SECTION A: FINANCIAL INSTITUTIONS
1. General introduction – summary
There has been an unquestionable shift of perception in matters of conflicts of interest, duty of care and loyalty (obligation de diligence and obligation de fidélité), resulting in self-regulatory, legislative and enforcement tightening. It is part of a growing realisation of the need to manage risks. And it is very much under the banner of risk management in general that it is being sold to the owners.
The casual dismissal of the risks of conflicts of interest, and of their potential harm to institutions, is not in place any longer. Still grudgingly in certain quarters, these risks are accepted as a reality, warranting management, by means of rules, in a spirit of good governance, and requiring compliance.
“Compliance”, a word and a department imported from the US and the UK, is now part of the scene in Zurich and Geneva, too.
Problems that emerged under the old regime – even if there were only a few have prompted a move away from self-regulation. It is no longer accepted wisdom that management knows best. Not surprisingly, there is concern that the pendulum may have swung too far, toward a state of over-regulation, with a tilted benefits and costs balance.
As one would expect in a country thought to look after two-thirds of world offshore private financial assets, private banking has been the most fertile change and testing ground. Swiss private banks, being mostly universal banks engaged in the whole range of financial services, including underwriting and securities trading, are particularly prone to be afflicted by (not to say benefit from) conflicts of interest.
There has been an exponential growth of regulations. Conflicts of interest are dealt with, expressly or not, under the Swiss codes (eg the mandate of the Code of Obligations), the Banking Act, the more recent Stock Exchange Act, various pieces of self-regulation, notably by the Swiss Bankers Association and, last but not least, the rich practice of the Federal Banking Commission (both as regulatory body and judge) and, of course, the courts.
The Federal Banking Commission has become the key player, investigating the market, regulating where (increasingly) empowered to do so and bringing any failing practitioners, whether banks or securities dealers (not yet independent investment managers, though, who, if not a bank or securities dealer, remain unregulated), to account. The Federal Banking Commission supervises the entire financial services industry (insurance excluded). The Federal Banking Commission’s composition, with academics and senior bankers sitting alongside civil servants, reflects its authority. Decisions of the Federal Banking Commission can be taken to the Swiss Supreme Court; which has upheld most such decisions.
Interestingly, whereas until a couple of decades ago the then three big banks were very much seen to be regulating the market, and in effect trusted to do so, today the Federal Banking Commission has set up two separate, dedicated compliance units dealing with UBS and Credit Suisse.
The Swiss Bankers Association, it is fair to say, which has produced many industry guidelines, has been, if not lagging behind, somewhat reactive.
2. Background/environment
Generally the changes have taken place against a background of growth and consolidation.
A change of structure in the wealth under management and a change of structure in the institutions managing that wealth, more perhaps than the scandals of the late 1980s and 1990s which were uncovered when the markets plunged (Banque Cantonale du Valais, Banque Cantonale Vaudoise, Banque Cantonale Genevoise etc), have shaped the current environment. New money has replaced old money, new managers have replaced old managers and, as a consequence, the undivided confidence of the past and the natural restraint of the old-style bankers are gone. New clients are aware of the pressure on bankers to produce income (no matter whether the institution is public or private) and request the assurance of some regulation, and its enforcement.
The notion that the Federal Banking Commission scolding banks for allowing managers to churn accounts, selling products not in line with client risk profile or failing to execute transactions timely, or blaming a respected Zurich bank for misallocating an IPO, would harm the image of Switzerland as a financial centre has given way to the conviction that a reliable financial centre needs to be, and be seen to be, properly policed.
The past few years have seen a considerable tightening of systems and procedures, with a view in particular to avoiding conflicts of interest. Investments managers are requested to determine better the profile of their clients, assessing more thoroughly their clients’ appetite or aversion to risk. Managing this risk for the client is being equated to managing the institution’s risk. Banks and other asset management firms have been developing so-called open architecture, offering third-party managers’ products (no more simple dumping of in-house products). They have improved substantially the description of their product range and the evaluation of the risks related thereto. They are also more open about their fees and commissions.
