Background: The increase in investment products and asset classes coupled with the growth in specialist investment advisers is a strong market trend, yet the law on "investment duties" remains largely historic and static. The legal framework for pension trustees (Pensions Act 1995, supplemented by the 2005 Investment Regulations and Court cases from the 19th century onwards) is arguably falling behind modern developments.

Reform

The Government commissioned report by Professor Kay, published in 2012, suggested the Law Commission should review the concept of "fiduciary duty" in relation to investment matters.  This was, as Professor Kay put it, "To address the uncertainties and misunderstandings on the part of the trustees and their advisors".

Law Commission's Report

The Law Commission has recently published its Consultation (October 2013) and seeks responses by 22 February 2014.  If readers have comments on trustees' investment duties we would be pleased to hear them.  Alternatively, comments can be sent direct to the Law Commission: fiduciary.duties@lawcommission.gsi.gov.uk.  The Law Commission's full Report is available on their website, as is their pre-prepared response form: http://lawcommission.justice.gov.uk/consultations/fiduciary_duties.htm. 

What is a "fiduciary "?

The Commission's definition of a fiduciary is:

"Someone who is obliged to act in the interests of others" the core duty being the obligation of loyalty.

Besides considering the legal meaning of fiduciary, the Law Commission review how far existing law requires those operating in the investment market to act in the best long-term interests of their clients and beneficiaries.  Operators in the market include investment advisers, fund managers and custodians.

The Law Commission conclude there is legal uncertainty over how far fiduciary duties apply to persons in the investment chain other than trustees. They suggest that regulation may need strengthening in some areas particularly for investment intermediaries and custodians.

Of particular concern are the legal duties/regulation of investment in the context of contract (non-trust) based defined contribution arrangements.  Contract based DC funds will increase vastly over the next few years due to auto-enrolment.

Practical issues for DB schemes

There are particular challenges for trustees of DB schemes evaluating whether to implement "fiduciary investment management". 

Historically, trustees have kept a close handle on scheme investments.  Typically, they directly appoint fund managers and base their strategic investment decision on the advice of their directly appointed  investment adviser.  In this context, the investment adviser advises and does not itself take investment decisions. 

In contrast, where a fiduciary investment manager is appointed, apart from setting the overarching investment strategy trustees cede considerable control over investment decisions to the fiduciary manager.  The contractual terms between the parties – trustees, fiduciary manager, fund managers – are therefore of particular importance to the trustees.  Some issues concerning fiduciary management:

  •  Although the law recognises the freedom of parties to contract as they see fit, in investment matters this is overridden by the duty of fiduciaries/fund managers to take reasonable care; this is consistent with section 33 Pensions Act 1995. Under section 33 trustees cannot exclude their duty of care in relation to investment matters;
  • The extent to which fiduciary duties should apply to fiduciary investment managers (e.g. in their dealings on behalf of the trustee with fund managers) remains to be worked out; and
  • If issues arise, whether trustees have sufficient direct rights of recourse against the fiduciary manager and/or against fund managers selected and monitored by the fiduciary manager is not always clear.

Conclusion on fiduciary management

As trustee boards grapple with the complexity of investment decisions and products, fiduciary investment management can seem a compelling solution.  However the legal framework for 'outsourcing' of the trustee investment function needs careful attention.  Bearing in mind trustees cannot exclude their duty of care in respect of investment matters (section 33 mentioned above), outsourcing the Trustee's  investment function is arguably not analogous to the outsourcing of other trustee functions such as scheme administration.

The Law Commission's review may lead to a tightening of the law and/or regulation of investment duties as applied to fiduciary investment management. This  may help scheme trustees to implement  more secure legal arrangements with their fiduciary investment manager.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.