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11 January 2013
On October 30 2012 the Federal Supreme Court rendered a landmark decision (4A_127/2012 and 4A_141/2012) regarding the restitution to banking clients of commission received from funds or producers of financial products by banks acting as asset managers for their distribution services.
In an important 2006 decision (ATF 132 III 460) the Federal Supreme Court decided that commission received from the depositary bank by external asset managers is, in the absence of any agreement to the contrary between the parties, subject to an obligation of restitution to the client in accordance with Article 400(1) of the Code of Obligations. However, the client and the independent asset manager may agree on a different solution; in particular, they can agree that the commission can be retained by the asset manager. This supposes that the client gives an informed consent, meaning that he or she must be fully and correctly informed about the commission. The nature of the information that must be provided to the client in order for the waiver to be valid was specified in a subsequent decision of August 2011 (ATF 137 III 393).
In January 2011 (6B_223/2010) the Federal Supreme Court still considered that the commission paid by the producers to the distributor represented remuneration for the bank's distribution activities. The distributor's remuneration was not seen as arising from its relationship with the final client, but rather as a consideration for distribution services rendered to the producers, and therefore the distributor was entitled to keep the commission.
In the case at hand the bank, acting as asset manager, was remunerated by the client and the issuers of investment funds and structured products. The bank's distribution activities were remunerated by the payment of commission, in particular the trailer fees corresponding to a portion of the management fees charged periodically on the assets of a fund. Upon an action by the client asking for the restitution of the commission received by the bank, the Upper Court of the Canton of Zurich partially admitted the claim and ruled in favour of restitution of the commission received from third-party issuers of financial products. In contrast, it ruled out the restitution of commission received from entities belonging to the same group of companies as the bank. For different reasons the bank and the client appealed against this decision.
In the Federal Supreme Court's view the commission received by the bank for the distribution of financial products must be restituted to the client. Under Article 400(1) of the code, the agent must, at all times and on request, account for the management of its business activities and restitute all the assets to the principal which are directly related to the execution of the order.
The court estimated that the perception of commission created a conflict of interest. The bank was encouraged to acquire or increase from its own initiative the stock of a particular product even though the operation might not be justified by the client's interests. The existence of a potential conflict of interest is sufficient irrespective of knowing whether, in a particular case, the conflict has actually worsened the client's position. The court saw the existence of a potential conflict of interest as sufficient to consider that the commission is directly related to the execution of the mandate, and hence that the fees must be passed on to the client.
In addition, the court said that with regard to the conflict of interest, commission perceived for the distribution of products from group companies must be treated like commission received from third-party producers. Hence, all those commissions are subject to a restitution duty regardless of whether the producer and the distributor belong to the same financial group.
Thus, the Federal Supreme Court partially quashed the decision of the Upper Court of the Canton of Zurich which refused to admit the restitution of commission received by the bank from entities of the same group.
The Swiss Financial Market Supervisory Authority (FINMA) noted the Federal Supreme Court ruling of October 30 2012 and issued Newsletter 41 (November 26 2012) on supervisory measures addressed to banks.
FINMA stated that it did not fall within its remit to decide and enforce civil law claims between supervised institutions and their clients. However, in terms of regulation FINMA expects banks to take adequate precautionary measures.
FINMA found that the Federal Supreme Court decision inferred the following conclusions regarding the relationship between asset-managing banks and their clients:
FINMA observed that the Federal Supreme Court did not address in depth whether the duty of restitution included commission made specifically to investment fund distributors for distribution expenses incurred. Moreover, for procedural reasons, the court decision did not comment on the possibility that banks may be able to charge costs incurred as reimbursable expenses.
The court decision did not comment on advisory mandates, which in principle also fall under the legal provisions for mandates in general. It remained open as to whether the duty of restitution also applied to 'execution-only' client relationships.
As part of the supervisory requirement to ensure proper business conduct, supervised institutions must systematically uphold their obligations under civil law (ie, banks must be managed and organised in such a way as to guarantee an overall level of compliance with their contractual obligations).
Therefore, FINMA expects the banks concerned to adopt the following precautionary measures:
FINMA will examine and monitor the measures taken and planned by the banks. FINMA will also evaluate whether it will be necessary to make adjustments to Circular 2009/1 "Guidelines on asset management".
Through its ruling the Federal Supreme Court extended the perimeter of commission that must be restituted to the client to include trailer fees.
Under this new precedent, every commission received in the context of a mandate relationship with the client, where there is a potential conflict of interest, must be restituted by the banks, irrespective of whether the commission was received from a third party or a group entity.
This ruling puts an end to the distinction made by some that banks acting as asset managers and distributors of financial products that receive trailer fees for the selling of products to their clients were not subject to the restitution duty as they were not independent asset managers and were not receiving so-called 'retrocessions'.
However, the Federal Supreme Court left one door open in explaining that the situation would be different in relation to other forms of remuneration granted to the distributor of financial products for various operations performed by the distributor, such as:
The decision will have an important practical effect. As soon as there is mandate between a client and a bank, the question of the restitution of commission can arise. In the case at hand, it was an asset management agreement, but the same question could be posed for an advisory agreement. The question of whether the execution-only relationship would also fall within the scope of this ruling remains open.
The FINMA newsletter is not the first time that FINMA has considered a violation of a private law obligation to be a failure at regulatory level. However, the requirement that banks proactively contact their clients and clarify the situation is unusual and leaves many questions unaswered as to the categories of client that must be contacted and the exact steps that banks must take in order to comply with the supervisory requirements.
For further information on this topic please contact Christophe Rapin or Christophe Pétermann at Meyerlustenberger Lachenal by telephone (+32 2 646 02 22), fax (+32 2 646 75 34) or email (firstname.lastname@example.org or email@example.com).
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