Fiduciary Duties and Regulatory Rules: LAW LAW

. .
FIDUCIARY DUTIES AND

REGULATORY RULES
LAW COMMISSION
LAW COM No 236
The Law Commission
(LAW COM N o 236)

REGULATORY RULES
REPORT ON A REFERENCE UNDER SECTION

3(1)(e) OF THE LAW COMMISSIONS ACT 1965
Presented to Parliament by the Lord High Chancellor

by Command of Her Majesty
December 1995
L O N D O N : HMSO
E14.10 net
- .
Cm 3049
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 Commissioners are:
The Honourable Mr Justice Brooke, Chairman

Professor Andrew Burrows
Miss Diana Faber
M r Charles Harpum
M r Stephen Silber QC
The Secretary of the Law Commission is Mr Michael Sayers and its offices are at
Conquest House, 37-38 John Street, Theobalds Road, London, W C l N 2BQ.
The terms of this report were agreed on 1 November 1995.
11
THE LAW COMMISSION
FIDUCIARY DUTIES AND REGULATORY RULES

CONTENTS
Paragraph Page
SECTION A: INTRODUCTION
PART I: - INTRODUCTION AND SUMMARY
OF MAIN RECOMMENDATIONS
Terms of reference 1.1

Background 1.2
Consultation paper 1.8
Subsequent developments 1.11
The consultation 1.12
The Oxford seminar 1.13
Recommendations 1.14
Structure of the report 1.16
Acknowledgements 1.17
SECTION B: LEGAL AND REGULATORY

DEVELOPMENTS
PART 11: INTRODUCTION AND SUMMARY
OF PROVISIONAL VIEWS ON
ACQUISITION OF KNOWLEDGE,
CONTRACTUAL TECHNIQUES
AND CHINESE WALLS
Introduction 2.1 8
Acquisition of knowledge by a firm 2.3 9
Contractual techniques 2.7 10
Trade custom and rules of practice 2.8 10
Exclusion clauses 2.1 1 11
Disclosure and consent 2.13 11
Chinese walls 2.16 13
PART 111: LEGAL DEVELOPMENTS - CASES

Introduction 3.1 14
El Ajou 3.2 14
Meridian 3.15 18
Kelly 3.24 21
Express contractual terms 3.29 23
Implied terms 3.30 23
Trade custom 3.36 27
Clark Boyce 3.37 27
Glynwill 3.41 29
...
111
Paragraph Page
PART IV LEGAL DEVELOPMENTS -

DIRECTIVES, STATUTES AND
REGULATIONS
Introduction 4.1 31
Directive on Unfair Terms in Consumer Contracts 4.2 31
Investment Services Directive 4.9 35
Criminal Justice Act 1993 4.12 36
PART V REGULATORY DEVELOPMENTS

Introduction 5.1 37
The Large-Report 5.2 37
The Personal Investment Authority 5.5 38
Rules on disclosure of commission 5.6 38
SECTION C: THE ISSUES ARISING FROM

CONSULTATION
PART VI: SUMMARY OF PROVISIONAL
CONCLUSIONS AND
CONSULTATION ISSUES
Introduction 6.1 40
Provisional conclusions and consultation issues 6.2 40
PART VII: MODIFICATION OF THE NORMAL

INCIDENTS OF A FIDUCIARY
RELATIONSHIP BY EXCLUSION
CLAUSES, DISCLOSURE AND
CONSENT, AND CHINESE WALLS
(Question 1)
Consultation issue 7.1 42
Summary of respondents’ views 7.2 42
Exclusion clauses 7.3 43
Disclosure and consent 7.4 43
As a matter of private law 7.12 48
As a matter of public law 7.19 50
Conclusion 7.31 56
PART VIII: CROSSING CHINESE WALLS

(Question 2)
The necessity of “crossing” Chinese walls 8.2 58
Taking an analyst out of circulation 8.3 59
Conclusion 8.6 60
PART IX: OVERLOOKING CHINESE WALLS,

STOP LISTS AND WATCH .LISTS
(Question 3)
iv
Paragraph Page
Summary of respondents’ views 9.2 61

Conclusion 9.4 62
PART X: SHOULD FIDUCIARY LAW TAKE

ACCOUNT OF REGULATORY
RULES? (Question 4)
Summary of respondents’ views 10.2 63 I
I
PART XI: - LEGISLATIVE PROVISION THAT
THE COURTS MUST TAKE
ACCOUNT OF REASONABLE
REGULATORY RULES (Question 5)
The need for legislation 11.2 64
No reform 11.3 65
“Safe harbour’’ type solutions 11.9 67
Conclusion on the main issue 11.13 69
Subsidiary issues 11.14 70
Legislative guidance as to what
constitutes reasonableness 11.15 71
Burden of proof 11.16 71
The time when reasonableness
should be determined 11.17 71
PART XII: OTHER LEGISLATIVE

POSSIBILITIES (Question 6)
Codification of fiduciary duties 12.2 72
Legitimation of generalised advanced consents 12.3 72
Reform of the rules on attribution of knowledge 12.4 73
Pooling of knowledge 12.5 73
Use of confidential information 12.8 74
Groups of companies 12.10 75
Recent legal developments 12.11 76
Views on reform 12.14 78
Exculpation of fiduciaries who the court considers have acted
honestly and reasonably 12.18 79
SECTION D: RECOMMENDATIONS
PART XIII: INTRODUCTION TO FINAL
RECOMMENDATIONS 13.1 80
PART XIV RECONSIDERATION OF OUR MAIN

PROVISIONAL CONCLUSION
Introduction 14.1 81
Reasons for considering that fiduciary law should take account
of reasonable regulatory rules 14.2 81
Does this policy represent the law? 14.6 82
Impact of contractual techniques 14.9 84
V
Paragraph Page
Examination of our provisional recommendation 14.13 86

Revised formulation of our provisional recommendation 14.15 87
Conclusion 14.20 89
PART XV: EXCULPATORY PROVISION

General 15.1 90
Guidelines 15.3 91
Scope 15.4 91
Relation to existing legislation 15.7 93
Particular features of section 61 15.8 94
Conclusion 15.12 96
PART XVI: CHINESE WALLS

Introduction 16.1 97
Doubts about the efficacy of Chinese walls 16.3 97
The need for Chinese walls 16.4 98
Resolving the doubt 16.7 99
Definition of Chinese walls 16.8 100
Degree of protection 16.12 102
To whom should it apply? 16.17 105
PART XVII: OTHER OPTIONS FOR REFORM

Reform of the rules on attribution of knowledge 17.1 108
Codification of fiduciary duties 17.2 108
Legitimation of generalised advanced consents 17.3 108
PART XVIII: SUMMARY OF

RECOMMENDATIONS 18.1 109
APPENDIX A: Draft Financial Services (Amendment) Bill with

Explanatory Notes 111
APPENDIX B: Relevant extracts from the Financial Services Act

1986 116
APPENDIX C: Core Rule 36 118
APPENDIX D: Relevant extracts from the Trustee Act 1925 119
APPENDIX E: List of persons and organisations who commented

on Consultation Paper No 124 120
APPENDIX F: List of those who attended the O5ford Seminar 124
APPENDIX G: List of others who have assisted with the project 125
GLOSSARY OF ABBREVIATIONS
In this report the following terms and expressions are used for the sake of brevity:
“BMBA” British Merchant Banking and Securities Houses

Association (now the London Investment Banking
Association)
‘Company Law Committee” The Law Society’s Standing Committee on Company Law
“DTI” Department of Trade and Industry
‘~FIMBRAy’ Financial Intermediaries, Managers and Brokers Regulatory

Association
“FSA” Financial Services Act 1986
ccIMRO’’ Investment Management Regulatory Organisation Limited
“ISD” Investment Services Directive, Council Directive

93/22/EEC (OJ L141, 11.6.93, p 27)
((the Large Report” the report by Mr Andrew Large called Financial Services
Regulation - Making the Two Tier System Work (May 1993)
LAUTRO’’ Life Assurance and Unit Trust Regulatory Organisation
“PIA” Personal Investment Authority
C C W B Y Y
Recognised Professional Body, ie a body which regulates
the practice of a profession and is recognised by the
Secretary of State under FSA, section 18
‘‘SFA” The Securities and Futures Authority Limited
The Securities and Investments Board
Self-Regulating Organisation recognised by the Secretary

of State under FSA, section 10
‘‘UCTA” Unfair Contract Terms Act 1977
‘‘UTCCD’’ Unfair Terms in Consumer Contracts Directive, Council

Directive 93/13/EEC (OJ L95, 21.4.93, p 29)
I
Cases I
“El Ajou” El Ajou v Dollar Land Holdings plc [1994] 2 All ER 685;
the decision of Millett J at first instance is reported at
[1993] 3 All ER 717 . .
“Meridian’’ Meridian Global Funds Management Asia Ltd v The Securities

Commission [1995] 2 AC 500
vii
“Kelly” Kelly v Cooper [ 1 9931 AC 205
“Clark Boyce ’’ Clark Boyce v Mouat [1994] 1 AC 428
“Glynwill” Glynwill Investments NV v Thornson McKinnon Futures

Ltd 13 February 1992 (unreported, Tuckey QC)
“Target Holdings’’ Target Holdings Ltd v Redferns [19951 3 WLR 352
...
Vlll
THE LAW COMMISSION
(Report on a reference to the Law Commission under Section 3(l)(e) of
the Law Commissions Act 1965)

REGULATORY RULES
To the Right Honourable the Lord Mackay of Clashfern, Lord High Chancellor of Great Britain
SECTION A
INTRODUCTION
PART 1
INTRODUCTION AND SUMMARY OF
MAIN RECOMMENDATIONS
Terms of reference
1.1 In April 1990 a reference was made to the Law Commission by the Minister for
Corporate Affairs in the following terms:
Certain professional and business activities are subject to public law regulation
by statutory and self-regulatory control. The Law Commission is to consider the
effect of such controls on the fiduciary and analogous duties of those carrying on
such activities, and to make recommendations. The inquiry will consider
examples from differing areas of activity but will be with particular reference to
financial services.
A parallel reference was made to the Scottish Law Commission.
Background
1.2 Situations in which professionals and businesses appear to owe conflicting duties to
different customers or in which there is a conflict between their own interests and
those of their customers are not new. However, the potential for such conflicts
increased as a result of the changes to the structure of the financial markets in the
mid-l980s, in particular the abolition of the Stock Exchange’s single capacity
requirement and the development of financial conglomerates offering a wide range
of services.
1.3 Our legal system primarily deals with such conflicts by treating the relationship
between the provider and recipient of such services as giving rise to fiduciary duties
on the part of the provider and conferring on &e recipient rights of action for
breach of the obligations imposed on the provider. Broadly speaking, a fiduciary
relationship is one in which a person undertakes to act on behalf of or for the
benefit of another, often as an intermediary with a discretion or power which affects
the interests of the other who depends on the fiduciary for information and advice.
1
1.4 The exact scope of the fiduciary’s obligations and the consequences of breach vary
according to the particular circumstances but the duties may conveniently be
summarised in the following basic rules:
(i) the “no conflict” rule A fiduciary must not place himself in a position
where his own interest conflicts with that of his customer, the beneficiary.
There must be a “real sensible possibility of conflict”;’
(ii) the ‘‘no profit” rule A fiduciary must not profit from his position at the
j
,
expense of his customer, the beneficiary;
(iii) the undivided loyalty rule A fiduciary owes undivided loyalty to his
customer, the beneficiary, not to place himself in a position where his duty
towards one customer conflicts with a duty that he owes to another customer.
A consequence of this duty is that a fiduciary must make available to a
customer all the information that is relevant to the customer’s affairs;2
(iv) the duty of confidentiality A fiduciary must only use information obtained
in confidence from his customer, the beneficiary, for the benefit of the
customer and must not use it for his own advantage, or for the benefit of any
other person.
1.5 Conflicts of interest and duty which could breach these obligations are most
common in financial services conglomerates because of the range of services they
provide, the composition of their customer base, and the different capacities in
which they conduct business. Problems arise in particular because, even if there is
functional segregation within the firm, knowledge possessed in one part of a single
corporate entity or partnership is treated in law as known to all parts of that entity
(the attribution of knowledge rule). Even where the conglomerate is not a single
corporate entity problems may arise where, as is often the case, some directors sit
on the boards of both the parent and a subsidiary company.
1.6 Examples of the types of conflict that can arise include dealing off one’s book or ,
buying on one’s own account, matching orders (“agency cross”), buying from a
customer and selling immediately to another customer (“riskless principal”
transactions), dealing in property in which the customer has an interest, preferential
or discriminatory treatment in, for example, the allocation of investment
’ Boardman ZJ Phipps [1967] 2 AC 46, 124, per Lord Upjohn.
Although there are limits on the obligation to use all relevant information; see paras 3.26,
3.3 5 below.
2
opportunities and failure to use all the information which the attribution of
knowledge rule deems to be available to a firm.3
1.7 The Financial Services Act 1986 introduced a new system for the regulation of firms
providing financial services. At the time of its enactment there was considerable
discussion of the relationship between the new regulatory system and the fiduciary
obligations described above. It was concern over the possible mismatch between the
duties imposed on fiduciaries at common law and in equity and the requirements
of the regulatory system introduced by the FSA which led this matter to be referred
to the Law Commission. However, although the report looks principally at the
financial services industry the terms of reference include all areas subject to statutory
and other forms of public law regulation.
Consultation paper
1.8 We published a consultation paper in May 1992.4 Our provisional conclusion was
that although instances where regulatory rules require firms to act in a manner which
would breach their fiduciary duties are rare, there are many instances where
regulatory rules permit, either expressly or impliedly, a lower standard of conduct
than that required by fiduciary law. We identified the following main areas of
potential mismatch between fiduciary obligations and regulatory rules:5
(i) disclosure of commission (including ccsofiyycommission) and other

remuneration;6
(ii) relaxation of the “no profit” rule;7
(iii) the operation of Chinese walls.*
For an explanation of these and other types of conflict which can arise, see Consultation
Paper No 124, para 2.4.12.
Fiduciary Duties and Regulatory Rules, Consultation Paper No 124.
Consultation Paper No 124, para 1.13.
For example, under “soft commission” arrangements a brokerldealer provides goods or

services to a fund manager in return for a guarantee that the manager will provide it with a
specified minimum amount of business. These arrangements give rise to conflicts between
the manager’s interests and those of its customers and the disclosure contemplated by the
IMRO and SFA rules (see IMRO Rule 1.7, SFA Rule 5-8) may fall short of that required
by common law and equity in relation to certain types of customer. See paras 2.13-2.15
below.
’ For example, the regulatory rules envisage that when a broker receives instructions from a
client to purchase stock it may purchase it from a market maker within its own
organisation or it may sell off its own book (eg SIB Core Conduct of Business Rules 2,
24). This could constitute a breach of the “no profit” rule.
A number of regulatory rules authorise or require f m s to put in place mechanisms for

preventing the flow of information between different parts of their business (eg SIB Core
Rule 36, SFA Rule 5-3, IMRO Chap I Rule 4.2). Prima facie, these are inconsistent with
the obligation owed by f m s to make available to their customers all the relevant
3
1.9 In the consultation paper we examined how this potential mismatch was, or could
be, resolved as the law stood. We considered three particular aspects to this.
(i) First, we looked at contractual techniquesg for avoiding potential breaches of

duty. We considered:
(a) whether regulatory rules and market practices could be incorporated

into contracts as trade customs;
(b) how far exclusion clauses could modify rights against fiduciaries; and
(c) whether it was possible or practicable to obtain sufficiently informed

consent by advanced disclosure in contracts to modify or displace the
fiduciary's duties.
(ii) Secondly, we looked at structural techniques for managing conflicts and in

particular the use of Chinese walls.
(iii) Thirdly, we looked at the public law dimension and considered how far the
regulatory system could be taken to have modified the common law and
equitable duties.
1.10 We concluded, provisionally, that the contractual and structural methods could not
safely be relied on in all cases but that a court would probably take into account
reasonable regulatory rules in determining the content of the fiduciary obligation.
Nevertheless, given the uncertainty on this latter point, we inclined to the view that
there should be legislation to resolve the position.
Subsequent developments
1.11 Since the publication of the consultation paper there have been a number of legal
and regulatory developments." The case of Kelly v Cooper'' has been of particular
importance. It examined the scope of fiduciary duties and the impact of express and
implied terms on those duties. It confirmed that where a fiduciary relationship arises
out of a contract, a clearly worded duty defining or exclusion clause will
circumscribe the extent of the fiduciary duties owed to the other party. There have
information in their possession.
These were said to be arrived at by the agreement of the parties. See Consultation Paper
No 124, para 3.1.1.
lo
For a detailed discussion of these developments, see Parts 111-Vbelow.
c)
'I
[1993] AC 205. See paras 3.24-3.36 below.
4
also been significant changes to the regulatory structure as a result of the
implementation of the Large Report, which was published in May 1993.”
The consultation
1.12 104 individuals and organisations responded to the consultation paper. The
responses were fairly evenly split between members of the legal profession (judges,
barristers, solicitors, academics and representative bodies) and those in the
commercial field (including banks, financial institutions, accountants, representative
and regulatory bodies). A list of respondents appears at Appendix E. The responses
revealed a substantial degree of concern about our provisional conclusions on the
effectiveness of contractual and structural techniques in avoiding and modifymg a
firm’s fiduciary duties to its customers although only a minority of those disagreeing
with the provisional conclusions felt that reform was in fact unnecessary. Following
the case of Kelly, however, a number of consultees who had previously favoured
reform indicated that they were now more confident that the use of contractual
techniques would avoid any problems and indeed some indicated that they no
longer considered reform to be necessary. The responses to the consultation paper
confirmed that problems arising from mismatch between regulatory rules and
fiduciary duties outside the financial services area were rare.
The Oxford seminar

1.13 In November 1993 together with The Securities and Investments Board (“the SIB”)
we held a seminar at Merton College, Oxford to assess the impact of the recent legal
and regulatory developments and to consider what options for reform were realistic
in the light of these developments and the responses which we had received on
consultation. This seminar was attended by representatives of the Treasury, the SIB,
The Law Society’s Standing Committee on Company Law (“the Company Law
Committee”), the British Merchant Banking and Securities Houses Association
(now the London Investment Banking Association) (“the BMBA”) and the Bank of
England. A list of those present appears at Appendix E It proved particularly useful
in enabling us to identify the common ground between the different parties with an
interest in the financial services sector. We have continued to discuss developments
with representatives of the organisations present at the Oxford seminar and many
others have also made valuable contributions to this project. They are listed in
Appendix G.
Recommendations
1.14 In the light of the responses to our consultation paper, and the legal and regulatory
developments since its publication, we have decided not to proceed with our
provisional recommendation that there should be legislation requiring a court to
take account of reasonable regulatory rules in determining the content of a fiduciary
’* For a description of this report, see paras 5.2-5.4 below.
5
0b1igation.l~ We have also decided not to recommend, in this report, the
introduction of an exculpatory provision for fiduciaries along the lines of section 6 1
of the Trustee Act 1925, which was one of the other options for reform canvassed
in our consultation paper. l4
1.15 However, we do recommend that there should be legislation to clarify the effect of I
Chinese walls, which are widely used by firms operating in the financial services
sphere to manage or avoid conflicts of interest and duty. We propose that the effect
of section 48(2)(h) of the Financial Services Act 1986 should be clarified so as to
give statutory
-
protection to a firm which operates an established Chinese wall
arrangement which complies with rules made by the SIB under that subsection. The
firm should be protected from liability where:
(i) information is withheld from a customer (or is not made available for the
customer’s use) pursuant to the Chinese wall arrangement;
(ii) a firm places itself in a position where its own interest on one side of the
Chinese wall conflicts with a duty owed to the customer of a department on
the other side of the Chinese wall and as a result of the Chinese wall neither
department is aware of the conflict; or
(iii) a firm owes conflicting duties to the customers of different departments on

different sides of the Chinese wall, and as result of the Chinese wall neither
department is aware of the ~0nflict.I~
Structure of the report

1.16 In Section B (Parts 11-V) of this report we consider the legal and regulatory
developments which have taken place since the date of publication of the
consultation paper and examine how they affect our provisional conclusions. We
take the opportunity in this section to summarise our provisional views, expressed
in the consultation paper, on the issue of acquisition of knowledge by a firm and on
the effectiveness of contractual techniques and Chinese walls (as a matter of private
law) l 6 in dealing with the potential mismatch between regulatory rules and fiduciary
l3 See Part XIV below.

l4
See Consultation Paper No 124, para 6.28. See P a h XV below.
l5 See Part XVI below.

l6
The discussion on Chinese walls involves consideration of the position as a matter of
private law and public law. The summary in Section B.concentrates on the private law
position as it is in this respect that there have been relevant legal developments. A
summary of our provisional views on the effectiveness of Chinese walls as a matter of
public law is contained in Section C where we consider respondents’ views on the relevant
issues.
6
d ~ t i e s .Section
'~ C (Parts VI-XII) considers the issues arising from consultation and
respondents' views on the impact of recent developments. Our final conclusions and
recommendations for reform are set out in Section D (Parts XIII-XVIII). Our
recommendations are summarised in the final part of that section (Part XVIII).
Acknowledgements
1.17 We are grateful to all those who commented on our consultation paper and to all
those who generously assisted us in subsequent correspondence and discussions. We
are also grateful to Professor Caroline Bradley, of the University of Miami, who gave
us valuable assistance with the preparation of the consultation paper. We would like
to express our particular thanks to Professor D D Prentice of the University of
Oxford who acted as our consultant throughout this project.
17
A summary of our provisional views on the general impact of the regulatory system on
common law and equitable duties as a matter of public law is included in Section D where
we set out our final conclusions and recommendations.
7
SECTION B
LEGAL AND REGULATORY
DEVELOPMENTS
PART I1
INTRODUCTION AND SUMMARY OF
PROVISIONAL VIEWS ON ACQUISITION
OF KNOWLEDGE, CONTRACTUAL
TECHNIQUES AND CHINESE WALLS
Introduction
2.1 There have been a number of legal and regulatory developments since the date of
publication of the consultation paper. In this section of the report we examine these
developments and assess their impact on our provisional conclusions. In Part I11 we
consider developments in the case law and examine the cases of EZAjou, Meridian,
KeZZy, Clark Boyce, and GZynwiZZ. In Part IV we deal with new directives, statutes and
regulations and in particular the Directive on Unfair Terms in Consumer
Contracts,’ the Investment Services Directive,2 and Part V of the Criminal Justice
Act 1993. In Part V we consider the regulatory developments arising from the Large
Report, the recognition of the Personal Investment Authority (“the PIA”), and the
changes to the rules on disclosure of commi~sion.~
2.2 Before turning to these legal and regulatory developments we summarise, in the
remainder of this part, the provisional views we expressed in the consultation paper
on the issues to which these developments relate. We consider in turn: fist, the
acquisition of knowledge by a firm; secondly, the extent to which what were termed
“contractual techniquesyy4can resolve conflicts of interest and duty, or conflicts
between the duties owed to two customers, so as to avoid a mismatch between
fiduciary obligations and what is required or permitted by regulatory rules; and
thirdly, the effectiveness of Chinese walls (as a matter of private law)5 as a means
of eliminating or minimising conflicts.6
’ Council Directive 93/13/EEC (OJ L95, 21.4.93, p 29).
Council Directive 93/22/EEC (OJ L141, 11.6.93, p 27).

’ The Financial Services (Conduct of Business) (Product and Commission Disclosure)
Rules 1994.
See para 1.9, n 9 above.
A summary of our provisional views on the effectiveness of Chinese walls as a matter of

public law is set out in paras 7.19-7.30 below.
Our provisional views on the impact, as a matter of public law, of regulatory rules on the
common law and equitable rights and obligations of those subject to them and their
customers are summarised in Part XIV. The consultation paper also considered the
effectiveness in legal and practical terms of policies of enforced separation (section 4.2),
the placing of specific prohibitions on particular types of acute conflict (section 4.3) and
independence policies (section 4.4).
8
Acquisition of knowledge by a firm7
2.3 In the consultation paper we said that there were two different means by which
knowledge could be acquired by a company.8 The first was to attribute directly to
the company the knowledge possessed by one of its officers or agents. There were
two broad approaches to this.’ One was the “functional” approach which involved
determining the purpose of a finding of knowledge on the part of the company and
from this “tailoring to the purpose in hand the net of human persons whose
knowledge will be ascribed to the company”. lo The other sought to identify who was
the “brain or nerve centre” of the company and attributed the knowledge of that
person to the company.l 1
2.4 The second means by which knowledge could be acquired by a company was under
standard principles of agency. We said that a company, as principal, would usually
be treated as possessing all the knowledge that is possessed by its officers and agents
which it was their responsibility to receive on behalf of the company and to
communicate to it. This meant that as regards any particular act or transaction the
I
company would be deemed to know the information acquired by its agents or
officers within the scope of their authority in connection with that act or
transaction. l 2
2.5 We said that a company would only be treated as having “forgotten” a piece of I
I
relevant information in exceptional circumstances. l3 We also stated that any matter I
known by any part of the company would be treated as known by all parts of the
~ o m p a n y .However,
’~ as companies are separate legal entities, knowledge possessed I
I
by one company which was part of a group would not be attributed to another
company in the same group.15 But we also said that the knowledge acquired by a 1
person when acting as a director of one company within a group could be attributed
to another company within the group if the director was under an obligation to
communicate the information to that other company.’6
Consultation Paper No 124, section 2.3. This expression is used to include partnerships
and companies.
Consultation Paper No 124, para 2.3.2.
Zbid, para 2.3.3.

lo
Wedderbum, “When does a Corporation Forget?” (1984) 47 MLR 345, 345.
I’
Zbid, at p 346. See now, however, paras 3.15-3.23. ‘
l3 Zbid, para 2.3.5.

- .
l4 Zbid, paras 2.3.6-2.3.7.
l5 Zbid, para 2.3.8.
Ibid, para 2.3.9.
I
2.6 So far as partnerships are concerned, we said that notice to one partner of any
matter relating to the affairs of the partnership would normally be imputed to the
other partners, although a number of cases appeared to qualify the breadth of this
rule where a firm had established arrangements to prevent knowledge from being
communicated from one partner to others within the firm.17
Contractual techniques
2.7 The three contractual techniques considered in the consultation paper were first,
trade custom and rules of practice; second, exclusion clauses; and third, disclosure
and consent.
Trade custom and rules of practice"

2.8 In the consultation paper we explained that a course of conduct might constitute a
trade custom if four conditions were satisfied. The first was that there was a course
of conduct; the second, that the course of conduct was certain and uniform; the
third that it was notorious; and the last that it was intended to be legally binding,
rather than being followed merely as a matter of convenience or commercial
exigency.l9
2.9 We said that, in general, there would be little difficulty in proving that the rules of
regulatory bodies satisfied the factual requirements of trade customs." However,
once it had been established that a regulatory rule fulfilled the requirements of a
trade custom, it would only be incorporated into the contract if it was reasonable.21
A custom which modified a firm's fiduciary duty would usually be held
unreasonable and would not, therefore, bind the customer in the absence of his fully
informed consent.22However, we suggested that there was a possibility that a trade
custom which permitted a fiduciary to act in a position of conflict might be held
reasonable if the custom provided adequate protection for the customer's interests,
for example, by fixing a fair price at which orders were to be m a t ~ h e d . ' ~
2.10 We provisionally concluded that, although the courts might adopt the latter
approach, English courts tended to favour the approach that conflicts of interest and
duty were incompatible with the position of a fiduciary. It was, therefore, our
17
Zbid, para 2.3.10.
18
Zbid, section 3.2.
19
Zbid, paras 3.2.2-3.2.7.
20
Zbid, paras 3.2.1 1-3.2.12.
21
Ibid, para 3.2.13.
22
Bid, para 3.2.16; Anglo-Afncun Merchants Ltd v Buyley [1970] 1 QB 31 1.
23
Consultation Paper No 124, para 3.2.17-3.2.22; North and South Trust COv Berkeley
[1971] 1 WLR 470; Jones v Canavan [1972] 2 NSWLR 236.
10
provisional view that a custom which permitted a fiduciary to act in a conflict
situation was unlikely to be upheld.24
Exclusion clauses25
2.11 We stated in the consultation paper that a fiduciary could not exclude liability for
fraud, deliberate breach of duty and, possibly, gross negligence.26Beyond that, our
provisional view was that, in general, no restrictions operated as a matter of
fiduciary law to prevent a fiduciary from contracting out of or modifying his
fiduciary duties, particularly where no prior fiduciary relationship existed and the
contract sought to define the duties of the parties.27This was because we considered
that the court would have regard to all the terms of the contract or instrument when
determining whether a relationship was fiduciary and, if so, the scope of the
fiduciary’s duties.”
2.12 However, we noted that in determining whether a relationship was fiduciary, and
if so, the extent of the fiduciary duties, a court would look at the substance of a
relationship and not merely its description in the contract. Thus, a statement in a
contract that, for example, a dealer is acting as principal would not be conclusive.29
We also pointed out that for an exclusion clause to be effective, it would have to be
clearly and unambiguously expressed since it would be strictly construed against the
person who sought to rely on it; ie contra pr~ferentem.~’ Finally, we said that such
a clause would be subject to the controls imposed by the Unfair Contract Terms
Act 1977, where applicable. The application of UCTA is examined in detail in the
consultation paper, and we do not propose to repeat it here.31
Disclosure and consen?’

2.13 We explained in the consultation paper that fiduciary duties could be modified or
displaced if the consent of the person to whom a duty was owed was obtained after
24
25 Zbid, section 3.3.
26 Ibid, paras 3.3.5-3.3.7, 3.3.13.
27 Zbid, para 3.3.13.
New Zealand Netherlands Society ‘Oranje’ Incorporated v Kuys [19731 1 WLR 1126; Jima
Ltd v Mister Donut of Canada L t d [1975] 1 SCR 2; Molchan v Omega Oil €5’ Gas Ltd
[1988] 1 SCR 348. See Consultation Paper No 124, paras 3.3.10-3.3.13.
29
Consultation Paper No 124, para- 3.3.12(iii).
30 Ailsa Craig Fishing COLtd v Malvern Fishing COLtd [1983] 1 WLR 964, 966, per Lord
Wilberforce; Consultation Paper No 124, paras 3.3.14-3.3.17. However we noted that the
strict construction rule did not apply to duty defining clauses which prevent a duty from
arising or modify a duty so that there is no breach of contract; ibid, para 3.3.15.
31
Consultation Paper No 124, paras 3.3.24-3.3.38.
32 Zbid, section 3.4.
11
the making of full disclosure of all material facts.33The extent to which a duty was
modified would depend on the extent of the disclosure and to what the beneficiary
had consented. We said that in some situations it would be impossible to obtain
sufficiently informed consent: where the matter in question was so complex and
technical, the conflict so acute and the customer’s understanding so limited that it
would be impossible to place him in a position where he had adequate
comprehension of the issues and consequences of giving a binding
Beyond this we said that no matter how severe the conflict, if the customer fully
understood the consequences of the fiduciary acting in the conflict situation his
consent would be effective.35 However, we concluded that it would often be
impractical or impossible to divulge the requisite information in advance of the
breach of duty, or at all.
2.14 We gave the example of a brokeddealer who might not know at the time of a
particular transaction whether it was executed off its own book, and we said that
where soft commission was taken it might be impossible to assess what part of the
benefit received by the brokeddealer was attributable to the transactions carried out
on behalf of the customer.36We said that if advanced disclosure could not be made,
the firm had to bear the risk that the customer might choose not to consent, and I
that even if consent was obtained in advance, a conflict which was not predicted
might subsequently arise, leaving the firm open to liability.
2.15 We thought it unlikely that the disclosure clauses in customer agreements would be
able to cover all eventualities in sufficient detail. We also said that there was
considerable doubt as to whether compliance with the disclosure requirements of
the regulatory rules would satisfy general law requirements, for example, where a
broker took soft c o m m i ~ s i o nWe
. ~ ~concluded that disclosure and consent were not
a reliable means of avoiding mismatches between fiduciary law and what is required
or permitted by the regulatory rules.
33
Zbid, paras 3.4.1, 3.4.4-3.4.11. Dunne v English (1874) LR 18 Eq 524; Parker v McKenna
(1 874) LR 10 Ch App 96, 1 18; Fullwood v Hurley [19281 1 KB 498; Boardman v Phipps
[1967] 2 AC 46; North and South Trust COv Berkeley [1971] 1 WLR 470. There are two
exceptions to the rule requiring full disclosure: (i) where a broker sells to a customer off
his own book and does not take commission on the sale it is sufficient for him to disclose
that he is acting as principal; (ii) where in accordance with the usual practice of the
business in which he is operating an agent receives remuneration from a third party in the
form of a commission or discount and the principal is aware that the agent will be
remunerated in this way, does not make further enquiry, and is not misled by the agent as
to amount; Consultation Paper No 124, paras 3.4.6-3.4.10.
34
Consultation Paper No 124, paras 3.4.17. SIB Principle 6 recognises that there may be
circumstances in which it is appropriate to decline to act in a situation of conflict.
35
36
Zbid, paras 3.4.33-3.4.36, 3.4.26-3.4.28, 3.4.38.
37 Zbid, para 3.4.28.
12
Chinese walls3*
2.16 In the consultation paper we stated that, broadly, Chinese walls were procedures for
restricting flows of information within a firm to ensure that information which was
confidential to one department was not improperly communicated (and this
included inadvertent communication) to any other department within the
~onglomerate.~’ We said that a Chinese wall would provide protection against any
allegation of breach of the duty of undivided loyalty where a customer had
consented to the firm carrying on business using a Chinese wall as part of its
organisational structure.4o If consent was not obtained we said that a strong
argument could be made that a Chinese wall designed to prevent a breach of the
criminal law should protect a firm from allegations that it had failed to use relevant
information on behalf of a customer. This was because a firm could not be expected
to commit an illegality on behalf of any customer and, therefore, steps that were
designed to prevent this from occurring would be legitimated to that extent.
However, we said that it would still be arguable that if a firm had not obtained its
customer’s consent to the use of a Chinese wall it should have refused to act and
avoided the ~onflict.~’ We considered that the position was even less clear where
there was a conflict between the interests of two customers and disclosure would not
be a criminal act.42Finally, we said that where there was a conflict between the
interests of a firm and a customer, for example where a firm sold to a customer
assets in which it had an interest, a Chinese wall was unlikely to provide
. ~ ~concluded that as a matter of private law the Chinese wall did not
p r ~ t e c t i o nWe
afford the type of protection that was needed for a firm to carry on its functions
with the degree of assurance that the wall was designed to provide.44
38
Zbid, section 4.5.
39
Zbid, para 4.5.1. We said that they normally involved some combination of (i) the physical
separation of the various departments to insulate them from each other; (ii) an educational
programme to emphasise the importance of not improperly or inadvertently divulging
confidential information; (iii) strict and carefully defined procedures for dealing with the
situation where the wall is crossed; (iv) monitoring by compliance officers of the
effectiveness of the wall; (v) disciplinary sanctions where there has been an improper
breach of the wall; ibid, para 4.5.2.
40 Zbid, paras 4.5.1, 4.5.16.

