Per Brennan J in Daly v Sydney Stock Exchange Ltd (1986) 160 CLR 370, 385:

"Whenever a stockbroker or other person who holds himself out as having expertise in advising on investments is approached for advice on investments and undertakes to give it, in giving that advice the adviser stands in a fiduciary relationship to the person whom he advises. The adviser cannot assume a position where his self-interest might conflict with the honest and impartial giving of advice ...

The duty of an investment adviser who is approached by a client for advice and undertakes to give it and who proposes to offer the client an investment in which the adviser has a financial interest, is a heavy one. His duty is to furnish the client with all the relevant knowledge which the adviser possesses, concealing nothing that might reasonably be regarded as relevant to the making of the investment decision including the identity of the buyer or seller of the investment when that identity is relevant, to give the best advice which the adviser could give if he did not have but a third party did have a financial interest in the investment to be offered, to reveal fully the adviser’s financial interest, and to obtain for the client the best terms which the client would obtain from a third party if the adviser were to exercise due diligence on behalf of his client in such a transaction ..."

The facts of Aequitus v AEFC were outlined in the materials dealing with bribery of fiduciaries in lecture 7.

In Commonwealth Bank v Smith, a customer approached the bank for a loan to buy hotels. The bank manager put them onto a hotel which was owned by another customer of the bank who coincidentally happened to be in overdraft at the time. He suggested to them that this would be a good purchase, but did not disclose that the bank held a valuation on the property significantly less than the purchase price being asked by the vendors. He discouraged them from approaching an accountant or hotel broker and encouraged them to use the same solicitors as the vendors were using. The bank manager disclosed the fact that he had a conflict and that he would not be able to disclose confidential information about the vendors but that was all. The purchase was not a good purchase and the customer sued alleging breach of fiduciary duty, misleading and deceptive conduct and negligent misstatement. The full Federal Court said (at p476):

"It is not a novel proposition that where a bank gives to a customer advice upon financial affairs, then in addition to any contractual rights the customer may have … the relationship between the parties may be such as to found either or both a common law duty of care and a fiduciary duty…

In many case, and the present is one of them, the bank as financier will have a manifest personal interest of its own in the matter. The question then becomes one of ascertaining when, given the apparent commercial self interest of the bank, the bank also may be taken to have assumed a fiduciary responsibility towards the customer in question. …

Aequitus v AEFC, supra, includes a useful summary of the difference between fiduciary duties and contractual/tortious duties. In that case, the plaintiff’s claim against the financial adviser was based around the dicta of Brennan J in Daly v Sydney Stock Exchange Ltd (1986) 160 CLR 370, 385 quoted above. The court said (at p1,058-9):

"It will be seen that the pleading closely tracks Brennan J’s remarks. Analytically, the pleading asserts positive duties of two kinds: duties to disclose various sorts of information … and duties to act in the best interests of another in the provision of advice …. The pleading does not expressly articulate the negative fiduciary duties of avoiding positions of conflict between interest and duty or between duties, and avoiding any unauthorised profit.

The defendants submit that none of the positive duties alleged in the pleading is properly to be described as a fiduciary duty. The only fiduciary duties, they say, are the negative duties, and these are not pleaded. Disclosure of information, leading to informed consent, may absolve a fiduciary from what would otherwise have been a breach of duty, but (the defendants submit) there is no fiduciary duty of disclosure as such.

The defendants’ point is not merely pedantic. If the positive duties are not fiduciary duties, their true source may be in contract or tort. As we shall see, the measure of recovery at common law differs from the measure of recovery for breach of fiduciary duty in equity.

It may seem surprising that a pleading based closely on Brennan J's considered words should be challenged as misconceiving the nature of fiduciary duties. But judicial thinking about the content of fiduciary duties has changed significantly over the last decade, especially in cases where the fiduciary and the principal are in a contractual relationship, or where the fiduciary owes the principal a duty of care. … In Australia, after acknowledging the co-existence of contractual and fiduciary rights in Hospital Products Ltd v US Surgical Corporation, the High Court has decided to confine the fiduciary component of the overall relationship to a number of specific duties: Breen v Williams …. The question in that case was whether a patient had the right to demand access to her medical records. In [a Canadian case], the Supreme Court of Canada had held that a patient was entitled to access to medical records partly because the doctor-patient relationship is fiduciary. The High Court rejected that reasoning.

