AIMA's Offshore Alternative Fund Directors' Guide 2nd Edition 2008

ALTERNATIVE INVESTMENT MANAGEMENT ASSOCIATION

Alternative Investment Management Association

AIMA’S OFFSHORE ALTERNATIVE FUND DIRECTORS’ GUIDE 2nd Edition, 2008

Sponsored by

INDEX Foreword 4 1. Introduction 5 1.1 Tax issues 5 1.2 Independent Directors 6 1.3 Local Director/Officer requirements 6 1.4 How to select and appoint Directors 7 1.5 Terms of appointment 7 1.6 Recommended practice 7 2. The Board 8 2.1 Skills, experience, age and other commitments 8 2.2 Directors’ remuneration 8 2.3 Choosing a (standing) Fund Chairman 9 2.4 Whether or not to use sub-committees 9 2.5 Liability 9 3. Board Meetings 10 3.1 Frequency of meetings 10 3.2 Physical vs Telephone Board meetings 10 3.3 Location of Board meetings 10 3.4 Record keeping 11 3.5 Example: Board meeting agenda 11 4. Relationship between the Board and Investment Manager 12 4.1 Matters over which the Investment Manager has discretion and matters which are reserved to the Board 12 4.2 Nature and frequency of information supplied to the Board regarding performance and subscriptions and redemptions 13 4.3 Policies on key operational issues 13 5. Relationship between the Board and Auditors 14 5.1 Supervision and approval of the Fund’s accounts and the audit process 14 5.2 Liability caps 14 5.3 Letters of Representation 15 6. Role of the Board 17 6.1 Review of investment performance 17 6.2 Monitoring adherence to investment policy and restrictions 17 6.3 Monitoring NAV calculation 17 AIMA’s Recommendations on Governance 18 6.4 Monitoring marketing and investor relations 18 6.5 Anti-Money Laundering (AML) responsibilities 19 6.6 Review of the appointment and performance of other service providers 20 6.7 Provision of information to shareholders 20 6.8 Compliance with listing rules and continuing obligations 20 6.9 Side letters 21 6.10 Approval of prospectus and constitutional documents 23 6.11 Exercising discretionary waivers 23 6.12 Governance in between formal Board meetings 24 6.13 Use of experts and advisers by the Board and the costs of doing so 24 7. Directors’ and Officers’ Liability Insurance 25 7.1 General guidance 25 7.2 How to obtain cover 26 7.3 Director indemnification and D&O policy deductibles 27 7.4 Level of cover 27 7.5 Key exposures to consider 29 7.6 Key/problematic exclusions 29







AIMA’s OAFD Guide 2008

Appendices A B C D E F G H I J

Guidance on tax issues: UK, Ireland and the US Supervisory Committee: Swiss requirement Hedge Fund Board responsibilities Matters to take into account in respect of annual audit and accounts Typical continuing obligations imposed by listing rules AIMA’s Industry Guidance on Side Letters Cayman Islands filing and regulatory requirements AIMA Working Group members About AIMA About the Sponsors

32 33 36 37 38 39 41 44 45 46 47

● Copies of the Guide will be available only in hard copy. ● AIMA members will receive the first copy at no charge. Subsequent copies will be £15. ● The cost to non-member companies is £50. Prices are exclusive of VAT, where applicable, and postage & packing.

AIMA’s OAFD Guide 2008



FOREWORD The original Offshore Alternative Fund Directors’ Guide was the initiative of members of AIMA’s Sound Practices’ and Alternative Investment Research committees in 2004. The Guide was first published in June 2005 and this revision was updated and re-published in January 2008. The Guide has three principal audiences in mind, which are, in no particular order of importance: ● Investment Managers and promoters of offshore alternative Funds; ● Individuals who are considering becoming Directors of an offshore alternative Fund; and ● The appointed Board of Directors of an offshore alternative Fund. The Guide considers the fundamental practical, legal and tax considerations when selecting and appointing Directors of an offshore alternative Fund (particularly, a Hedge Fund); it explains the basic tasks which Fund Directors should carry out and suggests ways in which Fund Directors should manage their relationships with the Fund’s service providers. It contains some detail as to requirements and general advice on several important issues, including in relation to review of the annual audited accounts and issues relating to Directors’ and Officers’ liability insurance. Naturally, the potential impact of taxation on a Fund is an important “driver”; consequently, consideration of the impacts of taxation in various specific jurisdictions affecting the Fund, service providers and the Directors is included. The 2007 revision of the Guide adds recommendations on independence and conflicts of interest, Directors’ duties and active contribution, as to expenses and meeting agenda items and fiduciary liability. It also covers auditors’ communications and representations to the Board and incorporates detailed recommendations on valuations, including those contained in AIMA’s Guide to Sound Practices of March 2007, and AIMA’s AntiMoney Laundering Matrix. The UK FSA’s approach to side letters and AIMA’s Guidance Note on Side Letters are included and additional guidance on practical considerations concerning liability insurance, key exposures and any new audit, accounting or regulatory provisions is given. Filing and regulatory requirements in respect of Cayman Island Funds are also set out in an Appendix. The Guide does not take account of any fund governance recommendations which may be made in the final report of the UK Hedge Fund Working Group (due for publication in January 2008). At the time we went to press with this Guide, the Group’s draft report was still under consultation; given the Group’s draft recommendations, we do not, however, expect new ground to be covered. The Guide is not to be taken or treated as a substitute for specific advice, whether legal advice or otherwise. It does not seek to provide advice on wider ranging corporate governance issues. We would like to thank and congratulate the members of the working group (who are listed in Appendix H), all of whom have volunteered their time and worked extremely hard to produce the original work and this revision of a valuable Guide. We intend to revise the Guide further as and when developments or additional material appear.

Steven Whittaker Chair of Working Group

© The Alternative Investment Management Association Limited, 2007 All rights reserved. No part of this publication may be reproduced in any material form (including photocopying or storing it in any medium by electronic means and whether or not transiently or incidentally to some other use of this publication) without written permission by the copyright holder except in accordance with the provisions of the Copyright, Designs and Patents Act 1988 or under the terms of a licence issued by the Copyright Licensing Agency. Application for permission for other use of copyright materials including permission to reproduce extracts in other published works shall be made to The Alternative Investment Management Association Limited. Full acknowledgement to authors, publishers and source must be given. Warning: the doing of an unauthorised act in relation to copyright work may result in both a civil claim for damages and criminal prosecution.



AIMA’s OAFD Guide 2008

Introduction

1.

INTRODUCTION

1.1

Tax issues

Most Hedge Funds which are managed by European Investment Managers are companies incorporated in offshore locations, such as the Cayman Islands, Bermuda, BVI and the like, or in Luxembourg, Ireland or the Channel Islands, which do not impose any taxation on the Fund. Factors such as the location of Board meetings or composition of the Board can, however, affect the Fund’s susceptibility to tax or tax residence. Tax issues are important for such companies because the domestic law of most taxing jurisdictions specifies the circumstances in which the relevant taxing authorities may impose taxation upon companies which are not incorporated in the jurisdiction in question. For example, if an offshore company were to be treated as tax resident in the UK, it would be subject to UK corporation tax on all its profits, wheresoever and howsoever earned. It would also be liable to withhold UK income tax from any interest payments. Any company incorporated outside the UK could, in certain circumstances, become UK taxable. As to the US, an offshore company that has US trading activity usually seeks to bring itself within a “safe harbour” from taxation which is provided in the US tax regulations. In short, a Fund that trades stock, securities or commodities for its own account can avoid US taxation on that activity. Exceptions are dividends and non-portfolio interest; these are subject to withholding tax. One challenging area today arises from the creativity that many Fund sponsors and Investment Managers exhibit. Products no longer neatly fit into the category of stock, securities or commodities and, therefore, cannot fit into the safe harbour. Such activities risk being labelled as trade or business activity and, therefore, may become subject to US taxation at full US corporate income tax rates. For example, a Fund may be subject to US tax on certain of its investments in companies or pass-through investment vehicles which operate businesses in the US and are also treated as partnerships for US federal income tax purposes. In addition, investments in US real property assets or in entities that invest primarily in US real property assets would subject a Fund to US income tax. Further, because the offshore jurisdictions do not have tax treaties with the US or the UK, they are considered “tax havens” from a US and UK viewpoint and as a result raise issues that need to be understood, such as withholding taxes, under US and UK law. It is, therefore, important that an offshore company which is incorporated in a tax neutral jurisdiction does not inadvertently subject itself to taxation in a taxing jurisdiction, thereby imposing an unnecessary tax burden. Particular consideration should always be given to the domestic law of the jurisdiction where the Fund’s Investment Manager is based since this can often increase the risk of causing the Fund to become taxable in that jurisdiction. For illustrative purposes, guidance on when an offshore company would become taxable in the UK, Ireland or the US is discussed in Appendix A. Recommended practice for reducing the risk of a successful claim by the UK, Irish or US tax authorities that a Fund has become taxable in one of those jurisdictions is described in Section 1.6 below.

AIMA’s OAFD Guide 2008



Introduction

1.2

Independent Directors

Best practice for any Fund would be to have a majority of independent offshore Directors and to avoid appointing Directors who represent the advisers or service providers to the Fund because of the potential for conflicts of interest. Independence has become an essential element of a Fund’s Board, from the perspective of investor expectation. This remains the expectation, even though there is no regulatory requirement for most Hedge Funds or Funds of Hedge Funds under the laws of the jurisdiction in which they are incorporated (e.g., Cayman Islands, Bermuda, BVI, Luxembourg and the Channel Islands) to appoint independent Directors. Note, however, that the rules of certain stock exchanges do impose requirements for a minimum number of independent Directors on Funds which seek a listing for their shares. Any Hedge Fund or Fund of Hedge Funds which seeks a listing for its shares on the Irish Stock Exchange will be required by the Irish listing rules to appoint at least two Directors who are independent. A Director will be considered independent where (i) he has no executive function with the Fund’s Investment Manager, investment adviser and their affiliated companies and/or (ii) he has an executive function with any other service provider but is not responsible for carrying out work on behalf of the Fund. However, consideration should be given to the potential for conflicts of interest to arise with an appointment of a Director who also represents an adviser or service provider to the Fund (see the first paragraph under Section 2.1 below). For a Fund of Hedge Funds which seeks a listing on the London Stock Exchange, the listing rules require, among other things, that the Fund has a majority of independent Directors, an independent Chairman and a maximum of one Director who is a Director of (or employee of or professional adviser to) the Investment Manager. A Fund (or a Fund of Hedge Funds) authorised in an EU Member State, the US, Guernsey or Jersey wishing to apply for authorisation for public sale in Switzerland will be required by the Swiss authorities to put in place a Supervisory Committee – see Appendix B.

1.3

Local Director/Officer requirements

Funds incorporated in certain jurisdictions are required to appoint one or more locally resident Directors. Such jurisdictions include: ● Bermuda: if the Fund is listed on a recognised stock exchange, a Bermuda resident representative is required; if the Fund is not so listed, either a Bermuda resident company secretary and a Bermuda resident representative or one Bermuda resident Director and a Bermuda resident company secretary or two Bermuda resident Directors are required; ● Ireland: two Irish resident Directors are required; ● the Isle of Man: one Isle of Man resident Director plus an Isle of Man resident company secretary are required; and ● Jersey: two Jersey resident Directors are required. Other jurisdictions, such as Malta, may have requirements to appoint locally resident Directors. Funds incorporated in the Cayman Islands, the British Virgin Islands and Luxembourg are not required to appoint locally resident Directors.



AIMA’s OAFD Guide 2008

Introduction

1.4

How to select and appoint Directors

Directors are drawn from a variety of sources and skills. When a Hedge Fund is launched, the Investment Manager or promoter usually identifies and arranges appointment of the initial Directors; they are often personal or business acquaintances of the Investment Manager, or may be employed by the Administrator or by the Investment Manager or are chosen from a firm which specialises in providing independent Directors to Funds. However, with increased regulatory and fiscal scrutiny of offshore Funds and wider issues as to corporate governance generally, there are now far greater expectations of Fund Directors, including independent Directors. The Directors of a Fund must have the necessary collective expertise to understand the Fund’s trading and the nature of the underlying investments, including their risk profile and liquidity. They need to have the ability and experience to evaluate the Fund’s performance and the performance of key service providers. In light of the potential tax problems associated with telephone attendance at Board meetings, individuals who are not able or willing to travel to Board meetings on a regular basis (e.g., perhaps because they have too many other directorships) should not be selected. The Investment Manager or promoter should consider carefully not only the experience and expertise of a potential Director but also the number of other directorships and commitments which the candidate has and assess whether he will have the time available to perform his duties properly. Particular care should be exercised where the potential Director is to be provided by a professional services firm. It is not uncommon for such candidates to have several hundred other directorships and very little time and attention to devote to another directorship. Potential Directors of a Fund should always be mindful of any actual, potential or apparent conflict of interest and appropriate disclosures should be made to the Fund’s investors and the Board; the Board may then excuse any Director concerned from discussion and/or voting on a particular subject when a conflict arises.

