When it was placed into administration on the morning of 15 September 2008, Lehman Brothers International (Europe) (in administration) ("LBIE") could account for approximately $2.16 billion of money in its segregated client accounts. This amount fell far short (by several billion dollars) of the amount which would later come to be claimed by the firm's clients. Although some of the shortfall was made up of money that had been passed to another subsidiary, LBIE was exposed as having manifestly failed to comply with client money regulations requiring the full segregation of client money.
This failure led to a series of litigation culminating in February 2012 when the Supreme Court ruled on principles for the designation and distribution of client money held by LBIE, bringing closure on a long running saga to determine how the money should be returned.
The outcome of the client money litigation was very important, not only for the parties involved who stood to gain or lose millions, but also for the financial services industry in the UK as a whole. The case did much to highlight weaknesses in the existing client money rules and spurred regulatory change in the area, a process which is still being carried out now with the updating of the Client Assets sourcebook rules ("CASS").
What is client money?
Along with the majority of relevant regulations in this case, the technical definition of client money is contained in chapter 7 of CASS ("CASS 7") - but for the purposes of this note client money can be understood to be money held by a firm regulated by the Financial Conduct Authority ("FCA") on behalf of a client, specifically for the purposes of investment business1. Examples of client money include money:
held pending investment; held in the course of settlement; or derived from client assets held in custody. CASS 7 - statutory trust, segregation and pooling
Under CASS 7, firms are required to segregate money received from clients in special accounts designed for that purpose, to make adequate arrangements to safeguard clients' rights over that money and not to use client money for its own purposes.
At the heart of the operation of CASS is the concept of a "statutory trust" under which all client money is held. The creation of a statutory trust means that client money is not a firm's property, rather it is held in a fiduciary capacity or by a firm as agent on behalf of the client.
Firms are permitted to deal with incoming client money using one of two approaches. Under the first, the "normal approach", firms must pay client money into trust status client bank accounts by the following business day. Under the second, the "alternative approach", client money may be paid into a firm's own accounts providing that a daily reconciliation of...