January 1, 2020

Do Investors in the Former CS Funds Hold a European ‘Trump Card’?

Twenty-two years after one of the biggest financial frauds of the 1990s, when more than Kc1.2bn (EUR48m) was stolen from 60,000 investors in the former CS Funds, investors have received neither compensation nor an apology from the Czech government. Despite the negligence of officials in the Ministry of Finance’s (MoF’s) Financial Analytical Unit (FAU) who failed not only to prevent the transfer of the stolen money abroad (despite being warned) but also file criminal charges on time once the culprits had absconded with the money. So serious were the failings, and so suspicious were the circumstances, there was even speculation at the time that some officials at the FAU may have deliberately helped the fraudsters. Whatever the truth in that matter, what cannot be denied, there was an almighty ‘cock-up’ which resulted in 60,000 ordinary Czech citizens losing their savings.

In such circumstances, in a healthy functioning democracy, one would have expected an investigation into where the government authorities went wrong, profuse apologies, and reassurances from the Minister of Finance that investors would be made whole on their loss even if it is too late to reclaim the stolen money from the perpetrators. However, this is the Czech Republic, where State officials are rarely held accountable for their actions and where the ‘big fish’ behind such frauds are seldom caught.

Indeed, the case brought by AKRO investiční společnost, a.s., (who took over the management of CS fondy after the fraud), against the State, on behalf of investors, is a ‘case study’ of how farcical the Czech justice system in practice is and how poorly protected investors are. The case of the former CS Fondy has turned into a never-ending game of ping-pong between the courts, resulting in confusing, contradictory, perverse, and, more recently, legally unenforceable judgments. It would be a joke, if it wasn’t for numerous, now elderly, investors affected. 

The recent culmination of the entire process of claiming damages against the Czech State, with the Constitutional Court formally rejecting AKRO’s constitutional complaint, without a detailed statement on the issue of fairness of the Czech courts’, is both incredible and shocking. In a bid to achieve some semblance of justice for those defrauded, AKRO recently announced its plans to appeal to the European Court of Human Rights in Strasbourg.

“Ping-Pong” – Justice Czech Style

  Justice Czech Style

A ‘Loaded’ Deck of Cards

When I discuss the case with friends and acquaintances, their reactions are always the same; knowing looks, a shake of the head, and comments such as: “you’ll never win against the State.” “Can’t you take it to the European Court?” …and “be careful!”.

These are, of course, not flippant remarks based on prejudice, but rather an experience. Simply ask: Which Ministry is the primary Ministry for capital market legislation? The MoF, of course. Which Ministry was the financial market regulator at the time? The MoF, of course. Which Ministry does the Financial Analytical Unit (FAU) fall under? The MoF, of course. Which Ministry does the tax office fall under? (I’ll explain later)…the MoF, of course… and so on, and so on. It’s no wonder many observers think it’s a lost cause even before it’s started. When did you last hear of the Czech government paying significant compensation for negligence or maladministration? Rare, isn’t it?

When asked about the European Court, I explain that now all redress under the Czech national legal system has to be exhausted the case can indeed be brought in the European Court in Strasbourg. The breaches of investors’ rights were blatant, and the precedents set by the European Court are now well established. AKRO’s corporate boards (which include two professors of Law) and legal team (headed by a former judge) remain confident of their arguments.

In terms of the “being careful,” physical safety hopefully isn’t an issue. Nevertheless, it’s interesting how ‘problems’ can suddenly occur. Some of our readers may remember when the entire case file went missing from the Municipal (Appeal) Court. More recently, in a nonsensical court judgment, the investment company’s assets were lumped together with those of the CS funds it manages. Perhaps some kind of punishment for bringing the case?

Furthermore, this year the Czech tax office (under the MoF) has reneged on their own written protocol with regard to the case. When AKRO initially won compensation for CS Fund investors, approx. CZK 64m of tax was paid to the tax office. In a pre-agreed protocol, the Czech tax office agreed to return the tax paid should AKRO subsequently have to return the compensation. AKRO returned the compensation, but now the tax office no longer wants to honor its pre-agreed written protocol. 

Robbed, Robbed, and Robbed Again?

