Select Committee on Finance and General Affairs debate -
Wednesday, 3 May 1995

SECTION 51.

Question proposed: "That section 51 stand part of the Bill."

Mr. Cullen

This is an important issue, but in terms of protection, compensation funds and so on, the Bill does not specify the level of fund, nor does it specify who will put it in place, who will contribute to it, what proportion it should be, whether it should grow annually and so on.

With regard to the protection of investors and given the Barings Bank debacle, which is not specifically applicable here, lessons can be learned. Many investors have been burned on bad investments in recent years, in many cases through following advertisements, bad advice or through incompetence in some companies. There should be a requirement for investor compensation, and I am pleased to see that is provided for. However, the provision is weak in that the specifications and fund levels are not included. Given this, who will ensure that it operates effectively?

Mr. J. Higgins

At present, there is a scheme of compensation operated by the Exchange. It is not very generous as the maximum amount is £16,000 if there is default and liability accrues as a result. This has not been included in the Bill because a separate investment compensation directive is coming from Brussels. In due course it will have to be legislated for so it will be included under separate legislation.

Mr. McCormack

Surely the section only obliges a firm to inform clients as to whether there is a compensation fund? Does it require that there be a compensation fund?

Mr. J. Higgins

Not yet, but there is de facto one in operation at present, and £16,000 is the compensatory amount.

Mr. Cullen

The sum of £16,000 is derisory in comparison with what could be required to be a suitable compensation fund. Why does the Bill not make reference to the forthcoming new directive? Has the directive been passed?

Mr. J. Higgins

The directive has not been passed. It has not been finalised yet by the EU.

Mr. Cullen

It will, therefore, be the subject of separate legislation.

Mr. J. Higgins

That is correct, and it will redress the Deputy's concern in this matter.

Question put and agreed to.

NEW SECTION.

Acting Chairman

Amendment No. 82 is consequential on amendment No. 61 and both may be discussed together. Acceptance of amendment No. 61 involves the deletion of section 52.

Mr. J. Higgins

It is not a totally new section. It is a re-elaboration of section 52, with some additions to it.

Mr. Cullen

Does the amendment replace section 52?

Mr. J. Higgins

It supersedes it. I Move amendment No. 61:

In page 52, before section 52, to insert the following new section:

"52.—(1) The Bank may, from time to time, impose requirements or may approve of rules in the rules of an approved stock exchange, or both, with respect to clients' money and clients' investment instruments, and such requirements or rules (in this Act referred to as ‘client money requirements') may include conditions under which member firms may hold money or investment instruments, or both, for clients.

(2) Without prejudice to the generality of subsection (1) of this section, client money requirements may include requirements or rules in relation to—

(a) the category or categories of member firm to which such requirements or rules apply;

(b) the type or types of accounts to be opened and kept by a member firm arising from its business as a member firm;

(c) the rights, duties and responsibilities of a member firm in relation to money and investment instruments received, held, controlled or paid by it arising from its business as a member firm, including the lodgement to and withdrawal from a client account of client money and client investment instruments;

(d) the acknowledgements or statements to be issued by a member firm in respect of client money and client investment instruments received, held, controlled or paid by it arising from its business as a member firm;

(e) the circumstances in which money other than client money may be paid into accounts containing client money and the circumstances in which, and the persons to whom, money held in such accounts may be paid out;

(f) the safekeeping of client investment instruments and documents of title relating to such investment instruments;

(g) the use of nominee companies by member firms;

(h) client entitlements, including the treatment or retention of interest, income or profit arising from any client money or investment instrument or documents of title in such cases as may be specified;

(i) the extent to which such client money requirements apply to associated and related undertakings.

