Introduction
Australian Securities Investment Commission (ASIC) has failed in its claim against Citigroup for insider trading and breach of fiduciary duties. Indeed, the Federal Court judgment of Jacobson J comprehensively dismisses ASIC’s submissions. In spite of this, the corporate watchdog has stated that it will not retreat from its pledge to crack down on insider trading. While it failed in these proceedings, it has given every indication that market participants should exercise more caution than ever before.
Background
These proceedings arose out of a proposed takeover of Patrick Corporation Ltd by Toll Holdings Ltd, in which Citigroup was engaged as Toll’s advisor. On the day before the takeover was announced, Andrew Manchee, a Citigroup employee, bought over one million Patrick shares. He was engaging in proprietary trading on the “public side"; that is, trading on Citigroup’s own behalf, not for any client. This trading was noticed by an executive in Citigroup’s corporate advisory team, the department advising Toll on the takeover bid. The corporate advisory team were situated on the “private side". The executive allegedly told Paul Darwell, Mr Manchee’s manager, “We may have a problem". This comment was made in relation to the employee’s trading of Toll shares. Mr Darwell took Mr Manchee outside and, over a cigarette, told him to stop buying Patrick shares. Mr Manchee then went back to his desk and began selling Patrick shares.
Interesting legal issues
A number of legal issues have resulted from this case, namely:
- Whether a person can be found guilty of insider trading when they acted contrary to the inside information - whilst the alleged information suggested prices would rise, instead of buying more Patrick shares, Mr Manchee sold shares.
- Whether Citigroup had a conflict of interest - on the one hand, Citigroup was advising Toll on its takeover bid and it was in Toll’s interests for Patrick’s share price to remain as low as possible. On the other hand, it was buying Patrick shares “in size", which had the possible effect of driving the price of Patrick shares up. One way of avoiding employees acting against the interests of clients is sharing information across the company. However, this is exactly the opposite of the requirement to erect Chinese walls (information barriers within an organisation for the purpose of avoiding conflicts of interest), which is a possible defence to insider trading. ASIC argued that to overcome this potential conflict of interest, Citigroup should have sought permission from Toll before trading in Patrick shares.
- Whether Citigroup was liable for insider trading through the conduct of its employees. If ASIC were successful, it would be the first time a company had been found liable for insider trading in Australia.
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Federal Court judgment
ASIC failed in its two insider trading claims. The first claim related to Mr Manchee selling Patrick shares after making the supposition that Citigroup was acting for Toll in a Patrick takeover. Jacobson J found that Mr Manchee was not an officer of the company within the meaning of s 9 Corporations Act 2001. Effectively, ASIC did not get over the first hurdle on this claim. While it was unnecessary to deal with the rest of the claim, Jacobson J held that even if Mr Manchee were an officer of the company, he did not make the necessary supposition that Citigroup was acting for Toll in the Patrick takeover.
The second insider trading claim was directed at Citigroup’s trading of Patrick shares on 19 August 2005. ASIC argued that the corporation traded while in possession of inside information (by its officers). It was conceded by Citigroup that certain of its officers, including the CEO, possessed the information. However, Citigroup successfully argued that it had adequate Chinese walls in place and they served their purpose in blocking compromising information flows between the private side and public side.
In addition to the insider trading claims, ASIC failed in its claim that Citigroup breached its fiduciary duty to Toll. Submissions on conflict of interest, deceptive and misleading conduct and unconscionable conduct hinged on the establishment of a fiduciary relationship. Once again, ASIC did not make it past the first hurdle. It was not necessary to consider whether Citigroup had breached the fiduciary duties it owed Toll as no such duties were owed. This was because they had been specifically excluded by the letter of engagement under which Toll retained Citigroup.
Conclusion
In retrospect, the Citigroup case was problematic on several fronts. There always appeared to be a lack of merit. Mr Manchee, on supposedly finding out the information about the Patrick takeover, did not go back to his desk and buy more Patrick shares. He did not take advantage of the information and thereby cause harm to the seller on the other end of the trade or compromise the integrity of the market. Technically speaking, taking advantage of inside information and causing harm to another market participant are not elements of the insider trading offence in Australia. However, common sense suggests that they are at the heart of the type of conduct that the legislature has sought to prevent.
Some will perceive the defeat as heralding a backdown by ASIC in its crusade against insider trading. In our view, that prediction is flawed. ASIC has made it clear over a period of time that it will monitor insider trading and bring proceedings with the full force of its resources. From a legal perspective, the Citigroup case fine-tunes the rules. It by no means reduces the burden either on corporations which employ Chinese walls or individuals who obtain inside information. The corporate watchdog will be even more vigilant and, now more than ever, the right mechanisms must be in place to shield corporations and individual traders from both civil and criminal liability.