41 Zbid, paras 4.5.17, 4.5.25.
42 Zbid, paras 4.5.17, 4.5.25.
43 B i d , paras 4.5.18, 4.5.25(iii).
44
Zbid, para 4.5.25. For problems associated with wall crossing and management oversight of
walls see ibid, paras 4.5.20-4.5.23.
13
PART I11
LEGAL DEVELOPMENTS - CASES
Introduction
3.1 In this part we examine the cases of El Ajou v Dollar Land Holdings plc‘ and Meridian
Global Funds Management Asia Ltd v The Securities Commission2which concern the
question of acquisition of knowledge by a company; and the cases of Kelly v C ~ o p e r , ~
, ~ Glynwill Investments NV v Thomson McKinnon Futures
Clark Boyce v M o ~ a t and
L t 8 which consider the role of contract in determining the scope of fiduciary
duties.6 -
El Ajou
3.2 This case concerns the question of acquisition of knowledge by a company. It
considers the two different means by which knowledge could be acquired, namely
by direct attribution because of the position or status of the person within the
company who has the knowledge and under the normal rules of a g e n ~ y .It~
addresses, in particular, the situation where a person who is an officer of two
companies acquires knowledge while acting for one of them.
3.3 The claim was brought by the Plaintiff (“El Ajou’’) against the defendant (“DLH”),
an English registered property development company, to recover moneys which he
had lost as a result of a fraud perpetrated against him by three Canadians. DLH was
not directly involved in the fraud but El Ajou asserted that it had acquired assets
representing the proceeds of the fraud with knowledge of the fraud and was
therefore liable to it under the knowing receipt head of constructive trust.
3.4 It was alleged that the knowledge had been acquired by DLH in the following way.
The Canadians had been clients of a Swiss company, owned by a Mr Ferdman,
which acted as a fiduciary agent for clients who did not wish their identities to be
disclosed. Ferdman was also a non-executive director and chairman of DLH. He
introduced the Canadians to DLH, and the Canadians and DLH entered into a
joint venture, for which the Canadians provided financing of approximately $2.6
million. These moneys represented the proceeds of the fraud perpetrated on El
’ [1993] 3 All ER 717 (Millett J); rev’d, CA, [1994] 2 All ER 685. See also Halifax
Mortgages Ltd v Stepsky [ 19951 3 WLR 70 1.
[1995] 2 AC 500.
[1993] AC 205.
[1994] 1 AC 428.
13 February 1992 (unreported, Tuckey Q-C).
These cases, in particular Kelly, also have significant implications for Chinese walls.
’ See paras 2.3-2.4 above.
14
Ajou. Later, after Ferdman had ceased to be a director of DLH, the Canadians
withdrew from the joint venture and DLH bought out their interest.
3.5 Both Millett J and the Court of Appeal held (i) that the proceeds of the fraud
perpetrated by the Canadians could be traced into the funding of the joint venture
and from there into the acquisition by DLH of the Canadians’ interest; and (ii) that
at the time Ferdman arranged for the moneys to be invested in the joint venture he
must have known that they were part of the proceeds of fraud. The question of
whether or not DLH could be held liable as constructive trustee for knowing receipt
depended on whether the knowledge of Ferdman’ as to the tainted source of the
funds could be attributed to DLH.’ Millett J and the Court of Appeal examined the
two means by which that knowledge could have been acquired.
3.6 Millett J held, at first instance, that Ferdman’s knowledge could not be attributed
to DLH because of his status. In determining whether DLH had the requisite
‘knowledge because of Ferdman’s position as its chairman and as a director, he
found as a fact that neither Ferdman, nor for that matter the board of DLH, played
any significant role in determining its business policy or in making its business
decisions. These responsibilities were performed by others who were not aware of
the fraud.
3.7 Millett J also held that Ferdman’s knowledge could not be attributed to DLH by
means of normal agency principles. Although Ferdman was an officer of DLH, he
had acquired knowledge of the Canadians’ fraud as an officer of the Swiss company
through which he carried on the business of Swiss fiduciary agent. Millett J held that
where a person is a common officer of two companies, knowledge acquired as an
officer of one will not be attributed to the other “unless he owes a duty to the first
company to communicate his knowledge to the second company as well as a duty
to the second company to receive it’’.lo On the facts of the case Ferdman could not
have been under any duty to the Swiss company to communicate information about
its clients or their associates to DLH without their authority.
3.8 On appeal his finding that Ferdman’s knowledge could not be attributed to DLH
because of his status as chairman and director was reversed. The Court of Appeal
Ferdman was the only member of the board who had this knowledge.
Both Millett J and the Court of Appeal held that the r6levant transaction for the purposes
of the “knowing receipt” claim was the acquisition by DLH of the Canadians’ interest in
the joint venture. However, the Court of Appeal differed fi-om Millett J in holding that if
DLH knew of the fraud at the time the joint venture was entered into, then this
knowledge could carry over to the acquisition of the Canadians’ interest. See para 3.14
below.
lo
[1993] 3 All ER 717, 742, citing inter alia Re Hampshire Land CO [1896] 2 Ch 743; and Re
Fenwick Stobart & CO Ltd, Deep Sea Fishery CO’sClaim [1902] 1 Ch 507; on which see
15
reasoned that Ferdman had the responsibility for arranging the receipt of the
moneys, for which purpose he was the “directing mind and will”” of DLH, and the
fact that with respect to other, more significant policy decisions he and the board
were an irrelevance did not affect the matter. Thus when the joint venture was set
up DLH knew that the moneys invested by the Canadians were the product of
fraud.
3.9 Turning to the question of agency, the Court of Appeal agreed with Millett J that
agency principles did not cause DLH to be affected by Ferdman’s knowledge.
Nourse LJ endorsed Millett J’s analysis of the occasions when the knowledge of a
common director could be attributed to the various companies of which he was a
board member. Hoffmann LJ, with whom Rose LJ agreed, refined this analysis. He
said that there were various categories of case where the agent’s knowledge will ipso
facto be treated as that of the principal and which he considered were based on
“distinct principles” .I2 He identified three such categories:l 3
(i) cases where the agent is authorised to enter into a transaction in which his
own knowledge is material, for example where a policy of insurance is avoided
for failure by a broker to make disclosure of material facts within his
knowledge, even though he did not obtain that knowledge in his capacity as
agent of the insured;I4
(ii) cases where the principal has a duty to investigate or is put on inquiry. If the
principal uses an agent then the knowledge of the agent will be imputed to the
prin~ipal;’~
(iii) cases where the agent has actual or ostensible authority to receive
communications on behalf of the principal, for example, a notice to quit.I6
11
Lennard’s Carrying COLtd v Asiatic Petroleum COLtd [1915] AC 705, 713, per Viscount
Haldane LC. For a discussion of the development of this point in the case of Meridian, see
paras 3.15-3.23 below.
[1994] 2 All ER 685, 702; he did not consider that they applied to the facts of El Ajou.
l3
For a general discussion of the cases, see Bowstead, n e Law of Agency (15th ed 1985) pp
412-420.
l4
See Blackburn Lowe Q COv vigors (1887) 12 App Cas 531. The other two examples cited
by Hoffmann LJ were Turton v London and North Western Railway CO(1850) 15 LTOS 92;
and Dresser v Nonuood (1864) 17 CBNS 466.
l5
It was in this category that he placed the so called “mad dog” cases, that is, where a dog
owner is fixed with knowledge of the dog’s vicious propensities through the knowledge of
his agent. Hoffinann LJ cited Baldwin v Casella (1872) LR 7 EX 325. A respondent to the
consultation paper also drew our attention to Cleverton v Uffernel (1887) 3 TLR 509; and
Colgett v Norrish (1886) 2 TLR 471.
l6
Tanham v Nicholson (1872) LR 5 561.
16
3.10 In other situations where an agent has a duty to communicate to his principal,
Hoffmann LJ considered that the court could infer that the agent had in fact
communicated the information, but that this was a rebuttable inference of fact.I7
3.11 The El Ajou decision does not substantially affect the treatment of acquisition of
knowledge by a company in the consultation paper. On the question of attribution
because of the status of the person acquiring the knowledge it makes it clear that the 1
Lennurd’s Currying COLtd principle’* is context specific; whether or not a company

will be held to have knowledge will depend on the particular transaction in respect
of which the- person who is allegedly its directing mind and will is acting.lgThis was
the view we had already expressed.20
3.12 Similarly, the categorisation of the cases put forward by Hoffmann LJ does not
affect the analysis in the consultation paper of the ways in which knowledge can be
acquired by a principal under the rules of agency.21What it does show, however, is
that the analysis needs to be extended, in particular to a situation where a principal
has a duty to enquire. What is unclear is whether or not the duty to enquire can
arise from professional regulatory rules, for example, the suitability rule which
implicitly requires a firm to obtain relevant information with respect to the
customers to whom the obligation is owed.22We can see no good reason why it
should not be so extended and, if this is the case, then a firm would be aware of the
information which the agent has acquired but which he has failed to pass on to the
firm, since the duty to know is one imposed on the firm which the firm is
discharging by using an agent.23
3.13 Hoffmann LJ’s reasoning would also be relevant in a situation where companies
shared a common director and the director had an obligation to communicate
information to one of the companies but failed to carry it out. In this situation,
(subject to the “distinct categories” identified by Hoffmann LJ referred to above),
the inference that he had so communicated it could be rebutted.
l7
On the facts of El Ajou this inference had been rebutted since Millett J found that
Ferdman had not communicated the information about the source of the moneys to DLH.
’* See para 3.8, n 1 1 above.
This point is explained and developed further in Meridian; see paras 3.15-3.23 below.
2o
See para 2.4 above. The legal context in which the rules of agency come into play was
explained by Lord Hoffmann in the subsequent case of Meridian; see para 3.17 below.
22
The SIB Core Conduct of Business Rules, Rule 16(1): “other relevant facts about the
customer of which the f m is, or reasonably should be, aware”.
23
For a possible limitation on this principle where the agent is not free to communicate the
information, see Halifax Mortgage Services Ltd v Stepsky [1995] 3 WLR 701.
17
3.14 Millett J had held that even if Ferdman’s knowledge had been attributable to DLH,
the company should not be affected with this knowledge because either (i) it had
not acquired the Canadians’ interest in the joint venture until after Ferdman
resigned from its board so that his knowledge could not be imputed to it for the
purposes of that transaction, or (ii) where knowledge of a director is attributed to
the company but not imparted to it, it should not be treated as continuing to
possess that knowledge where the director has ceased to hold office or dies.24The
Court of Appeal disapproved of this part of the judgment, not on the grounds that
it was not possible for a company to forget, but on the more limited grounds that
it considered the initial investment in the joint venture and the subsequent
acquisition of the Canadians’ interest to be effectively part of the same t r a n ~ a c t i o n . ~ ~
Once knowledge was treated as being the knowledge of the company in relation to
a given transaction, the company continued to be affected with that knowledge for
any subsequent stages of the same transaction.26However, EZAjou, and in particular
the judgment of Millett J in that case, supports the proposition that it might be
possible for a company to forget.27
Meridian
3.15 This case also concerns the acquisition of knowledge by a company. Koo and Ng
were respectively Chief Investment Officer and senior portfolio manager of Meridian
Global Funds Management Asia Ltd (“Meridian”), a substantial Hong Kong
investment management company. They organised an unsuccessful fraudulent
attempt to take over a New Zealand company (“ENC”) and use the company’s
funds to finance the take over. Meridian became caught up in the fraud under
which it acquired an interest in the shares of ENC. Under New Zealand legislation,
Meridian was obliged to disclose its interest to ENC as soon as it knew or ought to
have known that it was a “substantial security holder” in ENC’s shares. Meridian
was joined as a party to proceedings brought by the Securities Commission against
the various participants in the fraud and, in the course of those proceedings, a
declaration was made against Meridian that it had breached its duty of disclosure
under the legislation.
3.16 The judge at first instance held that Meridian knew that it was a substantial security
holder for the purposes of the relevant legislation by attributing to it the knowledge
of Koo and Ng. Without too much discussion of the juridical basis he felt it was
obvious that if Koo and Ng had authority to enter into the transaction, their
knowledge that they had done so should be attributed to Meridian. The New
Zealand Court of Appeal affirmed the decision ‘on the somewhat different grounds
24 [1993] 3 All ER 717, 742-743.

25
26 [1994] 2 All ER 685, 706, per Hoffmann LJ; 698, per Nourse LJ; 700, per Rose LJ.
27 See Consultation Paper No 124, para 2.3.5. See para 2.5 above.
18
that KOO’S knowledge should be attributed because he was the “directing mind and
will” of the company.28
3.17 In the Privy Council, Lord Hoffmann gave the opinion of the Board. He pointed !
out that there appeared to be some misunderstanding of the true principle upon I
~
which the Lennard’s Carrying CO Ltd case (from which the expression “directing
mind and will” was derived) was based. He said that the rules of attribution, which
!
determine which acts count as acts of the company, were primarily to be found in
I
1
the company’s constitution, typically the articles of association, (which he referred
to as the primary rules of attribution) but that these were supplemented by the
principles of agency (which he referred to as the secondary rules of attribution). The
company will appoint servants and agents whose acts, by a combination of the
general principles of agency and the company’s primary rules of attribution will
count as acts of the company. Having done so, it will be subject to the general rules
by which liability for the acts of others can be attributed to natural persons (notably
estoppel, ostensible authority in contract and vicarious liability in tort).
3.18 This was usually sufficient to enable one to determine the company’s rights and
obligations. But there were situations where a rule of law, either expressly or by
implication, excluded attribution on this basis (for example, if the rule required
some act or state of mind on the part of the person “himself”, as opposed to his
servants or agents). Unless the court was to come to the conclusion that the rule
was not intended to apply to companies at all, it had to fashion a special rule of
(direct) attribution for the particular substantive rule. It was always a matter of
interpretation of the substantive rule as to whether, and in what manner, it was
intended to apply - whose act (or knowledge, or state of mind) was for this purpose
intended to count as the act (or knowledge, or state of mind) of the company.
3.19 Against this background, Lord Hoffmann examined the Lennard’s Carrying COLtd
case. The provision in question was section 502 of the Merchant Shipping Act 1894
which provided a shipowner with a defence to a claim for the loss of cargo if he
could show that the casualty happened “without his actual fault or privity”. In
considering how to apply this provision to a company, Viscount Haldane had,
according to Lord Hoffmann, “looked for the person whose functions in the
company, in relation to the cause of the casualty, were the same as those to be
expected of the individual shipowner to whom the language primarily applied”.’’
This person, who was responsible for monitoring the condition of the ship,
authorising repairs etc, was described by Viscount Haldane as “the directing mind
and will” of the company.
28
Lennard’s Carrying COLtd v Asiatic Petroleum Ltd [1915] AC 705, 713, per Viscount
Haldane LC. See paras 3.8, 3.1 1 above.
29
[1995] 2 AC 500, 509.
19
3.20 In the Lennard’s Carrying CO Ltd case the company did nothing except own ships
and so there was no need to distinguish between the person who ran the company’s
business in general and the person who was responsible for the condition of the
ships. But in other cases it was more difficult to find an appropriate “directing mind
and will” of the company. Lord Hoffmann said that the phrase would often be the
most appropriate description of the person designated by the relevant attribution
rule, but that not every case should be forced into the same formula.
3.21 Turning to the New Zealand securities legislation, Lord Hoffmann said that the
purpose -of the provision was to ensure immediate disclosure of the identity of
persons who became substantial security holders in public companies. In the case
of a corporate security holder, the knowledge of the person who, with the authority
of the company, acquired the relevant interest should count as knowledge of the
company for these purposes, otherwise the policy of the legislation would be
defeated. The fact that Koo acquired the shares in ENC on behalf of Meridian for
a corrupt purpose and did not give the required notice because he did not want his
employers to find out had no effect on the attribution of knowledge and the
consequent duty upon Meridian to notify. It was not necessary to inquire whether
Koo could have been described in some more general sense as the “directing mind
and will” of the company.
3.22 Lord Hoffmann stressed that it should not be understood that whenever a servant
of a company had authority to do an act on its behalf, knowledge of that act would
for all purposes be attributed to the company. It was a matter of construction in
each case whether the rule required that such knowledge be attributed.
3.23 The Meridian decision develops further the consideration of the question of
attribution because of the status of the person acquiring the knowledge. We have
said3’ that El Ajou made it clear that the Lennard’s Carrying CO Ltd principle was
context specific - whether or not a company would be held to have knowledge
would depend on the particular transaction in respect of which the person who is
allegedly its directing mind and will is acting. Meridian takes this point further. It
indicates that the phrase “directing mind and will” is simply one way of describing
the person whose knowledge is to be regarded as that of the company for the
purposes of the particular substantive rule. It is a matter of construction of the
relevant rule (assuming the usual rules of agency cannot be applied) how it is to be
translated to a corporate entity - whose knowledge (if anyone’s), in the
circumstances of the particular case, is to be relevant. Although the Meridian case
develops and clarifies the law on this point, it remains in line with the approach set
out in the consultation paper.31
30
See para 3.11 above.
31 Consultation Paper No 124, para 2.3.3.
20
Kelly
3.24 This case concerns the scope of fiduciary duties and the impact of express and
implied contractual terms on those duties. The plaintiff in this case was the vendor
of a property and the defendants, a firm of estate agents, acted for him on the sale.
The defendants also acted as agents for the vendor of the adjoining property. They
showed a prospective purchaser, Mr Perot, around both properties. He made an
offer for the adjacent property, which was accepted, and then made an offer for the
plaintiff’s property. The defendants passed on the offer to the plaintiff, but did not
inform him that Mr Perot had agreed to buy the adjacent property. The plaintiff
accepted the offer and both sales were completed. It was the plaintiff’s case that a
purchaser interested in acquiring adjoining properties might be prepared to pay over
the ordinary price for the properties. Had he known that Mr Perot was interested
in both properties he would have had the opportunity of seeking a higher price. The
plaintiff brought an action for damages for breach of fiduciary duty on the grounds
that the defendants (i) had failed to disclose the material fact that Mr Perot was also
negotiating to buy the adjacent property, and (ii) had put themselves in a position
where their duty to the plaintiff to disclose all relevant information pertaining to the
sale conflicted with their personal interest in obtaining commission on both sales.
3.25 The Privy Council emphasised the contractual nature of the relationship between
principal and agent and held that the rights and duties of a principal and agent are
dependent upon the express and implied terms of the contract between them.32It
cited the dictum of Mason J of the High Court of Australia in Hospital Products Ltd
v United States Surgical C ~ r p o r a t i o nin~ which
~ he said that where a basic contractual
relationship provided the foundation for the erection of a fiduciary relationship, the
fiduciary relationship must accommodate itself to the terms of the contract so that
it was consistent with and conformed to them. Lord Browne-Wilkinson, who
delivered the opinion of the Board, concluded that “in the present case, the scope
of the fiduciary duties owed by the defendants to the plaintiff (and in particular the
alleged duty not to put themselves in a position where their duty and their interest
conflicted) are to be defined by the terms of the contract of agency”.34
32
[1993] AC 205, 213-214. This contractual approach has been criticised; see Reynolds,
“Agency” [1994] JBL 144, 149: “the rather brusque reasoning, and the citation of two
cases on commercial distributors, seems to deny fiduciary obligations at all and to leave
everything to express and even implied terms of the contract. Variable as the degree of
fiduciary liability is, such reasoning cannot be appropriate to agency law in general. And it
would be most unfortunate if it was taken as a cane bluvche for persons acting in
potentially inconsistent capacities in the area of financial services”; and Ian Brown,
“Divided Loyalties in the Law of Agency” (1993) 109 LQR 206, 209: “Fiduciary duties
are not dependent upon contractual undertakings nor, perhaps, should it be the dominant
principle to ‘define’ these fundamental obligations by reference to the contract in question
when the parties are at liberty to fix their rights and duties expressly. The Privy Council’s
hypothesis appears to let the rail of contract wag the dog of‘duty”.
33
(1984) 156 CLR 41, 97.
34 [1993] AC 205, 215.
21
3.26 The contract between the plaintiff and the defendants in Kelly did not expressly set
out or seek to limit the scope of the fiduciary duties owed by the defendants. When
considering the rights and duties which arose in that case, Lord Browne-Wilkinson
said that the business of estate agents inevitably gave rise to conflicts of interest
between different principals, and that despite this “estate agents must be free to act
for several competing principals otherwise they will be unable to perform their
function”.35 He emphasised that the customer of an estate agent would know that
the agent would also act for vendors of comparable proper tie^,^^ and concluded that
in such cases it must be an implied term of the contract that the agent is entitled
to act for other principals selling competing properties and to keep confidential the
information it obtains from each.37He also said that it was not a breach of duty for
the defendants to have a direct financial interest in securing commission on the sale
of the adjacent property “since the contract of agency envisaged that they might
have such a conflict of intere~t”.~’ The position as to confidentiality was said to be
even clearer in relation to stockbrokers “who cannot be contractually bound to
disclose to their private clients inside information disclosed to the brokers in
confidence by a company for which they also act”.39
3.27 However, the Privy Council in Kelly distinguished the case of North and South Trust
COTI Berkeley4’ which held that as a general principle an agent must have express
35
This seems to adopt the approach of implication of terms into contracts on the ground of
necessity of giving business efficacy to the contract. For this approach see The Moorcock
(1889) 14 PD 64, 68; Liverpool City Council v Zruin [1977] AC 239, 253: “although there
is an apparently complete bargain, the courts are willing to add a term on the ground that
without it the contract will not work”; Chitty on Contracts - General Principles (27th ed,
1994) Vol I, ch 13.
36 [1993] AC 205, 214-215.

37
This approach has been criticised; see Ian Brown, “Divided Loyalties in the Law of
Agency’’ (1993) 109 LQR 206, 208-209 who argues that “ [ a b agent owes a duty to
communicate facts to his principal with due diligence and the defendant’s dilemma in
Kelly should have been resolved by his seeking the consent of both principals to reveal
Perot’s interest to the other. In the absence of dual consent it is suggested that the
defendant should have terminated both agencies, or at least one of them”. He also
suggests that both principals might have consented to divulge the facts to the other in the
hope of legitimately gaining the ascendancy over Perot, and that the Privy Council’s
analysis “enables the agent to classify information as confidential when it is by no means
clear that it would be so characterised by his principals, thereby allowing the agent to
consolidate his own position to the possible detriment of the principals’ best interests, viz I
in Kelly, the agent’s ensuring his commission on the sales of both houses”. See also I
Mortgage Express Limited v Bowerman and partners [1995] EGCS 129, described at para
3.39, n 71 below, and Halifax Mortgage Services Ltd v Stepsky [1995] 3 WLR 701.
38 [1993] AC 205, 215.

39 Ibid, at p 214.
40
[1971] 1 WLR 470. This case concerned the practice of Lloyd’s insurance brokers of
acting as agent for both the customer and the underwriter in settling a claim.
22
. ~ ~ two principals
consent before acting for two parties in the same t r a n ~ a c t i o nThe
in Kelly were involved in different transactions, and the general principle that a firm
must not act for two customers in the same transaction unless it has obtained their
informed consent, is still valid.
3.28 We consider the impact of Kelly on our provisional conclusions by looking at four
aspects: first, the use of express contractual terms to define the extent of the
fiduciary duties; secondly, the extent to which terms may be implied into contracts
which limit the fiduciary duties; thirdly, the use of Chinese walls; and lastly, the
incorporation of terms by trade custom.
Express contractual terms

3.29 This decision confirms our provisional view that the court will have regard to all the
terms of the contract or instrument when determining whether a relationship is
fiduciary and, if so, the scope of the fiduciary’s duties.42Subject to the proviso that
the court will have regard to substance and not the decision makes it clear
that where a fiduciary relationship arises out of a contract, a clearly worded duty
defining or exclusion clause will circumscribe the extent of the fiduciary duties owed
to the other party.44 It also indicates that an unambiguous general advanced
disclosure made in a contract will be effective, provided that the contract clearly
delimits the rights and duties of the parties to it and displaces the obligation to
make full disclosure of all material facts. We are, therefore, no longer of our
provisional view that a general advanced contractual disclosure is unlikely to be
widely effective.
Implied terms
3.30 Where appropriate provision has not expressly been made in the contract and where
the customer’s informed consent has not been obtained to the firm so acting, Kelly
is authority for the proposition that a firm may be permitted (i) to act for customers
with conflicting interests in different transactions and to keep confidential the
information obtained from and (ii) in some circumstances to put itself in a
position where its duty to a customer conflicts with its own self-interest. To this
extent, we have revised our provisional view that in order for a firm to avoid
4’
North and South Trust COv Berkeley [1971] 1 WLR 470, 482. See Consultation Paper No
124, para 3.2.17.
42
See para 2.1 1 above.
43
See para 2.12 above and paras 3.41-3.42 below. A clause may also be subject to the
UCTA reasonableness test and the requirement of fairness in the Unfair Terms in
Consumer Contracts Directive; see paras 2.12 above and 4.2-4.8 below.
44
This assumes that the f m manages its relationships with its customers so as to avoid the
introduction of new rights and obligations into it over time. Most respondents did not
regard this as a problem. See para 7.3 below.
45
See para 3.32 below for a possible limitation on this.
23
breaching its fiduciary duties to its customers by acting in a situation of conflict it
is necessary46for it expressly to make a sufficiently clear and precise provision in the
contract with the customer, or obtain the customer’s informed consent to its so
acting.47
3.31 However, there are three situations of conflict in which, despite Kelly, it will be
necessary either to make appropriate provision in the contract or obtain the I
informed consent of the customer in order to avoid breaching a fiduciary duty. The I
first is where the firm is acting for two customers in the same tran~action.~’ The
second is where there is a conflict between the firm’s own interest and the duty
which it owes to a customer and that conflict is more acute than that which arose
in Kelly. The conflict of interest in Kelly arose from the agent’s financial interest in
securing a second commission on the sale of the adjoining property in a situation
where the plaintiff “was well aware’’ that the defendants would be acting for vendors
of comparable properties. The conflict would be more acute if, for example, (i) a
firm has a direct beneficial interest in a transaction with a customer, such as where
it sells its own property to a cu~tomer,~’ or (ii) the discretionary fund management
arm of a firm purchases the commercial paper issued by a company for a client at
a time when the corporate finance department is calling in a loan to that company
which will cause it to default on the commercial paper. The third situation is where
there has been “ i n i q ~ i t y ”This
. ~ ~ might arise when a sectoral analyst who has been
made an insider by the corporate finance department in relation to a particular stock
returns to his normal duties before the inside information he has obtained is in the
public domain or has ceased to be price sensitive. If, on the basis of his last I
published opinion, the analyst advised a customer to purchase the stock, despite ~
having inside knowledge that the stock was about to fall in price, although the court ~
would not hold that the analyst should have committed a criminal offence and
disclosed the inside information to the cu~torner,~’ it might well consider that the
46
There are two exceptions to this; see para 2.13, n 33 above.
47
Although, where possible, it is preferable to make express provision to avoid any doubt.
48
See Hurrods Ltd z, Lemon [1931] 2 KB 157, discussed at paras 12.6-12.7 below. In a
simple agency cross where the transactions of two customers are matched and the
customers are protected by the requirement of best execution, the rules on trade custom
will probably provide a solution; see para 7.6 beloyl.
49
This would have been the case in Kellr, for example, if the adjoining property had been
beneficially owned by the estate agents.
50
In El Ajou [1994] All ER 685, 703, Hoffmann LJ rejected a submission that on the basis
of Kelly no term could be implied into a contract requiring an agent to disclose that
money was the proceeds of kaud. This was because a “confidence in iniquity” would not
be enforced.
5’ See para 3.35 below.
24
I
firm should not have placed itself in a position of conflict which would require it
deliberately to mislead a customer.52
3.32 Beyond these three situations the extent to which terms may be implied into
contracts which limit the fiduciary duties owed to the other party will depend on
whether Kelly is given a wide or a narrow interpretation. The agent in Kelly offered
a single service, the provision of estate agency services. When illustrating the
principle by relation to stockbrokers, Lord Browne-Wilkinson referred only to
customers of the broker.53 The Privy Council did not consider the duties which
would (or -would not) be owed to the customer of one department of a
multifunctional financial conglomerate in relation to the functions carried out by
other departments of the conglomerate. In principle, we believe that the reasoning
in Kelly is equally applicable to the situation where a conflict arises between the
interests of two or more customers of different departments of a financial
conglomerate for whom it is acting in different transactions. However, in Kelly Lord
Browne-Wilkinson emphasised that the plaintiff would be “well aware” that the
defendants would be acting for the vendors of competing properties, and that the
exclusion of the relevant fiduciary duties was necessary if estate agents were to be
able to perform their function. While it will be clear to any customer of a broker
that the broker acts for other customers, and that the broker would not be able to
operate without doing so, the large range of different functions which the different
departments of a financial conglomerate carries out for customers may be less
obvious to any one customer of a particular department, especially if the customer
is an inexperienced private customer.54If a court were to adopt a narrow view of
Kelly it might hold that there was a duty on the firm not to put itself in a position
of conflict without making full disclosure to the customer,55in a situation where a
customer was not aware that a firm would be acting for other customers in different
transactions with competing interests.
Chinese walls
3.33 Kelly did not involve a Chinese wall and the Privy Council did not consider Chinese
walls. It does not therefore give express judicial recognition to their effectiveness,
52
See para 8.6, n 4 below.
53 [1993] AC 205, 214.