(3) Without prejudice to the generality of subsection (1) of this section and notwithstanding the provisions of subsection (2) of this section, an authorised member firm shall—

(a) designate all accounts containing money entrusted to it or received by it for or on account of a client a ‘Section 52 account' in all financial records maintained by it,

(b) hold client money in an account or accounts with an institution or type of institution as may be specified by the Bank from time to time,

(c) keep at an office or offices within the State such books and records (including books of accounts) in respect of client money and client investment instruments as may be specified from time to time by the Bank and notify the Bank of the address of every office at which any such books or records are kept,

(d) ensure that any books or records required under this section are examined, at such intervals as may be specified by the Bank, by an auditor who shall report to the Bank and state whether in his opinion the provisions of the client money requirements imposed or rules approved under subsection (1) of this section and the provisions of this subsection have been complied with and on such other matters as may be specified in the client money requirements imposed under subsection (1) of this section,

and an authorised member firm which does not comply with the provisions of paragraph (a) or (c) of this subsection or which does not ensure that books and records kept in respect of client money and client investment instruments are examined by an auditor at such intervals as shall be specified by the Bank or which knowingly holds client money in an account or accounts with an institution other than an institution or type of institution as may be specified by the bank from time to time, shall be guilty of an offence.

(4) (a) The Bank may specify different books and records for the purposes of this section and in relation to different member firms or different classes of member firms.

(b) Books and records to be kept pursuant to this section shall be—

(i) in addition to any books or other records to be kept by or under any other section of this Act or any other enactment, and

(ii) retained for at least such period as the Bank may specify.

(5) No liquidator, receiver, administrator, examiner or creditor of a member firm shall have or obtain any recourse or right against a client's money or a client's investment instruments or a client's documents of title relating to such investment instruments received, held, controlled or paid on behalf of the client until all proper claims of the client or of the client's heirs, successors or assigns against the client's money or the client's investment instruments or documents of title have been satisfied in full.

(6) A person with which an account is kept in pursuance of client money requirements or rules under this section shall not incur any liability as constructive trustee where money is wrongfully paid from the account unless the person permits the payment with knowledge that the payment is wrongful or having deliberately failed to make inquiries in circumstances in which a reasonable and honest person would have done so.

(7) It shall be an offence for a director, officer or employee of a member firm or any of them to misappropriate fraudulently any money or investment instruments held, controlled or paid on behalf of a client by that member firm.".

This is almost a complete new section and it is very important, dealing as it does with the protection of client money and investment instruments. The section has been examined thoroughly in the interval since second stage and the amendments I propose are intended to strengthen and improve the section. They do this in three ways, first, in subsection (2), by expanding and clarifying the power of the Central Bank to impose requirements on member firms with regard to client money and investment instruments, second, in subsection (3), by clarifying and amending the offence provisions and third, in subsection (3), by inserting an additional offence. The number of amendments involved is not large and the most straightforward way to proceed is to replace the section.

The changes in subsection (1) are merely drafting points, while subsection (2) specifies the powers of the Central Bank to impose requirements with regard to client money and investment instruments. Protection of client money and investment instruments is a complex area. To give the committee an illustration, the detailed rules which apply to stock broking firms in the UK run to about 70 pages. It was always clear that section 52 would have to be underpinned by detailed requirements imposed by the Central Bank and that these would have to be regularly amended and adjusted as the need emerged. Breaches of requirements can be investigated by a committee established under section 65.

If the committee determines that a member firm has breached a requirement, it can require it to pay a sum of up to £500,000 to the bank. This power to impose requirements is central to ensuring that member firms handle client money and investment instruments properly. I propose, therefore, to extend significantly the list in subsection 2 of items about which the Central Bank can impose requirments in relation to client money and instruments. The new subsection, therefore, essentially retains the old subsection 2 but adds, for example, power to impose requirements about the rights, duties and responsibilities of member firms in relation to client money and instruments and about acknowledgements and statements to be issued by member firms when client money is received or paid out. The bank will also have power to make such requirements apply to associated or related undertakings of a member firm.

Turning to subsection 3, I propose to remove the provision in paragraph (a), that an authorised member firm must, on pain of an offence, "hold money and investment instruments of clients on trust", and the provision in paragraph (b), that client money must be held in an account whose title contains the word "client". The purpose of these provisions was to fulfil a requirement in the Investment Services Directive that money and assets of clients be protected particularly in the event of a member firm's insolvency. Instead, the new subsection 5 will deal directly with this situation by providing explicitly——

Acting Chairman

We are due to leave this room at 3.50 p.m. and it is past that now. There is a suggestion that we might come back at 6 o'clock for one hour and, if there is agreement, I suggest we might come back then.

