Yesterday I attended a Consultation Workshop at Hogan Lovells LLP on the Law Commission's Consultation on Fiduciary Duties of Investment Intermediaries. The event was attended by a variety of people from different backgrounds including trustees, academics, lawyers and fund managers to name a few. The Panel consisted of three members, David Hertzell - Law Commissioner; Nick Cray - Chief Operating Officer at Hogan Lovells; and Dominic Hill - Partner in the financial services department at Hogan Lovells.
The Consultation was a result of the Kay Review - see here for Consultation paper and Kay Review - that stated that a series of recommendations, particularly recommendation 9 that stated 'The Law Commission should be asked to review the legal concept of fiduciary duty as applied to investment to address uncertainties and misunderstandings on the part of trustees and their advisers'.
I hope to respond to the Consultation in detail but below I outline some initial observations that I wish to explore further at a later date. I intend this blog post to initially be putting my thoughts down from what I know and most would require further investigation to reach substantive conclusions.
From Kay Review and Consultation Paper two areas could be discussed. First, who in the investment chain owes fiduciary duties. This the Law Commission sees as a difficult question given the flexibility of fiduciary duties, but I believe this is caused by a misconception and a need to separate the two elements of a fiduciary that are first, when does the duty of loyalty arise and second, if so, what is the scope of that duty. This approach can be seen in University of Nottingham v Fishel [2000] I.C.R. 1462, 1494. Failing to do that it can often lead to erroneous statements such as those cited from Henderson and Others v Merret Syndicates Ltd and Others [1995] 2 A.C. 145, 205 that not all fiduciaries will owe the same duties in the same circumstances. This cannot be correct given Lord Millet's judgment in Bristol and West Building Society v Mothew [1998] Ch. 1 that the duty peculiar to fiduciaries is the duty of loyalty. If the duty peculiar to fiduciaries is the duty of loyalty then all fiduciaries must owe the duty of loyalty. Whilst not endorsed specifically, this seems to be supported by Sedley LJ in Plus Group Ltd v Pyke [2002] EWCA Civ 370 at [80]. To ascertain when the duty of loyalty arises one must consider three questions. What is the duty of loyalty, what is the purpose of it and finally when is that purpose fulfilled. If someone is determined to owe the duty of loyalty they are subject to the full expanse of fiduciary jurisdiction. If someone owes the fiduciary duty of loyalty one can turn to the second issue as to the scope of that duty. With this application to investment intermediaries it may become apparent who does and does not owe fiduciary duties in the investment chain.
This leads to another area that needs further consideration in respect of Kelly v Cooper [1993] AC 205, discussed 11.28-11.38, which considers terms of a contract may limit the scope of fiduciary duties. In essence this is true. This limiting of scope is on the basis that equity cannot alter the terms of a contract validly entered in to. As seen in Ranson v Customer Systems plc [2012] EWCA Civ 841 at [68] equity needs something to be "hung from". Therefore the duty is circumscribed by what the parties agree as someone cannot be loyal for something they did not take responsibility for. However, the courts must be careful as to what they imply in to contracts between parties as they did with Kelly v Cooper. There needs to be some differentiation between conflicts and interests in proposed transactions as is the case in the Companies Act 2006 with ss. 175 and 177. s. 177 breaches may be excused where a principal ought reasonably to have been aware of the conflict but s. 175 breaches require full disclosure with authorisation to act. Implied terms that the estate agent is authorised to act for multiple principals is unlikely to amount to full disclosure with authorisation.
The second issue in respect of the Law Commission's consultation concerns best interests. The question/statement I raised was how to promote best interests beyond short-term financial gain? The Commission looks at whether the law allows financial intermediaries and trustees to consider the long-term interests of the ultimate beneficiary through investment beyond the short-term interest of financial gain through transactions. The answer to this question seemed to be a resounding yes that the law does allow intermediaries to consider wider, long-term interests. This was evidenced in Chapter 10 of the Consultation paper by cases such as Cowan v Scargill [1985] Ch. 270; Harries v Church Commissioners [1992] 1 W.L.R. 1241; Martin v City of Edinburgh District Council [1989] Pen. LR 9, 1988 SLT 329; and Buttle v Saunders [1950] 2 All E.R. 193. Whilst this is the status of the Common Law the legislation in this area is not entirely reflective of this ability to consider wider, long-term interests. The Occupational Pension Scheme (Investment) Regulations 2005 SI 2005 No 3378, reg 4 provides that the investment of assets is 'in the best interests of the beneficiaries' and in a manner 'calculated to ensure the security, quality, liquidity and profitability of the portfolio as a whole'. The wording would seemingly focus most people's minds on profit in the short term.
