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Editorial

Retrocessions: Criminal Consequences of Non Disclosure

October 2018 - Finance. Legal Developments by Bär & Karrer.

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In a recent decision 6B_689/2016 of 14 August 2018, the Swiss Federal Supreme Court held that the failure to disclose adequately retrocessions may constitute an act of criminal mismanagement. After a short summary of the legal framework governing the disclosure of retrocessions, the present briefing analyses this decision and its practical impact in particular for Swiss financial institutions dealing with external asset managers.

Background

Retrocessions and other distribution fees paid to asset managers have been the subject of major legal development over the past 12 years in the Swiss banking and financial sector. Over the course of several groundbreaking decisions (FSC 132 III 432; FSC 137 III 393; FSC 138 III 755), the Swiss Federal Supreme Court held that an asset manager was entitled to retain retrocessions and other distribution fees it received in connection with its mandate only on the basis of a comprehensive waiver based on an informed consent, otherwise it is required to hand them over to its client. The disclosure requirements defined by case law are exacting: the information should at the very least define the parameters based on which the retrocessions are calculated and include the range, expressed as a percentage of the assets under management, of the expected compensation, so as to put them into perspective with the management fees. Furthermore, the client must be informed of the risks arising out of the conflict of interests generated by retrocessions and the measures taken to avoid or mitigate them (FSC 137 III 393).

These principles have been, further, codified in the new regulatory framework applicable to financial service providers in the Financial Services Act. Until now, however, the Swiss Federal Supreme Court had dealt with this issue in connection with civil law disputes and could leave untouched the criminal aspects of this issue, in particular in light of the provision on criminal mismanagement (article 158 Swiss Criminal Code, "SCC") (see FSC 6B_845/2014 dated 16 March 2015, E. 3.2.2). This is the key issue that the Swiss Federal Supreme Court addressed in its decision of 14 August 2018.

Approach of the Swiss Federal Supreme Court: Failure to disclose may be an act of criminal mismanagement

As a matter of civil law, the duty of accountability is two pronged: first, it implies an obligation to account to the principal of the activity carried out in connection with the mandate and disclose any profits collected. The second prong is a duty to hand over any such profits to the principal. While the Swiss Federal Supreme Court had settled, in a case predating the developments in civil law, that a breach of the duty to hand over retrocessions does not constitute an act of criminal mismanagement as long as the asset manager did not act in a manner that was damageable to the interests of its client because of the retrocessions (SFC 129 IV 124), the question whether a breach of the obligation to account for retrocessions by failing to duly inform the client could constitute a criminal offence was unsettled and subject to doctrinal controversies. In its decision 6B_689/2016 of 14 August 2018, the Swiss Federal Supreme Court takes a harsh approach: it considers that, in the context of a mandate relationship, the duty of accountability (article 400(1) of the Swiss Code of Obligations) gives rise to a qualified obligation to act and to preserve the interests of the principal. Consequently, a breach of the duty to inform the principal may, even by mere omission, constitute an act of criminal mismanagement pursuant to article 158 SCC.

Furthermore, the Swiss Federal Supreme Court holds that the asset manager cannot claim that it acted in good faith by relying on a generic waiver that did not meet the exacting standards set forth by such Court in its above-mentioned decisions. Quite to the contrary, it ruled that this defense was without merits since the requirements for a valid waiver had been set forth in its precedent of 2006 (SFC 132 III 460). This conclusion is extremely severe since it establishes criminal intent to breach the duty to inform the client on the sole basis that the defendant did not abide with the standards defined by the case law of the Swiss Federal Supreme Court. The conclusions of the Swiss Federal Supreme Court are all the more harsh, considering that the first decision of 2006 related to a case where the asset manager had not even included a generic waiver of the obligation to hand over retrocessions. Therefore, the considerations of the court in 2006 regarding the disclosure standard required to achieve an informed consent were mere obiter dicta and, looking back at the evolution of the case law on retrocessions, the watershed moment came five years later, when the court held in its decision of 2011 that the duty of accountability applied to all benefits received in connection with a mandate, including distribution fees and intra-group payments unless the client gave its informed consent to waive this duty (FSC 137 III 393).

A landmark decision due to peculiar circumstances

While the decision 6B_689/2016 of 14 August 2018 sets a new milestone in the field of retrocessions, the facts and circumstances surrounding that case are very peculiar: in the case at hand, the defendant was not only acting as an asset manager but had also been appointed as legal guardian of his incapacitated client. Further, the guardian committed various other gross breaches and criminal offences in the performance of its mandate. After facing significant losses in the aftermath of the financial crisis of 2008, the asset manager forged statements to conceal the losses from its clients and used client assets to meet reimbursement's requests of other clients. The asset manager also forged documents to avoid questions by the custodian bank. Finally, it charged management fees in excess of those agreed with the guardianship authority. The factual background therefore certainly played a decisive role in the decision of the Swiss Federal Supreme Court. Nevertheless, the Court framed its judgment in general and unequivocal terms. Moreover, the Swiss Federal Supreme Court also issued a press release relating to this decision and announced that it would publish it in its official reporter, a sign that it should be read as an important precedent rather than an isolated decision.

Practical impact

Given the peculiar circumstances of the case, the impact of this decision on the financial industry at large is difficult to predict. In any event, any financial institution paying or receiving retrocessions and other distribution fees should consider the potential implications of this decision:

- First and foremost, asset managers and financial institutions receiving retrocessions and other distribution fees should ensure – if this is not already the case – that their waivers provide for sufficient disclosure to ensure an informed consent and, in the negative, consider taking appropriate remedial action;

- Second, financial institutions should not accept to pay retrocessions and other distribution fees unless they are comfortable that the recipient either hands them over to its clients or relies on a valid waiver to retain them. This measure can be implemented by seeking an explicit representation when entering into an agreement with the recipient and seeking additional comfort if there are reasons to believe that the representation may not be correct;

- Finally, since aggravated criminal mismanagement, which supposes that the asset manager committed the breach of duty with the aim to unlawfully enrich itself or a third party, is a crime and, hence, a potential predicate offence to money laundering under Swiss law, financial institutions maintaining accounts where retrocessions and other fees are paid must consider the risks of such transactions from an anti-money laundering perspective: if they have a doubt whether the asset manager holds a valid waiver that entitles it to retain the retrocessions, the financial institutions are required to investigate the matter and, if the clarifications are not conclusive, report their suspicions to the Money Laundering Reporting Office of Switzerland.

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