This article analyses the Swiss Federal Supreme Court’s recent case law on the requirements for a valid retrocession waiver clause in execution-only relationships and discusses FINMA’s draft circular on rules of conduct under FinSA/FinSO in this context.

 By Stephanie Walter (Reference: CapLaw-2024-62)

1) Background

Over the past 18 years, the retention of third-party compensation by private banks and asset managers has been the subject of major legal development. Through a series of groundbreaking decisions (FSC 132 III 432; FSC 137 III 393; FSC 138 III 755), the Swiss Federal Supreme Court (“FSC“) held that a financial institution could retain retrocessions and other distribution fees received in connection with its mandate only if there was a comprehensive waiver based on informed consent; otherwise, these fees must be handed over to the client. The disclosure requirements established by case law are stringent: at a minimum, the information provided must outline the basis for calculating the retrocessions and include the expected compensation range, expressed as a percentage of the assets under management, to contextualize them against the management fees. Additionally, clients must be informed of the risks associated with conflicts of interest generated by retrocessions and the measures taken to avoid or mitigate these risks (FSC 137 III 393). These principles have been codified into the regulatory framework for financial service providers, the Financial Services Act (“FinSA“), which came into effect in 2020. 

Until recently, the FSC only had to judge on waiver clauses in discretionary asset management agreements (FSC 138 III 755, consid. 6; FSC 137 III 393, consid. 2; 4A_355/2019 of 13 May 2020, consid. 3.2). In all these instances, it rejected the notion of a valid waiver for different reasons. In its decision 4A_496/2023 of 27 February 2024, the FSC had to judge for the first time on the criteria under which a client can waive its right to retrocessions in an execution-only mandate. Moreover, the FSC has, for the first time, deemed the wording of a retrocession waiver clause to be legally effective.

2) Approach of the Swiss Federal Supreme Court and Cantonal Courts

a) 4A_496/2023 of 27 February 2024

To date, it remains unclear whether there is an obligation to surrender retrocessions based on art. 400 para. 1 CO in execution-only relationships. There is a disagreement within legal doctrine on the matter, and cantonal courts have adopted varying stances. In its decision 4A_496/2023 of 27 February 2024, the FSC acknowledged this ambiguity but commented for the first time on the requirements for an effective retrocession waiver clause in an execution-only mandate. 

The FSC had to assess the judgment of the Commercial Court of the Canton of Berne (“CCB“) as regards a claim of an assignee of a bank client for the restitution of retrocessions (CCB 22 21 of 6 September 2023). The CCB had denied the bank’s obligation to surrender the retrocessions collected from 2013 onwards due to the validity of a waiver clause. The assignee, to whom the client had assigned any claims against the bank, appealed against the CCB’s decision.

The decision is rooted in a longstanding banking relationship between a client and his bank, lasting from December 2008 to July 2022. The bank’s records indicate that the client had substantial expertise in finance, including structured products and private equity. Although the client did not enter into an asset management agreement, investment advice was consistently provided by the bank from 2018 onwards. However, the client mainly invested on his own initiative, rather than following the bank’s investment advice. The CCB, therefore, considered the client relationship an execution-only mandate, which also included subordinate investment advice.

The bank’s general terms and conditions of 2008 only mentioned the existence of retrocessions. From 2013 onwards, the client had however received and accepted the bank’s revised general terms and conditions, which detailed the retrocessions by product (collective investment schemes and structured products) and by assets under management for asset management and investment advisory relationships. The revised general terms and conditions of 2013 also contained a waiver clause that described the calculation method of the retrocessions. The supplementary information sheet for investment funds contained the percentage bandwidths of the retrocessions per asset class. The percentages paid to the bank’s group companies and third-party companies were stated separately. The retrocessions were also expressed as a percentage of the investment amount on an annual basis. Furthermore, the distribution fee for structured products was stated separately as a percentage. The CCB moreover considered that the client was entitled to request more detailed information on the retrocession amount from the bank at any time. 

In its decision, the CCB acknowledged the restitution request for the years 2011 and 2012 but rejected it for the subsequent years. The CCB held that the level of information provided from 2013 onwards fulfilled the criteria set out by the FSC for the validity of a waiver, as the client knew “for which transactions (reason for the remuneration) which remuneration (type of remuneration) was due and in what amount”. Moreover, the client could assess from the comparison of the different product categories where the bank’s conflict of interest was most significant. 

In its judgement, the FSC held that the appellee had failed to demonstrate that the information provided from 2013 onwards was insufficient. The client had been provided with every version of the general terms and conditions since 2013, allowing him to acquaint himself with them thoroughly. Considering the facts of the case, particularly the client’s financial expertise, the FSC considered it not “unusual” to waive the right to restitution. Consequently, the FSC supported the view that the disclosure of the percentage ranges per product category could not be deemed “insufficient” for the validity of a waiver clause in an execution-only mandate. The FSC thus rejected the restitution claim of the appellee based on the validity of the waiver from 2013 onwards. Further, it held that the assignee did not react to the CCB’s finding that the client would have had the right to request more detailed information from the bank at any time, i.e., before or after making the disputed investments.