The most recent adoption of the international Global Investment Performance Standards (GIPS) by the Swiss Bankers Association must be seen in that same context of improvement of transparency, so as not to fail the client to the advantage of the bank. True, compliance will remain voluntary; the GIPS will not form part of Swiss positive law. So-called soft laws should not be underestimated, though; since the GIPS are issued by the Swiss Bankers Association, they must be regarded as a code of best practice, which will not be ignored by a Swiss judge, depending on the circumstances, when assessing a bank’s liability.
It is the perception of a potential conflict of interest between institutional brokerage and client advice which has led a couple of the most respected private bankers to part way with their institutional brokerage business. They have chosen to side with the client, the buyer.
3. Applicable laws, regulations and codes
Banking in general
All banks are governed by the old Federal Banking Act. This does not contain any specific provisions on conflicts of interest. Conflicts of interest are caught under Art 3 (2) (c), which sets out a guarantee of proper conduct. It is under this catch-all provision that the Federal Banking Commission, followed by the courts, has laid down a whole range of management duties and responsibilities which, directly or indirectly, are designed to prevent conflicts of interest.
Securities dealings
Stock exchanges and professional trading in securities (and public takeover offers) are governed by the 1995 Federal Act on Securities Exchanges and Securities Trading (Stock Exchange Act). This relatively recent piece of legislation contains not only a general guarantee of proper conduct provision (Art 10) (2) (d)) similar to the one found in the Banking Act, but a provision setting out expressly securities dealers’ duty of disclosure, diligence and loyalty. In this last respect it reads, “the securities dealer shall ensure that in the event of any potential conflict of interest his client’s interest are not adversely affected”. These duties were substantiated by the Swiss Bankers Association, in January 1997, in a Code of Conduct for Securities Dealers governing securities transactions. The Federal Banking Commission and the courts in their turn have developed a whole set of duties in relation to conflicts of interest.
Financial research
In January 2003 the Swiss Bankers Association issued Directives on the Independence of Financial Research. Chief among its stated purposes is the avoidance of conflicts of interest or, when unavoidable, their proper disclosure and handling. It is against the international background of questioning the independence of financial analysts at banks that the Swiss Bankers Association decided to act. Meanwhile the Federal Banking Commission has elevated these directives to the status of a generally binding code of conduct, applicable across the banking and securities dealer industry. Their directives are (already) in the process of review in connection with the proposed overhaul of the Swiss banking legislation.
The regulations need not fear comparison on an international level; certain provisions go well beyond similar regulations in other countries. The Swiss Bankers Association is very aware that the integrity of financial research is a cornerstone of the Swiss investment management industry. The directives apply equally to the buy and sell side, in contrast to the case in several countries. They are aimed at both equities and fixed income. And they apply to primary and secondary research. All publications by banks including mere recommendations are within the ambit of the regulations, so long as they stem from the bank’s financial research department. The directives cannot be circumvented by channelling research and recommendations through foreign affiliates.
Securities offerings
In March 2004 the Swiss Bankers Association issued Allocation Directives for the New Issues Market governing the allocation of equity-related securities offered by way of a public offering with a view to ensuring fairness and transparency in the allocation process. They apply to all public offerings of shares, participation certificates, dividend right certificates, convertible bonds and warrants offered in Switzerland. They apply to all banks in Switzerland, including branches and subsidiaries of foreign banks.
The directives were very much the product of the boom in technology IPOs, which gave rise to various claims of unfair allocation. Thus, in 2003 Bank Vontobel was held by the Federal Banking Commission to have made an excessive and unfair allocation to its nostro account, in breach of Banking Act Art 3 and Stock Exchange Act Art 10 (the catch-all general guarantee of proper conduct provision); the (detailed) directives followed.
Investment funds
The Swiss Funds Association has issued a Code of Conduct, dealing essentially with information flows, designed to avoid conflicts between management and investors.
Insurance
The Federal Act on the Supervision of Insurances does not contain any specific conflicts of interest provisions. Conflicts of interest are not seen as an acute issue in the industry.
