HSBC, UBS May Be Liable on Madoff as Fund Custodians

Date: Thursday, January 15, 2009
Author: Alan Katz, Jon Menon and Vernon Silver, Bloomberg.com

HSBC Holdings Plc and UBS AG may be liable for as much as $3.2 billion of losses linked to Bernard Madoff in a dispute over the duties of financial custodians at funds in Luxembourg and Ireland.

At stake is the image of the European fund industry, French Finance Minister Christine Lagarde wrote in a Jan. 12 letter to the European Commission and Luxembourg Prime Minister Jean- Claude Juncker. European funds’ assets grew 59 percent to 6.8 trillion euros ($9 trillion) over the past six years, partly because rules protecting investors made them attractive.

“If they aren’t required to pay the money, then investor protection doesn’t mean anything and people might as well just invest in offshore funds,” said Isabelle Wekstein-Steg, a lawyer at Wan Avocats in Paris who is representing 10 French retail investors and two institutions that face Madoff-related losses at Luxembourg funds. “UBS didn’t do its job of knowing at all times where the assets were, and the same with HSBC.”

Custodians are charged with oversight of funds and they manage cash inflows and payments to investors. Those looking to recoup money would have to prove the banks failed to fulfill their duties, according to nine lawyers surveyed by Bloomberg News. HSBC has said it isn’t liable and UBS declined to comment on the issue.

HSBC and UBS’s custodian roles for the Luxembourg funds are limited because they were set up by investors specifically looking to place money with Madoff, said Paul Mousel, co-head of the financial services practice at law firm Arendt & Medernach in Luxembourg. He’s representing both banks.

‘Very Small Role’

“The arrangements that were put in place from the beginning are arrangements that gave to the custodian a very, very, very small role to play, especially regarding the safekeeping of the securities, which allegedly would have been purchased by the investors’ moneys,” Mousel said.

He said he’s not aware of any lawsuits filed on the issue. On Jan. 9, Wekstein-Steg sent a letter to Luxembourg’s financial regulator on behalf of her clients requesting that custodians reimburse their investments.

It’s impossible to say whether the custodian has any exposure without seeing the contracts of each fund, according to Julian Randall, a lawyer at Barlow Lyde & Gilbert LLP in London.

“What is clear is that there is unlikely to be any point to suing Madoff himself, and those who have lost money will be looking very hard at anyone, like HSBC, who was close to the action and also has assets,” he said.

Ponzi Scheme

If investors do pry money from the custodians, it would add to the combined $81.7 billion in writedowns and credit losses UBS and HSBC have reported since the start of the global financial crisis in 2007.

London-based HSBC has $1 billion of “potential exposure” after making loans to institutional clients who invested with Madoff, it has said. Madoff’s firm collapsed last month after he told his sons it was a $50 billion Ponzi scheme, according to a complaint filed by the U.S. Federal Bureau of Investigation.

HSBC spokesman Patrick McGuinness declined to comment beyond the company’s Dec. 15 statement that it “does not believe its custodial arrangement should be a source of exposure to the group.”

UBS, based in Zurich, has said it doesn’t have material exposure to Madoff’s firm and declined to comment on the liability issue.

What Investors Wanted

“Bernard L. Madoff Investment Securities LLC and Madoff’s collective investment vehicles were not on the UBS Wealth Management recommended list as direct investment options,” spokeswoman Tatiana Togni wrote in a Jan. 12 e-mail in response to questions. At the $1.4 billion LuxAlpha Sicav-American Selection fund in Luxembourg, for which UBS is a custodian, “UBS has supported wealthy individuals by establishing a fund structure at their request.”

In a separate custodial issue, a Luxembourg court today ruled that UBS’s local unit must give a French money manager the 30 million euros ($39 million) the bank is holding on its behalf. Oddo & Cie. sold shares of LuxAlpha in November. UBS didn’t send the funds after Madoff’s Dec. 11 arrest because, as custodian, it needed to ensure that any action it took was in the interest of all investors, Mousel said on Jan. 12.

UBS rose 0.7 percent to 13.72 Swiss francs ($12.26) at 10:59 a.m. in Zurich. HSBC was down 3.4 percent at 569 pence ($8.31) in London.

EU Review

Funds sold in the European Union to retail customers must follow rules on how money can be invested, called the Undertaking for Collective Investment in Transferable Securities, or UCITS. The rules also set out the responsibilities of custodian banks. Liability is determined under national laws in each member state.

The EU said yesterday that it’s reviewing how rules that require EU-regulated mutual funds to safeguard clients’ assets are enforced around the 27-country bloc.

France’s Lagarde said in her letter that not all member states impose the strict obligation for custodians to reimburse investors for assets that were entrusted to them, as France does.

Luxembourg Budget Minister Luc Frieden said French criticism of investor protection rules in the country is unjustified. The laws for custodian banks in Luxembourg are “identical” to those in France, he said.

Ireland, Luxembourg

Luxembourg and Ireland have worked to become distribution centers for investment funds, said Bernard Delbecque, director of economics and research at the European Fund and Asset Management Association. Luxembourg accounted for 30 percent of the overall 5.2 billion euros of assets in UCITS funds in Europe at the end of September, he said. Ireland ranked third with 11 percent, behind France.

This month, financial regulators in both countries said in separate statements that custodians retain responsibility for monitoring and supervising funds, even if assets are placed with a third party.

Luxembourg’s rules specify that the custodian’s role should be seen as supervisory, “which implies that the depositary must have knowledge at any time of how the assets of the UCI have been invested and where and how these assets are available,” according to a document by the country’s central bank.

UBS is the custodian for LuxAlpha and the $419 million Luxembourg Investment Fund-U.S. Equity Plus, both of which are covered by UCITS. HSBC is the custodian for the $226 million Herald LUX-US Absolute Return Fund and Dublin-based $1.1 billion Thema International Fund Plc. The net asset values are the most recent provided by each fund, according to Bloomberg data.

Redemptions Suspended

The Thema and Herald funds are managed by Bank Medici AG, the Austrian bank founded by Sonja Kohn, whose clients invested $3.2 billion in Madoff funds. The Luxembourg Investment Fund is managed by UBS, and LuxAlpha by Access International Advisors, whose chief executive offer, Thierry Magon de la Villehuchet, was found dead Dec. 23 at his office in New York.

All four funds have suspended redemptions.

Two investors in the Thema fund said they invested in European funds to benefit from the added protection that brought.

Bernd Greisinger, a money manager in Liechtenstein who runs the BG Umbrella Fund for LRI Invest SA, said he chose Thema because it was a European-regulated fund that had to be deposited through a bank. Greisinger put in an order at the end of November to sell Thema shares for $2 million to $3 million. He hasn’t received the funds, he said.

Glenn Gramolini, a Geneva-based manager of Themis MN Fund PLC, which invested in Thema six years ago, said he bought the fund because the money was in the custody of a respected bank.

“Nowhere in the prospectus was it written that the funds would be handed to Madoff,” he said. “He would have been managing the funds. I would never invest in the funds when a manager is a custodian.”

To contact the reporter on this story: Alan Katz in Paris at akatz5@bloomberg.net; Vernon Silver in Rome at vtsilver@bloomberg.net; Jon Menon in London at jmenon1@bloomberg.net