1.5

Terms of appointment

The role of a Fund Director is a non-executive one and there will not usually be any service agreement or formal terms and conditions regulating his responsibilities, although this is becoming more common. Usually, there are no provisions for any fixed tenure or for retirement and re-appointment. The articles of association (or equivalent) of a Fund will, however, usually specify the events or circumstances in which a Director may be removed from office.

1.6

Recommended practice

Tax issues will not always be clear-cut. There is inevitably an element of subjectivity and one’s “gut reaction” as to where a Fund is actually run is often a good guide. However, by adopting the following guidelines, the risk of a successful claim by the UK, Irish or US tax authorities that the Fund has become taxable in one of these jurisdictions can be reduced: ● the majority of the Directors and the majority of those Directors attending each Board meeting (or committee meeting) should be resident outside the UK and Ireland; ● the Chairman of the Board or of any meeting should not be a UK or Irish resident; ● if the Investment Manager is not based in the US, or is based in the US but does not seek to defer its fees, the majority of the Directors and the majority attending each Board meeting (or committee meeting) can be resident in the US. Accordingly, sensitivity to tax issues may arise if a US manager is deferring fees in the offshore vehicle; ● the Board of Directors should have sufficient collective expertise and experience among its members to be in a position to reach reasoned and well-informed decisions on matters relating to the Fund’s investment policies and strategies; ● the Board of Directors should make all strategic decisions affecting the Fund at Board meetings held outside the UK and Ireland. A UK or Irish resident Director should not make any unilateral decisions whilst physically present in the UK or Ireland. No meetings should be held in the UK or Ireland when there are UK or Irish resident Directors; ● regular face-to-face Board meetings should be held, preferably quarterly; and ● telephone attendance at Board meetings should be avoided wherever possible. When they are held, on exceptional occasions, the guidance given under Section 3.2 below should be followed.

AIMA’s OAFD Guide 2008



The Board

2.

THE BOARD

2.1

Skills, experience, age and other commitments

Any Director should have sufficient and relevant knowledge and experience to carry out his duties as Director. He should also be able to devote sufficient time to carry out those duties and that should be reflected in his remuneration (see section 2.2 below). Whilst the Administrator (or another service provider) may be willing to provide one of the Directors, it is better to avoid appointing Directors who represent the advisers or service providers to the Fund because of potential for conflicts of interest. There are no hard and fast rules about choosing ‘good’ Fund Directors but the following guidance may be helpful: ● a diversity of skills, experience and backgrounds can be useful in ensuring that key specialist areas are adequately covered. For example: prior experience on Fund boards and / or of Hedge Funds; knowledge of the principles of good governance, of current regulatory issues and of industry trends; an ability to introduce capital; technical knowledge as to the Fund’s investment strategy; knowledge of accounting and administration; knowledge of valuation and instrument types; ● to avoid any misunderstandings, a Director’s expected level of involvement should be explained in advance. Directors should also be made aware of the obligations upon them in the jurisdiction of the Fund concerned; ● it is important to get the balance right between Directors who may be affiliated with the Investment Manager and independent Directors. The Investment Manager may wish to control the Board but should not do this at the expense of leaving the independent Directors feeling disenfranchised or outnumbered or of jeopardising the offshore tax status of the Fund; ● ‘trophy’ Directors who are too busy to contribute effectively should be avoided as this undermines Board effectiveness; ● the Directors should be able to make a meaningful contribution and add value to Fund operations; ● Directors should be proactive, prepare for meetings in advance, raise questions or seek reports on areas which concern them; ● Directors should make their own assessment of risk and risk mitigation – i.e., as to how they are managing the risks perceived through delegation, controls, procedures, etc; and ● delegation without oversight is not effective – all delegated activities need some level of periodic upward reporting to the Board.

2.2

Directors’ remuneration

It is recommended that Directors should: ● set their own compensation, to avoid potential conflicts in having it set by the Investment Manager they oversee; and ● have the power, in appropriate circumstances, to hire their own lawyer to advise them (paid for out of the Fund’s assets). Currently, the typical remuneration ranges from very low (e.g., $5,000 p.a.) to approximately $15,000 p.a. or more. Some professional Directors may ask for more. Remuneration may be lower in offshore jurisdictions and higher in European jurisdictions such as Ireland and Luxembourg; €10 - 20,000 may now apply in Ireland. Where there are ‘umbrella funds’ within a Fund of Hedge Funds, a basic fee with an additional fee for each sub-fund may apply. Directors should also be entitled to claim reasonable expenses; if they travel a considerable distance to attend meetings, they may have the right to claim travel and accommodation expenses and may also receive an ‘attendance fee’, as compensation for time otherwise wasted in travel. Factors to be taken into account in setting remuneration include the likely demands on a Director’s time, the nature of the role and responsibilities and the Director’s skill and experience.



AIMA’s OAFD Guide 2008

The Board

Typical requirements of Fund Directors might be: ● attendance at quarterly Board meetings, with set agenda and written papers circulated in advance of the meeting, to allow proper preparation time; ● such meetings will review and approve annual audited accounts (unless there is an audit committee, which will report to the Board, which may approve accounts and associated documentation and review and approve semi-annual accounts; ● further, specially convened meetings for discussion of “one-off” matters - e.g., nominations of additional or replacement Directors, changes to service providers’ contracts or to the prospectus. For further details of the role of a Director, see Section 6.

2.3

Choosing a (standing) Fund Chairman

If the Investment Manager is located in the UK, the Chairman, if one is appointed, should not be a UK resident. Otherwise, it is usually for the Board to decide who is Chairman. Some jurisdictions (e.g., Bermuda) require the Chairman to be named in the prospectus.

2.4

Whether or not to use sub-committees

There is no obligation on a Board to create any sub-committees. However, there may be circumstances when matters may be better or more quickly dealt with by the creation of smaller, specialist decision-making subgroups. For example, a Board might choose to create sub-committees in the following areas:

● ● ●

audit; the process of granting discretionary waivers; and pricing/valuation.

Any sub-committees should, however, be formally created with written terms of reference ratified by the Board. All proceedings and decisions of sub-committees should be formally reported to the Board and fully ratified by resolution. In determining the membership of sub-committees and where any meetings are held, the Directors must be mindful of all comments elsewhere in this Guide relating to taxation and the exercise of central management and control.

2.5

Liability

The matter of fiduciary liability will often need to be addressed when attracting Directors. See Section 7 of this Guide with regard to Directors’ and Officers’ liability insurance cover and the issue of indemnification.

AIMA’s OAFD Guide 2008



Board meetings

3.

BOARD MEETINGS

3.1

Frequency of meetings

Board meetings should be held sufficiently frequently so that the Board is effectively able to carry out its role (as to which, see Section 6 below) and so that relevant guidance on the broader tax issues is complied with (see Section 1 above and Appendix A). The frequency of Board meetings needed to enable the Board to perform its role effectively is ultimately a matter for each Board to decide in light of its duties. However, relevant guidance on broader tax issues must be taken into account. For example, where the Fund has a UK (or, to take at least one other jurisdiction applying similar tax restrictions, an Irish) Investment Manager or Director, it is recommended that the Board of the Fund should meet quarterly outside the UK (or Ireland) in order to reduce the risk that the Fund could become taxable in the UK (or Ireland).

3.2

Physical vs Telephone Board meetings

It is acknowledged that it is not always possible for an individual to travel to every face-to-face Board meeting and on some occasions a Director may wish to participate by telephone. From a practical perspective, Board meetings which are attended by telephone tend not to be as effective as meetings which are attended physically by the Directors. Relevant guidance on the broader tax issues must also be taken into account. For example, from the point of view of avoiding UK or Irish tax residence, the following requirements should be complied with where the relevant Director is a UK or Irish resident: ● a UK or Irish Director’s participation by telephone (from the UK or Ireland) must be avoided unless the Board meeting would not be quorate without the participation of that Director; ● Board meetings by telephone should not be chaired by a UK or Irish resident Director; ● the Directors physically present at the meeting must themselves have the necessary experience and ability to make decisions on the Fund’s business affairs; ● the telephone call should be initiated from the Board meeting rather than by the UK or Irish resident Director or, where a conference call facility is used, it should not be arranged from the UK or Ireland; and ● written Board minutes should be taken at each meeting and be signed outside the UK or Ireland by the meeting’s Chairman. Where a Fund holds regular Board meetings to discuss various issues from time to time, it may not be detrimental if one meeting is held at which the Director attending remotely by telephone is the most experienced in relation to the particular issue in question, although it is always desirable to avoid this where possible.

3.3

Location of Board meetings

It is often the case that offshore jurisdictions do not require any Board meetings for a company incorporated in that jurisdiction to be held in any particular location – for example, a Cayman Islands incorporated Fund is not required to hold any Board meetings in the Cayman Islands. In practice, due to a mixture of travel, cost and convenience issues, the Boards of offshore Funds do not meet in their jurisdictions of incorporation either at all or on a regular basis. Where an offshore Fund’s Board chooses not to meet in the jurisdiction of incorporation of the Fund, it is strongly recommended that the Board avoid holding meetings regularly in any single jurisdiction and it should, as a general rule, hold Board meetings in many different jurisdictions so as to reduce the risk of the Fund becoming taxable in any one of those jurisdictions.

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AIMA’s OAFD Guide 2008

Board meetings

In no circumstances should a Fund’s Board meet in the UK or Ireland because of the risk that the tax authority in either jurisdiction might deem the Fund to be taxable within it. The Board should not meet at all in those jurisdictions where there are UK or Irish resident Directors.

3.4

Record keeping

Both for general corporate governance reasons and having regard to relevant guidance on the broader tax residence issues, the documents and records (including minute books) for the Fund should be kept outside the jurisdiction in which the Investment Manager is resident.

3.5

Example: Board meeting agenda

These are typical matters which might be considered at Board meetings:

● ● ● ● ● ● ● ● ●

● ● ● ● ● ● ● ● ● ● ●

approve and sign (where required) the Fund’s semi-annual accounts; approve and sign the Fund’s annual accounts and the audit process; review investment performance; review and approve valuation policy (or revision thereof); review adherence to investment policy and restrictions; review any issues regarding NAV calculation; review marketing and investor relations; review ERISA/Pension Plan asset status of the Fund, or risk that this will be achieved, where there are US investors; exercise discretionary powers – e.g., - to accept subscriptions below minimum - to accept redemptions at short notice - to waiver an early redemption fee - to apply any “gate”; review and approval of side letter requests; review compliance with listing rules and continuing obligations; review compliance with regulations applicable from time to time (for example, the EU Savings Tax Directive (the Council Directive 2003/48/EC of 3 June 2003 on taxation of savings income in the form of interest payments), MiFID and the US “new issues” and “soft dollar” rules); receive and review reports from the Investment Manager, the Administrator and the custodian/prime broker; approve and sign the audit engagement letter and the audit management representation letter; obtain and review adequacy of supporting comfort representation letters from delegates; approve renewal of Directors’ and Officers’ Liability Insurance; review need for prospectus and other documents to be updated; review Anti-Money Laundering compliance by the Administrator; review the appointment and performance of the Administrator, auditors and other relevant service providers; and updates on matters of regulatory, accounting, audit or industry importance which may impact on the Fund.

AIMA’s OAFD Guide 2008

11

Relationship between the Board and Investment Manager

4.

RELATIONSHIP BETWEEN THE BOARD AND INVESTMENT MANAGER

The Investment Manager will, for legal purposes, often be treated under the laws of its jurisdiction as a fiduciary of the Fund (e.g., this is the case for UK based Investment Managers). As a result, the Investment Manager may owe several duties to the Fund, including: ● a duty of good faith; ● a duty to avoid conflicts of interest between itself and the Fund, as well as between the Fund and other clients of the Investment Manager; and ● a duty not to profit secretly from the Fund. The scope of any fiduciary duties owed by the Investment Manager to the Fund will be based on the scope of the Investment Manager’s role. As a result, the Investment Management Agreement (“IMA”) and related documentation of the Fund (e.g., the prospectus) will be of primary importance. The informed consent of the Fund, as evidenced either in the IMA or otherwise (e.g., by Board action) would be a defence to a claim that such fiduciary duties have been breached. In certain respects, the Fund and the Investment Manager may limit the scope of these fiduciary duties by mutual agreement, although such limitations should be explicit and unambiguous. In addition to fiduciary duties, an Investment Manager may also have other obligations to the Fund for which claims may be made in case of breach. These could include causes of action for: ● negligence; ● misrepresentation; and ● breach of contract. The Board’s ongoing review of the Investment Manager’s performance will necessarily include an evaluation of whether or not these duties have been fulfilled.

