Law Commission Consultation Paper No 215 FIDUCIARY DUTIES OF INVESTMENT INTERMEDIARIES A Consultation Paper ii THE LAW COMMISSION – HOW WE CONSULT About the Law Commission: The Law Commission was set up by section 1 of the Law Commissions Act 1965 for the purpose of promoting the reform of the law. The Law Commissioners are: The Rt Hon Lord Justice Lloyd Jones, Chairman, Professor Elizabeth Cooke, David Hertzell and Professor David Ormerod QC. The Chief Executive is Elaine Lorimer. Frances Patterson QC, the Commissioner for Public Law, left the Law Commission at the end of September 2013, but participated in discussions relating to this Consultation Paper. Topic of this consultation: Evaluating the law of fiduciary duties as it applies to investment intermediaries. Geographical scope: United Kingdom. Availability of materials: The consultation paper and summary are available at: http://lawcommission.justice.gov.uk/consultations/fiduciary_duties.htm. Duration of the consultation: 22 October 2013 to 22 January 2014. Comments may be sent: By email to [email protected] OR Before 4 November 2013, by post to Folarin Akinbami, Law Commission, Steel House, 11 Tothill Street, London SW1H 9LJ. Tel: 0203 334 0200 After 4 November 2013, by post to Folarin Akinbami, Law Commission, 1st Floor, Tower, 52 Queen Anne’s Gate, London SW1H 9AG. Tel: 0203 334 0200 After the consultation: After analysis of the responses, we will present a final report to the Government by June 2014. Consultation principles: The Law Commission follows the Cabinet Office Consultation Principles, which provide guidance on type and scale of consultation, duration, timing, accessibility and transparency. The Principles are available at: https://update.cabinetoffice.gov.uk/resource-library/consultation-principles-guidance. Information provided to the Law Commission We may publish or disclose information you provide us in response to this consultation, including personal information. For example, we may publish an extract of your response in Law Commission publications, or publish the response in its entirety. We may also be required to disclose the information, such as in accordance with the Freedom of Information Act 2000. If you want information that you provide to be treated as confidential please contact us first, but we cannot give an assurance that confidentiality can be maintained in all circumstances. An automatic disclaimer generated by your IT system will not be regarded as binding on the Law Commission. The Law Commission will process your personal data in accordance with the Data Protection Act 1998. iii iv THE LAW COMMISSION CONSULTATION PAPER NO 215 FIDUCIARY DUTIES OF INVESTMENT INTERMEDIARIES CONTENTS Paragraph Page GLOSSARY xi PART 1: INTRODUCTION CHAPTER 1 Introduction The Kay Review 1.3 3 Other reviews 1.11 5 This project 1.17 6 The meanings of “fiduciary duty” 1.20 7 Who invests in UK equities? 1.25 8 The role of pension funds 1.29 10 Other trusts 1.36 11 Long-term trends in equity markets 1.38 11 Previous Law Commission reports 1.45 14 The structure of this consultation paper 1.46 15 Thanks and acknowledgments 1.60 17 v Paragraph Page PART 2: MARKET PRACTICE CHAPTER 2 The pensions landscape Types of occupational pension scheme 2.4 21 The changing nature of occupational pensions 2.24 25 Private personal pensions 2.28 27 Pension schemes and equities 2.29 28 Pension scheme regulation: a dual system 2.32 29 Pension challenges 2.42 31 From surplus to deficit: the problems of DB schemes 2.44 31 Workplace DC schemes: do they offer value for money? 2.59 35 A comparison with Australia 2.68 36 Conclusion 2.70 37 CHAPTER 3 The investment chain A DB pension investment chain 3.4 38 Buying and owning shares: how the process works 3.45 47 A trust-based DC investment chain 3.65 51 A contract-based DC investment chain 3.72 52 Case study examples 3.81 54 Conclusion 3.94 55 PART 3: CURRENT LAW CHAPTER 4 Current law: introduction Four sources of law 4.1 59 The structure of this Part 4.11 61 vi Paragraph Page Fiduciary and other duties 4.12 61 Company directors’ duties 4.15 62 Avenues of redress 4.20 63 CHAPTER 5 Fiduciary duties Who is subject to equitable fiduciary duties? 5.3 65 What are the equitable fiduciary duties? 5.15 68 Modifying fiduciary duties through consent 5.33 73 Remedies for breach of fiduciary duty 5.44 76 Conclusion 5.55 79 CHAPTER 6 Duties on the exercise of a power and duties of care Duties connected to the exercise of a power 6.2 80 Duties of care: general principles 6.33 89 Trustees’ duties of care 6.47 92 Trustees’ exemption clauses 6.68 97 Conclusion 6.77 99 CHAPTER 7 Legislation governing pension trustees Pensions Act 1995 7.4 100 Pensions Act 2004 7.21 104 Overlap with the Trustee Act 2000 7.28 106 Conclusion 7.41 109 CHAPTER 8 Financial Conduct Authority rules The Financial Conduct Authority Handbook 8.3 111 vii Paragraph Page European Directives 8.7 112 Who is subject to the rules? 