The proceedings
On 28 June 2007, the Federal Court dismissed all of the claims alleged against Citigroup Global Markets Australia Pty Limited (Citigroup) in proceedings brought by the Australian Securities and Investments Commission (ASIC).
Freehills acted for Citigroup in the proceeding.
The proceeding arose out of the purchase by a Citigroup proprietary trader, Mr Manchee (a ‘public side’ employee), of over one million shares in Patrick Corporation Limited (Patrick), and the sale of approximately 200,000 Patrick shares on the same day. These transactions occurred at a time when private side employees working in the investment banking division of Citigroup were acting for Citigroup’s client, Toll Holdings Ltd (Toll), on a proposed takeover bid for Patrick. The shares were traded by Mr Manchee for Citigroup’s own account on the last trading day before Toll announced its bid for Patrick.
ASIC alleged that Citigroup:
- failed to adequately manage conflicts of interest as required under section 912A(1)(aa) of the Corporations Act
- engaged in misleading conduct under section 1041H of the Corporations Act and section 12DA of the ASIC Act
- engaged in unconscionable conduct under section 12CA(1) of the ASIC Act, and
- engaged in insider trading under section 1043A of the Corporations Act.
ASIC’s pleaded allegations in relation to conflicts management, misleading conduct and unconscionable conduct (together the conflicts-based claims) were all premised on the establishment of a fiduciary relationship between Citigroup and Toll.
No fiduciary relationship
Justice Jacobson observed that outside the established fiduciary categories (for example, solicitor/client and trustee/beneficiary), the most that can be said is that a fiduciary relationship exists where a person has undertaken to act in the interests of another and not in his or her own interests.
His Honour said that the relationship between a financial adviser and its client may be fiduciary if the adviser holds itself out as an expert on financial matters and undertakes to perform a financial advisory role for the client. However, all of the facts and circumstances must be carefully examined to see whether the relationship is, in substance, fiduciary.
Justice Jacobson said that in the context of a contractual relationship, if a fiduciary relationship is to exist, the fiduciary relationship must conform to the terms of the contract. Accordingly, the question of whether any fiduciary relationship existed between Citigroup and Toll was to be determined by the proper construction of the mandate letter entered into between Citigroup and Toll.
His Honour said that it was open to parties to a contract to exclude or modify the operation of fiduciary duties. There is ‘no restriction in the law to prevent a fiduciary from contracting out of, or modifying, his or her fiduciary duties, particularly where no prior fiduciary relationship existed and the contract defines the rights and duties of the parties’. His Honour found that the terms of the mandate letter expressly excluded a fiduciary relationship. That exclusion was effective and Citigroup was not, contrary to ASIC’s submission, bound to obtain Toll’s informed consent to the exclusion of the fiduciary relationship.
This finding was sufficient to dismiss all of the conflicts-based claims. However, Justice Jacobson went on to make findings as to the ‘informed consent’ of Toll, the applicability of the exemption under sub-regulation 7.1.29(3) of the Corporations Regulations, the absence of any conflicts of interest on the facts and the adequacy of Citigroup’s conflicts management arrangements.
Informed consent
His Honour noted that a fiduciary may be absolved from liability for what would otherwise be a breach of duty by obtaining fully informed consent. His Honour rejected an argument that informed consent would be required for a term of a corporate advisory mandate which excluded a fiduciary relationship to be effective. Even so, his Honour went on to find that in this case informed consent could be implied from Toll’s knowledge of Citigroup’s structure and method of operations. The evidence given by Mr Chatfield, Toll’s Chief Financial Officer, showed that Toll had sufficient knowledge of the real possibility of proprietary trading by Citigroup. Mr Chatfield knew that Citigroup was a large financial conglomerate which did not act exclusively for Toll. He also knew that Citigroup had a proprietary trading desk which he considered could operate for the benefit of Citigroup so long as knowledge of Toll’s confidential information did not leak to the proprietary traders. This, the court held, amounted to ‘informed consent’.
The exemption under regulation 7.1.29(3)(c) applies
Justice Jacobson held that in this instance Citigroup’s provision of financial services was subject to an exemption under the Corporations Regulations, specifically sub-regulation 7.1.29(3). This had the effect that the corporate advisory services provided by Citigroup were not financial services to Toll for the purposes of section 912A(1)(aa). This precluded the application of that provision, although it did not effect the conflicts-based claims based on misleading conduct and unconscionable conduct under the ASIC Act.
Citigroup’s conflict management arrangements were adequate
The court held that Citigroup’s conflict management arrangements were adequate within the meaning of section 912A(1)(aa). Justice Jacobson observed that, unlike the duty in equity of a fiduciary to eliminate or avoid conflicts, section 912A(1)(aa) does not require a licensee to eliminate conflicts. Elimination is but one way of managing conflicts. In that regard, while a Chinese wall does not eliminate conflicts of interest, it can be a means to ‘manage’ such conflicts.
Justice Jacobson said that a Chinese wall must be ‘an established part of the organisational structure’, for the purposes of determining whether Chinese walls constituted adequate arrangements for the management of conflicts of interest within section 912(1)(aa). His Honour observed that the type of organisational arrangements which would ordinarily be effective for a Chinese Wall include physical separation, training, wall crossing procedures and records, monitoring by compliance and sanctions for breach.
No supposition made constituting inside information
Justice Jacobson dismissed both of ASIC’s allegations of insider trading.
The first insider trading claim covered Mr Manchee’s sale of approximately 200,000 Patrick shares late in the afternoon, after he was told by his boss, the Head of Equity Derivatives, Mr Darwell, not to buy any more Patrick shares. ASIC alleged that as a result of what was said to him, Mr Manchee made a supposition that Citigroup was acting for Toll in the Patrick takeover. This supposition was alleged to constitute ‘information’ within the meaning of section 1043A of the Corporations Act and the sale was said to constitute insider trading.
Justice Jacobson observed that this claim failed on two fronts. First, Citigroup’s liability was premised on Mr Manchee being an ‘officer’ of Citigroup. His Honour found that Mr Manchee was not an officer. Secondly, his Honour found that Mr Manchee did not make the alleged supposition. His Honour found that the fact that Mr Manchee sold, rather than purchased, shares after allegedly making the supposition was consistent with Mr Manchee’s explanation that he took from what Mr Darwell said that there was a concern about the risk of his overexposure in Patrick shares.
While the court held that Mr Manchee did not make the supposition alleged by ASIC, his Honour found that a person’s internal uncommunicated thought processes were capable of constituting ‘information’ for the purposes of the insider trading laws.
Citigroup’s Chinese wall arrangements upheld
In respect of the second insider trading claim, ASIC alleged that Mr Manchee’s trading throughout the day, at a time when certain Citigroup executives possessed knowledge that Citigroup was acting for Toll in the Patrick takeover, constituted insider trading.
Justice Jacobson held that the Chinese wall defence provided under section 1043F of the Corporations Act applied so as to absolve Citigroup of liability. Mr Manchee, the person who traded in Patrick shares, was not in possession of inside information. Mr Darwell, the person who communicated with Mr Manchee, was also not in possession of inside information. Finally, Citigroup’s arrangements satisfied the statutory criteria in that they could reasonably be expected to ensure that advice on the Toll/Patrick transaction was not communicated.
Justice Jacobson cautioned, however, that Chinese walls may not be as solid as the name implies.
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