Analysis
Lehman Brothers International (Europe) (LBIE), an English unlimited company, was the principal European trading company in the Lehman Brothers group. LBIE entered administration on 15 September 2008. The administrators made several applications to the court for directions.
The issues on appeal concerned the application of chapter 7 of the Client Assets Sourcebook (CASS 7) issued by the Financial Services Authority (FSA). CASS 7 was intended to transpose the Markets in Financial Instruments Directive 2004/39/EC (MiFID) and its Implementing Directive into English law, under the FSA’s rule making powers contained in the Financial Services and Markets Act 2000.
Rules in CASS 7 provided for client money to be identified and paid into accounts segregated from the firm’s house accounts. It provided for client money to be held on trust and pooled in the event of inter alia the failure of the firm and distribution pari passu should there be a shortfall. A statutory trust was imposed by CASS 7.7.2 on client money received and held by a firm. Entry into administration was a ‘primary pooling event’ (PPE) pursuant to CASS 7.9.6(1), which required client money in a ‘client money account’ (a term not defined in CASS 7) to be pooled. Such pooled client money was required by CASS 7.9.6(2) to be distributed rateably in accordance with each client’s net client money entitlement. LBIE had adopted the ‘alternative approach’ to accounting for receipts of client money, as in was entitled to do pursuant to CASS 7.4.13G and CASS 7.4.16G. The alternative approach meant that instead of paying client money directly into a segregated account, LBIE was permitted to pay client money into its house accounts and carry out a daily reconciliation. On assumed facts, there had been a failure on a significant scale by LBIE to identify and segregate client money.
The three issues appealed to the Supreme Court were:
(i) when does the statutory trust created by CASS 7.7.2 arise;
(ii) do the pooling arrangements apply to client money held in house accounts or only to money held in segregated accounts on the occurrence of a PPE; and
(iii) is participation in the client money pool dependent on actual segregation of client money (the contribution basis for participation) or can clients whose money ought to have been segregated could also participate (the claims basis for participation)?
Briggs J had held that the trust was created at the point of receipt and that the scope of the pooling arrangements and the right of participation in the pooled funds were dependent on a client’s contribution having actually been segregated when a PPE occurred. The Court of Appeal agreed that the trust was created at the point of receipt but held that the client money pool consisted of all moneys held on behalf of clients and that the pool was to be shared on the basis of the amount that ought to have been segregated, whether it had been segregated or not at the time when a PPE occurred.
Held (dismissing the appeal, Lord Hope and Lord Walker dissenting on the second and third issues)
1. CASS 7 should be interpreted as far as possible so as to give effect to the Directives. It is important not to allow the exceptional facts of this appeal to influence the outcome. The purposes of MiFID and the Implementing Directive were to provide high level protection for clients and to safeguard their rights in insolvency (paras [129] and [138]).
2. As to the first issue, the statutory trust created by CASS 7.7.2 arises at the point of the firm’s receipt of the client money (paras [128] and [169]). An interpretation of CASS 7.7.2R by reference to the Directives is strongly supportive of the case that a trust of client money arises on receipt rather than on segregation (para [135]). Fiduciary duties arise on receipt, regardless of the account the moneys are paid into (paras [190] and [191]). It would be odd if client money ceased to be the client’s money on receipt and then became the client’s property again upon segregation (paras [194] and [195]).
3. As to the second and third issues, CASS 7 is intended to protect all the clients’ money and all the clients’ money is subject to a statutory trust on receipt. There is nothing surprising that once a PPE occurs, the treatment of client money is subject to a different regime from that to which it was subject before. It is not inherently unlikely that the draftsman intended the clients’ proprietary interests in segregated funds should have those interests disturbed by the distribution rules in the event of a PPE. There was a policy choice to be made. The choice that was made depends on the true construction of CASS 7, not on general principles of trust law. Where there was a choice of interpretations, the court should adopt the one affording a high degree of protection for all client money. The linguistic points are not conclusive and a purposive approach supported the claims basis for participation (paras [144] and [160]).
4. Where a firm adopts the alternative approach to receipts of client money, CASS 7 contemplates that client money will be held in the firm’s own account. The question of whether a house account of a firm can be a ‘client money account’ arises both where a firm adopts the alternative approach and where it has wrongly retained client money in its own account. An examination of the test shows two possible interpretations and the correct interpretation is the one best promoting the purpose of CASS 7 as a whole. To exclude identifiable client money in house accounts from the distribution regime runs counter to the policy in CASS 7. A bifurcated scheme would provide clients with different levels of protection based on the arbitrary happenstance of whether the firm has segregated money on behalf of that client (paras [161] and [168]).
Judgment LORD HOPE: [1] This appeal is concerned with the meaning and application of the ‘client money rules’ and ‘client money distribution rules’ contained in chapter 7 of the Client Assets Sourcebook (CASS 7) issued by the Financial Services Authority for the safeguarding and distribution of client money in implementation of the Markets in Financial …Continue reading "Re Lehman Brothers Intl (Europe) [2010] EWCA Civ 917"