Directors and Conducting Officers duties

Directors and Conducting Officers duties
Michèle Eisenhuth, Partner, Arendt & Medernach Jérôme Wigny, Partner, Elvinger, Hoss & Prussen ALFI/IFBL/ILA Seminar – 20 & 21 March 2012

Table of contents General principles Funds directors
Conducting officers Liability Consequences of the recent financial crisis and corporate governance (CSSF Circular 11/512) New UCITS IV requirements: CSSF Regulation 10-4 / CSSF Circulars 11/508 and 11/512 Remuneration policies

I. General principles Appointment by the general meeting of shareholders mandate given by simple majority of votes cast in the general meeting exception: cooptation until the following general meeting Conditions competence – determined at board level good reputation and integrity availability and independence (to act in the best interest of the company and not a shareholder or the promoter) possibility to nominate a legal person (representative) minimum of three directors no condition as regards nationality or residence

I. General principles (ctd.)
Management of the company to undertake everything necessary or useful to achieve the company’s objective (Law of 1915, art. 53) powers reserved to the general meeting by the law by decision of the shareholders: the board of directors has general powers, whereas those of general assembly are only residual

Rules governing the mandate appointment (Civil Code, art ss.) mandate, i.e. a power given by one person to another to do a specific task in his name agreement: written or oral; agreement of the appointee is needed (explicit or tacit) normally no remuneration revocation (Civil Code, art ss.) fixed term deceased or incapacitated dissolution of the company decision of the general meeting (ad nutum); no justification is necessary resignation (not at an inconvenient moment for company; notification of the company); no justification is necessary

Rules governing the mandate (ctd.) authority (Civil Code, art ss. and 1998 ss.) general authority, management and administration of the company the principal is bound by the acts of the agent collegiality (no individual power) delegation (Civil Code, art. 1994) no individual responsibility of the agent if he was authorised to sub-delegate to a specific representative incurs responsibility if not authorised or was authorised without specification of the identity of the representative (he will be responsible for his choice) no general delegation obligation to supervise

Rules governing the mandate (ctd.) no personal obligations (Law of 1915, art. 58) liability exceptions: limitations cannot be opposed to third parties (Law of 1915, art. 53§3) whether limitations mentioned in the articles of association or stemming from a decision of the general assembly, even if published except if it can be shown that the third party had knowledge of the limitations ultra vires the company remains liable for the acts of its board of directors, even if those exceed the object of the company except if it can be proven that a third party had knowledge (or could not ignore) that the act exceeded the object of the company)

II. Funds directors Legal provisions (Law of 2010, art. 129 (5))
“ … of sufficiently good repute and have sufficient experience, also in relation with the type of UCI concerned.” Prior authorisation from the CSSF copy of passport CV (dated and signed) declaration of honour (CSSF template) excerpt of criminal record / affidavit Legal provisions (Law of 2010, art. 129 (5)) “ … of sufficiently good repute and have sufficient experience, also in relation with the type of UCI concerned.” Ensure that the number and the expertise of the board members is adapted to the complexity of the fund’s activity -> complementary knowledge and skills Ensure an adequate balance btw independent and other directors -> evidence sufficient autonomy Prior authorisation from the CSSF copy of passport CV (dated and signed) declaration of honour (CSSF template) excerpt of criminal record / affidavit

