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Where Trust is Misplaced : Global Trader Europe

By

Vivien Tyrell & Peter Fidler

Edwards Angell Palmer & Dodge UK LLP

On 24 March 2009, Sir Andrew Park sitting as a High Court judge in the UK Companies Court

handed down his judgment in the case of Global Trader Europe Limited (Global Trader)1. The

case is highly significant both for the global financial services industry and for those having to

deal with the insolvency or near insolvency of financial institutions. The directors of this minor

player in the derivatives arena would not have known that their company's treatment of its

various types of clients and counterparties would become the focus of attention by the legions of

lawyers, bankers and accountants dealing with the largest financial group collapse the world had

ever seen: Lehman.

Sir Andrew Park's judgment is identified in a substantial number of the issues which the

administrators of Lehman Brothers International Europe (LBIE) have brought before the UK

court for determination. A directions hearing with preliminary matters takes place on 19 June.

The extent to which the findings in the Global Trader case are to be applied in LBIE will be

determined within the next few months. Whether some or all of the findings will be the subject

of appeals will be a question in the forefront of interested parties' thinking.

The Global Trader judgment is easy to read, a blessing for those having to grapple with the

complexities of the relationships between such financial products providers and their

counterparties and clients. The judgment gives a judicial interpretation of the application of the

UK client asset and money rules implemented under the Financial Services and Markets Act

2000 (the CASS Rules) where none has been given before. It is therefore essential reading for

those faced with advising clients on the interpretation of those Rules.

The facts and findings of Global Trader

Global Trader was a "broker" authorised by the FSA and went into administration in February

2008. It went into creditors' voluntary liquidation in June 2008. It had clients who wished to

enter into either or both of two kinds of financial transactions, contracts for differences and

spread bet trades. The term "broker" is in this context an Americanism as Global Trader was not

an agent for its clients; it entered into contracts with its clients as a principal. To hedge its own

positions, Global Trader entered into back to back transactions with other counterparties, but

those transactions are not relevant to the issues in this case.


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Before a change in the regulatory provisions which came into effect on 1 November 2007, some

of its clients were designated as private customers and others as intermediate customers. From 1

November 2007 the classification changed to retail clients and professional clients. The basis of

the two classifications was not the same but for the purposes of the case the Judge was able to

equate the private customers with retail clients and the intermediate customers with professionalclients and for simplicity we will only use the terms private and intermediate customers.

When Global Trader received payments from private customers (mostly margin payments), it

considered that it was required by FSA regulations to treat the money as trust money, to keep it

separate from its own moneys and keep it in one or more segregated accounts. It believed that it

was not obliged to segregate money received from intermediate customers but was entitled to

take such money into its own bank accounts and use it to meet its own expenditure, and that is

what it did. It was argued on behalf of the intermediate customers that Global Trader was not

entitled to treat such money in that manner and that such money should have been held in trust insegregated accounts in the same way as it treated monies received from private customers and

that this gave the intermediate customers concerned trust rights over that money.

When it went into administration it had around 2 million in segregated accounts for the private

customers. It was held that such monies were held on trust for those private customers, and for

no others.

There was a further amount of some 540,000 which Global Trader had instructed its bank to

transfer from one or more of its own accounts into a segregated account. Global Trader hadrealised that the segregated account held that amount less than it should have done, because

some money which should have been paid out of Global Trader's own funds was in fact paid out

of the segregated account. It therefore instructed its bank to transfer that sum from its own

account to the segregated account to make good the segregated account. It went into

administration on the same day as those instructions were given to the bank and the bank did not

comply with those instructions. If the bank had complied with the instructions that money would

have been held on trust for the private clients, subject, presumably, to any preference claim. The

private clients entitled to the segregated accounts claimed that the 540,000 should be treated in

the same way as the funds in the segregated accounts, but they were held to be purely unsecured

creditors, and not to have any trust rights, in relation to this sum.

As and when trades closed at a loss to Global Trader and profit to the client, Global Trader

became liable to the client for the amount of such profit. When such profits arose in favour of

private customers, the amount of the profit was paid into the segregated account. Because of its

mistaken belief that intermediate customers were not entitled to have their monies treated as

client monies, when such profits arose in their favour, the amount of the profit was not paid into

a segregated account. It was argued on behalf of such intermediate customers that a

corresponding amount of money in Global Trader's own accounts became money which it held

on their behalf and so became subject to the statutory trust in their favour. It was held that such


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clients did not have any trust rights in respect of such amounts and that their claim in respect of

such profits was an unsecured claim.