4. The requirements
Banking and securities dealings
Interestingly the 1997 Code of Conduct distinguishes between the obligations derived from securities dealers’ duty of diligence and those stemming from their duty of loyalty: the former requires best execution, immediate allocation and accountability and transparency; the latter, equal treatment, chronological execution (by order of execution entry) and prohibition of front-running. Further, banks and securities dealers must put in place all appropriate systems and procedures to prevent conflicts of interest and, when such conflicts are unavoidable, to deal with them a manner not detrimental to the client. They must set clear responsibilities (committees and officers) to decide investment policy, its implementation and supervision (appropriate measures will depend on the firm’s size and structure). Investment advice and the preparation and provision of securities and cash statements shall be entrusted to different officers. Proprietary trading must be duly segregated and supervised; clear rules must also be set regarding employee securities transactions.
Chinese walls are required as a matter of good practice (Banking Act Art 3
(2) (c) and Stock Exchange Act Art 10 (2) (d)). Banks and securities dealers must, by way of appropriate internal regulations regarding premises, organisation, procedures and training, duly enforced, avoid conflicts of interest by means of restrictions to the free flow of information.
However, in a much-noticed yet unreported case in 1999 (Biber), the Swiss Supreme Court ruled that there are limits to the effectiveness of Chinese walls. That is, in certain circumstances a conflict of interest may not be resolved by Chinese walls. First, the court held that prudential management actually prevented information restrictions at top-management level, and hence, Chinese walls could only be erected underneath top management; then, not only did the walls need to be proof, but top management needed not to interfere in any way. Second, a financial institution could not rely on Chinese walls in respect of information pertaining to a conflict of interest so serious that acting in this conflict, no matter how effective the walls, would still impact on the reputation of the institution.
Financial research
The Swiss Bankers Association’s directives deal with the matter at three levels: first, any financial research division must be surrounded by Chinese walls. Second, financial analysts must be separated in all organisational respects, including especially reporting and remuneration. Third, material non-public information not available to clients may not circulate between various units of the bank, or, if such circulation cannot be avoided, prior consent by a dedicated compliance officer must be obtained.
Securities offerings
The Swiss Bankers Association’s directives call for clear allocation procedures that warrant fair and equal treatment. In particular, allocations against the promise of any future consideration are prohibited (eg so-called laddering, the payment of special commission premiums and spinning).
Underwriters may allocate a reasonable stake of an offering to their nostro account, subject to the consent of the issuer, however. And any so-called friends and family allocation must be disclosed in the prospectus.
5. Outlook
Are the checks and balances in place right and sufficient to ensure the credibility of the industry in a liberal market economy? The Swiss Government does not think so. A Supervision of the Financial Market bill has been published. This proposed new piece of federal legislation is designed to provide for a new supervisory authority for all financial services, including insurance, and to harmonise and beef up the catalogue of sanctions against violations of the laws and regulations. An additional chapter will deal with a proposed extension of these supervisory powers to introducing brokers, currency traders and independent asset managers.
Switzerland and the EU have signed and ratified a series of bilateral treaties, the first set of which is in force, the second being scheduled to become effective in the Summer of 2005. These treaties require a lot of EU compliance from Switzerland. The EU Markets Abuse Directive and the Markets in Financial Instruments Directive, however, do not and are not scheduled to apply in Switzerland.
6. Useful references
www.ebk.ch (Federal Banking Commission)
www.swissbanking.org (Swiss Bankers Association)
www.vsv-asg.ch (Association Suisse des Gérants de fortune (ASG))
www.sfa.ch (Swiss Funds Association (SFA))
SECTION B: AUDITORS
1. General introduction – summary
The climate in which the auditing profession operates has changed greatly over the past decades, especially in the last few years, for reasons well known. The near future is expected to bring about further substantial changes; final consultations for the proposed enactment of extensive new legislation on auditing are underway.
For the time being the relevant Swiss law and practice are essentially confined to two provisions of the Code of Obligations (CO), namely Art 727c and Art 755, and to the Guidelines on Independence issued by the Swiss Chamber of Chartered Accountants (Treuhand-Kammer/Chambre Fiduciaire).