II. Funds directors (ctd.)
General obligations under UCITS IV determine the fund’s strategy, risk profile and targeted investors (distribution policy) determine investment policies and investment restrictions approve prospectus / simplified prospectus / KIID choose ManCo (if any) and other services providers and approve relevant contracts delegate the management (supervision) designate the minimum two conducting officers approve the risk management process with the conducting officers  new requirements of CSSF Circular 11/512 approve the compliance by the ManCo, the self-managed UCITS, with the new UCITS IV requirements (see below) General obligations under UCITS IV determine the fund’s strategy, risk profile and targeted investors (distribution policy) Involvement of the board at an early stage :ratification of new sub-funds launches and their investment objective and policy, marketing strategy, volatility and determination of risk profile (procedure) Regular presentations of the business plan to the board Information of the board regarding the registration of the fund/sub-funds in foreign jurisdictions and on the distribution/marketing strategy determine investment policies and investment restrictions approve prospectus / simplified prospectus / KIID choose ManCo (if any) and other services providers and approve relevant contracts Due diligence process delegate the management (supervision) designate the minimum two conducting officers approve the risk management process with the conducting officers  new requirements of CSSF Circular 11/512 Appropriate, adequate and effective RMP in place which covers all types of risks and the overall portfolio of the fund/sub-funds Documented and formalized, regularly reviewed and revised and ensure regular reporting approve the compliance by the ManCo, the self-managed UCITS, with the new UCITS IV requirements (see below) Mandate lawyers to ensure compliance

II. Funds directors (ctd.)
Discharge of their obligations act in the best interests of the fund  cf. UCITS IV new rules of conduct regularly assess compliance with Code of Conduct principles and new UCITS IV requirements (see below) allocation of duties between them information obligation (escalation procedure), receipt of regular reports regular meetings (legal minimum: 1; best practice for a fund: 3-4) detailed agenda: documents received well in advance; detailed minutes and follow-up from previous meeting(s) Discharge of their obligations act in the best interests of the fund  cf. UCITS IV new rules of conduct Identify conflicts of interest, disclose them and establish procedures to handle them regularly assess compliance with Code of Conduct principles and new UCITS IV requirements (see below) Via a checklist allocation of duties between them Committees BUT maintain corporatism information obligation (escalation procedure), receipt of regular reports Reports from service providers, conducting persons etc. regular meetings (legal minimum: 1; best practice for a fund: 3-4) With services providers and without (“executives sessions”) detailed agenda: documents received well in advance; detailed minutes and follow-up from previous meeting(s)

III. Conducting officers
UCITS IV provisions substance: one conducting officer located in Luxembourg continuous supervision of delegated functions Regulatory conditions: CSSF Circulars 03/108 and 05/185 sufficient good repute and appropriate experience prior authorisation from the CSSF: copy of passport, CV (dated and signed) and excerpt of criminal record/affidavit + declaration of honour (CSSF template) UCITS IV provisions substance: one conducting officer located in Luxembourg continuous supervision of delegated functions Via reports of service providers Regulatory conditions: CSSF Circulars 03/108 and 05/185 sufficient good repute and appropriate experience prior authorisation from the CSSF: copy of passport, CV (dated and signed) and excerpt of criminal record/affidavit + declaration of honour (CSSF template)

III. Conducting officers (ctd.)
Self-managed UCITS / UCITS designating a ManCo *Majority of promoter representatives on the BoD may conflict with corporate governance principles min. 2 conducting officers 1 BoD 1 oversight level promoters  BoD* EUR initial capital restricted scope of activity min. 2 conducting officers 2 BoD 2 oversight levels promoters  BoD*+? ManCo capital based on all AUM extended scope of services several UCITS + non-UCITS UCITS IV  ManCo passport

Conducting officers may be: directors, managing directors, general managers, employees of the promoter “Four eyes principle”  at least two persons acting jointly Conducting officers  the board of directors’ watchdog Independent frame of mind: the conducting officers may, in the best interests of the shareholders, provide instructions to the services providers or propose to the board to withdraw a mandate in case of wilful misfeasance or mismanagement

Oversight and governance duties – agents of the board conduct the fund’s day-to-day activities with the board, classifies the fund: UCITS IV  subjective classification assess with the board, the matching between the fund’s strategy, investment policies and the risk profile of the targeted investors overview the compliance with the investment strategy and policies define, continuously assess and overview the risk management process (independent from the fund management) cf. new requirements of CSSF Circular 11/512 monitor accounting and analytical reports