4.1

Matters over which the Investment Manager has discretion and matters which are reserved to the Board (and note Board responsibilities in ‘check list’ attached as Appendix C)

Matters in which the Investment Manager has discretion should be determined by the IMA, which is put in place between the Fund and the Investment Manager. The Investment Manager needs discretion for day-today investment activity, dealing, portfolio construction and risk management/control of the Fund. The Board is responsible to the shareholders for ensuring that the Fund adheres to its investment objectives and restrictions. Thus, regular reporting to the Board is essential to enable the Board to determine whether the Investment Manager is continuing to act within its investment management parameters and that no “style drift” has occurred. Whilst it is the Fund which will have contractual agreements with the prime broker and Administrator, it is the Investment Manager who will deal with those parties on a day-to-day basis and, as such, it should be the Investment Manager’s responsibility to inform the Board whether those contractual relationships are working effectively. It remains, however, the Board’s duty to satisfy itself that all contractual service relationships are properly working and the service providers should receive regular reports of the Board’s meetings (quarterly, at least), which review the service and detail any errors or problems arising. For Swiss funds or UCITS (Undertakings for Collective Investment in Transferable Securities), such reports should be made monthly. Some Funds have a separate class of founder shares, which confer certain exclusive voting rights on the holder and which are, typically, held by the Investment Manager or an offshore management entity related to the Investment Manager. The Directors should be aware that: ● auditors may be required to consolidate the accounts of the holder of the founder shares with those of the Fund if they provide “control” of the Fund for accounting purposes; and ● exclusive voting rights must be disclosed in the prospectus.

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Relationship between the Board and Investment Manager

4.2

Nature and frequency of information supplied to the Board regarding performance and subscriptions and redemptions



The Board’s information requirements will depend on the particular strategy or activities of the Fund. In all cases, such information should include copies of all information that is provided to investors (usually monthly or quarterly newsletters), together with key documents filed on behalf of the Fund with regulatory agencies and exchanges. This information should be expanded at quarterly Board meetings, to incorporate a more detailed explanation behind any performance or valuation figures. The future prospects for the Fund are also a responsibility of the Board. To monitor this, they will need information on subscriptions, redemptions and business development strategies (typically the responsibility of the Investment Manager, under the IMA, or of a third party distributor, under a separate distribution agreement). In terms of frequency of information, subscriptions and redemptions should be reported at regular quarterly Board meetings. Subscriptions and redemptions information should also be reported at any special Board meeting which occurs at a critical time for the Fund where redemption requests have built up and would have a considerable impact on a particular dealing day. Examples of such circumstances could include: 1 subscriptions made at about the time the Fund is due to close (to new subscriptions); 2 ERISA/pension plan assets that may have an impact on current investors; and 3 large redemptions, which could destabilise/affect the liquidity “gate”. Redemption information is particularly critical for funds investing in less liquid assets or strategies.

4.3

Policies on key operational issues

Many of the key operational issues for which the Board has responsibility will either involve the actions of the Investment Manager or will be dependent on information provided by, or sourced from, the Investment Manager. These should include but not be limited to: ● delineation of functions. Again, it must be noted that a UK Investment Manager cannot be seen to be taking material policy decisions (as opposed to day to day portfolio management decisions) on behalf of the Fund in the UK. Therefore, the Directors need to be provided with sufficient information to enable them to take overall responsibility for establishing and overseeing the Fund’s investment policies and strategies; ● compliance with stock exchange listing requirements; ● review of the Investment Manager’s functions and of any developments within it (and any potential impact on the Fund); ● regulatory compliance by the Investment Manager and the reporting of any breaches of limits; ● parameters for variations of risk controls; internal risk controls will vary from time to time, despite being within the limits set in the Fund prospectus; and ● reporting any changes which may lead to “style drift”. Assessing the performance of the Investment Manager is an ongoing responsibility of the Board, to be carried out at every Board meeting. Such an exercise is, in large part, a forward-looking exercise. As such, the Board’s decision should not be based solely on past performance. Consideration must also be given to such related factors as:

● ●

the expertise and skill of the specific individuals within the Investment Manager responsible for the Fund; and the resources and commitment of the Investment Manager provided to the Fund.

AIMA’s OAFD Guide 2008

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Relationship between the Board and auditors

5.

RELATIONSHIP BETWEEN THE BOARD AND AUDITORS

5.1

Supervision and approval of the Fund’s accounts and the audit process

It is a standard requirement for a Fund to produce annual and sometimes semi-annual accounts (or financial statements). Annual accounts are then audited by independent auditors. The principle of Directors’ responsibility is not affected by the fact that, more often than not for a Fund, the Administrator rather than the audit firm itself will actually produce the accounts. It is the Directors’ responsibility to select suitable accounting policies and apply them on a consistent basis, making judgements and estimates that are prudent and reasonable. They are also responsible for ensuring that the financial statements give a true and fair view of the Fund’s state of affairs at the end of the year and of the profit or loss for the year in question. In practice, the Directors delegate responsibility for maintaining the Fund’s books and accounts and the preparation of year end accounts to the Administrator and, to this end, the Directors may wish to seek an appropriate letter of comfort from the Administrator. Some accounting standards or local legislation, such as the UK’s, require the inclusion of a specific section on “Statement of Directors’ responsibilities in respect of the accounts”. At the very least, standard audit reports use wording to the effect of: “These accounts are the responsibility of the Fund’s management; our [the auditors’] responsibility is to express an opinion on these accounts based on our audit.” Auditors are appointed by a Fund (the appointment being approved by its Board of Directors) and are typically re-appointed annually. Their terms of appointment are governed by a Letter of Engagement (L/E), which typically sets out a wide variety of matters, including limitation of liability on the part of the auditors. When considering the appointment of auditors, the Directors should take into account the time frame for the provision of audited accounts, the necessity for any additional tax reporting (e.g., PFIC or K1s for US taxable investors), fees, liability caps and whether (as is the case for Cayman Islands incorporated funds) additional sign off by auditors in the Fund’s jurisdiction of incorporation is required. Auditors are required by auditing standards to communicate certain matters with “those charged with governance”. These matters cover such areas as independence, changes in accounting policies, going concern issues, material misstatements, etc. These communications may be oral or in writing. It is considered good practice for auditors to present their audit plan to the Board in advance of the audit work commencing. In addition, auditors usually present their audit findings to the Board following the audit, as the financial statements are being approved. Examples of matters which a Board may wish to take into account in relation to the annual audit and report production process are included in Appendix D.

5.2

Liability caps

The letter of engagement of the auditors to a Fund incorporated in an offshore jurisdiction, such as the Cayman Islands, will usually contain a provision which imposes a financial cap on the liability of the auditor for any losses arising out of a failure by the auditor to carry out its duties properly. The level of such a financial cap is typically a multiple of the annual audit fee or, alternatively, a relatively small monetary amount. The Directors of such a Fund should be aware that this is currently a feature of the audit services marketplace for offshore alternative funds and that, if such a cap is imposed, it should be disclosed in the Fund’s prospectus. This issue is often the subject of negotiation between the Board and the audit firm; accordingly, the outcome might vary from situation to situation. The auditors of Funds incorporated in certain other jurisdictions, such as Ireland for example, are not permitted to impose such a liability cap in their letter of engagement with the Fund since this is prohibited by applicable rules in the Fund’s home state.

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5.3

Letters of Representation

After conducting their audit and before signing the audit opinion, auditors seek a Letter of Representation (L/R) from the Fund’s Directors as to a variety of matters of a factual and opinion nature relating to the records, systems and situation of the Fund which they have audited. The content of L/Rs will often vary as between audit firms, between jurisdictions and from year to year and according to the nature of the Fund and applicable audit standards; matters typically covered, however, will include but are not limited to:

● ● ● ● ● ● ● ● ● ● ●

an acknowledgement of responsibilities; belief that the accounts are fairly presented; a representation that all the appropriate books and records have been made available; a representation that all material transactions have been properly recorded; an acknowledgement of responsibility for establishing and maintaining adequate internal controls; ownership of the Fund’s assets; that the investments and other financial instruments are valued in accordance with the criteria set out in the Fund’s prospectus; representation that all related party transactions have been disclosed; representation that all contingent liabilities have been made known to the auditors; a statement of unadjusted differences which the Directors approve as immaterial for restatement of the financial statements; and management’s responsibility for assessing fraud risk.

Particularly as Directors are generally ‘non-executive’ in their role, they will wish to review the accounts and the L/R carefully as personal liability may attach should the accounts or the representations prove inaccurate. Such a review might focus on several areas: ● contents of the accounts, particularly as to: the auditors’ report, to ascertain whether the auditors have expressed an unqualified opinion; the schedule of investments, to ensure no breaches of investment restrictions, as outlined in the prospectus, have occurred and that the Fund is following its documented investment mandate; liquidity checks and any changes or matters of significance which have arisen in the period; ● content of the L/R, particularly identifying any areas where the Directors might wish to seek limitations (see below) or obtain comfort; ● a ‘representation comfort letter’ from the Fund’s Administrator, particularly as to all matters within the latter’s knowledge or control (which in practice will be many items); ● the availability and content of a similar ‘representation comfort letter’ from the Fund’s Custodian, if there is one; ● good practice would be to ensure that each set of accounts, the L/E (where applicable, as it may not be reissued every audit) and L/R are submitted to all Directors contemporaneously so as to give each Director sufficient time to review the contents and in context. Audit and accounts production timetables can often become quite tight, so an adequate Director review period should be built into the timetable at the outset; and ● where the accounts have been reviewed by the Investment Manager or Administrator (both of whom would normally be expected to be closely involved), the relevant service provider should be asked to highlight for the Directors any matters of significance arising during the year and to provide an explanation of any queries the Directors may have.

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Briefly, when considering how Directors may accept or limit their own responsibility under the L/R, they may wish to consider these factors: ● the Directors of a Fund are almost invariably non-executive but this would never absolve them from overall responsibility for the preparation and accuracy of the accounts; ● a Fund is often required by regulators or stock exchanges (such as the Irish Stock Exchange), by professional investors themselves and/or by good practice, to appoint independent professionals to carry out certain functions, such as administration and custody; ● even if such appointment were not required, the specialist nature of the skills would often make this a practical necessity; ● due diligence should be adopted by or on behalf of the Directors in respect of the relevant professionals, both in their selection and the ongoing performance of their duties (see Section 6 following); ● representation may be sought by the Directors from those relevant professionals, as to the delegated areas covered; ● the professionals so appointed are not mere delegates (as the appointment of a mere bookkeeper would be) but are independent contractors acting in a professional capacity. There should be some reflection of that fact in the L/R – i.e., provided they have exercised due diligence (which may include the seeking of a separate representation comfort letter from the professional concerned), to ask nonexecutive Directors to take unqualified responsibility would often be unreasonable. This approach will assist in reflecting appropriately in the audit process and documentation the responsibilities of the Directors and those of such others; and ● audit practice may differ in some jurisdictions, mainly arising from differences between accounting standards, audit standards, or fund law, regulation and practice (and therefore auditors’ assessment of their risk and responsibility). There can sometimes be an additional auditor requirement for some of the representations to be given by the Investment Manager, which may or may not be appropriate as the Investment Manager is in a different position from the Directors. If representations are needed by the auditor from the Administrator or Investment Manager and are thought appropriate, they should be tailored to their knowledge or role.

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6.

ROLE OF THE BOARD

6.1

Review of investment performance

This is arguably one of the most important functions of the Board because good investment performance by the Investment Manager is the key deliverable as far as the investors are concerned. In practice, the Board will rely on the Administrator to report on the performance of each share class, in terms of figures and it will expect copies of all investment reports sent to investors by the Investment Manager, who should report to the Board for each of its quarterly meetings as to total performance, market conditions and any problems encountered; such reports will explain how the performance was achieved and what risk profile was adopted to generate returns. The Board will also want to understand how the performance compares both with the Fund’s investment objective and with a representative sample of peer managers.