54
See A Alcock, “Kelly v Cooper - a timely decision” (1994) 14(7) Company Lawyer 134,
136: “Customers of estate agents use them because of their other customers. However,
private client investors do not generally pick a stockbroking firm because of its corporate
finance connections ... . Indeed, since Big Bang, most private client investment businesses
have been separated from the big corporate finance brokers, so that a private client
investor will not necessarily expect his broker to be conducting a conflicting corporate
finance business. Any limitation of the undivided loyalty rule extending beyond the rival
interests of investing customers may not meet-the ... ‘officious bystander’ test without prior
notification, at least to private clients”.
55
In such circumstances the court would, however, be likely to hold that there was no duty
to use the information for the benefit of the customer.
25
but it does have significant implications for them, in particular in relation to the
fiduciary’s duty of disclosure and his duty not to put himself in a position of
conflict. We consider these two aspects both where there is express provision in the
contract for a Chinese wall and where there is not.
3.34 Since Kelly has confirmed that the scope of fiduciary duties can be defined by the
terms of the contract of agency,56it is now clear that the duty of disclosure to a
customer will be limited where it is an express term of the contract between firm
and customer either (i) that the firm utilises Chinese walls to restrict the flow of
information and that the customer is not entitled to any information which the
actual member of the firm with whom he deals does not (and would not reasonably
be expected to) have in his p o s ~ e s s i o n ,or
~ ~(ii) that the firm is not obliged to
disclose to the customer any information the disclosure of which would or might be
a breach of duty to any other person, or which properly does not come to the
attention of the person dealing with the customer.58However, where Chinese walls
are used to manage conflicts, such express terms may be insufficient on their own
to avoid liability for breach of a firm’s duty not to put itself in a position where its
own interests conflict with those of the customer, or where it owes conflicting duties
to another customer, since they neither disclose expressly the fact that such conflicts
may exist, nor seek to vary those duties.59
3.35 Where a contract does not acknowledge and provide for the use of Chinese walls the
position is less clear. The Privy Council in Kelly recognised that a firm could not be
obliged to use confidential information gained from one customer for the purposes
of another and said that brokers could not be contractually bound to disclose inside
information disclosed to them in confidence by a company for which they also act.60
In the light of this statement, Chinese walls could be seen simply as devices
designed to ensure that something that could not be contractually done was in
56
See paras 3.25, 3.29 above.
57
An example of such a term given to us by one consultee was: “You recognise and accept
that practices and procedures, including those commonly known as Chinese walls, are
maintained in parts of our Group and of individual Group companies to restrict the flow
of information. You agree that, when we are acting for or dealing with you, any
information of which none of our individual executives having the conduct of the matter
has actual or properly obtainable knowledge shall not for any purpose be taken into
account in determining our responsibilities to you. It is agreed between us that evidence of
any such Chinese wall is not conclusive evidence of its effectiveness”.
58
See, for example, Institutional Fund Managers’ AssociatiodBritish Merchant Banking and
Securities Houses Association Terms and Conditions>or Discretionaly Fund Management (Ed
I F W B M B A 2 ) September 199 1, clause 3 1 .
59
Arguably, it is implicit in the nature of Chinese walls, which are widely used in practice,
that conflicts between the f m ’ s interests and those of its customers, or between the
interests of different customers, may arise-so that term {i), which discloses that a Chinese
wall may be used, is effective in these situations. However, it is clearly preferable for the
contract to spell out expressly that the duties are varied so as to permit such conflicts.
6o See para 3.26 above.
26
actual fact not done. However, as explained aboveJ6'Kelly is not authority for the
proposition that a firm can, without more, put itself in a position where its own
interest conflicts with a duty owed to a customer, or where it owes conflicting duties
to two customers for whom it is acting in the same transaction. Thus in the
situation where either (i) a firm's own interest on one side of a Chinese wall
conflicts with the interests of a customer for whom another department of the firm
on the other side of the wall is acting,62or (ii) different departments of a firm on the
opposite sides of a Chinese wall act for different customers in the same transaction,
the firm, while not being obliged to use inside information for the customers, might,
nevertheless, breach the duty not to put itself in a position of conflict, Moreover,
although we believe that the approach taken in Kelly will usually mean that a firm
will not be in breach of fiduciary duty where it acts for two customers with
competing interests in dzfferent transactions, much will depend on whether on any
future occasion the court takes a wide or narrow view of Kelly in the circumstances
of the particular case.63
Trade custom
3.36 In Kelly the Privy Council did not consider the rules relating to the incorporation
of terms into contracts by trade custom. However, as we explain in Part VI1 of this
report, we believe that the approach taken in Kelly64 may have an influence on the
way the rules on incorporation by custom are interpreted in the future. We have
therefore departed from our provisional conclusion on this matter.65 We now
consider that an English court would take the same approach as the New South
Wales Court of Appeal in Jones z, Canavan66 and hold that a trade custom which
permits a fiduciary to act in a position of conflict is reasonable if the custom also
provides adequate protection for the customer's interests.
CZark Boyce
3.37 This case also concerns the role of contract in determining the scope of fiduciary
duties. It involved the loan of a sum of money to a businessman on the security of
the house of his mother, the plaintiff. The defendant solicitors acted for both the
plaintiff and her son in the mortgage transaction. Before acting for the plaintiff, the
defendants repeatedly advised her to seek independent legal advice and advised her

62
An example of such a situation is example (ii) in para 3.31 above.
63 See para 3.32 above.

64
In Kelly the court was prepared to take a pragmatic approach and look at the commercial
context in which the transaction took place. This approach was echoed in Target Holdings
Ltd v Redfems [1995] 3 WLR 352. See para 3.40, n 72 below.
65 See paras 2.8-2.10 above.

"
[1972] 2 NSWLR 236. See para 2.9 above and Consultation Paper No 124, paras 3.2.20-
3.2.22.
27
of the consequences of non-payment of the loan by her son. The son went bankrupt
and the plaintiff became liable to repay the loan and arrears of interest. The plaintiff
sued the defendants alleging, inter alia, that they had breached their fiduciary
obligations by failing (i) to refuse to act for her; (ii) to advise her that it was not in
her interests to enter the transaction; and (iii) to advise her adequately of the need
for independent legal advice.
3.38 The Privy Council held that there was no general rule of law that a solicitor should
never act for both parties in a transaction where their interests might conflict. A
solicitor could so act if he had obtained the informed consent of both parties to his
so doing. Informed consent was said to mean “consent given in the knowledge that
there is a conflict between the parties and that as a result the solicitor may be
disabled from disclosing to each party the full knowledge which he possesses as to
the transaction or may be disabled from giving advice to one party which conflicts
with the interests of the To this extent the decision confirms what we said
in the consultation paper to the effect that fiduciary duties can be modified or
displaced if the consent of the person to whom a duty is owed is obtained after full
disclosure of all material facts has been made.68
3.39 However, the Privy Council went on to emphasise the importance of establishing
precisely what services are required of the fiduciary when a court has to determine
whether or not informed consent has been ~btained.~’ It indicated that the scope of
a solicitor’s duties to a client is limited by his instructions and said that a fiduciary
duty “cannot be prayed in aid to enlarge the scope of the contractual duties”. As
there was no contractual duty on the defendants to advise the plaintiff on the
wisdom of entering into the transa~tion,’~ there could be no fiduciary duty to give
that advice. Nor was there a duty to refuse to act for the plaintiff since she was fully
67
[1994] 1 AC 428, 435.

69 [1994] 1 AC 428, 436. - .
70 Ibid, at p 437. All that was required of the defendants in the circumstances of the case was
that they should carry out the necessary conveyancing on the plaintiff’s behalf and explain
to her the legal implications of the transaction; ibid, at p 437.
28
aware of what she was doing and had declined to seek independent advice, although
advised to do
3.40 The importance given in Clark Boyce to the role of the contract when determining
the extent of the fiduciary duty relating to disclosure of material facts underlines the
approach taken by the Privy Council in Kelly. It is another indication that, where
the relationship between fiduciary and beneficiary arises out of a contract, the courts
will have regard to the terms of the contract in determining the scope of fiduciary
Glynwill
3.41 This case also considered the extent to which the contract can determine the scope
of fiduciary duties. The defendant firm was a foreign exchange dealer. It acted for
the plaintiff in currency transactions, charging a commission and also, in some
cases, taking a mark-up on the price at which it had bought in the market.73It did
not disclose the mark-up to the plaintiff. The plaintiff contended that the defendant
was acting as its agent and was therefore liable to account for the mark-up. The
defendant claimed that it was acting, as the contract between it and the plaintiff
specified, as principal. However, the deputy judge concluded that in the light of the
other evidence, including the agreement of commission and the market order
method used by the plaintiff^,^^ the trading relationship was one of principal and
71
In Mortgage Express Ltd v Bowerman and partners [1995] EGCS 129, it was held by the
Court of Appeal that there was a duty on a solicitor, who was acting for both a lender and
borrower in a conveyancing transaction, to inform both of his clients of information which
cast doubt on the valuation obtained. It was common ground that, had the information
been confidential to the borrower, the solicitor should have sought instructions to disclose
the information to the lender and, if such consent was refused, he should have declined to
act. There would have been a conflict between the duty of confidentiality and the duty to
protect the lender’s interest. However, this was not the case and no question of conflict
arose. The solicitor was simply negligent in failing to inform the lender of the information
which was relevant to the valuation of the property. See also Halifax Mortgage Services Ltd
v Stepsky [1995] 3 WLR 701.
72
Both cases demonstrate the courts’ willingness to examine the commercial context of
transactions involving fiduciary duties. This approach was echoed by the House of Lords
in Target Holdings Ltd v Redferns [1995] 3 WLR 352 where a solicitor wrongly paid away
moneys received as part of a conveyancing transaction. In examining the transaction Lord
Browne-Wilkinson distinguished between the equitable principles applicable to traditional
trusts and those applying to bare trusts arising in commercial transactions. In this case the
money was held on a bare trust and the solicitor’s obligation to restore the funds was
extinguished once the underlying commercial transaction had been completed. There was
no reason for the specialist rules which had developed in relation to traditional trusts to be
applied in this commercial context. Lord Browne-Wilkipson emphasised that the
depositing of the money with the solicitor was just one aspect of the arrangements between
the parties, which were for the most part contractual.
73
For the current regulatory position on this practice, see SFA Board Notice 143, 6th
August 1993.
74
“On a market order, that is to say, to buy at market rate without limit of price (which I
find was the method most frequently used by the plaintiffs ...) [the defendant] could mark
up the price which they obtained from the market maker without telling the client they
had done so. The client would be stuck with the price at which their order was filled
29
agent. The plaintiff was therefore entitled to recover the amount of the mark-up
from the defendant.
3.42 This case demonstrates that the categorisation of a relationship in a contract is not
conclusive. It illustrates the point made in the consultation paper that in
determining whether a relationship is fiduciary the court will look at the substance
of a relationship in the light of its commercial context and the entirety of the
obligations undertaken by the firm, and not just at the label which is given to the
relationship in the contract.75We believe that this principle survives Kelly, and that
although -the terms of the contract are of primary importance in delimiting the scope
of fiduciary duties, the court will not give effect to a “mere shamyy76
which contrives
to evade the real nature of the relationship.
without having had an opportunity to accept or rejgct it. So there would be a sale by [the
defendant] to the client at a price which it had never been able to consider in
circumstances where the seller has taken no risk, knows the buyer’s position and is also
making a commission on the transaction ... . Such uncertainty, where the market may be
changing every second, illustrates how untenable [the defendant’s] position is.”
- .
75
See para 2.12 above and Consultation Paper No 124, para 3.3.12(iii).
76
Ex p Delhasse (1877) 7 Ch 5 11, 526, per James LJ; 532, per Baggallay LJ. See Consultation
Paper No 124, para 3.3.12(iii).
30
PART IV
LEGAL DEVELOPMENTS - DIRECTIVES,
STATUTES AND REGULATIONS
Introduction
4.1 In this part we consider legislative developments and examine the Directive on
Unfair Terms in Consumer Contracts;’ the Investment Services Directive;2 and Part
V of the Criminal Justice Act 1993.
Directive on Unfair Terms in Consumer Contracts

4.2 The UTCCD was implemented in the UK, under section 2(2) of the European
Communities Act 1972, as the Unfair Terms in Consumer Contracts Regulations
1994.3These regulations came into force on 1 July 1995 and were accompanied by
Guidance Notes issued by the DTI in July 1995.4 The directive subjects terms in
standard form consumer contracts to a requirement of fairness and therefore has a
potential impact on the effectiveness of duty defining/exclusion clauses in modifying
rights against fiduciaries so as to avoid a mismatch between fiduciary duties and
requirements imposed by regulatory rules. To a certain extent the UTCCD overlaps
with the Unfair Contract Terms’Act 1977 which was considered in detail in the
consultation papery5but it is in some respects wider and in other respects narrower
in its application. The DTI has considered the relationship between UCTA and the
UTCCD6 and despite the suggestions of many consultees to its original consultation
document’ that it should align the two, by equating the test of reasonableness in
UCTA with the test of fairness in the directive, it has come to the conclusion that
it is not possible to do so. While recognising that in most cases the application of
these tests will achieve the same result, the DTI considers “that it would be
inconsistent with the proper implementation of the directive to treat the concept of
’ Council Directive 93/13/EEC (OJ L95, 21.4.93, p 29).
SI 1994 No 3159. See generally, G H Treitel, The Law of Contract (9th ed 1995) pp 245-
259; Hugh Beale, “Legislative Control of Fairness: The Directive on Unfair Terms in
Consumer Contracts” in Good Faith and Fault in Contract Law (J Beatson, D Friedmann
ed 1995) p 231.
Department of Trade and Industry, The Unfair Terms in Consumer Contracts Regulations
1994 (SI 1994 No 3159) Guidance Notes (July 1995).
See para 2.12 above and Consultation Paper No 124, paras 3.3.24-3.3.38.
Department of Trade and Industry, Implementation of the EC Directive on Unfair Terms in

Consumer Contracts (93/13/EEC), A Further Consultation Document (September 1994).

Consumer Contracts (93/13/EEC), A Consultation Document (October 1993).
31
fairness as equivalent to the existing test of reasonableness in the Act”.’ As a result
the U T C C D creates a separate regime alongside UCTA.
4.3 Unlike UCTA, the U T C C D applies only in favour of natural persons acting for
purposes outside their trade, business or profession (referred to as ‘ ‘ C O ~ S U ~ ~ ~ S ” ) ~
and to contract terms which have not been “individually negotiated”.” However,
it is not limited to “exclusion clauses” and so any distinction between duty defining
and exclusion clauses is irrelevant.” On the other hand, terms which define the
main subject matter of the contract, or concern the adequacy of the price or
remuneration against the goods or services sold or supplied (the so called “core
provisions”) are excluded from the test of fairness, in so far as these are in.plain,
intelligible language.12In the financial services field the U T C C D will cover contracts
for the sale and purchase of securities and for the provision of advice and other
services (such as portfolio managernent).l3 The DTI takes the view that it does not
apply to the creation and issue of financial securities as the issuer is neither selling
goods nor supplying a service.14
4.4 The directive does not apply to terms which “reflect mandatory statutory or
regulatory provisions”. l5 This phrase is slightly confusing. The word “mandatory”
suggests requirements which must be followed or satisfied. The French text refers
to “dispositions ... imperatives” which in general means provisions which cannot be
contracted out of by the parties. However, recital 13 specifically states that this
Department of Trade and Industry, Zmplementation of the EC Directive on Unfair Terms in

Consumer Contracts (93/13lEEC), A Further Consultation Document (September 1994).
Art 2; regs 2(1), 3.
lo Art 3; reg 3.
I’
For a discussion on this point in relation to UCTA, see Consultation Paper No 124, paras
3.3.28, 3.3.31.
Art 4(2); reg 3(2).

l3
Unlike UCTA, the UTCCD also applies to insurance contracts although not to terms
which define and circumscribe the insured risk and the insurer’s liability, see recital 19.
Under the regulations, these restrictions are treated simply as examples of the “core
provisions”. See paras 3.26-3.27 of the Guidance Notes.
l4
A number of recitals make specific reference to the sale of goods and supply of services
(recitals 2, 5, 6 and 7) and the DTI has indicated that it regards the Directive as applying
only to such contracts (see Department of Trade and Industry, Zmplementation of the EC
Directive on Unfair Terms in Consumer Contracts (93/13lEEC), A Consultation Document
(October 1993) and paras 3.4-3.12 of the Guidance Notes). This is reflected in the
definitions of “seller” and “supplier” in the regulations (reg 2(1)) which differ in this
respect kom the definition of “seller or supplier” in the directive (Art 2(c)). For an
opposing view, see Hugh Collins, “Good Faith in European Contract Law” (1994) 14(2)
O E S 229, 242. On the specific question of shares and bonds, see paras 3.23-3.25 of the
Guidance Notes. On the question of scope, see also-Richard Thomas, “Unfair Terms in . ...
Consumer Contracts Regulations - The Impact in the Financial Services Industry” (May
1995) BJIB & FL 214, 217.
l5 Art l(2).
32
wording “also covers rules which, according to the law, shall apply between the
contracting parties provided that no other arrangements have been established”. It
therefore envisages that the phrase does cover provisions which the parties can vary
by agreement. In the light of this ambiguity the DTI has omitted the word
“mandatory” from the implementing regulations.’6The question remains, however,
as to what terms can be said to “reflect statutory or regulatory provisions”.
4.5 It seems that the exclusion was aimed at avoiding cases of “double jeopardy” where
a contract which satisfies accepted criteria under national or international law is then
susceptible to attack as unfair under the new dire~tive.’~ The full text of the
exclusion refers also to terms which reflect “the provisions or principles of
international conventions to which the Member States or the Community are party”
and a particular concern of a number of Member States was that terms which were
accepted in international conventions on transport should not be subject to further
scrutiny under the directive.”
4.6 Looking at the regulatory structure under the FSA, it seems clear that in so far as
the rules of the SIB and (probably) the SROs and RPBs” impose obligatory
requirements on firms carrying on regulated business, terms in the contracts
between the firms and their customers which incorporate those requirements cannot
be challenged as unfair under the UTCCD. At the other extreme, it cannot be said
that just because a firm operates in a regulated environment and complies with the
regulatory rules by which it is bound its contractual terms are above challenge.
There must, at the very least, be a direct correlation between the term and a
particular regulatory rule. Subject to this point, the exclusion contained in the
directive is capable of applying broadly, but much will depend on the interpretation
given by the courts and ultimately by the European Court of Justice.”
16
SI 1994 No 3 159, Sched 1. They have also slightly amended the wording of the provision
in the regulations so that it refers to any term “incorporated in order to comply with or which
reflects ... ”.
l7
See para 3.15 of the Guidance Notes.
See Depamnent of Trade and Industry, Implementation of the EC Directive on Unfair Terms
in Consumer Contracts (93/13JEEC), A Consultation Document (October 1993).
We consider that the rules of the SROs and RPBs would probably be considered as
“regulatory provisions” for these purposes even though they have no statutory rulemaking
powers since they operate within-a statutory framework‘set up under the FSA and, in
order to obtain recognition, must comply with the requirements of scheds 2 and 3
respectively of the Act which include provisions in respect of their rules. The same may
also be said of Recognised Investment Exchanges and Clearing Houses, see FSA, ss 36-39.
2o
One particular area of doubt may be the extent to which terms which reflect practices
which are “permitted” rather than “required” by the self-regulatory bodies could be
subject to challenge under the directive. See Richard Thomas, “Unfair Terms in
Consumer Contracts Regulations - The Impact on the Financial Services Industry” (May
1995) BDB & FL 214.
33
4.7 The U T C C D requires member states to ensure that terms which are “unfair” shall
not be binding on the consumer.21A term is to be regarded as unfair if (i) it is
“contrary to the requirement of good faith” and (ii) it “causes a significant
imbalance in the parties’ rights and obligations arising under the contract to the
detriment of the consumer”.22Good faith is not defined in the Directive but the
recitals provide guidance as to the factors which are relevant in its as~essment.’~
These are reflected in schedule 2 of the implementing regulations which provides
that regard shall be had to the following matters:
- the s-trength of the bargaining positions of the parties;

- whether the consumer had an inducement to agree to the term;
- whether the goods or services were sold or supplied to the special order of the
consumer;
- the extent to which the seller or supplier has dealt fairly and equitably with the
consumer.
4.8 It is difficult to assess how the unfairness test will be applied to duty defining and
exclusion clauses. Many clauses may be considered to cause a “significant
imbalance” in the parties’ rights to the detriment of the consumer. But to be unfair
they must also be contrary to the requirement of good faith. The factors to be taken
into account in assessing good faith are similar to those contained in schedule 2 of
UCTA for determining the “reasonableness” of a term for the purposes of certain
sections under the Act. It seems, therefore, that the concept of good faith may well
include elements of reasonablenes~.~~ In the circumstances it seems unlikely that
English courts will find that a term passes the UCTA reasonableness test but fails
the U T C C D fairness test. However, there may be cases where terms would be
contrary to the requirements of good faith and yet are deemed reasonable and vice
Further, the courts will be bound to follow any decisions of the European
Court of Justice on the meaning of “good faith” which could lead to a divergence
between the two concepts.
21
Art 6; reg 5.
22
Art 3(1); reg 4. Art 3(3) sets out an “indicative and non-exhaustive list of terms which
may be regarded as unfair”; see also sched 3 of the implementing regulations.
Recital 16.
24
The European Parliament recommended the introduction of a test of reasonableness in an
amendment to the original proposed Directive (Opinion of 20.11.91, Minutes 42 11 (PE
157.273)’ Amendment No 10) but the Commission did not take up this suggestion when
redrafting the Directive. According to Meryll Dean, “Unfair Contract Terms: The
European Approach” (1993) 56 MLR 581, at the Council meeting on 29 June 1992, when
the common position text was agreed it was made clear that reasonableness should form
part of the test of unfairness in Art 3(1).
25
Consumer Contracts (93113IEEC), A Further Consultation Document (September 1994).
34
Investment Services Directive
4.9 The ISD enables a firm authorised to provide investment services in one member
state to provide investment services in any other member state without requiring
local authorisation. The ISD places responsibility for authorisation and prudential
supervision on the “home state”26and gives responsibility for conduct of business
rules to the “host Home member states must draw up prudential rules
which require investment firms, inter alia, to “be structured and organised in such
a way as to minimise the risk of clients’ interests being prejudiced by conflicts of
interest between the firm and its clients or between one of its clients and another” .28
The rules of conduct to be drawn up by host member states must, as a minimum,
implement certain principles set out in the directive. These include the requirement
that an investment firm “tries to avoid conflicts of interests and, when they cannot
be avoided, ensures that its clients are fairly treated”.29
4.10 The ISD is due to be implemented by measures coming into force no later than 31
December 1995. The Treasury and the SIB have published consultation documents
on its implementation which do not propose widespread changes to the existing
structure.30Very broadly, the FSA will be amended by regulations to allow firms
authorised to conduct ISD investment business in other member states to carry on
that business in the UK without seeking authorisation here, subject to a notification
procedure. These “passported” firms will either become members of the relevant
SRO for their business (in which case they will have to abide by the conduct of
business rules of the SRO) or they will be regulated direct by the SIB. Section 48
of the FSA will be amended so as to apply to passported firms broadly in the same
way as it does to UK authorised persons, including the power for the SIB to
designate rules to apply to them under section 63A.31No significant changes are
proposed to the substance of the rules and principles themselves, although a clearer
distinction between “prudential” rules which are the responsibility of the home state
and “conduct of business” rules which are the responsibility of the host state is
envisaged.
26
The state where the investment f m ’ s registered ofice or, if it has no registered office, the
state where its head office is situated, Art l(6).
27
The state in which the investment firm has a branch or provides services, Art l(7).
28
Art 10.
29
Art ll(1).
30
H M Treasury, Implementation of .the Investment Services Directive and the Capital Adequacy
Directive, A Consultation Document issued by HM Treasury (July 1994); SIB, Implementation
of the Investment Services Directive and Capital Adequacy Directive, Discussion Paper (July
1994). The SROs have also issued consultation documents; see for example SFA, The
Investment Services Directive, Board Notice 194 (14 July 1994); IMRO, Implementation of The
Investment Services Directive, Consultation Document 23 (June 1995); -PIA, Implementation of
the Investment Services Directive and Capital Adequacy Directive, Information Document (May
1995).
31
See Consultation Paper No 124, paras 2.5.6-2.5.9. See also para 5.3 below.
35
4.1 1 In the consultation paper we considered very briefly a draft of the directive and
noted that any Chinese wall arrangement that was recognised by the implementing
legislation would be squarely part of public law which could override the common
law.32In fact, the implementing legislation will not deal with Chinese walls directly,
but it will allow the SIB to apply its existing conduct of business rules, including
those made under section 48(2)(h) which deal with Chinese walls,33to passported
firms in the same way as UK firms.34We do not consider, therefore, that the ISD
itself has any effect on the extent to which Chinese wall arrangements may be
regarded as having public law authority so as to modify inconsistent common law
and equitable duties.35 However, the directive is relevant in considering how any
reform which we propose is to apply to passported firms.36
Criminal Justice Act 1993

4.12 The Company Securities (Insider Dealing) Act 1985 has been repealed by the
Criminal Justice Act 199337and replaced by Part V of the latter Part V is
intended to implement the Insider Dealing Dire~tive.~’ Although Part V differs in
a number of respects from the 1985 Act, these differences have no significance for
any of the issues addressed in this report. Insider dealing remains a criminal
offence.40Therefore what was stated in the consultation paper with respect to the
1985 Act, that the law would not compel a fiduciary to disclose information where
such disclosure would constitute a criminal offence,41applies with equal force to
Part V.
32
Consultation Paper No 124, para 4.6.2. See further on the public law aspects of Chinese
walls paras 7.19-7.30 below.
33
See para 5.4 below. See also Consultation Paper No 124, paras 5.3.16-5.3.22.
34
What constitutes “conduct of business” rules for the purposes of the ISD may not be
exactly the same as what are at present referred to as conduct of business rules by the
various regulatory bodies. If particular regulatory requirements are in fact “prudential”
rules for the purposes of the ISD they may not be applied to the passported firms. The
ISD does not refer specifically to Chinese walls although both Art 10 (conduct of business
rules) and Art 11 (prudential rules) refer to conflicts of interest (see para 4.9 above). We
consider that rules on Chinese walls made under FSA, s 48(2)(h) do qualify as conduct of
business rules for these purposes.
35
Our views on this point are set out at paras 7.19-7.30 below.
36
See para 16.17, n 41, n 42 below.
37
Criminal Justice Act 1993, Sched 6. I
38
Part V came into effect on 1 March 1994. See also Money Laundering Regulations SI
1993 No 1933; Insider Dealing (Securities and Regulated Markets) Order SI 1994 No
187; Traded Securities (Disclosure) Regulations SI 1994 No 188.
39
40
Criminal Justice Act 1993, s 52(3). The penalties are set out in s 61. As with the 1985
Act, breach of Part V does not render any contract-void or unenforceable; s 63(2). This
does not mean that the contract, if executory, would be enforceable; see Chase Manhattan
Securities Ltd v Goodman [1991] BCLC 897.
41
Consultation Paper No 124, paras 4.5.16-4.5.17, 4.5.25.
36
PART V
REGULATORY DEVELOPMENTS
Introduction
5.1 In this part we examine recent regulatory developments. We consider the Large
Report,’ which made recommendations about the future of financial services
regulation; the recognition of a new self-regulating organisation, the PIA, which was
set up to regulate the investment business primarily done with or for the private
customer; and the recent changes to the rules on disclosure of commission.2
The Large Report

5.2 In July, 1992, in the wake of the Maxwell affair, the Chancellor of the Exchequer
asked Andrew Large, the chairman of the SIB, to undertake a review of the way the
SIB carries out its responsibilities under the FSA with particular reference to the
way it exercises oversight of the recognised bodies for which it is respon~ible.~
The
Large Report sets out his findings and conclusions. The main recommendations of
the report have now been substantially im~lernented,~ but further changes to the
regulatory structure are under c~nsideration.~
5.3 For the purposes of the present project the most important point arising from the
Large Report was the recommendation that the SIB should act more as a standard
setter and less as a formal legislator, and that the recognised bodies should be given
greater freedom to develop their own rules.6 Large recommended that the SIB’S
power to designate rules should be used more sparingly in the future and that, in
due course, existing core conduct of business rules should be de-designated.’ This
recommendation has now been implemented and, with the exception of Rule 36 and
Rule 40(4)(a) and (b) (so far as relevant to Rule 36), the Core Rules are no longer
designated.’ This means that any recommendation for reform which was dependent
upon the previous structure of designation of Core Rules would conflict with the
new approach and be impractical.’
’ Large, Financial Services Regulation - Making the Two Tier System Work (May 1993).
The Financial Services (Conduct of Business) (Product and Commission Disclosure)

Rules 1994.
The full terms of reference are set out on page 1 of the Large Report.
See SIB, Annual Report 199411 995 p 1 1.
See “SIB to press for rewrite of City rules” Financial Tihzes 19 July 1995.
Large Report, chapter 6.
Large Report, paras 6.10-6.1 1.
The Financial Services (Dedesignation) Rules -and ReguIations 1994.
It also means that any reform would have to be sufficiently flexible to cope with changes
to the rulebooks of the self-regulating organisations and with any additional changes to the
regulatory regime which may prove necessary in the future.
37
5.4 Core Rule 36 deals with Chinese walls. In its consultation document prior to
dedesignation” the SIB indicated that, because doubts had been expressed in the
past about the efficacy of Chinese walls at common law, it seemed “appropriate that
firms should continue to enjoy the statutory comfort which can be conferred by a
designated SIB rule”.” We have already summarised our conclusions in the
consultation paper on the effectiveness of Chinese walls as a matter of private law
and given our views on the impact of recent legal developments on those
conclusions.” We discuss in Part VI1 below how far Chinese walls arrangements can
be said to have statutory recognition as a result of the designated Core Rule 36.13
The Personal Investment Authority

5.5 A further example of changes to the regulatory regime is the setting up of the PIA
which was recognised by the SIB as a self-regulating organisation with effect from
18 July 1994. The PIA’s role is to regulate investment business which is primarily
done with or for the private customer. Its members have been drawn largely from
those firms which were previously members of FIMBRA and LAUTR0I4 (which are
being d i ~ b a n d e d ) .The
’ ~ PIA’s initial “transitional framework” of rules relies on and
incorporates substantial parts of the existing rules of FIMBRA and U U T R O , but
it is introducing its own rules in stages, following extensive consultation with
member firms.16
Rules on disclosure of commission

5.6 In the consultation paper we explained that for an agent to take a commission, full
disclosure must be made to the customer. We expressed the view that, unless
validated by custom or within the “usual practice rule”,17disclosure of only the basis
of commission is unlikely to satisfy common law requirements. In the field of life
insurance the rules on disclosure of commission have been tightened up
considerably, following concern initially expressed by the Office of Fair Trading that
it was necessary to increase disclosure requirements to ensure market
Io
SIB, Dedesignation of n e Core Conduct of Business Rules, The Client Money Regulations and
The Financial Supemision Rules, Consultative Paper 83 (August 1994).
Zbid, para 11.
See paras 2.16, 3.33-3.35 above. For further discussion on this point, see paras 7.12-7.18
below.
l3 See paras 7.19-7.30 below.

l4
See Consultation Paper No 124, para 2.5.1 1.
I5
The SIB revoked the recognitions of FIMBRA and LAUTRO as SROs in June 1994.
Revocation was made subject to a transitional wind-down period which has been extended
to 1 October 1996.
l6
The PIA’s primary concern has been to produce rules in relation to the ISD and Capital
Adequacy Directive, but it hopes to cover all areas in the course of 1996.
”
38
competitiveness.” New rules have been issued by the SIB,” the most significant
parts of which came into effect on 1 January 1995. It is now necessary for sellers of
life insurance to provide, amongst other things, full details of all commission to be
received (including non-cash benefits such as the use of a company car) in writing
before the contract is concluded.” We consider that the new rules will satisfy the
common law requirements of full advanced disclosure of commission in the area
which they cover.
5.7 In the area of non life products, such as unit and investment trusts, the PIA has also
proposedz1 major changes to the content and form of information to be given to
customers. The new rules which have been put forward would involve a regime
similar to that for life insurance. It is envisaged that these will be operative by the
second half of 1996.
18
Office of Fair Trading, The Marketing and Sale of Investment-Linked Insurance Products
(March 1993); Office of Fair Trading, Fair Trading and Life Insurance Savings Products
(March 1993).
The Financial Services (Conduct of Business) (Product and Commission Disclosure) Rules
1994. . .
Zbid, Part 5.
PIA, Consultative Paper No 8, Product and Commission Disclosure (1995); PIA, Consultative Paper
No 2, Product and Commission Disclosure (1994).
39
SECTION C
THE ISSUES ARISING FROM
CONSULTATION
PART VI
SUMMARY OF PROVISIONAL
CONCLUSIONS AND CONSULTATION
ISSUES
Introduction
6.1 In this section we examine the responses received to the consultation issues and
consider their impact on our provisional conclusions. We deal with each of the
questions raised in the consultation paper in turn in Parts VII-MI. Before doing so,
we summarise our primary provisional conclusions on the issues on which
consultees were invited to comment.'
Provisional conclusions and consultation issues

