Fund-Manager Pay Rules Included in EU Madoff Fraud Response

Fund-Manager Pay Rules Included in EU Response to Madoff Fraud
Bernard Madoff, seen here, pleaded guilty in 2009 to orchestrating what prosecutors called the biggest Ponzi scheme in history and is serving a 150-year sentence in U.S. federal prison. Photographer: Jin Lee/Bloomberg News

The European Union will unveil tougher rules for banks that safeguard investment funds’ assets as part of a push to prevent a fraud similar to the Ponzi scheme orchestrated by Bernard Madoff.

The European Commission, the 27-nation EU’s executive arm, will publish the measures tomorrow in a package of draft laws on retail financial services, according to a statement on the authority’s website. The proposals will include pay rules for managers of EU-regulated funds known as UCITS.

Under the rules, banks and other institutions that act as so-called depositaries for UCITS will “have an incentive to pay a lot of attention to the information they provide and the services they offer,” Michel Barnier, the EU’s financial services chief, said in an interview on June 28.

Madoff, 74, pleaded guilty in 2009 to orchestrating what prosecutors called the biggest Ponzi scheme in history and is serving a 150-year sentence in U.S. federal prison. The fall-out of the fraud included the liquidation of four UCITS funds, a type of investment vehicle targeted at retail investors that is allowed to operate across the EU.

Luxembourg has been the center of more than 100 lawsuits over Madoff-related funds. The country is the second-largest mutual fund market after the U.S. with about 3,874 registered funds holding 2.2 trillion euros ($2.8 trillion) in assets as of May.

Millions Lost

Investors who lost millions of dollars through Access International Advisors LLC’s LuxAlpha Sicav-American Selection vehicle and Luxembourg Investment Fund filed complaints against UBS AG, the custodian for at least some of the funds, in Luxembourg. Lawsuits were also filed against HSBC Holdings Plc’s local unit, custodian for the third Madoff-linked fund, Herald (Lux) US Absolute Return.

The three Luxembourg funds were dissolved in 2009. LuxAlpha, the biggest of the three, invested 95 percent of its assets with Madoff and had $1.4 billion in net assets a month before Madoff’s December 2008 arrest. A fourth, Dublin-based Thema International Fund Plc, had $1.1 billion in assets before the arrest.

The EU’s proposal will set how banks and other depositary institutions should carry out their safe-keeping and oversight duties, as well as establishing common rules on liability.

Sanctioning Powers

It would also ensure that national regulators have the power to impose fines and other sanctions on funds and depositaries that break the rules.

The plans must be approved by national governments and by lawmakers in the European Parliament before they can enter into force.

Rules on how UCITS managers are compensated are designed to mitigate the threat that they could be tempted to take excessive risks to boost profits, Barnier said.

The rules will include limits on the size of a manager’s bonuses relative to fixed salary, according to an EU official. They would also curb the extent to which pay is linked to short-term performance, said the official, who couldn’t be named because the plans aren’t yet public.

A separate proposal, to be published tomorrow, would force sellers of insurance to disclose more details about how they are paid, the official said. The commission will also set out minimum information that retail customers should be provided when deciding whether or not to take part in an investment fund.

OTC Derivatives

Separately, Barnier said that he is confident of reaching an agreement with the U.S. over the scope of over-the-counter derivatives trading rules.

Barnier wrote to U.S. regulators in April urging them to delay enforcing rules on EU banks amid concerns that the measures could overlap with European requirements and create unnecessary costs.

“I think the message I sent was understood and now we’re working on it,” he said. “I have confidence that it will be resolved, and that we will reach a deal to accept each others’ rules as equivalent.”

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