Last week, the Law Commission produced a report on fiduciary duty in financial services (it was a recommendation of my 2012 Report on equity markets that they be asked to do so).  The obligations a financial intermediary owes to its clients are, as the Commission explains, a complex mixture of common law, regulation, contract, and custom and practice.

The world was once simpler.  A century ago, Mr Jackson, a stockbroker, had sold  to his client Mr Armstrong dubious shares from his own portfolio. Taken to Court, he faced the stern wrath of Mr Justice McCardie.  ‘The prohibition of the law is absolute.  It will not allow an agent to place himself in a situation which, under ordinary circumstances, would tempt a man to do what is not the best for his principal’.  Mr Jackson was ordered to make good all Mr Armstrong’s losses.   

  McCardie J would have regarded  the concept of a broker dealer as a contradiction in terms. But as one pioneer of the new breed of broker dealers which emerged in the 1960’s, Bernard Madoff, would explain, paying for order flow was as innocuous as financing a rack of tights at the supermarket till. In due course, market makers would be accepting payment to allow high frequency traders to access their dark pools. That was  as innocuous as licensing  pickpockets to roam the supermarket aisles.

The management of conflict of interest is a slippery slope, and one that Madoff would in due course slide off.  Even Goldman Sachs sometimes finds it uncomfortable. Mr Parks, former head of the firm’s Mortgage Department, struggled to explain the Abacus transaction, in which Goldman had constructed and sold to its clients synthetic CDOs based on mortgage pools hedge fund manager John Paulson had selected as especially likely to fail.  After a series of equivocal responses, the exasperated Senator Collins asked ‘could you give me a yes or no to whether or not you have a duty to act in the best interest of your clients?, to which Mr Sparks  finally explained ‘I believe we have a duty to treat our clients well’.

In the older, simpler world of McCardie J, handling other people’s money involves an onerous responsibility.  And all the money in the global financial system is, in fact, other people’s money.  The Abacus transaction was one link in a chain.  At one end were the depositors and policyholders of the banks and insurance companies that held the Abacus bonds.  At the other were the beneficiaries of the institutions which had invested in Paulson’s funds.  Quite possibly some of the same people were on both sides of the deal.

The regulatory requirement to ‘treat customers fairly’ is a good deal weaker than a duty to act in the best interests of a client:  but even that obligation is weakened as one moves along the chain to the professional investor and the ‘eligible counter-party’.  But why should savers lose protection against abuse because they trust intermediaries with their money?  Savers – at least most of them – have not chosen to enter a game in which they choose their players in the hope that they will outwit the players whom others have chosen to represent them.  They have not decided to bet on team BlackRock to beat team Fidelity or vice versa. They are looking for a safe home for their cash and their savings.

When you talk to people in the financial world, you encounter many – notably in retail banking and asset management – who have a strong sense of responsibility to their customers and clients:  and others who appear to recognise no obligation other than to make as much money as possible for their firm and – particularly – themselves. The only way to restore trust in the finance industry is to emphasise the former more and the latter less.

     Both brokers and dealers have a role to play in making markets.  But what is unacceptable is to spout the rhetoric that proclaims the primacy of the interests of the client while the reality is quite different.  Mr Justice McCardie saw that  you could be an agent or a trader, but you could not be both at the same time, and you had to make entirely clear to the customer which role you were playing.  That is surely as wise today as a century ago.