Law Commission Consultation on Fiduciary Duties of Investment Intermediaries: A brief comment

Following on from my previous post I thought it worthwhile to note a few comments/thoughts I had on the Commission's Report on Fiduciary Duties of Investment Intermediaries.

On the whole the report gives a largely accurate portrayal of the law and is a helpful document. There are a few points that I would raise. The main point surrounds what is actually meant by contract first in determining the application of fiduciary duties.

The first point is between 3.33-3.40 in the report on duty-duty conflicts and modifying fiduciary duties. Certainly the position is correct that a fiduciary acting for two principals must obtain authorisation to do so. However, as I pointed out in my response and the Report accepts, this is not the end of the matter as the fiduciary must still comply with their other duties.

With modifying fiduciary duties at 3.37-3.40 the Report adopts a contract first approach, relying strongly on a privy council decision in Kelly v Cooper [1991] AC 205 and other Commenwealth decisions. It would perhaps have been worthwhile to assert English authorities for this proposition. Particularly since Hospital Products Ltd v United States Surgical Corporation (1984) 156 CLR 41 has received positive judicial treatment as has Kelly v Cooper. The proposition from these cases is that contract will shape the fiduciary relationship and the duties will accommodate themselves to the contract. Fiduciary duties cannot be superimposed to alter the contract. The conclusion reached was that where a term is included in the contract, whether express or implied, that allows a fiduciary to act for multiple principals then they are free to do so. In Kelly v Cooper this was in the context of estate agents as fiduciary.

These points, however, lack detail. There are issues not addressed. It is often stated to reason by analogy in the context of fiduciary duties is dangerous and it has recently been approved that implying such terms that allow an estate agent to act for multiple principals is not automatically applicable to other types of fiduciary. See Northampton v Richard Andrew Cowling [2014] EWHC 30 (QB) at [185]. Is the report arguing that such a term is implied in to investment intermediary contracts? If so, does it apply to all types of investment intermediaries? Also, approving through an implied term to allow a fiduciary to act for multiple principals, does this always mean the principal would be prevented from claiming a conflict of interest? There perhaps needs to be a bit more clarity on how duties may be modified by contract in distinguishing between approving conflicts and attempts to stop their application all together. There is a lot more consideration needed to reconcile Professor Kay's view that contract cannot override fiduciary duties and the Reports position that they can. (see 10.48-10.49 of the Report)

There remains the issue of when fiduciary duties arise. Discussed at 3.23 the Report gives acceptance to Edelman's view that the 'greater degree of trust, vulnerability, power and confidence reposed in the fiduciary, the more likely a reasonable person would have such an expectation' [to loyalty]. The Report at 3.24 sees this as a useful way to determine when the relationship arises. Unfortunately, it lacks precision and certainty. How much trust must be placed in one person until they are reasonably entitled to loyalty. This may lead to arbitrary court discretion without true consideration of why loyalty is imposed on an individual. This may have severe consequences either way since someone who owes loyalty must suspend self-interest. Without going in to detail myself here, the issue is not one of a sliding scale based on reasonableness but a binary approach to loyalty. The question that needs to be answered is did you or did you not undertake responsibility for the other person's interests at the expense of your own and anyone else's interests. I do not think, based on this alone, investment intermediaries are any better off in knowing if they owe fiduciary duties. However, chapter 10 of the Report does provide some more detailed insight but at 10.20 of the Report, for example, there is mention that it is possible fiduciary duties might be owed based on legitimate expectations in regards to actuaries. The use of the words 'possible' and 'might' emphasise the uncertainty such a test brings.

The next issue is the content of fiduciary duties from 3.25 (see also 10.43-10.47). The Report notes that not all fiduciaries owe the same fiduciary duties and some relationships may give rise to more onerous duties. However, the very next paragraph states that the distinguishing duty of a fiduciary is loyalty. This appears to be a stark contradiction. How can you owe different duties if the one duty is loyalty? How can you be more loyal than another fiduciary? You can't be a bit loyal. If loyalty is more onerous or different duties are owed in different circumstances the Report does not give one example to support this. If you are in a fiduciary relationship you are subject to the fully expanse of fiduciary jurisdiction. The confusion is mainly based on the notion that it is not fiduciaries owe different duties but they do not owe them in the same circumstances.

My final thought is that if fiduciary duties can be restricted by terms of a contract then this gives considerable power to the stronger party. This may lead to significant abuse and certainly more consideration is needed on this point. 

Fiduciary duties of investment intermediaries: Commission Report published

Today, the Law Commission published its report after consultation on fiduciary duties of investment intermediaries. The four documents published today as well as previous documents leading to the report can be found here. 

Law Commission Consultation on Fiduciary Duties of Investment Intermediaries with Hogan Lovells

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.

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.