6.2

Monitoring adherence to investment policy and restrictions

Every Fund is required to state its investment policies and restrictions in its prospectus, making current and prospective investors aware of the types of investments the Fund may make and the goals it is trying to achieve. The Directors’ role is to monitor the Fund to see that it complies with its stated investment policies and restrictions. The periodic monitoring of compliance with the Fund’s investment policies and restrictions will, however, either fall to the Fund’s Investment Manager or Administrator. The Directors should, therefore, ask the Fund’s Investment Manager or Administrator to produce a report on the Fund’s compliance with its stated investment policies and restrictions for consideration at each Board meeting.

6.3

Monitoring NAV calculation

The Board of Directors has ultimate responsibility for the valuation of the Fund. They delegate this responsibility to either an Administrator or to the Investment Manager; it is market practice for European and offshore Funds (i.e., most non-US Funds) to have valuation delegated to an Administrator – only in very specific and exceptional circumstances should the Investment Manager have responsibility for valuation. Documented pricing procedures should be approved by the Board in advance of the Fund’s launch and should be disclosed in the Fund’s prospectus. The Investment Manager and the Administrator must also ensure compliance with the valuation provisions disclosed in the Fund’s prospectus. However, another very important function of the Investment Manager and the Administrator where valuation is concerned is to communicate with the Board on valuation issues regularly. A formalised process for reporting valuation issues (for example, stale pricing, liquidity, difficult trading markets, illiquid assets, side pockets or subjectivity) to the Board and any Valuation Committee on a regular basis should be put in place. This allows the Board to delegate the responsibility but also to fulfil the requirement that there is adequate oversight and supervision. AIMA’s “Guide to Sound Practices for Hedge Fund Valuation” (March 2007) makes 15 recommendations in respect of Hedge Fund valuations - as to governance, transparency, procedures, processes and systems and sources, models and methodology. As AIMA’s Guide says, a clearly stated Pricing Policy, together with clearly stated procedures, should be agreed between the Board, on behalf of the Fund, the Auditors, the Investment Manager and the Administrator and it should be signed off by the Board, the Investment Manager and the Administrator. A basic summary of that agreed document should be incorporated into the offering document and the document itself should be included in the list of contracts, agreements and other documentation which investors may review. The pricing document should also be referred to within the Administration Agreement and it is probably helpful to attach it as an Appendix to that agreement.

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The 4 recommendations in relation to governance (the focus of this Guide) are reproduced below but it should be noted that they are not intended to represent a comprehensive or prescriptive set of rules. Rather, they are intended as principles-based guidelines for valuation sound practices.

Recommendations on Governance 1

In advance of the Fund’s launch a summary of practical and workable valuation practices, procedures and controls should be enshrined in a Valuation Policy Document and approved by the Fund’s Governing Body (typically, the Directors), after consultation with relevant stakeholders. The Valuation Policy Document should be reviewed on a regular basis by the Governing Body.

2

The Valuation Policy Document should explicitly clarify the role of each party in the valuation process, should identify price sources for each instrument type and should include a practical escalation or resolution procedure for the management of exceptions.

3

The Governing Body of the Fund should ensure adequate segregation of duties in the NAV determination process, which may be achieved by delegating the calculation, determination and production of the NAV to a suitably independent, competent and experienced Valuation service provider (typically, the Fund’s Administrator). If the Investment Manager is responsible for determining the NAV, and/or acts as the Fund’s Governing Body, robust controls over conflicts of interest should be established.

4

Oversight of the entire valuation process and, in particular, resolution of pricing issues associated with hard-to-price illiquid positions and exotic instruments remains the ultimate responsibility of the Fund’s Governing Body.

6.4

Monitoring marketing and investor relations

In terms of new business activities, the Directors should make themselves aware of the overall plans that the Investment Manager, and any distributors it has appointed, have to promote the Fund. The Directors should also be aware what the target client base is, what the capacity of the Fund is and what restrictions may or may not apply on marketing in certain jurisdictions. A report should be available quarterly, summarising gross and net subscriptions, so that the size of the Fund against its theoretical capacity can be monitored. Once a year, the Directors should ask for a new business presentation by the Investment Manager to ensure that the proposition to the investors is aligned with the description of the Fund contained in the prospectus. In terms of relations with existing investors, a summary of shareholder correspondence should be provided quarterly by both the Investment Manager and the Administrator/Transfer Agent, highlighting key issues being raised so that the Board is aware of common themes such as concerns about performance or concerns about efficient administration. It is advisable for the Directors to be aware of the size of the shareholder base and how it breaks down by type of investor.

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6.5

Anti-Money Laundering (AML) responsibilities

AML laws and regulations are detailed and technical in nature and have evolved and changed considerably over the last several years in a number of jurisdictions. A detailed explanation of AML laws and regulations is beyond the scope of this Guide except to note that there is no one set of AML compliance rules that satisfies the needs of all jurisdictions. AIMA has published an online AML ‘Matrix’ which reviews the requirements in a number of jurisdictions. The recommendations of good practice for Boards of Directors in this context are as follows: 1 The Board should understand the nature of the AML requirements which apply in respect of the Fund and whether responsibility for implementing the necessary procedures has been delegated, as will often be the case, to the Administrator or the Investment Manager. 2

The Board should obtain regular feedback from the Administrator or Investment Manager, to ascertain that the formal procedures in place are being adhered to and that any suspicious findings were raised and investigated accordingly. All suspicious findings and the results of the subsequent investigation should be promptly reported to the Board.

3

The Board should additionally obtain and review the Administrator’s SAS 70 (or equivalent controls report, if it has one) covering all aspects of the Administrator’s operations, including its AML procedures, as well as the exit letter from regulator investigations/audits at the Administrator, if either exists.

4

If no such report exists, consider the need, given the risk profile of the Fund.

5

The AML policies and procedures adopted by the Administrator or the Investment Manager should be in compliance with the AML laws and regulations which apply to the Fund in its jurisdiction of incorporation as well as in the jurisdictions of the Administrator and the Investment Manager.

6

The Board should ensure any changes in the applicable AML laws and regulations are promptly addressed and suitable procedures adopted.

7

The policy adopted should generally also ensure that, until the AML procedures are completed satisfactorily, any new subscription monies remain in the subscriptions bank account and are not transferred into the prime brokerage account.

8

The policy adopted should also ensure that redemptions are paid into the account from which the original investment was wired. In the event that the redeeming investor requests that redemption proceeds be paid into an account different from that from which the investment was paid, the redeeming investor would normally be asked to substantiate in writing the reason(s) for the new account.

9

In the event that a subscription has been accepted without receipt of the full AML documentation, the Administrator must retain the redemption proceeds until the outstanding documentation has been provided.

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6.6

Review of the appointment and performance of other service providers

The Directors should put in place a structure for the regular review of service providers such as the Fund’s Administrator, prime broker and/or custodian and auditors to ensure their continued competitiveness and effectiveness. In practice, the Directors will be heavily reliant on the Investment Manager for much of this process. In particular, the Directors should satisfy themselves that the Fund’s auditor is not conflicted by any work for the Investment Manager and that any potential conflict has been satisfactorily resolved. Certain audit or tax services may require Board pre-approval to ensure that a review has been conducted for conflicts. Any potential for conflict arising from the Administrator providing ‘middle office’ functions for the Investment Manager and ‘back office’ functions for the Fund should also be disclosed.

6.7

Provision of information to shareholders

Directors are responsible for ensuring that shareholders receive, as a bare minimum, the information that is promised to them in the Fund’s prospectus; such information typically includes audited annual accounts, unaudited half-yearly accounts and periodic valuations. The Directors should seek positive assurance from the Administrator that mailings to shareholders have occurred within statutory deadlines. Directors should also add themselves to mailing lists maintained by the Investment Manager for periodic performance or sales updates. A diligent Director will not only absorb the investment update but will also want to be comfortable that information provided is timely, accurate and relevant.

6.8

Compliance with listing rules and continuing obligations

If the Fund’s shares are admitted to listing on a stock exchange, both the Fund itself and the Fund’s Directors will be responsible for ensuring that the Fund complies with the continuing obligations imposed by the rules of that stock exchange. Breaches of the listing rules can lead to the relevant exchange imposing sanctions on the Fund or the Fund’s Directors (such as financial penalties or a public statement censuring the Fund, such as a temporary or even a permanent de-listing of the Fund’s shares). A brief description of the nature of some typical continuing obligations is set out in Appendix E. Directors of listed funds should develop an understanding of the nature and detail of the listing rules applicable and be able to monitor compliance with them.

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6.9

Side letters

It has become increasingly common for investors in Hedge Funds (particularly, institutional investors such as funds of funds, pension plans and government plans) to seek special terms and conditions to govern their investments. Such terms and conditions are often documented in “side letter” agreements with the Fund and/or its Investment Manager. Set out below are some general points which Directors should take into account when considering requests to enter into side letters. If the Fund enters into side letters, the Directors should ensure that the terms in any letter are explained to them by the Investment Manager and, if needed, by the Fund’s lawyers, prior to acceptance. The Board should be made aware of all such arrangements. It needs to be understood by the manager, the adviser and the Board as to which of them should be (or legally is able to be) the signatory of such letters. Directors should also ensure that the use of side letters is monitored on a regular basis for actions that are needed. Both the Investment Manager and Directors should, for example, review “most favoured nation” (MFN) clauses particularly carefully. MFN clauses seek to obtain for an investor the best terms that the Fund or Investment Manager has granted to any other investor in the Fund. A mistake made in connection with a side letter could mean that the Investment Manager and/or Directors may be sued by an investor. Depending on the quantum and extent of such side letter arrangements, the Board may request that monitoring for compliance with the terms is implemented and periodic reporting on same is made to the Board.

The Fund’s prospectus The first consideration when a side letter is requested is whether the Fund’s prospectus and/or articles of association (or equivalent) permits the Fund to enter into a side letter in respect of the relevant special terms and conditions. The Fund’s Directors should take legal advice if they are unsure of the position.

Directors’ duties The Directors must also consider their fiduciary duties as Directors, which include a duty to act bona fide in what they consider to be the best interests of the Fund. This duty is owed to the Fund itself and the effect of this is that the Directors are not entitled to consider solely the interests of a specific shareholder or the Investment Manager in determining whether or not to enter into a side letter. For example, where greater portfolio transparency rights are requested by an investor, the Directors should consider whether this would confer a material advantage over other investors and whether their duties require that the same transparency should be provided or offered to all investors. The Fund’s strategy, the nature of the information to be provided and its timeliness will be relevant factors in making this assessment.

If the Fund is listed on a stock exchange If, for example, the Fund is listed on the Irish Stock Exchange, note that the listing rules require the Fund to ensure equality of treatment for all shareholders who are in the same position. Side letters can, therefore, cause difficulties for the Fund in terms of complying with its listing rule obligations. The Directors should seek advice from the Fund’s listing sponsor if in doubt.

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Signatories to the side letter This depends on the issue which is covered by the side letter – some issues will require the Fund’s Directors to sign (e.g., capacity undertakings or more favourable redemption terms) and others may be signed only by the Investment Manager (e.g., fee rebates and, subject to the terms of the IMA, additional portfolio information).

Requirement for a new share class Generally speaking, a separate share class will be required unless either the prospectus already provides flexibility to grant the relevant special rights or the right is one which can properly be granted by the Investment Manager (e.g., a rebate of fees by the Investment Manager or, subject to the terms of the IMA, the provision of additional portfolio information).

Must disclosure be made to the other existing investors? The Fund’s Directors and/or the Investment Manager should ensure that existing investors have received adequate disclosure that other investors in the same class of shares may be permitted to invest on different and/or more favourable terms and conditions in order for the Directors to fulfil their Directors’ duties and the Investment Manager to fulfil its common law fiduciary duties.

FSA regulated Investment Managers Where a Fund’s Investment Manager is regulated by the FSA in the UK, the FSA has clarified its approach to the use and disclosure of side letters by the Investment Manager. In summary, the Investment Manager will be required to disclose the existence of a side letter which contains “material terms”, and the nature of such terms, where the Investment Manager is party to the side letter or is aware that the Fund, of which the Investment Manager or an affiliated entity is the Investment Manager, is a party to it. For this purpose, a material term can be defined as: “Any term the effect of which might reasonably be expected to be to provide an investor with more favourable treatment than other holders of the same class of share or interest which enhances that investor’s ability either (i) to redeem shares or interests of that class or (ii) to make a determination as to whether to redeem shares or interests of that class, and which in either case might, therefore, reasonably be expected to put other holders of shares or interests of that class who are in the same position at a material disadvantage in connection with the exercise of their redemption rights.” AIMA issued an Industry Guidance Note on Side Letters (in September 2006 and a supplement thereto in October 2006 – together, “AIMA’s Guidance Note”) following discussions with the FSA on this requirement. Although AIMA’s Guidance Note is not “FSA Guidance”, the FSA has reviewed it and confirmed that it will take it into account when exercising its regulatory functions. A copy of AIMA’s Guidance Note is contained in Appendix F.

