The Consolidated Rules and Regulations 2011 of the Nigerian Securities and Exchange Commission permit companies to act as custodians of investors in the Nigerian capital market. The Rules define a custodian of securities as a "person who has custody, as a bailee, of securities or certificates issued in the investor's name with the investor's name appearing in the issuer's register as the beneficial owner of the securities." It states that such a custodian also includes "persons having custody of dematerialised and other securities on behalf of its clients." These provisions, among others, assume that an investor is better protected under the doctrine of bailment and is therefore worthy of consideration.
The Nigerian legal system is based on the English common law, such that except where expressly modified by statute, case law or the constitution, common law rules apply. In this case, common law will apply to determine the application of bailment in custody arrangements.
Palmer on Bailment points to an almost universal agreement that no one can become a bailee without possession of a tangible chattel. This invariably means that a person cannot become a bailee of assets that are incapable of physical possession.
Dematerialised securities have been identified by many including J Benjamin in her book Interests in Securities as incapable of transfer by physical possession. Where securities are dematerialised, the custodian receives title to intangible assets comprised in its electronic records.
Interestingly, the Rules recognizes these book entry records as constituting interests in securities, but still chose to confer the status of bailee on custodians of such assets. Without physical possession, which is the bedrock of the doctrine of bailment, it is difficult to see how a custodian can act as a bailee of dematerialised securities. Thus, any attempt to create such a relationship may fail before courts in Nigeria.
It is submitted that the best way to ensure that the dematerialised assets of an investor are treated separately in the event of insolvency of a custodian is to create a trust. The custodian acting as the trustee in equity will obtain legal title to the intangible assets of the investor and can trade or carry out other functions with third parties for the benefit of the investor who retains equitable interests in relation to the assets.
The problem with creating such a trust is that the investor merely retains equitable interest which is ranked behind legal interests in the event of insolvency of the custodian.
Where the custodian is a banking institution as contemplated by the Rules, the Banks and Other Financial institutions Act 2004 (Bofia) and the Nigerian Deposit Insurance Corporation Act 2006 (NDIC) would ordinarily regulate priority of distributions in the event of insolvency. However, Bofia only provides for priority of deposit liabilities of the insolvent bank over all other liabilities. It is doubtful that the investor would be categorised as a debtor capable of being ranked alongside depositors of the bank on insolvency. Even with such categorisation, it is doubtful that the NDIC provision which guarantees payment to depositors only up to a maximum of N$200,000 ($1,270) will provide any comfort to investors with huge exposures in the capital market.
It could be argued that the general corporate law provides the statutory platform for resolution of investors' claims on insolvency of the custodian. If that argument is accepted, it should be noted that preference will be given to secured creditors and that investors of the custodian may be treated as general creditors on insolvency of the custodian. That argument may, however, prove difficult to adopt in view of the fact that arrangements involving dematerialised securities fall outside the purview of the general corporate law which covers only certificated securities.
Failure to recover under any of the mechanisms above may expose the investor to recovery from the Investor Protection Fund established pursuant to sections 197 and 198 of the Investment and Securities Act 2007 which may still be insufficient to satisfy the investors' claims.
There is therefore need to seek appropriate counsel before entering into custody arrangements in Nigeria.
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