Custody of investments -- new rules; Solicitors' Investment Business (Custody) Amendment Rules 1998

The Council of the Law Society has made some amendments to the Solicitors' Investment Business Rules 1995 which will require firms to introduce some new procedures and to undertake additional record keeping in relation to the custody of investments.

The amendments will come into effect on 31 March 1998 and will apply to all firms which are authorised by the Law Society to conduct inve stment business.It has been necessary to make these amendments to the rules in order to take account of:-- amendments to the Financial Services Act 1986 which extended the scope of the Act to cover the custody of investments (SI 1996/2958); and-- the 'Standards for the Custody of Customers' Investments' which were issued by the Securities and Investments Board (now known as The Financial Services Authority).The amendment rules introduce a new appendix 8 which applies where a firm provides 'custody services' to a client.

'Custody services' are defined in the amendment rules as:".

.

.

safeguarding and administering or arranging for the safeguarding and administration of assets belonging to another person where those assets consist of or include investments, or may consist of or include investments, so far as those services fall within paragraph 13A of schedule 1 to the Act and are not excluded by Part III thereof;'It is important to note that such services involve both safeguarding and administering assets belonging to another; the one activity without the other would not fall within the definition.

This means that a firm will not be providing custody services if it merely holds an investment for safekeeping but does not administer those investments by, for example, collecting and dealing with dividends or carrying out corporate actions such as proxy voting.The existing rule on the safekeeping of documents of title (rule 17) has been replaced with a new rule which requires firms to comply with appendix 8 in relation to the provision of custody services.

However, firms are not required to comply with appendix 8 where the firm or a partner, employee or officer of the firm is a personal representative or a trustee provided that the firm is not separately remunerated for the custody services.

This exception takes account of the exemption in paragraph 22(2A) of schedule 1 to the Financial Services Act 1986 but is wider as it applies to the activities of the firm rather than merely the activities of the individual trustee.The new appendix 8 sets out detailed requirements relating to the custody of investments.

The main areas covered by the appendix are as follows:-- registration of title to clients' investments;-- the safekeeping of clients' assets;-- the use of nominees;-- clarification of the respective responsibilities of the firm and the client in relation to the custody of investments;-- the appointment of third party custodians;-- records of title documents;-- annual reconciliation procedures; and-- annual statements to clients.Paragraph 10 of appendix 8 provides exemptions from some of the requirements where the custody services are incidental to other non-Discrete Investment Business (DIB) services, for example, where they are incidental to the administration of an estate.

In such circumstances, the majority of appendix 8 will still apply but the firm will not be required to write to the client setting out the respective responsibilities of the firm and the client (paragraph 4(2)) nor will it be required to send the client an annual statement (paragraph 9(1)).

Similar exemptions to those set out above apply where the firm or a partner, employee, or officer of the firm is acting as the donee of any registered enduring power of attorney or is a receiver appointed by the Court of Protection or is acting as the donee of a trustee power of attorney.

However, in the case of a donee of a trustee power of attorney, the exemption only relieves the firm of the obligation to send the client an annual statement, the remainder of appendix 8, including paragraph 4(2), still applies.The full text of the amendment rules is set out below.

Further guidance may be obtained from Alison Matthews of the Law Society's professional ethics division or Jackie Corcoran of the monitoring and investigation unit; telephone: 0171 242 1222.SOLICITORS' INVESTMENT BUSINESS (CUSTODY) AMENDMENT RULES 1998(Rules dated 14 January 1998 made by the Council of the Law Society with the concurrence of the Master of the Rolls under section 31 of the Solicitors' Act 1974, Schedule 15, paragraph 6 of the Financial Services Act 1986 and section 9 of the Administration of Justice Act 1985.)With effect from 31 March 1998, the Solicitors' Investment Business Rules 1995 shall be amended as follows:(1) In the guidance note to rule 16(5) replace '17(4)' with 'appendix 8, paragraph 7.'(2) Rule 17 shall be replaced by a new rule as follows:'17.

CUSTODY OF CLIENTS' ASSETS(1) Where a firm provides custody services to a client, it shall comply with appendix 8.(2) This rule shall not apply to the provision of custody services where the firm or a partner, employee or officer of the firm is a personal representative or a trustee (other than a bare trustee) provided that the firm is not separately remunerated for the custody services.'(3) In rule 32 add the following definitions:(a) after the definition of 'contingent liability transaction' insert:'custody services means safeguarding and administering or arranging for the safeguarding and administration of assets belonging to another person where those assets consist of or include investments, or may consist of or include investments, so far as those services fall within paragraph 13A of Schedule 1 to the Act and are not excluded by Part III thereof;Guidance note1.

