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Fiduciary Duty and Intermediated Securities Report – A Bombshell at the End

The Law Commission was asked to undertake a review of how the law of fiduciary duties applies to investment intermediaries and to evaluate whether the law works in the interests of end investors. This followed a recommendation in the Kay Review undertaken by Professor John Kay where he attacked the excessive “intermediation” in financial markets, the lack of clarity of responsibility, the difficulties trustees have in interpreting their duties and related factors that seemed to be undermining the ethics of financial markets. In particular he suggested that clarifying “fiduciary duty” as it applied to pension trustees, and possibly extending it to intermediaries might be useful. For example, most investment managers only have a contractual responsibility to their client and not a fiduciary duty. They are also bound by FCA regulations of course, but their clients might not be able to sue for any breach of those rules.

Professor Kay recommended that all those in financial markets should apply fiduciary standards in their dealings with each other whenever they exercise discretion over the investments of others or give advice on investment decisions. He thought that fiduciary standards “require that the client’s interests are put first, that conflict of interest should be avoided, and that the direct and indirect costs of services provided should be reasonable and disclosed”.

The Law Commission therefore undertook a public consultation and have now produced their final report. It is available from here: .

In summary, they have rejected significant change to the law of fiduciary duty, or its wider extension. So there will be no revolution in this area. Even on extending the right of private persons to sue intermediaries for breach of FCA rules (which of course was very much opposed by intermediaries), they leave to the Government to debate that issue further.

They also rejected any review of “stock lending” which is a very questionable practice, but simply suggest that the fees retained should be made more transparent.

At this point you may have thought this whole exercise has turned out to be a damp squib. But there is a real bombshell at the end of the report where they discuss the problem of intermediated securities – such as nominee account holdings.  The report says there are four problems in this area: 1) Legal uncertainty as the law has not kept pace with market practice; 2) Difficulties in exercising rights where rights are often lost; 3) Lack of transparency over who ultimately owns shares and 4) Potential risks from the long chains of intermediaries.

This is what the report says on these issues:

Given the importance of this area, we think that there is a need for a clear statement of legal principles. In our advice to HM Treasury in 2008, we recommended that the UK should ratify the UNIDROIT Convention, to provide a clear harmonised system reflecting current market practice. We continue to think that there is a need for the UK to work at a European and international level to bring clarity to the law and to reduce the practical difficulties caused by the intermediated system. We accept that a UK-only solution would be unworkable. However, this does not mean that the UK should simply leave the issue to the European Commission.”

And: “We recommend that the Government should review the current operation of the system of intermediated shareholding, with a view to taking the lead in negotiating solutions at a European or international level.”

This is well said and a major step forward because the Unidroit Convention would give clarity to the rights of beneficial shareholders in nominee accounts. The Government was previously recommended to sign up to it, but did nothing. Let us hope they take note of these strong recommendations and actually do something on it.


Roger Lawson 1/7/2014

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