6.2 First, we said that as a general rule, neither exclusion clauses nor disclosure and
consent were a foolproof means of modifymg the normal incidents of a particular
fiduciary relationship so as to avoid any mismatch between fiduciary duties and the
duties imposed by regulatory rules.2 Second, we said that it was unclear whether,
as a matter of private law, the existence of an effective Chinese wall would provide
protection to a fiduciary in a conflict ~ i t u a t i o nFinally,
.~ we concluded that although
this might already be the law, the uncertainties about the current position should
be resolved by a statutory rule that the court should take account of reasonable
regulatory rules in ascertaining the precise content of relevant fiduciary obligation^.^
6.3 We also considered four further legislative possibilities in the consultation paper:
first, the codification of fiduciary d ~ t i e s secondly,
;~ the legitimation of generalised
advanced consen& thirdly, a change to the rules of attribution within a corporation
or partnership so that the present irrebuttable presumption of knowledge between
' Our provisional conclusions on a number of the matters, and the reasons for them, have
already been summarised at paras 2.3-2.16 above in considering the impact of recent legal
and regulatory developments.
* Consultation Paper No 124, para 7.9.
Zbid, para 7.13. We did suggest, however, that there may be a public law solution in so far
as rules made under FSA, s 48(2)(h) may modify common law and equitable duties; see
Consultation Paper No 124, para 7.20. See also paras 7.19-7.30 below.
. .
Consultation Paper No 124, paras 7.22-7.23.
Ibid, para 7.25(i).
Ibid, para 7.25(ii).
40
different parts of an organisation would be replaced by a rebuttable p r e s ~ m p t i o n ; ~
and finally, that legislation could provide for the exculpation of fiduciaries who,
although they have breached their fiduciary duties, are considered by the court tQ
have acted honestly and reasonably.' We provisionally concluded that the first of
these was both impractical and undesirable and that the second was unattractive as
it might not make an adequate distinction between acceptable and unacceptable
practices. We did not form any provisional view on the remaining two possibilities.
We will now consider respondents' views on these matters and on the specific issues
on which comment was invited.
Ibid, para 7.25(iii).
* Ibid, para 7.25(iv).
41
PART VI1
MODIFICATION OF THE NORMAL
INCIDENTS OF A FIDUCIARY
RELATIONSHIP BY EXCLUSION CLAUSES,
DISCLOSURE AND CONSENT, AND
CHINESE WALLS (Question 1)
Consultation issue
7.1 The first matter on which we invited comment was set out in the following terms
in the consultation paper:'
Can conflicts between fiduciary duties and what is permitted by the regulatory
rules be completely avoided by the use of all or some, and if so which, of the
following methods of modifying the normal incidents of a particular fiduciary
relationship:
(a) exclusion clauses,
(b) disclosure and consent, and

! ,
(c) Chinese walls?
Our provisional view is that, under private law, they cannot.
Summary of respondents' views

7.2 Respondents to the consultation paper were divided in their views on this issue.
Most of the financial services practitioners said that these methods were completely
effective, while most of their legal advisers and most of the academic lawyers who
replied thought that they had limitations. Overall, at the initial stages of
consultation, there was uncertainty as to the extent to which these methods were
capable of modifylng particular aspects of fiduciary duties. However, after the
decision of the Privy Council in KeZlyJ2a number of respondents, including the SIB
and several legal practitioners, indicated that they now considered that contractual
techniques, and in particular duty defining clauses, should be effective in most
circumstances. Few comments were received from those operating in sectors other
than the financial services industry, but comments from accountancy and surveyors'
interests indicated that problems of mismatch between fiduciary duties and
regulatory rules rarely occurred, because t h e regulatory rules governing those
activities tended to require full disclosure and consent in conflict situations. There
- .
' Consultation Paper No 124, pp 240-241.
See paras 3.24-3.36 above.
42
follows an analysis of the breakdown of opinion on the separate points raised in the
question.
Exclusion clauses
7.3 At the stage of written submissions, most of the respondents who addressed this
issue thought that exclusion clauses, and more particularly duty defining clauses,
circumscribed the extent of fiduciary duties, although a small number thought that
they would not always do so. Few gave any reasons in support of their view.
However, after the decision in Kelly there was virtual unanimity among those who
made further submissions to us that exclusion and duty defining clauses were an
effective means of varying the incidents of a fiduciary relationship. Although some
respondents acknowledged that these techniques might not always prevent the
introduction of new duties into a relationship as it evolved, this was not regarded
as a major problem. One respondent suggested that if a firm did not manage its
relationships with its clients in such a way as to avoid the introduction of new duties
over time, it did so at its own risk. We examined Kelly in detail in paragraphs 3.24-
3.36 above, and concluded that it is now clear that the scope of the fiduciary duties
owed by an agent to his principal is defined by the express and implied terms of the
contract of agency, and that a clear and unambiguous3 duty defining or exclusion
clause will delimit the scope of the fiduciary duties owed to the ust tom er.^ However,
in determining whether a relationship is fiduciary, and if so the extent of the
fiduciary duties, its description in the contract will not be conclusive if it does not
reflect the true substance of the relati~nship.~
Disclosure and consent

7.4 Two thirds of the respondents who commented on disclosure and consent, thought
that in the consultation paper we had taken too narrow a view of the circumstances
in which general advanced disclosures would be effective. The main reason they
gave was that, where general advanced disclosure was sanctioned by regulatory
rules, this situation would give rise to a trade custom permitting a reduced level of
disclosure. Another reason given by one respondent was that the courts might be
prepared to adapt to modern day realities and accept that conflicts of interest are
inevitable in multifunctional financial conglomerates, and to take a more flexible
position on general advanced disclosure in some (unspecified) circumstances,
alrhough he acknowledged that there was no clear authority to support this
proposition.
Exclusion clauses are strictly construed against the person who seeks to rely on them, ie
contra proferentem; see para 2.12 above.
See paras 3.25, 3.29 above. Exclusion and duty defining-clauses will also be subject to the
controls imposed by UCTA and the Directive on Unfair Terms in Consumer Contracts,
where applicable; see paras 2.12, 4.2-4.8 above.
See paras 2.12, 3.41-3.42 above.
43
7.5 As to the first reason given, where a general advanced disclosure is made in a
contract it is not necessary to turn to the rules on trade custom to establish whether
I
it is effective to limit the extent of the fiduciary's duties. This is because it is now
clear that the scope of an agent's fiduciary duties can be defined by the terms of his
contract with his principal.6 However, it is necessary to consider whether the rules
on incorporation of a contractual term by trade custom make other forms of
disclosure (or non-disclosure) effective where permitted by regulatory rules. The
rules on incorporation of terms into contracts by trade custom were summarised in
paragraph 2.8 above. We said in the consultation paper' that, as a general rule,
there would be little difficulty in proving that the rules of regulatory bodies satisfied
the factual requirements for trade customs. However, once it had been established
that a regulatory rule fulfilled the requirements of a trade custom, we said that it
would only be incorporated into the contract if it was reasonable. It was our
provisional view that a custom which modified a firm's fiduciary duty would usually
be held to be unreasonable, and that it would not, therefore, bind the customer in
the absence of his fully informed consent. However, we noted the possibility that a
trade custom which permitted a fiduciary to act in a position of conflict might be
held to be reasonable if it did so only where the trade custom protected the
customer's interests, for example, by fixing a fair price at which orders were to be
matched.*
7.6 Although a number of respondents disagreed with our conclusions on the law
relating to trade customs, none cited any authority in support of their view, other
than those we had already discussed in the consultation paper.g In Kelly and Clark
Boyce the Privy Council did not consider the rules on incorporation of terms into
contracts by trade custom." However, we believe that these cases indicate that the
courts will adopt a less restrictive approach to the interpretation of fiduciary duties
than we thought likely at the time of the consultation paper. An important feature
of Kelly for the purposes of this discussion is that the Privy Council implied a term
that the estate agent did not have to divulge relevant confidential information and
that this implication arose from the structure of the industry.'' We, therefore,
believe that in future cases the court will follow Jones v C ~ n u v a n and
' ~ hold a trade
Kelly v Cooper [1993] AC 205 and Clark Boyce v Mouat [1994] 1 AC 428. See paras 3.24-
3.40 above.
' Consultation Paper No 124, para 3.2.12.
North and South Trust COv Berkeley [1971] 1 WLR 470; Jones v Canavan [1972] 2
NSWLR 236. See paras 2.8-2.10 above.
Consultation Paper No 124, section 3.2.
lo See para 3.36 above.

- .
On the position in relation to stockbrokers, see n 14 below.
[1972] 2 NSWLR 236. See paras 2.8-2.10 above and Consultation Paper No 124, paras
3.2.20-3.2.21.
44
custom which permits a fiduciary to act in a situation of conflict to be reasonable
if it incorporates adequate protection for the customer’s interests. If so, in situations
where a regulatory rule permits a lower level of disclosure than that required of a
fiduciary by common law and equity, the court might be willing to hold that it is an
implied term of the contract that the customer is entitled only to the level of
disclosure permitted by the relevant rule, provided that it incorporates adequate
protection for the customer. For example, SFA Conduct of Business Rule 5-33(3)
permits a broker who simultaneously matches the transactions undertaken by two
customers, taking a commission from each, not to disclose to either customer the
nature or amount of the commission received from the other.13 The courts might
nowl4 hold that it is a trade custom that the firm is able to match transactions
without disclosing the double commission it has received, and that this custom is
incorporated into the contract with the customer because the customer’s interests
are adequately protected by SFA Conduct of Business Rule 5-39 which provides
that the firm must provide best execution.15
7.7 Another example is the disclosure of soft commission arrangements in accordance

with IMRO Rule 1 .7.16This rule provides that before a firm enters into a customer
agreement authorising it to effect transactions for the customer under a soft
commission agreement, it must inform the customer in writing of the existence of
the soft commission agreement and the firm’s policy relating to soft commission
agreement^.'^ It must also send an annual report to the customer giving details of
several matters. These must include the percentage of total commission paid by the
firm under soft commission agreements, the value of goods and services (“softing
services”) received by the firm expressed as a percentage of the total commission
paid by the firm, a summary of the softing services received by the firm, a list of
counterparties to soft commission agreements, and the total commission paid from
13
See SFA Conduct of Business Rule 5-34 and Consultation Paper No 124, para 3.4.23 on
disclosure where the firm is required to send a contract note to the customer.
In Kelly the Privy Council said that it was clear that stockbrokers could not be
contractually bound to disclose to one customer information obtained from another, and
indicated that such an agent must be entitled to act for other customers selling competing
shares. But it was not made clear whether the court would imply a limit on the fiduciary
duty of undivided loyalty where a broker matches the transactions of two customers.
Although the decision in Kelly does not extend to the situation where an agent acts for two
parties in the same transaction (see paras 3.27 and 3.31 above), we believe that since
matching transactions is a simple case in which the customer is adequately protected by
the requirement of best execution, the courts would probably adopt the more flexible
approach to implication by custom outlined in the text above.
l5
See Consultation Paper No 124, paras 3.4.21-3.4.25 on disclosure of double commission.
l6
See also SFA Conduct of Business Rule 5-8.
l7 IMRO Rule 1.7(3).
45
the portfolio of that customer.’* We explained in the consultation paperlg that,
although this disclosure would probably protect the firm from liability for placing
1
itself in a position where its duty to the customer conflicted with its own interest,
it might not protect the firm from liability for making a secret profit (by retaining
the element of the softing services which is attributable to the customer’s transaction
without making full disclosure of this element and obtaining the customer’s consent
to its retention). However, if a court were to adopt the wider approach to
implication by trade custom, we believe that it would hold that the level of
disclosure required by the rules would be sufficient and that there was no secret
profit. This is because the rules on soft commission are designed to ensure that
customers’ interests are safeguarded. They specify that the only benefits which may
be provided under a soft commission agreement are those which can reasonably be
expected to assist in the provision of investment services to customers, and which
are so used; that the broker must agree to provide best execution; that the firm must
be satisfied that the terms of business and methods by which the relevant broking
services will be supplied do not involve any potential for comparative price
disadvantage to the customer; and that in transactions in which the broker acts as
principal the firm is satisfied that commission paid under the agreement will be
sufficient to cover the value of the softing services to be received and the costs of
execution.20
7.8 This argument that a trade custom which is underpinned by regulatory rules and
which incorporates adequate protection for the customer permits a reduced level of
disclosure would not assist in cases where the regulatory rule is regarded merely as
setting the minimum standard of disclosure, and it is common practice to make
further disclosure. In those cases it would be difficult to show that there was a
sufficiently uniform and certain course of conduct to amount to a trade custom. Nor
will the argument necessarily provide a solution in cases where the regulatory rules
do not address the question of disclosure. If the rules permit a practice which
conflicts with fiduciary requirements, but do not address the question whether that
practice should be disclosed to the customer, the need to obtain the informed
consent of the customer to the practice will only be obviated as a matter of custom
if the practice itself satisfies the requirements of a trade custom. For example, Core
Rule 36 on Chinese walls does not specify whether or not it is necessary to disclose
that a Chinese wall is in place, and it appears to assume that it is not necessary to
obtain the consent of the customer where information has not passed across the
The variety in the type and monitoring arrangements of Chinese walls which
IMRO Rule 1.7(4).

l9
. .
‘O IMRO rule 1.7(1).

”
See Consultation Paper No 124, para 4.5.13. The full text of Core Rule 36 appears at
Appendix C.
46
can satisfy the rule make it unlikely that a sufficiently certain and uniform practice
can be established in relation to Chinese walls to enable the use of any particular
Chinese wall to constitute a trade custom.22
7.9 The position where the regulatory rules do not address the practice in question at
all is even clearer. One example is the rule relating to the disclosure of commission
to a non-private customer.23 In such circumstances it cannot be argued that a
regulatory rule authorising a lower level of disclosure has been incorporated into the
contract. Although it may be anomalous for a lower level of disclosure to be
permitted ig relation to a private than a non-private customer, if the rules do not
address the issue there is no conflict between common law and equitable
requirements and the provisions of the regulatory rules, and the matter is outside
the remit of this project.
7.10 We indicated above24that one respondent considered that we had taken too narrow
a view of the circumstances in which general advanced disclosure would be effective
because the courts would adapt to modern day realities. In the light of the Privy
Council decisions in Clark Boyce and Kelly, we agree that the courts are adopting
a less restrictive approach to questions about fiduciary duties where a fiduciary
relationship has a contractual basis.25We now believe that a sufficiently precise
general advanced disclosure made in a contract will be effective provided that the
contract clearly delimits the fiduciary duties owed to the customer and displaces the
obligation to make full disclosure of all material facts, and the customer has not
been misled as to the nature of the relationship between the parties.26 We also
believe that when issues about informed consent arise, the court will look at
precisely what services were required of the fiduciary when assessing whether there
has been adequate disclosure of material facts and it will not require disclosure of
matters which fall outside the scope of the contractual
Chinese walls
7.11 This part of the question raised two issues: first, whether Chinese walls modify
fiduciary duties as a matter of private law; and second, whether, as a matter of
public law, section 48(2)(h) of the FSA authorises the SIB to make a rule (Core
22
Although, as we explain in paras 7.19-7.30 below, Chinese walls may be susceptible to
another solution; they may be effective as a matter of public law. See paras 2.16, 3.33-3.35
above and 7.11-7.30 below on Chinese walls generally.
23
SFA Conduct of Business Rule 5-33(2), which permits'limited disclosure of commission,
applies only to private customers. See Consultation Paper No 124, paras 3.4.19, 5.3.13-
5.3.15 on SIB Core Rule 18(2).
24 Para 7.4.
25 See paras 3.24-3.40 above. See also Target Holdings, para 3:40, n 72 above.
26
See paras 3.25, 3.29, 3.40 above.
47
Rule 36) modifying both the duty of disclosure which arises under the undivided
loyalty rulez8and the present law on attribution of knowledge within a single entity.
As a matter of private law

7.12 On the first issue, a number of respondents disagreed with our provisional
conclusion that as a matter of private law, the Chinese wall did not afford the type
of protection that is needed for a firm to carry on its functions with the degree of
assurance that the wall is designed to provide.” They considered that Chinese walls
could prevent the attribution of knowledge. The main reasons3’ they gave were that
too muckemphasis had been placed on the law firm disqualification casesJ31that the
decision in Kelly opened the way for the legal recognition of Chinese walls, and that
the consultation paper’s analysis of the law on attribution of knowledge was faulty.
7.13 It is helpful to distinguish three different stages in considering whether Chinese

walls can offer sufficient protection to firms as a matter of private law. The first
concerns the process of acquisition of knowledge by the firm; the second addresses
the issue of whether knowledge, once acquired by a firm, is treated as being in the
possession of all parts of the firm; the third considers how far it is possible to escape
the consequences of knowledge. The law firm disqualification cases and Kelly are
relevant to the third stage. The criticisms on attribution relate to the second stage.
The first stage is important since if there is no acquisition of knowledge by the firm
in the first place there can be no conflict of duty in respect of that knowledge.
7.14 We considered the law on the acquisition of knowledge in paragraphs 2.3-2.6 and
3.2-3.23 above.32We concluded that knowledge would be acquired by a company
where either (i) the status of the person within the firm who has acquired the
knowledge (“the agent”) with respect to the relevant transaction results in his
knowledge being that of the firm;33 or (ii) where knowledge is attributed under
28
See para 1.4 above.

30
A number of respondents also referred to the case of Bowater v Norton Opax. This was an
interlocutory, unreported decision of Brooke J in chambers (5 September 1989), in which
he refused to grant an injunction on the application of a party to a takeover struggle,
which objected to a fm, whose services it had previously used, now acting for the party
with which it was in conflict, even though effective Chinese walls were in place in that
fm.
3’
Re a Solicitor (1987) 131 SJ 1063; Lee (David) do (Lincoln) Ltd v Coward Chance
[1991] Ch 259; Re a Firm ofSolicitors [1992] 1 All ER 353. See further Consultation
Paper No 124, paras 4.5.7-4.5.11. See Re a Firm ofSolicitors [1995] 3 All ER 482, for a
recent discussion of these cases.
32 . .
See also paras 12.4-12.13 below.
33
As indicated above, Meridian has confirmed that it is a question of construction in each case
whether the knowledge of the agent will be attributed directly to the company for the
purposes of the particular transaction in question; see para 3.23 above.
48
normal rules of agency because, adopting the categories of Hoffmann LJ in El
A.024,~~either the knowledge of the agent is directly material to the transaction, or
the firm has a duty to enquire, or the agent has actual or ostensible authority to
receive communications on behalf of the firm. If any of these conditions are satisfied
the knowledge will be treated as being the knowledge of the firm even if it was not
communicated to it by the agent.
7.15 In the consultation paper we said that where the firm is a company, then as a matter
of principle any matter known by one part of the firm would be known by all parts
of the firm.35A Chinese wall will not prevent the attribution of knowledge between
the component parts of the firm.36The criticisms of our analysis on this point are
addressed at paragraphs 12.5-12.7 below. For the reasons given there, we still
consider that the statement is correct, since it flows from what we regard as a
principle that there cannot be “partial ignorance”, and since no one has cited any
case which recognises such a state.
7.16 The key question, therefore, is the extent to which the firm can escape the
consequences of knowledge. With regard to the impact of the law firm
disqualification cases, we explained in the consultation ~ a p e ?that
~ the reasoning
in these cases could not automatically be transferred to relationships other than
those between lawyer and client, because it was influenced by special considerations
which are unique to the lawyer-client relationship. Our doubts about the
effectiveness of Chinese walls, on their as a means of preventing breach of
fiduciary duty were not based primarily on those cases, but on the “undivided
loyalty” and “no conflictyyprinciples of fiduciary law which, in the absence of
anything in a contract to the contrary, mean that the fiduciary must not place itself
in a position where its own interest conflicts with that of a customer or where its
duty to one customer conflicts with the duty owed to another, and that it must
make available to a customer all the information in its possession that is relevant to
that customer’s affair^.^'
7.17 As explained in paragraphs 3.34-3.35 above, in the light of the decision in Kelly we
have reconsidered our provisional conclusion on the effectiveness of Chinese walls
1
34
See para 3.8 above.
35
Consultation Paper No 124, paras 2.3.6-2.3.7. See also para 2.5 above.
36
Although it might do so as between different companies which form part of a group. See
paras 2.5 above and 12.10 below.
37
38
As we stated in the consultation paper, if the informed consent of the customer is obtained
to the use of the Chinese wall to staunch information flows within the firm, the Chinese
wall will provide protection; Consultation Paper No 124, para 4.5.16 and para 2.16 above.
39
See para 1.4 above and Consultation Paper No 124, paras 2.4.9, 4.5.17-4.5.18, 4.5.25.
49
on their own4' as a means of preventing breach of fiduciary duty. We indicated that
Kelly does not legitimise Chinese walls in themselves as a means of managing
conflicts of interest and of duty. However, we believe that the approach taken in
Kelly will generally mean that a Chinese wall will protect a firm where different
departments on either side of the wall are acting for different customers in different
transaction^.^' But, where either (i) a firm's own interest on one side of a Chinese
wall conflicts with the interests of a customer for whom another department of the
firm on the other side of the wall is acting, or (ii) different departments of a firm on
the opposite sides of a Chinese wall act for different customers in the same
transaction the firm, while not being obliged to use confidential or inside
information for the customers, might breach the duty not to put itself in a position
of
7.18 Reasons have already been given why the variety in the type and monitoring
arrangements of Chinese walls which can satisfy Core Rule 36 means that they are
unlikely to satisfy the requirements of a trade custom.43We, therefore, remain of the
view expressed in the consultation paper that unless appropriate provision is made
in an express contractual term, Chinese walls cannot, as a matter of private law,
always be relied upon as a means of modlfying a firm's duty not to put itself in a
position where its duty towards one customer conflicts with the duty that it owes to
another customer, or with its own interest.
As a matter of public law

7.19 In relation to the second issue, our provisional view was that, although the matter
was not without doubt, FSA, section 48(2) (h) probably authorised rules which
modified the common law and equitable duties owed to the customer to disclose or
make use of relevant information where a Chinese wall was used.44This view was
based on the wording of section 48(2)(h) which authorises the making of rules:
enabling or requiring information obtained by an authorised person in the course

of carrying on one part of his business to be withheld by him from persons with
whom he deals in the course of carrying on another part and for that purpose
enabling or requiring persons employed in one part of that business to withhold
information from those employed in another part.
40
Ie in the absence of a contractual provision permitting their use; see para 3.35 above.
4'
Although it was pointed out that much will depend on whether the court takes a wide or
narrow view of Kelly; para 3.32 above.

- .
44
Consultation Paper No 124, paras 5.3.20-5.3.21, 5.4.1. On the question of acting in a
position of conflict, see para 7.21 below.
50
7.20 We said tha as a firm could not be ‘‘enabled’’ to withhold information if it was in
any event free to do so, it could be argued that the subsection must be concerned
with the situation where there was a common law or equitable duty of disclosure.
If that was correct we said that unless the section empowered the modification of
such duty, a firm would not be “enabled”. We also pointed out that if the section
did not empower the modification of the common law or equitable duty of
disclosure, a regulatory requirement to “withhold” information would subject a firm
to conflicting regulatory and fiduciary duties. The reason for this was that
withholding information, as “required” by the regulatory rules, would necessarily
constitute a breach of the common law or equitable duty to disclose the
information, while disclosure to satisfy the general law would necessarily breach the
regulatory “ r e q ~ i r e m e n t ”We
. ~ ~indicated that this interpretation of the subsection
was supported by an additional factor, the fact that by FSA, section 48(6),
compliance with rules made under section 48(2)(h) is a defence to a criminal charge
under section 47.46We said that to that extent it was clear that the rules had an
effect beyond the regulatory scheme. We suggested, moreover, that it would be odd
if that which was required to avoid criminal and regulatory liability automatically
involved exposure to another kind of liability (for breach of common law or
equitable duties) .47
7.21 In considering the effect of rules made under section 48(2)(h) in the consultation
paper, our discussion centred on the obligation to disclose or to use information. It
is of course equally important from a firm’s point of view that it should not be
regarded as having breached its obligations simply by the fact of continuing to act
in a situation where it owes conflicting duties to two customers on either side of a
Chinese wall, or where its own interests on one side of the wall conflict with those
of a customer on the other side. This distinction between using information and
acting in a conflict situation was highlighted earlier in considering the impact of
Kelly on Chinese walls.48In so far as section 48(2)(h) and Core Rule 36 authorise
a firm to withhold information in certain situations, we consider that they also
authorise the firm to act despite the conflicts which necessarily arise in those
situations. In other words, although section 48(2)(h) and Core Rule 36 only refer
to the withholding of information, by implication they also have the effect of
enabling a firm to act in a position of conflict.
7.22 Most of the respondents who commented on our provisional view, agreed with it.
However, three respondents disagreed with that view. Two suggested that Core Rule
36 was ultra vires. One of those, Mr A G J Berg, put forward two reasons for this
45
46
See para 7.23 below. The full text of FSA, ss 47 and 4816) appears at Appendix B.
47
51
point of view. First, he said that rules made under section 48, including those made
under paragraph (h) of subsection (2), must “regulate the conduct of investment
b u s i n e s ~ ”To
. ~ ~do so they must impose “Obligations or restrictionsn on the activities
of authorised persons.50 Core Rule 36 does not impose sufficient obligations or
restrictions since it leaves it to each individual firm to decide what information it
will disclose to or withhold from the people with whom it deals and the
circumstances in which such information will be disclosed or withheld. It cannot
therefore, according to Mr Berg, be construed as regulating investment business.51
However, the case on which Mr Berg relies is clearly directed at the interpretation
of the particular statutes under consideration, namely the Agricultural Marketing
Acts. These Acts contained sections which set out various mandatory and optional
provisions which were to be included in schemes set up under the Acts. The court
took all those provisions into account in deciding whether the scheme being
challenged was of the type envisaged by the Acts. The scheme was in fact primarily
directed at advertising and publicity, and not at regulation in the sense envisaged
by the statutes. In our view, it is the rules as a whole which must be looked at in
considering whether they are authorised under section 48, and not just one
particular rule. There is no doubt that the rules made under section 48 do “regulate
investment business” on any reasonable interpretation, and Core Rule 36 is just one
part of that body of rules.
7.23 Secondly, Mr Berg said that rules made under paragraph (h) of subsection (2) in
effect exempt firms from criminal liability under section 47,52and that it cannot
have been intended that they should create an exemption without imposing real
requirements and constraints, strict compliance with which would be necessary if
the benefit of the exception was to be obtained. He suggested that this view is
supported by the wording of section 48(6) which refers to matters done “in
49
According to h4r Berg FSA, s 48(2) is merely an “in particular” list of certain matters for
which provision may be made by rules “regulating the conduct of investment business”
under subsection (1).
50
Tuker z, Ministry of Agriculture, Fisheries and Food [ 19601 2 All ER 834, where the Court of
Appeal held that a purely discretionary scheme could not properly be described as one
“regulating the marketing of an agricultural product” for the purposes of the Agricultural
Marketing Acts 1931 to 1949.
5’
For a discussion on the expression “regulating investment business” in the context of
construing whether FSA, s 48(2)(h) authorises rules modifying common law duties, see
para 7.29 below.
52
FSA, s 47 creates certain offences relating to misleading statements and practices and
includes an offence of making a statement which a person (including a firm) knows to be
misleading for the purposes of inducing another person to enter into an investment
agreement. By virtue of FSA, s 48(6) it is a defence to liability under FSA, s 47 if the firm
has acted in conformity with rules made under FSA, s.48(2)(h) (ie Core Rule 36). In
other words, the f m would not be treated as “knowing” information for these purposes if
the department dealing with the other person was unaware of it as a result of a Chinese
wall complying with Core Rule 36. The full text of FSA, ss 47, 48(2)(h) and 48(6)
appears at Appendix B and the full text of Core Rule 36 appears at Appendix C.
52
conformity” with rules made under paragraph (h) of subsection (2). Core Rule 36,
he said, effects a “general and unconditional” disapplication of the offences under
section 47 which section 48(2)(h) does not empower the SIB to grant.53We do not
agree. Section 48(6) does not require any particular matter to be included in rules
made under paragraph (h) of section 48(2), and paragraph (h) itself does not set out
any “requirements or constraints” which the rules must impose other than those
which are in fact contained in Core Rule 36. Liability under section 47 is triggered
by a person’s knowledge. Far from being a “general and unconditional”
disapplication of offences under that section, Core Rule 36 does set out clearly the
circumstances in which a person (which includes a firm) can rely on lack of
knowledge (or the failure to use knowledge in the possession of one part of the firm)
as a defence to those offences. It is also sufficiently flexible to allow for the fact that
firms carry on business in a variety of ways and adopt very different organisational
structures. It would be impractical to impose a single structure on all firms carrying
on investment business.
7.24 The third respondent who disagreed with our provisional view, D r H M c V ~ ~ , ~ ~
made five points. First he suggested that since the interpretation of FSA, section
48(2)(h) is uncertain, the benefit of the doubt ought to be resolved in the favour of
investors. He said that the general law offers investors greater protection than the
regulatory rules, and argued that the section ought not to be construed as effecting
a modification of the general law. There are various interpretative principles and
presumptions that may be used in construing statutory provision^.^^ Dr McVea’s
first comment appears to draw on two of ese. The first is the principle that the law
7 of & e s
should not be subject to casual change56so that it should be clear that an Act was
intended to amend the common law before it is interpreted as doing so; the second
is the presumption that an enactment is to be given a “purposive constr~ction”,~’
that is to say one which gives effect to the purpose of the enactment - in this case
investor protection. However, an alternative presumption is the one against
ab~urdity.~’ The interpretation we preferred in the consultation paper would avoid
the absurdity that a person may be required by a rule made under section 48(2)(h)
to act in a manner which necessarily breaches his common law or equitable duties.59
Further, a purposive construction could also support this interpretation. If an overall
picture is taken, the regulatory system may be regarded as enhancing investor
53
Mr Berg also doubts the Wednesbury reasonableness of Core Rule 36.
54
His views have since been published; H McVea, Financial Conglomerates and the Chinese
Wall - Regulating Conflicts of Interest (1993) pp 243-244.‘
ss
See F A R Bennion, Statutory Interpretation (1992 2nd ed) Divisions Four and Five.
56 Zbid, at p 561.
- .
57 Zbid, at p 659.
ss Ibid, at p 679.
59
Consultation Paper No 124, para 5.3.20 and para 7.27 below.
53
protection. It gives investors the benefit of active regulation and monitoring of
investment business, including the exercise of investigative and enforcement powers;
it also gives them compensation funds, and in the case of private investors a new
statutory action for damages for breaches of regulatory rules.60
7.25 Secondly, Dr McVea argued that permitting section 48(2)(h) to modify common
law and equitable duties would give too much discretion to the SIB. We disagree.
The powers of the SIB are restrained by Schedules 7 and 8 of the FSA which
require it t o promote and maintain high standards of integrity and fair dealing in the
carrying on of investment business,61 and they set out standards with which the
SIB’S rules must comply.62In any event this is a question of policy, and irrelevant
to the issue of statutory interpretation.
7.26 His third proposition was that the difference in the position of persons authorised
by RPBs and those authorised by SROs would not arise if section 48(2)(h) did not
authorise the making of regulatory rules which modified common law and equitable
rights and duties.63This is true, but it does not seem to us that this casts any light
on the interpretation of section 48(2)(h) since that section was present in the
original version of the FSA in 1986, whereas section 63A, which led to the
difference in the treatment of RPBs and SROs, was not inserted until 1989.64
7.27 His fourth argument was that the consultation paper, though criticising the
“separate spheres of operation” argument (that regulatory rules and the general law
simply operate in separate spheres)65in relation to section 48(2)(h) as leading to
possible uncertainty, accepted it where there was no power in the statute to modify
the general law. This is not entirely correct. We said that the “separate spheres of
operation” argument was workable (although it might lead to confusion) in the case
of section 48(2)(g) because it was possible to satisfy both the lower regulatory
requirement (eg disclosure of arrangements for commission but not amount) and
the more extensive requirement of the general law (eg disclosure of the amount of
commission). Thus, it would not inevitably cause a conflict in the sense that
60
FSA, s 62. See Consultation Paper No 124, paras 5.4.15, 6.8.
61
FSA, sched 7, para 5. See ss 114(1), 115(3).
62
FSA, sched 8. See ss 114(9)(b), 115(5).
63
Rules made under FSA, s 48 do not apply to members of RPBs but can be designated to
apply to members of SROs, FSA, s 63A( 1). See also Consultation Paper No 124, para
5.4.22.
64
Companies Act 1989, s 194. Before the 1989 Act came into force, the rules made under s
48 only applied to those authorised by the SIB. On dedesignation of certain SIB rules, see
paras 5.2-5.4 above.
65
54
compliance with one requirement would necessarily breach the other.66However,
in relation to section 48(2)(h), “separate spheres of operation” could lead to direct
conflict between the rules and the fiduciary obligation, because a rule which
“required” the withholding of information would necessarily breach the common
law or equitable duty to disclose the i n f ~ r m a t i o n . ~ ~
7.28 Finally, he argued that our provisional view on section 48(2)(h) cut against the
thrust of the “double layer of law approach” which held currency among many
policy makers and parliamentarians at the time of the enactment of the FSA.
However, the Financial Services Bill received so many amendments in the course
of its passage through Parliament that the statements made by the initial policy
makers cannot be taken as a guide to the interpretation of the version which
eventually was enacted as the FSA. Moreover, other sections of the FSA, sections
55 (client money) and 81 (unit trusts), cut across the “double layer of law
approach” and empower the making of regulations which modify common law and
equitable regulations.68
7.29 Another, more convincing, point which came up during the course of consultation
was that FSA, section 48 is limited to authorising the making of rules “regulating
the conduct of investment business by authorised person^'^.^^ It was said that this
wording restricted the powers under the section, including that under section
48(2)(h), to the making of rules which operate in the regulatory context. On this
interpretation it gives no authority for the making of rules which alter common law
and equitable rights, and any difficulties of mismatch between rules made under the
section and common law or equitable obligations are the result of the way the
regulator chose to exercise its power. However, there are difficulties with this
interpretation, since it does not address the argument outlined in paragraphs 7.19-
7.20 above that if the term “enabling” is not to be deprived of meaning, section
48(2)(h) must permit the modification of the common law and equitable duty of
disclosure to a customer,70 and that a “requirement” by a regulatory rule to
66
67
Ibid, para 5.3.20. Although after KeZly it seems that there is unlikely to be an obligation to
disclose confidential information to a customer, this was not so at the time the FSA was
enacted.
68
The Government’s white paper, Financial Services in the United Kingdom: A New
Framework for Investor Protection (1985) Cmnd 9432 did not exclude these sections from
the double layer of law approach, although they cut across it.
69
FSA, s 48(1).
70
It was suggested that on the restricted interpretation of s 48, customers would not fall
within the expression “persons with whom [the fm] deals in the course of carrying on
lpart of the f m ’ s business]”, and that the “persons employed” are merely an example of
the persons with whom the fm deals. We disagree; we think that “deals” denotes that a
transaction is taking place with a third party. In our view the first part of the subsection
relates to the firm withholding information from customers and other persons with whom
the fm deals in the course of carrying out part of its business, and the second to the
55
withhold information from a customer would necessarily breach the general law duty
of disclosure, unless it was modified by the section. It was also argued that the fact
that by FSA, section 48(6) compliance with rules made under section 48(2)(h) is
a defence to a criminal charge, but not to a breach of a civil law duty, indicated that
section 48(2)(h) had a narrow effect. However, if rules made under section. 48(2)(h) L .
modify common law and equitable duties, of disclosure, there is no need for a
I’ * % A
L I
defence to an allegation of breach of a civil law, du and the absence of one would
nu& ancl
have no bearing on the interpretation of the subsect@ 4fj(2)(h).71
id, b.
7.30 In conclusion,
- we are not entirely convinced by the a r g u rpi , q p pyt @ y,a r d b,y, the
L, /%AL _c L I i
respondents who disagreed with our provisional interpretatioq of s e c ~ o n48(2) (h),

