Month: April 2014

What are some of the key issues relating to securities held by an account provider on behalf of several investors in a single account?

The single account in this case is called an “omnibus account”.

In practice, client assets are typically held through an omnibus account in the name of the custodian or its nominee, rather than in individual accounts for each underlying client.

“Omnibus” accounts

An “omnibus” account is an account opened in the name of an account provider, the securities credited to which belong to several clients of the account provider. Typically the account provider will be obliged to maintain accounts on his own books recording the interests of these clients in respect of the securities credited to the account in the account-provider’s name. Omnibus accounts may contain a mixture of the account provider’s own and clients’ assets. This type of account is not permitted in some countries such as Lithuania, Finland, to name but a few.

 “Nominee” accounts

A “nominee” account is typically distinguished from an omnibus account by two features.

• While a nominee may open an account for the purpose of holding several clients’ securities, this is not necessarily so. Often a nominee acts for a single client, for example an omnibus account provider (who acts for many clients). Single-client nominee accounts are common when a global account provider, being foreign, is not permitted by the membership rules applicable to the local CSD to participate directly in the CS.
• A nominee’s duties and discretions will usually be much narrower than those of other account providers. An omnibus account provider will commonly be granted discretionary powers by its client, whereas a nominee is likely to be permitted only to do such acts as are strictly necessary to maintain the client’s holding of securities.

Providers of both nominee and omnibus accounts are likely to know (although it is not always mandatory under the applicable legal system for them to know) that their account-holder is acting as nominee or holding a pool of securities for many investors.

Legal reasons for omnibus accounts

In practice, a combination of tradition and operational and legal reasons rather than ease of settlement of transfers are likely to dictate the use of omnibus accounts. Practice has become entrenched, so that where omnibus accounts are common, the law has tended to support their existence. The following legal factors may be relevant in particular countries:

• In countries where local investors are obliged to hold their securities directly in the CSD/issuer the need for omnibus accounts only arises in respect of foreign investors who already use a global account provider to hold their securities.
• In countries where the person who is registered at CSD/issuer level is regarded as the owner of the securities, to the exclusion (in most circumstances) of other claimants, there may be obstacles to recognition of custodial arrangements. The operational set-up is likely to have been created historically in a way which does not envisage that a CSD participant would need multiple accounts. In order to operate a separate account for each investor, the account provider would have to persuade the higher-tier intermediary to operate multiple accounts for the account provider, and pay (or charge investors for) the additional fees associated with many accounts. Instead, it may be simpler to establish an omnibus account.
• Even in countries where omnibus accounts are common (where direct holdings are not compulsory and indirect holdings are standard practice), there may be operational influences on account structures. A higher-tier intermediary may be unwilling to agree to a single-investor-per-account holding pattern, for example because the higher-tier intermediary is constrained by systems limitations on scaling up to the degree implied by each of its account provider clients having multiple accounts. Another factor is the need to have separate identifiers for each account. Where an omnibus account is used, the task of allocating securities received to buyers is carried out by the account provider. A settlement system may (but may not) be able to supply the account provider with identifiers to facilitate the allocation of securities received to the sub-accounts maintained by the account provider for its clients. Where a stock exchange operates a straight-through processing system linked into the relevant CSD, the choice of account structure may be affected by the amount of detail that the various systems can support.

In any of these cases, the technical and operational systems will have grown up domestically in a manner which suits the local legal arrangements, and may be difficult to adapt wholesale. Rather, individual market participants have developed ad-hoc arrangements to cope with local market expectations.

