Following the collapse of Lehman Brothers in 2008, the investment bank Special Administration Regime (SAR) was introduced to deal with failed investment banks or other firms that deal with client assets.
Investment management firm Strand Capital Limited, operated mainly as a discretionary fund manager. It applied to court to formally initiate insolvency proceedings under the SAR. As part of the application, clarification was sought as to whether the special administrators, once appointed, would be able to comply with the inherently contradictory obligation to undertake a reconciliation of client assets 'immediately' on their appointment in accordance with regulation 10H of the Investment Bank Special Administration Regulations 2011. Regulation 10H requires that: "immediately after being appointed as the administrator[s], the administrator[s] must carry out a client money reconciliation…".
The High Court said that special administrators should be appointed for Strand, and considered the trickier question of the interpretation of regulation 10H.
The requirement to carry out a reconciliation arises because, on appointment, the special administrators take control of two separate types of asset classes: i) firm money and assets, which belong to the firm and can be used to pay-off creditors in line with normal insolvency rules; and ii) client money and client assets which are strictly held for customers on their behalf in accordance with the Financial Conduct Authority (FCA) Client Assets Sourcebook (CASS) rules, which fall outside the normal insolvency regime and must be returned to each customer. Assets cannot be returned, however, until the special administrators complete the entire reconciliation exercise.
Ordinarily, under the CASS rules companies carry out regular reconciliations so the information is readily available to appointed special administrators. But when special administrators were appointed, Strand had no employees and had undertaken no regulated activities in over a month. Access to its critical IT infrastructure had been removed. The vast majority of company data was kept electronically on a cloud, rather than in paper form, and access had been blocked, rendering data virtually inaccessible to the special administrators or Strand's caretaker director. On top of that, there had been potential issues relating to the CASS adherence of Strand's operations prior to the special administration application, which required an historic review.
Strand had over 3,000 customers with £100m of assets under management, which would be subject to the reconciliation exercise.
When considering the complexities and the scale of the reconciliation task required, the judge said: "Quite clearly reconciliation, even if all of the records were immediately available, would be a process which would have to be undertaken over time and would not be something which could be done in a second, in a scintilla, in a moment."
After considering common law principles in relation to impossibility and in the context that the 2011 Regs require return of the client assets 'as soon as is reasonably practicable', the judge ruled that the very task with which Regulation 10H is concerned is one which is extremely important and urgent, but one that is necessarily concerned with "a process to be completed rather than something which occurs at a pinpoint in time".
The word 'immediately' must, therefore, be read as referring to the commencement of the process rather than the completion of it. The special administrators must take all necessary steps to achieve a reconciliation with "all due expedition, with all reasonable speed, or without delay".
The decision provides important and sensible guidance for special administrators, whilst reminding them of the urgency and importance of the reconciliation task.
The appointed joint special administrators have since reported in an update to clients that they are continuing to work with the FCA and the Financial Services Compensation Scheme to complete the reconciliation exercise and return client assets to customers.
Jen McCormick is a restructuring expert at Pinsent Masons, the law firm behind Out-Law.com