HSBC Must Pay Madoff Investors Only If Luxembourg Court Says So

By Stephanie Bodoni

Nov. 19 (Bloomberg) -- HSBC Holdings Plc’s Luxembourg unit must compensate investors only if a local court finds the bank breached its custodial duties over a dissolved fund that placed assets with conman Bernard Madoff, the country’s financial regulator said.

The Commission de Surveillance du Secteur Financier, in a statement posted yesterday on its Web site, ordered HSBC Securities Services (Luxembourg) SA “to review and complete the necessary internal rules and relevant forms in order to fulfill all the tasks relating to its function” as custodian bank of local mutual funds “within a period of three months.”

Europe-based custodian banks face increased scrutiny by the European Commission following the Madoff scandal. Madoff, 71, pleaded guilty in March in federal court in Manhattan and was sentenced on June 29 to 150 years in prison for using money from new clients to pay earlier investors. He directed a multibillion-dollar Ponzi scheme from his now-defunct New York money management firm.

HSBC’s Luxembourg unit was custodian for Herald (Lux) US Absolute Return Fund, which was managed by Bank Medici. Investors in France, Ireland and Luxembourg, the world’s second- largest mutual fund market after the U.S., are suing custodians, seeking the repayment of billions of dollars.

The decision whether HSBC’s unit “committed a civil tort which would oblige it to contribute, together with all other persons held liable” to pay damages “falls exclusively to the courts and tribunals,” the regulator said.

Bank Comment

“HSBC believes that it has complied with all its obligations as the depositary bank of the Herald Lux SICAV and agrees with the commission that it is exclusively up to the civil courts to determine the outcome of this matter,” the London-based bank said in an e-mailed statement yesterday. “HSBC continues to believe that it has good defenses to any claims brought against it and will vigorously defend itself against any such claims.”

Luxembourg Finance Minister Luc Frieden, in an interview in June, said custodian banks for Luxembourg-based mutual funds, such as HSBC’s unit, had “clear” obligations to compensate investors for Madoff-related losses. Yesterday is the first time the regulator, an independent body that is part of the government administration, expressed itself on HSBC’s liabilities. The CSSF said it concluded its HSBC review Nov. 17.

HSBC, Europe’s largest bank by market value, is facing investor complaints in Ireland for allegedly failing in its duties as custodian handling money in the Irish Thema International Fund Plc. The European funds at issue are known as Undertakings for Collective Investment in Transferable Securities, or UCITS. Custodians manage cash inflows and payments to investors.

UBS Cases

UBS AG is also being sued in Luxembourg over its role as custodian for two local funds, including Access International Advisors LLC’s LuxAlpha Sicav-American Selection fund, which once had assets of $1.4 billion, and invested 95 percent with Bernard L. Madoff Investment Securities LLC.

The CSSF in a May 27 finding after its review into UBS’s liabilities said the Swiss bank’s local unit had to indemnify mutual fund investors “according to its obligations as a Luxembourg depositary bank, subject to valid and opposable contractual clauses to the contrary.”

In its three-page statement yesterday, the regulator clarified its position further, saying that the final decision concerning contractual liabilities between private parties “can only be taken conclusively by a competent Luxembourg court.”

Madoff Links

The regulator also reacted to a lawsuit and press reports saying it knew before Madoff’s December 2008 arrest of links between him and three local funds that went into liquidation this year.

“The documents submitted to the CSSF” for the registration of the three funds “included no reference neither to the identity of BMIS nor, more importantly, to the multiplicity of functions carried on de facto by one entity,” the regulator said, referring to Madoff’s firm.

Between the funds’ creation and Madoff’s arrest “the CSSF was never informed in a transparent manner, by the professionals involved, of the structure actually set in place nor of the role played in practice by BMIS.”

To contact the reporter on this story: Stephanie Bodoni in Luxembourg at sbodoni@bloomberg.net