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6.10

Approval of prospectus and constitutional documents

The Directors both collectively and individually take overall responsibility for all matters relating to the Fund. A key part of this duty is the approval of the Fund’s prospectus, the subscription documents, the Fund’s constitutional documents and its material contracts. This approval will usually be given at the inaugural Board meeting of the Fund. The authority to commit the Fund to the obligations under the various material contracts as well as the statements in the prospectus is vested in the Directors. When a Fund’s shares are being listed on a stock exchange, the prospectus will also constitute listing particulars and further responsibility and potential liability for the contents of the prospectus is thereby imposed on the Directors. The Directors should carry out a periodic review of the Fund’s prospectus and subscription documents (e.g., annually) to ensure that they remain up to date. Material contracts should also be reviewed periodically, although less frequently. The Directors should also review such documents whenever material changes or revisions are made.

6.11

Exercising discretionary waivers

It is normal practice for Funds to reserve the right for the Board of Directors to exercise a discretionary waiver, on request by an investor, over certain terms and conditions relating to subscription or redemption. All such areas of discretion should be clearly set out in the Fund’s prospectus. In case of doubt, the Directors should seek advice. Typically, the areas where discretion may be reserved to the Board are:

● ● ● ● ●

accepting late subscription or redemption notices/monies after stipulated cut-off times; accepting subscription amounts or permitting continuing investments that are less than the stated minimum; waiver of a minimum lock-up period; waiver of early redemption penalties; and waiver of the application of the “gate” (i.e., the power to defer excess redemption requests if redemptions on any one dealing date exceed a stated maximum threshold).

When exercising a discretionary waiver, the Directors will rely on advice from the Investment Manager that, in doing so, the interests of existing investors are not being compromised. They may also wish to ensure that a waiver on any particular dealing date is applied equitably across all subscribing or redeeming investors who are affected. The Directors should take into account whether the Fund’s prospectus requires the relevant waiver to be applied generally in respect of all investors or whether it can be applied to particular investors. Because most waivers are sought at short notice, the Directors may wish to delegate the authority to agree the waiver to the Investment Manager within certain pre-agreed parameters or to a single Director or a committee. Where the Investment Manager exercises this authority, the Investment Manager should be required to report regularly to the Board when waivers have been granted.

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6.12

Governance in between formal Board meetings

Fund Boards should decide how executive authority is to be exercised in between Board meetings because it is unrealistic to expect all governance decisions to be made only at the physical quarterly Board meetings. Several options are possible:

● ● ● ●

a telephone Board meeting (see the recommendation in Section 3.2) can be called for each item as it arises; decisions can be made via unanimous circular written resolutions; decisions can be delegated to an executive management group constituted as a formal sub-committee of the Board with its own terms of reference; or decisions can be delegated to one or other service provider (although this is the least preferred option).

Whereas Directors can delegate decision-making to other bodies, they cannot avoid responsibility for the decisions or actions thereby arising. The Directors should define in advance those more routine items of business that can be delegated to a sub-committee or a service provider. Any decisions made by a delegated body should be reported to the Board in writing at the next regular meeting so that they can be ratified.

6.13

Use of experts and advisers by the Board and the costs of doing so

In addition to the legal advisers appointed to the Fund, who will provide advice to the Directors on issues of law in relevant jurisdictions, the Board may wish to receive independent guidance from time to time on a specialist topic from a party other than one of the contracted service providers. In such circumstances, a specialist adviser can be appointed to provide advice to the Board on either a standing basis or a case-by-case basis. Such specialist topics could include liability insurance, taxation, regulatory developments or valuation of illiquid assets. The Directors must be aware of whether, and in what circumstances, they are permitted to appoint an expert or an adviser and whether the costs of doing so are chargeable to the Fund; the prospectus will provide guidance on what is permissible although there are rarely quantitative limits on what constitutes a reasonable level of expenditure. As it is possible that a representative of the Investment Manager may be one of the Directors and it may not wish the Board to spend money on an independent adviser, it may be sensible to provide that a majority Board decision may elect to appoint such an external adviser.

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Directors’ and officers’ liability insurance

7.

DIRECTORS’ AND OFFICERS’ LIABILITY INSURANCE NOTE: This section should not be viewed or considered as detailed commentary, which would require legal advice.

7.1

General guidance

Directors’ and Officers’ Liability Insurance (D&O) policies tend to come “off the shelf” in pre-printed form; this may convey a set-in-stone legitimacy, discouraging attempts to negotiate more favourable terms. A D&O policy should be viewed as a multi-million dollar negotiable contract, which should be more akin to a negotiated commercial contract than a “take it or leave it, off the shelf” insurance product. Different D&O policies share the same structure but can also vary as to the detail of specific provisions, sometimes dramatically. D&O policies state, in a variety of different ways, that the insurers shall pay on behalf of the Directors loss that the Directors incur from claims made against them, which arise from their wrongful acts committed in their capacity as Directors of the Fund. Directors are often in a difficult position with regard to insisting on Fund-specific D&O insurance being put in place. It may be that the sponsor says that the cover is superfluous since the Fund Director will be covered by a group policy arranged by the sponsor. Insisting on stand- alone cover can be the only way in which a Director ensures that he has unencumbered assets to defend and settle any litigation against him. Being part of a group policy exposes the Directors to the possibility that the sponsor of the Fund may do something to prejudice the Directors’ cover. If the sponsor is based in a different jurisdiction from the Fund, then it is likely that the group policy will have been placed in the sponsor’s jurisdiction. This raises the potential difficulty, in the event of a dispute, of the Director collecting payment of his claim from the insurer in a foreign jurisdiction. A similar problem may occur with indemnity agreements given to Directors by overseas entities. When considering their options for D&O insurance, the Directors are not only protecting their personal liability; they are also protecting investors’ assets. In the event of the non-performance of a D&O policy following a claim, the investors will suffer because the Fund’s assets will need to be used to indemnify the Directors.

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7.2

How to obtain cover

Specialist advice A D&O policy is a highly technical legal document, usually written by a specialist team of insurance lawyers employed by the insurance company. If the policy is poorly negotiated on behalf of a Fund’s Directors, then the outcome of any claim may be extremely detrimental to the Directors and the Fund and benefit the insurance company instead. There is no substitute for good advice; Funds should employ an insurance broker who specialises in D&O insurance and who is also a specialist in the investment sector. It is important that the broker undertakes a process of due diligence on the Fund, to understand fully the insurance risk profile of the Fund, as the broker will be making representations about the risk to insurance companies. Following the due diligence exercise, a broker should be able fairly quickly to provide a number of different proposals for D&O cover and be able to demonstrate clearly the differences between the various D&O products on offer. If Directors ask third party service providers, such as administrators, to arrange the D&O cover then it makes sense for them to ensure that the decision on which D&O options should be submitted to the board for approval is based on qualitative advice. Fund Directors should also consider employing a specialist insurance lawyer to review the D&O products on their behalf. Thought needs to be given, not just to how the D&O policy will respond to claims in the jurisdiction in which the Fund is domiciled, but also as to how it may respond in other key jurisdictions.

Proposal form for D&O insurance Fund Directors (or, normally, one Director on behalf of all other Directors) will be required by the insurers to complete a signed and dated proposal form (in the US, known as an application form). This form usually contains a number of detailed questions and a declaration at the end as to the truth of the statements made in the proposal form. The D&O policy usually deems the proposal form incorporated in the D&O policy and, therefore, forming the basis of the contract agreed between the insurer and the Fund. Great care, therefore, needs to be taken to ensure that the proposal form is correct. Incorrect statements in the proposal form can negate the contract - at the very least, as respects the Director who has made the incorrect statements. Different D&O policies will define differently what constitutes the proposal made to the insurers by the Fund - i.e., is the proposal the signed proposal form and, say, the audited accounts or is it all additional information supplied? Again, care must be taken to ensure that all additional disclosed information is correct as it may form the basis of the contract. Defining what does and does not constitute the proposal for the insurance can be key to avoiding a dispute. Ideally, the insurer would like to see audited accounts, the latest investor report, the Fund due diligence document and a profile of the investor base. Providing a detailed risk profile to the insurer should help them understand the risks better and provide better terms.

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7.3

Director indemnification and D&O policy deductibles

The scope of the applicable indemnification provisions will differ in various jurisdictions and is normally outlined in the Fund’s articles of association and/or the Fund’s prospectus. Irrespective of what the Fund documentation says, the key to whether Directors can be indemnified for their loss, on a contemporaneous basis or after the settlement of any litigation, will normally be enshrined in the relevant company law in which the Fund is domiciled. Under Cayman Islands Law, for example, it seems generally accepted that Funds will be able to indemnify their Directors in many circumstances. Subject to its limit of liability and any deductible (also known as a policy excess or retention) imposed by the insurer, the D&O policy will, effectively, act as a replacement for any indemnity the Directors may be allowed from the Fund. Most D&O policies provide broadly similar cover within their insuring clauses. The main insuring clauses are normally in two parts: the first part covers the personal liability of the Director incurred whilst acting as a Director of the Fund and the second part covers the Fund, but only where the Fund is able to indemnify the Director. In the event of a claim, the insurers will prefer to pay the claim under the second insuring clause and they do so by stating that they will presume (normally except in a situation where the Fund is financially impaired) that the Fund has indemnified the Director to the fullest extent permissible by the applicable law (called “presumptive indemnification” by insurers). The reason the insurers prefer to have the claim under the second insuring clause is because there is a policy deductible (i.e., the first part of any claim, for which the Fund is liable), whereas the first insuring clause, the Directors’ personal liability cover, almost always has a nil deductible. If the Fund is unable to indemnify the Directors, due to its financial impairment, many policies will agree to indemnify the Directors from “the ground up”, i.e., the insurers waive their rights to apply the policy deductible to the loss of the Directors (even though the loss would be indemnifiable by the Fund), the insurers will normally retain their right to reclaim the amount of the deductible from the Fund.

7.4

Level of cover

Cover for Fund Directors only A standard D&O policy covers natural persons who are past, present and future Directors of the Fund and responds to claims made against them during the period of the policy. Many Boards, whilst being made up of only non-executives, will be a mix of independent Directors and individuals connected to the Investment Manager and the Fund’s other service providers. The D&O policy has a single aggregate limit of liability, which has to be shared by all of the Directors, for all claims which are made during the period of the policy (normally 12 months). In the event of litigation against the Fund’s Board, it may be that the different non-executive Directors of the Fund have very different views on the defence and settlement of the claim and there may be conflicting positions, so that each Director may want to instruct his own legal team to conduct his personal defence. Having many law firms and Counsel working on the same claim, for different Directors, could quickly erode the aggregate limit of liability.

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Directors’ and officers’ liability insurance

Fund and manager group policies It may be that the Directors are insured within a single joint-policy, which potentially covers: ● the Directors and Officers of the Fund; ● the Investment Manager of the Fund and its employees (Professional Indemnity Insurance); ● the Fund’s corporate liability (and potentially, indemnities provided by the Fund to the service providers under the material contracts); and ● the General Partner of a Limited Partnership. Having all of the above parties insured within a single annual aggregate limit of liability can be a cost effective solution but it can create tensions, particularly if the Directors or the Fund needs to claim against the Investment Manager. The Directors need to consider whether there will be enough cover to meet their personal liabilities (and indirectly, therefore, to protect the Fund’s assets from having to indemnify them) in the event that there is a claim under a joint policy that is made against the Directors and other parties who are also covered. The indemnity is paid out on a first come, first served basis, so that if the cover is inadequate, somebody will be left without any insurance protection.

