In a case involving Lehman Brothers International, the UK Supreme Court ruled that a statutory trust arises with regard to client money upon receipt of the money by the firm and not when the money is placed in a segregated client account. It would not achieve the investor protection purposes of the Markets in Financial Instruments Directive and FSA rules, reasoned the Court, if a trust did not arise until segregation of client money since it would then become arbitrary and dependent upon the firm’s own practices. (In the Matter of Lehman Brothers International (Europe), UK Supreme Court, Feb 29, 2012)
The appeal arose from the insolvency and administration of the Lehman Brothers group of companies. Lehman Brothers International (Europe) was the principal European trading company in the group and is incorporated in England as an unlimited company with its head office in London. In this case, the firm failed to identify as client money, and therefore also failed to segregate, vast sums received from or on behalf of a significant number of its clients. The issues on this appeal are of great importance to financial institutions and regulatory authorities, and the amount of money involved is enormous.
The Court ruled that client money is subject to the statutory trust created by the Financial Services and Market Act and implementing Financial Services Authority rules as soon as it is in the firm’s hands irrespective of where the firm puts the money. Thus, the trust extended to any client money that is held in the firm’s house account and has not yet been segregated as well as to money that has been segregated.
Where money is received from a client, or from a third party on behalf of a client, reasoned the Court, it would be unnatural and contrary to the primary purpose of client protection for the money to cease to be the client’s property on receipt, and for it to become his or her property again on segregation.
The FSA rules are intended to protect all clients who provided money to the firm and have contractual claims. The rules were adopted to fulfill the EU requirements contained in the Markets in Financial Instruments Directive and should therefore be interpreted, as far as possible, to give effect to the purposes of MiFID to provide a high level of protection for clients and safeguarding their rights to funds in the event of the insolvency of the firm to which their funds have been entrusted. Ruling that a trust of client money received by a firm arises upon receipt, rather than only upon segregation, better serves the MiFID objectives of protecting clients’ rights in relation to their funds and providing a high level of protection for clients.