In the second part of our explanation of trusts we discuss the workings of trusts that could be used to keep client money. Eddey Norman explains

Last week we looked briefly at trusts and it is interesting to note that a trust does not need to take a particular form nor does it need to be in writing.One of the important features of a trust is that the legal ownership of trust property has to pass to the trustees. Property can be either a chose (legal jargon for a thing) in action, such as rights under a life policy or a chose in possession such as a diamond ring. Property can also be real property, such as a house.Indeed one of the key jobs of a trustee is to 'perfect' the legal title to trust property.This creates an interesting position if someone else believes they have a right to what is claimed to be trust property. That someone could be, perhaps, a creditor or the Inland Revenue.A simple explanation of the situation of a trust account for clients is that the insured is the settlor, the broker is the trustee and the insurer is the beneficiary. In other words the ownership of the money passes from client to broker and then to insurer. It is a bare trust.The rules of the trust need to be agreed between trustee and settlor. These should include details of the trustees rights, responsibilities and remuneration. If the trustee (the broker) acts outside those rules then there could be civil or criminal charges.

Capital adequacyIf there is an issue from any party (say a creditor of the insured or the broker) then the matter would be decided by the courts.Perhaps it can be seen that although a carefully worded trust should not be challengeable, there is a risk and this is why the FSA seeks a greater level of capital adequacy from brokers who choose this route of holding a client's money.Having said that, there is one way that even a small level of uncertainty about whether a trust can be challenged can be all but removed. It is called a statutory trust.For any other trust, in the event of a dispute, a court will decide whether or not a trust exists and, if it does, how it should be interpreted and how the parties should act and their rights and responsibilities. The court will draw on case law.For a statutory trust, in the event of a dispute, all the court would have to do is to confirm or otherwise that the trust met with the requirements of an Act of Parliament (or a legal instrument drawing from such an Act).

Statutory trust exampleFor simplicity, let us take a fictitious Act of Parliament. The Protection of Teenagers Investments Act. This Act states that a statutory trust exists when a parent (the settlor) puts money into a building society account for the benefit of a legal child (the beneficiary) between the ages of 19 and 21. The interest is to be rolled up in the account.The account will not be liable to tax if the investment does not exceed £1,000 per annum.If those conditions are met, then the trust is a statutory trust and cannot be challenged, unless an intention to defraud can be proved.Let us suppose that at age 18 the child runs up a debt and claims the money. If the stipulations are met, he cannot have it, despite the fact that under a non-statutory trust, if he were the only beneficiary he could probably force the winding up at age 18. If, however, a court found that the interest had not been rolled up (a condition for statutory trust status), it is likely that it would be held that this was not a statutory trust and the child's claim may succeed.Consider these comments in the light of the FSA's proposals about statutory trusts and you will see that there are very good reasons why the rules for operating such accounts are so specific. It also becomes clear that the risk to the public is less and so the capital adequacy requirement is more relaxed.It also explains why the British Banking Association is currently designing wordings for statutory trust accounts.The reason that brokers handle customers' money dates back to the days when there were no direct debits or bank accounts for the general populace. It was then quite natural to act as a collector of insurance company money. Even as the necessity of the role dwindled, so the holding of a credit account and extended credit turned into a benefit for the broker.Ultimately, every professional adviser attempts to hold a customer's money for some time. Solicitors and accountants are good examples as well as insurance brokers. But in a world of low interest and tight credit terms, is it not the case that a broker might actually be better off handling no money and simply concentrating on giving good advice?And if that is not acceptable to the broker is not the statutory trust the best option for customer and broker?And if that is not acceptable to the broker should there not be swingeing capital adequacy requirements for brokers who present an increased risk to customers.Consider that the directors of a broking firm earning £4m a year in commission probably have the opportunity to misuse or steal £20m at some time during a year. For commission of £400,000 the figure is £2m and even for commission of £40,000 the amount is quite sufficient to repay the average mortgage and have funds left over.It is an absolute credit to the broking industry that the nefarious use of client money has been very small over more than a century, but it does happen and even once is too often.

Risk managementIt is important that practitioners understand that premiums due to insurers are not the property of brokers. How would you feel if the banks took three months to clear a cheque for you? The fact is that we complain anyway if it is three working days!The key learning point is that as indignant as we might be, the FSA is simply moving towards a regime of risk management and a common sense position of security and equity vis a vis someone else's money. The reality is that a couple of centuries of market custom will take some time to unravel. There is no better market champion than the likes of Simon Bolam , former IBRC councillor and owner of Edinburgh broker EH Ranson, to represent, on behalf of brokers, the cause of care and diligence on the part of the FSA. But changes are happening and will continue to happen. It is, perhaps, most important that brokers do not put their heads in the sand and believe that it will all go away.

  • Eddey Norman is responsible for financial services training and competence at RWA Group
  • Using this CPD pageFor the vast majority of practitioners and indeed support and supervisory staff in our industry, CPD is about regular learning and study that is planned, recorded, timed and evaluated. If you are a member of a professional body with a CPD requirement then there will be certain rules regarding the quality and nature of study material, and the way in which it is recorded.For staff of GISC members this means recording on your individual training file what the learning was, who provided it and when.It might be structured, such as a course, a learning programme or exam study. But it can be unstructured. This form of study encompasses reading the trade press, technical material or taking part in activities to support your professional body. Some CPD requirements are points related (a little antiquated) and others require a time value to be allocated. For example, it might take one hour to read Insurance Times each week. Most of that could be put as a time value but, in reality, perhaps only an half hour was devoted to learning something. The rule is to be honest with yourself and record the time that is relevant. Always take time to make a note of what you felt you gained from the activity. This is useful information for anyone else considering the same activity.In response to the popularity of our CPD programme each week's CPD page can now be downloaded from our website.

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