Information can be a very valuable resource for an investor. Acting on a good tip ahead of the market can make the difference between significant and marginal returns.
The law has long recognised that there must be limits on the financial advantage to gained from such information, often depending on how it is acquired. Taking advantage of privileged information for personal gain is a breach of fiduciary duty and, in many countries (including the UK), a criminal offence.
The tension between fiduciary duties and prudent investing can be particularly acute if an investor assumes a privileged role where they will have regular access to market-sensitive information, for example as a senior executive of a publicly listed company or as a government minister. One solution is for the investor to settle a “blind trust”, so called because the investor gives up all oversight and control of their investments. Someone else controls the investments as trustee, while the investor can continue to benefit.
From media reporting on blind trusts, you might be forgiven for thinking that there is something suspect about them, that they are only used by people with something to hide.
The reverse is true. By facing accusations of (real or, just as importantly, perceived) conflict of interest head-on and settling a blind trust, an investor put the question of conflict beyond doubt and can take on their privileged role safe in the knowledge that their integrity cannot be called into question.
A blind trust is effectively a nominee arrangement. The investor transfers all their market-sensitive investments to third party trustees to hold until the investor terminates the trust in writing (usually when they no longer hold their privileged role), loses capacity or dies.
When the blind trust ends, the trustees transfer assets back to the investor (or their attorneys or personal representatives). The investor usually has the power to appoint new or replacement trustees while the blind trust continues.
The trustees exercise all investment decisions on behalf of the investor and have all other powers of an absolute owner, subject to the usual fiduciary duties of trustees. The trustees would, for example, take on oversight of any discretionary investment management mandate.
The investor can still receive income from their assets and periodic updates on performance as long as any reporting is in general terms, for example referring only to assets classes and not specific holdings.
Blind trusts are recognised by HMRC as being transparent for all tax purposes. Income received and gains realised in the trust should be reported on the investor’s personal tax return. The trustees will give the investor (or their accountants) all the details of income and gains that they need to report on their personal tax returns.
Deeds to create blind trusts are relatively simple to prepare, but this simplicity can be deceptive. Each investor’s assets are different and need individual consideration. Similarly, the duties and responsibilities of the privileged role will dictate whether particular assets need to be transferred to a blind trust or not. For example, investment properties owned by the CEO of a publicly listed mining company might not be transferred to a blind trust but the same properties owned by the CEO of a mortgage lender or a minister with responsibility for housing policy might well be subject to the blind trust.
Shares in private companies need to be given careful thought. There may, for example, be restrictions on share ownership in the Articles of Association. If the investor has an active role in the company (for example as a director) they may have to consider their position.
A key duty of any company director is exercising management and control of the company. A director’s duties are personal and fiduciary and cannot be delegated. If an investor transfers their shares in a private company but retains their directorship, they risk undermining the purpose of the blind trust, and finding themselves in a conflicted position nevertheless.
For the blind trust to work, the investor has to undertake that they will play by the spirit of the rules and not just the letter. After all, it is in the investor’s interests that the blind trust arrangements can withstand proper scrutiny.
In the deed creating the blind trust, the investor usually undertakes to avoid as far as possible any sources of information about their investments, not to instruct the trustees either directly or indirectly (for example, by giving hints), not to contact investment managers and not to exercise any information rights they might have in respect of any assets in the trust fund.
Such undertakings can put the trustees in an unusual position. Trustees are used to being open and collaborative with their beneficiaries, updating them as necessary and hoping to make them feel that their needs and wishes are central to the trustees’ decision-making. However, this approach can jeopardise the proper operation of a blind trust.
Trustees might have to have difficult conversations with an investor who is persistently pushing against the limits of the information barrier. Trustees should be confident in pushing back so that they safeguard the integrity of the blind trust.
Taking on a privileged role can be rewarding for an investor, but they should take care to put their personal affairs in order first.
This publication is a general summary of the law. It should not replace legal advice tailored to your specific circumstances.
© Farrer & Co LLP, June 2023