Contrary to its previous position on retrocession waiver clauses in asset management agreements, the FSC deemed the wording of the waiver clause, which was reproduced in the CCB’s ruling, sufficient. Consequently, for a retrocession waiver clause in an execution-only or investment advisory mandate to be valid, the retrocession amount must be disclosed as a bandwidth of percentages per product category and the client must have the right to request further information from the financial service provider at any time.

b) 4A 574/2023 and 4A 576/2023 of 24 May 2024

In its most recent decisions on restitution claims in execution-only mandates (4A 574/2023 and 4A 576/2023 of 24 May 2024 published on 26 June 2024), the FSC has gone even further. It ruled that the principles developed in the context of asset management agreements are not directly applicable to mandates where clients order the transactions themselves, i.e., execution-only and investment advisory. Further, the FSC has confirmed the validity of a retrocession waiver clause for such relationships. 

The FSC had to assess appeals against a judgment of the Commercial Court of the Canton of Zurich (“CCZ“) of 23 October 2023 (CCZ 210069-O). The assignee of the bank clients asserted claims against the bank for the restitution of retrocessions that the bank had collected from third-parties. The bank invoked waiver clauses in its general terms and conditions, which were sent to the clients when they opened the account in 2011 and again when those terms were updated in 2014.

The general terms and conditions of 2011 stated that the amount of retrocessions depends on the transaction type and the investments made for the client as well as on the reinvestment frequency. Further, the terms outlined that the bank has implemented organizational measures as regards the bank’s conflicts of interests deriving from third-party inducements. According to the waiver clause, the retrocessions received by the bank could range from 0% to 5% of the average annual assets under management. Form no. 10 of the standard advisory agreement in the account opening documentation contained an almost identical clause. The bank had also offered in the terms of 2011 to provide more detailed information on the retrocessions for particular financial instruments upon the client’s written request. 

In the subsequent general terms and conditions of 2014 and the according fee schedule, it was stated that the bank receives retrocessions in advisory agreement relationships for the buying and holding of financial instruments, such as investment funds and/or structured products, and the execution of stock exchange transactions. Further, it was disclosed that the retrocession amount depends on the transaction type, the executed investments and on the reinvestment frequency. Upon written request and on an individual basis, the bank would disclose the retrocession amount received, provided it could be attributed to the client relationship with a reasonable amount of effort. The general terms of 2014 also contained specific language on the measures taken by the bank to prevent its clients from the bank’s conflicts of interest.

To enable the client to make an informed investment decision, the bank had disclosed the applicable ranges of the recurring fees (as percentages per annum) for the relevant product categories held by the client:

– Money market funds: 00.50 %

– Bond investment funds: 00.50 %

– Equity investment funds: 00.50 %

– Alternative investment funds: 00.75 %

– Structured products: Not applicable

– Stock exchange transactions: Not applicable

In its ruling, the CCZ held that the waiver clause in the general terms and conditions of 2011 was invalid as it did not contain sufficient information on the calculation of the retrocession amount. In particular, the CCZ deemed the 0% to 5% range excessively broad and vague, preventing the client from identifying possible conflicts of interest of the bank. The bank was therefore obliged to surrender the retrocessions that were collected during the effectiveness of the terms of 2011. 

On the general terms and conditions of 2014, the CCZ however ruled that the waiver clause contained sufficient (technical) reference values on the existing retrocession agreements with third-parties. The breakdown into different product categories / asset classes and the indication of percentage ranges of 0% to 0.75% for the individual categories enabled the client to quite accurately calculate the retrocessions received by the bank for an ordered transaction. Further, the CCZ held that for investment advisory or execution-only relationships, the client’s investment amount formed an appropriate base value to calculate the bank’s retrocessions because, unlike in asset management agreements, there are no managed assets that could serve as a base value and that the respective principles could therefore not be directly applied.

Consequently, the CCZ held that the general terms of 2014 provided for a valid retrocession waiver clause. The bank was therefore not obliged to surrender the retrocessions for the respective years.

In its decision, the FSC upheld the judgement of the CCZ. It thereby confirmed the approach of several other cantonal courts, which apply distinct rules depending on the type of contractual relationship between the bank and the client to assess the validity of a retrocession waiver clause. In doing so, the FSC confirmed that the legal principles established for asset management agreements do not directly apply to execution-only and investment advisory mandates. This distinction is crucial as the FSC had previously ruled that, within asset management mandates, a waiver is only valid if the retrocession amount is disclosed in relation to the assets under management.