Limit of liability of the policy In determining an appropriate level of cover, Fund Directors should seek advice about the potential legal costs of defending complicated and protracted litigation and/or investigations brought by investors and/or regulators. As the D&O policy will also pay damages, consideration needs to be given to potential damages and any punitive awards in setting the limit of D&O cover. The annual aggregate limit of liability of the policy needs to pay for all legal fees and damages (including potentially punitive damages in certain territories) incurred by the Directors in connection with all claims made. With all parties insured by a single limit, the limit will need to be adequate to fund the defence costs for a complicated defence, where each party might require its own defence team. It is possible that there may also be litigation in more than one jurisdiction in respect of the “same” claim. The question of damages and what might be a sufficient limit to pay the compensatory or punitive damages part of the claim is much more difficult and needs to reflect the overall size of the Fund and what magnitude of event or drawdown might be a trigger for investor litigation. Many policies are denominated in Dollars. If the Directors are likely to incur costs in a currency other than Dollars (e.g., the potential cost of using UK Counsel in Cayman litigation), then the prevailing exchange rates need to be considered in setting an adequate limit. Directors should undertake a cost/benefit analysis when setting the level of their D&O cover and will need to bear in mind that inadequate limits of cover, or a poorly constructed D&O policy, may mean that the Directors will have to call on a Fund’s assets for indemnification where the D&O policy fails to respond.

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As a rule of thumb, and not based on the actual relative exposures of a Fund’s Directors to defence costs and damages awards, the following limits of D&O cover are indicative, based on the assets of the Fund: Fund assets (US$) 0-0.5bn 0.5 bn to 1bn 1bn to 2.5bn 2.5bn to 5bn >5bn

7.5

Limit of D&O cover (US$) 5m 5m to 10m 10m to 15m 15m to 30m >30m

Key exposures to consider

The price of the D&O insurance is important but the breadth of the cover is vital and it is the quality of the cover which determines its value. Whilst considering their options, Directors need to think about what their and the Fund’s key exposures are and whether the D&O policy correctly addresses these. These exposures would include investor litigation, regulatory claims and investigation, asset valuation problems, misrepresentations in the prospectus, extradition to the USA and service provider claims and indemnities.

7.6

Key/problematic exclusions

Most D&O policies provide broadly similar cover within their insuring clauses. However, the most important differences in cover are normally contained in the policy definitions and exclusions, particularly the additional exclusions endorsed onto the policy by the insurers.

Policy definitions D&O policies respond to the legal liability of the Directors for “loss” resulting from a “claim” for a Director’s “wrongful act”. The words in quotations are normally defined terms and all these definitions need to be triggered for the policy to respond in the first instance (even before any exclusions are applied by the insurer). “claim” should be broadly defined so that the policy will respond to all likely routes of litigation, including any initial written demand, even if the demand does not quantify the claim in monetary terms. “loss” defines what the insurers will pay (generally, defence costs and damages/settlements) and what the insurers will not pay (generally, fines and taxes). Care needs to be taken to check whether the insurers have included or excluded punitive damages cover, as the claim may be heard and an award made in a US court. “wrongful act” is fairly universally broadly defined as any act or omission committed by the Director whilst acting in his capacity as a Director of the Fund. It is particularly important to review how the policy will operate for litigation in the US. How does the policy define the jurisdictions in which it responds? Is it full worldwide cover or does it exclude the US or some US statutes?

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Directors’ and officers’ liability insurance

Policy exclusions It is important to look at exclusions not just in terms of the particular thing that is excluded by them, but also as to what the preamble to the exclusion says. The preamble largely dictates how broadly the exclusions can be applied by the insurers. D & O policy exclusion preambles The preambles below, numbered (1) to (3), are representative of the different types used in exclusions. They range from: 1 “For ”… XYZ This type of exclusion is known as a “for language exclusion” and the intent is that it only excludes the direct loss from XYZ that is specifically excluded by the exclusion. The insurers’ stated intent is that indirect loss is not necessarily excluded by this exclusion.

2

“Arising out of, based upon or attributable to”… XYZ. This type of exclusion seeks to exclude direct or indirect loss where the originating cause of the loss is XYZ.

3

“Arising out of, based upon or attributable to, or in any way involving, directly or indirectly” … XYZ. This type of exclusion is known as an “absolute exclusion”. The preamble to the exclusion is so broadly written that if litigation mentions XYZ, even if it is not the main focus of the claim, then the insurers will have the right to deny cover.

D&O policy exclusions There are a number of additional exclusions which are often applied to standard D&O policies by insurers and the Fund’s Directors need to look at the specific wording of the exclusion, in conjunction with the exclusion’s preamble, to see how broadly each exclusion can be applied. It is important to look at what the exclusions actually say, rather than just rely on any stated intent, and to consider what the impact might be when considering the likely triggers of litigation under a D&O policy. Many policies exclude claims under the following exclusions:

Market fluctuation exclusion The depreciation or loss of investments when such depreciation or loss is a result of any fluctuation in any financial, stock, commodity or other market when such fluctuation is outside the influence or control of a Director.

Investment performance exclusion Any stock or commodity or investment failing to perform as represented or as expected to perform.

Money laundering exclusion In respect of any claim arising out of, based upon, attributable to or in any way involving any actual or alleged act of money laundering.

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Major shareholder exclusion (or closely held exclusion) Where any shareholder owns more than 15% of the Fund.

ERISA exclusion Claims made under the US Employee Retirement Income Security Act of 1974 .

SEC exclusion Claims made under the US Securities Act of 1933 or the Securities Exchange Act of 1934.

Jurisdiction exclusion Claims made in the US or the enforcement of US court decisions in other territories.

Market abuse exclusion Punitive damages exclusion Regulator claims exclusion Insolvency exclusion Can exclude claims from a Fund’s insolvency. Fund Directors should be particularly wary of this exclusion since in the event of insolvency there will be no indemnity from the Fund and the Directors will be relying on the insurance to fund their defence costs. The potential impact of some, or all, of these exclusions needs to be considered in line with the protections that the Directors are seeking for themselves and for the Fund’s assets.

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APPENDICES

Appendices

APPENDIX A - Guidance on tax issues: UK, Ireland and the US Guidance (for illustrative purposes only) on when an offshore company would become taxable in the UK, Ireland or the US (see Section 1.1 above)

Basic rule in the UK The basic rule in the UK is that an offshore company will be considered taxable in the UK if central management and control of the company is exercised in the UK. Central management and control should be distinguished from the day-to-day running of the Fund. Central management and control is the strategic decision making process and would generally include matters such as the setting and regular review of the investment policies and strategies of the Fund and determining whether the Fund should appoint a new Investment Manager. This contrasts with the day-to-day running of the Fund, which would include decisions such as whether or not to buy or sell a particular investment (which will usually be delegated to the Investment Manager). Central management and control is normally exercised by the Board of Directors of the Fund but it could in appropriate circumstances be exercised by any other person (e.g., the Fund’s Investment Manager). UK tax susceptibility is a question of fact and it is necessary to show in each case that central management and control of the Fund is genuinely exercised outside the UK.

Location of Board meetings In identifying where the central management and control of a Fund is exercised, the starting point is its Board of Directors. Normally, the Fund’s constitution will give the Board the relevant powers and, in considering where the Fund is taxable, the location of its Board meetings is the best place to begin. However, it is not automatic that taxation will arise in the jurisdiction in which Board meetings are normally held; most obviously, the Board may not, in practice, be exercising central management and control. Two questions in particular will be relevant:

1

Does the Board have any real discretion or is it only allowed to take decisions within narrow parameters set down by (for example) the promoters of the Fund? If its discretion is too tightly restricted, it may not be exercising central management and control.

2

Is the Board truly taking decisions when it meets? It may be merely rubber-stamping the decisions of those to whom it has delegated powers or, alternatively, its members may take decisions in the UK before flying offshore for a meeting whose only purpose is presentational.

Restrictions on the discretion of the Board The question of restrictions which may be imposed on the Board of a Fund is a difficult one in the context of determining UK taxability. It is obviously appropriate that objectives or other guidelines (for example, restrictions on borrowing or leverage) should exist. These will be incorporated into the prospectus or the document under which the Fund’s shares are offered to investors. These determine the parameters of the business to be carried out and for which the Fund is established and which it is the Directors’ responsibility to manage. The limits on the Board’s discretion imposed by the terms of the prospectus should not compromise the independence of the Board. The non-UK taxable status of the Fund may, however, be called into doubt if the Board is simply authorising actions already determined by the Fund’s promoters in the UK.

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Appendices

Delegation of discretion The constitution of the Fund may permit the Board to authorise individual Directors or set up a committee to take decisions on its behalf. This should be avoided unless the Director is resident, and carries out his duties, outside the UK or the committee meets outside the UK and is not comprised of a majority of non-UK resident Directors. The appointment of an Investment Manager or Administrator of the Fund does not contravene this principle provided that the duties delegated do not amount to “central management and control”. The Board must retain the overall responsibility for the setting and regular review of the Fund’s investment policies and strategies and determining whether the Fund should appoint new Investment Managers.

Location of real decision making process The UK tax authorities may be sceptical that Board meetings are anything more than a rubber-stamping process if a majority of a Board of Directors are UK resident and are not themselves resident in the jurisdiction where Board meetings regularly take place. If, for example, a majority of the Directors of the Fund live and work in the UK but fly out to an offshore location every three months for meetings, it will be difficult to convince the UK tax authorities, should they review the position, that the Directors are not communicating with each other in discussing the business of the Fund when in the UK, so that the Board meetings are purely presentational. It is not sufficient for the Board merely to meet in an offshore jurisdiction; it must actually exercise central management and control – in other words, the real strategic decisions must be taken offshore. The UK tax authorities may also be sceptical that Board meetings are the real decision making forum if the Board lacks members with expertise and experience so it cannot reach reasoned and well informed decisions on matters relating to the Fund’s investment policies and strategies.

Basic rule in Ireland The circumstances in which an offshore company will be considered taxable in Ireland are substantially similar to those in which an offshore company can become taxable in the UK. As a result, many of the recommended practices to prevent such circumstances arising apply equally in respect of Ireland and Irish resident Directors of such a Fund as they do to the UK and UK resident Directors.

Basic rule in the US An offshore company will not be subject to US federal income taxes on income or gains from trading stock, securities or commodities (except in respect of any dividends received in the course of such trading, as discussed below), provided that it does not engage in a trade or business within the US to which such income or gains are effectively connected. Pursuant to safe harbour provisions under the US Internal Revenue Code of 1986, as amended (the “Code”), a non-US corporation will not be considered to be engaged in a US trade or business so long as the corporation is trading stock, securities or commodities for its own account, provided that the non-US corporation is not a dealer in stock, securities or commodities. However, if the activities of a non-US corporation were not able to utilise the safe harbour provisions, there is a risk that such corporation would be required to file a US federal income tax return for the year in which such activities took place and pay tax at full US corporate income tax rates as well as an additional thirty percent (30%) branch profits tax. Activities in which an investment manager risks the possibility of US taxation include real estate investments and investments in partnerships, limited liability companies or Subchapter S corporations which operate businesses in the US.

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Appendices

Dividend income An offshore company would be subject to US withholding tax at a rate of thirty percent (30%) on its US sourced dividends, unless a reduced rate is applicable under a US tax treaty with the company’s country of domicile.

Interest income Non-US corporations are not subject to US federal income or withholding tax on US source interest income (other than in the case of certain contingent interest or interest received from a borrower ten percent (10%) or more of the equity of which is owned by the corporation), provided that certain restrictions apply. The corporation must not be engaged in a trade or business within the US to which such interest income is effectively connected. In addition, the corporation’s interest-bearing securities must qualify as registered obligations. Further, the corporation must supply an IRS Form W-8BEN or its equivalent to the security issuer when required to do so by the IRS.

Recommended practice Under current US law, a majority of the Directors of an offshore Fund can be US residents, unless the Investment Manager chooses to defer any portion of its management fees or incentive fees, a practice adopted by many US Investment Managers. If a US Investment Manager defers its fees, a majority of the Directors of the Fund should be non-US residents, since the control of the Fund should be outside the US.

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Appendices

APPENDIX B - Supervisory Committee: Swiss requirement (see Section 1.2) Where a Hedge Fund or Fund of Hedge Funds authorised in an EU Member State, the U.S., Guernsey or Jersey (the “Home Jurisdiction”) wants to apply for authorisation for public offering in or from Switzerland, the Swiss authorities will require that a Supervisory Committee be established locally in the Home Jurisdiction (i.e., the members of the Supervisory Committee must be resident in the Home Jurisdiction) and that the following terms are imposed on it:

●

●

the Directors have delegated to the Supervisory Committee the responsibility for supervising (i) compliance with the Fund’s Investment Restrictions, (ii) the day-to-day asset allocation of the Fund and (iii) the Investment Manager’s activities. The Supervisory Committee must also have the duty to ensure that, at all times, the Investment Manager and the other services providers to which any functions have been delegated by the Fund are in compliance with the terms of the delegation agreement, the applicable law and regulations in the Fund’s Home Jurisdiction, the Articles of Association and the Prospectus; and the Supervisory Committee must ensure compliance by the Fund with the Investment Restrictions and oversee the implementation of its investment objectives and policies and review periodically all day-to-day investment decisions taken by the Investment Manager.