So just to be clear, investors in the former CS funds have lost money due to the actions of the State in the following ways:

  • 1997  Through the bungling of State officials, which allowed more than CZK1.23bn to be stolen (‘tunneled’) from the funds.
  • 2018  Though the MoF paid CZK2.080bn compensation in 2012 when in 2018, this money was returned, following a judgment overturning a previous decision, 8,05% p.a. Interest was added to the money that had to be returned. CZK717m additional loss.
  • 2019  Czech tax office reneges on its pre-agreed written protocol. Investors still await the return of the CZK64m tax paid on the initial compensation.

As a result of this, as it currently stands, investors have lost everything, even their existing assets in the funds. Furthermore, in last November’s judgment, Prague Municipal Court, by not distinguishing between the three separate funds and the assets of the investment company, the assets and liabilities were all ‘lumped together.’ It means investors in one fund are liable to pay the liabilities of a completely separate fund. Absurd. It undermines one of the basic tenants on which the investment fund industry is based. 


Were Investors’ Claims Really Statute Barred?

AKRO’s case against the Czech State failed for one reason alone: the application of the Statute of limitations, which prescribes a three-year timeframe within which a claim needs to be filed. Given that AKRO filed a claim against the Czech Republic – Ministry of Finance, on 11th August 2003. For the claim to be Statute barred, it needs to be proven that AKRO (the complainant) knew all the pertinent facts before 11th August 2000.

In 2018, the District Court of Prague 6 concluded that AKRO knew, already in 1999, the operative events which enabled AKRO, on behalf of investors in the former CS funds, to file an action for the compensation for damage, i.e., AKRO knew that the CS Fund investors had sustained damage and that the Czech Republic was liable for it due to maladministration by the Ministry of Finance. 

The reason, and the manner with which AKRO’s investors lost looks completely contrived. Having repeatedly failed to prove its innocence, the State has resorted to a shameful trick to deny thousands of investors their right to compensation. Apart from the obvious point: AKRO had no reason to delay filing a complaint if indeed it had all the facts. Instead, the May 2018 judgment by the Prague 6 District Court:

  • Ignored the fact, the action for maladministration against the Czech State was filed on 29th February 2000, thereby suspending the limitation period in relation both to the Ministry of Justice and to the Ministry of Finance. The Courts confirmed it at the start of AKRO’s proceedings. Yes, AKRO initially focused on maladministration by a public notary (under the Ministry of Justice). Still, it was only from this indictment that AKRO learned of the facts from which the liability of the Czech State also due to the maladministration by the Ministry of Finance. Both ministries are, of course, State institutions. By distinguishing between the two ministries, the State is playing semantics: The State is after all the State. Put it another way; you can’t wriggle out of a murder charge by saying: “Aha, I used my left hand to deliver the fateful blow, not my right one like you originally thought!”  
  • Ignored the fact that at the beginning of the court case, the courts had decided that the case was not Statute barred. It is therefore outrageous that this basic tenant of Law should have only become an issue years later after the third annulment of the judgment of the court of appeal! Lawyers refer to this in terms of a lack of ‘good manners’ – an understatement if ever I heard one!
  • However, most outrageously of all, the Prague 6 District Court refused to admit evidence that may have clarified at what date AKRO knew the pertinent facts. The MoF based its argument on the allegation that AKRO’s then Chairman knew all the pertinent facts before 11th August 2000. While all the MoF’s evidence was admitted into court, when AKRO wanted to cross-examine the former Chairman to establish what he did know (as opposed to what he may have known), that was denied! Hardly fair, given that the whole outcome of this long-running case hinged on what he was believed to know. The Municipal (Appeal) court noted that this could have been a ‘procedural error,’ but it couldn’t be taken into account by the Municipal Court. “Why not?” I hear you ask.
  • Used evidence not discussed at the hearing. In the reasoning of the judgment, the District Court even introduced evidence that was not proposed by anybody (a record from the hearing at the Regional Court in Hradec Králové, file No. 39 Cm 221/1997 of 1st November 1999) which the court did not even read during the hearing. Is this an example of trying to justify an iniquitous decision after the event? 
  • Ignored the fact that the Police only achieved criminal convictions in 2007. Looked at in those terms, AKRO’s filings for maladministration by the State in February 2000 and August 2003 were impressively fast. 

Has the State Overplayed its Hand?

