Lord Eldon Redux: Information Asymmetry, Accountability and Fiduciary Loyalty

Judicial and scholarly discourse about fiduciaries’ duty of loyalty has emphasized the ‘no conflict’ and ‘no profit’ rules as a vehicle for coping with opportunistic behaviour much more than disclosure duties. In a new article published in the Oxford Journal of Legal Studies, I seek to rebalance this image of the structure of fiduciary loyalty by considering the roots of the fiduciary duty as an institutional response to acute information asymmetries. In this view, a duty of self-abnegation (‘no conflict’) and a duty of full disclosure stand on equal footing. Only together can they constitute the fiduciary’s duty of loyalty to fulfil her mission of promoting the beneficiary’s interest.

The fundamental insight that acute information asymmetries bedevil fiduciary relations was articulated in special detail in a line of decisions by Lord Eldon in the early 19^th century. Moreover, he has identified the special danger to fiduciary relations from information that modern economic theory dubs ‘non-observable’ and ‘non-verifiable’ - respectively, information that is unavailable to the principal and to the court - which makes the principal helpless. The duty of loyalty constitutes society’s formal (legal) attempt to mitigate the risk of fiduciary power abuse. Without full disclosure of all material information, the proscriptions of the ‘no conflict’ and ‘no profit’ rules lose their efficacy and fiduciary loyalty as a whole is rendered hollow.

The article traces the origins of full disclosure as a main pillar in fiduciary loyalty in the duty to account through a detailed review that combines insights from economic theory, accounting history, and legal history. This regime resulted from an evolutionary process that began with the Norman Conquest and was perfected in the course of the ‘long thirteenth century’ (c1180-c1320). During that period, English landlords turned from deriving mostly fixed income from their manors through rents to ‘direct farming’, which involved selling to the market with a view to maximising revenue.

With landlords as essentially absentee owners, the manor emerged as (possibly the first) profit-maximising firm, complete with separation of ownership and control, and a hierarchy of professional managers. That hierarchy comprised stewards, bailiffs and reeves, among whom the latter were the actual managers of the manorial firm, who enjoyed clear informational superiority. To control the management of the manor, a system of manorial accounting was developed. Charge and discharge accounting, which was employed in the Royal Exchequer for audit purposes, was adopted and adapted by adding a functionality of full disclosure that was implemented in a strict fashion.

This accountability system proved tremendously successful. Small-scale ‘exchequers’ became commonplace. Searching inquiries before an audience in the Exchequerian tradition were held regularly by itinerant auditors in manor houses and in monasteries, by sheriffs in their town castles, and even in public houses (including a discharge for ale and wine at the audit). Accountability in this format thus was institutionalised as a social norm - a mode of behaviour widely perceived as accepted and expected. In tandem, this type of accountability also became a legal norm as an action of account against reeves and bailiffs. In a gradual expansion over centuries (during which Equity courts took over it), account was applied to additional actors that today we readily classify as fiduciaries - from guardians and partners to trustees and directors.

By illuminating the historical, economic, and accounting aspects of accountability, my article sheds light also on the legal structure of fiduciary loyalty. From the inception of direct farming as an open-ended enterprise conducted for, or on behalf of another, it was clear that a strict regime of full-disclosure-based accountability is crucial for its viability. Views that narrow their focus to the proscription of unauthorised conflict and profit thus unjustifiably downplay the fiduciary’s core liability to account throughout her mission. That full disclosure is framed prescriptively, while traditionally the fiduciary obligation has been described in proscriptive terms, should not obstruct one from recognizing its true role in fiduciary loyalty. A fuller recognition of this role could enrich discussions of additional open issues in fiduciary law.

Amir Licht is Professor of Law at Radzyner Law School, Interdisciplinary Center Herzliya, Israel.