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Bank Liable for Losses caused by Madoff Fraud

Cass Com, 25 November 2014, No 1318414  

The commercial chamber of the French Supreme Court (Cour de cassation) has ruled that a bank was partially liable for losses caused to an investor in Madoff shares, even though the investor was sophisticated, and not advised by the bank. The bank was acting on an RTO (reception and transmission of orders) basis. The decision is difficult to reconcile with previous case law concerning the limited duties of information on banks acting on an RTO basis, and will concern banks who transact such business.

An asset holding company (the Company) specialising in buying and selling shares on behalf of related high-net-worth individuals, had made subscriptions in 2007 and 2008 to shares issued by a BVI ‘Madoff feeder fund,1 Groupement Financier, Ltd (the Fund). The family office acting on behalf of the Company had placed two separate orders with the bank holding the Company's security account (the Bank), mentioning the amount to be invested, the ISIN code of the shares and the cash account to be debited. The Company subscribed to the Fund on the advice of its family office.

According to its memorandum and articles of association, Groupement Financier, which is currently in liquidation, could only issue registered nominative shares (its overall functioning and nature were similar to an open-ended collective investment scheme (SICAV)). In August 2007, the status of the Fund changed, from a private fund to a professional fund, but its key actors (investment manager, administrative agent, custody bank, etc), as well as the Fund's strategy and level of risk, remained unchanged, it being a Madoff feeder fund.

As is often the case with off-shore funds and in accordance with a "market practice" fairly common in the BVI and in Luxembourg, the Fund's operating memorandum (opmem) stipulated that the administrative agent2 (the Agent) would only accept subscription and redemption requests from institutional clients. It further indicated that subscriptions by private clients would have to be placed "via the client's house banks in their country of domicile". The opmem also provided for a subscription modus operandi: "The client will place his subscription order with his bank. The client's bank will then subscribe in its own name, on behalf of its client".

Such modus operandi was followed in this case: (i) the Company placed its subscription orders; (ii) the Bank subscribed in its own name but on behalf of the Company; and (iii) it then debited the Company's cash account and credited the Company security account upon reception of the subscription confirmation from the Agent. As a result of these steps, the Company became the holder of a securities account in which shares of the Fund were registered, and the Bank appeared in the shareholders' register of the Fund in its name but on behalf of the Company. When the Madoff fraud became public, by the end of 2008, the shares became worthless.

The Company subsequently filed a civil claim against the Bank claiming that:

  • because it had placed subscription orders to buy nominative shares, it was meant to appear in the register of the Fund in its own name. Given that only the Bank appeared in the register, the Company argued that it was neither the holder nor the owner of the shares and that the Bank should therefore reimburse to it the sums invested.
  • the Bank had failed to execute its mandate properly, including through failing to properly inform the Company of the risks associated with its investment.

In a 2011 judgment, the Paris Commercial Court denied all these claims and decided that the Company had full ownership of the shares registered in the security account. In particular, the judges held that when subscribing to nominative shares in its own name but on behalf of its client, the Bank acted in compliance with its duties as a commission agent ("commissionaire"), both under French law and the contractual terms governing the relationship with its client. Article L.132-1 of the French Commercial Code provides that "the commission agent is the one who acts in his own name or under a firm name for the account of a principal (commettant)".

In 2013, the Paris Court of Appeal confirmed that the Company had full ownership of the shares, but partially overruled the judgment of the Paris Commercial Court. In its decision, it considered that since the Bank acted in the capacity of a "commission agent" and given that it was the only party to receive information from the Fund, it had a duty to inform its client of any difficulty encountered in the course of its mandate (mission), including the specific conditions stipulated by the Fund's opmem and the change of the Fund's status having occurred in 2007. Because the Bank had failed to inform the Company that it could not subscribe to the Fund in its own name nor of the 2007 change in the Fund's status, it had deprived the Company of a chance to decide not to invest in the Fund. As a result, the Court held the Bank partially liable for the Company's losses and ordered it to compensate the Company for up to 30% of the sums invested.
On 25 November 2014, the Supreme Court fully confirmed the decision of the Paris Court of Appeal.


This is a controversial decision for banks. In this case, the Bank performed a purely technical service. It received two subscription orders from the Company and transmitted them to the Agent. The Bank therefore only provided a service of reception and transmission of orders (RTO) which, under Article D 321-1 of the French Monetary and Financial Code, consists in "receiving and transmitting orders3 on behalf of a third party to an investment services provider or to an entity (…)".

Based on French civil and regulatory law, the duties of information on financial intermediaries providing RTO services are largely limited to an obligation to warn an inexperienced investor about the financial exposure associated with the proposed transaction. According to case law,4 the duty of the bank to warn its client of the risks associated with a transaction only lies where (i) the financial instrument is of a so-called "speculative nature" (caractère speculatif) – ie instruments bearing a high level of exposure, traded on future markets or (ii) the client is not a sophisticated investor (investisseur averti) and is therefore unable to assess its financial exposure. This is a constant case law from the French Supreme Court.5

In this case the shares issued by the Fund did not match the definition of a speculative financial product and the Company was a sophisticated investor benefitting from the advice of a family office (as found by the Supreme Court).
The Supreme Court decided to focus on specific obligations assigned to commission agents, including a duty to inform their principal of any unusual event or anomaly encountered in the course of its mandate. The "unusual event" was, according to the Supreme Court, the subscription terms and conditions of the Fund and the change to the Fund's status having occurred in 2007.

However, the subscription modus operandi imposed by the Fund was a classic market practice known to all parties involved, including the Company. It is also not clear how the 2007 change to the Fund's status would have caused any difficulty to the Bank when it acquired the shares on behalf of the Company. One therefore wonders to what degree such circumstances, which had no unusual influence on the subscription process, can amount to anomalies which the commission agent should have flagged to the principal before executing its orders.

Not only does this ruling ignore landmark decisions from the Supreme Court governing the duty of information weighing on RTO service providers, but it also raises an issue of causation.

The Supreme Court confirmed that, because the Bank had failed to inform the Company of the subscription conditions stipulated by the opmem and the change in the Fund's status, it should be held liable for up to 30% of the sums invested in the Fund. In doing so, it created a direct link of causation between the lack of information attributed to the Bank and the investment decision made by the Company which ultimately led to losses. Yet it appears difficult to accept that an asset holding company advised by a family office and willing to invest in a Madoff feeder fund would have given up investing should the Bank have fully informed it of these matters. The only true cause of the losses incurred by the Company is the fraud perpetrated by Madoff.


1. A fund whose sole asset is an account managed by Bernard L. Madoff Investment Securities LLC.
2. An investment services provider registered in an EU Member State.
These orders must relate to financial instruments.
Cass. com., 5 Novembre 1991, n° 89-10005 (« Buon » case) ; Cass. com, 19 Septembre 2006, n°05-15.305 (« Benefic » cases).
Com., 17 mai 2011, n° 10-30.650 ; Cass. com., 30 mai 2012, n° 11-11.063.

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