Notes

36

1

Meetings of Directors appointed to such a Supervisory Committee will probably have to take place on a regular basis (i.e., on a monthly or quarterly basis), depending on the investment policy of the Fund and the periodicity of investment decisions.

2

The members of the Supervisory Committee must have online access to the Fund’s portfolio, in order to be in a position to oversee the investment policy and review on a day-to-day basis the investment decisions.

3

Where a Director serves on a Supervisory Committee, an additional fee may be appropriate (see Section 2.2 above).

AIMA’s OAFD Guide 2008

Topic Monitoring of Fund versus investment objectives Monitoring of Fund versus investment risk parameters Pricing policy for all Fund assets Monitoring NAV calculation Suspend NAV Creation of reserves Assess shareholder suitability Application of the redemption gate Compulsory redemption Suspend redemptions Suspend payment of redemption proceeds Share transfers Refusal of a subscription Oversight of AML arrangements Monitor performance of each service provider

Appointment of auditors Approval of the Fund’s accounts and the audit process Side letters Maintenance of Fund documentation Waivers for minimum subscriptions

Waivers for late notice redemptions Waivers of redemption penalties Management of sub-committees Convene shareholder meetings Directors’ and Staff Dealing Disclosure of/prevention of conflicts of interest Declare dividends

Board Role

Monitoring adherence to investment policy and restrictions

Monitoring adherence to investment policy and restrictions

Monitoring NAV calculation

Monitoring NAV calculation

Monitoring NAV calculation

AIMA’s OAFD Guide 2008

Monitoring NAV calculation

Monitoring marketing and investor relations

Monitoring marketing and investor relations

Monitoring marketing and investor relations

Monitoring marketing and investor relations

Monitoring marketing and investor relations

Monitoring marketing and investor relations

Monitoring marketing and investor relations

Anti-money laundering responsibilities

Review of appointment and performance of service providers

Review of appointment and performance of service providers

Compliance with listing rules and continuing obligations

Side letters

Approval of prospectus and constitutional documents

Exercising discretionary waivers

Exercising discretionary waivers

Exercising discretionary waivers

Governance

Governance

Other

Other

Other

Yes/No?

Yes/No?

Yes/No?

Yes/No?

Yes/No?

Yes/No?

Yes/No?

Yes/No?

Yes/No?

Yes/No?

Yes/No?

Yes/No?

Yes/No?

Yes/No?

Yes/No?

Yes/No?

Yes/No?

Yes/No?

Yes/No?

Yes/No?

Yes/No?

Yes/No?

Yes/No?

Yes/No?

Yes/No?

Yes/No?

Yes/No?

Policy?

Dividends declared by resolution

Directors’ declarations

Dealing policy

Calendar of forward events

Board oversight

Management sub-committee

Management sub-committee

Management sub-committee

Changes adopted by resolution

Log of side letters

Annual audit review

Letter of Engagement

Key Performance Indicators

AML policies of Administrator and HFM

Definitions of eligible investors

Definitions of eligible investors

AML restrictions

Permissible circumstances listed

Definitions of eligible investors

Limits of XX$ or $XXmn

Definitions of eligible investors

5% limit on creation of reserves

Board resolution required

Approval of any exceptions

Pricing policy

Board oversight

Board oversight

Board’s Control Mechanism?

HFM

N/A

Nominated Fund Directors

HFM

N/A

Management sub-committee

Management sub-committee

Management sub-committee

HFM

HFM

Audit sub-committee

HFM

HFM

Administrator and HFM

Administrator and HFM

Administrator and HFM

Administrator and HFM

Administrator and HFM

Administrator and HFM

Administrator and HFM

Administrator and HFM

Administrator and HFM

Administrator and HFM

Administrator and HFM

Administrator and HFM

HFM

HFM

Delegated Party

Quarterly report to Board

As required

As required

Quarterly report to Board

Annual review of ToR

Quarterly report to Board

Quarterly report to Board

Quarterly report to Board

As required

Quarterly review of log

Annual audit review

Annual audit review

Quarterly report to Board

Quarterly report to Board

Quarterly report to Board

Quarterly report to Board

Quarterly report to Board

None currently

Quarterly report to Board

Quarterly report to Board

Quarterly report to Board

Quarterly report to Board

Quarterly report to Board

By exception only

Review of written policy

Quarterly report to Board

Quarterly report to Board

Reporting to Board

Appendices

APPENDIX C - Hedge Fund Board responsibilities (see Section 4.1)

37

Appendices

APPENDIX D - Matters to take into account in respect of annual audit and accounts Matters which a Board may wish to take into account concerning the annual audit and accounts production process (see Section 5.1)

●

●

● ● ● ● ● ● ● ● ● ● ● ● ● ● ●

38

Agree audit and related (e.g., PFIC or K1) fees in writing early on in the year to be audited and provide a fee estimate to the Administrator for expense accruals. If these are provided early in the year, they are likely to be estimates because, if a Fund doubles in size or changes its structure, there will obviously be a need to reassess the fees. Agree in advance of the year end the timetable and process responsibilities (especially the roles of the auditor, Investment Manager and Administrator). As auditors may run very close to deadlines, it may be advisable to agree a deadline some time ahead of the regulatory deadline, to ensure that the Directors have sufficient time to review the audit and accounts. Confirm with the auditors if they will be asked to make a formal presentation to the Board on the audit planning, approach and results of the audit work performed. Ensure any new auditing, accounting or regulatory provisions have been considered and factored into the audit approach (e.g., new US GAAP requirement under FIN 48 for assessment of all tax positions taken). Confirm and observe any applicable deadlines to be met – e.g., pursuant to the prospectus and under the Irish Stock Exchange listing rules (if applicable). Agree the format of the accounts, particularly where there are any new audit standards or a new audit firm or office is involved. Consider any applicable Irish Stock Exchange content requirements (and responsibility for checking compliance) and inclusion of the Directors or Investment Managers’ report (these may not automatically be covered by the auditors). Ensure that the final audited accounts are sent to all local regulators and/or stock exchanges, as required and all other regulations (e.g., consent letters, etc.) are complied with. Remember Commodity Pool Operator statement and deadlines if the Investment Manager is CFTC registered. For a Cayman incorporated Fund, ensure that the Cayman office of the auditors is involved early so they do not make significant changes later. Establish the auditors’ letter of engagement (L/E), including any updates. Be aware of the different limitations of liability between different offices of the Fund’s auditors and between different audit firms. Establish the form and content of any Directors’ letter of representation (L/R) required by the auditors at an early stage (particularly, check the responsibilities which the auditors think the Directors have). Seek from the Administrator an appropriate letter of comfort in relation to the Directors’ L/R since they have done most of the work and have the most knowledge on the state of the records. Remember to read critically the notes to the accounts (they frequently contain more than accounting principles and may be factually inaccurate if not reviewed by those governing the Fund and overseeing changes on an ongoing basis). Identify the availability of the Fund Directors so they have time to consider and approve the accounts, the auditors’ L/E and the L/R. Establish print quantities and/or email format for accounts to be circulated to registered holders and underlying investors. Where electronic copies are issued, there are usually certain terms, outlined in the auditor’s L/E, to be adhered to. Obtain and file electronically signed PDF accounts as this is often required for investor due diligence requests (e.g., Cayman e-filing requirement).

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Appendices

APPENDIX E - Typical continuing obligations imposed by listing rules (see Section 6.8)

Disclosure obligation The overriding obligation imposed is that the information necessary to enable the public and shareholders to evaluate the financial position of the Fund and to avoid the creation of a false market in the Fund’s shares must be made public knowledge without delay. This means that the relevant stock exchange will require that an announcement be made of such information as soon as possible. The stock exchange releases such announcements to the Regulatory News Service, which feeds summary information to various services such as Bloomberg and Reuters. This overriding obligation does not prevent the Fund from disclosing information to its advisers, parties with which it deals, or to any regulatory or statutory authority. However, in such cases, procedures must be in place to prevent persons with this information from dealing in shares before the information becomes public. If the Fund is listed on more than one stock exchange, the Fund must usually ensure that the same information is provided to each stock exchange. Any announcement released by a Fund must contain all material information relating to the matter being announced.

Routine announcements Certain routine announcements (e.g., the Fund’s net asset value per share) must typically be sent to the stock exchange at the same time as they are released to the market. The Fund’s Administrator would normally prepare and send such routine announcements to the stock exchange.

Notification of interests in shares The Fund will also typically be obliged to notify the stock exchange of interests (that it is aware of) in the Fund’s shares held by certain persons such as the Fund’s Directors and certain family members and the Fund’s Investment Manager.

Controlling shareholders Where the Fund’s shares carry voting rights, a Fund may be obliged to notify the stock exchange of the holdings of certain controlling shareholders. For example, the Irish Stock Exchange requires notification of the holdings of:

● ●

any person who is entitled to exercise, or to control the exercise of, 30% or more of the rights to vote at general meetings of a Fund; or any person who is able to control the appointment of Directors who are able to exercise a majority of the votes at the Board meetings of the Fund.

Restrictions on dealings in shares The Fund may also be required to adopt rules prohibiting certain persons (e.g., the Directors and the Investment Manager) from dealing in the Fund’s shares at any time when they are in possession of price sensitive information.

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Appendices

Financial reports The stock exchange will typically require the Fund to prepare an annual report including full audited financial statements and a semi-annual interim report including unaudited financial statements. The annual and interim reports must be sent to shareholders within a certain time period of the end of the financial year and must be received by the stock exchange within the same timeframe. Audited annual reports and unaudited interim reports must typically be prepared in accordance with stock exchange policy and acceptable accounting standards.

Issues requiring the prior approval of shareholders Under the rules of the relevant stock exchange, certain issues must be voted on by the shareholders before a Fund may take any action. For example, the rules of the Irish Stock Exchange require a shareholder vote in respect of: ● any proposed material change in the investment policy and/or objective of the Fund (only if the change is within three years from the date on which the Fund commenced operations); ● certain related party transactions; ● any proposal to change the open or closed-ended status of the Fund (shareholder approval is not necessary where this fact has been disclosed in the listing particulars of the Fund); ● any matter of which the Fund or its sponsor is aware which could materially adversely affect the rights attaching to the shares in a manner which is not provided for in the listing particulars of the Fund; or ● any proposal to issue shares at less than the net asset value per share, where those shares are not offered first on a pro-rata basis to existing shareholders. In exceptional circumstances, the Irish Stock Exchange reserves the right to require prior shareholder approval of any proposal which may result in a substantial change in the nature and substance of a Fund.

Circulars If the approval of shareholders is required on any matter, a Fund must send a circular to shareholders. The circular should be submitted to the relevant stock exchange in draft form (unless it relates solely to an Annual General Meeting at which only ordinary business is to be conducted).

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Appendices

APPENDIX F - AIMA’s Industry Guidance on Side Letters Introduction and status Following discussions with the UK’s FSA as to clarification of various issues arising out of its Feedback Statement 06/2 (FS06/2) regarding the use and disclosure of side letters, AIMA issued this Industry Guidance (which is accessible to the public via AIMA’s site). The decision whether to follow this Industry Guidance is for the firms concerned. However, the FSA has reviewed it and confirmed that it will take it into account when exercising its regulatory functions, although this cannot affect the rights of third parties. This is not FSA Guidance and, in the event of any conflict, the FSA Handbook prevails.

Disclosure requirement In summary, firms will be required to disclose the existence of side letters which contain “material terms”, and the nature of such terms, where the firm is a party to the side letters or is aware that a Fund of which the firm or an affiliated entity is the Investment Manager is a party to them. Firms will not be required to disclose the existence of side letters which contain no material terms.

What is a material term? A material term can be defined as: “Any term the effect of which might reasonably be expected to be to provide an investor with more favourable treatment than other holders of the same class of share or interest which enhances that investor’s ability either (i) to redeem shares or interests of that class or (ii) to make a determination as to whether to redeem shares or interests of that class, and which in either case might, therefore, reasonably be expected to put other holders of shares or interests of that class who are in the same position at a material disadvantage in connection with the exercise of their redemption rights”. Common examples of terms which are likely to be regarded as material terms would include preferential redemption rights (including an agreement to accept a shorter notice period for redemptions), “key man” provisions, redemption “gate” waivers and portfolio transparency rights. Common examples of non-material terms would include fee rebates and “most favoured nation” clauses. A term which would otherwise be a material term may not, however, be a material term if it does not, in practice, provide one investor with more favourable treatment. For example, where a side letter contains a term granting a shorter notice period for redemptions, but the fund undertakes to accept an identical notice period in respect of all other investors in the same share class, the term would be “cured” of its materiality.