Oversight and governance duties – agents of the board (ctd.) liaise with services providers and supervise their activities with the board, oversee distribution network, KIID, KYC/AML policies, market timing prevention as well as fair valuation procedures and practices keep abreast of legal/regulatory requirements and fund industry issues report to the board & others (CSSF, auditors, etc.) Etc. Oversight and governance duties – agents of the board (ctd.) liaise with services providers and supervise their activities with the board, oversee distribution network, KIID, KYC/AML policies, market timing prevention as well as fair valuation procedures and practices keep abreast of legal/regulatory requirements and fund industry issues Request expert advice (auditors, lawyers, etc.) report to the board & others (CSSF, auditors, etc.) Etc.

IV. Consequences of the recent financial crisis and corporate governance
Board members have a fiduciary duty towards the fund’s investors Until recently: only a few rules of conduct imposed by UCITS III (e.g. Law of 2002, art. 85 and 86) as well as derived from MIFID for ManCo exercising additional activities (Law of 2002, art. 77 (4))  new rules of conduct imposed by UCITS IV (see below) Alfi Code of Conduct – September 2009 In the context of the recent market conditions, it is strongly advisable that all sensitive decisions (esp. those related to credit risk/liquidity risk, valuation, etc.) be taken by the fund’s board Board members have a fiduciary duty towards the fund’s investors Until recently: only a few rules of conduct imposed by UCITS III (e.g. Law of 2002, art. 85 and 86) as well as derived from MIFID for ManCo exercising additional activities (Law of 2002, art. 77 (4))  new rules of conduct imposed by UCITS IV (see below) Alfi Code of Conduct – September 2009 In the context of the recent market conditions, it is strongly advisable that all sensitive decisions (esp. those related to credit risk/liquidity risk, valuation, etc.) be taken by the fund’s board Attention: corporatism (not only involve one or two directors)

IV. Consequences of the recent financial crisis and corporate governance (ctd.)
Focus on and measures to be taken by the board to ensure appropriate: investor protection: right to exit the fund and to be treated equally (e.g. to avoid that only illiquid assets remain in the fund in case of massive redemptions) risk assessment: crisis revealed new types of risks: specific credit risk, counterparty risk, liquidity risk, valuation risk, operational risk  continuous assessment of the risks to respond to the potential changing risk landscape fund and risk management: fund’s board/conducting officers to develop guidelines with regards to adequate management / pricing and rating of fund assets Focus on and measures to be taken by the board to ensure appropriate: investor protection: right to exit the fund and to be treated equally (e.g. to avoid that only illiquid assets remain in the fund in case of massive redemptions) risk assessment: crisis revealed new types of risks: specific credit risk, counterparty risk, liquidity risk, valuation risk, operational risk  continuous assessment of the risks to respond to the potential changing risk landscape RMP fund and risk management: fund’s board/conducting officers to develop guidelines with regards to adequate management / pricing and rating of fund assets

Focus on and measures to be taken by the board to ensure appropriate: (ctd.) compliance with new requirements of CSSF Circular 11/512: calculation of the global exposure on a daily basis, specific disclosures in the fund’s prospectus / annual report (e.g. level of leverage), etc. transparency in the sales documents of the investment policy and the associated risks + appropriate provisions in case of extreme or abnormal market conditions Risk transparency at the level of the prospectus: Global exposure determination methodology, distinguishing btw commitment approach, relative VaR or absolute VaR approach Expected level of leverage and the possibility of higher leverage levels (for UCITS using a VaR approach) and method used to determine the level of leverage (sum of the notionals or commitment approach) Information on the reference portfolio for UCITS using the relative VaR approach Risk transparency at the level of the annual report Method used to calculate global exposure, distinguishing btw commitment approach, relative VaR or absolute VaR approach Information on the VaR limit including (at least) the lowest, the highest and the average utilisation during the last financial year, as well as on the type of model and on parameters Leverage level reached during the last financial year (for UCITS using the VaR for the global exposure determination)