Under current legislation, courts will not step in until a financial loss has occurred. Absent such a loss, the industry is left basically to self-regulation and policing. Auditors acting for banks are the notable exception, as they have to be especially licensed and approved by the Federal Banking Commission.
Conflicts of interest are feared to arise particularly where auditors also render consultancy services to their clients and where they otherwise build up too close a relationship with their clients. That said, the need for small and medium-sized companies for one-stop shop solutions is acknowledged. Conflicts of interest in these latter cases are perceived as far less serious in their consequences.
2. Background/environment
In the early 1970s the Swiss Supreme Court held that auditors must be what came to be known as “independent in fact” (ATF 99 Ib 111). Auditors had to act “regardless of their own interest”. This requirement has since been tightened, first in the course of a major overhaul of Swiss company law in 1991. Auditors now also have to be able to demonstrate that, no matter the reality, there is no appearance of dependency from their audited client.
In 2001 the Swiss Chamber of Chartered Accountants re-edited its Guidelines, then dating back to 1992.
The recent scandals, international and domestic, have brought the issues of independence and possible conflicts of interest of auditors to the fore. These issues are paramount in the corporate governance debate.
Whilst it is generally accepted that changes are warranted, the argument is made that many of the newly proposed requirements may be too tight on small and medium-sized companies. As in most other economies, the overwhelming majority of Swiss enterprises fall into this category. It is widely seen as crucial that their business environment be not unduly burdened by overly restrictive regulation.
Switzerland has not eluded recent international developments, most notably the Sarbanes-Oxley Act (SOXA). SOXA is perceived as becoming some sort of universal standard potentially leading to compliance more in form than substance. Whilst Swiss companies subject to SOXA contend that its strict requirements are an opportunity to review internal standards and gain better control over operational risks, there is admittedly a substantial financial burden coming along. Additional internal compliance expenses are reported to have skyrocketed and audit costs often doubled.
Swiss authorities are keen on concluding a legislative process that has been going on for more than ten years. New legislation applying to auditors, explicitly addressing the issue of conflicts of interest, is expected to be enacted soon (see section B.5 below, Outlook).
3. Applicable laws and regulations
As things stand, public regulation, statutory and case law, relating to conflicts of interest is thin, with only a couple of provisions in the Code of Obligations (Arts 727c and 755) and one significant case tried by the Swiss Supreme Court in recent years. There is a fair amount of writing by commentators though; and this exerts great influence in Switzerland. As a result, the Guidelines issued by the Swiss Chamber of Chartered Accountants (the Guidelines) carry considerable weight. Although technically speaking applicable only to members of the Chamber, the prevailing view is that the Guidelines apply to all auditors regardless of membership and the judge will apply it as a binding usage, subject to the principle of “comply or explain”.
International regulations have an ever-greater bearing on the Swiss auditing environment. Standards and rules set by regulations, particularly with an Anglo-Saxon, background rub off onto Swiss legislative and regulative projects. Swiss auditors either being members of an international association or auditing companies with shares listed in the US are likely to be or are subject to SOXA and regulations of the US Securities and Exchange Commission.
The rules currently applying to auditing in Switzerland are not as far-reaching as in other jurisdictions and their enforcement is still left largely to self-regulation. Whilst it is generally recognised that the current statutory and self-regulatory environment has been providing an independent and largely sufficient surveillance, the need for a more state-controlled system is hardly contested in order to stay abreast of the times.
4. The requirements
Currently, conflicts of interest are not expressly addressed by Swiss statute. The ban on acting in a conflict is deemed to be caught under the requirement of independence.
Article 727c CO sets out the requirement of independence. Auditors must be independent, from the board of directors of and from any shareholder with a majority vote in the audited company. Auditors may not be employees of the audited company, nor may they provide any services deemed incompatible with the audit mandate. In the case of a group of companies, if a shareholder or a creditor so requests, auditors must be independent from any affiliate (Art 727c
(2) CO).
Article 755 CO provides for the liability of auditors to (i) the audited company, (ii) its shareholders and (iii) its creditors for any losses suffered in the event of breach of duty. Provided that the loss can be shown to be the result of a conflict of interest, auditors may be held liable.