When money was paid to Global Trader by intermediate customers, Global Trader believed that

it was not client money and paid it into its own account. Although Global Trader was mistaken

in this belief and such money was trust money when received by Global Trader, it lost its

identity after payment into Global Trader's own account and the clients accordingly lost their

trust rights in respect of such monies.

Certain profits arose in favour of private customers after the appointment of the administrators. It

was argued on behalf of the private customers that they had trust rights in respect of such profits.

The Judge held that when Global Trader went into administration it, and the rights and

obligations between it and its clients, became subject to the insolvency regime and that the

private customers lost the protection of their segregated status in respect of credits arising afterthat date.

Money which was trust money when received by Global Trader has been described as losing its

identity once it was paid into Global Trader's own accounts. The possibility that the intermediate

customers might succeed in a tracing exercise was expressly left open. It is not known whether

they will attempt to do this. There would be significant hurdles. The account went into overdraft

from time to time.

It is understood that there will be no appeal in Global Trader.

Possible distinctions between Global Trader and LBIE

On a number of the issues described above the judge followed two earlier decisions (MacJordan2,

a building construction case relating to retention moneys, and BA Peters3, a boat builder where

deposits should have been paid into a client account) where the documentation required sums to

be held on trust. In both cases it was held that if the facts on the ground do not match the

documents, if the money which should have been held as trust money is not kept separate but is

mixed with the company's own funds, the money loses its status as trust money and the creditors

have purely an unsecured claim, subject to any tracing rights (which in those cases did not afford

any assistance). The fact that it is the FSA regulatory regime with regard to client money which

required certain money to be held as trust money does not override the ordinary principles of

trust law where the rules were not complied with. It does not have the effect of making money

client money when it has not in fact been kept separate from the firm's own money, i.e. where the

facts on the ground do not correspond with the regulatory regime.

There are certain immediate distinctions between the facts of Global Trader and those of LBIE:

1. The CASS Rules identify two approaches to dealing with client money and assets to betaken by a company subject to them: the Normal Approach 4, which is what was applied in


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the case of Global Trader and The Alternative Approach5which was mainly applied by

LBIE. The Normal Approach requires all client monies immediately upon receipt to be

paid into the client's segregated account. The Alternative Approach allows client monies

to be swept into the company's general account (i.e. to be mixed with the company's own

funds) and then later to be reconciled and allocated to the client segregated account. Aquestion for determination is, therefore, whether this regulatory sweeping and mixing of

funds followed by the later allocation dispels the Global Trader conclusion that funds

which should have been segregated, but were not, cannot be included in the clients'

segregated account unless traced. If the company's approved processes are applied, does

that not obviate the need for tracing and amount to a statutory substitute?

2. Questions relating to the UK's Financial Collateral Arrangements (No.2) Regulations

2003 were not dealt with in the Global Trader's judgment. These regulations were

implemented following EU Directive 2002/47/EC and provide special conditions to avoiddislocation in the financial markets by the insolvency of one or more of its participants.

Under Regulation 12 contractual close-out netting arrangements are allowed to take

effect despite the insolvency of one of the parties to the relevant transaction. If close-out

provisions are allowed to take effect on insolvency under Regulation 12, it is surely

arguable that termination amounts arising on close-out should be treated as profits or

losses generated prior to the administration and profits arising to clients who are "in the

money" by this means should therefore be segregated to the client account.

There will be great interest generated by the LBIE directions hearing (and any subsequent

appeals). There is one further thought: the FSA has announced that it intends, in the course of its

monitoring visits to authorised firms, to focus on compliance with the CASS Rules. It will be

interesting to see what beneficial effect this will have in future on observance of these Rules. It

is, perhaps, fair comment to say that inadequate record keeping, non-compliance with the client

money rules (or other trust regimes) and eventual insolvency are not unknown bedfellows.


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1 Global Trader Europe Ltd (In Lquidation), Re [2009] EWHC (Ch)2 MacJordan Construction Ltd v Brookmount Erostin Ltd [1992] BCLC 3503 Moriarty v Various Customers of BA Peter Plc [2008] EWCA Civ 1604; [2009] BPIR 2484 CASS 7.4.14G and 7.4.17G5 CASS 7.4.14G and 7.4.19G

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