Role of the depositary in a Luxembourg UCITS fund – a general overview as a result of the

Madoff case
Date: 2 February 2009
By Olivier Sciales of Chevalier & Sciales (Luxembourg law firm)
www.cs-avocats.lu

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.

Please note that the information contained herein is not intended to be a comprehensive study or
to provide legal advice, and do not substitute for the consultation with legal counsel required
before any actual undertakings. We undertake no responsibility to notify any change in law or
practice after the date of this document.

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