Fiduciary Duties And Regulatory Rules In Citigroup Case

Breach of duty by Citigroup: ASIC Claim

Discuss about the Fiduciary Duties and Regulatory Rules.

Federal court of Australia adjudged in favour of Citigroup Global markets Australia Pty Limited (Citigroup) in civil proceedings brought by Australian Securities and Investment Commission (ASIC). Citigroup conducted business through various divisions. Departments involved in the present case were, first investment banking where employees were known as private side employees because they held sensitive information of the business and second equity trading employees were known as public side employees. The two departments are segregated from each other by a barrier known as Chinese wall so as to restrict flow of information. (Stringer and Harkness 2007)

Present case arose when in the year 2005; Toll Holding ltd. employed Citigroup so as to advise them over Tolls proposed takeover bid of Patrick Corporation Ltd. amounting to A$4.6 billion. The parties entered into a mandate letter with regards to the provisions of these advisory services.  Citigroup’s investments banking division provided extensive advice to Toll over a period of 8 months. The day on which Toll was to present his bid for Patrick, a proprietary trader of the equity trading department purchased significant amount of Patrick shares on account of Citigroup. (Carvalho 2008) The investment baking and the advising board were on the private side of the business hence they were aware of inside information during the course of their employment whereas the proprietor was in the public side department. Private side employees came to know about the proprietary trading of Patrick’s shares and for the said reason they had certain communication with the head of equities, then the head of equities had a conversation with the proprietary trader and asked him to stop buying Patrick’s shares. The proprietary trader under the impression that Citigroup would be overexposed sold 20% of Citigroup’s shareholding within a fraction of 20 minutes before the trade was closed. (Jacobson 2007)

ASIC pursued a claim against Citigroup in Sydney courts, irrespective of the fact that Toll did not raise any claim. Claims raised by ASIC are as follows: (Seeto 2008)

Citigroup had established fiduciary relationship with Toll by virtue of being an advisor, and by purchasing Patrick’s shares it has breached fiduciary duty obligations bestowed upon him by virtue of Section 912A(1) of the Corporations Act, 2001. it has also been alleged that Citigroup got engaged in unconscionable conduct which allowed arise of conflict of interest resulting in  breach of  Section 12CA(1) of the Australian Securities and investments Commission Act, 2001

Citigroup has acted in contravention of provision mentioned in Section 1043A of the Corporations Act, 2001. The bank has also contravened Section 12DA of the Australian Securities and investments Commission Act, 2001, by placing reliance on two facts, first that the sale of 20% of Citigroup shareholding at the time of possession of inside information constituted insider trading and second they challenged the restriction on flow of information by Chinese wall (Melbourne Law School 2017) which Citigroup had in place.

Fiduciary relationship imposes a strict duty of loyalty; common law courts have for the said reason restricted to apply fiduciary relationship principle on commercial transactions. But it cannot be asserted that fiduciary relationship does not exist in commercial transactions at all, it may exist where the fiduciary is entrusted to act in a manner which is in the best interest of the beneficiary. ASIC asserted that there existed a fiduciary relationship between Toll and Citigroup by placing reliance on the fact that where investment banks when carrying advisory functions act as fiduciaries, as there is a fiduciary relationship between the advisor and his clients.( Ritchie 2008)

Denied existence of fiduciary relationship

ASIC contented that Citigroup has failed to fulfill its role as a fiduciary in three ways: first, as it breached the ‘no conflict rule’ laid in Section 912A(1) (aa) of the corporations Act, 2001 wherein the financial services licensee is obligated to have adequate arrangements for managing conflict of interest, here Citigroup’s own interest conflicted with Tolls interest, as the Patrick’s share prices were low before Toll announced its takeover bid and Citigroup was earning profit by transacting in Patrick’s shares. Share prices of Patrick’s shares rose up to 15% due to trader’s sale of 20% shares of Citigroup and for the said reason Toll had to buy shares at an inflated price.

Second, the no profit rule has been breached by Citigroup by not accounting to Toll for the profits it made by transacting in Patrick’s shares.

Third, the principle of good faith has been breached as Citigroup acted in a manner which was not in the best interest of Toll, which the former was obligated to being in the position of fiduciary.

Section 1042G of the Corporations Act, 2001 implies the fact that the knowledge of body corporate is consonant with the knowledge of its officers. Interpretation to this section is that the knowledge of the officer (Section 9 of the Corporations Act, 2001) is the knowledge of the corporation. ASIC placed reliance on this section to assert that Citigroup is guilty of insider trading by selling almost 200,000 shares while in possession of the inside information that Citigroup was advising Toll on its takeover bid. (Allens 2007) Another claim of insider trading was based on the fact that the Chinese wall placed by Citigroup was not sufficient to manage conflict.

