29 Jan 2008

ASIC v Citigroup - The compliance implications

by Greg Seeto

An effective compliance program is important in the prevention of insider trading.

In ASIC v Citigroup Global Markets Australia Pty Ltd (No 4) [2007] FCA 963, the Federal Court of Australia expressed two key principles:

  • The law does not prevent an investment bank from contracting out of fiduciary relationships in certain circumstances; and
  • The adequacy of "Chinese Wall" arrangements (also known as "information barriers") can determine liability for insider trading. In addition, the effectiveness of a company's compliance program is a factor the court will take into account when considering alleged breaches of the insider trading provisions.

This article aims to expand on the later point, and highlights the importance of having appropriate internal compliance procedures in place, especially in the realm of Chinese Walls.

Key facts

While the facts of the case were quite complex, for the present purposes, the key facts are:

  • Citigroup Global Markets Australia Pty Ltd conducted business through various business divisions, including:
    • Investment Banking ("Private Side employees") ("IB"); and
    • Equities Trading ("Public Side employees") ("ET").
  • Private Side employees were exposed to confidential, market sensitive information, whereas Public Side employees were not to be exposed to such information. To restrict the flow of information between the business divisions, Citigroup set up "Chinese Walls".
  • The current proceedings arose after the ET division purchased shares in Patrick Corporation Limited. This was done at a time when the IB division was acting for Toll Holdings on a proposed takeover bid for Patrick. The shares were purchased on the last trading day before Toll announced its bid for Patrick.
  • When IB became aware of the purchase, steps were taken that resulted in ET being told to stop buying any more of Patrick's shares. ET did not purchase any more shares, but half an hour before the close of trading, ET sold 200,000 of shares that it had purchased that day at profit.
  • Toll subsequently announced its takeover bid for Patrick the following day.

Main issues

Though the Australian Securities and Investments Commission did not allege that ET was in possession of insider information when it purchased the shares, it contended that:

  • Citigroup, as an adviser to Toll, occupied a relationship that was in the circumstances, fiduciary. In purchasing the shares in Patrick, Citigroup breached its fiduciary duty, thus breaching its obligations under section 912A(1) of the Corporations Act 2001. Further, Citigroup breached the provisions of section 1043H of the Act and section 12DA of the ASIC Act which prohibited misleading and deceptive conduct (the "Fiduciary Claim"); and
  • Citigroup was in contravention of the insider trading provisions contained in section 1043A of the Act because:
    • As a result of what was said to ET after IB discovered the potential conflict, ET had made a supposition that Citigroup was acting for Toll in the proposed takeover of Patrick. ASIC alleged that this supposition constituted "information" within the meaning of that term in section 1042A of the Act. Accordingly the sale of the 200,000 shares was alleged to have constituted insider trading by Citigroup ("first Insider Trading Claim"); and
    • The second claim saw ASIC challenge the Chinese Walls Citigroup had in place. ASIC alleged that because senior IB personnel knew that there was a substantial likelihood that Toll would launch its takeover bid, that knowledge was attributable to Citigroup as a whole. Accordingly, ASIC alleged that Citigroup engaged in insider trading, because Citigroup's ET division bought the shares ("second Insider Trading Claim").

The Court's findings

  • The Fiduciary Claim failed at the outset, as the letter of engagement by which Toll was retained by Citigroup specifically excluded the existence of a fiduciary relationship. The Court held that the law did not prevent an investment bank from contracting out of a fiduciary obligation at the commencement of the relationship.
  • For the first Insider Trading Claim to succeed, the employee who made the trade not only had to be in possession of insider information, but his knowledge had to be attributable to Citigroup. Under section 1042G(1)(a), the employee's knowledge was not attributable to Citigroup unless he was an "officer" of Citigroup as defined by section 9 of the Act. In this case, the claim failed because the employee was not an officer. The Court held that an "officer" for the purposes of the Act was someone with a senior management role, which this particular employee did not have. Further, the Court held that the employee had not made the supposition pleaded by ASIC, namely that Citigroup was acting for Toll in relation to the takeover of Patrick.
  • The second Insider Trading Claim also failed on the basis that Citigroup successfully raised the Chinese Wall defence found in section 1043F of the Act. In other words, Citigroup demonstrated to the Court that it had compliance arrangements in place that could reasonably be expected to ensure that price sensitive information held by IB was not communicated to ET (or other Public Side employees). As required by the section, the decision to purchase the shares was made by a person other the persons who held the information and no information was communicated or advice given by IB with respect to the purchase.

Compliance implications - Chinese Walls

When considering the adequacy of Citigroup's Chinese Walls, the Court noted that the arrangements required to satisfy the Act did not require absolute perfection, rather it only required that reasonable steps be taken. The test stated in section 1043F of the Act was an objective test and required arrangements that could reasonably be expected to ensure that the information was not communicated.

The Court outlined the following relevant procedures that were required for effective Chinese walls:

  • physical separation by departments
  • educational programs
  • procedures for dealing with crossing the wall
  • monitoring by compliance officers; and
  • disciplinary sanctions.

Although the defence under section 1043F was upheld, the Court endorsed warnings that Chinese Walls needed to "insulate the trader" (ie. ET) from information to satisfy the requirements of the section.

Written policies and training procedures

The Court found that adequate procedures were in fact in place, referring to Citigroup's written policies and compliance procedures. The written policy (among others) required Private Side employees (IB) not to communicate "material non-public information" to persons on the public side (ET) without involving legal or compliance personnel to assess the materiality of the information, and when appropriate, to implement "wall crossing" procedures.

Citigroup's written policies were available to all employees, regular training was provided and the policies were clear that employees were to be alert to the possibility of conflicts, and escalate any issues in relation to actual, apparent or potential conflicts of interest.

Further, Citigroup had written policies and procedures in place which set out the considerations that were to apply as to whether a public side employee should be brought over the Chinese Wall.

Note however, the Court also said that "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".

Escalation procedures

There was also a clear escalation policy, in which IB was able to advise the appropriate persons of the potential conflict, including the Compliance Department, Citigroup's General Counsel and Chief Executive Officer. Accordingly, Citigroup's in-house compliance division was able to properly advise IB and ET on what could or could not be disclosed to each other, and accordingly maintained the protection that the Chinese Wall provided.

The Court found that such an escalation procedure supported the view that Citigroup had adequate Chinese Walls in place.

Conclusion

  • ASIC v Citigroup demonstrates how having an adequate compliance system in place can protect you and your company from liability under the Corporations Act's insider trading provisions.
  • Chinese Walls aim to restrict the flow of information between different divisions in an organisation. As demonstrated in ASIC v Citigroup, if Chinese Wall requirements and its relevant compliance schemes are adhered to, a Company can escape potentially large fines and damage to its reputation.
  • ASIC v Citigroup is a timely reminder and warning of the importance of having adequate compliance measures in place, especially in relation to Chinese Walls.

ASIC has stated that it will not lodge an appeal against this decision.

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Clayton Utz communications are intended to provide commentary and general information. They should not be relied upon as legal advice. Formal legal advice should be sought in particular transactions or on matters of interest arising from this communication. Persons listed may not be admitted in all States and Territories.