Cayman Islands: Primeo Fund v HSBC: Grand Court Rules That Madoff Feeder Fund Was "The Author Of Its Own Misfortune"

Last Updated: 30 August 2017
Article by Andrew Pullinger, Shaun Tracey and Hamid Khanbhai

In a landmark judgment of the Grand Court of the Cayman Islands delivered on 23 August 2017 in Primeo Fund (in Official Liquidation) ("Primeo") v Bank of Bermuda (Cayman) Ltd ("BBCL") and HSBC Securities Services (Luxembourg) S.A ("HSSL"),1 Mr Justice Jones QC dismissed the claim brought by Primeo, a Madoff feeder fund, against its custodian and administrator seeking damages of approximately US$2 billion. Following a twelve-week trial, the Judge found that Primeo was "to a very substantial degree the author of its own misfortune". Even though the defendants were found to be liable to Primeo in respect of the defendants' own acts or omissions as well as, in the case of the custodian, for the wilful default of BLMIS in its capacity as sub-custodian, Primeo failed to establish the relevant causal link between such acts or omissions and the loss that was allegedly suffered. Primeo's claim also failed on other grounds including limitation and because it infringed the rule against reflective loss. Notwithstanding the dismissal of the claim, the case illustrates the risks of providing services to funds that have an abnormal business model and provides guidance to fund service providers, particularly custodians and administrators, concerning the scope of their obligations.


Primeo, a Cayman Islands investment fund, was established and managed by Bank Austria. From 1993 until December 2008, Primeo invested with Bernard L Madoff Investment Securities LLC ("BLMIS"), the company through which Bernard Madoff perpetrated his infamous Ponzi scheme.

BLMIS's 'holy grail' of equity returns with bond-like volatility came with strings attached: Madoff insisted upon BLMIS performing the triple functions of investment manager, broker, and de facto custodian to its clients. Many institutional investors were willing to accept this concentration of responsibilities (and therefore risk) in exchange for the stellar returns that Madoff was apparently able to generate consistently for decades.

In 2003, Primeo began investing some of its funds with BLMIS indirectly, through two other Madoff feeder funds: Alpha Prime Fund Ltd ("Alpha") and Herald Fund SPC ("Herald"). Following an in specie transfer on 1 May 2007, all of Primeo's investments with BLMIS were indirect, through Primeo's shareholding in Herald and Alpha.

Primeo appointed BBCL and HSSL as its administrator and custodian respectively (together, the "Defendants") at a time when both of those entities were part of the Bank of Bermuda group of companies, which was subsequently acquired by HSBC in 2004.

Upon Madoff's arrest, Primeo entered liquidation but it was not until 2013 that the liquidators of Primeo sued the Defendants for the alleged losses suffered by Primeo as a result of the fraud.

Claims and defences

As against the custodian, Primeo alleged that HSSL breached its contractual duties concerning the appointment and supervision of BLMIS as its sub-custodian. As against the administrator, Primeo alleged that BBCL breached its obligations in connection with the maintenance of books and records for Primeo, and in determining the net asset value ("NAV") per share at the end of each month. In his judgment, Mr Justice Jones QC observed that "at the core of the administration claim is a dispute about the role of independent fund administrators". Primeo alleged that, had the Defendants complied with their obligations, Primeo would have withdrawn its investments with BLMIS prior to the fraud being uncovered and reinvested elsewhere.

The Defendants denied they had breached their contractual obligations to Primeo. The Defendants contended further that Primeo was well aware of the risks associated with BLMIS and that it would have continued to invest with BLMIS in any event. The Defendants argued that Primeo was in any case not the proper claimant for the loss because Primeo's losses were merely reflective of the losses suffered by Herald and Alpha, in which Primeo was a shareholder at the time of Madoff's arrest. The Defendants also argued that Primeo's claim was time-barred insofar as it sought to recover losses arising from a cause of action which accrued prior to 20 February 2007 (i.e. six years prior to the issue of the writ by Primeo against the Defendants). If Primeo succeeded in making out its claim for damages, the Defendants argued that a very substantial reduction would have to be made to reflect the contributory negligence on the part of Primeo.