Furthermore, the FSC held that the assignee did not demonstrate the impossibility of calculating the retrocession amount with the information provided by the bank in the terms of 2014. The FSC confirmed that the waiver clause of 2014 contained both a valid advance waiver as well as a legally effective waiver for retrocessions previously received. The clients had therefore validly waived all retrocessions received for the respective accounts.

This confirms that, for both execution-only and investment advisory relationships, a waiver that discloses the pertinent percentage of retrocessions for each product category without a reference to the assets under management is deemed legally effective. The obligation to disclose the expected retrocessions relative to the total value of a client’s assets under management cannot be applied to investment advisory and execution-only mandates.

3) FINMA’s Draft Circular on Rules of Conduct under FinSA/FinSO

On 15 May 2024, the Swiss Financial Market Authority (“FINMA“) published a draft of a new circular addressing conduct obligations under the FinSA and the Financial Services Ordinance (“FinSO“) and initiated a public consultation. 

The draft circular reflects FINMA’s experiences with the application of conduct obligations by financial service providers under its supervision or that of a supervisory organization. The aim of the draft circular is to increase transparency regarding FINMA’s supervisory practices and to ensure a consistent level of investor protection. 

FINMA reports in its explanatory report to the draft circular that despite a recent decline, most financial service providers still receive retrocessions. Additionally, many clients unknowingly consent to these retrocessions through pro forma waivers hidden in the fine print. According to FINMA, certain financial institutions charge a fee to disclose information on the retrocessions they retain.

The draft circular addresses these findings and introduces inter alia key parameters on the waiver form. For its legal effectiveness, the disclosure must be truthful, comprehensive, and easily noticeable. This includes the visual highlighting of the respective information by way of e.g., bold print, color, larger font size, or a frame, if the information is provided to the client in a standardized manner. Such visual emphasis is in line with civil law, as it ensures that the waiver clause does not fail the “unusualness” test. Alternatively, financial service providers can also inform their clients on third-party compensation by way of a separate notification letter or information sheet. If referenced in the contractual documents, the separate information must be physically handed out/sent to the client or the direct link to the website must be indicated. 

The draft circular and the explanatory report also outline the criteria for the content of a valid waiver: if the actual retrocession amount cannot be determined prior to rendering the financial service or concluding the agreement, the financial service provider must disclose the calculation parameters and the anticipated range of retrocessions per product category. This requirement pertains to all financial services, including transaction-related investment advice and execution-only mandates. For asset management agreements and portfolio-related investment advice, FINMA requires the financial service provider to additionally inform its clients about the compensation range, which shall be based on the portfolio value and the agreed investment strategy. Alternatively, financial service providers can directly disclose the effective retrocessions per recommended financial instrument. Given that an investment advisory client’s portfolio composition relies on the client’s (future) investment decisions, there is uncertainty regarding which financial instruments the service provider should use to estimate the prospective amount of retrocessions at the inception of the investment advisory mandate. The explanatory report suggests that the financial service provider may presume that the client will adhere to the agreed investment strategy and the given recommendations.

The draft circular also states that financial service providers must, upon request, disclose any third-party compensation received to its clients. This information shall be provided free of charge. However, if the client repeatedly exercises this right within a short period of time, or in cases requiring exceptional effort, the financial service provider may impose a moderate and at most cost-covering fee for providing such information.

The draft circular has faced significant opposition from the industry, especially from the Swiss Bankers Association (“SBA“). It particularly criticized the requirement to disclose bandwidths for portfolio-related investment advice. In line with the FSC’s most recent decisions outlined above and the approach of several cantonal courts, the SBA argues that in portfolio-based advisory relationships, the composition of the financial instruments cannot be directly controlled by the financial institution, as in an asset management agreement, since the client takes the investment decisions himself. The client only decides when he commissions the transactions, and not when signing the advisory agreement, which instruments he will use to implement the agreed investment strategy. In other words, the financial instrument selection and thus the absolute amount of the compensation received by the financial service provider during the contractual relationship cannot be fully anticipated for investment advisory clients at the time of concluding the agreement. Furthermore, the SBA argues that the portfolio value can be subject to significant market fluctuations or reductions during the year due to the decisions made by the client. Therefore, the SBA proposes to use the investment amount and not the portfolio value as base value for disclosing the percentage ranges of the expected third-party compensations. This is in line with cantonal case law on investment advisory relationships, such as the judgment of the CCZ of 23 October 2023 outlined above.

The public consultation on FINMA’s draft circular ended on 15 July 2024. FINMA is currently reviewing the feedback received and preparing a report to integrate the comments into the final version of the circular. The circular is expected to enter into force at the beginning of 2025.

Stephanie Walter (stephanie.walter@baerkarrer.ch)