8.9 112 What do the rules require? 8.27 117 Enforcement 8.71 128 Conclusion 8.77 130 PART 4: ANALYSIS CHAPTER 9 Applying the law to the investment chain: our terms of reference Our terms of reference 9.2 133 Pension trustees’ investment strategies 9.5 134 Others in the investment chain 9.9 134 Workplace defined contribution pensions: problems in practice 9.13 135 The meaning of fiduciary duties 9.15 135 CHAPTER 10 Pension trustees’ duties to invest in the “best interests” of others Cowan v Scargill 10.5 136 Other relevant cases 10.13 139 The duties on pension trustees 10.23 141 The statement of investment principles (SIP) 10.33 143 Stewardship 10.36 144 Factors raised with us 10.41 145 1. Wider factors aimed at securing financial returns 10.43 145 2. Macroeconomic factors 10.67 152 3. Quality of life factors 10.79 154 4. Ethical factors 10.98 158 viii Paragraph Page 5. The views of the beneficiaries 10.117 162 Investment managers to whom powers are delegated 10.122 164 How far do these principles apply to other trusts? 10.131 166 Conclusion 10.135 166 CHAPTER 11 Duties on others in the investment chain: the courts’ general approach General principles 11.12 170 A summary of recent cases 11.56 179 Claims brought by unsophisticated clients 11.59 180 Cases brought by sophisticated clients 11.77 184 Conclusion 11.91 186 CHAPTER 12 Duties on others in the investment chain: specific examples A three stage process 12.4 189 Contract-based pension schemes 12.7 190 Other intermediaries in the investment chain 12.23 193 Investment consultants 12.24 193 Brokers 12.33 195 Investment managers 12.41 197 Collective investment schemes 12.51 199 Custodians 12.57 201 Conclusion 12.67 203 CHAPTER 13 Workplace defined contribution pensions: problems in practice The current workplace pension market 13.5 204 The regulation of DC pensions 13.10 206 ix Paragraph Page Problems with workplace DC pensions 13.29 212 Dual regulation 13.61 221 A comparison with Australia 13.69 223 Conclusion 13.78 225 PART 5: CONCLUSIONS AND QUESTIONS CHAPTER 14 Conclusions and questions Pension trustees’ duties to act in the best interests of beneficiaries 14.3 229 Fiduciary-type duties in contract-based pension schemes 14.37 237 Workplace DC pension schemes: do fiduciary duties work in practice? 14.45 239 Fiduciary duties in the rest of the investment chain 14.54 242 CHAPTER 15 List of questions 249 APPENDIX A: TERMS OF REFERENCE 251 APPENDIX B: CONSUMER REDRESS SCHEMES 253 APPENDIX C: FIDUCIARY LAW IN AUSTRALIA: A PAPER BY CLAYTON UTZ 259 APPENDIX D: LIST OF CONSULTEES 280 x GLOSSARY Active investment An approach to investment which involves the continuous buying and selling of investments. An active investment manager will typically seek to outperform an investment benchmark. Actuary A professional who specialises in statistics and risk who gives advice on a pension scheme’s assets and liabilities. They will predict movements in the scheme, such as deaths, retirements and withdrawals, and estimate the costs of providing the benefits due and accruing in the future. Annuity A fixed sum of money paid to individuals each year upon retirement. This may be for an agreed period or for the rest of the individual’s life. The amount of money paid will depend on the individual’s total accumulated pension savings. Asset manager See “investment manager”. Association of British Insurers (ABI) A trade association representing the majority of UK insurers. Automatic enrolment Also known as “auto-enrolment”. A new legislative requirement introduced by the Pensions Act 2008 which requires all employers (beginning with the largest) to automatically enrol their qualifying employees into a qualifying pension scheme. Best of sector Also known as “best of class”. Companies that perform best in their industry sector against specified indicators. Broker An individual or organisation that acts as an intermediary between a buyer and seller, usually in return for the payment of a commission. Bundled scheme A pension scheme where the pension provider also administers the scheme. COBS Conduct of Business Sourcebook. The section of the Financial Conduct Authority’s Handbook that deals with business standards. xi Contract-based scheme These may be work-based or individual. In work-based contract-based schemes, the employer appoints a pension provider, usually an insurance company, to administer their pension scheme. The employees enter into a contract directly with the pension provider, although the employer may make arrangements to collect and pay contributions.