After hearing evidence from more than 25 factual and expert witnesses including three of Primeo's former directors and a number of experts in the fields of custody and fund administration, Mr Justice Jones QC dismissed Primeo's claim in its entirety, on the following grounds:

  • Causation: Primeo failed to prove that any breach of duty by the Defendants had caused its losses. In other words, even if the Defendants had acted as Primeo alleged they should have, the Court was not persuaded that the directors of Primeo would have decided to withdraw the investments placed with BLMIS and would have ceased to invest further with BLMIS. Although the custodian was also found to be strictly liable for any wilful default of BLMIS in its capacity as sub-custodian, there was no loss for which the Defendants could be held strictly liable. Primeo's loss did not flow from any wilful default of BLMIS qua sub-custodian. Following the in specie transfer on 1 May 2007, BLMIS was no longer sub-custodian to Primeo; Primeo held only shares in Herald and Alpha, and they were in the custody of the custodian, HSSL.
  • Reflective Loss: The rule against reflective loss operated to bar the recovery of any of Primeo's alleged loss, because Primeo was seeking to recover losses suffered by way of a diminution in the value of its shareholdings in Herald and Alpha. As a matter of law, Herald and Alpha were the proper claimants in respect of those losses, and any recoveries obtained by Herald and Alpha would flow to Primeo as a shareholder. In arriving at this conclusion, the Court determined that the appropriate standard against which to assess the merits of the claims by Herald and Alpha against HSSL was that such claims have 'a real prospect of success' (as opposed to being 'likely to succeed' as contended by Primeo).
  • Limitation: Causes of action accruing prior to 23 February 2007 are time-barred under the Limitation Law. This covered almost all claims arising from breaches that occurred while Primeo invested directly with BLMIS, as opposed to indirectly through Alpha and Herald.

In any case, the Judge determined that he would have reduced any damages awarded against the administrator by 75% on account of Primeo's contributory negligence.

Although Primeo's claim failed on several bases, the Judge's findings and observations concerning the roles and responsibilities of administrators and custodians will be of significant interest to the funds industry in the Cayman Islands and abroad.

Custodian: Breach of Duty

The Judge found that during the years 1993 to 2002, the custodian was not responsible for investments placed by Primeo with BLMIS. Rather, BLMIS was the legal as well as de facto custodian of Primeo's assets placed with BLMIS for investment.

However, in August 2002, the custodian entered into a Sub-Custody Agreement with BLMIS (the "2002 Sub-Custody Agreement"), which was governed by Luxembourg law. The validity, purpose, scope and effect of the 2002 Sub-Custody Agreement were vigorously contested.

The Judge found that the 2002 Sub-Custody Agreement was effective to appoint BLMIS as the sub-custodian in respect of Primeo's assets held at BLMIS, because it amounted to an "implied tri-partite agreement" between HSSL, BLMIS and Primeo to do so.

It followed, according to the Judge, that from August 2002 the custodian had contractual duties to use due skill and care in the appointment of any sub-custodian, to assess the ongoing suitability of the sub-custodian, and to ensure that the most effective safeguards were in place in relation to the sub-custodian to ensure the protection of Primeo's assets. The Judge found that the custodian was in breach of these duties.

The key issues were whether a reasonably competent global custodian would have made, and then continued, the appointment of BLMIS without requiring (or at least recommending) that BLMIS:

  1. establish a separate securities account with the central securities depository in New York, the Depositary Trust Company ("DTC"), for Primeo's benefit rather than accepting that Primeo's securities would (purportedly, because they never in fact existed) be held in BLMIS's single omnibus client account at DTC and/or make use of a DTC reporting system known as the Institutional Delivery System (the "ID System"); and
  2. establish a separate account with the Bank of New York ("BNY") for treasury bills that BLMIS claimed to hold for Primeo (which also never in fact existed).