Focus on and measures to be taken by the board to ensure appropriate: (ctd.) portfolio liquidity and adequate valuation: board/conducting officers to put in place escalation procedure for liquidity and valuation problems (e.g. contingency plans for funds facing massive redemption requests + pricing committee ) adequate training of distribution network (KYC/AML policy, delivery of KIID, etc.) product quality management: to ensure that products sold correspond to investors’ expectations and risk profile in accordance with the new UCITS IV requirements enhanced role of compliance officers / new internal audit function (see requirements of UCITS IV below) management of conflicts of interest (cf. ALFI Code of Conduct + new requirements of UCITS IV - see below) Focus on and measures to be taken by the board to ensure appropriate: (ctd.) portfolio liquidity and adequate valuation: board/conducting officers to put in place escalation procedure for liquidity and valuation problems (e.g. contingency plans for funds facing massive redemption requests + pricing committee ) Reporting adequate training of distribution network (KYC/AML policy, delivery of KIID, etc.) product quality management: to ensure that products sold correspond to investors’ expectations and risk profile in accordance with the new UCITS IV requirements enhanced role of compliance officers / new internal audit function (see requirements of UCITS IV below) management of conflicts of interest (cf. ALFI Code of Conduct + new requirements of UCITS IV - see below)

V. New UCITS IV requirements
CSSF Regulation 10-4, art. 10: increased obligations for ManCos to monitor implementation of principles set forth in the directive CSSF Circular 11/508 Scope ManCos Self-managed SICAVs (to a certain extent) Organisational requirements Head of office of a ManCo (Law of 2010 Law, art. 102(1)e)) sufficient human and technical resources, including to control the activities undertaken by its delegates no letter box entity (substance)

V. New UCITS IV requirements (ctd.)
CSSF Circular 11/508 (ctd.) Organisational requirements (ctd.) General requirements in terms of procedures and organisation (CSSF Regulation 10-4, art. 5) (P) precise and clear manual of procedures to be complied with by delegate in case of delegation of part of its functions by the ManCo Resources (CSSF Regulation 10-4, art. 6) (P) skilled staff members with the necessary expertise for the discharge of its tasks by the ManCo and for efficient monitoring of the delegated activities Complaints handling (CSSF Regulation 10-4, art 7) one staff member responsible possibility to delegate  this requirement applies to self-managed SICAVs

CSSF Circular 11/508 (ctd.) Organisational requirements (ctd.) Electronic data processing and accounting procedures (CSSF Regulation 10-4, Art. 8, 9, 15 and 16) suitable electronic systems permitting a timely and proper recording of each portfolio transaction and subscription or redemption orders adequate accounting procedures to ensure that all assets and liabilities can be identified and valued in a correct manner possibility to delegate Control by senior management and supervisory function (CSSF Regulation 10-4, art. 10) New distinction btw “senior management” and “supervisory function” Ultimate responsibility for ensuring compliance with legal and regulatory obligations  applicable to self-managed SICAVs ?

CSSF Circular 11/508 (ctd.) Organisational requirements (ctd.) Permanent compliance function and internal audit function (CSSF Regulation 10-4, art. 11 and 12) (P): cannot be undertaken concurrently by the same individual possibility to delegate Permanent risk management function (CSSF Regulation 10-4, art. 13) (P) possibility to delegate BUT appropriate monitoring by a risk manager officer cannot be undertaken concurrently by the same individual responsible for the compliance function this requirement applies to self-managed SICAVs Personal transactions (CSSF Regulation 10-4, art. 14) written procedures to record all personal transactions

CSSF Circular 11/508 (ctd.) Conflicts of interest (P) Conflicts of interest policy (CSSF Regulation 10-4, art. 18 and 22) (P) recording of situations which may give rise to a conflict of interest  this requirement applies to self-managed SICAVs Strategies for the exercise of voting rights (CSSF Regulation 10-4, art. 23) effective strategy to be set up for determining how and when voting rights attached to instruments held in the managed portfolio are to be exercised to the exclusive benefit of the UCITS concerned

