Madoff case - Luxalpha SICAV - Decision by the CSSF to withdraw the fund from the list and request of liquidation
On 3 February 2009, the Luxembourg regulator (CSSF) has announced, in view of the establishment of the responsibilities of the various intermediaries in relation to Luxalpha SICAV and the custodian bank UBS (Luxembourg) S.A., to take the following two decisions, namely (1) to withdraw Luxalpha SICAV from the list on the basis of article 94 (2) of the Law of 20 December 2002 on undertakings of collective investments which provides that maintaining an entry on a list shall be subject to observance of all the provisions of laws, regulations or agreements relating to the organisation and operation of UCIs and the distribution, placing or sale of their units and (2) thereafter to request the judicial liquidation of Luxalpha SICAV.
The decision to withdraw Luxalpha SICAV from the list of authorized UCIs is based on the fact that Luxalpha SICAV does not observe any longer the provisions in relation to the organisation and functioning of Luxembourg undertakings of collective investments. This withdrawal has as consequence the suspension of all payments made by Luxalpha SICAV and the prohibition by Luxalpha SICAV to perform any acts other than conservatory acts. The decision of withdrawal will become permanent after a period of one month, except in case of appeals. As soon as the decision of withdrawal will become permanent, the CSSF will request from the Luxembourg court (tribunal d'arrondissement) the judicial liquidation of Luxalpha SICAV. In case of a liquidation decided upon by the court, the court will appoint a liquidator to realize the assets of the SICAV.
Luxembourg - Investment Funds - CSSF press release on the Madoff case
The CSSF has recently announced in its press release of 23 January 2009 that a number of Luxembourg funds and sub-funds as set out hereunder have decided to suspend their NAV as well as redemptions, subscriptions and conversions of shares / units:
- Herald (Lux)
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Sub-fund US Absolute Return Fund
- Luxembourg Investment Fund
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Sub-fund U.S. Equity Plus
- Luxalpha Sicav
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Sub-fund American Selection
- Norvest
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Sub-fund Arbitrage
- Global Fund Selection Sicav
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Sub-fund Balanced Sub-fund
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Sub-fund Growth Sub-fund
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Sub Fund X-tra Alternative Investments Sub-fund
- Carat (Lux) Sicav
- Sub-fund Global One
- LRI Invest Alpha Stable €
- BG Umbrella Fund
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Sub-fund BG Global Classic
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Sub-fund BG Global Dynamic
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Sub-fund BG Global Challenge
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Sub-fund BG Global Balance
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Sub-fund BG Global Discovery
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Sub-fund BG Stable Value
- M.A.R.S. Fund
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Sub-fund One (c)
- Pareturn
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Sub-fund Best Selection
The CSSF furtermore noted that the above UCIs are currently exposted up to EUR 1,7 billion.
Role of the depositary in a Luxembourg UCITS fund
This article intends to provide general guidance as to the role of a depositary in a Luxembourg investment fund (and more particular in relation to a UCITS fund (part I of the Law of 2002) in the form of a SICAV (“hereafter referred to as the “fund”), and does not purport in any manner to give any opinion or advice on any cases set out hereunder or any other cases related to the Madoff case.
The effect of the alleged Ponzi scheme in which Bernard Madoff was implicated – involving losses of more than $50 billion – are already widespread. The CSSF has recently announced in its press release of 23 January 2009 that a number of funds and sub-funds (as set out hereunder) have decided to suspend their NAV as well as redemptions, subscriptions and conversions of shares/units. A consequence of the Madoff case is that the liability of the main actors of the investment funds involved is called into question.
Any finding of liability in the forthcoming litigations is likely to involve thorny issues. Indeed a fund requires the services of a large number of actors (the board of directors of the funds, the promoter, the depositary, the central administration agent, the auditor, etc.) and it is unclear how far in the hierarchy the (potential) liability shall extend. In any case, the diversity of the regimes of responsibility under which each actor is subject (whether it is contractual liability or not) will probably cloud the issue. Matters will also be made more complex by the wide variety of legislations that come into play as a result of the internationalization of investments.
(I) Duties of the depositary
The role of the depositary bank is set out in the Luxembourg law of 20 December 2002 as amended (the “Law of 2002”), and in the circular of the IML (currently named the CSSF) 91/75 (as amended by the circular 05/177). The Law of 2002 provides that the custody of the assets of the fund must be entrusted to a depositary. However, a crucial clarification by the CSSF in Circular 91/75 provides that: “the concept of custody used to describe the general mission of the depositary, should be understood not in the sense of ‘safe-keeping’ but in the sense of ‘supervision’, which implies that the depositary must have knowledge at any times of how the assets of the UCI have been invested and where and how these assets are available”. The physical deposit of all or part of the assets may be made either with the depositary itself or with any professional designated by the fund in agreement with the depositary. The general mission of a depositary is threefold, encompassing the preservation of the assets of the UCI, the control of some of its operations, and the day-to-day administration of the assets of the fund.
