Alert

Who does this affect?

All investment banks who provide advisory services and who trade on their own account or on behalf of clients.

What do you need to do?

In an aggressive regulatory environment, check that retainer letters effectively deal with conflicts of interest and that Chinese wall procedures are adequate to prevent liability for insider trading.

Author
Rowan Mawa  
Solicitor

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Ashley Black  
Partner
T +61 2 9296 2074

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Sydney
Michael Barker  
Roger Forbes  
Greg Golding  
Kate Mills  

Melbourne
Stephen Minns  
John Waters  

Perth
Nicholas Creed  

Brisbane
Berkeley Cox  

Canberra
Ian Johnson  

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The Federal Court has held that the law will enable an investment bank to contract out of, or modify, any fiduciary obligations owed to a client.

The decision in ASIC v Citigroup Global Markets Australia is also relevant for financial services companies that operate on a public/private division. Liability for insider trading will be determined by the adequacy of Chinese wall arrangements. The courts require not only extensive written procedures, but also that all employees understand and apply them to a host of possible conflicts of interest and duty.

The impacts

This is a significant win for investment banks. It provides greater certainty that the courts will uphold the efficacy of retainer arrangements which seek to exclude fiduciary obligations. It also emphasises the importance of internal compliance procedures such as Chinese walls in preventing liability for insider trading. Such clarification is important given ASIC's aggressive regulatory approach.

Background

ASIC sued the Australian arm of the global investment bank, Citigroup, alleging breaches of fiduciary duty to its client Toll Holdings. The breaches were alleged to have occurred in August 2005 when Citigroup’s private arm advised Toll on a proposed takeover of Patrick Corporation. At the same time, Citigroup’s public arm was trading in Patrick shares (a practice known as proprietary trading). ASIC alleged that the relationship between Toll and Citigroup was fiduciary in character and this meant that there were several conflicts of interest and statutory contraventions.

ASIC also claimed that Citigroup contravened the insider trading provisions of the Corporations Act 2001 due to the conduct of its proprietary trading desk and the inadequacy of its Chinese wall procedures.

The bank contracted out of a fiduciary duty

Justice Jacobson found that Citigroup did not owe Toll a fiduciary duty because the letter of engagement under which Toll retained Citigroup as its adviser specifically excluded a fiduciary relationship. Furthermore, Citigroup did not have a duty to obtain Toll’s express consent to proprietary trading in Patrick shares. As there was no fiduciary relationship, all of ASIC’s claims for conflict of interest and other related claims failed.

A proprietary trader’s knowledge of “insider information” is not attributable to the bank

ASIC unsuccessfully claimed that a Citigroup proprietary trader who sold Patrick shares on the eve of the takeover announcement made the supposition that Citigroup was acting for Toll after he was instructed not to buy Patrick shares.

The Court found that the proprietary trader did not make that supposition. Further, that proprietary trader was not an “officer” of Citigroup according to s 9 of the Act so any such supposition was not attributable to the bank for insider trading purposes.

Chinese walls can be an effective defence to insider trading claims

ASIC also claimed that Citigroup was liable for insider trading because its senior officers knew that the proposed takeover was imminent and that knowledge was attributable to the bank. This claim failed because Citigroup made out the Chinese walls defence under the Act. It had arrangements that could reasonably be expected to ensure that the potentially price sensitive information from the private side was not communicated to the proprietary trader. While it was impossible that every conceivable risk can be covered by Chinese wall procedures and followed by employees, the law does not require absolute perfection - it requires reasonableness.