A firm will not be providing custody services to a client if it merely holds an investment for safekeeping by, for example, holding a share certificate in its strong room, but does not administer the investment.2.

'Administration' in this context includes (but the list is not exhaustive) any one of the following services:(a) collecting and dealing with dividends and other income associated with the assets;(b) carrying out corporate actions such as proxy voting (including exercising rights conferred by an investment on behalf of the beneficial owner);(c) operating nominee accounts, including pooled accounts, which identify each client's assets in a ledger;(d) settling transactions in investments;(e) operating through depositaries, including dematerialised means of ownership;(f) cash processing associated with clients' assets;(g) maintaining accounts with clearing houses;(h) appointing and operating through sub-custodians in other jurisdictions.'(b) after the definition of 'EIS share' insert: 'eligible custodian means:(a) a person authorised under the Act to provide custody services within paragraph 13A of Schedule 1;(b) an EC credit institution whose authorisation includes the provision of custody services;(c) An European Investment Firm whose authorisation includes the provision of custody services; or(d) a body corporate which maintains its head office outside the UK and which the firm is satisfied is a person who(i) provides custody services, and(ii) in the provision of custody services is either regulated or supervised by a regulatory body or government agency, or is subject to independent and regular review by auditors with qualifications prescribed by law or by such a body or agency;'(c) after the definition of 'ov erseas professional' insert:'own nominee means a corporate nominee which is a recognised body and is either controlled by the firm or whose directors are accustomed to an act in accordance with the directions or instructions of the firm'.(d) after the definition of 'these rules' insert:'title documents means a client's document of title, or a certificate evidencing a client's title to an investment (including a life policy or pension contract), or a record on a register of investments held in uncertificated form which is accepted as evidence of a client's title to that investment;'(4) In Appendix 3, paragraph 10 shall be replaced by the following paragraph:'Details of title documents held by the firm or its own nominee at date of statement.'(5) After Appendix 7 add a new appendix as follows:'APPENDIX 8CUSTODY RULES (RULE 17)1.

TITLE TO CLIENTS' INVESTMENTS(1) A firm shall ensure that evidence of title to a client's investments is maintained in such a way that those investments are separately identifiable from investments belonging to the firm, whether title to the client's investments passes by registration or delivery.(2) Where a client's investments are registrable they must be properly registered in the client's name or, with the client's consent, in the name of a nominee.(3) For the purposes of paragraph 1(2) above, the nominee shall be the firm's own nominee unless the client, for the client's own convenience, instructs the firm in writing to register the client's investments in the name of another nominee.-- Guidance noteClients' investments would not be properly registered if they were registered in the same name as that used for investments belonging to the firm, its own nominee or a third party custodian unless they are held in a separate account designated solely for the use of clients' investments.2.

SAFEKEEPING OF CLIENTS' ASSETS(1) A firm shall not release the client's investments (or assets), or title documents, into the control or possession of another person without the client's authority.(2) A firm shall not:(a) use a client's investments for its own account;(b) pool (or commingle) the investments of different clients except where those clients have been notified of the implications for them and have given their clear and express consent in writing;(c) engage in stocklending of clients' pooled (or commingled) investments except where each of the clients whose investments are pooled (or commingled) has given clear and express consent in writing to their use for stocklending;(d) use for the account of one client the investments of any other client except pursuant to paragraph 2(2)(b) above or where both clients have given their clear and express consent in writing.3.

SECURITY AND INTEGRITY OF CUSTODY ARRANGEMENTSA firm shall have security arrangements, including appropriate systems and controls, which are adequate to safeguard client's title documents.-- Guidance note1.

Arrangements including custody facilities and systems for the transfer of assets, must be appropriate to the value and risk of loss of the clients' assets.2.

Data processing facilities and records relating to investments must be appropriately safeguarded.4.

