What are the methods for distributing client money in the event of insolvency

The way clients recover money in the event of business failure somewhere in the supply chain varies according to circumstances and according to whether the funds were held in general or designated accounts.

Primary pooling

The main trigger for a primary pooling event is intermediary insolvency. A primary pooling event will not occur where a third party or a bank becomes insolvent.

A primary pooling event will result in all client money in each of the intermediary’s client accounts (general and designated) forming a common pool: each client will have a claim on the aggregate, but not to a specific sum. Since any shortfall in client entitlements will be shared, an individual client may lose out – ie be unable to recover their money in full. When this happens, they can go on to make a claim on the intermediary’s own accounts, but the chances of success will be slim: most clients are unsecured creditors.

The primary pooling rules will not be applicable where the client money is received after the intermediary’s insolvency. Such monies must be placed in a client money account opened after the event and held in accordance with the client money rules. Unless they relate to a transaction that has not been completed or they were due at the time of the primary pooling event, they must be returned to the client as soon as possible.

Secondary pooling

A secondary pooling event occurs on the failure of a third party to which client money held by the intermediary has been transferred. In such circumstances, the intermediary will only be legally responsible for any shortfall if it has failed in its fiduciary duty (whether as agent or trustee) to the client. (On transfer of the money, it retains the role of fiduciary.) The intermediary may decide to make up any shortfall in the client money themselves. If it does, a secondary pooling event will not occur.

Failure of a bank

If a bank in the chain collapses, all the intermediary’s general accounts – including all those held at other banks – will be pooled, and any shortfall will be borne by all the clients holding money in them. Designated accounts will also be pooled – but only at the bank that has failed. In other words, client money in designated accounts elsewhere will be ‘safe’.

In a secondary pooling event, designated accounts will have no right to claim any monies in a client bank account of the intermediary.

Failure of a third-party broker or settlement agent

The failure of a broker or settlement agent to whom the intermediary has transferred client money is treated in much the same way as that of a bank. All client monies in the firm’s general client bank accounts are pooled. All clients of the intermediary with monies in general client accounts bear the shortfall of the sums paid to the failed broker – irrespective of whether that broker placed their insurance.

Client money held in designated accounts does not have to be pooled.