What are they ?
They could be banks. But they could also be "non-banks" or "Financial Companies" since the above elements are not qualifying attributes of banking activity under Swiss law, basically extending credit facilities (otherwise than temporary and secured by managed assets), remunerating deposits, or placing the counterpart of these deposits in anything else than liquid assets.
The activities of a Financial Company as opposed to those of a Bank are not governed by the rigorous and complex Federal Law on Banking and Savings Institutions (LB), which, although being merely administrative in nature, still addresses all administrative, civil and even criminal cases which may arise from financial activities. LB also provides for the Bank's Auditors to check and report on the prescribed and strictly defined "irreproachable conduct" in dealing with customers. Such obligation does not exist for Financial companies' auditors.
This dichotomy between banks and non-banks creates the erroneous impression that outside the strict banking context there could exist a vacuum sheltering reprehensible misconduct from the sanction of the law.
It is true that in contrast to the over-detailed situations provided for in Banking Law, the Civil and Criminal Codes offer only standard provisions which, most of the time have not been specifically designed to address financial activities, and thus sometimes need interpretation, for instance the article of the law on mandate (394 CO), application of market prices (428 and 436 CO), the general regime of civil liability for damages caused to third parties (41 CO), the criminal law on breach of trust (140 CP), offence against patrimony (148 CP), embezzlement (149 CP), dishonest management (159 CP) etc.
The major difference between the general legal regime and Banking Law lies in that the latter not only defines a code of conduct but also practically organizes the prevention of infringements and the external control of compliance. For a bank, the threat of denunciation to the Federal Banking Commission (leading to possible administrative sanctions), combined with a civil action and possibly a criminal complaint constitutes an effective dissuasion from malicious misconduct, particularly in asset management.
A large majority of Swiss Financial Companies agree with the necessity to put in place for their activity a system similar to the banking law. They realize that the misconduct of a very small minority may jeopardize the reputation of all of them and, in the long run, make their clients turn over their asset management operations to the banks. This is why a number of leading Financial Companies have organized themselves in an association, with a Code of Conduct largely inspired by the banking self regulation. In addition, law is evolving : The law on Stock Exchanges and Securities trading (LEx) introduces a regime for securities dealers (which may include Independent Fund Managers and Financial Companies) similar to that of the banks. Moreover a federal law on "Financial Services" is under consideration.
When frauds related to asset management arise in Financial Companies, they are often cases of pushing the limits - a long series of infringements of the civil code, uncontrolled by the auditors (if any), and unnoticed by the clients. These infringements become more severe with time, until they sometimes get criminal, for example:
- the application of spreads on the effective market prices;
- the allocation of the more expensive tranches of security purchases to clients;
- the pre or post dating, according to the market evolution, of transactions between Nostro/personal accounts of the managers and the clients' accounts, hence generating no-risk profit for the managers and certain losses for the clients;
- the attribution of forward transactions at maturity only (losses to the clients, profits to the managers) etc.
At a certain point, the dividing line becomes extremely thin between reducing a client's profit and transfering losses to him, as it becomes even thinner between transfering losses to him and directly embezzling money from him, for instance:
- using the client's assets to guarantee credits to the company or to offshore companies belonging to the managers,
- using his money to finance transactions which are not posted to his account,
- selling him matured options at a nominal value or maintaining these options in the portfolio at a fictitious value after maturity,
- selling him parts in investment funds at a higher value than really covered by assets,
- issuing "free" shares in investment funds in the favour of offshore companies belonging to the managers (hence diluting the value of the existing paid-in shares of the clients), etc.
Small to medium sized private customers, for whom confidentiality is of utmost priority, sometimes prefer small and flexible non-banking structures, not availing themselves of the differences in regulations. Their secrecy concern constitutes a major root of fraudulent practices : it overwhelms their appreciation of the risks, as well as reducing their requirements for financial performance. It is a facilitating factor since it perverts the usual reporting of transactions (clients often prefer their mail to be held in the manager's hands, and they collect it with long delays, sometimes never!). And last, they would be afraid of suing a swindler, for fear of loosing the precious anonymity. These clients are the priviledged victims of fraudulent practices.
The secrecy related practices also complicate the usual controls of third party positions by the auditors. Even if auditors are not obliged to report on the "irreproachable conduct" of Financial Companies, they cannot ignore potential litigations which may arise from the Companies' asset management activity. And experience shows that a global control of the order of magnitude of the performance of client portfolios is largely insufficient to identify effective misconduct or fraud. Only an analysis of the management of individual portfolios would establish whether a company is not at some time "pushing the limits" too far.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
For further information on this topic, please contact Deloitte & Touche SA Geneva, Marie Christine Chalon, Senior Manager in charge of Fraud Prevention and Investigations Tel: +41 22 788 0246 or enter a text search 'Deloitte & Touche' and 'Business Monitor'.
