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Supreme Court widens scope of 'client money'

01 March 2012

The Supreme Court yesterday ruled that client money held in un-segregated accounts should be treated the same as client money held in segregated accounts, ...

… enabling un-segregated account holders to share in the client money pool on the insolvency of a firm with whom the account is held.

This decision, which is also likely to have a significant impact on how firms hold client money, means that segregated account holders, who may previously have believed their money to be safe, may not be able to reclaim the full value of their accounts due to the greater number of claimants against the client money pool.  Conversely, clients whose money was not segregated gain protection.

The decision comes from the latest in a long line of cases relating to the insolvency of Lehman Brothers International (Europe), the principal European trading subsidiary of Lehman Brothers Holdings Inc, which collapsed in September 2008.  The point in question was whether the client money pool should be used to pay out the claims solely of those clients whose money was held in segregated accounts, or whether participation in this pool should also be available for those clients whose money had not been segregated by Lehmans.

The Decision

The Supreme Court, on a majority decision (3:2), affirmed the previous decision of the Court of Appeal on each of the three appeal questions concerning the scope of the statutory trust over client money under CASS 7. The Court held:

  • A statutory trust over client monies arose at the time Lehmans received monies from a client, as opposed to when those monies were segregated from Lehmans' own assets (this part of the decision was unanimous)
  • The client money pool includes client money held in Lehmans' 'house accounts', as well as in segregated client accounts
  • A claimant with a contractual claim for client money has a right to share in the client money pool on the basis of the amount which should have been segregated at the time of a Lehmans' insolvency (the "claims basis" for participation), as opposed to how much had actually been segregated at the time of the insolvency (the "contribution basis" for participation)

The Court took a purposive approach to the interpretation of the CASS rules, rather than making the decision on the basis of the general principles of the law of trusts. The decision of the majority focuses on the purpose of CASS 7, which is to provide a high level of protection to clients' money. This is contrasted to the dissenting judgments, which focus on the trust law issues underpinning CASS. Lord Walker's dissenting judgment noted that, immediately before the insolvency (the "primary pooling event"), many of the un-segregated account holders would have had no beneficial interest in any identifiable trust property, although by the majority's decision these un-segregated account holders will now have the same entitlement as segregated account holders.


This wide-ranging decision will have important implications from both a regulatory and insolvency perspective, not all of which will be immediately clear. It appears likely that there will be further litigation on this and similar points, as insolvency practitioners and claimants in high profile insolvencies seek further clarification as to who is entitled to participate in the client money pool.

The decision broadens the scope for protection of clients' money, as it protects clients from the failure of firms properly to segregate client monies, although this means that more diligent investors, who ensure that their monies are segregated, will receive no greater protection than those who do not carry out such checks. It is debateable whether this decision provides greater clarity in the short term, as those who previously expected the return of all their money will now likely not recover in full. Lord Walker commented in his judgment that the majority decision "makes investment banking more of a lottery than even its fiercest critics have supposed".

Investment firms will likely also have to review how they hold client money, particularly concerning the use of 'house accounts', although the judgment does not provide any practical insight as to what changes will need to be made. It might well not be until the FSA's anticipated review of the client money rules that these issues are resolved. In any event, the decision is unlikely to reduce the FSA's enthusiasm for enforcement action against firms whose CASS book-keeping is inadequate or which fail to segregate client monies.

For insurance intermediaries, the case is of less obvious relevance because CASS 7 is based largely on MiFID, whilst they are subject to CASS 5. Whether the purposive approach would be applied to the interpretation of CASS 5 remains to be seen.

The decision will also add further weight to existing questions over London's status as an international trading centre, which have arisen in part due to complaints over the speed of the return of client monies to investors with funds in the high profile Lehmans and MF Global UK insolvencies. This decision is likely further to draw out the timescale for distributions to clients, alongside the issues raised by this decision over the safeguarding of client money in the UK. Insolvency practitioners will now need to trace monies held in un-segregated client accounts in order to increase the client money pool, increasing the timeframe for final distributions to be made to clients and drawing out administrations as a whole.

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