Advantages of omnibus accounts

The following advantages of using omnibus accounts can be stated:

• Cost. Only one account is needed for many investors. This should reduce fees associated with (a) maintaining the account and (b) transfers, where credit and debit entries offset and the settlement processing technique permits internalised (or net) settlement.
• Voting and corporate actions. Provided that an account provider can gather in the voting instructions for the collectively held securities (and contrary voting is permitted – see below) the volume of voting instructions required to be processed by the issuer will be significantly reduced. Likewise, for other corporate actions, the account provider will be responsible for processing the instructions and entitlements for all the investors under its account, thereby reducing the burden on the issuer.
• Internalised settlement. Investors could “settle” across the books of an account provider instead of using the CSD. If each investor’s holding is held in a separate account with an upper-tier intermediary, “internalised settlement” is impossible, since an account provider acting as lower-tier intermediary needs to process a transfer from a selling investor client to a buying investor client by means of external instructions to the upper-tier intermediary. By contrast, if an omnibus account is used, and the ordinary processing algorithms permit, an account provider would not need to issue any external instructions to settle such a transfer. Internalised settlement could reduce the cost of transfers and improve service levels (eg by offering “transfer finality” at an earlier moment than if settlement occurs at a higher tier intermediary).
• Reduced burden for issuers. Issuers do not need to deal directly with large numbers of investors where they are required legally only to recognise the persons who hold directly from them. This shifts the burden of dealing directly with investors to the account providers. Account providers may be freer to negotiate the level of service provided to their account holders, whereas issuers will generally be required to treat all holders alike.

Disadvantages of omnibus accounts

The following disadvantages may arise with regard to the use of omnibus accounts:

• Effect of permanent shortfalls. Assuming it cannot be made good by the account provider, a permanent shortfall on an omnibus account is bound to cause loss to some investors; the question arises how the loss should be borne. The answer to this question may range from “all investors lose any claim to anything held by the account provider”⁹through to “rateable loss-sharing”. More complex solutions are theoretically possible, including forensic accounting to identify precisely “whose” securities were lost¹⁰. This is a highly practical question, as the insolvency of an account provider is likely to be strongly correlated with accounting deficiencies and the existence of shortfalls. In some countries a clear and simple statutory solution is provided.
• Forced borrowing. Shortfalls are likely to arise routinely and without malpractice by the account provider, as a result of operational error (which could be error on the part of some other person). Provided that the account provider (a) is required by regulatory rules to conduct reconciliations and to take action to remove imbalances, and (b) is not insolvent, the difficulties of permanent shortfalls (discussed above) should not arise.
• However, while a temporary imbalance remains, the consequence of a shortfall may be that the investors entitled to what remains will to some degree be making securities loans to any investor who wishes to dispose of the whole of its holding. Lending may be beyond the capacity of some investors and would in many cases require the consent of the lender. Regulatory rules typically require account providers to explain to investors that their securities may be utilized to satisfy other investors’ instructions.
• Distance between issuer and investor. Where an omnibus account is used, the structure necessarily implies that securities are held indirectly. The issuer knows that the registered holder is not the investor, but not who the investors are. Corporate communications are made more difficult. Some countries have established rules which empower issuers to stay in touch with investors where an omnibus account is used. Distance between issuers and investors also engenders delay: by the time an investor at the end of a chain of intermediaries receives notice of a vote or other corporate action, it may be very close to the last practical moment for action or even too late.
• Corporate actions. If securities are consolidated or rights issues relate to holdings of specific numbers of securities (eg a 2-for-5 issue) the account provider will typically receive replacement or additional assets which do not divide perfectly among the investors in precisely the ratio in which the investors held the original securities. Some rounding and cash-settlement of differences is necessary, which may affect investors differentially. The outcome for many investors is likely to be different¹³ (though not necessarily worse) from that if their securities were held in accounts segregated at the higher-tier intermediary. Investors typically confer discretion on account providers to handle this kind of situation.
• Conflicting votes. Where an account provider holds securities for many investors, some may wish to vote in favour of a particular matter and others may wish to vote against. In theory there may be a risk in theory that the relevant legal system does not permit a single investor to vote contrarily: part of his vote for, and part against.
• No title. If the relevant legal system does not recognise the omnibus account as a valid
  form of co-ownership, there is in theory a risk that the investor has no property rights at all if the account provider pools his securities with those of other investors.¹⁵
• The disadvantages listed above are likely to be more acute where the legal or regulatory system has not developed a clear code to cater for omnibus accounts. These difficulties may be aggravated in a cross-border context where the legal solutions chosen in different countries are different, or where one of the countries involved does not “recognise” omnibus accounts.