CSSF Circular 11/508 (ctd.) Rules of conduct (CSSF Regulation 10-4, art. 25 to 32) to act in the best interests of the UCITS and their unitholders to comply with due diligence requirements when executing investment decisions to comply with best execution principle when executing orders for the UCITS to comply with reporting obligations when handling subscription and redemption orders

CSSF Circular 11/508 (ctd.) Rules of conduct (CSSF Regulation 10-4, art. 25 to 32) (ctd.) to comply with new inducement requirements: fees, commissions and non-monetary benefits paid to or by the UCITS or a person on behalf of the UCITS; fees, commissions and non-monetary benefits paid to or by a third party or a person on behalf of such third party; existence, nature, amount must be clearly disclosed to the UCITS prior to the provision of relevant service; designed to enhance the quality of the service and not impair management company’s compliance with duty to act in best interests of UCITS; proper fees e.g. custody costs, settlements and exchange fees, regulatory levies, legal fees etc.  these requirements apply to self-managed SICAVs

CSSF Circular 11/508 (ctd.) Risk management (CSSF Regulation 10-4, art. 42 to 50) New CSSF Circular 11/512 market and counterparty risks operational and liquidity risks any other risk that may be material for the UCITS managed to calculate the UCITS’ global exposure at least on a daily basis to disclose specific information in the UCITS’ prospectus and annual report (level of leverage, etc.)  these requirements apply to self-managed SICAVs

VI. Remuneration policies in the financial sector (ctd.)
European initiatives  EC Recommendation (2009/384/EC) dated 30 April 2009 Remuneration policies in the financial services sector (for all financial undertakings having their registered office or their head office in the EU)  CRD III Directive (2010/76/EU) of 24 November 2010 (Not applicable to UCITS and their Mancos) Applicable to credit institutions and investment firms within the meaning of MIFID; aims at translating the principles contained in the foregoing recommendation into legally binding requirements

European initiatives (ctd.)  Consultation paper of the European Commission dated 14 December 2010 on the UCITS depositary function and on UCITS managers’ remuneration rationale of remuneration policy for UCITS managers: new products and techniques make UCITS more vulnerable level playing field between credit institutions and investment firms (CRD III), alternative investment fund managers (AIFMD) and UCITS managers  consistent remuneration policies across all financial services to avoid migration of more risky practices into the UCITS sector scope: UCITS fund managers: ManCos self-managed SICAVs

European initiatives (ctd.)  Consultation paper of the European Commission dated 14 December 2010 on the UCITS depositary function and on UCITS managers’ remuneration (ctd.) categories of staff whose professional activities may have a material impact on the risk profile of a managed UCITS in particular: senior management, including board of directors, persons carrying out supervisory or risk management functions and any employees receiving total remuneration that take them into the same remuneration bracket as senior management To apply the principle of sound remuneration policy in accordance with the principle of proportionality (size, internal organisation, nature, scale and complexity of activities) Feedback statement: Remuneration rules should be adjusted to the UCITS model (≠ credit institutions / AIFM) Substantial portion of variable remuneration paid out by units/shares is not suitable in a UCITS environment

European initiatives (ctd.)  AIFMD (2011/31/EU) dated 8 June 2011 Remuneration policy to be put in place scope: categories of staff including senior management, risk takers, control functions and any employees receiving total remuneration that takes them into the same remuneration bracket as senior management and risk takers, whose professional activities have a material impact on the risk profiles of the AIFMs/AIFs they manage rules derive from EC Recommendation 2009/384/EC proportionality principle  CRD IV (Not applicable to UCITS and their Mancos) On 20 July 2011, the Commission adopted a legislative package to strengthen the regulation of the banking sector. The proposal replaces the current Capital Requirements Directives (2006/48 and 2006/49) with a Directive and a Regulation and constitutes another major step towards creating a sounder and safer financial system. The Directive governs the access to deposit-taking activities while the Regulation establishes the prudential requirements institutions need to respect.