. I
and we still incline to the view that it probably authorises rules modifylng a firm’s
common law or equitable duties of disclosure, and that Core Rule 36 probably has
this effect. However, the range of opinions on the effect of the subsection have led
us to accept that the matter is not free from In Part XVI, therefore, we
consider whether Chinese walls are so essential to the operation of the financial
services industry that legislative provision is required to put the matter beyond
doubt.
Conclusion
7.31 Although many respondents questioned our provisional conclusions on each of the
issues outlined in the question, none has persuaded us that our original analysis of
the legal position was incorrect. The impression we have obtained is that many were
influenced by the fact that since the reforms in the structure of the financial markets
in the mid-l980s, and in particular the abolition in October 1986 of the Stock
, ~ ~cases have come to court in which a
Exchange’s single capacity r e q ~ i r e m e n tno
breach of fiduciary duty on the part of a financial services practitioner has been
alleged. This has given rise to a level of reassurance about the effectiveness of the
methods currently in use to modify and exclude fiduciary duties. On the other hand,
we are aware of at least one case reported in the press in which such issues were
raised,74and we are also aware of three recent Canadian cases where allegations of
withholding of information between employees for the purposes of the firm’s withholding
from customers etc. Our view is supported by Blair, Financial Services - The New Core
Rules (1991) p 13.
7’
See also para 7.20 above.
72
See also P Graham, “The Statutory Regulation of Financial Services in the United
Kingdom and the Development of Chinese Walls in Managing Conflicts of Interest” in
Commercial Aspects of Trusts and Fiduciary Obligatiohs (McKendrick ed 1992) p 43, 52.
73
See Consultation Paper No 124, para 2.2.5.
74
In 1992 Morgan Grenfell was served with a writ by one of its former fund management
clients, GPG, alleging that Morgan Grenfell had allowed its own interests to conflict with
those of GPG and had failed to comply with its fiduciary duties. The claim arose because
Morgan Grenfell’s treasury management division acted as discretionary fund manager for
GPG, while its corporate finance division was acting as lender to Egerton Trust. There
was a Chinese wall between the two divisions. The treasury division purchased Egerton’s
56
breach of fiduciary duty were raised by customers of financial services practitioners.
Two of these claims were successful.75
7.32 As we explained above,76we now consider that the decisions in Kelly and Clark
Boyce enable contractual techniques to go a long way towards avoiding a mismatch
between fiduciary duties and what is required or permitted by regulatory rules.
Moreover, although the matter is not without we think that there is a
reasonable argument that a Chinese wall which satisfies the requirements of Core
Rule 36 would, as a matter of public law, operate to modlfy inconsistent duties
owed at common law and equity. We consider in Part XVI whether reform is
required to put the matter beyond doubt.
commercial paper on GPG’s behalf, and shortly afterwards, the corporate finance division
called in a loan to Egerton, despite a warning kom Egerton that such a move would force
it to default on the commercial paper. The case raised questions about the effectiveness of
Chinese walls designed to insulate the corporate finance and fund management arms of
securities houses. For details see Norma Cohen, “GPG Issues Writ Against Morgan
Grenfell” Financial Times 26 May 1992. We have no way of knowing whether this is an
isolated incident or just the tip of the iceberg.
75
Hodgkinson v Simms [1994] 3 SCR 377; Bishop v Richardson Greenshields of Canada Ltd
(1993) 50 CPR (3d) 66; Beaulieu v LOM Western Securities Ltd (1993) 50 CPR (3d) 113.
In the third case the defendant broker was found liable for breach of fiduciary duty where
its employees acquired stock in an oversubscribed allotment
. .in competition with the
plaintiff customer, without making full disclosure.
76
See paras 3.24-3.40, 7.2-7.10 above. See also paras 14.9-14.12 below.
77
See paras 7.19-7.21 above and 16.3 below.
57
PART VI11
CROSSING CHINESE WALLS (Question 2)
Consultation issue
8.1 The second matter on which the views of respondents were sought was set out in
the following terms in the consultation paper:’
A number of questions arise out of the practice of members of firms, for instance
analysts, temporarily “crossing” a Chinese wall.
(a) How necessary is it for members of firms to “cross” a Chinese wall?
(b) Does taking an analyst out of circulation until the confidential information
he has learned by crossing the wall is no longer price sensitive give rise to a
serious risk of indirectly communicating the nature of the information to a
shrewd customer?
Our preliminary view is that, although there are undoubtedly practical difficulties
in taking an analyst out of circulation, they are not so great that this method of
proceeding could not for this reason alone be adopted. We believe that other
ways of handling the analyst who returns to his former position, in particular
confining his advice to that set out in a previously published document, are
unlikely to afford an adviser a defence to an action for breach of the duty to
disclose relevant information.
The necessity of “crossing” Chinese walls

8.2 The responses to paragraph (a) of this question revealed that it was often thought
necessary and desirable for members of financial services firms to cross Chinese
walls in certain defined situations. It was said that it was important that one part of
a firm or group of companies should be able to call in aid the services of experts in
other parts of the firm or group. The most common example was that of an industry
or sectoral analyst being required to assist the corporate advisory division of a firm
in connection, for example, with a public flotation or a new rights issue.’ One
respondent suggested that crossing walls was usually a matter of convenience rather
than of necessity, because it would be too expensive to employ two experts
specialising in the same sector: one to deal with investors and the other to advise
companies. In practice, we think there is little difference between the two positions:
Consultation Paper No 124, p 241.
* This was also revealed by the responses to our Issues Questionnaire (November 1990);
Consultation Paper No 124, para 4.5.20. One respondent to the consultation paper said
that analysts were commonly made insiders to brief them on the financial results of a
company for whom the firm acted as broker after the markets had closed the day before an
announcement about the company.
58
financial constraints tend to make wall crossing a matter of necessity. However, it
appeared that crossing walls was less necessary in other spheres of activity, such as
the provision of accountancy services.
Taking an analyst out of circulation

8.3 Most of the respondents who commented on paragraph (b) thought that taking an
analyst out of circulation, so that he would not be able to advise customers until the
confidential information which he had received was stale or part of the public
domain, was an appropriate way to deal with any problems that might arise from
making him -an insider, although one respondent noted that this might disadvantage
small firms. The point was made that it would be wrong for an analyst to continue
to be held out to his customers as an independent objective expert when he had
crossed over to a partisan position.
8.4 Respondents said that in order for the removal of an analyst from circulation to be
a practical option, it was important to take care that he was not made an insider for
too long before the matter on which his advice had been required, for example, a
flotation, takeover or rights issue, was announced, and that, so far as possible, he
was not given any information which was not going to be published (such as profit
forecasts). It was noted, however, that placing an analyst “in quarantine” would
nevertheless cause problems where the proposed flotation, takeover or rights issue
failed to go ahead. In those circumstances the information acquired by the analyst
might remain price sensitive for a long period of time, and it might not be
practicable to keep him out of circulation for the extended period. A majority of
those who commented on the issue whether keeping an analyst out of circulation
would have a signalling effect thought that there was little risk of t h k 3 It was said
that, in general, analysts covered several stocks, and that a customer who knew that
an analyst was unavailable would be unlikely to be able to deduce from this the
precise matter with which he was involved.
8.5 Only one respondent described other ways of handling the situation where an
analyst has become an insider. It said that its policy was that an analyst could not
be made an insider unless the Head of Research (who does not write research or
give advice) had given permission. One of the factors which would be taken into
account when granting permission was whether the analyst’s normal business could
be conducted if he was brought inside in relation to a particular stock. If by making
him an insider his activity would need to be restricted, consideration would be given
as to how the stock in question could be covered by another analyst. Because of
this, this respondent said that it would be unusual for an analyst whose day to day
activity covered the stock in question to be made an insider in relation to that stock
for more than a day.
Although one respondent suggested that much would depend on the timing of the removal
from circulation.
59
Conclusion
8.6 We accept the conclusion of most respondents that (i) it is expedient for analysts
to be able to cross Chinese walls, and (ii) that provided the situation is carefully
handled, so that the analyst becomes an insider only at a late stage when the
transaction under consideration is firm and close to completion, and the information
given to the analyst is restricted to that which will be included in the public
announcement, it ought to be possible to take an analyst out of circulation until the
information is in the public domain. Problems will arise, however, if confidential
price sensitive information acquired by the analyst is not subsequently made public,
for example, if the proposed transaction falls through, and the firm wants the analyst
to return to his original duties before that information has ceased to be price
sensitive. We consider that a firm that makes an analyst an insider will have to bear
the risk that if the proposed transaction on which the analyst was called to advise
fails to proceed, and the analyst is allowed quickly to return to his original duties,
it may be liable for breach of fiduciary duty4 unless it has made provision to the
contrary in the analyst’s customers’ contract^.^ It was our provisional view that the
practice of taking an analyst out of circulation until the information he acquired is
no longer price sensitive does not give rise to such a serious risk of indirectly
communicating the nature of the information to a shrewd customer that it should
not for this reason be adopted.6 This view has been confirmed by the responses on
consultation.
Although the f m would not be called upon to disclose the inside information as it would
be a criminal offence to do so, this does not justify the firm putting itself in a position
where its obligations to the customer are compromised; see paras 3.31, 3.35 above.
See paras 3.25, 3.29, 3.39 above.
60
PART IX
OVERLOOKING CHINESE WALLS, STOP
LISTS AND WATCH LISTS (Question 3)
Consultation issue
9.1 The third question which we put to respondents was in these terms:’
A number of questions arise out of the fact that those in managerial positions
and compliance officers “overlook” a Chinese wall in the sense that their “need
to know” in order to discharge their duties results in their obtaining information
otherwise retained behind a Chinese wall.
(a) Is it feasible to use stop lists and watch lists as a solution?
(b) Can the inadvertent signalling effect, which may result from placing a share
on a stop list, be avoided in those situations in which firms use such lists?
Summary of respondents’ views

9.2 The responses to this question indicated that stop lists and watch lists were not
intended to provide a solution to any problems which might be created by
management overlooking a Chinese wall (although one respondent thought they
might help to overcome such problems). Watch lists and stop lists were said to be
devices for monitoring the operation and effectiveness of Chinese walls, and for
avoiding liability under the insider dealing legislation.2The signalling effect of watch
lists was thought to be minimal, but a few respondents thought that stop lists could
have a signalling effect unless a security was only placed on the list once the
information about it had been made public (by which time it was said that the
major period of difficulty with regard to dealings in the security would have passed).
We received very few comments on the issue whether the use of such lists breached
a firm’s duty to its customers, and we remain of the view expressed in the
consultation paper that, unless an express contractual term permits the use of such
lists, or the consent of discretionary customers is obtained, their use will risk
breaching the duty to give best advice to discretionary customers.
9.3 The problem caused by management overlooking Chinese walls was not, generally,
regarded by respondents as significant. It was said that senior managers who were
above Chinese walls would usually only be involved in decisions of strategy and
policy, and that they would not deal with customersj make markets or take decisions
affecting day to day transactions. However, one respondent acknowledged that this
was not always the case, and that there would be great difficulties where senior
. .
’ Consultation Paper No 124, pp 241-2.
As to which see paras 2.16, 4.12 above.
61
managers became involved in specific cases. Another pointed out that even if senior
management did not deal with customers or make markets, attribution of knowledge
would cause a problem, particularly where there was a conflict between the firm’s
interests and those of a customer, rather than a conflict between the duties owed to
two clients. It suggested that the firm would have to rely on contractual exclusions
and compliance with the rules of its SRO to be completely safe. In fact, as has been
explained elsewhere, Chinese walls within a single company will not prevent the
attribution of knowledge irrespective of whether or not the wall is overlooked, but
they may assist in dealing with the consequences of that k n ~ w l e d g e . ~
Conclusion
9.4 In conclusion, most respondents did not appear to consider that problems caused
by management overlooking Chinese walls could be overcome by the use of stop
lists and watch lists. These lists were not designed to be used for this purpose, and
in the case of stop lists there could be an inadvertent signalling effect. However,
most respondents did not regard management oversight as causing particular
problems.
See paras 2.5, 3.2-3.23, 7.15 above and 12.5-12.9 below.
62
PART X
SHOULD FIDUCIARY LAW TAKE
ACCOUNT OF REGULATORY RULES?
(Question 4)
Consultation issue
10.1 The next issue on which we invited comment was expressed in these terms:’
Should fiduciary law take account of rules made by regulatory bodies operating
in the public
- law sphere? Our provisional view is that it should: either because
there is statutory authority for rules to modify common law and equitable
obligations (as we believe to be the case in respect of FSA, sections 55 and 81
and may be the case in respect of FSA, section 48(2)(h)); or because the court
should take account of reasonable regulatory rules in ascertaining the precise
content of the common law or equitable duty.
We said that reasonableness was not confined to the restricted public law meaning
of Wednesbury2reasonableness.
Summary of respondents’ views

10.2 Almost all the respondents to the consultation paper thought that fiduciary law
should take account of regulatory rules. Many suggested that this, the “hybrid”
model set out in the consultation paper,3 might already represent the legal position.
A few went even further, and said that compliance with a regulatory rule should
automatically provide a defence (a “safe harbour”) to an action for breach of a
fiduciary duty.
Ibid, paras 5.4.6 and 5.4.23. In Associated Provincial Picture Houses Ltd v Wednesbury
Corporation [1948] 1 KB 223 Lord Greene MR stated the basic principles of judicial
review of discretionary powers; ie propriety of purpose, relevance of considerations taken
into account, and the residual ground of “unreasonableness” or “irrationality”.
63
PART XI
LEGISLATIVE PROVISION THAT THE
COURTS MUST TAKE ACCOUNT OF
REASONABLE REGULATORY RULES
(Question 5)
Consultation issue
11.1 The fifth matter which we put to respondents was in these terms:’
Should legislation provide that the courts must take account of reasonable
regulatory rules in ascertaining the precise content of common law and equitable
obligations? If so:
(a) should there be legislative guidance as to what constitutes “reasonableness”,
(b) on whom should the burden of proof lie, and
(c) should “reasonableness” be determined at the time the rule was made, at the
inception of the relationship between the parties, or at the time the rule is relied
on?
The need for legislation

11.2 The results of consultation confirmed our provisional view that problems of
mismatch between what is required or permitted by regulatory rules and the
obligations imposed on fiduciaries by the common law and equity lie principally in
the field of financial services.2 Most of the comments made on this question,
therefore, related to the regulatory rules made under the FSA regime. Respondents
were divided equally between those who agreed with our provisional conclusion that
there should be legislation requiring the court to take account of regulatory rules,3
those who thought that legislation was unnecessary, and those who favoured a form
of legislative “safe h a r b ~ u r ”Those
.~ who favoured the first approach added little to
the arguments set out in the consultation paper, which were mainly to the effect that
there should be an acceptance that the views of regulators in an area of public law
remitted to them by the legislature are entitled to some weight, but that the court
should not completely abdicate control in their favour both for constitutional
Ibid, para 5.4.1.
Zbid, paras 7.18-7.23.

. .
It is worth noting, however, that the majority of respondents commenting on question 1
considered that existing contractual and structural methods were in fact effective in dealing
with problems of mismatch between fiduciary duties and regulatory rules; see para 7.2
above.
64
reasons and in order to retain the safeguard which exists a t present that regulatory
bodies must take account of fiduciary duties when making rules.5
N o reform
11.3 The respondents who favoured the second approach included the BMBA. They
thought that the courts were already likely to take into account reasonable regulatory
rules and that legislation was unnecessary. We will examine in paragraphs 14.6-14.8
below whether the courts will, under the present law, take into account reasonable
regulatory rules when ascertaining the content of a fiduciary duty. We conclude that
they probably will, but that the matter is not entirely free from doubt.
11.4 The respondents who opposed reform were influenced by a number of additional
factors. They pointed out, for example, that in the seven years since Big Bang and
the enactment of the FSA, the relationship between fiduciary duties and regulatory
rules had not caused any problems, which were not capable of private settlement.
It is difficult to assess the weight to be attached to this point since, although no
cases may have reached the court as yet, we have already noted6 that there is
potential for litigation. A few respondents suggested, moreover, that the lack of
disputes did not necessarily indicate that the present situation was satisfactory: it
might reflect ignorance on the part of most of those affected of the fact that a
fiduciary duty had been broken, or a reluctance on the part of professionals to test
a Chinese wall in court.
11.5 More pragmatic considerations as to why legislative change was inappropriate were
also put forward. The first was “regulatory fatigue”. This had resulted from the
many revisions to the rule books of the SROs, and the introduction of the so called
“New Settlement” created under the Companies Act 1989.7 This has led to
opposition to any additional adjustments (however small) to the regulatory
environment because it is feared that this would cause further upheaval. Second,
there was concern that any legislation which we might recommend would not be
implemented expeditiously. If this happened, it was said that there would be an
undesirable level of uncertainty in the interim period between the date of
publication of the report and the date of implementation. Finally, there were fears
that any legislation we recommended might be altered in the course of the
parliamentary process, with the result that a proposal which might initially have
merit would be amended in such a way as to make it undesirable and over-
complicated.
Companies Act 1989, s 63A. See also Consultation Paper No 124, para 2.5.7.
65
11.6 We do not consider that the legislation suggested in the question would result in
further upheaval, since it would be designed to clarify and restate the existing
position, rather than create wholesale change to the regulatory environment. While
we can understand the second and third considerations, our remit is to deal with the
legal problem which we have identified, and we have no option but to place faith
in the legislative process. In any event, we do not believe that a recommendation
that there should be legislation directing the court to take account of reasonable
regulatory rules in ascertaining the precise content of fiduciary obligations would
increase uncertainty in the period before implementation, provided that the
recommendation made it clear that the legislation was being introduced merely to
clarify the present legal position.
11.7 More convincing was the objection expressed by a few respondents that it was
undesirable for the court to have to reach a view on the reasonableness of the
regulations in proceedings for breach of fiduciary duty, to which the regulator might
not be a party. We were also concerned by the point raised by one respondent that
to direct the court to take into account a regulatory rule in ascertaining the precise
content of the fiduciary duty might not address the main issue. He said:
If, for example, a fiduciary sells his own property to his client he is obliged to
account for any profit that he has made. If an SRO rule says that a broker dealer
selling as principal must show on his contract note that he has sold as principal
and must give the client best execution, how can this be relevant in ascertaining
the precise content of the common law [duty]? The [common law duty] is that
the fiduciary may not sell his own property to his client, in the absence of prior
informed consent and, if he does, must account for any profit. The SRO’s rule
is undoubtedly reasonable but it does not help in ascertaining the content of the
common law duty.
Although there is another solution to the example given, since there is an exception
to the requirement of full disclosure where a broker sells to a customer off his own
book,* it suffices to illustrate the point that regulatory rules are not at present
designed to address the precise content of common law and equitable fiduciary
duties. Although it would be possible for the regulatory bodies to reformulate their
rules to avoid this difficulty, this would be a major exercise. We consider it
unrealistic to expect them to do so. Moreover, we are reluctant to recommend any
reform which would require wholesale amendment of the rules, as this would result
in undesirable disruption and upheaval to the regulatory environment.
11.8 These objections led us to consider another solution: that of providing a legislative
defence to an action for breach of fiduciary duty where a firm has complied with a
See para 2.13, n 33 above. See also Consultation Paper No 124, paras 3.4.6, 3.4.33-
3.4.34.
66
regulatory rule, unless it was unreasonable for the firm to have relied on the rule in
the particular case, having regard to such obligations as “know your ~ u s t o m e r ” . ~
However, when this solution was suggested to a selection of respondents
representing those with an interest in the financial services field, it met with little
favour, primarily on the grounds that there was no need for legislation because
contractual techniques were thought to provide an adequate solution, and that it
would not materially increase certainty. As explained in paragraphs 14.15-14.20
below we have now rejected this option.
<‘Safeharbour” type solutions

11.9 Approximately one third of the respondents to the consultation paper advocated the
introduction of legislation which provided a “safe harbour”, whereby compliance
with a regulatory rule which permitted that which was prohibited by fiduciary law
would constitute a defence to an action for breach of fiduciary duty. These
respondents thought that the solution which we provisionally favoured would do
little to increase certainty and was not worth pursuing. The safe harbour approach
was formulated in a number of different ways. Some respondents, including, at first,
the SIB,” suggested a general safe harbour. However in addition to the problems
with this approach which we set out in the consultation paper,” other respondents
argued that it would be perceived as giving too much power and “carte blanche” to
the regulators. Although a primary aim of the rules is to “afford investors an
adequate level of protection”,12 the failures in the regulatory system exposed by
events such as the Maxwell disaster which led to the Large review;13 the problems
arising from sale of home income plans;14 and the recent complaints about mis-
selling of personal pension^,'^ have made it undesirable at this juncture wholly to
remove customers’ private law rights leaving them entirely dependent on the
SIB Statements of Principle, principle 4. See further, paras 14.13-14.16 below.
lo
The SIB’S view was expressed in the context that legislation was not an urgent priority.
I’
That it would be constitutionally inappropriate to permit the rules of self-regulatory
bodies, which are not subject to direct Parliamentary safeguards, to alter common law or
equitable obligations under the general law; and that it would remove the safeguard that at
present rulemaking by regulatory bodies must take account of fiduciary obligations
wherever possible; Consultation Paper No 124, para 6.18.
FSA, ss 114(9), 115(2), 115(5). See further Consultation Paper No 124, para 2.5.6.
l3
Large, Financial Services Regulation - Making the Two Tier System Work (May 1993)
Foreword paras 1, 6, 23, 24; Summary paras 8 and 9; Chapter 1 paras 1.45-1.49. See also
IMRO, Submission to the House of Commons Social Security Committee (February 1992).
l4
For details see Large, Financial Services Regulation - Making the Two Tier System Work
(May 1993), paras 1.54-1.55. See also SIB, Annual Report 1.993194 pp 43-44.
l5
See SIB, Pension Transfers and Opt Outs, Further Safeguards for Future Business (March
1994) and SIB, Pension Transfers and Opt Outs: Review of Past Business (October 1994). See
also SIB, Annual Report 1994195 pp 5-6, 40-41.
67
regulatory system for protection.16It is noteworthy that FIMBRA did not favour a
safe harbour type solution and in its response to the consultation paper stated that
“in the sphere of civil litigation, there has been continued reliance upon the
remedies provided by the common law in total preference to the s 62 statutory right
of action for damages based on a contravention of statutory or SRO rules”.
1 1.10 Whatever the views on the merits of a general safe harbour, it is clear that after the
Large Report,I7 it is no longer practical for such a solution to depend on compliance
with designated Core Rules.” We have already noted in paragraph 11.9 the
difficulty of giving more power to regulators. This would be exacerbated if a safe
harbour depended on compliance with the rules of an SRO which may be regarded
as largely representative only of business or professional interests.” This has led us
to conclude that a safe harbour is not a viable option, and the SIB has now
indicated that it no longer favours a general safe harbour: indeed, it considers that
there is no need for legislation.20
11.1 1 An alternative formulation of this approach was put forward by the Company Law
Committee and described as a “modified safe harbour”. Under this option
legislation would provide that, to the extent set out in a statutory instrument to be
made by the Treasury, any specified fiduciary duty would be deemed to be met if
a firm had complied with the specified relevant Core Rule made by the SIB. The
statutory instrument would be subject to affirmative resolution of Parliament, so
there would be Parliamentary safeguards. This, and the fact that the safe harbour
would be restricted to Core Rules made by the SIB under a delegated power from
the Treasury pursuant to FSA, section 63A, would overcome the constitutional
objection to the general safe harbour.’l It was suggested that it could also be
provided that the Treasury must be satisfied that the relevant Core Rule was framed
after taking into account the general law protection which would have applied had
it not been abrogated. This would avoid the second objection to the general safe
16
The same may not be true of certain specific areas, and we recommend the introduction of
a safe harbour in respect of a Chinese wall which fulfils the requirements of rules made by
the SIB under FSA, s 48(2)Q. See paras 16.7-16.21 below.
With the exception of Core Rules 36 and 40(4)(a) and (5) these are no longer designated;
the Financial Services (Dedesignation) Rules and Regulations 1994. As we have explained,
the SIB has, following the Large Report, sought to act more as a standard setter and less
as a formal legislator with the SROs having greater.keedom to develop their own rules; see
paras 5.2-5.4 above and 16.10 below.
l9
2o
This is on the basis that FSA, s 48(2)(h) .authorises. rules which modify common law and
equitable duties of disclosure and that Core Rule 36 does so (see paras 7.19-7.20 above);
and that Kelly helps to avoid other difficulties.
68
I
harbour, that it would remove the incentive to take into account fiduciary duties
when framing regulatory rules.22It was not envisaged that there would be wholesale
abrogation of fiduciary duties, and the Core Rules which it might be appropriate to
target were said to be 2 (material interests), 3 (soft commissions), 15.2 (customers’
rights), 18.2 (charges), 25 (dealing ahead of publications), and 36 (Chinese walls).
11.12 Although at first sight we were attracted by the modified safe harbour, there are two
significant problems with it. The first is that it would require identification of all the
practices authorised by Core Rules which might be inconsistent with fiduciary
duties. Because
- of the large range of activities covered, it would be impossible to
predict every possible scenario where mismatch between what was permitted or
required by the Core Rules and by fiduciary duties would arise. If something was
missed out, and an action for breach of fiduciary duty was brought where a Core
Rule had been complied with, there would be a danger that a court would refuse to
take the rule into account at all on the expressio unius est exclusio a l t e r i ~ principle
s~~
of statutory c o n ~ t r u c t i o nbecause
~~ it had not been specified in a statutory
instrument. Secondly, this method would rely on the exercise by the Treasury of the
power to make statutory instruments. This would require the Treasury initially to
identify the Core Rules which caused difficulties and the circumstances in which
they did so, and then to make a policy decision as to whether it was appropriate for
the rule to take precedence over the fiduciary duty in the particular circumstances.
ij
Having done so it would have to keep the situation under continuous review so that ,
account could be taken of any changes in the Core Rules, market practice, and the 1 .
regulatory climate generally. This would place a heavy burden on the Treasury. In
any event, whatever the views on the merits of this proposal at the time it was made,
it is no longer feasible after the Large Report, since it relies on designation of Core
Rules. As has been explained Large recommended that rule making be
handed over, so far as possible, to the SROs, and, with the exception of Rule 36
and Rule 40(4)(a) and (b), the Core Rules have now been de-designated. The
Company Law Committee has recognised that the modified safe harbour is no
longer workable. In our view, it is no longer a realistic solution.
Conclusion on the main issue

11.13 None of the comments made on consultation have convinced us that our provisional
view that the courts should take account of regulatory rules was incorrect. The !
question whether there should be legislation to this effect is more difficult to answer.
A large body of consultees, including the BMBA and the SIB, considers that such
22
23
“TOexpress one thing is impliedly to exclude another”. I .
Bennion, Statutory Interpretation (2nd ed 1992) p 873.
25
69
legislation is unnecessary. The cases of Kelly and Clark Boyce have indicated that
contractual techniques can go a long way towards avoiding any problems which
might be caused by mismatch between fiduciary duties and what is required or
permitted by regulatory rules.26Although these considerations do not address the
question of principle as to whether the regulators' views in an area of public law
remitted to them by the legislature ought to be accorded some recognition by the
courts, they do weigh against pursuing a recommendation which does not have the
full support of those who are most likely to benefit from it. As we explain
we believe that a court will probably take account of regulatory rules in determining
the content of a fiduciary's duties, and we do not consider that any doubts on this
point justify pursuing the provisional recommendation in light of the limited support
it received from consultees." We have also been persuaded that the original
formulation of the proposal, which would require the courts to pronounce on the
reasonableness of a rule in proceedings to which the regulator may not be a party,
is un~uitable.~' Accordingly, although we were not persuaded by a number of the
initial arguments put forward against reform,3oand we are not as confident as some
of the respondents to the consultation paper that Kelly provides a complete panacea
to any problems created by mismatch between fiduciary duties and what is required
or permitted by regulatory rule^,^' we have decided not to recommend this
s~lution.~'
Subsidiary issues
1 1.14 Since we have decided not to pursue our original proposal for legislation on the
main issue, we do not intend to discuss in detail respondents' views on the
subsidiary issues: whether there should be legislative guidance as to what constitutes
reasonableness, on whom the burden of proof should lie, and the time when
reasonableness should be determined. What follows is just a brief summary of the
outcome of consultation on these matters.
26
See paras 3.24-3.40 above and paras 14.9-14.12 below.
" Paras 14.6-14.8.
We do consider, however, that in relation to the particular issue of Chinese walls reform
would be desirable; see paras 16.1-16.7 below.
29
As we explained in para 1 1.8 above, the second founulation of this approach, which would
simply require the court to consider whether it was. unreasonable for a firm to have relied
on a rule in a particular case, also met with little favour because of the new confidence in
contractual techniques.
30
See paras 11.3-1 1.6 above.
31
See paras 3.31-3.32 above and paras 14.9-14.12, 14.17 below.
32
See further, paras 14.13-14.20 below.
70
Legislative guidance as to what constitutes reasonableness
1 1.15 Most of the respondents who commented on this issue thought that there should
be no legislative guidance as to what constitutes reasonableness, primarily because
of the difficulty of drafting a suitable definition, and because it was thought that
guidance would restrict the court’s freedom to consider all the circumstances of the
case when determining questions of reasonableness. Others suggested relevant
factors that the court should be directed to take into account, including the degree
of protection afforded to customers by the regulatory scheme, the availability under
the regulatory scheme of compensation for customers who suffer loss due to
breaches of duty, the consideration whether the customer was aware of and
consented to the regulatory rule in question, and the nature of the regulatory body,
and in particular whether it was independent of the regulated profession. It was also
suggested that guidance should not be exhaustive, but that the court should be able
to consider all the circumstances of a case.
Burden of proof
1 1.16 Over three quarters of the respondents who commented on this part of the question
thought that the burden of proof should be placed on the person who alleged that
I
the regulatory rule was unreasonable. The main reason they gave was that the public
law nature of the rules made it undesirable that they should be presumptively
unreasonable. The respondents who thought that the burden of proof should lie on
the firm were influenced by the fact that the firm would be relying on the rule to
reduce its common law obligations, by the general interests of investor protection,
and by the fact that the firm would generally have the resources and be in the best
position to discharge the burden.
The time when reasonableness should be determined