Authorities on whether pre-contractual statements are promissory or representational

A statement may be on a matter of importance upon which the representee was intended to and did rely without being promissory: J J Savage & Sons Pty Ltd v Blakney [1970] HCA 6; (1970) 119 CLR 435. In that case, the vendor of a boat and engine, in the course of pre-contractual negotiations, provided his estimate of the speed the boat would reach if powered by a particular engine. The High Court described the statement as an expression of opinion as the result “of approximate calculation based on probability” which tended against the inference of a promise that the boat would in fact achieve the nominated speed. Statements of opinion on future matters are less likely to be found to be promissory even if they induce entry into a contract.

In J J Savage & Sons Pty Ltd v Blakney [1970] HCA 6; (1970) 119 CLR 435, the High Court considered whether a statement made in the course of negotiations for the construction of a motor boat was promissory or representational. During the negotiations the plaintiff requested the defendant’s manager to place in writing his views upon various engines that might be used in the boat. The defendant set out in a letter details in relation to three types of engines and made recommendations in favour of one engine, of which the “estimated speed” was stated to be 15 miles per hour. The plaintiff ordered a boat with the engine recommended by the defendant. A written contract was executed in which no reference was made to the capacity of the boat to attain any particular speed. The boat supplied to the plaintiff was not capable of a speed in excess of 12 miles per hour. The plaintiff sued the defendant for breach of warranty, alleging that the representation in relation to “estimated speed” was a condition or warranty of the contract, alternatively that it was a collateral warranty to the contract. The Full Court of the Supreme Court of Victoria held that the representation was a collateral warranty by the defendant that the boat would attain a speed of approximately 15 miles per hour. An appeal to the High Court was allowed. Barwick CJ, Kitto, Menzies, Owen and Walsh JJ said, at 442 – 443:

“The Full Court seems to have thought it sufficient in order to establish a collateral warranty that without the statement as to the estimated speed the contract of purchase would never have been made. But that circumstance is, in our opinion, in itself insufficient to support the conclusion that a warranty was given. So much can be said of an innocent representation inducing a contract. The question is whether there was a promise by the appellant that the boat would in fact attain the stated speed if powered by the stipulated engine, the entry into the contract to purchase the boat providing the consideration to make the promise effective. The expression in De Lassalle v. Guildford [1901] 2 KB 215, at p 222 that without the statement the contract in that case would not have been made does not, in our opinion, provide an alternative and independent ground on which a collateral warranty can be established. Such a fact is but a step in some circumstances towards the only conclusion which will support a collateral warranty, namely, that the statement so relied on was promissory and not merely representational.

When the letter which we have quoted was written, the negotiations for the construction and delivery of the boat were incomplete. On receipt of the letter there were three courses open to the respondent. He could have required the attainment of the speed to be inserted in the specification as a condition of the contract; or he could have sought from the appellant a promise – however expressed, whether as an assurance, guarantee, promise or otherwise – that the boat would attain the speed as a prerequisite to his ordering the boat; or he could be content to form his own judgment as to the suitable power unit for the boat relying upon the opinion of the appellant of whose reputation and experience in the relevant field he had, as the trial judge found, a high regard. Only the second course would give rise to a collateral warranty.”

Whether a statement (be it of fact, intention or opinion) is promissory, is determined objectively by reference to the whole of the relevant circumstances: Hospital Products Ltd v United States Surgical Corporation [1984] HCA 64; (1984) 156 CLR 41. Gibbs CJ said in that case (at 61 – 62):

“If the parties did not intend that there should be contractual liability in respect of the accuracy of the representation, it will not create contractual obligations. In the present case [the respondent], who made his statements fraudulently, had, of course, no intention that they should amount to contractual undertakings, but he could not rely on his secret thoughts to escape liability, if his representations were reasonably considered by the persons to whom they were made as intended to be contractual promises, and if those persons intended to accept them as such. The intention of the parties is to be ascertained objectively; it ‘can only be deduced from the totality of the evidence’: Heilbut, Symons & Co. v. Buckleton [1912] UKHL 2; [1913] A.C. 30, at p. 51.”