Mr. Cullen

As the only Opposition Deputy present, I am quite happy to come back at 6 o'clock.

Acting Chairman

Is that agreed? Agreed. We will be back here at 6 o'clock.

Sitting suspended at 3.54 p.m. and resumed at 6 p.m.

Acting Chairman

Before we adjourned we were dealing with section 52, amendment No. 61 which is linked with amendment No. 82.

Mr. J. Higgins

This section deals with the regulations in relation to client money. I will repeat some of what I said prior to the adjournment.

I propose to remove the provision in subsection (3) (a) that an authorised member firm must, on pain of an offence, hold money and investment instruments of clients on trust. The provision in paragraph (b) that client money must be held in an account the title of which contains the word "client", will also be removed. The purpose of these provisions was to fulfil a requirement in the Investment Services Directive that money and assets of clients be protected, particularly in the event of a member firm's insolvency. The new subsection (5) will deal directly with this situation. It explicitly provides that no liquidator, receiver, administrator, examiner or creditor of a member firm will have any rights over client money or investment instruments, held by the member firm, until all proper claims of the client against the money or assets have been satisfied.

Subsection (2) (e) of the amended draft makes it clear that the Central Bank can impose requirements on member firms that set out the circumstances in which money, other than client money, can be paid into an account containing client money. This ensures that the Central Bank can control the handling of client money accounts by members firms. Such requirements can be enforced through the determination committee provided for under section 65 of the Bill. It will still be an offence for a director, an officer or employee of a member to misappropriate client money or investments. This is provided for under the existing subsection (5) which is being retained as the new subsection (70) It will also be an offence under the new subsection (3) (a) which obliges member firms to designate all accounts containing client money as section 52 accounts. This is to ensure that a member firm's records in relation to client money are properly kept and facilitate inspection of them by the Central Bank, auditors and inspectors. Paragraph (c) of this subsection provides that the Centeral Bank can specify the books and records relating to client money and assets which a member firm must keep. Non-compliance with this subsection by a member firm will be an offence. Subject to minor drafting amendments paragraph (d) will remain unchanged.

Subsection (4) is new and gives the Central Bank power to specify books and records which member firms must keep in respect of client money and assets. It reflects the provisions of sections 15 and 27 which govern the keeping of accounts by stock exchanges and member firms. Subsection (5), as I already stated, makes it explicit that liquidators etc., cannot have any recourse to client funds unless the client's claims have already been met. Subsections (6) and (7) have new numbers but are otherwise unchanged.

With these amendments we have aimed to provide the best possible protection for clients by giving the Central Bank power to impose requirements in a wide range of areas which it can change flexibly as needed. Under section 55 of the Bill the Central Bank will have effective power to enforce these requirements. I commend the new section to the committee. Amendment No. 82 is consequent on amendment No. 61. It involves the changing of a subsection's number in consequence of the new section being accepted.

Mr. Cullen

I welcome the new section. I have not heard any complaints about it. The protection of clients' money is extremely important. Do I understand subsection (5) to mean that if a company goes into liquidation the first recourse on a claim would belong to the clients, whose money the company held, before all other assets could be divided?

Mr. J. Higgins

That is the position.

Mr. Cullen

The supreme position is that the client has the right of receiving his money back before any other liabilities are paid.

Mr. J. Higgins

Yes. Before anyone else.

Mr. McCormack

What is the procedure when the remaining funds do not meet the client's requirements?

Mr. J. Higgins

In that situation there is a shortfall to be made up and there is a compensation provision to cover this. I explained previously that compensation provisions will be legislated for separately. There is a separate directive in preparation which has not yet been produced by the authorities in Brussels. When that arrives it will be dealt with by way of separate legislation.

Amendment agreed to.

Acting Chairman

Acceptance of this amendment involves the deletion of section 52 of the Bill. Is that agreed? Agreed.

Section 52 deleted.