11.17 Virtually all the respondents who addressed this issue thought that the
reasonableness of a regulatory rule should be determined at the time it was relied
upon. Two suggested that the court should also be able to consider reasonableness
at the time when the rule was made, in order to cater, for example, for the situation
where there was a change of circumstances but insufficient time had passed to
enable the relevant rule to be revised accordingly.
71
PART XI1
OTHER LEGISLATIVE POSSIBILITIES
(Question 6)
Consultation issue
12.1 The final matter we put to respondents was in these terms:'
What other legislative possibilities should be considered, either as alternatives to

that summarised in (5) above or as supplements to it? We have mentioned:
(a) the codification of fiduciary duties,
(b) legitimation of generalised advanced consents,
(c) reform of the rules on attribution of knowledge within a corporation or

partnership, and
(d) exculpation of fiduciaries who the court considers have acted honestly and
reasonably.
Codification of fiduciary duties

12.2 The respondents to the consultation paper were virtually unanimous in agreeing
with our provisional conclusion that codification of fiduciary duties would be
impractical and undesirable.2The two consultees who were attracted by codification
acknowledged that this approach would have practical difficulties. We conclude that
the provisional conclusion was correct and that this option should be rejected.
Legitimation of generalised advanced consents

12.3 A majority of respondents opposed the legitimation of generalised advanced
consents for the reasons given in the consultation paper. Initially the BMBA
supported this option if legislation in other areas was thought necessary. However,
it has since indicated that following Kelly it is very confident that present contractual
arrangements and disclosures are effective, and that it no longer supports reform.
We consider that the provisional view was correct, and that this option should not
be pursued, since legitimation of generalised advanced consents would be unlikely
to be able to distinguish between acceptable and unacceptable practice^.^
' Consultation Paper No 124, p 243.
72
I
Reform of the rules on attribution of knowledge
12.4 A number of respondents criticised the treatment in the consultation paper of the
law on attribution of k n ~ w l e d g eBefore
.~ examining the views expressed on reform
of this area, we will consider the criticisms of our analysis of the law. We do this in
four parts. First, we look at the pooling of knowledge within a company; secondly,
we examine the use of confidential information by the company; thirdly, we consider
the attribution of knowledge between different companies within the same group;
and fmally we re-cap on the impact of recent legal developments in this area.
Pooling of knowledge
12.5 We stated in the consultation papes that “[wlhere [a] firm is a company, then as
a matter of principle any matter known to part of the firm would be known by all
parts of the firm; it is difficult to see any legal basis for holding that there is ‘partial
ignorance”’. There are three elements to this proposition: (i) it deals with the
attribution of knowledge within a company, hence statements as to what the
position is in respect of a partnership are irrelevanq6 (ii) it assumes that the
knowledge has been acquired, hence it in no way contradicts what was said in
paragraph 2.3.4 of the consultation paper, since this deals with the mechanics of
acquisition;’ (iii) it is axiomatic, in that it flows from what is taken as a principle
that there cannot be partial ignorance. No one cited a case to us or a principle
which would recognise the state of “partial ignorance” and no one put forward a
legal argument as to how this could be the position.’
12.6 The case law dealing with attribution, as is clear from the consultation paper, is
admittedly exiguous and, while it is open to more than one interpretation, we still
consider that it supports our proposition. One respondent perceptively argued that
Harrods Ltd z, Lemon’ was not a case of “pooling of knowledge”. Instead it involved
a situation where a fiduciary had conflicting fiduciary obligations to the vendor and
purchaser of real property. However, Avory J at first instance said that the estate
department (which acted as agent in selling the house for the vendor) and the
building department (which carried out the survey for the purchaser) were not
“separate entities”, and that Harrods Ltd had to be treated as “one person” in law.”
See para 2.3-2.6 above.
On partnerships, see ibzd, para 2.3.10. See also para 2.6 above.
For a discussion on the mechanics of acquisition of knowledge by a company, see paras

2.3-2.4, 3.2-3.23, 7.14 above.
* See para 7.15 above.

, .
[1931] 2 KB 157.
lo
Zbid, at p 162. This aspect of the decision was not dealt with on appeal but neither were
the views of Avory J dissented from on this point.
73
It is arguable from this that as “one person” the knowledge would have been
pooled.
12.7 Even if one accepts the more restricted interpretation of Harrods Ltd ZI Lemon put
forward in the previous paragraph, namely that it is not authority for the “pooling
of knowledge” between different parts of a firm in the manner we suggested, but
addresses only the question of conflicting fiduciary duties, the case does not provide
an answer to many of the problems which arise as a result of the different capacities
in which the firm acts. There will still be many situations where there will be a
conflict of interest between a firm’s customers for whom it is acting” and there will
also be situations where the firm itself has a conflict with the customer.”
Use of confidential information

12.8 In many situations a firm will be in possession of confidential information relating
to a client which could be put to the beneficial use of other clients. As regards the
use of such knowledge, we said in the consultation paper that a firm should be
obliged to use all the knowledge in its possession for the benefit of a client and that
“all parts of the firm must act in the light of all information possessed by the
firm”.l3 Some commentators, including the BMBA, considered that this over-stated
the duty on a firm to use information for a client, in that it could oblige a firm to
breach a confidence owed to one client to further the interests of another client. We
were persuaded by these responses that the statement in the consultation paper may
have been too wide,14 and Kelly has subsequently confirmed that our view was
indeed too wide.15
I1
This was the situation in Harrods Ltd v Lemon itself. The Court of Appeal accepted that
the plaintiff may have owed conflicting fiduciary duties but held that the defendant had
accepted the position with full knowledge of the facts and therefore could not resist paying
the commission owed on the sale of the property. By implication, had the customer not
been fully aware of and accepted the position the company may have been unable to
recover the commission because of breach of its fiduciary duties in acting for both clients.
One respondent said that the interpretation that we had placed on Lloyds Bank v Savory &
CO[1933] AC 201 was too wide and it was only Lord Wright who had stated that the
bank could not split up its knowledge. The real issue in that case was stated in the dissent
of Lord Blanesburgh, and this was whether the bank had behaved negligently in opening
the accounts in the way that it did with the result that s 82 of the Bills of Exchange Act
1882 could not be relied on. Even if this interpretation is accepted, it does not eliminate
the problem, since once a duty is posited and the knowledge exists, a firm will be held to
be negligent in not searching the information out ip that if it had done so the relevant
information can be presumed to have come to light. .
l3
l4
We are not addressing here the question whether or not the f m has a contractual
obligation to use such information or a duty in tort. These matters arise independently of
any fiduciary duties that a firm owes to a client.
l5 See paras 3.30-3.32 above.
74
12.9 In dealing with the effect of information in the possession of a firm three situations
have to be clearly distinguished: (i) a situation where a firm has confidential
information relating to client A which would be of relevance to a separate and
distinct transaction involving client B; (ii) a situation where a firm has confidential
information relating to client A and it would be relevant to a transaction between
client A and client B in which the firm is acting; and (iii) a situation where a firm
has confidential information relating to itself and is entering into a transaction with
a client.I6As regards (i), as stated in the previous paragraph, the firm does not have
to use the confidential information for the benefit of either client, and it is therefore
possible for the firm to act for both ~1ients.l~However, as regards (ii) and (iii), there
is a conflict of interest in relation to the same matter’’ and in these cases we have
difficulty in seeing how the firm can act without the consent of the clients in either
situation.’’ Both Harrods Ltd v Lemon2’ and North and South Trust CO v Berkeleg‘
are examples of the type (ii) transaction and, if a fiduciary was held to be in breach
of duty in this situation, it would be, a fortiori, in the type of transaction set out in
(iii).
Groups of companies
12.10 Some respondents said that our statement of law in the consultation paper relating
to the attribution of knowledge of a director who served on the boards of a parent
and subsidiary company within a corporate group22required further expansion.
What we intended by this statement was that the director should have an obligation
to communicate on behalf of one company and an obligation to receive on the part
of the other.23This will depend on the facts of any given case. We said that it would
be possible for a group to organise its affairs to prevent attribution from occurring,
16
One respondent considered that in dealing with attribution, a distinction needed to be
drawn between information relating to the firm and information relating to the client. This
distinction is undoubtedly valid, but it confuses attribution of knowledge with the use that
can be made of that knowledge. Arguably it does not address the point raised in
transaction (ii) in the text.
l7
See para 3.30 above. However, note that if a court were to take a narrow view of Kelly it
might hold that the f m should not have placed itself in a position where its duty to one
customer conflicted with the duty owed to another; see para 3.32 above.
See P D Finn, “Fiduciary Law and the Modem Commercial World” in Commercial Aspects
of Trusts and Fiduciary Obligations (McKendrick ed 1992) pp 23-27.
2o [1931] 2 KB 157.
[1971] 1 WLR470.
22
“The answer to this depends on whether the director is under an obligation to
communicate the information to either entity”; Consultation Paper No 124, para 2.3.9.
23
In fact, this analysis was in due course refined by Hoffmann LJ in El Ajou. See paras 3.9-
3.13 above.
75
but suggested that this may be difficult where a director who is on the board of the
parent company sits on the board of a subsidiary and overlooks a Chinese wall for
the purposes of discharging his responsibilities as a member of the parent
company.24The point was made by one respondent that this practice was essential
for the prudent management of corporate groups, for the purpose, for example, of
controlling group exposure. It was also pointed out that it would be possible to
impose on the director a duty to preserve confidentiality. We agree with these points
but much will depend on the particular facts of a case. If the director has received
information which he has an obligation to the subsidiary to communicate and to the
parent to-receiveJZ5then receipt by him will be treated as receipt by the parent.
Recent legal developments

12.1 1 We have already considered the legal developments which have occurred since the
publication of the consultation paper.26The most significant cases with regard to
attribution are EZAjou, Meridian and Kelly. As explained above,27the first two of
these cases do not have a significant impact on the analysis of attribution in the
consultation paper, although Hoffmann LJ’s judgment in El Ajou offers a refinement
of the analysis of acquisition of knowledge by reference to agency principles.28The
information which was attributed to DLH because of the knowledge of Ferdman
had been acquired by him in connection with his relationship with another company
(the Swiss company). There was (per Nourse LJ) no duty owed by him to the Swiss
company to communicate this knowledge to DLH and (per Hoffmann LJ) no duty
on DLH to enquire, and therefore Ferdman’s knowledge could not be attributed to
DLH under agency principles. On Hoffmann LJ’s analysis, even if there was a duty
owed to DLH to communicate the information to it (which he thought there
probably was) the presumption that Ferdman had communicated it could be
rebutted as the case did not fall within one of the “distinct c a t e g ~ r i e s ”On
. ~ ~the
facts that presumption had been rebutted, since Millett J found that Ferdman had
not communicated the information about the source of the moneys to DLH.
However, the knowledge was attributed to DLH because Mr Ferdman’s status
24
25
Or if he comes within one of Hoffmann LJ’s categories discussed at para 3.9 above.
26 See Part I11 above.
27
See paras 3.11-3.13, 3.23 above.
28
Lord Hoffmann’s judgment in Meridian also explains and refines the principles which lie
behind the direct attribution of knowledge to a company by reason of a person’s status.
29 See para 3.9 above. These include the situation where a company has a duty to investigate
which it fulfils by using an agent.
76
within DLH with respect to the particular transaction resulted in his knowledge
being that of DLH.30
12.12 As we explained earlier,31Hoffmann LJ’s reasoning in this case could be relevant to

the situation discussed in paragraph 12.10 above, where a director sits on the board
of both a parent and subsidiary company. The p r e ~ u m p t i o nthat
~ ~ he communicated
to the parent company information which he acquired as a director of the subsidiary
could be rebutted so long as the circumstances did not fall within one of the
“distinct categories”. Further, depending on the internal arrangements within the
parent company, it may be possible to prevent knowledge which he acquired as a
director of the subsidiary from being directly attributed to the parent because of his
status in respect of a particular t r a n ~ a c t i o n . ~ ~
12.13 The third case, Kelly, has also been analysed fully.34The decision does not consider
the principles governing the attribution of knowledge since there was actual
knowledge in that case. However, it recognises that a firm is under no obligation to
use confidential information relating to one client in carrying out a transaction for
another client with respect to which the information is relevant.35The court singled
out the case of “stockbrokers”, who it considered “cannot be contractually bound
to disclose to their private clients inside information disclosed to the brokers in
confidence by a company for which they also act”.36It is important to note that the
opinion of the Privy Council is couched in terms of “not being contractually bound
to disclose”, and that it does not state that a fiduciary “can by contract exclude the
obligation to disclose”. However, as has been already observed, although the
decision confirms that there is no duty to use or to disclose confidential information
relating to another customer, it does not in all situations entitle the firm to put itself
30
As Meridian makes clear it is a question of construction in each case whether the
knowledge of a particular officer will be attributed directly to the company for the purpose
of the particular transaction in question; see paras 3.22-3.23 above.
3L Para 3.13 above.
32
Such a presumption would only arise if he had a duty to communicate the information to
the parent company; see para 3.10 above.
33
For example, if he has no part in dealing with or giving advice to clients. Both El Ajou and
Meridian made it clear that the question of whether knowledge will be attributed to a
company because of a person’s status depends on the circumstances of the particular
transaction in question and the purpose of the substantive rule in respect of which the
knowledge is relevant.
34 See paras 3.24-3.36 above. ~.

35
36
[1993] AC 205, 214. See para 3.26 above.
77
in a situation where it owes conflicting duties to its customers, or where its own
interests conflict with those of a customer.37
Views on reform
12.14 There was strong support on consultation for the reform of the rules on attribution
of knowledge within a corporation or partnership, although some respondents
commented that this would only be necessary if Chinese walls were not otherwise
legitimated. In so far as there were any views on the form that the reform should
take, there appeared to be a preference for a restatement of the law relating to
attributio-n by providing clear protection where a Chinese wall had been used,
although some respondents suggested that the irrebuttable presumption of
knowledge should in general be replaced by a rebuttable p r e s ~ m p t i o n . ~ ~
12.15 However, a small number of respondents advocated caution as regards the reform
of the law relating to attribution. They were motivated by two reasons: (i) it could
provide a positive and undesirable incentive for a firm to be ignorant to the
detriment of its and (ii) attribution is an extremely complex issue, involving
as it does not only the issues addressed in the consultation paper, but also, inter alia,
both criminal liability4' and liability for breach of regulatory rules where knowledge
is a relevant factor.
12.16 As regards (i), one respondent gave as an example of where this might arise the case
of a broker holding client money, pending investment in a deposit account with a
deposit taker with whom it had corporate links. It was suggested that the customer
would expect the broker to have informed himself so far as possible as to the good
standing of the deposit taker, and if the deposit taker came into financial difficulties,
he would expect the broker to withdraw the funds as soon as possible. It was said
that a broker who had failed to make such enquiries as any outside broker would
have made should not, in these circumstances, be able to use a Chinese wall as a
defence for failing to obtain the appropriate information. However, several other
respondents considered that as a matter of practice the problem of wilful ignorance
was one that simply did not arise.
12.17 As regards (ii), this is a contention with which we agree. Given that this report deals
only with one facet of the attribution of knowledge to partnerships and companies,
it would not be appropriate to recommend its modification without a more far I
I
ranging enquiry examining all aspects of the subject. For example, any modification I
i
37
38
One response advocated the reform of s 16 of the Partnership Act 1890.
39
On this see Consultation Paper No 124, para 6.26.
40
See the brief discussion of this topic in Involuntary Manslaughter, Consultation Paper No
135, paras 4.32-4.33.
78
of the law on attribution would raise important questions relating to criminal and
tortious liability. Answers to these difficult questions go beyond our remit in this
project.
Exculpation of fiduciaries who the court considers have acted honestly and
reasonably
12.18 There was almost unanimous support for a legislative provision for the exculpation
of fiduciaries who, although they have breached their fiduciary duties, have acted
reasonably, along the lines of section 61 of the Trustee Act 1925 and section 727
of the Companies Act 1985. It was said that in the multiplicity of circumstances in
which allegations of breach of fiduciary duty could arise, a general exculpatory
provision would help to reduce technical and unreasonable points being taken in the
course of litigation. Even the respondents who did not favour reform on the main
issue41supported this reform. Only one respondent opposed this option. It argued
that the strength of fiduciary obligations helped to ensure that regulators through
their rules gave the greatest possible protection to customers, and that this strength
should not be watered down by exculpatory legislation. We do not consider that this
would happen. The obligations owed by a fiduciary would remain unchanged. The
power would merely give the court the discretion to relieve a fiduciary of liability for
breach of duty where, in its opinion, he had acted honestly and reasonably. We are
inclined to the view that reform along these lines would be useful. However, for the
reasons set out in paragraphs 15.2-15.12 below, we are not making a
recommendation to this effect in this report.
41
That statute should provide that a court should take into account reasonable regulatory
rules when considering an alleged breach of fiduciary duty. See paras 11.2-1 1.13 above.
79
SECTION D
RECOMMENDATIONS
PART XI11
INTRODUCTION TO FINAL
RECOMMENDATIONS
13.1 In this section we set out our recommendations. In Part X N , we reconsider our
main provisional conclusion that statute ought to provide that account should be
taken of reasonable regulatory rules when a court is ascertaining the precise content
of a fiduciary obligation, and say why we are not now making a recommendation
along these lines. We address in this section not only the original recommendation
itself, but also a revised formulation, which we considered during the course of
consultation, that there should be a statutory defence to an allegation of breach of
fiduciary duty where a firm can show that it has complied with a valid regulatory
rule, unless it was unreasonable for it to have done so in the particular
circumstances of the case. In Part XV, we consider the merits of an exculpatory
provision for fiduciaries who have breached their fiduciary duties but have acted
honestly and reasonably, and explain why we do not make a recommendation for
such a provision in this report. In Part XVI, we set out our recommendations
regarding Chinese walls. In Part XVII, we give our recommendations on the other
options for reform. Part XVIII contains a summary of our recommendations.
80
PART XIV
RECONSIDERATION OF OUR MAIN
PROVISIONAL CONCLUSION
Introduction
14.1 The outcome of consultation, and the legal and regulatory developments since the
date of publication of the consultation paper,’ have persuaded us not to proceed
with our provisional conclusion. T h e focus of this part is the provision of financial
services, since the responses to both the issues questionnaire2 and the consultation
p a p e l indicate that the problems which arise out of mismatches between what is
required or permitted by regulatory rules and what is required or permitted by
fiduciary obligations arise primarily in this field of activity. We begin by
summarising our reasons for considering that fiduciary law should take account of
reasonable regulatory rules. We then examine whether this policy represents the law
at present. Next we refer back to our earlier discussion of the impact of contractual
techniques. We then examine our provisional recommendation for reform in the
light of these considerations, and this is followed by consideration of the revised
formulation of our provisional recommendation. Finally we set out our conclusions,
and explain why we no longer advocate the recommendation in either its original
or revised formulation.
Reasons for considering that fiduciary law should take account of

reasonable regulatory rules
14.2 We discussed the arguments for and against the policy that fiduciary law should take
account of rules made by regulatory bodies operating in the public law sphere in
Part VI of the consultation paper. What follows is a summary of the three main
points which have influenced our views.
14.3 We start with our belief that the law governing the conduct of fiduciaries should
take account of the new situation4 which was created by the abolition of fixed
commissions, the removal of the requirement of single capacity in stock-exchange
transactions, and the decision to permit the development of financial
conglomerate^.^ In this new situation it is no longer realistic to follow the classic
Consultation Paper No 124 (May 1992).
Law Commission Issues Questionnaire, Fiduciary Duties and Regulatory Rules (November
1990). See further Consultation Paper No 124, para 1.5-1.15, Appendix 1.
Consultation Paper No 124.
This new situation was given statutory recognition by the enactment of the Financial
Services Act 1986. . .
As to which see Consultation Paper No 124, section 2.2. See generally P D Finn
“Fiduciary Law and the Modem Commercial World” in Commercial Aspects of Trusts and
Fiduciary Obligations (McKendrick ed 1992) p 7.
81
formulations of fiduciary obligations and to require conduct which can only be
achieved by a person or organisation acting in a single capacity6 The regulatory
system incorporates safeguards for customers, such as the requirement to obtain best
e x e c ~ t i o n , and
~ it also gives customers the benefit of a pro-active system,
compensation funds, and, in the case of private investors, a statutory right of action
for breach of the rules.8
14.4 The second main point is that if the regulatory system were to operate as an
additional layer of protection, leaving fiduciary obligations untouched, regulatory
rules would either be required to replicate common law rules, or there would be two
independent systems of law, one operating in the regulatory sphere and the other
in the courts. To allow the two systems to operate side by side would be confusing,
complicated and undesirable, and the retention of the second system in an unaltered
’
form might subject people to conflicting duties.’
14.5 Finally, the decision to use a particular form of regulation and a particular
regulatory body was a legislative one, and the regulatory bodies to whom Parliament
has delegated the achievement of the new statutory purposes are likely to have
expertise in the areas remitted to them.” Thus, although the new system is
described as self-regulating, it is the product of legislation and is a form of public
law regulation. It is, therefore, appropriate to take some account of regulatory rules
when assessing liability for an alleged breach of a fiduciary obligation.
Does this policy represent the law?

14.6 We now consider whether this policy represents the present law: whether fiduciary
law does in fact take account of reasonable regulatory rules. The effect of regulatory
rules on common law and equitable fiduciary duties depends on two factors: first,
whether the regulator had authority to make rules which altered such duties; and
secondly, if it had such authority, whether this authority was in fact exercised when
the rules were made.’’ It is reasonably clear that FSA, sections 81(1) (unit trusts)
’ SIB Core Conduct of Business Rule 22.
FSA, s 62. See Consultation Paper No 124, para 6..8.
The main areas of potential conflict at present concern the disclosure of commission
(including “soft” commission) and other remuneration, relaxation of the “no profit” rule,
and the operation of Chinese walls. See para 1.8 above..
lo
Consultation Paper No 124, paras 5.5.3, 7.19.
I’
82
and 55 (client money) authorise the making of rules modifymg common law and
equitable rights and obligations.12 As we have discussed above,13 section 48(2) (h)
(Chinese walls) probably also does so, but the range of different opinions on this
point means that this conclusion is not free from doubt. The position is less clear,
however, in relation to the other rulemaking powers in the FSA, and to the rules of
the SROs and RPBs.14
14.7 We explained in the consultation paper15 that where there is a mismatch between
a regulatory rule and a common law or equitable duty there are three possible
outcomes. First, the court might hold that there is no authority to make such a rule
and declare the rule invalid. Secondly, the court might give the rule a restrictive
interpretation so that it does not affect common law and equitable duties, or
operates only in the regulatory sphere. Thirdly, the court might recognise that the
rule is made pursuant to statutory authority in one of two ways. It might conclude
that there was authority to modify common law and equitable rights. In that case
it could give the regulatory rule statutory force so that it would successfully modify
the equitable right with which it is in conflict. Alternatively it could give some
recognition to the public law nature of the regulatory rule by taking it into account
when determining the precise content of the equitable or common law obligation.16
In each factual context the outcome will depend on the strength of the presumption
that statutes do not alter the common law in the circumstances of the particular
case.17
14.8 In the consultation paper we illustrated the differing strengths of the presumption
by using three models. First, there was what was termed the “private law model”
where the presumption was strongest. Under this, the court would hold that there
was no authority to make rules altering private law rights and obligations unless the
enabling statute conferred such authority expressly or by necessary implication. l8
Second, there was the “public law model”, where the presumption was weakest.
Under this, it is the nature and scope of the statutory scheme, rather than any
express power to alter private law rights contained in the statute, that is important
in determining the scope of the rulemaking powers.” The final model, representing
12

l4
See generally, Consultation Paper No 124, Part V.
l5
Consultation Paper No 124, para-5.4.2.
l6 Ibid, para 5.4.3.
Ibid, para 5.4.4. - .
Zbid, paras 5.4.5, 5.4.8-5.4.12.
Zbid, paras 5.4.6, 5.4.13-5.4.22.
83
a middle way, was the “hybrid model”. Under this, some recognition would be
given to the public law nature of the regulatory rule by taking account of it when
determining the content of the fiduciary obligation.” Although it was our view that
where the scope of a rulemaking power was uncertain, the hybrid model probably
represented the law,’l we pointed out that this was not without doubt since the
model had not been considered by the courts in the context of mismatches between
regulatory rules and the common law and equity.22The legal position has not
changed since the publication of the consultation ~ a p e ?and
~ we still incline to the
view that the hybrid model represents the law,24although there is always the risk
that a court faced with a mismatch might adopt a different approach.
Impact of contractual techniques

14.9 The case for a reform of the law in order to put this point beyond doubt becomes
weaker to the extent that it is possible to avoid any problems caused by a mismatch
between a regulatory rule and fiduciary duty by the use of contractual technique^.^^
We indicated earlie?6 that the approach of the Privy Council in Kelly has confirmed
the belief of many of the respondents to the consultation paper that fiduciary duties
can be modified by the express or implied terms of a particular contract so as to
avoid any problems of mismatch.
14.10 We have already discussed the impact of the decisions in Kelly and Clark B ~ y c e . ~ ~
We concluded that, by making it clear that an agent’s fiduciary obligations can be
defined by the terms of the contract of agency, they went a long way towards
enabling firms to deal with any problems which might arise as a result of
mismatches between fiduciary and regulatory requirements by using the express
20
Ibid, paras 5.4.23-5.4.29.
21
Ibid, paras 5.4.5, 5.4.8-5.4.12, 5.5.3, 6.17-6.21, 7.21-7.22.
22
Ibid, para 6.15.
23
Recent cases such as Kelly and Target Holdings have, however, indicated that the courts are
prepared to take a pragmatic approach to disputes which arise in the sorts of areas covered
by this project and look at the commercial realities of the situation. This would tend to
support the view that they will give due weight to relevant regulatory rules in an
appropriate case. See para 3.40, n 72 above.
24
This approach is supported by Lord Hoffmann in a speech delivered at a conference of
superannuation lawyers in Australia on 24 February 1994, where he referred to the need
for a “combination of moral [equitable] principle with tact in abstaining from interference
where the ground is adequately covered by other mles”. In the case of rules in the
financial services sphere he said that “the need for respect and restraint on the part of the
courts in the interests of certainty in the market and the practical functioning of business is
just as great as in the case of statutory regulation”.
25
Consultation Paper No 124, para 6.10. ~.
26
21
84
terms of their contracts to limit the extent of their fiduciary duties.28We said that
the decision in Kelly also indicated that in certain circumstances, where an agency
contract was silent on the matter, the fiduciary duties of an agent would be
restricted by implied terms of the contract.29Finally, we considered that the Privy
Council’s approach lent support to the view that a trade custom which modifies a
fiduciary obligation, would now be regarded as reasonable if the custom also
provides adequate protection for the customer’s interest^.^'
14.1 1 We noted, however, that there were limitations on the extent to which Kelly enabled
the use of contractual techniques to avoid problems of mismatch. We explained that
there would be limitations on the Circumstancesin which the court would imply into
a contract terms modifylng the fiduciary duties which would otherwise be owed. We
identified three situations in which the court would be unlikely to do so. The first
was where a firm had acted for two customers in the same t r a n ~ a c t i o nThe . ~ ~ second
was where the conflict between a firm’s own interest and its duty to a customer was
more acute than the simple receipt of commission on a rival transaction, for
example, where a firm had a direct material interest in a transaction with a
customer.32The third was where there had been “iniquity” or m a l p r a ~ t i c eBeyond .~~
these three situations we said that the position would depend upon whether Kelly
was given a wide or a narrow i n t e r p r e t a t i ~ nWe
. ~ ~also noted that the wide variety
of Chinese walls and of the different ways in which they are monitored make it
unlikely that any sufficiently certain and uniform practice can be established in
relation to Chinese walls to enable the use of any particular Chinese wall to
constitute a trade custom.35
14.12 Kelly will provide a solution where the following conditions are satisfied. First, the
duty defining and exclusion clause must clearly cover the transaction in question:
it will have to do so unambiguously since it will be subject to the contra proferentem
rule of i n t e r p r e t a t i ~ nSecondly,
.~~ in those situations where the relationship between
28
See paras 3.29, 3.40, 7.3 above.
29
Where a firm acts for different customers with conflicting interests in different
transactions, and in some circumstances where the firm’s own interest conflicts with the
duty owed to a customer; see paras 3.30-3.32 above.
30
31
32
35
See para 7.8 above.
85
the firm and client has altered over time, this altered relationship will also have to
be caught by the clause.37And thirdly, it must be the substance of the relationship
between the client and the firm that is covered by the clause and not what the
parties call it.38If these three conditions are satisfied, then Kelly provides a way of
solving the problems that arise from any mismatch between fiduciary rules,
regulatory rules and market structure.
Examination of our provisional recommendation