If an intelligent bystander would reasonably infer that a contractual promise was intended, that would suffice even though neither party in fact had it in mind: Hornal v Neuberger Products Limited [1957] 1 QB 247 at 256 per Denning LJ.

Whether a statement is promissory or representational depends upon the intention of the parties, and their intention is to be ascertained objectively from the totality of the evidence. See Hospital Products Ltd v United States Surgical Corporation [1984] HCA 64; (1984) 156 CLR 41, at 61 – 62. The distinction between a representation on the one hand and a promise on the other is, however, fine, and the distinction is difficult to apply. See Ross v Allis-Chalmers Australia Pty Ltd (1981) 55 ALJR 8, at 11 – 12.

In Hyundai Elevator Co Ltd v Liftronic Pty Ltd, unreported; CA SCt of NSW; Mahoney, Priestley and Handley JJA; 9 December 1994, Priestley JA said, at 19:

“… the question whether the words used were promissory over and above being representational is to be decided objectively. The subjective intentions of the parties, if they could be known, would not be conclusive. If both had in fact had it in mind that the statements were promissory, then it is very likely that this understanding would have been manifested so that a reasonably intelligent bystander would have recognised that a binding promise was being offered; but, if there were no outward manifestation of the internal understanding it would be for the court to decide from whatever communications had passed between the parties whether or not the statements were promissory: cf Taylor v Johnson [1983] HCA 5; (1983) 151 CLR 422 at 428 – 429.”

In Australian National Nominees Pty Ltd v GPC No 11 Pty Ltd [2004] NSWSC 773 the plaintiffs lent money to the first or second defendant in response to invitations to the public, contained in information memoranda, to lend money to those defendants. The loans were to be secured by promissory notes. The plaintiffs contended that the terms embodied in the information memoranda were terms of the contracts of loan evidenced by the promissory notes. Einstein J held that the terms of the information memoranda were merely representational. His Honour was unable to discern from the information memoranda an objective intention that the words upon which the plaintiffs relied were promissory in character.

In Gates v The City Mutual Life Assurance Society Limited (1986) 160 CLR 1, the statement in issue was of an intention in relation to a future matter. The statement was to the effect “that the total disability benefit under the provisions [the insurer’s agent] was recommending for inclusion in his existing and new policy would be payable to [the appellant] if he suffered an injury or illness which left him physically incapable of carrying on his occupation as a self-employed builder”. Gibbs CJ said (at 5):

“The question whether the statements constituted a collateral contract depends on the intention of the parties … In the present case the statements were not promissory in form –– they purported to be descriptive or explanatory of one of the terms of the formal written contracts into which the parties proposed to enter. I find it impossible to say that either of the parties actually intended that the statements should constitute a term of the contracts between them or … that an objective inference can be drawn that they did so intend. The statements were representations and nothing more.”

In Emu Brewery Mezzanine Ltd (In Liq) v Australian Securities and Investments Commission [2006] WASCA 105 BUSS JA at [90] said:

In my opinion, the statements in the Information Memorandum relied on by the respondent were not intended, objectively, to have contractual force. Some of the statements are imprecise and lack detail, and others are merely explanatory or descriptive. The absence of precision and detail is more consistent with the statements as a whole being intended, objectively, to be representations. No doubt, the sole or dominant purpose of the statements was to induce potential investors to invest in the promissory note issue. However, even if the investors were induced to invest in reliance on the statements, that circumstance would not, in itself, be sufficient to support a conclusion that the statements were intended, objectively, to be promissory. In my opinion, the statements were not, either individually or collectively, the subject matter of an assurance. They conveyed representations, but did not constitute enforceable promises.