Fortunately for investors, the European Court has proved many times that it does not tolerate national public authorities using “a formalistic procedure with sophisticated reasoning to enforce obvious injustice.” The example, described above, dependent on numerous questionable assumptions, and in less than transparent circumstances, would appear a classic example of what the European Court is referring to. 

But What about the Penalty Interest?

Concerning the CZK717m of default interest, the Municipal (Appeal) Court found that the right to default interest arose from the Law and did not find grounds for refusing that right. However, the court didn’t take into account that AKRO didn’t have free use of that money, instead, following a regime set by AKRO’s Supervisory body (the Czech National Bank), the money was placed in safe, low yielding bank deposits in the individual mutual funds and under the CNB’s daily supervision. With such deposits, the funds were therefore held in low-yielding money market instruments (during a time of zero or negligible interest rates). However, when the money had to be given back, after more than four years, default interest at 8.05% p.a. was added! In a strange twist, during the pre-trial period, the State in a purposeful and unjustified manner caused a six-month delay to the hearing (from which it has also benefited with the 8,05%p.a. interest!). So next time the State voluntarily offers you money to settle a claim, but then continues to dispute the judgment, be careful: Especially, in light of case law of the Czech Supreme Court, where you cannot return the money to the Czech State without forfeiting one’s entire claim. 

 “Beware of Czech officials bearing gifts”

The Grand Chamber of the Supreme Court delivered a unifying case-law judgment No. 31Cdo 3309/2011 in which it concluded that the payment in respect of a substantive-law liability (e.g., through maladministration), even based on a later annulled judgment, does not constitute unjust enrichment and results in the termination of the liability. AKRO manages mutual funds, i.e., the assets of third-parties, and cannot make unjustified payments, especially if in returning compensation already received, the return of such payment would waive all rights to the compensation. So why was statutory interest charged when (after the somewhat dubious judgment discussed above) the money was returned to the State from the accounts of the individual mutual funds? 

Additionally, even if you assumed AKRO’s claim was time-barred for legitimate reasons, the investors’ right to that compensation isn’t in dispute. Therefore, a payment from the State as compensation for this damage cannot be considered unjust enrichment because investors had a legitimate right to that compensation, even though the court later found AKRO’s claim time-barred. It is what makes the charging of penalty interest so iniquitous. This action by the Czech State robs investors for a second time. 

In other words, the State rewarded itself both for its negligence and for delays in bringing the case to trial. How perverse is that?

Investors’ Cheated out of their Basic Rights

You don’t need to be a legal expert to understand that admitting all the evidence of the MoF, with regard to the Statute of Limitations, while refusing to admit any evidence from AKRO, specifically a cross-examination of the former Chairman of AKRO was grossly unfair. It seems the court was happy to speculate about what AKRO’s former Chairman might have known and when, but strangely reluctant to allow any direct questions to be put to him. This kind of pseudo-justice is somewhat reminiscent of the Communist era.

However, investors weren’t only denied their right to a fair trial; they were also denied their fundamental right to both own property (the funds) and to be compensated for damage caused by maladministration by a Czech, public authority. Through an incorrect assessment of the Statute of Limitations, the Czech State has taken back compensation, which was rightly investors’, charging interest on top! As a result, investors are left with nothing, losing whatever assets they had in the funds. 

Finally, investors were denied their right to have their case tried within a reasonable time frame. AKRO’s dispute with the Czech MoF has been taking place since 2003. From the outset, the MoF has defended itself with an objection that the limitation period expired. If the right was indeed statute-barred, the Czech courts should have dismissed the action without undue delay right at the start of proceedings. However that was not the case, the District Court for Prague 2, by its judgment of 25th January 2005, upheld the action and concluded that the right was not statute-barred. Similarly, the Municipal (Appeal) Court in Prague upheld the action by its judgment of 27th September 2012, stating that the right was not statute-barred because the limitation period was suspended by filing an action against the Czech Republic, the Ministry of Justice. It is therefore unacceptable, 15 years after the onset of the dispute, investors’ compensation should have had to be returned, with penalty interest, based on an expired limitation period.

It is 22 years since the CS funds were defrauded and 25 years since investors first invested in those funds. Most investors are now elderly, and many have died in the intervening period (some no doubt in poverty). For the deceased, the European Court’s decision will be somewhat academic. For the remaining 40,000+ former CS fund investors, the outcome is anything but academic, with a negative result causing a real loss on investment.