In the High Court's view, the essential fiduciary obligations were to avoid conflicts between interest and duty or between duty and duty, and profits arising out of the fiduciary office, in the absence of fully informed consent. Obligations to act in the interests of another, or to act prudently, are not fiduciary obligations. According to Dawson and Toohey JJ (at 93), what the law extracts from a fiduciary relationship is loyalty, often of an uncompromising kind, but no more than that. Gaudron and McHugh JJ (at 113) held that a fiduciary is obliged not to obtain any unauthorised benefit from the relationship and not to be in a position of conflict, but "the law of this country does not otherwise impose positive legal duties on the fiduciary to act in the interests of the person to whom the duty is owed". Gummow J (at 137) said that the special position of the trustee does not provide a proper foundation for "the imposition upon fiduciaries in general of a quasi-tortious duty to act solely in the best interests of their principals". Fiduciary obligations often arise in cases where one person is under an obligation to act in the interests of another, but that does not mean that the obligation to act in the interests of another is a fiduciary obligation.

… The reasoning in Breen v Williams is quite a distance away from Brennan J's dictum in Daly v Sydney Stock Exchange, and yet Daly v Sydney Stock Exchange was cited by Gummow J (at 134) without any hint of disapproval. It would be possible to reconcile the cases by orienting each case to its facts, on the basis that the doctor-patient relationship is less comprehensively fiduciary than the financial adviser-client relationship. But that distinction would not give effect to the conceptual analysis which found favour with five of the six judges who decided Breen v Williams. The logic of their analysis is that most of the observations of Brennan J do not relate to the fiduciary character of the adviser's position.

In my opinion, in light of the reasoning in Breen v Williams, Brennan J's dictum should be taken to refer, for the most part, to the contractual aspects of the adviser-client relationship. The duty to provide "best advice" and to disclose knowledge and information arise out of the adviser's "undertaking", and are therefore implied terms of the contractual retainer. And disclosure may also relieve the adviser from the fundamental fiduciary duty not to "assume a position where his self-interest might conflict with the honest and impartial giving of advice"."

In Option Investments (Aust) Pty Ltd v Martin, a futures broker brought an action against a client for the shortfall after the client had defaulted in margin payments and the broker had closed out the position at a loss. The client resisted the claim, arguing negligence and breach of fiduciary duty, because the broker had waited for 4 months to close out the position and, as a result of further falls in the market, the client had a much greater shortfall to make good. Lush J, affirmed on appeal, gave judgment for the broker and dismissed the client’s counterclaim. He held that while a futures broker who closes out a position is under a duty to sell in good faith, since he has the power for the protection of his own interest, he is entitled to select the time of sale unless otherwise contractually bound or ordered by his client. At p142:

"A broker’s duty is to execute the orders which his client gives him. He is under no duty to give advice, though if he does he must of course do so honestly and with appropriate skill and ability. He is under no duty, and has no general authority, to initiate transactions, for instance, the sale of securities held, without his client’s instructions. The relationship has fiduciary aspects relating to moneys and securities held by the broker, but otherwise the broker’s duty is to execute orders."

In Kelly v Cooper [1993] AC 205, an estate agent acted for the plaintiffs and another seller of adjoining prime beachfront properties in Bermuda. A wealthy American agreed to buy the neighbouring property and then made an offer for the plaintiffs' property. The agent did not disclose the fact that the buyer had purchased the adjoining property. The plaintiffs sued for breach of fiduciary duty arguing that had they been informed that the buyer had purchased the neighbouring property, they would have held out for a better price. The claim was rejected by the Privy Council. Lord Browne-Wilkinson, delivering the judgment of the Council, said (at p214):

"It cannot be sensibly suggested that an estate agent is contractually bound to disclose to any one of his principals information which is confidential to another of his principals. The position as to confidentiality is even clearer in the case of stockbrokers who cannot be contractually bound to disclose to their private clients inside information disclosed to the brokers in confidence by a company for which they also act. Accordingly in such cases there must be an implied term of the contract with such an agent that he is entitled to act for other principals ... and to keep confidential the information obtained from each of his principals."

In Jones v Canavan, a client instructed his broker to buy 200 shares in T as soon as the market opened. The broker also held a sell order for 400 shares in T at $60 per share. The market opened at $60 and so the broker crossed 200 of the 400 in favour of the buying client. The share price of T fluctuated widely over the day and fell significantly afterwards. The client sought to resist paying for the shares on the basis of the common law rule that an agent cannot act for 2 competing principals without the informed consent of both principals. Judgment was given in favour of the broker. The evidence established a market custom of marrying buying and selling orders and that custom was sufficiently notorious and certain to be implied into the contract between the broker and client and to be enforceable. The court found that the custom was reasonable because of the way in which the price was fixed for "crossing" buying and selling orders under market rules and it did not result in a conflict of duty.