NOMINEES AND RESPONSIBILITIES IN RELATION TO CUSTODY SERVICES(1) Where a firm uses its own nominee to hold title to client's investments, the firm shall:(a) ensure that its own nominee acts, in relation to each title document, only in accordance with the firm's instructions; and(b) accept responsibility to its clients for the acts and omissio ns of its own nominee.(2) Where a firm provides custody services, it shall clarify in writing with its clients the custody services which are to be provided and the respective responsibilities of the firm and the client in relation to:(a) arrangements for recording, registering and separately identifying title to the client's investments;(b) procedures for giving and receiving clear instructions;(c) provision of periodic statements or statements of title documents;(d) any liens or other security interest held by the firm over the client's investments;(e) the use of its own nominee, in accordance with paragraph 4(1);(f) losses of the client's investments; and(g) the appointment of sub-custodians, the review, as appropriate, of their performance and extent, if any, of the firm's responsibility for losses caused by their fraud, wilful default or negligence.-- Guidance noteSee exemption in paragraph 10 below.(3) A firm shall not disclaim responsibility for losses of investments due to fraud, wilful default or negligence arising from it or its own nominee's activities.(4) A firm shall (where appropriate) notify its clients that there may be different settlement, legal and regulatory requirements in overseas jurisdictions from those applying in the United Kingdom, together with different practices for the separate identification of clients' investments.5.

APPOINTMENT OF A THIRD PARTY CUSTODIAN(1) A firm shall use due skill, care and diligence (including undertaking an appropriate risk assessment) in selecting and appointing a third party custodian.(2) A firm shall not appoint, or recommend to its client, a third party custodian who is not an eligible custodian, unless the firm has disclosed this fact to the client.(3) If a firm appoints a third party custodian:(a) services shall be supplied under a written agreement between the firm and the custodian which covers, where relevant, the matters set out in paragraphs 4(2) and 4(3) of this appendix;(b) the firm shall require the custodian to:(i) have appropriate arrangements for the safekeeping of clients' assets;(ii) distinguish, within its own records, the firm's clients' title documents from those of the firm;(iii) hold the firm's and the firm's clients' title documents separate from those of the custodian; and(c) the firm shall take reasonable steps to review the custodian's performance under the agreement.(4) Where a firm appoints a third party custodian to hold clients' title documents overseas, the firm shall comply with paragraph 5(3) above, where it is reasonable to do so, unless the client agrees otherwise.-- Guidance noteThe firm's own nominee is not a third party custodian.6.

CLIENT APPOINTING ITS OWN CUSTODIANWhere a firm's client appoints its own custodian, the firm shall agree in writing any necessary consequential arrangements (for example, for settlement) with the client's custodian.7.

RECORD OF TITLE DOCUMENTS(1) The firm shall keep a record of all title documents held by the firm or its own nominee specifying:(a) the client's name;(b) the nature, amount and, where appropriate, nominal value of the title documents;(c) where the title documents are kept;(d) the date on which each title document came into or left the custody of the firm or its own nominee; and(e) whether the title documents have been lent or held as collateral.(2) Where a firm appoints a third party custodian, the firm shall keep a record of the clients' investments which are subject to the arrangements.(3) The records kept under this paragra ph shall be separate from the client files and title documents and kept for at least 6 years from the date when the firm, its own nominee or the third party custodian cases to hold such documents.8.

CHECKING TITLE DOCUMENTS(1) A firm shall at least once a year reconcile its records, which are held under paragraph 7 above, with the title documents held by the firm, its own nominee or a third party custodian.(2) Where any difference arises, the firm shall investigate the discrepancy and make good, or provide the equivalent for, any shortfall for which it is responsible as soon as reasonably practicable.9.

REPORTING TO CLIENTS(1) A firm shall send the client a statement at least once a year, made up to a date not more than one month previously, specifying the title documents held for the client by the firm or its own nominee and identifying any which have been lent or which are held as collateral.-- Guidance note1.

Where the firm provides the client with a periodic statement under rule 25 of these rules, it will not be necessary for the firm to send a separate statement of title documents held by the firm or its own nominee as the appropriate information will be contained in the periodic statement.2.

See exemption in paragraph 10 below.(2) Where a firm has appointed a third party custodian, the firm shall ensure that the client receives a statement at least once a year of any title documents held for the client by the custodian.10.

EXEMPTION(1) Paragraphs 4(2) and 9(1) above shall not apply where the activity is incidental or where the firm or a partner, employee or officer of the firm is acting as the donee of any registered enduring power of attorney or is a receiver appointed by the Court of Protection.(2) Paragraph 9(1) above shall not apply where the firm or a partner, employee or officer of the firm is acting as the donee of a trustee power of attorney.-- Guidance noteFor the purposes of this paragraph the activity is the provision of custody services.