On 1 August 2022, the Court of Justice of the European Union (“CJEU”), in delivering a ruling in the case of HOLD Alapkezelő Befektetési Alapkezelő Zrt. v Magyar Nemzeti Bank, clarified that the payment of dividends to senior executives of a fund manager, who also have a direct or indirect interest in that company, must comply with the provisions on sound remuneration policies set out in Article 14b of Directive 2009/65/EC (“UCITS Directive”) and Article 13 and Annex II of Directive 2011/61/EU (“AIFMD” together with the UCITS Directive, the “Directives”) where such payment may have the effect of circumventing those provisions.

Legal Context

The AIFMD and UCITS Directive require the investment fund industry to establish and apply remuneration policies that promote sound and effective risk management and that do not encourage excessive risk-taking which is inconsistent with the relevant risk profile, rules or instruments of incorporation of the investment funds concerned. The mentioned Directives contain various provisions laying out remuneration policies and practices which must be adopted by fund managers, yet they do not contain a legal definition of the term ‘remuneration.’ They merely show that the remuneration policies and practices include fixed and variable components of salaries and discretionary pension benefits.

Guidelines issued by the European Securities and Markets Authority (“ESMA”) under the Directives clarify the term ‘remuneration’ to the effect that it includes: (1) all forms of payments and benefits paid by the fund manager; (2) any amount paid by the fund itself, including any performance fees paid directly or indirectly for the benefit of the employees concerned, as well as carried interest; and (3) any transfer of units or shares of the fund. The common features of all the above components of remuneration, according to the ESMA Guidelines, is that they are granted in exchange for professional services provided by the relevant employees of the fund manager.

Advocate General Kokott, in her opinion delivered on 16 December 2021, referred to the ESMA Guidelines which state that the applicability of the remuneration rules depends only on the effects of an expected payment and not on its designation. This is because the establishment of remuneration policies is about controlling behaviour. Consequently, it is apparent from the ESMA Guidelines that dividends or similar distributions that the employees concerned receive as owners of a fund manager are not covered by those guidelines unless the material outcome of the payment of such dividends results in a circumvention of the relevant remuneration rules.

Case Background

The National Bank of Hungary – ‘Magyar Nemzeti Bank’ (the “Bank”) – imposed a penalty on Hold Alapkezelő Befektetési Alapkezelő Zrt. (“HOLD”), a Hungarian investment fund manager (the “Management Company”) managing both AIFs and UCITS funds, for infringement of the national provisions relating to remuneration policies and called on the Management Company to adapt its remuneration policy to the prudential requirements.

Since 2014, the management company applied a remuneration policy to certain categories of staff including the managing director, investment manager and portfolio manager. All the mentioned categories held ordinary and preference shares in HOLD. In addition, two of these employees were single shareholders of two unlisted limited companies, which held shares issued by HOLD. During the financial years 2015 to 2018, HOLD paid dividends on the preference shares and the ordinary shares to the employees and the companies concerned.

In 2019, the National Bank of Hungary, acting in its powers as a supervisory authority, obliged HOLD to implement a remuneration policy and practices which were in line with the Directives, as transposed into Hungarian law. The Bank held that the dividends paid directly and indirectly to the employees could result in those persons having an interest in HOLD generating short-term profits and thereby being induced to take risks that are not compatible with the risk profile of the investment funds managed by HOLD and the interests of the funds’ shareholders. This meant that the rules for payment of those dividends circumvented the rules on deferred payment of performance-based remuneration.

Judicial Proceedings before the Hungarian Courts

The Management Company brought an action before the Budapest High Court in Hungary against that decision, arguing that the dividends did not constitute ‘variable remuneration’ and did not come within the scope of its remuneration policy. HOLD held that a shareholder’s right to dividends is a property right and that the payment of dividends, despite it being variable, is not paid to employees for their professional services based on performance criteria.

The Budapest High Court dismissed the action on the ground that dividends paid to the employees concerned can be treated as remuneration, even though, formally, they do not constitute payment in exchange for services rendered. The court held that those dividends which are considerably higher than fixed and variable remuneration, give rise to an interest on the part of those employees in the short-term profits of the investment fund, encourages risk-taking and constitutes a means of payment making it possible to circumvent the applicable remuneration policy rules.

The Supreme Hungarian Court, where an appeal was brought by HOLD, considered it necessary to request the CJEU’s preliminary ruling on whether the dividends which were distributed to the employees concerned fell within the scope of the remuneration policies of the investment fund manager.

CJEU’s Considerations and Ruling

Regarding the interpretation of the concept of ‘remuneration’, the CJEU, firstly, held that provisions of European law which make no specific reference to the law of the Member States to determine meaning and scope must normally be given an autonomous and uniform interpretation throughout the European Union.

Secondly, the interpretation of the European law in question requires account to be taken not only of its wording, but also of its context and the objectives and purpose pursued by the act of which it forms part.

Thirdly, the CJEU held that the listing of two specific categories in the Directives does not exclude the application of the remuneration policies and practices to forms of payment other than salaries and discretionary pension benefits.

Fourthly, the CJEU referred to Recommendation 2009/384 and to the Advocate General Kokott’s opinion and held that in order to ensure that the Directives’ objectives are achieved, the provisions governing remuneration must be applied to any payment or benefit that a UCITS management company or AIFM makes or pays to employees which come within the scope of those provisions. Even if the payment or benefit does not constitute remuneration in consideration for professional services rendered, if it encourages those employees to take risks and facilitate the circumvention of the requirements flowing from those provisions, then it will fall within the scope of the remuneration provisions.

Fifthly, the CJEU stressed that the mere fact that the profits of the fund manager are impacted by the profits of the UCITS or AIFs under management is not in itself sufficient for it to be considered that those employees would thereby be driven to take decisions that might adversely affect the healthy and balanced management of those investment funds or the interests of the persons who have invested in those funds. By contrast, it must be ascertained whether there is a connection between the profits generated by the UCITS or AIFs, the profits generated by the fund manager, and the amounts paid by that manager to its employees as dividends of the shares they hold in that company such that those employees have an interest in those UCITS or AIFs generating the highest possible profits in the short-term.

Last but not least, the CJEU also clarified that it is for the referring court, in the main proceedings, to determine whether a connection, as described above, exists and to verify: (1) the size of the shareholding of the employees concerned in the fund manager; (2) voting rights attached to those shares; (3) the type of shares; (4) the dividend distribution policy; (5) the potentially minor nature of the amount of fixed remuneration paid to employees by that manager and whether those employees actually find themselves induced to take excessive risks such as those described above.

After considering, inter alia, the reasons mentioned above, the CJEU ruled that a dividend policy of a fund manager may fall within the scope of the provisions of the Directives regarding remuneration where the payment policy of those dividends is such as to induce those employees to take excessive risks which are detrimental to the interests of the UCITS or AIFs managed by that company and to the interests of their investors and is capable of facilitating the circumvention of the requirements flowing from those provisions.

The author would like to thank Martina Azzopardi, a Legal Intern at Ganado Advocates, for her assistance in preparing this law report.

This article was first published in the Malta Independent (17 August 2022).

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