Undisclosed principal

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Brokerage Anatomy


Resources: Bank of England Financial Stability Papers | FIA/ISDA documentation |
Trading capacities: Principal | Undisclosed principal Riskless principal | Agent | Undisclosed agent
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Possible agency scenarios

Here are the possible “undisclosed agency” scenarios at the time of contract:

An undisclosed principal is a principal whose identity the agent has not revealed. A principal you don’t know is a principal you can’t sue.

It does not — or at any rate, ought not — apply where an agent has neglected to mention the agency relationship altogether. An agent who has failed to reveal he is an agent at all (regardless for whom) — call that fellow an “undisclosed agent” — is, in this commentator’s contrarian opinion, better known as a “principal”. Or a liar. but the law takes a kinder view, about which you can read a lot more here.

Back to a disclosed agency with an undisclosed principal. Where an agent strikes a bargain without revealing its principal’s identity, it puts its counterparty at a disadvantage, since the counterparty does not, and cannot, know against whom it should seek to enforce the bargain. Here the agent cannot escape responsibility if the principal fails.

The common law’s rather practical response is to make the agent de facto personally responsible for performance of the contract on behalf of its undisclosed principal. It is the agent’s problem to sort it out with its own client.

It is unquestionably the general rule of our law that an undisclosed principal, when subsequently discovered, may, at the election of the other party, if exercised within a reasonable time, be held upon all simple non-negotiable contracts made in his behalf by his duly authorized agent, although the contract was originally made with the agent in entire ignorance of the principal.
Mechem on Agency, 2nd Ed., § 1731

This is correctly described as still being an agency obligation, but an unconditional one: The agent must, unconditionally, perform the contract on behalf of its undisclosed principal and then make its own arrangements with the principal for reimbursement of moneys paid out (or received) on its behalf. The agent’s other remedy is to disclose the principal and invite the agent to take matters up with it directly — but even in this case the counterparty may elect to require the agent to perform the bargain.

Unallocated trades

A legal conundrum that arises in the context of bulk agency orders placed by an asset manager with a broker-dealer on behalf of several clients. Typically the agent will place the order first without naming the principals, only to advise the broker to which principals it should allocate the securities later in the day.

Agents will often proudly declare that at no time, in no circumstances, can they ever be liable as a principal for transactions they instruct in this way on behalf of their clients.

This convenient outlook — I mean, they would say that, wouldn’t they? — provokes more questions that it answers: if the agent isn’t responsible for unallocated trades, then, until they’re allocated, who is? The broker doesn’t know who the principal is, so it can hardly take up matters with it directly. On the other hand, asset managers will hotly deny any kind of personal liability, appealing to their regulatory status, meagre capitalisation, or sheer importance as a valued client in intimating that this risk ought to be the broker's problem.

But denying principal responsibility, in the eyes of the common law, is a rather optimistic disposition. An agent who has not disclosed its principal must perform, unconditionally, on its principal’s behalf. This the agent might not characterise as a principal obligation, but against the rest of the world, it may as well be. The counterparty’s interest is to be paid; it does not care by whom. Nor, under the common law, can agent the shed that responsibility even by naming the principal: the counterparty now has a choice against whom to enforce —- though this the parties may vary by agreement.

So much bunk — all of these reasons. The manager, as agent, chose not to disclose its principal. By doing so it accepted unconditional responsibility for settling its client’s transactions.