Interestingly, only one significant case relating to the requirement of independence of auditors has been tried by the Supreme Court in recent years. It concerned a company acting as auditor to another despite the two having the same sole director. The court held this to be unacceptable. Under these circumstances, there was no room for independence as required by statute; the situation was in effect tantamount to a mutual audit. However, since the statutory requirement of independence under Art 727c (2) CO was introduced for the sole benefit of group companies, it did not apply in the event (ATF 123 III 31).
The Guidelines set out the requirement of independence applicable to auditors in more detail. Auditors of listed companies and other companies subject to banking, stock exchange or investment fund legislation must replace the audit project manager after a maximum of seven years. “Cluster risks” such as fees in excess of 10 per cent of total revenue from one single client are to be avoided. The majority of the board of directors or management of an auditing firm must be qualified auditors. Contingency fees or fixed fees are prohibited. Although widely criticised and seen as an outright call for conflicts of interest, the Guidelines still allow auditors simultaneously to act as accountants in smaller matters. The Guidelines do not contain any provision whereby auditors are appointed for a minimum fixed period.
Today sanctions (other than by trade organisations) are confined to damages in the event of financial loss to the audited company, its shareholders or its creditors (Art 755 CO). This weakness of the current system is seen as one of its chief shortfalls, which the proposed amendments intend to remedy (see section B.5 below, Outlook).
5. Outlook
Far-reaching changes are likely to be made to Swiss auditing legislation in the near future. For more than a decade the legislator has been evaluating various proposals. Domestic and international developments have influenced the legislative process, including especially the events leading to SOXA. In 2003, the Federal Department of Justice drafted proposed legislation aimed at improving the provisions governing the auditing process and boosting confidence in the profession.
As a result amendments to the current provisions of the CO relating to accounting and auditing and the enactment of a new Federal Accounting and Auditing Act (AAA) are expected in the course of 2006. The thrust of the changes is to adapt the rules to the needs of the economic and business environment and to bolster state supervision of the auditing industry. The CO amendment proposals provide for a new definition of the auditing requirement, specify duties and tasks of auditors in more detail and define the required qualifications of auditors. The requirement of independence is set out in detail and, in comparison with current rules, tightened. In contrast to current legislation, the AAA shall apply irrespective of the company’s legal form.
The new CO provisions are expected to provide for various degrees of audits, namely (a) full audit, (b) review and (c) voluntary audit, depending essentially on whether or not the concerned company is in the capital market (equity or debt) and on the company’s size.
The AAA is intended to bring about a fundamental change to the supervisory environment, currently based on self regulation, at both national and international level.
6. Useful reference
www.treuhand-kammer.ch (Swiss Chamber of Chartered Accountants)
SECTION C: LAWYERS
1. General introduction – summary
If there has been a shift in perception in matters of conflicts of interest and duty of confidentiality, it is by way of a growing awareness of practitioners and sharpening of the related requirements. The duty of confidentiality is but one facet of the duty of loyalty, and the obligation to avoid conflicts of interest its corollary. We owe it to the bigger firms, cross-border associations and various links to other professions and industry, to have brought the issue to the fore, not to say to have led the debate.
This debate has come to the public at large as a reminder of the true nature and place of the lawyer in society, or the challenge to it. It is likely to be some time before a Swiss parliamentarian will state, as a US senator notoriously did, that lawyers behave like businessmen and should be treated accordingly.
There is a worry about the erosion of confidentiality under the assaults of money laundering and other hasty security-related legislation.
The Swiss Code of Obligations, the Swiss Criminal Code and cantonal Bar Association Codes of Conduct used to be the sources of the law and practice. As from 2002, Switzerland has a federal statute regulating lawyers, next to cantonal statutes, and a growing body of case law. In 2005 the Swiss Bar Association issued a Code of Conduct in which it specifically prohibits a lawyer to act in the event of conflicts of interest.
Cantonal bar associations and, more importantly now cantonal courts, supervise, interpret and enforce the refreshed rules. The Swiss Supreme Court has the final word.