14.13 We have already reported3’ that although most respondents to the consultation
paper thought that fiduciary law should take account of regulatory rules, support for
legislation to this effect was limited. Some thought that the present state of the law
was acceptable and that there was no need for reform on this issue.40Others thought
that the only solution which would provide the necessary degree of certainty was a
safe-harbour type solution whereby compliance with a relevant regulatory rule would
automatically constitute a defence to a claim for breach of fiduciary duty, and when
it became clear that this solution was no longer viable they preferred to have no
reform at all to the middle way we had suggested.41
14.14 In Part XI4’ we gave reasons why we believe that effective answers can be given to
many of the arguments put forward by respondents against this option for reform.
In the end, however, we were persuaded that reform along these lines might cause
difficulties, both because the court might have to reach a view on the reasonableness
of the regulations in proceedings for breach of fiduciary duty to which the regulator
might not be a party, and also because it might require wholesale amendment of the
rules of the regulatory bodies which would result in undesirable disruption and
upheaval to the regulatory e n v i r ~ n m e n t . ~ ~
37
See para 7.3 above.
38
39
See paras 10.2, 11.1-11.13 above.
4’
See paras 11.9-1 1.12 above. We have already indicated why we do not favour a general
“safe harbour”; see paras 11.9-1 1.10 above. Apart from the practical problems arising
from dedesignation of the Core Rules, as a matter of principle we consider that it would
be constitutionally inappropriate to permit the rules of self-regulatory bodies, which are
not subject to direct Parliamentary safeguards, to alter common law and equitable
obligations under the general law, and that it would remove the safeguard that at present
rulemaking by regulatory bodies must take account of fiduciary obligations wherever
possible. We also consider that recent publicised failures in the regulatory system have
made it undesirable to remove customers’ private law rights, thereby leaving them entirely
dependent on the regulatory system for protection.. .
86
Revised formulation of our provisional recommendation
14.15 This conclusion led us to consider other possible means of achieving the result that
in an action for breach of a fiduciary duty, a court determining liability would take
into account the fact that the defendant had complied with a reasonable regulatory
rule. We therefore developed the idea of creating a statutory defence to an allegation
of breach of fiduciary duty, if a firm could show that it had complied with a valid
regulatory rule, unless it was unreasonable for it to have relied on that rule in the
particular circumstances of the case.44We thought that it should be made clear that
references to unreasonableness in this context should only encompass those
situations where it would be manifestly unjust for a firm to be able to rely on a rule
in the particular circumstances of a case.
14.16 The revised formulation of this option for reform differs from its initial formulation
in the consultation paper in that it would not affect the content of the fiduciary duty
in question. However, it would still achieve the intended result of protecting a firm
from liability for breach of fiduciary duty if it had complied with a valid45regulatory
~ ~the firm to have relied on the rule. As
rule, provided it was not ~ n r e a s o n a b l efor
with the initial formulation, its adoption would, therefore, ensure that a court would
be able to take account of and give appropriate recognition to the expertise of the
regulatory bodies in the area of public law remitted to them by the legislature,
without completely abdicating control to the regulator^.^^ On the other hand, the
formulation of the option as a defence would have the advantage that it would avoid
the difficulties to which a “taking into account” provision would give rise unless the
current regulatory rules are amended.48
14.17 However, when we discussed the merits of this proposal with a number of
respondents, including the SIB, the Company Law Committee, and the BMBA, it
was not supported. Two reasons in particular emerged from these discussions. The
main reason given by a number of respondents stemmed from their confidence that
market solutions, such as contractual and structural arrangements, enabled firms to
deal with any mismatches between fiduciary obligations and regulatory
requirements, thus obviating the need for any reform. This confidence had increased
as a result of the approach of the Privy Council in Kelly. We have already discussed
the case of Kelly at some length4’ and concluded that contractual techniques can go
44
For example, when regard was had to such obligations as “know your customer”
45
A regulatory rule would only be valid if it satisfied the test of Wednesbuy reasonableness
(for the meaning of this, see para 10.1, n 2 above). ,
46
For the meaning of “unreasonable” in this context, see para 14.15 above.
47
See para 11.2 above and Consultation Paper No 124, para 6.21.
48
49
See paras 3.24-3.36, 14.9-14.12 above.
87
a long way towards avoiding a mismatch between fiduciary duties and what is
required or permitted by regulatory rules, although we are not as confident as some
respondents that Kelly provides a complete panacea to any problems which might
arise as a result of such a mismatch.
14.18 The second reason put forward in the discussions was that the introduction of the
defence would do little to increase certainty. Most respondents considered that
where it was unclear whether a rulemaking power authorised the modification of
common law and equitable obligation^,^^ a court, faced with a mismatch between
what is required or permitted by a regulatory rule on the one hand and by a
common law or equitable fiduciary duty on the other, would give some recognition
to the public law nature of the regulatory rule by taking account of it when
determining the content of the fiduciary obligation, adopting the “hybrid model”
outlined above.51In other words, they were fairly confident that the court would
already take into account reasonable regulatory rules. For this reason, they thought
that the defence was unlikely to offer greater protection than the present law, and
that it would do little to increase certainty. As we have previously indicated,52 we
consider that where the scope of a rulemaking power is uncertain the hybrid model
probably represents the present legal position, although the matter is not entirely
without doubt.
14.19 Although any statutory requirement of “reasonableness” or “unreasonableness”

inevitably introduces a measure of uncertainty, any uncertainty in the operation of
the proposed defence would be minimised if the test of unreasonableness was
formulated in such a way that it only caught extreme behaviour which gave rise to
manifest injustice.53In most cases there would, therefore, be no doubt that it was
reasonable for the firm to have relied on the rule, and the defence would operate.
This solution would, in our opinion, provide more certainty than the present
position, in which it is open to argument whether a fiduciary who has acted in
accordance with a regulatory rule may (in the absence of anything in his contract
to the contrary, or a reasonable trade custom, or the customer’s informed consent)
nevertheless be liable for breach of a fiduciary obligation. We, therefore, believe that
the concerns about uncertainty may have been overstated. As we noted in the
consultation paper, commercial bodies cope satisfactorily with the “reasonableness”
50
We are here concerned only with regulatory rules made under a rulemaking power which
does not clearly authorise the modification of common law and equitable obligations.
Where there is authority to modify private law rights, as there is in FSA, ss 55 and 81,
(see Consultation Paper No 124, paras 5.3.4, 5.3.5, 5.4.1, 5.4.3, 5.5.2) the regulatory rule
will modify the fiduciary duty and there will be no problem of mismatch.
5’ See para 14.8 above.
88
test54 imposed by the UCTA regime in relation to standard written terms of
business.55We therefore consider that the introduction of a legislative defence along
the lines proposed in paragraph 14.15 above would have been useful in removing
the threat of liability for breach of fiduciary duty from a fiduciary which had acted
reasonably and complied with its regulatory obligations. It would have ensured a fair
result where contractual techniques proved inadequate, either because of human
error in drafting, or because of the difficulties of predicting rule changes in advance,
or of foreseeing the potential conflicts which may arise in complex situations.
Conclusion
14.20 However, in the light of both the responses to consultation and the legal and
regulatory developments since 1992 we have decided not to pursue our provisional
recommendation (either in its original or its revised formulation). As we have said,
a majority of respondents did not support it. We said in the consultation papeP6
that we believed that a court, faced with a mismatch between fiduciary duties and
what is required or permitted by regulatory rules, would probably take account of
regulatory rules in determining the content of the fiduciary duty. Although there
have been no cases since then directly on this point, we believe that the approach
of the courts in cases such as Kelly and Target Holdings would tend to support this
c o n c l u ~ i o nWe
. ~ ~also accept that contractual techniques can go a long way towards
dealing with most problems of mismatch which are likely to occur. We do not
consider that, in general, the remaining difficulties and uncertainties are such that
we should pursue the provisional recommendation in the light of the limited support
it received on consultation. However, as we explain below,58in the particular case
of Chinese walls we do consider that legislation is desirable to clarify the position,
and we set out our recommendations on this point in Part XVI. We are also
inclined to the view that it would be useful to introduce a general form of
exculpatory provision,59 an idea widely supported on consultation, but, for the
reasons we give in Part XV below, we are not recommending the introduction of
such a provision in this report.
54
See Unfair Contract Terms Act 1977, ss 3, 1 1 .
55
56
Consultation Paper No 124, paras 5.5.3, 7.22.
57
58 See para 16.7 below.

59
See para 12.18 above and para 15.1 below.
89
PART XV
EXCULPATORY PROVISION
General
15.1 We gave very careful consideration to the possibility of giving the court a
discretionary power to relieve from liability a fiduciary who it considers has acted
honestly and reasonably and ought fairly to be excused, along the lines of section
61 of the Trustee Act 1925 and section 727 of the Companies Act 1985. This
option found widespread support on consultation in relation to all spheres of
fiduciary activity,' although it was not a proposal which was developed in the
consultation paper in any detail.' At first sight it would have been a simple means
of providing a safety net for a fiduciary who had complied with regulatory rules in
circumstances where it was reasonable for him to have done so, but where
contractual methods and public law failed to provide appropriate p r ~ t e c t i o nIt. ~had
the particular advantage of flexibility, since it would not have been tied to any
I
particular system of regulation and would, therefore, have provided a long lasting
I
solution. It also built on a familiar legislative technique of which the courts already
have experience .4
1
15.2 However, when we came to examine the details of this option, and after we had
discussed it further with a number of interested parties, we eventually concluded
that it would not be appropriate to make a recommendation for such a provision at
this stage and in the context of this report. There were, for instance, strongly
opposing views on the form which such a provision should take. Some people
1
1
expressed concern that the creation of a discretionary right to relief would introduce
greater uncertainty than existed at present in areas of activity like financial services,
and that it would lead to increased litigation and wasted costs. Others pointed out
that the provision would have to be understood not only by specialist Chancery
practitioners accustomed to the operation of sections 61 and 727 but by a much
wider group of judges, barristers and solicitors. It was suggested, therefore, that we
should spell out in very precise terms the way in which the court was to exercise its
discretion. An analogy was drawn with Schedule 2 of the Unfair Contract Terms
' See para 12.18 above.
See Consultation Paper No 124, para 6.28.
Although the exculpatory provision would not have .expressly required compliance with the
regulatory rules, a court would have been unlikely to exercise its discretion under the
provision unless the firm had fully complied with the relevant regulatory rules.
Namely, that used in s 61 of the Trustee Act 1925 and s 727 of the Companies Act 1985.
90
Act 1 9775where the clear statements of Parliamentary intention were said to be very
helpful.
Guidelines
15.3 This led us to consider the possibility of introducing guidelines on the meaning of
the word “reasonably” and on the types of situation in which the fiduciary “ought
fairly to be excused”. However, when we discussed this proposal with a number of
the main parties with a specialist interest in the financial services field, they strongly
opposed a provision which included any such guidelines. Two reasons were given
in particular. First, it was said that it would be almost impossible to envisage all the
factors which might be relevant in a given case, particularly as it was anticipated that
the provision would only rarely be invoked.6 It was therefore important that the
courts should be given as much leeway as possible. The guidelines would either be
so wide and general that they would be obvious and of minimal assistance, or they
would be more specific in which case there was a risk that they would fail to
encompass all the situations with which a court might be confronted and could be
misleading in a particular case. Secondly, it was said that guidelines would have the
unfortunate effect of divorcing the new provision from sections 61 and 727. One of
the advantages of an exculpatory provision which we have already noted7 is that it
would have built on a familiar legislative technique. With the introduction of
guidelines the new provision could no longer be seen as being merely an extension
of existing legislation to other fields of activity, and there would be an obvious and
undesirable departure from the existing provisions.
Scope
15.4 The second point raises other more general concerns about the introduction of a
new exculpatory provision, namely what its scope should be and how it would relate
to the existing legislation. On the question of scope, the issue to which this project
was directed was the mismatch between fiduciary duties and regulatory rules. The
responses to the consultation paper confirmed that the possibility of mismatch was
not regarded as causing significant problems outside the financial services field. This
suggested that the provision should only apply to fiduciaries within this field, But
to limit the provision in this way would lead to considerable difficulties of definition,
whether it was done by reference to the nature of the activity undertaken or the
category of fiduciary involved.
Which sets out factors to be taken into account in determining whether a contractual term
satisfies the requirement of reasonableness for the purposes of certain sections under the
Act.
We have already indicated that we consider that any reform.would be very much a safety
net in the event that contractual techniques and public law failed to provide adequate
protection in an appropriate case; see para 15.1 above.
91
15.5 For example, one option we considered was to confine the relief to breaches of
fiduciary duty committed “in the course of carrying on investment business”. This
would have the advantage of tying the provision to an existing definition under the
FSA.8 However, this definition is not free from difficulties. One example given to
us was the classification of bondsg and loan notes.” Although both instruments can
be traded, only bonds constitute investments under the FSA.” It would be odd if
exculpatory relief were available in respect of transactions involving bonds, but was
unavailable in respect of those involving loan notes. The point was also made that
the same transaction could involve both investment and non-investment business
so that relief might be available in respect of only part of a transaction. Similar
problems would arise if the provision was limited by reference to the category of
person to benefit rather than by reference to the nature of the activity.12Whilst these
difficulties of definition are present under the FSA regime and could be dealt with
by careful drafting, they do demonstrate the need to consider any new exculpatory
provision in a wider context.
15.6 Moreover, it may be regarded as anomalous that some types of fiduciary (namely
trustees and directors) at present have the benefit of an exculpatory provision while
others do not. There is a case for introducing an exculpatory provision which applies
to fiduciaries of all kirids. The case of Boardman ZJ P h i ~ p s illustrates
’~ the potential.
for “hard cases” which have nothing to do with a mismatch between regulatory rules
and fiduciary duties.14 The court’s power to grant an equitable allowance to a
fiduciary in such cases to mitigate the harshness of the equitable rules may have
See FSA, s 1(2), (3).
Bond is a generic term used to cover a wide variety of debt securities.
lo
A loan note is an instrument issued in respect of money borrowed to pay for goods or
services.
I’
See FSA, Sched 1, para 2.
For example, members of RPBs such as solicitors and accountants carry out activities
which in many respects are similar to those of members of SROs (eg investment and
corporate finance advice) but in other respects their business can be compared to that of
other professionals such as estate agents, surveyors and licensed conveyancers whose
activities fall outside the FSA altogether.
l3 [1967] 2 AC 46.
l4
In that case, a solicitor who had for some time acted for the trustees of a trust purchased
shares on the basis of information acquired by him_wKle acting for the trustees. The result
of the exercise, as had been intended by the solicitor, was in fact to increase greatly the
value of other shares owned by the trust and he had acted in good faith throughout.
Nevertheless, the solicitor was held to be a constructive trustee of the shares for the
beneficiaries of the trust and liable to account to them for the profit he had made.
92
been cut back re~ent1y.l~ In this context, the consideration of an exculpatory
provision for firms operating in the financial services sector may be seen as part of
a much wider problem relating to the liability of fiduciaries and the relief that is or
ought to be available to them.
Relation to existing legislation

15.7 How a new provision would relate to existing legislation is another question that
gives rise to difficulties. If it was thought desirable to avoid any overlap with the
existing provisions then it would be necessary to exclude from the scope of the new
provision those fiduciaries who are already covered by sections 61 and 727. This
would not be a simple task, particularly as the exact scope of those sections
themselves is unclear. For example, it is not entirely clear how far a constructive
trustee can rely on section 6 1: although constructive trustees are included within the
definition of “trustee” given in section 68(17) of the Trustee Act 1925,16 it is
difficult to see how there can be a “breach of [constructive] trust” which is an
essential ingredient for the application of section 61 .I7 There are many cases where
a constructive trust will arise or be imposed where there has been a breach of
fiduciary duty.” If we were simply to exclude “trustees” from the scope of the new
provision, a fiduciary who had breached his fiduciary duty and was held to be a
constructive trustee might (without more) be left without any right to seek relief,
since he would have been excluded from the new provi~ion’~ and might not be able
to rely on the existing section 61. If, on the other hand, the new provision was to
cover some of the same ground as the existing legislation, this would mean that in
a particular case a fiduciary could seek to rely on the two provisions in the
l5
See Guinness v Saunders [1990] 2 AC 663, 701 where Lord Goff stated that the exercise of
the jurisdiction should be “restricted to those cases where it cannot have the effect of
encouraging trustees in any way to put themselves in a position where their interests
conflict with their duties as trustees”. The statements in the House of Lords in that case
are in sharp contrast to those of the Court of Appeal in O’SuZZivan v Management Agency
&Music Ltd [1985] QB 428 where the defendants, who were held to have been in breach
of their fiduciary duties to the plaintiff in their dealings with him, were nevertheless
entitled to reasonable remuneration for the work they had done on his behalf, such
remuneration to include all expenses and a “fair profit”. A liberal allowance was also given
to the defendant solicitor in Boardman v Phipps, see n 14 above.
l6 See Appendix D.
I7
The full text of s 61 appears at Appendix D.
Where a fiduciary uses his position to obtain a benefit or where he profits in any way from
a breach of his fiduciary duties he is obliged to account for the profit he has made without
the informed consent of the beneficiary. But in addition he may be regarded as holding the
profit (or any property which represents the profit) as constructive trustee. See Boardman v
Phipps [1967] 2 AC 46; Attorney General v Reid [1994] 1 AC 324.
By virtue of the definition of “trustee” in s 68(17) of the Trustee Act 1925.
93
alternative. This could give rise to unnecessary complications, lengthen the
proceedings and add to the costs.20
Particular features of section 61

15.8 The difficulties of scope and overlap would be exacerbated if the new provision was
significantly different from sections 61 and 727. This would be the case, as we have
already indicated, if the new provision were to incorporate guidelines. But there are
also three other features of the operation of section 61 which we consider would
need reviewing in any new provision operating in the financial services field and,
unless a similar review of the current legislation was carried out, differences between
the old and new provisions could arise which would cause confusion and lead to an
undesirable fragmentation of the law in this area.
15.9 The first of these features relates to “self dealing”. By this expression we mean the
situation where a fiduciary buys property from or sells property to the beneficiary.21
In Tito v Waddell (No 2)22Megarry VC held, in considering whether a claim was
statute barred under the Limitation Act 1939, that self dealing was neither a breach
of trust nor a breach of duty; rather he categorised it as a d i ~ a b i l i t yAlthough
.~~ this
case did not involve an application by a trustee for relief, this analysis does suggest
that self dealing would not fall within the terms of section 61, which applies where
“a trustee ... is or may be personally liable for any breach of Megarry VC’s
analysis was followed by Vinelott J in Movitex Ltd v B ~ l f e l 8when ~ he was
considering whether certain provisions in a company’s articles infringed section 205
of the Companies Act 1948.26Any new provision should be capable of covering a
20
On problems of scope in relation to s 727 see Guinness v Saunders [1990] 2 AC 663. See n
24 below.
See Consultation Paper No 124, paras 3.4.33-3.4.36.
22 [1977] Ch 106.
23
[1977] Ch 106, 248. In fact, in Tito v Waddell (No 2) Megamy VC drew a distinction
between what he referred to as the self dealing rule and the fair dealing rule. The first
involved the purchase by a trustee of trust property fi-om himself and could be set aside by
the beneficiary ex debito justiciae; the second involved the purchase by the trustee of the
beneficiary’s beneficial interest and could be set aside unless the trustee could establish the
propriety of the transaction. However, he categorised both rules as disabilities.
24
In Guinness v Saunders [1990] 2 AC 663, counsel for the plaintiff referred to the self
dealing rule in arguing that s 727 was not available to a director (the second defendant)
who was seeking to retain a payment he had receiued which had not been disclosed to the
full board. Neither Lord Templeman nor Lord Gaff (who gave the only reasoned
speeches) dealt specifically with self dealing when refusing relief.
25 [1988] BCLC 104.

- .
26
This section, now s 310 of the Companies Act 1985, prohibits, inter alia, provisions in the
articles which exempt a director fi-om liability in respect of any “negligence, default, breach
of duty or breach of trust”. The provision in the articles modified the self dealing rule and
provided that a director could be interested in a contract with his company provided he
94
claim that, for example, a broker failed to make adequate disclosure when dealing
off his book or when buying on his own and in view of the uncertainty
arising from the classification in Tito ZI Waddell (No 2), this is a point which would
have to be addressed in drafting the new provision.
15.10 The second feature of section 6 1 which would have to be considered carefully in the
context of drafting a new provision concerns its application to professional trustees.
Although there is no doubt about the court’s jurisdiction to grant relief under
section 61 to a trustee who is remunerated, there appears from the cases to be a 1
marked reluctance to do so.28 Any new provision along the lines envisaged above
would be pointless unless it was in practice used to exculpate paid providers of
financial services. Again, therefore, it may be necessary to make express reference
to this point in any new provision.
15.1 1 The third feature of section 61 which would need reconsidering in any new
provision is a procedural We have been told by a leading Chancery
practitioner that at present a trustee may seek relief at trial without having to plead
particulars of his case.3oWe consider that this rule offends the modern practice of
I
requiring parties to disclose their cases in advance of trial and can result in the
expenditure of unnecessary costs.31
made disclosure of his interest in the manner required by the articles. Vinelott J held that
this provision did not infringe s 205 since, as the self dealing rule imposed a disability, the
provision did not involve exempting directors from liability for “breach of duty or breach
of mlst”.
’’ Megarry VC’s analysis would seem to include only buying by brokers from their customers
for their own account under the fair dealing rule; selling by a broker off his own book
would therefore come under a more general “no profit” rule. However, the cases on
brokeddealers do not draw any significant distinction between buying from and selling to
the customer; see the cases cited in paras 3.4.33-3.4.36 of Consultation Paper No 124.
See the comments of Willmer LJ in Re Pauling’s Settlements Trusts [1964] Ch 303, 338-
339. See also National Trustee COof Australasia v General Finance COof Australasia Ltd
[ 19051 AC 373; Bartlett v Barclays Bank Trust COLtd [19801 Ch 5 15. In fact, as one party
with whom we raised this issue explained, “a discussion of section 6 1 in this context
cannot practically be divorced from an analysis of the legal principles involved in the
standard of care required of a trustee in dealing with the administration of a trust”. A
professional trustee may quite properly be expected to exercise a higher standard of
diligence and knowledge than an unpaid trustee; see Re Waterman’s Will Trusts [1952] 2
All ER 1054.
29
This is also a feature of s 727 of the Companies Act 1985; see Re Kirby’s Coaches Ltd
E19911 BCC 130.
30
Singlehurst v Tapscott Steamship CO [1899] 107 LTJ 347, See also the Note to RSC Ord
18/8/18.
3’
This rule was criticised by Hof€inann LJ in Re Kirby Coaches Ltd [1991] BCC 130, 131-
132.
95 ’
Conclusion
15.12 These considerations have persuaded us that it would not be appropriate to
recommend a new exculpatory provision for fiduciaries without carrying out a much
wider review of exculpatory provisions and fiduciary duties in general, including a
detailed examination of the existing legislative provisions and the position of persons
such as those who intermeddle in trusts or receive trust property in breach of trust.
We would need to consult fully on these difficult issues and to ensure, as far as
possible, that a consistent and coherent approach was adopted. Such an exercise is
outside our remit in the present project which is directed only at situations where
there is a-mismatch between regulatory rules and fiduciary duties. The discussions
we have had with interested parties since we published the consultation paper have
showed us that although there was general support for the principle of introducing
an exculpatory provision, its introduction was not regarded as essential. Indeed, a
limited provision incorporating guidelines was not considered to be helpful by those
we consulted who had an interest in the financial services area. We have already
explained32that we consider that contractual techniques can go a long way towards
dealing with any problems of mismatch which are likely to occur and that we do not
consider that, in general, the remaining difficulties and uncertainties are such that
!
we should pursue reform on the main issue in the light of the limited support
received for it.33
15.13 In conclusion, we are still inclined to the view that a form of exculpatory relief for
fiduciaries along the lines of section 61 of the Trustee Act would be desirable.
However, we believe that there is a much greater need to take a global look at I
exculpatory clauses, examining section 6 1 of the Trustee Act 1925 and section 727
of the Companies Act 1985 as well as the position of fiduciaries and others (such
as those who intermeddle in a trust or who receive trust property in breach of trust).
It is only in this way that a coherent and consistent approach to exculpatory
provisions can be developed. Such an examination is outside the scope of the
present project.
32
33
We do, however, recommend reform in respect of Chinese walls; see Part XVI below.
96
PART XVI
CHINESE WALLS
Introduction
16.1 In the consultation paper we said that Chinese walls were broadly “procedures for
restricting flows of information within a firm to ensure that information which is
I
confidential to one department is not improperly communicated (and this includes
inadvertent communication) to any other department within the conglomerate”. ’
Chinese walls are widely used in the financial services sector to avoid breaches of
the insider dealing legislationY2
to manage or avoid conflicts between the duties owed
-
to different customers, or conflicts between the firm’s interest and the duties owed
to customers, which arise (or would otherwise arise) out of the different activities
of the component parts of a firm on different sides of a wall, and to ensure the
independence of the different activities of an investment house where information
is already in the public domain.
16.2 In this part we summarise the doubts we have expressed about the effectiveness of
Chinese walls as a means of managing conflicts of interest and duty, we consider the
need for them in the financial services industry, and we explain how we consider
that any remaining doubt should be resolved. We then examine the details of our
recommendation on Chinese walls by considering in turn the definition of Chinese
walls, the degree of protection which we consider should be afforded, and the
persons to whom the recommendation should apply.
Doubts about the efficacy of Chinese walls

16.3 We said earlie? that a Chinese wall would not prevent the attribution of knowledge
between the component parts of a company (although it might do so as between
different companies which form part of a group). We explained that unless
appropriate provision is made in the contract between firm and customer, a Chinese
wall cannot in all cases be relied upon, as a matter of private law, to limit the
. ~ also said5 that although FSA,
fiduciary duties the firm owes to the c u ~ t o m e rWe
section 48(2) (h) probably authorises the making of rules which modify common law
and equitable duties (that is, the duty of care imposed by the law of negligence and
’ Consultation Paper No 124, para 4.5.1. See para 2.16 qbove. The main components of a
Chinese wall are set out at para 2.16, n 39 above. ,
Para 7.15 above. See also paras 2.5, 12.10 above. . .
97
fiduciary duties),6 and that, as a matter of public law, Core Rule 36 probably does
so, the matter is not absolutely beyond doubt. We conclude that there is some
doubt as to the effectiveness of Chinese walls as a means of managing conflicts of
interest and conflicts of duty, and that it is necessary to consider whether they are
so essential to the operation of the financial services industry that this doubt should
be resolved by legislation.
The need for Chinese walls

16.4 The responses both to our issues questionnaire7 and to the consultation paper’
indicated that Chinese walls are widely used in organisations which provide financial
services, and that they are essential if the industry is to operate in its present form
with multifunctional investment houses performing a wide range of services. In the
consultation paper we explained how these financial conglomerates had developed
after a number of reforms to the structure of the financial markets in the mid-l980s,
in particular the abolition in October 1986 of the Stock Exchange’s single capacity
requirement ‘that segregated broker and dealer functions, the abolition of the rules
relating to outside ownership of members of the Stock Exchange, and the abolition
of fixed commissions.9 These political and administrative decisions were given a
statutory form by the enactment of the FSA.
16.5 As we have already said,” in this new situation it is no longer realistic to require
firms to act in a single capacity in order to avoid the possibility of breaching their
fiduciary duties. In practice the new situation requires that firms must be enabled
to manage and avoid conflicts by stopping information flows between departments
by means of Chinese walls. This was recognised in section 48(2)(h) of the FSA and
also by Core Rule 36, which attempts to accord protection to a firm which
establishes a Chinese wall without its having to obtain the consent of the customer
in cases where information has not passed across the wall.”
16.6 We believe that it is essential to remove any doubts, however tenuous, about the
legal efficacy of the practice of withholding information by means of a Chinese wall
which complies with the regulatory requirements as a method of managing conflicts
We said in paragraph 7.20 that a firm could not be “enabled” to withhold information (as
provided by FSA, s 48(2)@)) unless there was a duty of disclosure. This argument applies
just as much to an obligation to disclose or use information arising fi-om a common law
duty of care as to an obligation arising from a fiduciary duty.
’ Issues Questionnaire (November 1990); Consultation Paper No 124, para 4.5.2.
* Consultation Paper No 124.
Consultation Paper No 124, paras 2.2.4-2.2.5. . .
lo See paras 14.3-14.5 above.
I’
98
of interest and duty. The Chinese wall is an essential device for the operation of the
modern financial conglomerate, and the determination of its effectiveness should not
be left to the uncertainties of litigation.12This point was strongly emphasised by the
Legal Risk Review Committee which said in its response to our consultation paper:I3
We think that it is essential that there should be no uncertainty about the

recognition of effective Chinese walls.
It is obvious that the policy to increase competition and efficiency and reduce
costs by encouraging multiple capacity collides directly with traditional rules
concerning the attribution of knowledge and the like. In practice, this situation
can be met only by a Chinese wall. There is no doubt that reliance on Chinese
walls is now entrenched in the market and there is a high degree of expectation
that the law will honour the wall.
This is based upon the common-sense proposition that a fiduciary’s conduct

cannot be polluted or poisoned by some improper motive if the fiduciary is
unaware of the other interest, whether his own or that of another client.
Resolving the doubt

16.7 One possible way of resolving this doubt would be to reform the rules on attribution
of knowledge to provide protection where a Chinese wall is used. However, for
reasons we have already given,14 we have decided that this would be inappropriate
in the context of this project. The other option, which we favour, is to legislate to
the effect that if a firm operates a Chinese wall which complies with relevant
regulatory requirements, it shall not be regarded as being in breach of duty where
(i) it withholds information from a customer (or fails to use information on his
behalf) pursuant to the Chinese wall arrangement; or (ii) it places itself in a position
where its own interest on one side of the Chinese wall conflicts with a duty owed
to the customer of a department on the other side and as a result of the wall neither
department is aware of the conflict; or (iii) it owes conflicting duties to the
customers of different departments on either side of the Chinese wall and as a result
of the wall neither department is aware of the conflict. As we have said,15 the
expression “breach of duty” includes both the duty to take reasonable care imposed
12
The importance attached to the Chinese wall in practice is shown by the fact that the SIB
has retained Core Rule 36 as a designated rule even though it has de-designated all the
other Core Rules; see para 16.10, n 25 below.
Consultation Paper No 124.

,
l5 See para 16.3 above.
99
by the law of negligence,16 and also fiduciary duties.17Accordingly we recommend
that:
There should be legislative provision that a firm shall be protected from

liability where:
(i) information is withheld from a customer (or is not available for the
customer's use) pursuant to a Chinese wall arrangement which complies
with regulatory requirements; or
(ii) a firm places itself in a position where its own interest on one side of
a Chinese wall which fulfils regulatory requirements conflicts with a duty
owed to the customer of a department on the other side of the Chinese
wall, and as a result of the Chinese wall neither department knows of the
firm's conflicting interest; or
(iii) a firm owes conflicting duties to the customers of different

departments on different sides of a Chinese wall which fulfils regulatory
requirements, and as a result of the Chinese wall neither department is
aware of the conflict.
Definition of Chinese walls