In each case, Primeo argued that a reasonably competent custodian would have required or recommended those options, that, if they had done so, Primeo's directors would then have asked BLMIS to set up such separate accounts for Primeo, and that if BLMIS had refused to do so Primeo would have withdrawn its funds from BLMIS and stopped making further investments. The Judge accepted that a reasonably competent custodian would have made such recommendations, though (as discussed above) he rejected Primeo's causation arguments.

Separate Account at DTC or ID System

BLMIS purportedly executed large scale bulk trades for all of its investment clients on an omnibus basis, and then separate agency trades for each client's part of the bulk (i.e. the assets were purportedly segregated by BLMIS in its books and records, rather than at the DTC). A separate account at the DTC in the name of BLMIS, but designated for either Primeo or all of the custodian's clients, would have meant that the agency trade made between BLMIS (as broker) and Primeo (acting by BLMIS as investment manager) would have been settled into the separate DTC account, with the result that the DTC would have issued a settlement notification in respect of this trade, which the custodian could have required to be sent directly either by SWIFT message or through the ID System.

Alternatively, the ID System, without a separate DTC account, would have allowed the custodian to obtain trade confirmations and settlement notifications directly from the DTC. The Judge found that the custodian could have been set up to receive a notification directly from the DTC as an 'interested party' whenever BLMIS identified part of a bulk trade as being allocated to Primeo.

In either case, he held, there would have been independent confirmation of an actual trade taking place and settlement into BLMIS's account, as well as the possibility of reconciling confirmations and statements received from BLMIS with those received from DTC.

Separate Account at BNY

BLMIS's purported strategy involved investing in US treasury bills for a large part of the time, including at month-end as a means by which to protect the confidentiality of BLMIS's purported trading strategy, and timing the trading of US equities. The treasury bills were purportedly held in BLMIS's omnibus account with BNY. The Judge found that BLMIS could have established a separate account in its own name designated for each of Primeo and the custodian's other clients. BLMIS could then have instructed BNY to issue monthly statements directly to the custodian and confirm year-end balances directly to Primeo's auditors, Ernst & Young. The Judge found that there was no regulatory or practical impediment to doing so, and it would not have interfered with BLMIS's 'triple function' business model – nor necessarily prevented Madoff from defrauding the custodian's clients. However, it would have allowed the custodian to confirm the requisite value of treasury bills at each month end, making it more difficult for Madoff to perpetuate his Ponzi scheme.


The custodian argued, among other things, that these might have been possible options but they did not constitute normal commercial practice, so they could not have been required of a reasonably competent custodian, and that any failure to make such recommendations did not amount to negligence.

The Judge found that, although it was not (and is still not) normal commercial practice for custodians to segregate assets by establishing separate accounts at the DTC and at BNY for their hedge fund clients, in the particular circumstances arising out of BLMIS's business model, a reasonably competent custodian would have done so. BLMIS's performance of roles as broker, dealer, and de facto custodian introduced operational risks which were not addressed by the normal, commercially acceptable procedures. The Judge found that "when the normal procedure is known to be ineffective, failing to apply a readily available alternative is negligent".

In addition to liability for its own acts and omissions, the Judge also found that, under the Custodian Agreement, the custodian was strictly liable for any wilful default of BLMIS acting as sub-custodian. But from May 2007, BLMIS was no longer Primeo's sub-custodian. Primeo held only shares in Herald and Alpha, and they were held by the custodian. Accordingly, no loss flowed from any wilful default by BLMIS qua sub-custodian – and so there was no loss for which the custodian could be held to be strictly liable.

Administrator: Breach of Duty

The Judge held that an administrator's role did not extend to performance of managerial and advisory functions. Rather, the core duties were the production of accounts and determination of the NAV by the exercise of independent professional judgment. The Judge held that "administrators are not expected to perform audit procedures, but they are concerned to satisfy themselves that the published NAV is accurate." The existence of assets is verified by the process of reconciliation and the pricing of assets by reference to independent pricing services such as those provided by Bloomberg.

The Judge made no criticism of the administrator in relation to satisfying itself about the pricing reported by BLMIS, because those prices matched the publicly available sources.

Although it was agreed between the expert witnesses that administrators would normally proceed on the assumption that information received from third parties is reliable, the key issue concerned whether, and if so how, an administrator must verify the existence of reported assets.