Whilst the law seems to accommodate wider interests, there is an 'accountability gap' in ensuring wider, long-term interests are considered. This was discussed at 3.31-3.32 of the Consultation paper that trustees did not want to dictate to the investment manager what to invest in, but the investment manager believed it was the trustees who should instruct them to consider wider, long-term interests. Arguably the burden should lie with the managers who are the professionals but the incentives have to be right for them to apply the long term interests. Therefore it seems the law has reached a dead-end, and only a few subtle changes may be necessary such as a restatement of Regulation 4 and perhaps a statutory statement of duties for clarity similar to Part 10 of the Companies Act 2006. The law requires the intermediaries, if classified as fiduciary, to remove any self-interest in the performance of their functions to the ultimate beneficiary, and allows the freedom of the intermediary to assess what they believe to be in the best interests of the beneficiary. How to create the right incentives may not be an easy answer but there seems to be strong focus on better shareholder engagement to create trust and confidence in the businesses that are invested in so long-term plans can be supported rather than questioned, but equally there should be appropriate monitoring to prevent that trust being misplaced. Whilst the duties may deter trust being abused such duties are only reactive and some controls ex ante may need to be assessed.
My final point is that the Law Commission must be careful not to classify best interests as a fiduciary duty based on remedial result. Not to go in to great detail but loyalty is about removing the risk of self-interest by banning conflicts of interest. Best-interests is wider than this in that someone may not act in the best-interests of a principal but the decision may have been free from self-interest. This confusion may be seen in ODL Securities Ltd v McGrath [2013] EWHC 1865, which I blogged about here. However, incorrect classification may have wider implications as discussed in Chapter 5, particularly 5.46-5.54. The decision in Mothew discusses the implications of considering all breaches by fiduciary a fiduciary breach. A remedy for breach of fiduciary duty is normally a restitutionary one. This is much more favourable to the claimant than a compensatory one. Whilst compensatory remedies may be available for breach of fiduciary duty as seen in Item Software (UK) Ltd v Fassihi [2004] EWCA Civ 1244, restitutionary remedies may not be used for breaches of best interests.
The Consultation was a result of the Kay Review - see here for Consultation paper and Kay Review - that stated that a series of recommendations, particularly recommendation 9 that stated 'The Law Commission should be asked to review the legal concept of fiduciary duty as applied to investment to address uncertainties and misunderstandings on the part of trustees and their advisers'.
I hope to respond to the Consultation in detail but below I outline some initial observations that I wish to explore further at a later date. I intend this blog post to initially be putting my thoughts down from what I know and most would require further investigation to reach substantive conclusions.
From Kay Review and Consultation Paper two areas could be discussed. First, who in the investment chain owes fiduciary duties. This the Law Commission sees as a difficult question given the flexibility of fiduciary duties, but I believe this is caused by a misconception and a need to separate the two elements of a fiduciary that are first, when does the duty of loyalty arise and second, if so, what is the scope of that duty. This approach can be seen in University of Nottingham v Fishel [2000] I.C.R. 1462, 1494. Failing to do that it can often lead to erroneous statements such as those cited from Henderson and Others v Merret Syndicates Ltd and Others [1995] 2 A.C. 145, 205 that not all fiduciaries will owe the same duties in the same circumstances. This cannot be correct given Lord Millet's judgment in Bristol and West Building Society v Mothew [1998] Ch. 1 that the duty peculiar to fiduciaries is the duty of loyalty. If the duty peculiar to fiduciaries is the duty of loyalty then all fiduciaries must owe the duty of loyalty. Whilst not endorsed specifically, this seems to be supported by Sedley LJ in Plus Group Ltd v Pyke [2002] EWCA Civ 370 at [80]. To ascertain when the duty of loyalty arises one must consider three questions. What is the duty of loyalty, what is the purpose of it and finally when is that purpose fulfilled. If someone is determined to owe the duty of loyalty they are subject to the full expanse of fiduciary jurisdiction. If someone owes the fiduciary duty of loyalty one can turn to the second issue as to the scope of that duty. With this application to investment intermediaries it may become apparent who does and does not owe fiduciary duties in the investment chain.