16.8 There is a very wide range of activities carried out by firms authorised under the
FSA. Even within a particular sphere of activity, firms carry on business in a variety
of ways and adopt very different organisational structures. We do not consider,
therefore, that it is possible or desirable to lay down detailed statutory requirements
for the structure of Chinese walls or the arrangements by which they should be
monitored. We consider that these matters should be dealt with by the SIB under
its delegated powers, in particular those which it has under FSA, section 48(2)(h).
We have already said that we think it undesirable to give the SIB power to modify
the entirety of customers' common law and equitable rights." Parliament has,
however, recognised a structure for the operation of the financial markets which
inevitably leads to breaches of some of the rules created by common law and
16
Although the scope of this project is limited to fiduciary duties, in this instance it is
necessary for our recommendation to apply to duties of reasonable care because the
proposed reform is intended to clarify the effect of the rulemaking power in FSA, s
48(2)(h) (see para 16.3 above) which probably permits the modification of common law
and equitable duties, including duties of care imposed by the law of negligence.
l7 See para 16.14 below.
See paras 11.9, n 11, 14.13, n 41 above.
100
equity.lgWe do not, therefore, consider it inappropriate that the SIB should possess
limited powers to modify common law and equitable rights and obligations in
relation to a practice which is essential to the operation of the market structure
recognised by ParliarnentJ2' and which attempts to manage or avoid the inevitable
conflicts to which this structure gives rise. Chinese walls amount to such a practice.
Although there may be concerns that, even in this limited area, the proposed reform
would give the SIB too much discretion, we have already noted that the SIB does
not have a completely free hand in rulemaking and is constrained by sections 114
and 115 and Schedules 7 and 8 of the FSA, which are designed to ensure that
investors receive adequate protection, and that high standards of integrity and fair
dealing are maintained in the carrying on of investment business.2'
16.9 We consider that the solution we recommend is desirable for a number of reasons.
First, it will allow the necessary flexibility since the SIB is familiar with current
market practices and will be sensitive to future developments. Secondly, it is based
on a power which the SIB already has and will therefore require a minimum of
change to the existing regulatory structure.22Thirdly, it will build on an already
recognised practice, since the legislature has already provided expressly that effect
should be given to rules of the SIB on Chinese walls outside the regulatory sphere,
by providing a defence to criminal proceedings under section 47 to a firm which has
complied with a rule made under section 48(2)(h).23Fourthly, it makes it clear that
the purpose of the reform is to clarify the effect which it is likely that rules made
under section 48(2)(h) already have.
16.10 We have already explained24that it would not be practicable for any general solution
to the problems which we have identified to depend on compliance with designated
Core Rules, since the SIB has made a policy decision to move away from detailed
rulemaking and has de-designated the Core Rules. However, Core Rule 36 remains
19
See paras 14.3-14.5, 16.4-16.6 above on the decisions to abolish single capacity, the rules
on outside membership of the Stock Exchange etc which were given statutory form by the
enactment of the Financial Services Act 1986.
2o See n 19 above.
See para 7.25 above. Similar constraints are placed on the rulemaking powers of the SROs
by FSA, ss 10, 12, 13, 63A and Sched 2; see Consultation Paper No 124, paras 2.5.12-
2.5.13.
22
As discussed below, it is not proposed to extend the new provision to persons other than
those to whom rules made under FSA, s 48 can apply. See paras 16.17-16.21 below.
23
FSA, s 48(6). See paras 7.20, 7.23 above.
24
101
d e ~ i g n a t e d It
. ~ is
~ also likely that the SIB will have to retain a rule under section
48(2)(h), because the defence provided by FSA, section 48(6) to criminal offences
under FSA, section 4726depends on compliance with such a rule. Accordingly we
recommend that:
What constitutes a Chinese wall for the purposes of the provision should be
laid down by the SIB pursuant to its delegated powers under FSA, section
48 (2) (h)
16.11 There is, however, one aspect of the structure of the Chinese wall which we
consider should be dealt with in primary legislation. We consider that it is important
to make it clear in the statutory provision that only “established” arrangements will
be covered. It is not intended that the statutory protection should apply to ad hoc
arrangements within firms, which are put in place to deal with particular conflicts.
We consider that such arrangements should properly be dealt with by agreement
with the customer(s) concerned. Although the requirement of an established
arrangement appears in the present Core Rule 36, it is not something which is set
out expressly in section 48(2) (h). Accordingly we recommend that:
Only Chinese walls which amount to established arrangements should

satisfy the requirements of the provision.
Degree of protection
16.12 We have already set out the three types of situation in respect of which we consider
that the fiduciary should be protected.27We consider that the new provision should
address only the position of Chinese walls between departments in the same legal
entity and should not be extended to Chinese walls between different companies
within the same group. There are two reasons for this conclusion. First, there is not
the automatic attribution of knowledge between different companies within a group
which we consider operates between different departments within the same legal
entity.2s As we have indicated,29 it is open to the companies within a group to
25
The Financial Services (Dedesignation) Rules 1994. In its earlier consultation document,
the SIB indicated that it intended to retain Core Rule 36 as a designated rule so that firms
could “continue to enjoy the statutory comfort which can be conferred by a designated
SIB rule”; see SIB, Dedesignation of The Core Conduct of Business Rules, The Client Money
Regulations and The Financial Supervision Rules, Copsultative Paper 83 (August 1994), para
11.
26
29
102
organise their affairs so that attribution will not occur.3oSecondly, section 48(2)(h)
deals only with Chinese walls within a single legal entity,3’ and we have already
indicated that the purpose of the new provision is to clarify the effect which it is
likely that rules made under that section already have.32 Accordingly we
recommend that :
The provision should only apply in respect of Chinese walls between

different departments of the same legal entity.
16.13 It is quite possible that part of a firm’s business will not involve investment business.
The firm may operate a Chinese wall which restricts the flow of information
between the investment and non-investment parts of its business which complies
with regulatory requirement^.^^ In so far as the firm may lawfully carry on those
businesses within the same entity34we consider that it should have the benefit of the
statutory protection whether the claim is brought by a customer of the investment
or the non-investment side of the business. In either case the information is being
withheld because of a Chinese wall which complies with regulatory rules.
Accordingly, we recommend that:
Where a person is lawfully carrying on another business in connection with

his investment business, the protection afforded by the provision should
apply in respect of a Chinese wall between the investment business and the
connected business in the same way that it will apply to a Chinese wall
between two different parts of the investment business.
16.14 We have also indicated that we consider that a firm should be protected from a
claim for breach of common law as well as equitable duty arising from the
withholding of information or from the fact of acting in the circumstances described
above. This is because there may be a common law duty to use or disclose
information that is quite separate from the fiduciary ~ b l i g a t i o nHowever,
.~~ it is only
30 Although there may be limitations to this. See para 12.10 above.
”
FSA, s 48(2)(h) refers to the withholding of information between two parts of the business
of an “authorised person” which it seems could only cover a single legal entity. See also
Consultation Paper No 124, paras 5.3.17, 5.4.22. Although para 2 of Core Rule 36 does
refer to groups it does not purport to have any effect outside the Core Conduct of
Business Rules. Nor could it do so as it must be read in the light of FSA, s 48(2)(h).
33
Para 1 of Core Rule 36 provides that information may be withheld between two parts of a
f m ’ s business “to the extent that the business of one of those parts involves investment
business or associated business”.
- .
34 FSA, s 48(4) provides that rules made under that section may also “regulate or prohibit
the carrying on in connection with investment business of any other business”.
35
103
where liability arises for those reasons alone that the firm should be protected. The
new provision is not intended to provide a defence to a claim that the firm has
breached its duties or obligations in some other way. Similarly, the new provision
should not interfere with any express contractual terms between a firm and its
customer. If the firm has agreed expressly not to act in positions of conflict, or if it
has confirmed in the contract that it has used or will use all the information in its
possession for the benefit of its customer, it should not be able to rely on the new
provision to avoid liability if it fails to fulfil the agreement it has made. On the other
hand, any defence afforded by the new provision should be in addition to any other
defences-available to the firm. We have already indicated that express contractual
terms can be effective in modifylng the duties and obligations which would
otherwise be owed by a fid~ciary,’~ and the new provision is not intended to limit
the effectiveness of such contractual techniques in any way. Accordingly we
recommend that:
The protection afforded by the provision should be without prejudice to:
(i) any express contractual duties or obligations which the firm has
undertaken towards its customer; and
(ii) any other defences available to the firm.
16.15 We raised the issue of ‘‘wilful ignorance” in paragraph 12.16 above, when we were
discussing respondents’ views on the question whether there should be reform of the
rules on attribution. We do not consider that the new provision we are proposing
would give rise to the type of problem outlined in that paragraph by providing a
defence, for example, to a broker who should have made enquiries and obtained the
information irrespective of the Chinese wall. The broker’s failure to obtain the
information in these circumstances would not have been because the firm had failed
to use information in its possession due to the Chinese wall. It would simply be
because the broker himself had failed to make normal enquiries.
16.16 A further question arises as to how the provision will operate where an analyst has
been brought over the wall to advise another department in respect of a particular
transaction, or where the wall is overlooked by senior management or compliance
staff.37This will largely depend on whether the activity complies with the SIB rules.
The requirements of the present Core Rule 36 would not be satisfied where an
analyst who had crossed a wall and obtained inside information continued to advise
customers in the normal way.38We consider it correct that the firm should not have
36
See paras 3.29, 3.40, 14.10 above.
37
See Consultation Paper No 124, paras 4.5.20-4.5.23.
38
See the example given in para 3.31 above.
104
a defence in this situation. As discussed above,39the most appropriate way to deal
with such an analyst is to remove him temporarily from his normal duties, and’the
firm must either make appropriate provision in its contracts with its customers, or
take the risk that if the proposed transaction on which the analyst has been required
to advise fails to proceed and he then returns to his normal duties, it may find that
it has breached its fiduciary duties to the analyst’s customers if the information
which he has been given is not made public. However, we consider that the defence
can and should apply to an arrangement over which there is normal oversight,
provided the person overseeing the wall does not himself deal with or act on behalf
of
To whom should it apply?

16.17 We consider that the new provision should apply to all persons who may be subject
to rules made under section 48(2)(h),41 that is SRO members and those regulated
direct by the SIB.42There are a number of reasons for limiting the provision in this
way.
16.18 First, we have already indicated that it is in the financial services sphere that
Chinese walls are most widely used.43The less complex nature of businesses outside
this area helps to lessen any problems. Indeed, the responses to the issues
questionnaire indicated that problems of mismatch between regulatory rules and
fiduciary duties (including problems arising from the use of Chinese walls) were not
I
39
Para 8.6 above.
40
The present Core Rule 36 requires an established arrangement over which no information
passes “in certain circumstances”. Although the expression “certain circumstances” is not
defined, we believe that it would exclude normal management and compliance oversight.
41
FSA, s 48(1) gives the SIB power to make rules regulating the conduct of investment
business by “authorised persons” but expressly excludes the applicability of such rules to
members of RPBs. Members of SROs and firms regulated direct by the SIB are authorised
persons (under ss 7 and 25 respectively). There are other categories of authorised person,
notably insurance companies (s 22), friendly societies (s 23), and operators of collective
investment schemes (s 24), but the SIB’Srulemaking powers have been either excluded or
limited in respect of them. (See Sched 10, para 4; Sched 11, para 14; and s 86(7)
respectively). There are also persons who are authorised under s 31 (that is persons
authorised in another member state whose law provides “equivalent” investor protection or
satisfies conditions laid down by a relevant Community instrument) who may be subject
to rules under FSA, s 48(2)(h) but Core Rule 36 has not been designated to apply to
them. Authorisation under s 31 is likely to be largely superseded by notification under the
ISD. “Exempted” and “permitted” persons (FSA, Chapter IV and Sched 1, para 23) are
outside the scope of the section as they are not “authorised persons”.
42
The new provision is also capable of applying to persons authorised under s 31 but the
present Core Rule 36 has not been designated to apply to them; see n 41 above. As
previously discussed, it is envisaged that f m s authorised in other member states which
come within the terms of the ISD will become members-or @e relevant SRO for their
business or be regulated direct by the SIB and-may be made subject to rules made under
FSA, s 48 broadly in the same way as UK authorised persons; see para 4.10 above.
43 See para 16.4-16.6 above.
105
regarded as a significant problem outside the financial services area. Conflicts which
do arise can be dealt with more easily by refusing to act in the particular situation
or by making full disclosure and obtaining the client’s informed consent to the
firm’s continuing to act.
16.19 Secondly, so far as RPBs are concerned, their rules tend to be much stricter than
those of the SIB on the question of conflicts and the use of Chinese walls. For
example, the solicitors’ professional conduct rules provide that a solicitor should not
accept instructions to act for two or more clients where there is a conflict or a
significant risk of conflict between the interests of those two clients.44The guidance
envisages that Chinese walls can only be used in very rare cases following the
amalgamation of two firms and then only when the best interests of clients permit
the amalgamated firm to continue to act and the clients have received full and frank
independent advice and have subsequently consented to the arrangement.45The
rules of actuaries46and insurance brokers4’ are also stricter. It would be undesirable
if a firm could rely on the less strict SIB rule as a defence to civil proceedings even
though it had breached its own professional conduct rules.
16.20 Finally, the use of Chinese walls by members of SROs and firms authorised by the
SIB has already been accepted by section 48(2)(h). This was as a result of a
conscious policy decision to allow such firms to operate as multifunctional financial
conglomerates. Our recommendation is aimed at clarifylng the law in respect of this
44
The Guide to the Professional Conduct of Solicitors (1993), Rule 15.01. For a general
discussion of the position under the earlier 1990 edition of the Guide, see Consultation
Paper No 124, paras 5.3.30-5.3.35.
45
The Guide to the Professional Conduct of Solicitors, Annex 15A.
46
There is no provision in the Memorandum on Professional Conduct (March 1993)
expressly permitting the use of Chinese walls. Para 8 states that if there is or might be a
conflict of interest the actuary must consider the egtent to which it is proper for him to
continue to act. If he is satisfied that it is, he should only do so after he has made full
disclosure to the client of the conflict.
47
The new Code is set out in the schedule to the Insurance Brokers Registration Council
(Code of Conduct) Approval Order 1994, SI 1994.No 2569. There is no provision in
relation to Chinese walls and para 2(4) requires brokers placed in a position of conflict to
withdraw from the matter unless, after full disclosure, all the relevant parties agree in
writing that they should continue to act. See also generally, Consultation Paper No 124,
para 5.3.38.
106
p r o v i ~ i o nand
, ~ ~ we do not seek to extend it beyond what is strictly necessary for the
proper functioning of the financial services markets.49
16.21 The particular position of accountants merits some further consideration. Use of
Chinese walls by them does appear to be more widespread than by members of
other RPBs. There are a number of very large firms which carry out a range of
activities (eg audit, corporate finance, insolvency services) where there is potential
for conflicts between the interests of different clients or between the interests of the
firm and a client. However, these conflict situations are likely to be relatively simple
and predictable (compared to the situations which arise in multifunctional finance
houses). It should therefore be possible for them to be dealt with by using a
combination of the contractual and disclosure methods discussed above. The
Institute of Chartered Accountants stressed in its response to the issues
questionnaire5’ and to the consultation papeI.5’ that the notification to and
agreement by the client is a fundamental element in the steps to be taken to deal
with any conflict of interest. This is a perfectly satisfactory procedure for dealing
with conflicts. Accordingly we recommend that:
The provision should apply to those persons who are subject to rules made
under FSA, section 48(2)(h).
48
Although rules made under FSA, s 48(2)Q can only be designated to apply to firms
which are authorised by membership of an SRO or by the SIB, they are commonly
regarded as giving protection from criminal liability under FSA, s 47 to any person
whether or not so authorised. This is because FSA, s 48(6), which provides the defence,
simply refers to things done “in conformity with” rules made under FSA, s 48(2)(h). Our
recommendation is not intended to affect the position in respect of FSA, s 48(6) in any
way.
49
So far as other authorised f m s are concerned and those who are exempt or permitted
persons, the types of business which they undertake and. the capacities in which they act
are generally more limited. The responses to the issues questionnaire indicated that those
seeking to carry out a wider range of activities would often become members of the
relevant SRO(s) for their businesses.
. .
50 Law Commission Issues Questionnaire, Fiduciary Duties and Regulatoy Rules (November
1990); See Consultation Paper No 124, paras 1.5- 1.15, Appendix 1.
5’ Consultation Paper No 124.
107
PART XVII
OTHER OPTIONS FOR REFORM
Reform of the rules on attribution of knowledge

17.1 We explained in paragraph 12.17 above that it would be inappropriate in the
context of the limited sphere of this project to recommend modification of the rules
on attribution of knowledge to partnerships and companies. We have, therefore,
decided not to recommend any reform of this area of the law.
Codification of fiduciary duties

17.2 The outcome of consultation’ confirmed our provisional conclusion that it would
be impractical and undesirable to attempt to codify fiduciary duties.’ Accordingly,
we do not recommend that this option for reform should be pursued.
Legitimation of generalised advanced consents

17.3 There was little support on consultation for the legitimation of generalised advanced
consent^.^ As was stated in the consultation paper, a general legislative legitimation
of clauses might not adequately distinguish between acceptable and unacceptable
practices4 Also, it is now clear that the scope of a firm’s fiduciary duties can be
defined by the terms of its contract with the customer.’ This means that generalised
disclosures made in the contract will be effective provided that the contract clearly
delimits the fiduciary duties owed to the customer and displaces the obligation to
make full disclosure of all material facts. We, therefore, confirm our provisional view
and recommend that this option should be rejected.
’ See para 12.2 above.
See paras 3.29, 3.40, 7.3 above.
108
PART XVIII
SUMMARY OF RECOMMENDATIONS
18.1 There should be legislative provision that a firm shall be protected from liability
where:
(i) information is withheld from a customer (or is not available for the customer’s
use) pursuant to a Chinese wall arrangement which complies with regulatory
requirements; or
(ii) a firm places itself in a position where its own interest on one side of a
Chinese wall which fulfils regulatory requirements conflicts with a duty owed to
the customer of a department-on the other side of the Chinese wall, and as a
result of the Chinese wall neither department knows of the firm’s conflicting
interest; or
(iii) a firm owes conflicting duties to the customers of different departments on

different sides of a Chinese wall which fulfils regulatory requirements, and as a
result of the Chinese wall neither department is aware of the conflict (para 16.7).
18.2 What constitutes a Chinese wall for the purposes of the provision should be laid
down by the SIB pursuant to its delegated powers under FSA, section 48(2)(h)
(para 16.10).
18.3 Only Chinese walls which amount to established arrangements should satisfy the
requirements of the provision (para 16.1 1).
18.4 The provision should only apply in respect of Chinese walls between different
departments of the same legal entity (para 16.12).
18.5 Where a person is lawfully carrying on another business in connection with his
investment business, the protection afforded by the provision should apply in respect
of a Chinese wall between the investment business and the connected business in
the same way that it will apply to a Chinese wall between two different parts of the
investment business (para 16.13).
18.6 The protection afforded by the provision should be without prejudice to:
(i) any express contractual duties or obligations’which the firm has undertaken
towards its customer; and
(ii) any other defences available to the f i m (para. 16.14).
109
18.7 The provision should apply to those persons who are subject to rules made under
FSA, section 48(2)(h) (para 16.21).
(Signed) HENRY BROOKE, Chairman

ANDREW BURROWS
DIANA FABER
CHARLES HARPUM
STEPHEN SILBER
MICHAEL SAYERS, Secretary
1 November 1995
- .
110
APPENDIX A
Draft
Financial Services (Amendment) Bill
ARRANGEMENT OF CLAUSES
Clause
1. Clarification of effect of s 48(2)(h) of 1986 Act.
2. Short title and extent.
111
Financial Services (Amendment) 1
DRAFT
OF A
B I L L
TO
Clarify the effect of section 48(2)(h) of the Financial Services A.D. 1995.
Act 1986.
B EITENACTED by the Queen’s most Excellent Majesty, by and

with the advice and consent of the Lords Spiritual and Temporal,
and Commons, in this present Parliament assembled, and by the
authority of the same, as follows:-
5 1.-(1) A person who is subject to rules made under section 48(2)(h) Clarificationof
of the Financial Services Act 1986 (withholding of information as effectof
between different parts of a person’s business) incurs no liability to a s.48(2)(h)
Act.
of 1986
person with whom he deals in the course of carrying on his investment
business-
10 (a) for failing to make information in his possession available to, or
to use such information for the benefit of, that person; or
(b) for failing, by not availing himself of such information, to avoid a
conflict of interest between himself and that person or between
that and another person with whom he deals in the course of
15 carrying on his investment business,
if he shows that the failure is due to established arrangements made by
him which comply with the provisions of the rules.
(2) Where a person who is subject to those rules lawfully carries on
another business in connection with his investment business subsection
20 (1) above shall apply to him as if references in that subsection to a person
with whom he deals in the course of carrying on his investment business
were references to a person with whom he deals in the course of carrying
on either of those businesses.
(3) Subsection (1) above-
25 (a) does not exonerate a person if he has expressly agreed that all
information in his possession is to be made Available or used by
him as mentioned in that subsection or that any such conflict of
interest as is there mentioned is to be avoided by him; and
(b) is without prejudice to any defence available apart from that
30 subsection.
112
EXPLANATORY NOTES
Clause 1 implements the Commission’s recommendation to clarify the effect of

section 48(2)(h) of the Financial Services Act 1986 (withholding of information as
between different parts of a person’s business). It gives statutory protection to a firm
which operates an established Chinese wall arrangement which complies with rules
made by The Securities and Investments Board pursuant to its delegated powers under
section 48 (2) (h) .
Subsection ( I ) sets out the types of claim in respect of which the firm is to have the
benefit of the statutory protection. These comprise not only the failure to disclose or
use information in the firm’s possession but also the failure to avoid acting in a conflict
situation where the failure is due to the Chinese wall and where the firm is dealing
with the customer (or both customers in the case of a conflict between the duties owed
to two customers) in the course of carrying on investment business.
Subsection (2) extends the statutory protection to situations where the firm is dealing
with the customer (or one of them where there is a conflict between the duties owed to
two customers) in the course of carrying on other business in connection with the
firm’s investment business.
Subsection (3) is included to make it clear that the statutory protection has no effect on
any express agreement which the firm has entered into with a customer nor on any
other defences available to the firm in respect of a claim by the customer.
113
2 Financial Services (Amendment)
(4) References in subsection (1) above to rules made under section

48(2)(h) of the 1986 Act includes references to any further provision
made for the purposes of the matters there mentioned by rules made by
virtue of section 48(3).
(5) The provisions of this section shall be deemed always to have had 5
effect.
Short title and 2.-(1) This Act may be cited as the Financial Services (Amendment)
extent. Act 1995.
(2) [Extent].
114
EXPLANATORY NOTES
Subsection (4) is included to make it clear that the rules with which the Chinese wall must
/ .
comply include not only those made under section 48(2)(h) itself but also any rules I
~
!
making further provision on the matter under section 48(3).
Subsection (5) makes it clear that the provision is to have retrospective effect. The purpose
of the bill is to clanfy
- the effect that rules made under section 48(2)(h) have always had.
Clause 2 contains the short title and extent of the bill. It makes no provision for extent
because the Law Commission cannot make recommendations for Northern Ireland and
Scotland but, as the Financial Services Act 1986 extends beyond England and Wales,
consideration should be given to extending the provision to these jurisdictions to achieve
a consistent approach.
115
APPENDIX B
Relevant extracts from the Financial Services Act 1986
SECTION 47
(1) Any person who-
(a) makes a statement, promise or forecast which he knows to be misleading, false

or deceptive or dishonestly conceals any material facts; or
(b) recklessly makes (dishonestly or otherwise) a statement, promise or forecast

which is misleading, false or deceptive,
is guilty of an offence if he makes the statement, promise or forecast or conceals the

facts for the purpose of inducing, or is reckless as to whether it may induce, another
person (whether or not the person to whom the statement, promise or forecast is
made or from whom the facts are concealed) to enter or offer to enter into, or to
refrain from entering or offering to enter into, an investment agreement or to
exercise, or refrain from exercising, any rights conferred by an investment.
(2) Any person who does any act or engages in any course of conduct which
creates a false or misleading impression as to the market in or the price or value of
any investments is guilty of an offence if he does so for the purpose of creating that
impression and of thereby inducing another person to acquire, dispose of, subscribe
for or underwrite those investments or to refrain from doing so or to exercise, or
refrain from exercising, any rights conferred by those investments.
SECTION 48
(1) The Secretary of State may make rules regulating the conduct of investment
business by authorised persons but those rules shall not apply to persons certified
by a recognised professional body in respect of investment business in the carrying
on of which they are subject to the rules of the body.
(2) Rules made under this section may in particular make provision- ....
(h) enabling or requiring information obtained by an authorised person in the

course of carrying on one part of his business to be withheld by him from
persons with whom he deals in the course of carrying on another part and for
that purpose enabling or requiring persons employed in one part of that
business to withhold information from those employed in another part;
. .
....
116
(3) Subsection (2) above is without prejudice to the generality of subsection (1)
above and accordingly rules under this section may make provision for matters other
than those mentioned in subsection (2) or further provision as to any of the matters
there mentioned except that they shall not impose limits on the amount or value of
commissions or other inducements paid or provided in connection with investment
business.
(6) Nothing done in conformity with rules made under paragraph (h) of
subsection (2) above shall be regarded as a contravention of section 47 above.
117
APPENDIX C
Core Rule 36
1. Where a firm maintains an established arrangement which requires information

obtained by the firm in the course of carrying on one part of its business of any kind
to be withheld in certain circumstances from persons with whom it deals in the
course of carrying on another part of its business of any kind, then in those
circumstances:
a. that information may be withheld; and
b. for that purpose, persons employed in the first part may withhold information
from those employed in the second;
but only to the extent that the business of one of those parts involves investment
business or associated business.
2. Information may also be withheld where this is required by an established

arrangement between different parts of the business (of any kind) of a group, but
this provision does not affect any requirement to transmit information which may
arise apart from the Core Conduct of Business Rules.
3. Where the Core Conduct of Business Rules apply only if a firm acts with
knowledge, the firm is not for the purposes of the Core Conduct of Business Rules
to be taken to act with knowledge if none of the relevant individuals involved on
behalf of the firm acts with knowledge.
4. In addition, in order to avoid the attribution of information held within a firm

to that firm for the purposes of section 47 of the Act, the effect of section 48(6) of
the Act is that nothing done in conformity with paragraph (1) of the core rule on
Chinese walls is to be regarded as a contravention of section 47 of the Act.
Reproduced with the kind permission of the SIB
118
APPENDIX D
Relevant extracts *om the Trustee Act 1925
SECTION 61
If it appears to the court that a trustee, whether appointed by the court or
otherwise, is or may be personally liable for any breach of trust, whether the
transaction alleged to be a breach of trust occurred before or after the
commencement of this Act, but has acted honestly and reasonably, and ought fairly
to be excused for the breach of trust and for omitting to obtain the directions of the
court in the matter in which he committed such breach, then the court may relieve
him either wholly or partly from personal liability for the same.
SECTION 68
In this Act, unless the context otherwise requires, the following expressions have the
meanings hereby assigned to them respectively, that is to say:-
....
(17) c‘Trustyy does not include the duties incident to an estate conveyed by way of
mortgage, but with this exception the expressions “trust” and “trustee” extend to
implied and constructive trusts, and to cases where the trustee has a beneficial
interest in the trust property, and to the duties incident to the office of a personal
representative, and “trustee” where the context admits, includes a personal
representative, and “new trustee” includes an additional trustee;
....
119
APPENDIX E
List of persons and organisations who commented on
Consultation Paper No 124
JUDICIARY AND PRACTITIONERS

(i) Judiciary
Judge Paul Baker QC
Lord Browne-Wilkinson
Mr Justice Campbell
Lord Jauncey of Tullichettle
Judge Peter Mason QC
Lord Justice Staughton
(ii) Barristers
Ian Geering QC (London Common Law & Commercial Bar Association)
Edwin Glasgow QC
(iii) Solicitors
W R Aldwinckle (Linklaters & Paines)
A G J Berg (Watson Farley Williams)
Cameron Markby Hewitt
Clifford Chance
D Hunter (Blythe Liggins)
L P Kehoe (Grant Thornton)
A D Kennedy (Beachcroft Stanleys)
Love11 White Durrant
M McKee (Clifford Chance)
J R Millar (Bischoff & CO)
Paul Phillips (Allen & Overy)
Simpson Curtis
Travers Smith Braithwaite
E I Walker-Amott (Herbert Smith)
P R Wood (Allen & Overy)
(iv) Legal Organisations

General Council of the Bar - Bar Council Law Reform Committee
The Law Society
The Law Society of Scotland
The Law Society’s Standing Committee on Company Law
Legal Risk Review Committee
- .
(v) Other Lawyers
Sir Wilfrid Bourne QC, KCB
120
ACADEMIC LAWYERS
A Alcock, University of Buckingham
Dr G Bean, University of Warwick
Professor J R Birds, Unit for Commercial Law Studies, University of Sheffield
D A V Boyle, Centre for Management Studies, University of Exeter
Professor S M Cretney QC, All Souls College, University of Oxford
Professor R Flannigan, University of Saskatchewan
Professor P Latimer, Monash University
Dr H McVea, University of Bristol
Professor A C Page, University of Dundee
Dr R M Thomas, Centre for Business & Public Sector Ethics
COMMERCIAL ORGANISATIONS
(i) Banks
Barclays Bank plc
Barclays de Zoete Wedd Ltd
Baring Brothers & CO Ltd
Charterhouse plc
Chase Manhattan Trustees Ltd
C Crouch (Robert Fleming & CO Ltd)
Penelope Curtis (N M Rothschild & Sons Ltd)
Hambros Bank Ltd
Hill Samuel Bank Ltd
James Cape1 & CO Ltd
1
Kleinwort Benson Ltd
M H Legge (Charterhouse Bank Ltd)
Lloyds Bank plc
R Pattimore (Scandinavian Bank Ltd)
Royal Bank of Scotland plc
Schroders Ltd
UBS Phillips & Drew Ltd
S G Warburg Group plc
Yamaichi International Ltd
(ii) Other Financial Services Companies

D 0 Brown (Independent Financial Advisory Centre)
G P Hagland (Albert E Sharp & CO)
*
M Harty (Credit Lyonnais Capital Markets plc)
Hoare Govett Ltd
Kleinwort Benson Investment Management Ltd
Mercury Asset Management plc
Thamesway Investment Services Ltd
121
(iii) Accountants
Ernst & Young
KPMG Peat Manvick
P F Green (Grant Thornton)
Price Waterhouse
(iv) Insurance
Pearl Assurance plc
REPRESENTATIVE BODIES
Association of British Insurers
British Bankers’ Association
British Merchant Banking and Securities Houses Association
City Capital Markets Committee
The Committee of Scottish Clearing Banks
Confederation of British Industry
Friendly Societies Liaison Committee
Institute of Chartered Accountants in England and Wales
Institute of Chartered Secretaries & Administrators
Institute of Investment Management and Research
Institutional Fund Managers’ Association
Joint Exchanges Committee
Life Insurance Association
National Association of Estate Agents
Royal Institution of Chartered Surveyors
Society of Pension Consultants
The UK Association of Compliance Officers
EXCHANGES
London Fox
London Metal Exchange
London Stock Exchange
R Rambridge (International Petroleum Exchange)
REGULATORY BODIES
Bank of England
Financial Intermediaries, Managers and Brokers Regulatory Association
Investment Management Regulatory Organisation Ltd I
The Investment Ombudsman

The Securities and Futures Authority Ltd
The Securities and Investments Board
GOVERNMENT BODIES
Office of Fair Trading
122
Public Trust Office
Serious Fraud Office
OTHER
C M Johnston
J Mitchell (International Consumer Policy Bureau)
J R Sheldon
A C Suretees (Reviewer of Complaints for the Institute of Chartered Accountants)
- .
123
APPENDIX F
List of those who attended the Oxford seminar (see para 1.13)
THE LAW COMMISSION

The Honourable Mr Justice Brooke
Professor Jack Beatson
Ros Innes
Nicholas Cox
Professor Dan Prentice (Consultant to the Commission)
THE SECURITIES AND INVESTMENTS BOARD

Michael Blair
Jane Welch
TREASURY
Paula Diggle
Jane Stokes
BRITISH MERCHANT BANKING AND SECURITIES HOUSES

ASSOCIATION (now the London Investment Banking Association)
Colin Condren
Kit Farrow
John Mayo
THE LAW SOCIETY'S STANDING COMMITTEE ON C O W ! LAW

Tim Herrington
Paul Nelson
BANK OF ENGLAND
Peter Peddie
.. .
124
APPENDIX G
List of others who have assisted with the project
Mads Andenas
Mrs Justice Arden
Lord Justice Balcombe
Colin Bamford, Financial Law Panel
William Blair QC
Martin Chester, The Law Society’s Standing Committee on Company Law
Professor Hugh Collins
Professor ROSS Cranston
Lord Justice Peter Gibson
Peter Graham, The Law Society’s Standing Committee on Company Law
Mr Justice Harman
Michael Hart QC
Lord Hoffmann of Chedworth
Christopher Jarman, Payne Hicks Beach
Mr Justice Knox
Leslie Kosmin QC
Richard McCombe QC
Lord Justice Morritt
Paul Newman
Robert Reid QC
Daniel Schaffer, Freshfields
Sir Richard Scott VC
Mr Justice Walker
Giles Wintle, Institute of Chartered Accountants in England and Wales
Derrick Wyatt
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. .

FIDUCIARY DUTIES AND

FIDUCIARY DUTIES AND

REPORT ON A REFERENCE UNDER SECTION

Presented to Parliament by the Lord High Chancellor

The Commissioners are:

The Honourable Mr Justice Brooke, Chairman

The terms of this report were agreed on 1 November 1995.

FIDUCIARY DUTIES AND REGULATORY RULES

Terms of reference 1.1

SECTION B: LEGAL AND REGULATORY

PART 111: LEGAL DEVELOPMENTS - CASES

PART IV LEGAL DEVELOPMENTS -

PART V REGULATORY DEVELOPMENTS

SECTION C: THE ISSUES ARISING FROM

PART VII: MODIFICATION OF THE NORMAL

PART VIII: CROSSING CHINESE WALLS

PART IX: OVERLOOKING CHINESE WALLS,

Summary of respondents’ views 9.2 61

PART X: SHOULD FIDUCIARY LAW TAKE

PART XII: OTHER LEGISLATIVE

PART XIV RECONSIDERATION OF OUR MAIN

Examination of our provisional recommendation 14.13 86

PART XV: EXCULPATORY PROVISION

PART XVI: CHINESE WALLS

PART XVII: OTHER OPTIONS FOR REFORM

PART XVIII: SUMMARY OF

APPENDIX A: Draft Financial Services (Amendment) Bill with

APPENDIX B: Relevant extracts from the Financial Services Act

APPENDIX C: Core Rule 36 118

APPENDIX D: Relevant extracts from the Trustee Act 1925 119

APPENDIX E: List of persons and organisations who commented

APPENDIX F: List of those who attended the O5ford Seminar 124

“BMBA” British Merchant Banking and Securities Houses

“DTI” Department of Trade and Industry

‘~FIMBRAy’ Financial Intermediaries, Managers and Brokers Regulatory

“FSA” Financial Services Act 1986

ccIMRO’’ Investment Management Regulatory Organisation Limited

“ISD” Investment Services Directive, Council Directive

LAUTRO’’ Life Assurance and Unit Trust Regulatory Organisation

“PIA” Personal Investment Authority

‘‘SFA” The Securities and Futures Authority Limited

The Securities and Investments Board

Self-Regulating Organisation recognised by the Secretary

‘‘UCTA” Unfair Contract Terms Act 1977

‘‘UTCCD’’ Unfair Terms in Consumer Contracts Directive, Council

“Meridian’’ Meridian Global Funds Management Asia Ltd v The Securities

“Clark Boyce ’’ Clark Boyce v Mouat [1994] 1 AC 428

“Glynwill” Glynwill Investments NV v Thornson McKinnon Futures

“Target Holdings’’ Target Holdings Ltd v Redferns [19951 3 WLR 352

FIDUCIARY DUTIES AND

A parallel reference was made to the Scottish Law Commission.

’ Boardman ZJ Phipps [1967] 2 AC 46, 124, per Lord Upjohn.

(i) disclosure of commission (including ccsofiyycommission) and other

(ii) relaxation of the “no profit” rule;7

(iii) the operation of Chinese walls.*

Fiduciary Duties and Regulatory Rules, Consultation Paper No 124.

Consultation Paper No 124, para 1.13.

For example, under “soft commission” arrangements a brokerldealer provides goods or