2. Background/environment
Like in most countries, the single practitioner was the rule, and the regulation of conflicts of interest was made for him. The emergence and development of the bigger law firms, no matter how integrated, has not led to any loosening of the rules regarding conflicts of interest. There has been no bending of the paramount principle of independence, the groundstone of the requirement of avoidance of conflicts of interest.
Confidentiality remains the bedrock of the profession. The duty owed by the Swiss lawyer to his client is undivided. As in many countries, the Swiss lawyer is an auxiliary of justice, never to the point of having to disclose anything to any parties against the will of his client, however. Nor does any duty of disclosure to the tax authorities take precedent either.
Arguably, the lawyers’ rephrased KYC duty may have had the unintended consequence of their not only knowing more about their clients, but also caring more and being more prudent in relation to potential conflicts. On the other hand, the media, league tables and directories have led to an erosion of a certain idea of confidentiality (only a few years ago no respectable Swiss firm would have bragged about their clients).
3. Applicable laws, regulations and case law
Under the mandate provisions of the Code of Obligations (Art 398 (2) CO) the lawyer owes his client a duty of diligence and duty of loyalty (Sorgfaltspflicht and Treuepflicht, obligation de diligence and obligation de fidélité). Any lawyer who accepts instructions while aware of a conflict of interest, or who fails to resign upon becoming so aware, opens himself to civil liability.
Moreover, the breach of professional confidentiality (Berufsgeheimnis, secret professionnel ) is a crime (Art 321 Criminal Code).
It was not until 2002 that the legal profession became regulated at federal level. The Federal Act on the Freedom of Movement of Lawyers (the new federal law) – lawyers admitted in one canton and practising in another used to be frowned upon – contains a specific provision prohibiting conflicts of interest. This is the new yardstick, left to the Swiss Supreme Court as ultimate arbiter.
Cantonal bar association rules, and the Federal Guidelines underpinning these, lay down an absolute ban on conflicts of interest.
In the wake of the new Federal law, courts have been kept busy:
4. The requirements
Theoretical vs actual conflict
Under the new Federal law, it is actual conflicts of interest which require attention and must be avoided. A mere apparent conflict does not constitute an impediment. However, when considering whether or not to accept instructions, a lawyer must carefully assess the risk of conflict: if he wittingly accepts a foreseeable conflict, he does so under penalty of civil liability in the event that he must later terminate the mandate because of that conflict.
Personal conflicts
A lawyer may not accept instructions and must discontinue his representation when the interest of his client conflicts with his own. Such a conflict is deemed to arise in the event that any client-related decision may lead to a personal advantage or disadvantage for the lawyer. A financial relationship between the lawyer and his client, including especially a loan, amounts to a conflict in any event.
Conflicts within law firm or association
Basically a law firm shall not be looked at any differently from a sole practitioner. The Zurich Supervisory Authority has held this rule to apply also to lawyers members of international associations, because of their prevailing common interest. In contrast, membership of mere international networks (eg Lex Mundi) is no impediment.
Chinese walls are ineffective. The obligation to avoid conflicts is absolute, not a matter of internal regulations.
Undivided loyalty
There is a general prohibition of representation of more than one party. However, a distinction is to be made between representation in litigation and non-litigation matters. The ban applies rigorously to the former: no exception is suffered, regardless of client’s consent. In non-litigation matters, multiple representation is possible, only exceptionally though, subject to all parties’ consent and to very clear and strong general disclosure. And should there arise a conflict in the course of the matter, then the lawyer must discontinue his representation of all parties.
Change of parties (acting against former client)
The lawyer’s duty of loyalty and confidentiality extends beyond the close of the mandate. A lawyer may act against a former client only absent any risk that he may use information come to his knowledge while acting for his former client. Subject matter proximity and time proximity will, of course, play a major part in the assessment.
5. Outlook
The legal environment having been reshaped recently there are no expected developments apart, of course, from a growth of the body of case law.
6. Useful references
www.swisslawyers.com (Swiss Bar Association)
www.zav.ch (Zurich Bar Association)
www.odage.ch (Geneva Bar Association)