To address the type of conflicts that arose in Jones v Canavan, it is generally a good idea for brokers to include in their client agreements a provision along the following lines:

(d)  

This clause also addresses the requirements of ASX MIR 3.2.2, 3.2.4 and 5.1.8(1)(b), which we looked at in lecture 4.

In Bonds & Securities Trading Pty Ltd v Glomex Mines NL [1971] 1 NSWLR 879, at pages 890-93, Street J, in notably colourful language, roundly criticised the practice of stockbrokers acting as underwriters (a role His Honour said was more befitting a merchant bank or financier) and trading on principal account because of the inherent conflicts involved. He said:

"I have thus far stated without comment the factual position disclosed by the evidence given in this suit, and made findings upon the rights of the parties arising out of that factual position. Lest it be thought that failure to comment should be taken to convey an acceptance by this Court of the disturbing business practices and low standards of commercial morality disclosed in this case, I feel bound to deprecate in express terms the manner in which the firm of John T. Martin & Co. conducted its affairs. That firm has now been suspended by the Stock Exchange of Melbourne Ltd. due apparently to having made financial default. Its deficiencies in observance of proper and honourable dealing as a broker might well have passed unnoticed had it not committed the cardinal sin of running out of money. It is not surprising to find Macleay's fraud and the misapplication of the plaintiff's money occurring in an office where questionable standards appear to have been the order of the day.

The occupation of sharebroking demands high standards of integrity. In carrying on his occupation a sharebroker acts, not for himself, but for his client. His remuneration is his brokerage, or commission. Clients, themselves, seek and act on his advice and permit him to handle their money and their shares. Those clients are entitled to expect from a broker not only competence, but also integrity and absence of conflicting personal interests. His position is one of trust and responsibility. By the recognition and pursuit of the high traditions of their occupation, brokers have aspired to the status of an honourable profession. The price they must pay for this status is that they forswear all compromise of their integrity, and that they repudiate the creation of personal interests which could bring them into conflict with their duty to their clients.

The courts have always looked askance upon situations in which a man occupying a position of trust engages in activities involving a potentiality of serving interests other than those which his position requires him to serve. It is, of course, far from the truth to suggest that, where a conflict arises between duty and self-interest, the latter will always, or even more frequently than not, prevail. But such a situation is fraught with the risk that human frailty will prove unequal to the resolution of the moral issues involved in the conflict. I quote again the words of Lord Cairns in Parker v. McKenna: "Now, the rule of this Court as I understand it, as to agents, is not a technical or arbitrary rule. It is a rule founded upon the highest and truest principles of morality. No man can in this Court, acting as an agent, be allowed to put himself into a position in which his interest and his duty will be in conflict."

In this case the firm of John T. Martin & Co. knowingly employed in senior positions in its Sydney office two out of four directors of a public company listed on the Sydney, Melbourne and Perth Stock Exchanges [Glomex Mines NL]: Pitts, the chairman of directors, and at the same time the underwriting, administration and personnel manager of the firm; and Handley, a director of the company, and at the same time an investment adviser of the firm. It is invidious that a broker should thus place himself or allow a senior employee to be thus placed in such a position of conflict. No doubt in many cases they can. But in point of moral commercial principle this is a compromise of the requisite highest standard.

Compounding this duality of interests is the disturbing fact that John T. Martin & Co. in December 1970 underwrote the public floatation of Glomex Mines NL … There is already some disquiet associated with a broker stepping outside his role and fulfilling underwriting functions such as are more becoming to a financier or merchant banker. The matter of concern in a broker acting as underwriter is the risk of loss to himself if the underwritten issue is not filled. The presence of this risk involves at least the prospect of tainting any advice he may tender to his clients in connection with the underwritten shares. … In the present case the multiplicity of interests affecting John T. Martin & Co., Pitts and Handley in this underwriting venture do not need elaboration. It must have been difficult indeed for a client of the firm to have obtained honest and disinterested advice in connection with this floatation.

There remains yet another aspect of concern in the circumstances disclosed in the present case. I had occasion in Hewson v. Sydney Stock Exchange Ltd. to draw attention to the vice inherent in members of the Stock Exchange trading in shares on their own account. Their duty is to act for their clients, not to enter the market themselves and trade in competition with them. The morally unhealthy practice of sharebrokers being also share traders is seen to have been blatantly carried on in the present facts. There is in evidence a resolution passed at a board meeting of Glomex Mines NL authorising Handley to take control of $100,000 "for investment through the Stock Exchange by way of trading in public securities and options", and, with an even more impudent repudiation of the moral fetters precluding share trading by brokers, authorising Handley or Martin to nominate two employees of John T. Martin & Co. for handling the investment, by way of trading, of a further sum of $100,000. Pursuant to this resolution some hundreds of trading transactions were effected on behalf of Glomex Mines NL through the office of John T. Martin & Co. in the five months following the passing of this resolution and ending with the suspension of the firm of brokers. It is disturbing that the firm should have countenanced and, indeed, aided, a senior employee in its office pursuing these relatively large scale and numerous transactions in the interests not of the clients of the firm but of the company of which Pitts and Handley were directors. Whichever way one seeks to rationalise or justify this course of conduct (for example, by postulating that the company was a client of the brokers), one is confronted with an unacceptable situation of conflict of interest.

