Fiduciary Duties of Investment Intermediaries

The Law Commission has published its Consultation Paper regarding 'Fiduciary Duties of Investment Intermediaries'. I blogged about the project initially here. The consultation paper and a summary can be found here and here respectively.

The consultation paper, according to para 1.1, sets out to: '... investigate how the law of fiduciary duties applies to investment intermediaries and evaluate whether the law works in the interests of end investors'.

I have only given it a cursory read so far but have initial observations in regards to defining of terms such as fiduciary - however, it is noted that the consultation now seems to have gone wider than fiduciary duties of investment intermediaries in to duties generally of investment intermediaries (see paras 9.15, 14.62 and 14.64). Fiduciary duties prevent any self-interest in the performance of the undertaking. The duty moulds itself to the particular undertaking of the financial intermediary to temper any self-regard in respect of that undertaking. Thus, if they act or omit to act because they are personally interested in what they are doing for their principal, any benefit obtained will be held for the principal. In short all other interests to the undertaking of the fiduciary (financial intermediary) must be subservient to the interests of the principal.

This seems as though it would be in the interests of end investors that there interests are placed first and the fiduciary must remove any self-interest or otherwise before acting. The principal's interests are therefore exclusive. It may be that the specific duties of the financial intermediary are not beneficial to the interests of the investors, which is why I think the consultation is now looking at duties generally, but first impressions would suggest that fiduciary duties are not the issue. However, continued recommendations on fiduciary duties would need a closer consideration regarding the defining of terms and when such a duty is owed.

 

ODL Securities Ltd v McGrath [2013] EWHC 1865 - fiduciary duties

This case of ODL Securities Ltd v McGrath [2013] EWHC 1865 concerned "fiduciary duties" owed by a head of risk for a company. At [17] it was said that 'Although not a director of ODL, Mr McGrath was in a closely analogous position and, as such, in my judgment owed the same fiduciary duties as he would if he had been a director. These duties encompass a duty to disclose matters which it was in the interests of ODL to know, including where appropriate ... his own misconduct'.

This post expresses concerns about the number of potential issues with this statement in respect of fiduciary duties.

1) Describing Mr McGrath's position as analogous to that of a director is particularly unhelpful in respect of fiduciary duties owed by individuals. Reasoning by analogy has been described as dangerous (see Ranson v Customer Systems plc [2012] EWCA Civ 841 at [24]) since the extent or scope of one's fiduciary duties differs from case to case. To describe the head of legal risk and directors as analogous is unhelpful in determining someone's fiduciary liability.

2) The wording says that because the positions of director and head of legal risk are analogous to one another then Mr McGrath owed the same fiduciary duties as if he was a director. The issue here is that all fiduciaries owe the same duty. The duty of loyalty is universal to all fiduciaries (Bristol and West Building Society v Mothew [1998] Ch. 1, 17-18, Plus Group Ltd v Pyke [2002] EWCA Civ 370 at [80]). Whether the fiduciary is a solicitor, trustee, parent, director, partner they all owe the duty of loyalty which is the defining feature of a fiduciary relationship. The premise needs to be whether Mr McGrath owed the duty of loyalty and not simply that he owed the duty because his position was similar to that of a director. A director as a fiduciary will owe the same fiduciary duties as a head of legal risk because they are both fiduciaries.

3) The duty of loyalty is designed to regulate the problem of opportunism where one has access to another's property and affairs for the exclusive benefit of that person. It prevents the fiduciary from obtaining an unauthorised benefit from their position that would conflict with the interests of the principal. Best interests are wider than this. It is possible to not act for the best interests of the principal without being personally conflicted. As Millet LJ explained in Mothew at [18] in respect of the duty to act with reasonable skill and care that 'mere incompetence is not enough [to breach your fiduciary duty]. A servant who loyally does his incompetent best for his master is not unfaithful and is not guilty of a breach of fiduciary duty'. Thus, there is only a breach if that incompetence is based on a conflict of interest. The same applies to the duty to act in the company's best interests. It would have been accurate of Flaux J to say Mr McGrath owed similar duties to that of a director, but not fiduciary duties. As Millet LJ said in Mothew at [16] 'unless the expression [fiduciary] is so limited it is lacking in practical utility'.

As another note this confusion with respect of fiduciary duties is also noted earlier at paragraph [15] where Flaux J describes a duty to disclose as part of a duty to avoid a conflict.

4) Equally the duty is proscriptive in that it bans conflicts of interest. It is not prescriptive in requiring positive action on behalf of the fiduciary. Therefore saying there is a fiduciary duty to disclose misconduct is mudding the waters of fiduciary jurisdiction.

5) The normal remedy for a breach of fiduciary duty is for the fiduciary to disgorge any personal benefit derived from the conflict and have it held on trust for the beneficiary who has a proprietary right to the benefit obtained. Simply failing to disclose misconduct, would potentially breach the duty to act in the best interests of the company if it was its best interests to know as was the case in Item Software v Fassihi [2004] EWCA Civ 1244 which was cited at paragraph [17] in this case. But the appropriate remedy was not to disgorge the benefit because there is no benefit to disgorge. It is possible a claim may be brought for equitable compensation (and indeed was the case here) if causation can be established between failure to disclose misconduct and harm done to the company but this is not like strict liability for breach of fiduciary duty which would simply require the disgorgement of the benefit once it is established that there was a conflict.

The facts concerned Mr McGrath who made a series of commercial loans who knew, at all materials times, was not the business of ODL. The loans were made by Mr McGrath of ODL to a company, or connected to a company, called A1 Holdings Ltd, which Mr Clements was personally interested in and a substantial creditor and shareholder; but Mr Clements was also the person who operated ODL's separate corporate finance business. When A1 Holdings Ltd went in to administration, Mr Clements was owed in excess of £3m. ODL sought equitable compensation/damages for the unauthorised loans made to A1 Holdings.

Some of the loans made were made without security, one was made to a company ran by a man Mr McGrath had only just met, and one was made with a promise of a personal payment of $1m to Mr McGrath from A1 Holdings. It is difficult to see how the failure to disclose his misconduct in authorising such loans that he was not authorised to make would be a breach of fiduciary duty. It is clearly a breach of the company's best interests to not disclose because the loans on any objective assessment were unlikely to be repaid, exposed the company to more risk when it was its business to be exposed to less risk, and it was not the nature of the company to make such loans. But without a conflict of interest it is not a breach of fiduciary duty, and even with the conflict in the third loan as to the personal benefit offered to Mr McGrath it is not the failure to disclose that gives rise to the breach of fiduciary duty but the benefit itself.

The judgment makes a series of references to dishonesty and fraud to demonstrate that Mr McGrath knew the loans were not in the interests of the company and had breached his fiduciary duty. This does nothing to add to his fiduciary liability. Liability is strict. Once there is a conflict, liability is established. It does not have to be established that the fiduciary acted fraudulently, dishonestly, acted in bad faith or did not try their hardest, for example. The fact he was dishonest and/or fraudulent in hiding the unauthorised loans did not matter. The loan where he was offered a personal benefit evidenced a conflict and he would have been in breach whether he honestly believed to be acting for the interests of the company or not. This is not to say the dishonesty and fraud does not demonstrate his breach of duty of care or best interests, but as stated, these are not fiduciary duties.

Therefore it seems in respect of breaches of fiduciary duty, Mr McGrath would have only done so in respect of those loans in which he was offered a personal benefit since he acted opportunistically for his own benefit creating the risk that he would not be loyal to the interests of ODL. The other loans, whilst breaches of his duty of care and duty to act in the best interests of the company, were not fiduciary breaches.