Nature of disclosure Firms should give a brief description of material terms contained in side letters which have been entered into (for example: “we have entered into side letters with investors, which contain material terms which: (a) grant preferential redemption rights; (b) contain a “key man” provision; (c) [etc]”). Firms are not expected to disclose the number of side letters, the dates on which they were entered into or the parties to them. Where side letters containing material terms have been entered into with investors whose shareholding or interest, individually or in aggregate, is significant (i. e., in excess of 10%), firms should consider highlighting this fact.

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Timing of disclosure Initially, firms will be expected to make disclosure by 31st October 2006 of all material terms contained in side letters entered into prior to that date. Such disclosure should extend to all side letters containing material terms, whether entered into before or after the publication of FS06/2, other than side letters entered into with investors who have previously redeemed their shares or interests. Thereafter, firms will be expected to keep this disclosure reasonably up-to-date and to make reasonably timely disclosure where a side letter is entered into which contains a material term of a category not included in the firm’s previous disclosures.

To whom must disclosure be made? Firms should make disclosure of relevant side letters both to existing and to prospective investors. In the case of existing investors, in particular, firms will need to consider to whom it is appropriate to make the disclosure (for example, the registered holder or, where relevant, the holder’s authorised representative such as its Investment Manager).

Method of disclosure Firms are at liberty to select the method by which they make disclosure. It is anticipated that many firms will choose to do so in their monthly, quarterly or half-yearly investor reports/newsletters.

SUPPLEMENT NO. 1 TO AIMA’S INDUSTRY GUIDANCE NOTE ON SIDE LETTERS

Introduction and status Since the publication of AIMA’s Industry Guidance on 27 September 2006 members of AIMA and others have raised certain issues relating to the interpretation of the side letter disclosure requirement. AIMA has discussed these issues with the FSA and is now publishing this Supplement to the Industry Guidance. The decision whether to follow this Supplement to the Industry Guidance is for the firms concerned. This is not FSA Guidance.

Disclosure requirement The requirement to disclose the existence of side letters which contain material terms and the nature of those terms (the “disclosure requirement”) applies only to a firm which is both (1) an FSA regulated discretionary investment manager which employs hedge fund techniques and (2) an authoritative source of information for fund investors on the investment strategy, risk profile and related matters affecting the relevant fund (“an authoritative source of information”). A discretionary investment manager will be regarded as an authoritative source of information if it is primarily responsible for generating the substance of such information. The disclosure requirement applies to discretionary investment managers whether they publish such information directly to fund investors or indirectly through the provision of such information to a third party, such as a fund administrator, which then publishes the information.

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The disclosure requirement does not apply (a) to firms which only (1) market shares or interests in a fund and/or (2) execute trades for the account of a fund and/or (3) give investment advice in relation to the investment of a fund’s assets but which (4) do not exercise any discretionary investment management authority over the fund’s assets nor (b) to firms which are fund of hedge fund managers. The disclosure requirement does not apply to a firm which is a party to a side letter, but is not itself an authoritative source of information, in circumstances where an affiliated investment manager is an authoritative source of information (for example, this would cover the situation where a US or other non- UK affiliate of the firm is the authoritative source of information).

Grey areas There remain a number of “grey areas” in relation to the application of the disclosure requirement in certain situations. These situations include (1) where a firm (a) is not a party to certain side letters but is aware that a fund of which an affiliated entity is the Investment Manager is a party to them, (b) is an authoritative source of information but (c) has no or limited contact with investors and prospective investors because all or most of such contact is the responsibility of a non-UK affiliated manager (such as a US affiliated manager) and (2) where a firm has responsibility for generating only part of such information in conjunction with a non-UK affiliated manager which also generates part thereof. AIMA intends to continue its dialogue with the FSA in relation to these grey areas and expects to publish further supplements to its Industry Guidance when the position is clearer. The FSA has indicated to AIMA that until then it will not insist on compliance with the disclosure requirement in relation to such areas. However, firms which are in any doubt as to the need for compliance are recommended to seek appropriate professional advice.

Timing of disclosure The FSA has confirmed to AIMA that it will consider that compliance with the initial disclosure requirement by 31 October 2006 will be satisfied where firms make such disclosure in their investor reports/newsletters which are sent out in early November 2006.

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APPENDIX G - Cayman Islands filing and regulatory requirements Background A fund vehicle organised under Cayman Islands law, whether in corporate, partnership or trust form, is required to be regulated under the Mutual Funds Law (the “Law”) if it issues equity interests which are redeemable or repurchasable at the option of the investor. There is an exemption from this requirement if there are fifteen or fewer investors (of record), a majority in number of which can appoint or remove the “operator” (the Board of Directors, general partner or trustee, as the case may be). For the purposes of this note, it is assumed that the minimum investment will be at least US$100,000 or equivalent, in which case registration is non-discretionary. Other than a requirement that the annual audit be signed off by a local firm, the Law does not mandate that any service providers to a Cayman Islands domiciled Fund be located in the jurisdiction. Likewise there is no restriction on the residence or domicile of Directors. To the extent services are provided locally, the supplier itself will be required to hold appropriate licences - for example, administration, investment management or advice, trusteeships and provision of Directors, registered office or custody facilities.

Obligations of a registered mutual Fund Where a Fund is required to register under the Law, the principal requirements are as follows: ● filing of form MF1 (and, in practice, a copy of the offering document) along with a registration fee of US$3,048.78; ● notifying any subsequent changes to the particulars disclosed in the form MF1 and, in practice, any supplement or revisions to the offering document; and ● filing of audited financials and (for fiscal periods ending after 1st January 2007) an electronic summary report “FAR” within six months of the end of such period.

Government fees The government fees payable on incorporation/registration of each fund vehicle are as follows: ● Exempted Company – US$573.17; ● Exempted Limited Partnership – US$914.63; ● Exempted Trust – US$609.76; and ● Foreign Company – US$1,036.59. Following incorporation/registration, annual government fees will generally be the same as the initial fee paid. The annual fee payable to the Cayman Islands Monetary Authority for a registered mutual Fund is also the same as the initial registration fee (currently US$3,048.78).



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This is the minimum government fee and is based on the authorised share capital of a company. Typically a Fund will be structured such that it falls within this minimum fee band.

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APPENDIX H - Working Group members Lead author Steven Whittaker



Simmons & Simmons

Guide contributors Dermot Butler Robert Kelly Henry Harford Shelby du Pasquier Deborah Tanner Olwyn Alexander Michael Tannenbaum Paul Hale AIMA

Custom House Administration & Corporate Services Ltd Baronsmead Partners LLP Maples & Calder Lenz & Staehelin Olympus Capital LLP PricewaterhouseCoopers LLP Tannenbaum Helpern Syracuse & Hirschtritt LLP Simmons & Simmons Andrew Baker Mary Richardson

Guide working group members Timothy Darvall Timothy Spangler Michele Gibbs

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Baker Steel Capital Managers LLP Kaye Scholer LLP Tannenbaum Helpern Syracuse & Hirschtritt LLP

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APPENDIX I - About AIMA

AIMA is the hedge fund industry’s global trade association. It is not-for-profit and has almost 2,000 corporate members in 47 countries. It has a strong reputation built on professionalism, expertise, leadership and innovation. Its direction is led by some of the most prominent players in the industry who - together with all member companies - are committed to building a robust and professional industry. AIMA focuses specifically on hedge funds, managed futures and managed currency funds rather than private equity, venture capital, real estate, etc. Its objectives are: ● to provide an interactive and professional forum for our membership and act as a catalyst for the industry’s future development; ● to be the pre-eminent voice of the industry to the wider financial community, institutional investors, the media, regulators, governments and other policy makers; and ● to offer a centralised source of information on the industry’s activities and influence, and to secure its place in the investment management community. AIMA’s membership includes fund of funds managers, institutional investors, hedge fund managers, prime brokers, lawyers, fund administrators, accountants, exchanges and other specialist service providers. Focusing on education, regulation, sound practices and government relations, AIMA is a business-to-business association that communicates with the fund industry, institutional investors, policymakers, regulators and the specialist financial media around the world. Key products created and distributed by AIMA include: ● Guide to Sound Practices for Hedge Fund Valuation (2007) ● Series of generic due diligence questionnaires for the selection of managers and service providers (available to AIMA members and institutional investors) - (fourth edition, 2007) ● ‘Asset Pricing and Fund Valuation in the Hedge Fund Industry’ ● Guides to Sound Practices for European (2007), Canadian (2004) and Asian Managers (2005) ● Guide to Sound Practices for Business Continuity Management for Hedge Fund Managers (2006) ● Guide to Sound Practices for Hedge Fund Administrators (2004) ● Guide to Fund of Funds Management and Investment (2002) ● Market Neutral and Hedge Strategies research (2002) ● AIMA Journal (published quarterly)

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APPENDIX J - About the Sponsors

Simmons & Simmons have been advising hedge fund sponsors and managers from the first development of the hedge fund industry in Europe. Our hedge fund practice is the largest of any UK law firm. The strength of the practice is recognised by Legal 500, the independent UK legal directory, which describes it as “the leading firm in hedge funds”. Our hedge fund team is predominantly based in London where the core team is led by 11 partners and supported by 35 associates. Specialist lawyers outside the core team are also involved to provide the full range of legal services required by hedge fund clients. Our hedge fund team includes leading practitioners in the field. Iain Cullen, Richard Perry, Neil Simmonds and Steven Whittaker are all recognised as “leading individuals” in Legal 500 and/or Chambers & Partners. We act for many of the best known hedge fund sponsors and managers. Our clients include both specialist hedge fund firms as well as many institutional fund management houses. www.simmons-simmons.com

Custom House Administration & Corporate Services Ltd is a specialist alternative investment and hedge fund administrator – indeed they describe themselves as “The Specialist Fund Specialist”. Custom House covers all aspects of the day to day operations of the fund, including maintaining the fund’s books and records, carrying out the valuations, calculating the NAV and handling all subscriptions and redemptions, as well as overseeing payment of the fund’s expenses and liaising with the auditor. Custom House, which administers in excess of US$25 billion, and which was the first hedge fund administrator to be awarded a Moody’s MQ (Management Quality) Rating, have since January 2007 been able to offer a 24/7 service through representative offices in Chicago and Singapore. Custom House is authorised by the Irish Financial Regulator, under Section 10 of the Investment Intermediaries Act, 1995 to act as an administrator of collective investment schemes. The authorisation does not extend to the representative offices in Chicago and Singapore. Custom House, which operates out of four Victorian town houses on the banks of the River Liffey in Dublin, is also authorised to act as a Paying Agent for Irish Stock Exchange listed asset-backed security and closed-end funds. www.customhousegroup.com

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About the Sponsors

Baronsmead is an independent, specialist broker providing financial risks insurance, guidance and advice to investment funds. We provide protection to the investment industry from the legal, regulatory and operational risks they face. Our specialist financial risks insurance products include: Directors’ and Officers’ Liability Insurance ● Professional Indemnity Insurance ● Fund and General Partner Corporate Liability Insurance ● Employee Dishonesty and Third Party Computer Crime Insurance ● ERISA Fiduciary Dishonesty Bond and ERISA Fiduciary Liability Insurance ● Prospectus Liability ● Outside Directorship Liability Insurance ● Employment Practices Liability Insurance ● Pension Trustee Liability Insurance ● As a dynamic business, we continue to expand our products and services in response to our clients’ requirements. Our clients range from long established fund groups to start up funds, all of whom benefit from our promise of delivering quality service. We act for traditional and alternative funds and management groups. We are located in London and Dublin, at the heart of the European funds industry, ideally placed to provide the best service to our clients. Baronsmead Partners LLP is authorised and regulated by the Financial Services Authority (FSA) and the Jersey Financial Services Commission (JFSC). We are members of the Irish Funds Industry Association, Jersey Finance and are also accredited Lloyd’s Brokers.

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ALTERNATIVE INVESTMENT MANAGEMENT ASSOCIATION

Enhancing understanding, sound practices and industry growth

The Alternative Investment Management Association 2nd Floor, 167 Fleet Street, London EC4A 2EA, UK Tel +44 (0)20 7822 8380 [email protected]

www.aima.org