The judgment in Global Trader Europe Limited delivered on 24 March 2009 will be of great interest to those firms who either hold “client money” or seek the protection of the client money regime. Briefly, the Financial Services and Markets Act 2000 (FSMA) and FSA rules protect a client from the credit risk of the FSA-regulated firm it is dealing with. Money received and held as client money benefits from a statutory trust. The firm must segregate client money from its own money. In the firm’s insolvency, client money would not be available to the general creditors of the firm. Instead, liquidators should return it to the client(s) entitled to it.
The facts of the Global Trader case are complex. What follows is a brief summary of the most important issues.
Failure to pay into segregated account
Global Trader was a CFD (contracts for difference) and spread bet broker. It entered into trades with clients as principal and backed them with similar trades with prime brokers. One of its clients could not post margin, and Global Trader in turn failed on a margin call from one of the prime brokers. It went into administration in February 2008.
The applicant liquidators applied for the court to decide questions about distributing its assets. Clients paid money to Global Trader as margin for losses that might be incurred on trades. Global Trader believed that it did not hold this money as client money for some of these clients. Instead, Global Trader paid this money into its own bank account and used it for its own purposes.
Several creditors argued that they were owed client money protection and that the money should have been paid into the segregated account. They argued that all or most of the funds held by the liquidators in accounts, which to outward appearances contained Global Trader’s own money, should be directed to be held on trust for themselves. The respondents also advanced a fall-back argument to the effect that they should share in the money held in the segregated account as at the date Global Trader went into administration.
The court found that moneys paid by clients before the implementation of the Markets in Financial Instruments Directive (MiFID) in November 2007 was indeed client money when paid. After that date, most of the margin money was not client money: it was subject to a title transfer collateral arrangement.
But the court found that the client money had effectively lost its identity when it was paid into Global Trader’s own account. So the respondents did not have a proprietary interest in the general funds held by the liquidators and therefore ranked as unsecured creditors only. The money failed to satisfy the “certainty of subject matter” test which is one of the requirements for establishing a trust under English law.
Closing positions and profits
The respondents also submitted that they were trust creditors entitled to a proprietary interest in profits created on closed trading positions. However, the court held that Global Trader (as debtor) did not become a trustee for the respondents (as creditors) and hold some of its own money on their behalf. Global Trader merely owed the respondents a contractual debt in a similar way as trade debts constantly arise during trading relationships. In addition, Global Trader did not pay the profits into client bank accounts, which was also fatal to the respondents’ case.
On the day of its liquidation, Global Trader told its bank to transfer money into a segregated account to correct a payment mistakenly made out of that account. The bank failed to do so, which created a shortfall in that account. The court ruled that Global Trader’s unsuccessful attempt to make the bank transfer did not create a trust of that money in favour of the respondents. The court also refused to order the liquidator to transfer the money from Global Trader’s general funds. FSA rules state that, on a firm’s failure, client money held in each client account of the firm is pooled, and the firm must distribute the pooled client money. The money to which the incomplete transfer issues relate was not part of that pool, and it would be contrary to FSA rules for that amount to be distributed to the trust beneficiaries otherwise than as part of that pool.
The real lesson from Global Trader lies in the importance of firms complying with the client money rules correctly. In an open letter to firms’ compliance officers dated 20 March 2009, FSA said that some firms were failing to comply with basic client money requirements. The letter was essentially a warning for firms to get their act together on an issue that has become so important following the Lehman debacle. Failure to do so could have disastrous consequences for both firms and their clients.