UBS is committed to rebuilding its battered reputation but complex litigation stemming from $1.7 billion of losses linked to convicted swindler Bernard Madoff might bring another costly setback.
Swiss wealth management giant UBS has put a bitter U.S. tax fraud row behind it through a settlement and, under Chief Executive Oswald Gruebel, is slowly emerging from a crisis that forced it to accept government aid last year.
But the threat is still looming of compensation to investors who lost out to Madoff via two Luxembourg funds set up by UBS.
About a year after the Madoff's Ponzi scheme was uncovered, a Luxembourg court will determine whether investors can bring direct claims against UBS, which acted as custodian but not as investment manager of the LuxInvest and LuxAlpha funds.
"Under Luxembourg law, investors can bring claims against a depositary bank directly...if it fails to carry out its tasks," said Isabelle Wekstein, a lawyer representing investors who want compensation from UBS in Luxembourg.
The funds, created in 2002 and 2004 respectively, were investing in Madoff products. Many investors were rich French individuals recruited by Madoff through a Ponzi scheme while holidaying on the French Riviera or skiing in Switzerland.
They chose to invest in Luxembourg and in this type of fund structure for tax reasons, lawyers told Reuters.
A first ruling involving a small group of investors, expected early next year, could set a precedent for other investors in some 100 cases.
The decision would also have a bearing on HSBC, whose Luxembourg subsidiary acted as a custodian for the Herald Fund, another vehicle which invested in Madoff and now stands to lose nearly $1 billion.
If the court rules against direct claims, the funds' liquidators, who represent investors, are still likely to push through with an action to recoup some of the money.
Activist investor group Deminor, representing some European investors who have lost 80 million euros ($115 million) in LuxAlpha, LuxInvest and separately the Thybo International fund, are seeking to recoup the full amount. They have sued UBS in Luxembourg and are preparing court action against HSBC.
A ruling ordering repayment to investors would mean another headache for UBS, which recorded the biggest annual loss of any Swiss company in 2008 and is heading for another loss in 2009.
The government of Luxembourg, whose standing as a global hub for funds has been bruised by the ripples of the Madoff affair, said earlier this year it would favor an out-of-court deal.
But lawyers acting on behalf of Madoff-hit investors say this is unlikely now that court action has started.
"UBS does not want to settle, so this is not an option," Wekstein said.
Jean-Pierre Martel, a lawyer representing some 40 clients mostly from France, Belgium and Switzerland who invested mainly in LuxAlpha, also said UBS did not appear to want to settle.
UBS has repeatedly said that it did not recommend any Madoff products to clients and that the fund documentation made it clear that its Luxembourg unit was not expected to be responsible for the safekeeping of the assets.
"The fund documentation contained an explicit waiver to that effect," UBS said in a written statement. "UBS does not have responsibility to the shareholders for the unfortunate results of the Madoff scandal."
A further complexity is defining who may be entitled to sue, as many investors invested in the funds through nominee accounts held by other actors, such as French banks.
"This has not moved in over a year....If the bank is really unethical it could let this case drag on for maybe 10 years. By then, some of the investors will have died, others will have given up," Martel said.
Investment management responsibility for larger fund LuxAlpha lies with Access International Advisors, whose founder Thierry Magon de la Villehuchet committed suicide in New York in December 2008 after Madoff's scheme was uncovered.
With Madoff jailed and the investment manager dead, investors are turning to the administrator UBS Fund Services and custodian UBS in the hope of recouping some of their losses in a legal battle that tests European Union investor protection laws.
"As administrator, UBS Fund Services' role was limited to such tasks as calculating the net asset value of the fund," the Swiss bank said in a statement.
Luxembourg's financial regulator CSSF found no wrongdoing by UBS but asked it to strengthen its supervision system. It asked the same of HSBC.
Investors in Madoff, who has been sentenced to 150 years in jail, have lost an estimated $65 billion worldwide.
Some financial players, who acted as investment advisers rather than custodians for several Madoff victims, have already offered to repay funds.
UBP, a Swiss private bank whose clients lost more than 1 billion Swiss francs ($956 million) to the Madoff fraud, in March offered to buy back clients' exposure for 50 percent of the cost.
Spain's Banco Santander agreed in May to pay $235 million, or 85 percent of investments, to settle a claim against hedge fund unit Optimal Investment Services.
The jury is still out on how big a blow a negative ruling would be for UBS after the headwinds it faced this year.
"The damage has already been done," said Bertrand Lavayssiere, Managing Director Financial Services at CapGemini, pointing to the billions of francs in client withdrawals UBS suffered this year. "The (clients) willing to get out did it already and one more thing is not going to change the world."
Just under 3,500 funds and specialized investment funds were registered in Luxembourg — Europe's largest funds center — at the end of September holding assets worth 1.7 trillion euros ($2.5 trillion), data from CSSF showed.
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