Counting the Cost – for Investors

Taking data as at 31st October 2018, 15 units the AKRO globální akciový fond (formerly fond energetiky), the largest fund, would be worth approximately Kc20,280 and 30 units Kc40,560. [15 and 30 units being what was possible for citizens to subscribe to in the voucher privatization]. Similarly, 15 units AKRO fond progresivních společností (formerly fond kapitálových výnosů) would be worth approximately Kc18,675 and 30 units Kc37,550. Finally, 15 units AKRO balancovaný fond (formerly fond pravidelných dividend) would be worth approximately Kc18,930 and 30 units Kc37,860. 

A successful outcome would provide thousands of elderly citizens with at least a modicum of financial security.

cost table

Counting the Cost – The Czech Capital Market

There is understandably widespread mistrust in the Czech capital market by the public. That mistrust would appear to be well-founded. The World Bank noted [1] that this stems from the mass privatization programs during the 1990s. Rather blandly, the World Bank observed: “the practical result, for the ordinary investor, was a loss of the investment. “Last year’s court decision with regard to the former CS funds rather underlines this point.

World Bank data points to the fact that just seven foreign-controlled companies now control 85% of all fund assets in the Czech Republic. As a result of the flagrant deficiencies in investor protection in the Czech capital market, many investment companies/funds in the Czech Republic effectively operate under a primary legal/regulatory jurisdiction outside of the Czech Republic.

 AKRO is an exception. AKRO is one of the few surviving independent Czech mutual fund companies, recently celebrating 25 years on the Czech investment market, and subject solely to the Czech legal/regulatory environment. While the Czech government policy is supposed to support the development of the domestic capital market, and presumably companies like AKRO, several points are noteworthy:

First, while the former CS fund court case has been in progress, 3 of the four mutual funds managed by AKRO, i.e., former CS fondy, have been closed to new investors as required by the Czech National Bank (so as not to dilute any award of compensation to the original investors). This means that since 1997 we have been unable to offer units in these funds to new investors. Frustrating, since in recent years, these funds have enjoyed good investment returns [the AKRO fond progresivních společností extremely pleasing returns] and would undoubtedly have attracted many new investors if it wasn’t for the overly protracted legal case.

Second, as already mentioned, last year’s Court decision made no distinction between the assets and liabilities of the separate CS funds, nor those of the investment company: They were all jumbled together. In so doing, a basic tenant underlying the entire European mutual fund industry was undermined. It makes a mockery of any pretensions the Czech Republic may have to be a serious financial center. Tragic, as this author has stressed on previous occasions [2] because the Czech Republic could, and should, be a regional financial center and is only being held back by the perception of weak investor protection and pervasive corruption regarding law enforcement. 

Counting the Cost – Society

Czechs want to live in a decent society where courts act with propriety, and public bodies are held to account for their actions. Alas, too often, public officials refuse to be held to account and take responsibility for their actions. Indeed, the impression is one of the civil servants not serving the public, but rather themselves, their political masters, and a select group of politically linked oligarchs. 

Coming back to the case of the defrauded CS fondy – if all the facts related to the maladministration of the Ministry of Finance were evident in 1999, why didn’t the MoF come forward at that time and apologize? 

The scandalous way the Czech State has tried to wriggle out of all responsibility for what happened in 1997 fools nobody. The insensitive gloating after last year’s ruling (just look at Czech Minister of Finance’s facebook page) only underlines how removed Czech officials are from those they are meant to serve. Don’t forget, at the time of the 1997 fraud, the MoF was the financial market supervisor. What is there to gloat about?

Concluding Remarks

That the Czech legal system isn’t fit for purpose and fails to support a modern functioning economy comes as no surprise: The Case of the investors in the former-CS fondy represents just another, albeit high profile, example. It is a somber reflection of the current system that investors should need to appeal for protection to their basic rights enshrined within the Czech Constitution at the European Court. The practical application of current Czech laws, paradoxically under the remit of the MoF, having robbed investors of those basic rights.

Jeremy Monk

Investment Director

AKRO investiční společnost, a.s.

[1] Capital Market Assessment/ Market Development Options, Czech Republic. World Bank Group. September 2017

[2] Prague Should Dance the BREXIT Fandango

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