provide for the fair and efficient administration of cross-border insolvencies that protects the interests of all creditors and other interested entities, including the debtor;
4. Afford protection and maximization of the value of the debtor's assets; and
5. Facilitate the rescue of financially troubled businesses, thereby protecting investment and preserving employment. 11 U.S.C. § 1501.

The cross-border cooperation, which is mandated by Chapter 15, results in lower winding up costs and, consequently more funds being available to the creditors and shareholders of the liquidated entity. Chapter 15 can also be used by offshore funds that are experiencing solvency problems and would like the opportunity to reorganize their affairs, either through formalAdministration or not, without having to file for full bankruptcy. However, if the United States does not recognize that an offshore fund can avail itself of Chapter 15, then more offshore funds will have to file for full insolvency than if such recognition was granted.

For Bear Stearns, and the directors of their two troubled offshore funds, it was important for them that the liquidation of the offshore funds be performed in accordance with Chapter 15 however; Judge Lifland noted that it was clear that the Centre of Main Interests (COMI) for these offshore funds was not in the Cayman Islands, but in the United States. Nevertheless, U.S. legislation, albeit now repealed, may provide good guidance and precedent as to what activities should not be performed within the United States to ensure that an offshore fund’s COMI is not considered to be in the United States.

Clearly, the world has moved on since 1997 and habits are hard to change. However, it is reasonable for investors and creditors to expect that their interests will be dealt with according to laws of their jurisdiction of choice, so it may behoove offshore fund sponsors to consider certain structuring elements of their offshore funds, which may not be difficult to implement, but may produce the desired legal recognition and treatment of investor and creditor interests.

Items for consideration would be:

• Ensuring that the full board of directors are located outside of the United States and that they hold regular board meetings, indicating that mind and management are not located in the United States;
• Maintaining an offshore operational bank account, and using this for receipt of subscriptions, payment of redemptions and payment of expenses;
• Accepting subscriptions and maintaining the share registration services outside the United States;
• Establishing the investment manager as an offshore entity, who oversees or approves the actions of the U.S. based investment advisor;

The fund establishing a physical presence in an offshore location from where an employee or delegate of the fund performs functions, particularly those of an investor relationship nature, expense approval, and other tasks currently performed in the United States by the investment manager.

So who should be concerned? Primarily investors should be concerned that the offshore fund into which they intend to invest is not going to be deemed to have its COMI in the United States, but rather the jurisdiction of their choice, and thus remain entitled to the benefits of Chapter 15 among other advantages. Due diligence procedures on an offshore fund should maybe now consider where the offshore fund’s COMI is likely to be determined; and the old Ten Commandments once again being performed offshore may now become prerequisite for the sophisticated investor. Everything old is new again.

Whilst no investor invests into an offshore fund expecting it to become insolvent or troubled, the recent extraordinary sub prime crisis demonstrates that no area of investment, no matter the pedigree of the investment manager, is immune to problems. Upfront planning and structuring may well pay dividends, literally, for those investors fortunate or far-sighted enough to have invested in an offshore fund that is certain as to the location of its COMI.

This article, Back to the Ten Commandments, details the upfront steps that fund sponsors might want to take to ensure certain protections in a potential bankruptcy proceeding. Roger Hanson and Ronan Guilfoyle, recognized leaders in the offshore hedge fund industry and authors of Back to the Ten Commandments, explain how to best apply these steps in order to prevent similar negative jurisdictional interpretations in the future

For more Information please contact:

Ronan Guilfoyle
Manager
dms Management Ltd
Tel: 345.814.3276
Cell: 345.926.8545
Email: rguilfoyle@dms.com.ky