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Kickback payments in Swiss asset management

Andreas Moll

On August 29 2011, the Swiss Federal Supreme Court rendered a decision concerning kickback payments by banks (retrocession) in favour of asset managers.

Kickback payments by a bank for transactions made by an asset manager on behalf of the client are problematic due to potential conflicts of interests: based on the agreement with the client, the asset manager is primarily obliged to safeguard the latter's interests. The possibility of receiving kickbacks from the bank might entice the asset manager to enter into transactions which are not in the best interest of the client, but beneficial to the asset manager.

This conflict of interests was the subject of a leading case of the Swiss Federal Supreme Court of March 22 2006. Referring to the statutory provisions regarding the agency contract, the court found that the asset manager is obliged to return to the client anything received as a result of the activities under the asset management agreement, including kickbacks.

In the same decision, the court held that the client may waive the right for the return of such kickback payments in advance, but did not offer any details on the requirements for such waiver. Ever since this decision, the conditions under which a client can duly waive the right for the return of kickbacks have been subject to a remarkable controversy in the Swiss legal doctrine.

In the case at hand, the client, a pension fund, signed an asset management contract with the relevant asset manager in 1996 which was terminated in 2006. The agreement included a provision pursuant to which the asset manager was entitled to possible kickback payments. Another provision stated that the transaction costs (courtage) would amount to 0.5%. During the time of the agreement, the bank paid out to the asset manager kick back payments in a total amount of over SFr3.5 million ($3.7 million) for the transactions executed for the client. After the termination of the agreement, the client demanded payment of the full amount.

The court analysed the various opinions of the Swiss legal doctrine. It came to the conclusion that, in order to duly waive the right in advance, a client needs to know all parameters required for evaluating the kickback payments and must be able to compare such payments to the ordinary salary of the asset manager. This also applies to institutional clients such as pension funds.

Pursuant to the court, these conditions were not met in the agreement in the case at hand. A contractual provision stating that "the asset manager is entitled to possible kickback payments" is not sufficient for the client to evaluate the expected kickbacks which the asset manager would receive based on the transactions effected on behalf of the client. Finally, the argument of the asset manager that the client knew that the total transaction costs would, in any case, not exceed 0.5%, did not change the court's opinion.

The decision of the Swiss Federal Supreme Court is sound: The asset manager is an agent of the client and should, at all times, safeguard the latter's interests. By getting kickbacks from the bank for transactions made on behalf of the client, the client's interests may become severely jeopardised. This decision is likely to enhance transparency in favour of the client investor. If an asset manager wants to keep kickback payments, he will be forced to declare such payments in sufficient detail.

Another option is to pay out such amounts to the client automatically and, at the same time, increase the basic fee. In the end, the client might pay the same total amount of fees for the services of the asset manager by having more transparency with regard to the asset manager's activities.

Andreas Moll

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