This means that the depositary must inter alia process the receipt of dividends, interests, etc.. However, the depositary does not have to execute itself all the duties incumbent upon it and can be assisted by third parties in the execution of transactions or can delegate to third parties the execution of transactions. However, this cannot lead to a situation where all duties are concentrated in the hands of one and the same party. The depositary must – in order to satisfy its obligation of supervision – organise its relations with the third parties in such way that it is immediately informed of all the transactions that the third parties execute in relation to the day-to-day administration of the assets which they hold.
The depositary must also:
- ensure that the sale, issue, redemption and cancellation of units effected on behalf of the fund are carried out in accordance with the law and the articles of incorporation;
- ensure that in transactions involving the assets of the fund, the consideration is remitted to it within the customary time limits; and
- ensure that the income of the fund is applied in accordance with the articles of incorporation.
The CSSF has argued that the term “ensure” as used in the Law of 2002 implies that the depositary must not “execute” itself the tasks but must verify the execution of the tasks imposed on it. It is important to note the difference between the duties of the depositary of, on the one hand a FCP (fonds commun de placement) subject to part I of the Law of 2002 and, on the other hand a SICAV or any other UCI which has not been constituted as a collective investment fund. In case of a FCP (part I of the Law of 2002), the depositary has two additional specific supervisory and monitoring duties such as (1) carrying out the instructions of the management company, unless they conflict with the law and the management regulations and (2) ensuring that the value of units is calculated in accordance with the law and the management regulations.
(II) Liability of the depositary
If anyone suffering damage must prove the depositary’s negligence in respect of its duty of supervision and the causal relationship thereof, the duty of supervision of the assets of the fund and consequently the liability for such supervision always resides with the depositary. As laid down in the Circular IML 91/75 (as amended by Circular CSSF 05/177), the depositary may, in no case, release itself from the duty of supervision and hence any provision of the articles of incorporation or any other agreement aiming to exclude or limit this liability are null and void, and under Article 34 (2) of the Law of 2002, the depositary’s liability shall not be affected by the fact that it has entrusted all or some of the assets in its custody to third parties. This has also been repeated in a press release issued by the CSSF on 2 January 2009 as a result of the Madoff case. The depositary may only be discharged from its duty of supervision when it is satisfied from the outset and during the whole duration of the contract that the third parties with which the assets of the fund are on deposit are reputable and competent and have sufficient financial resources. Importantly, the CSSF stated that it would not limit its analysis to the depositary banks concerned but would verify that all the parties involved acted with the diligence imposed by Luxembourg law.
The above elements are likely to be crucial in the litigations flowing from this groundbreaking swindling. The current regime governing the liability of a depositary is likely to be subject in the forthcoming months to substantial reforms, involving the enactment of more stringent – and probably more precise – investor protection rules. Indeed France, backed by Mr. Luc Frieden, the Luxembourg Minister for the Treasury and Budget, is currently calling for legislation to strengthen the protection of investors across Europe.
Footnote
Funds mentioned in the press release of the CSSF of 23 January 2009
- Herald (Lux)
- Sub-fund US Absolute Return Fund
- Luxembourg Investment Fund
- Sub-fund U.S. Equity Plus
- Luxalpha Sicav
- Sub-fund American Selection
- Norvest
- Sub-fund Arbitrage
- Global Fund Selection Sicav
- Sub-fund Balanced Sub-fund
- Sub-fund Growth Sub-fund
- Sub-fund X-tra Alternative Investments Sub-fund
- Carat (Lux) Sicav
- Sub-fund Global One
- LRI Invest Alpha Stable €
- BG Umbrella Fund
- Sub-fund BG Global Classic
- Sub-fund BG Global Dynamic
- Sub-fund BG Global Challenge
- Sub-fund BG Global Balance
- Sub-fund BG Global Discovery
- Sub-fund BG Stable Value
- M.A.R.S. Fund
- Sub-fund One (c)
- Pareturn
- Sub-fund Best Selection
Luxembourg - Investment Funds - Impact of the Madoff fraud case
The Luxembourg regulator (CSSF) has on 22 December 2008 issued a press release analysing the impact of the Madoff fraud case on the Luxembourg investment funds.
