Chinese wall holds up at investment bank

Update, 13 November: Clayton Utz’s take on the case here.

Here’s a long Sydney Morning Herald article about the latest big Chinese wall case, this time not in the context of a law firm, but of Citigroup, an investment bank. Here’s The Age‘s shorter version. The case is ASIC v Citigroup Global Markets Australia Pty Ltd (No. 4) [2007] FCA 963. Here’s a summary by Corrs Chambers Westgarth. Here’s Minter Ellison’s effort. And here’s Allens Arthur Robinsons’ take. The bank’s Chinese wall was declared ok in a 40,000 word long judgment, and his Honour found that Citigroup had successfully contracted out of a fiduciary relationship from the outset, in its retainer letter. But the judge did have this to say about one of the Bank’s key witnesses at [454]ff:

“Adequate arrangements require more than a raft of written policies and procedures. They require a thorough understanding of the procedures by all employees and a willingness and ability to apply them to a host of possible conflicts. Mr Monaci’s entire statement was the result of reflection by him in hindsight which he did not take into account in the particular circumstances that arose on 19 August 2005. The 83-page statement was prepared for him in draft by his solicitors and adopted by him. In my respectful view, Mr Monaci’s evidence would have been more convincing if he had personally involved himself in its preparation.”

The Federal Court summarised Justice Jacobson’s 28 June 2007 decision like this:

‘2. Citigroup Global Markets Australia Pty Limited (‘Citigroup’) is the Australian arm of Citigroup Inc, a global financial services company. Citigroup’s business in Australia is conducted through various divisions and business segments. They include investment banking and equities trading.

3. Citigroup has established ‘Chinese walls’ to restrict the flow of information between different departments. Employees who work in areas such as the Investment Banking Division and who are exposed to confidential, market sensitive information, are known as private side employees. Those who work in areas such as Equities and who are not so exposed, are known as public side employees.

4. These proceedings arise out of the purchase by a public side employee of Citigroup of over 1 million shares in Patrick Corporation Limited (‘Patrick’) at a time when private side employees working in the Investment Banking Division were acting for Citigroup’s client, Toll Holdings Ltd (‘Toll’) on a proposed takeover bid for Patrick. The shares were purchased by the proprietary trader for Citigroup’s own account on the last trading day before Toll announced its bid for Patrick.

5. The Australian Securities and Investments Commission (‘ASIC’) does not allege that the proprietary trader was in possession of inside information when he purchased the shares. However, when private side employees became aware of the proprietary trader’s purchase of the shares, steps were taken from within the private side that resulted in an instruction to the trader to stop buying any more shares in Patrick. The trader did not buy more shares but in the half hour before the close of trading, he sold nearly 200,000 of the parcel of Patrick shares that he had purchased earlier that day.

6. ASIC contends that Citigroup, as an adviser to Toll, occupied a relationship that was in critical respects, fiduciary. ASIC also contends that in purchasing the shares in Patrick, Citigroup placed itself in a position where its duty of loyalty to Toll conflicted with its interests arising from the purchase of the shares in Patrick. The gravamen of the claim is that Citigroup contravened its obligations under s 912A(1)(aa) of the Corporations Act to have in place adequate arrangements for the management of conflicts of interest.

7. All of the claims of conflict of interest and duty and breach of s 912A(1)(aa) depended upon the existence of a fiduciary relationship between Citigroup and Toll. However, the claims failed at the outset because the letter of engagement under which Toll retained Citigroup as its adviser specifically excluded the existence of such a relationship. The Court held that the law does not prevent an investment bank from contracting out of a fiduciary capacity; whether it should be able to do so is a matter for the legislature, not the courts.

8. ASIC relied on a number of propositions of law to overcome the effect of the engagement letter and sought to impose on Citigroup a duty to obtain Toll’s express consent to proprietary trading in Patrick shares. The Court held that the propositions relied on by ASIC had no application in the present case.

9. ASIC claimed in the alternative that Citigroup breached the provisions of s 1043H of the Corporations Act and s 12DA of the ASIC Act which prohibit misleading and deceptive conduct. However, those claims also depended upon the existence of a fiduciary relationship between Citigroup and Toll. Accordingly, both of those claims failed for the reasons above. So too did a further alternative claim for unconscionable conduct under s 12CA of the ASIC Act.

10. ASIC also makes two claims against Citigroup of contravention of the insider trading provisions contained in s 1043A of the Corporations Act. The first claim covered the trader’s sale of Patrick shares late in the afternoon, after he was given instructions not to buy those shares. ASIC alleges that, as a result of what was said to him, he made a supposition that Citigroup was acting for Toll in the proposed takeover of Patrick. This is said to constitute “information” within the meaning of s 1042A of the Corporations Act and the sale is alleged to constitute insider trading by Citigroup.

11. This claim failed because the trader was not an “officer” of Citigroup within the meaning of s 9 of the Corporations Act. His knowledge was therefore not attributable to Citigroup for the purposes of the insider trading provisions: see s 1042G(1)(a) of the Corporations Act. In any event, the Court held that the trader did not make the supposition alleged by ASIC.

12. The second insider trading claim covers all of the trading undertaken by the trader on the day in question. ASIC alleges that senior officers of the Corporate Investment Banking division of Citigroup knew that there was a substantial likelihood that Toll would launch its takeover bid on the next working day after the shares were purchased. Thus it is said that even though those officers did not know of Citigroup’s trading, their knowledge was attributable to Citigroup so as to make it liable for insider trading.

13. The second insider trading claim failed because at the time when Citigroup traded in the shares, it had arrangements that could reasonably be expected to ensure that the information was not communicated to the trader. That is to say, Citigroup had in place, inter alia, Chinese walls which insulated the trader from the information so as to satisfy the requirements of s 1043F of the Corporations Act.

14. Although the defence in s 1043F of the Corporations Act was upheld, the Court endorsed warnings given in an earlier authority about the risk of leakage of information through the structural barriers commonly known as Chinese walls.’

[The whole text of that part of the judgment stating the law of fiduciary relationships in the adviser-client relationship is set out in the previous post.]

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