Jacobson J adjudged that Citigroup had excluded fiduciary duty, he owed to Toll. Fiduciary duty can be modified or excluded by fiduciary either by contracting for the same or by consent. In common parlance the duty of a fiduciary is delimited by engagement letters. The mandate letter entered into by Citigroup and Toll expressly mentions that Toll would engage Citigroup “as an independent contractor and not in any other capacity including as a fiduciary” and “Citigroup may provide services to other parties with conflicting interests.” (Ferguson & Ma 2014) Hence on the basis of the foresaid mentioned mandate letter clauses the court concluded that Citigroup has excluded its fiduciary duty. For arriving at this conclusion Jacobson J heavily relied on an English Law commission report 1995 (LAW COM No 236 1995) wherein the law commission arrived at a conclusion that despite of the fact that contractual as well as fiduciary relationships can co-exist but the exclusion clause would be effective only if the fiduciary relationship conforms to the terms of the contract. In other words it can be said that if the engagement letter expressly excludes the existence of fiduciary relationship then then there does not exist such relationship between the parties to the contract irrespective of the nature of the relationship they are into. (APESB 2017)

The position of existence of fiduciary relationship lay in the case of Kelly vs. Cooper (1993) has been affirmed to an extent in the present case. Kelly vs. Cooper adjudged that a fiduciary can limit his duties towards beneficiary by expressly mentioning the exclusion clause in a contract which defines the relationship between the parties and the consequences of the exclusion clause are known to the fiduciary without ambiguity. (Swarb 2016)

In case of absence of express contract between the parties to modify the duty fiduciary owes to the beneficiary, there can be an informed consent of the beneficiary to conduct the breach of the fiduciary duty. (McCabe 2007) In the present case there was a mandate letter which expressly excluded existence of fiduciary relationship between Citigroup and Toll. But Jacobson J for the purpose of record considered the existence of informed consent of toll to Citigroup for transaction in shares on his own account along with advisory services for the proposed takeover of Patrick. Jacobson J held that there was no express informed consent on behalf of Toll so there should be an implied consent on behalf of Toll’s, as Toll had expertise in mergers and acquisitions according to its Chief financial officer and that it is the core competency of the company. Hence by virtue of existence of expertise it can be argued that Toll was unaware of Citigroup’s proprietary dealing in Patrick’s shares on the latter’s own account. Therefore from the above discussion it can rightly be inferred that there was implied consent on behalf of Toll.

Court interpreted the term information under section 1042A of the Corporations Act, 2001 as that information could be non- specific information and the inference drawn from that information is also information. (High Court of Australia 2012) ASIC’s claim that the shares were sold while in possession of the material information and therefore breached the provision of insider trading could be effective if they were able to prove that the proprietor trader was an officer as per Section 9 of the Corporation Act.  Court dismissed the claim of insider trading, stating that as per section 9 of the Corporations Act, proprietor trader of Patrick’s shares on behalf of Citigroup was neither a director nor he occupied a management position so as to be termed as an officer.            

In relation to the claim raised by ASIC with regard to the effectiveness of restriction on the flow of information by presence of Chinese wall the court observed that in accordance of Section 1043F of the Corporations Act, 2001 which refers to Chinese wall arrangements by bodies corporate, the Citigroup’s Chinese wall is in place and adequate. Section 1043F(b) does not mandate a standard of absolute perfection for Chinese wall, and for the said reason the court held that the Citigroup’s established arrangements were adequate so as to meet the requirements as laid in the section. Jacobson J held that Chinese walls are an important aspect of any strategy which is built to manage conflicts. Citigroup’s Chinese wall was effectively established which would efficiently restrict the flow of information between different departments, and it enabled protection of client’s interest as there was protection of financial information from misuse. The English Law Commission report 1995 also established essentials of Chinese walls which included physical separation of the various departments of a body corporate, educational programmes emphasizing on the importance of non-disclosure of confidential information, procedures should be well defined and strict so as to enable to deal with situations in which the Chinese wall is to be crossed, effectiveness should be monitored, and sanctions to be imposed in case of breach. (Law Com No. 236 1995) Citigroup Chinese wall possessed all these essentials. Jacobson J also observed that mere laying down procedures is no sufficient there should be a willingness to understand the procedure and implement them in most of the contracts.

In the present case the defense of Section 1043F of the Corporations Act, 2001 can be taken not only by establishing that the procedure and the Chinese wall established were in place rather it is to be proved that material information was not been communicated from one department to the other. The facts of the present case state that the terms of conversation held between the private side employees and the head of equities were with regard to the Proprietary trading of Patrick’s shares, and the private side was worried about the fact that the dealing would affect their conflict of interest in advising Toll for the proposed takeover bid, despite of the fact that the proprietor did not have knowledge of the takeover, (Jacobson 2007) and the conversation  between head of equities and proprietary trader was oblique as the head of equities not  inform the proprietor about the reason to stop trading in Patrick’s shares. (Ali & Gregoriou 2008) So it can be asserted that material information was not communicated form the private department to the proprietary trader. So the Chinese walls should not only be at adequate place but they should be effective to deal with the situations of conflict of interest.

Conclusion

To conclude it can be asserted that in commercial relationships, the parties can expressly define their relationship in case it does not fall under established fiduciary relationships categorically as that it is not fiduciary in nature. It is prudent to expressly exclude the existence of fiduciary relation in the relationship clause. the confirms to the fact that the corporations can rely on the strategies of Chinese wall, contractual exclusion clause and informed consent so as to manage its conflict of interests. There are still more impetus required in the Chinese wall principle to disqualify the conflict of interests in commercial dealings.

References

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