Luxembourg initiatives: regulatory framework  CSSF Circular 10/437 implementing EC Recommendation (2009/384/EC) scope: all “financial undertakings” subject to the CSSF’s prudential supervision which shall include a) credit institutions, b) investment firms, c) managers of pension funds and of collective investment schemes; persons who are members of the administrative and management bodies of the financial undertakings and staff whose professional activities have a material impact on the risk profile of the financial undertakings Establishment of a remuneration policy by the board of directors of funds especially when staff receive a variable remuneration

Luxembourg initiatives: regulatory framework (ctd.)  CSSF Circular 10/437 (ctd.) ceiling of the variable component postponement of the main fraction of a significant premium contractual allowances should reflect the actual performance “welcome bonus” limited to the first year withholding partial or total of premiums “clawback” when fraud

CSSF Circular 10/496 applicable to credit institutions and branches of credit institutions originating from non-EU MS : Not applicable to UCITS or their Mancos CSSF Circular 10/497 applicable to investment firms and branches of investment firms originating from non-EU MS, and modifying CSSF Circular 07/290 on capital ratios requirements for investment firms and management companies : Not applicable to UCITS or their Mancos CSSF Circular 11/505 detailing the application of the principle of proportionality when establishing and applying remuneration policies that are consistent with sound and effective risk management as laid down in CSSF Circulars 10/496 and 10/497: Not applicable to UCITS or their Mancos Law dated 28 October 2011 implementing Regulation (EC) No 1060/2009 of the European Parliament and of the Council of 16 September 2009 on credit rating agencies and amending the amended law of 1993 in respect of remuneration policies: Not applicable to UCITS or their Mancos

VII. Liability Civil liability Mismanagement (Law of 1915, art. 59§1)
contractual liability mandate negligence (act or omission; damage; causation (i.e. damage caused by negligence) only as regards the shareholders exception: Civil Code, art (action oblique) if the company is passive the creditor has to act with the goal of safeguarding his interests if he succeeds, payment to the company

VII. Liability (ctd.) Civil liability (ctd.)
Mismanagement (Law of 1915, art. 59§1) (ctd.) no action in favour of minority shareholders individual liability exoneration no negligence in exercise of management functions (reference to a normally prudent person; best effort obligation) discharge given by the general assembly scope of indemnification

VII. Liability (ctd.) Civil liability (ctd.)
breach of statutes or the Law of 1915 (Law of 1915, art. 59§2) contractual liability as regards shareholders liability in tort as regards third parties joint liability (Civil Code, art. 1200) Limited exoneration (performance obligation) the director has to provide information of the violation at the next general meeting discharge (only binding as regards the company) scope of indemnification Criminal liability (Law of 1915, art. 162 to 173)

VII. Liability (ctd.) Criminal liability of legal entities
A specific regime on criminal liability regarding legal entities has been introduced in Luxembourg by a law dated 3 March 2010 Scope of the law The Law provides that a legal entity might be criminally liable when a crime (“crime”) or a misdemeanour (“délit”) has been committed in its name and in its interest by one of its legal corporate bodies or by statutory or de facto managers/directors (“dirigeants de droit ou de fait”). A /0.0/12 Aug 2009

VII. Liability (ctd.) Criminal liability of legal entities (ctd.)
Concurrent liabilities A legal entity might be held liable for criminal offence without prejudice to the personal criminal liability incurred by directors/managers of the said legal entity. Sanctions fines special seizures/attachments exclusion from public contracts bids dissolution and liquidation A /0.0/12 Aug 2009

Contact us Michèle Eisenhuth Partner at Arendt & Medernach
Tel : Jérôme Wigny Partner at Elvinger, Hoss & Prussen Tel:

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