This leads to another area that needs further consideration in respect of Kelly v Cooper [1993] AC 205, discussed 11.28-11.38, which considers terms of a contract may limit the scope of fiduciary duties. In essence this is true. This limiting of scope is on the basis that equity cannot alter the terms of a contract validly entered in to. As seen in Ranson v Customer Systems plc [2012] EWCA Civ 841 at [68] equity needs something to be "hung from". Therefore the duty is circumscribed by what the parties agree as someone cannot be loyal for something they did not take responsibility for. However, the courts must be careful as to what they imply in to contracts between parties as they did with Kelly v Cooper. There needs to be some differentiation between conflicts and interests in proposed transactions as is the case in the Companies Act 2006 with ss. 175 and 177. s. 177 breaches may be excused where a principal ought reasonably to have been aware of the conflict but s. 175 breaches require full disclosure with authorisation to act. Implied terms that the estate agent is authorised to act for multiple principals is unlikely to amount to full disclosure with authorisation.
The second issue in respect of the Law Commission's consultation concerns best interests. The question/statement I raised was how to promote best interests beyond short-term financial gain? The Commission looks at whether the law allows financial intermediaries and trustees to consider the long-term interests of the ultimate beneficiary through investment beyond the short-term interest of financial gain through transactions. The answer to this question seemed to be a resounding yes that the law does allow intermediaries to consider wider, long-term interests. This was evidenced in Chapter 10 of the Consultation paper by cases such as Cowan v Scargill [1985] Ch. 270; Harries v Church Commissioners [1992] 1 W.L.R. 1241; Martin v City of Edinburgh District Council [1989] Pen. LR 9, 1988 SLT 329; and Buttle v Saunders [1950] 2 All E.R. 193. Whilst this is the status of the Common Law the legislation in this area is not entirely reflective of this ability to consider wider, long-term interests. The Occupational Pension Scheme (Investment) Regulations 2005 SI 2005 No 3378, reg 4 provides that the investment of assets is 'in the best interests of the beneficiaries' and in a manner 'calculated to ensure the security, quality, liquidity and profitability of the portfolio as a whole'. The wording would seemingly focus most people's minds on profit in the short term.
Whilst the law seems to accommodate wider interests, there is an 'accountability gap' in ensuring wider, long-term interests are considered. This was discussed at 3.31-3.32 of the Consultation paper that trustees did not want to dictate to the investment manager what to invest in, but the investment manager believed it was the trustees who should instruct them to consider wider, long-term interests. Arguably the burden should lie with the managers who are the professionals but the incentives have to be right for them to apply the long term interests. Therefore it seems the law has reached a dead-end, and only a few subtle changes may be necessary such as a restatement of Regulation 4 and perhaps a statutory statement of duties for clarity similar to Part 10 of the Companies Act 2006. The law requires the intermediaries, if classified as fiduciary, to remove any self-interest in the performance of their functions to the ultimate beneficiary, and allows the freedom of the intermediary to assess what they believe to be in the best interests of the beneficiary. How to create the right incentives may not be an easy answer but there seems to be strong focus on better shareholder engagement to create trust and confidence in the businesses that are invested in so long-term plans can be supported rather than questioned, but equally there should be appropriate monitoring to prevent that trust being misplaced. Whilst the duties may deter trust being abused such duties are only reactive and some controls ex ante may need to be assessed.
My final point is that the Law Commission must be careful not to classify best interests as a fiduciary duty based on remedial result. Not to go in to great detail but loyalty is about removing the risk of self-interest by banning conflicts of interest. Best-interests is wider than this in that someone may not act in the best-interests of a principal but the decision may have been free from self-interest. This confusion may be seen in ODL Securities Ltd v McGrath [2013] EWHC 1865, which I blogged about here. However, incorrect classification may have wider implications as discussed in Chapter 5, particularly 5.46-5.54. The decision in Mothew discusses the implications of considering all breaches by fiduciary a fiduciary breach. A remedy for breach of fiduciary duty is normally a restitutionary one. This is much more favourable to the claimant than a compensatory one. Whilst compensatory remedies may be available for breach of fiduciary duty as seen in Item Software (UK) Ltd v Fassihi [2004] EWCA Civ 1244, restitutionary remedies may not be used for breaches of best interests.
It's good that you write about it.
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