The CSSF noted that the impact on Luxembourg investment funds which are directly or indirectly exposed to the Madoff case amounts to 1.9 billion Euro which represents only 0.15% of the total net assets of undertakings of collective investment as at 30 November 2008. The CSSF furthermore noted that it does not imply that this amount is entirely lost but that it represents the maximum responsibility at stake.
Investment Funds - Guidelines of the Committee of European Securities Regulators (CESR) concerning eligible assets for investment by UCITS
The CSSF has issued on 26 November 2008 circular 08/380 in relation to the CESR's guidelines concerning eligible assets for investment by UCITS. This Circular replaces circular 08/339.
The only amendment that has been made compared to circular 08/339 is point 24 paragraph 1. The amended paragraph reads as follows: “Techniques and instruments relating to transferable securities and money market instruments include, but are not limited to, collateral under the provisions of directive 2002/47/EC on financial collateral arrangements, repurchase agreements, guarantees received, and securities lending. The requirement to comply with the provisions of Article 21 of Directive 85/611/EEC imply in particular that if UCITS are authorized to use repurchase agreements or securities lending, these operations must be taken into account to calculate the global exposure of the UCITS.”
Investment Funds - From UCITS III to UCITS IV
Undertakings for Collective Investment in Transferable Securities (UCITS III) were introduced by the law of 20 December 2002 (the “2002 Law”), and benefit from a European Passport enabling them to be freely marketable throughout the EU countries. However, unsatisfactory elements relating to the current state of the Law paved the way to discussions about a possible ‘mutation’ from UCITS III to UCITS IV.
Those include, inter alia, details in the cross border distribution, in the simplified prospectus, and in the management company passport. In this context, the European Commission on 16 July 2008 published proposals to enhance the efficiency of the current legislative framework for UCITS. This could create, more than 20 years after the enactment of the first UCITS Directive, a genuine pan-European single market for investment funds, which would improve market efficiency and investor protection. Two types of legislative changes are contemplated: some aiming to enhance the working of existing provisions (in particular in relation to the notification procedure, the management company passport and the simplified prospectus), and others intended to introduce new single market freedoms (by creating inter alia a facilitating framework for fund mergers).
Cross Border Distribution
The first proposal aims at simplifying the procedures enabling the cross-border distribution of UCITS. In the current regime, detailed documentation must be filed on behalf of the UCITS with the regulator in the host Member State, which has theoretically two months to confirm compliance with the host Member State’s advertising laws. However, in practice, this process usually takes much longer and it is therefore unnecessarily time-consuming and costly. Consequently, it impedes greatly cross-border distribution and calls into question the concept of a single market to its very roots.
To cope with this problematic deficiency, it is proposed to replace the current regime with a simple, electronic, regulator-to-regulator notification procedure by which a UCITS seeking to market its units in another Member State informs its own regulator of its intention to do so and sends to it the necessary notification documents. Those documents shall consist of a Key Investor Information Document (see below) - which the UCITS is in the obligation to translate into the local language of the host Member State -, the full prospectus, the constitutive documents and the latest annual and any subsequent half yearly reports. A consequence of the new regime is that the marketing of units in the funds will be possible within three days of the file’s transmission from home to host regulator.
The home regulator reviews that information, and, if complete, transmits them within one month of receipt of the documents to the host regulator with an attestation confirming that the UCITS fulfils its obligations, and the UCITS may commence inward marketing in the host Member State from the date of transmission. The transmission of that information should take place electronically (see point II of this newsletter).
Key Investor Information
The concept of simplified prospectus is deemed to be another failure of the UCITS III regime. Originally, it was intended to provide investors with all basic information relating to the UCITS, in order to enable them to make an informed investment choice. In practice, the simplified prospectus failed to meet those expectations, as it is often very lengthy, and implemented differently across the EU.
It is therefore suggested to replace this simplified prospectus by a ‘key investor information’ document, which will provide key facts to investors before the conclusion of a contract. It will have to be set out in a common format in all Member States, thereby allowing for effective comparison, and shall be presented in a brief manner and in non-technical language, likely to be understood by retail investors. Key information shall include a short description of the investment objectives and policies of the UCITS, past performance, costs and associated charges and risk/award profile of the investment including appropriate risk warnings. Investors should note that this document is considered as pre-contractual information and hence liability should not be imposed solely on the document itself unless it is misleading or inaccurate.
Fund Mergers
Pursuing its general aim of promoting a single market, the European Commission proposed to remove barriers to amalgamation of funds which would, inter alia, cope with the proliferation of small and inefficient funds.
