Tuesday, August 10, 2010

UK Appeals Court Says Hedge Funds’ Client Money in Lehman Should Be Pooled Equally

The pool of hedge funds’ client money held by Lehman Brothers International when it entered bankruptcy administration includes not only segregated monies in segregated accounts but also all identifiable client money in the firm's house accounts, ruled a panel of the UK Court of Appeals, and that such pool should be distributed on a claims basis. The pool arose under Financial Services Authority rules, implemented under the Financial Services and Markets Act, and fashioned to comply with the MiFID Directive in relation to client money held by investment firms. CRC Credit Fund Limited v. GLG Investments PLC Sub Fund: European Equity Fund, UK Court of Appeal, Case No: A2/2010/0113,0114,0119,0121,

The court held that a statutory trust arose on the receipt of funds. A client would have no knowledge which approach a particular firm was adopting with regard to client funds, said the court, and it was unlikely that the FSA intended that there should be two categories of client. The fact that some funds were segregated and some were not was simply a matter of administrative flexibility and was not intended to affect clients' substantive rights. It was thus proper to pool both client money in the segregated accounts and identifiable client money in other accounts.

There is no requirement in MiFID as to what should happen to client money once a firm enters insolvency save that which is implicit in the MiFID requirement to safeguard client funds. Thus, while MiFID does not directly confront the issue of whether if a firm fails client monies are to be pooled, the court found that it is implicit in safeguarding the assets
of clients that the clients should all share in the remaining assets. The court further stated that it was open to the FSA to determine that the failure of the firm should be treated as a common misfortune in which those who had claims to the recovery of client money should share without distinction.

In his concurring opinion, Lord Neuberger noted that, while it is true that the MiFID Directive nowhere refers to the creation of a trust, that was irrelevant given that the Directive is intended to apply across the EU to all member states and the concept of a trust is not familiar in civil law jurisdictions. Quite apart from this, Lord Neuberger concluded that the MiFID prohibition on a firm using client money for its own purposes is enough to create a trust in English law. Further, Lord Neuberger noted the MiFID reference to securities and funds entrusted to a firm by a client.

Lord Neuberger said that treating clients of a firm as "in it together", and pooling client money to be paid out to all clients, is appropriate since the two groups of clients were intended to be treated similarly, rather than face a degree of randomness. The alternative approach would be that clients with money in house accounts would enjoy less protection than that enjoyed by clients with money in segregated accounts. Yet all clients who deposit money with firms for MiFID business are intended to receive protection which complies with the Directive, reasoned Lord Neuberger, who views a single and consistent level of protection as the general thrust of MiFID, whose purpose is to maximize client protection and ensure that client money is protected as soon as it is paid into an account by the firm.

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