UK: Lehman Brothers (In Administration): The Long And Winding Road To Distribution

Last Updated: 14 June 2012
Article by Rita Sarkar

The UK Supreme Court's decision in Re Lehman Brothers International (Europe) (In Administration) caps the extensive litigation which developed in the aftermath of the collapse of Lehman Brothers International (Europe) (Lehman Brothers) almost four years ago.

It all began on 15 September 2008 when Lehman Brothers went into administration following what the Courts have referred to as its performance failures on 'a truly spectacular scale', foremost of which was the failure to protect its clients' monies.

As part of its business of providing a wide range of investment banking services and in common with other financial services institutions (firms), Lehman Brothers held a considerable amount of funds on behalf of its clients (Client Money). The Financial Services Authority (FSA), as the regulator of the UK financial services industry, implemented strict rules (FSA Rules) for the protection of Client Money with a view to ensuring that firms are prevented from using Client Money as their own working capital and also that, in an insolvency, Client Money would be protected from any claims by the creditors of the insolvent firm. Therefore, firms are obliged to hold Client Money, not as their own property but in a fiduciary capacity on behalf of their clients.

The key principle underpinning an effective fiduciary arrangement is that of segregation of Client Money. Segregation is a cornerstone of the FSA Rules - it requires firms to segregate Client Money from the firm's money (Firm Money) so that the former is held separately from the latter and, therefore, is readily identifiable. The FSA Rules allow two ways of achieving segregation of Client Money:

  • the firm immediately pays any Client Money into a separate Client Money Account - this is known as the 'normal approach'; or
  • the firm may initially pay any Client Money into its own bank account  (Firm Account) but if it does so, the firm would have to promptly thereafter - and on a daily basis - segregate Client Money into a separate Client Money Account - this is known as the 'alternative approach'.

The alternative approach allows firms the flexibility needed when dealing with complex investment services (eg those involving multiple investment products and multiple currencies) in which the normal approach would be unduly burdensome; however, this approach is subject  to authorisation by auditors which must  be provided to the FSA and the overriding consideration remains the protection of Client Money held by the firm. It is clear that, under  the alternative approach, there is a period of time during which Client Money will be mixed with Firm Money in the Firm Account.

Prior to going into Administration, Lehman Brothers was handling money in more than 50 currencies on behalf of more than 1,500 clients in different time zones. Therefore, it perhaps comes as no surprise that Lehman Brothers chose the alternative approach. However, what was surprising was the level of its failure to segregate vast sums received from or on behalf of a significant number of its clients - the Courts described this as a 'shocking underperformance'. This inevitably caused considerable difficulty to the Administrators in identifying funds for distribution to the clients.

The Administrators made several applications to the Courts for guidance on how to deal with the Client Money held by Lehman Brothers. The litigation commenced in the High Court, progressed to the Court of Appeal and ultimately reached the Supreme Court amidst sharply different views being expressed by the Judges. In view of the wide-ranging implications of any Court rulings in the matter, sufficient numbers of Lehman  Brothers' clients were joined in a representative capacity to ensure that the voices of affected clients would be heard and the FSA also participated in the litigation.

The 3 principal elements of the Supreme Court's decision are as follows:

  • Client Money is held on trust  for the client from the time of receipt by the firm;
  • in an insolvency, identifiable yet un-segregated Client Money in the Firm Account will be included in the funds for distribution to clients of the firm (separately from the general creditors of the firm) (Client Money Pool);
  • clients can participate in the Client Money Pool distribution on the basis of the amount of Client Money which should have been segregated at the date of insolvency (and not on the amount which had actually been segregated on that date).

Client Money is held on trust from the time of receipt

Under the UK's insolvency laws, mere segregation of Client Money, without the imposition of a trust, would not give adequate protection in the event of a firm's failure. Therefore, the FSA Rules provide that a firm receives and holds Client Money as trustee on behalf of the client.

The Supreme Court held that the trust on Client Money arises upon receipt of the money by the firm, not upon segregation. Otherwise, it could mean that the greater the level of performance failure in a firm (eg the Lehman Brothers' failure to segregate Client Money), the lesser the protection for their clients which would clearly be an unsatisfactory result.

Client Money pool includes identifiable, un-segregated funds in firm account

This issue involved the interpretation of specific FSA Rules which provide that in the event of an insolvency, Client Money held by a firm is treated as pooled (to form the Client Money Pool) for distribution to clients.

The Supreme Court held that the Client Money Pool consists of not only the Client Money segregated in the insolvent firm's Client Money Account, but also any identifiable Client Money in the Firm Account. Given that their purpose is to provide a high level of protection to all clients, it would defeat the objective of the FSA Rules if clients of firms adopting the alternative approach (such as Lehman Brothers) stand to receive lesser protection on the arbitrary basis of whether the firm had in fact segregated their funds into the Client Money Account.

Participation in the Client Money Pool distribution is based on segregation which should have occurred

The Supreme Court was asked to decide whether participation in the Client Money Pool distribution is based on the amount of Client Money which had actually been segregated at the date of insolvency ('the contributions basis') or the amount  which should have been segregated at that date ('the claims basis').

Echoing the other two elements of its decision, the Supreme Court held that the 'claims basis' was the correct mode of participation in the Client Money Pool distribution. Given that the starting point is that all Client Money is held on trust from the time of receipt by the firm (irrespective of segregation) and the purpose of the FSA Rules is to provide a high degree of protection to all clients whose  funds are held by the firm, it is axiomatic that the Client Money Pool distribution should be based on the amount which should have been segregated at the date of insolvency.

In practical terms, this means that clients whose funds had actually been segregated stand to receive a lesser return in the light of the Client Money Pool being widened to include those whose funds had not, in fact, been segregated. However, in the Supreme Court's view, 'there is nothing unrealistic in a scheme [in] which...all clients share in the common misfortune of the [firm's] failure'.

The failure of Lehman Brothers triggered a global recession, the effects of which continue to be felt today. Notwithstanding the staggering figures involved - the affiliates of the Lehman Brothers Group (of companies) alone advanced Client Money claims exceeding US$3 billion in aggregate - and the inevitable result  that there will now be further delays in making a distribution to clients of Lehman Brothers, the Supreme Court's decision leaves no room for doubt that safeguarding the funds of, and thus protecting, all clients of a firm is of paramount importance

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.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
In association with
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement

Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of www.mondaq.com

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.

Disclaimer

Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.

Registration

Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.

Cookies

A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.

Links

This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.

Mail-A-Friend

If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.

Security

This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at enquiries@mondaq.com.

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.