In this context, the proposal provides a framework for domestic and cross-border mergers of UCITS, introducing a basic principle that all UCITS are entitled to merge, regardless of the structure (e.g. corporate, unit trust or contractual). It should be pointed out that approval by investors is only necessary if required by national law. However a maximum threshold ceiling of 75% of the votes cast by unit holders is envisaged and this will be especially significant in Luxembourg since 100% unit holder approval is currently required to merge a Luxembourg UCITS with another UCITS. The proposals are however silent as to whether merging funds must have similar investment objectives and policies.
Master-Feeder Structures
The European Commission also innovated by proposing to introduce the ability to establish limited master-feeder structures. This could result in significant economies of scale and a reduction of charges for investors. The feeder UCITS and the master UCITS must enter into a legally binding agreement in which the feeder fund will be required, inter alia, to have at least 85% of its assets in a single master fund. Additionally, the feeder fund will have to act in the best interests of its investors and to monitor effectively the master UCITS.
Management Company Passport
The most controversial element introduced by the UCITS III regulation was undoubtedly the management company passport, originally designed to enable a manager that managed UCITS in a number of jurisdictions to centralise its activities within a single jurisdiction. The rationale being that this would result in significant economies of scale and better control as all activities would be carried out in a single company. However, the lack of EU-wide consensus on what the passport entailed resulted in different opinions when it came to interpreting the meaning of the management company passport concept. Opponents to a full cross-border passport point out that the regulator of a UCITS having a management company not regulated in the same jurisdiction could deprive the UCITS regulator of the means to monitor and enforce compliance with regulatory provisions in force in the UCITS domicile. Others are concerned with the fact that such a measure would be likely to create problematic regulatory and tax issues. The Commission has therefore requested CESR to provide advice on how to operate by 1 November 2008. On 31 October 2008, CESR had completed their work on the management company passport issues and published their advice to the European Commission. For more information, we refer to the CESR advice that can be found at the following address: http://www.cesr.eu/popup2.php?id=5367. It mainly followed the draft paper that was issued in September 2008 containing advice on issues relating to definition of domicile, applicable law and supervisory responsibilities, authorisation procedures for UCITS funds whose management company is established in another Member State, on-going supervision of the management of the fund, and finally on how to deal with breaches of rules governing the management of the fund.
The controversy over the management company passport shows how much the mutation from UCITS III to UCITS IV is far from being achieved. The UCITS proposals will however be presented to the EU council of Ministers and the European Parliament for approval. If they are adopted by mid 2009, it is contemplated that these provisions will come into force in mid 2011.
Investment Funds - CSSF Circular - Clarification of the relationship between the custodian and the prime broker in case of a SIF
In a Circular issued on 5 September 2008, the CSSF clarified the interaction between the prime broker and the custodian of a SIF. In Luxembourg, the prime broker must be a financial institution subject to the control of a supervisory authority of a State with a supervisory regime recognised to be equivalent to that provided by EU legislation. Prime brokers are essential to SIFs that implement a hedge fund strategy or that make use of derivatives. By setting up four guidelines, the Circular should facilitate the use of prime brokers by SIFs.
Scope
Those rules are exclusively applicable to specialized investment funds, i.e. funds set up under the 2007 Law on Specialized Investment Funds (the ‘SIF Law’) and hence the provisions of this Circular do not cover funds set up under the 2002 Law.
Guidelines
Acceptance of the prime broker by the custodian
The custodian has to approve the SIF’s choice of prime broker given the fact that the custodian has to arrange its relationship with the SIF and the prime broker so as to be able to fulfil its duty of supervision of assets. The approval by the custodian of the SIF’s choice of prime broker is limited to ensuring that the prime broker fulfils the following criteria:
- The prime broker is a financial institution regulated by a supervisory authority in a state in which the supervisory regime is recognised as being equivalent to the regime provided ofr by Community law;
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The prime broker is a financial institution which is recognised and specialized in this type of transactions.
Relationship between the prime broker and the custodian
The custodian has the right to information and a right of intervention concerning the composition of the portfolio of the SIF. It must also have access to the assets that are entrusted to the prime broker. The contractual relationship between the SIF and the prime broker or between the custodian and the prime broker will contain the required procedures to that effect. However, the custodian does not need to have information about the correspondents to which the prime broker has entrusted the SIF's assets.
General administration tasks
In the case of a SIF having the form of a fond commun de placement (commun fund), the prime broker might be contractually required to carry out all operations concerning the day-to-day administration of the SIF's assets.
Disclosure
The sales documents of a SIF using a prime broker must contain an accurate description of the implications of such use and the related risks.