The Defendants' expert gave evidence that it was common for an administrator to rely on single-source reporting, especially during the period from 1993 to 2008. The administrator would "tie" to the custodian's statement, and in this case the de facto custodian was the broker, BLMIS. Therefore, it was not negligent of the administrator to rely upon BLMIS's monthly statements when calculating Primeo's NAV.

However, the Judge rejected that evidence. He accepted that might have been the case within large international banking and financial services groups, promoting their own 'in-house' branded investment fund products, but, in such a case, all the various service providers, including the administrator itself, were likely to be separate entities within the same group. An in-house fund would have been marketed as such, but in the case of BLMIS it was the same entity carrying out all of the functions.

The Judge found that single-source reporting in relation to a hedge fund with the characteristics of BLMIS was unique in the hedge fund industry. He found that the "relatively high risk of fraud or error inherent in the BLMIS model must have been manifestly obvious to all concerned". The Judge found the use of single-source reporting to be negligent but not grossly negligent (the contractual standard for imposing liability on the administrator) for the years 1993 to 2005, because during that period Primeo's auditors had been content to rely upon clean (but fraudulent) audit reports from BLMIS's auditors as evidence that Primeo's assets existed.

The Judge found that from 2005, however, this factor no longer assisted the administrator because Primeo's auditors began relying upon custody confirmations provided by the custodian (which confirmations had appended BLMIS's account statements).

The Judge found that the administrator's reliance upon information solely from BLMIS in these circumstances did not account for the risks of using single-source reporting. The administrator's preparation of Primeo's NAVs from 2 May 2005 onwards was therefore found to have been in breach of contract amounting to gross negligence.

Indirect investments

By May 2007, Primeo was only an indirect investor in BLMIS because its only assets were shares in Herald and Alpha. The Defendants argued that this meant the administrator had no duty to "look through" the published NAV of Herald and Alpha, but was entitled to rely upon those NAVs unless there was any obvious error (which there was not) for the purpose of calculating Primeo's NAV.

The Judge confirmed that there is ordinarily no obligation on administrators to "look through" the NAVs published by master funds. However, HSSL also provided custody and administration services to Herald and Alpha. The Judge inferred that the NAV calculations made in respect of Herald and Alpha after May 2007 were flawed for the same reason as for Primeo's beforehand. The Judge therefore found that the administrator's reliance on Herald and Alpha's published NAVs when producing Primeo's NAVs also amounted to gross negligence.

However, the Judge also ruled that, if Primeo had made out its claim against the administrator, he would have reduced any damages award by 75% on account of Primeo's contributory negligence: Primeo was largely the author of its own misfortune because its directors and investment advisers were well aware of the risks inherent in the BLMIS structure.


This judgment addresses a range of issues that will be of significant interest to fund directors and service providers. For industry professionals, the headline point is the serious risks to fund service providers posed by investment structures that are abnormal or high risk.  The judgment also establishes that a fund service provider may have an obligation to recommend a course of action to its client to address abnormal risks, even when those risks are well-understood by the client, and that a failure to do so may amount to a breach of contract.


1 Campbells represented the successful Defendants. The factual and legal issues raised in these proceedings are complex and go beyond the scope of this brief client advisory note. Should you have any questions, or wish to discuss any aspect of this judgment, please contact the authors below.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on

Click to Login as an existing user or Register so you can print this article.

Similar Articles
Relevancy Powered by MondaqAI
Some comments from our readers…
“The articles are extremely timely and highly applicable”
“I often find critical information not available elsewhere”
“As in-house counsel, Mondaq’s service is of great value”

Related Topics
Similar Articles
Relevancy Powered by MondaqAI
Related Articles
Up-coming Events Search
Font Size:
Mondaq on Twitter
Mondaq Free Registration
Gain access to Mondaq global archive of over 375,000 articles covering 200 countries with a personalised News Alert and automatic login on this device.
Mondaq News Alert (some suggested topics and region)
Select Topics
Registration (please scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of

To Use you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.


The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.


Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions