A recent appeal in the Supreme Court was concerned with the meaning and application of the “client money rules” and “client money distribution rules” contained in Ch 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 Instruments Directive 2004/39/EC (“MiFID”). Re Lehman Brothers International (Europe) (In Administration) [2012] UKSC.

The central feature of the client money rules is the requirement that CASS 7 imposes on MiFID firms to segregate money that they receive from or hold for or on behalf of their clients in the course of MiFID business by placing it into a client money account so that it is kept apart from the firm's own money.

Under English law the mere segregation of money into separate bank accounts is not sufficient to establish a proprietary interest in those funds in anyone other than the account holder. A declaration of trust over the balances standing to the credit of the segregated accounts is needed to protect those funds in the event of the firm's insolvency. Segregation on its own is not enough to provide that protection. Nor is a declaration of trust, in a case where the client's money has been so mixed in with the firm's money that it cannot be traced. So segregation is a necessary part of the system. When both elements are present they work together to give the complete protection against the risk of the firm's insolvency that the client requires.

In its judgment on 29 February, the Supreme Court narrowly upheld the decision of the Court of Appeal on each of three appealed questions relating to 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 Lehman Brothers (International) Europe (LBIE) received those monies, not when those monies were segregated from LBIE's own assets.
  • The client money pool includes client money in LBIE's house accounts, as well as in segregated client accounts.
  • Any client with a contractual claim to client money has a right to share in the client money pool: there is no requirement that client money should have actually been segregated on the client's behalf.

In an ideal world, the CASS rules would ensure that upon a firm’s insolvency, the clients would receive back their money in full, free from the claims of the firm’s creditors.  However, LBIE failed to identify, and as a result, to then segregate client money.

The decision reflected the majority's focus on giving effect to the natural meaning of the language in CASS, together with the primary purpose behind it of giving a high level of protection to clients' money, not a consideration of general principles of trust law.  For client money to cease to be client money on receipt and to only become client money again on segregation would be artificial – whereas an immediate trust of all identifiable client money provides a level of protection which does not depend on the competence and/or conduct of the firm in applying the appropriate segregation processes.  All identifiable client money should be treated as pooled, as the exclusion of identifiable client money held in house accounts would result in a lower level of protection for those clients whose money ought to have been segregated but was by chance being held in a house account at the time the firm failed.  Participation in the client money pool does not require actual segregation, consistent with the purpose of protecting all client monies received prior to a firm’s failure.

Although clients for whom money was not segregated will welcome the decision, it is also likely to lead to further delay in any distributions by the administrators as they seek to trace client monies in the relevant house accounts.