Amendments to the SICAR law
On 15 October 2008, the Luxembourg Parliament amended the existing SICAR law of 15 June 2004 with the aim to make the SICAR regime more attractive to private equity and venture capital investors.
The main amendments that have been voted are briefly set out hereunder:
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Umbrella structure
The new SICAR law has introduced the possibility to create multiple compartments. The principle of compartment segregation already well known for SIFs, securitization vehicles and UCITS funds is now also applicable to the SICAR. Compartment segregration means that the liabilities of the SICAR can be split into different compartments each of which are treated as separate entities making distinct transactions. The rights of investors and creditors are limited to the risks of a given compartments's assets. Each of the compartments can be liquidated separately without triggering the liquidation of other compartments of the SICAR. The main advantage of the umbrella SICAR is that it can issue several tranches of securities corresponding to different collateral and providing different values, yields and redemption terms. It is important that the constitutional documents of the SICAR expressly provide for the possibility to have multiple compartments and expressly outline the rules that are applicable to them. The issue document must outline the investment policy of each compartment. The shares of the umbrella SICAR may be of different value.
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Minimum capital
The share premium (if any) will be taken into account for the computation of the minimum capital. The share capital increased by the share premium must be at least 1,000,000 Euro to be reached within a period of 12 months from its authorisation by the CSSF.
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No requirement to publish the NAV
Under the initial SICAR law it was required to provide the net asset value to the investors every 6 months. This provision has been abolished.
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Valuation of assets
The valuation of the assets of the SICAR must be based on the fair market value (rather than the foreseeable sales price estimated in good faith).
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Reduction of the duties of the custodian
The SICAR law has reduced substantially the duties of the custodian. More in particular, the following duties do not need to be fulfilled by the custodian under the new SICAR law:
- control that the subscription price for the securities of the SICAR has been received within the time limits set forth in the constitutive documents;
- control that in transactions involving the assets of the SICAR, a consideration is paid or delivered to it within the customary time limits;
- control that the income of the SICAR is applied in accordance with its constitutive documents.
The abolition of the above control duties previously imposed on the SICAR will certainly reduce the annual costs charged by the custodian of a SICAR.
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Annual report
The annual report must be provided to investors within a period of 6 months after the end of the financial year rather than be "published" as was required under the initial SICAR law.
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Limited partnership (société en commandite simple)
The SICAR can now be set up as a société en commandite simple (limited partnership) with a variable share capital.
CSSF - precisions on the prohibition of uncovered short selling
On 29 September 2008 the CSSF issued a press release providing precisions on the prohibition of naked short selling in publicly quoted banks and insurance companies. As can be seen from the precisions below, the CSSF prohibition does not cover market transactions that follow a clear hedging intent or market transactions which are necessary for the orderly functioning of the markets.
The following precisions or exemptions apply in light of the general rules and principles set out in the press release dated 19 September 2008:
- Uncovered (naked) short selling, in this context, means a transaction which results in creating a net short position or increasing any net short position that was held prior to 19 September 2008. Only net short positions (and not gross short positions) are prohibited (provided there is no duration mismatch between the netted positions). The prohibition also covers OTC transactions.
- The prohibition applies to all uncovered short selling where the underlying assets are shares of credit institutions or insurance undertakings admitted to trading on the regulated market of the Luxembourg Stock Exchange (excluding securities admitted to trading on the EuroMTF).
- The short selling rules cover not only the shares themselves but all instruments (for instance contracts for differences, options, futures or depository receipts) that give rise to an exposure to the issued share capital of a company.
- Market makers are generally exempt from the new short selling rules. This exemption covers market makers only when, in the particular circumstances of each transaction, they are acting in that capacity and with the intent of providing liquidity and of exercising genuine market making activities.
As regards Luxembourg market participants, in case they are entering into transactions in respect of securities admitted to trading on any other regulated market, they shall apply the rules as set out by the competent regulator of that regulated market.
CSSF - ban on naked short sales
In a press release of 19 September 2008, the Luxembourg regulator (CSSF) considers that in light of the current market situation, naked short sales are incompatible with the regulatory requirements governing market conduct, in particular where such sales distort or manipulate the market.
The CSSF therefore prohibits market participants from performing this type of short sales where the underlying assets are stocks of a credit institution or insurance undertaking traded on a regulated market, whether on own account or on behalf of clients. When performing such transactions on behalf of their clients, market participants must ensure that the clients are able to deliver the stocks on the settlement date.
The ban comes into force with immediate effect.
In addition, it should be borne in mind that the spreading of false rumours or information constitutes market abuse and is subject to the sanctions provided for in Chapter V of the Law of 9 May 2006 on market abuse.