The loss suffered by the unfortunate plaintiff in the present suit was due in part to John T. Martin & Co. having been acting in the dual capacity of broker for both buyer and seller. One wonders how the broker could get the best price for both buyer and seller so as to justify an entitlement to charge full commission to both … Although there is no suggestion that the plaintiff would not have been content to proceed with the transaction had it been forewarned of the dual role the firm was filling, where a broker does take upon himself this dual role then it is even more necessary for care to be exercised to avoid any possibility of prejudice to a client by reason of this dual capacity. The ambiguity of Handley's position in relation to the custody of the scrip is, at the least, distasteful."

The conflicts to which Street J referred often arise in the context of underwritten offers and placements, where the broker/underwriter has a clear conflict between their duty as underwriter to get the offer/placement away at the best (highest) price for the offeror/placee, their duty to broking clients to purchase shares at the best (lowest) price for them and their personal interest in ensuring there is no underwriting shortfall for which they may be liable. One such recent example involved Goldman Sachs JBWere and its role as a joint lead manager in the book build allocation of quoted securities of Just Group Limited. ASX publicly released a copy of a management letter it issued to Goldman Sachs JBWere in relation to the matter in January 2005, which contains some useful guidance on the proper conduct of book builds for offers and placements. A copy of the management letter can be viewed at: https://www.asxonline.com/intradoc-cgi/groups/participant_services/documents/communications/asx014784.pdf.

While Kelly v Cooper (supra) is helpful, I would not recommend that a financial services organisation leave these matters to implication but instead include an express contractual term in any advisory engagement expressly negativing a duty to disclose information obtained from other clients. I would suggest a clause along the following lines:

"It is possible that we have obligations not to disclose, or it would otherwise be inappropriate for us to disclose, information which may be relevant to our advisory role that we have obtained in other circumstances, for example while acting for another client. To avoid any conflict, you agree that we are excluded from any duty to disclose to you, or to provide advice based on, any such information."

This clause should be supplemented by the one suggested below dealing with Chinese walls.

Similarly, I would recommend that brokers include in their client agreements a provision along the following lines:

"It is possible that we have obligations not to disclose, or it would otherwise be inappropriate for us to disclose, information which may be relevant to a transaction on your account that we have obtained in other circumstances, for example while acting for another client. To avoid any conflict, you agree that we are excluded from any duty to disclose to you any such information or to have regard to any such information when effecting a transaction on your account."

CA s912(1)(aa) was introduced by schedule 10 of the Corporate Law Economic Reform Program (Audit Reform and Corporate Disclosure) Act 2004. The explanatory memorandum for the Bill said (at 5.599 -5.600):

"There are three main types of conflicts of interest:

•    

conflicts within the financial services business (Category 1);

- examples are conflicts within one area of the financial services business, such as dealing on behalf of various clients, or across different areas of the business, such as between publishing research in a client newsletter and market making;

•    

conflicts between something within the financial services business and something outside the financial services business (Category 2);

- examples are where outside factors give rise to conflicts within the financial services business, such as a conflict of interest between the financial services licensee lending (as principal) to a particular enterprise and the financial services licensee underwriting a public offer for the same enterprise. Alternatively, a conflict may arise where the objectivity of research is compromised by the analyst's personal interests or relationships;

•    

conflicts outside the financial services business (Category 3);

-  where a factor outside the financial services business gives rise to a conflict with another factor outside the same financial services business. Examples include where those conflicts might arise between two non-financial services businesses of a merchant bank (for example; corporate lending and dealing on the bank's own behalf). Such conflicts are unrelated to the financial services business.

The purpose of proposed paragraph 912A(1)(aa) is to specifically require licensees to have adequate arrangements for managing Category 1 and Category 2 conflicts of interest. Licensees will not be obliged under the Corporations Act to manage Category 3 conflicts of interest, which occur wholly outside their financial services business. They may have other obligations to manage such conflicts."

In ASIC v Citigroup Global Markets Australia Pty Limited (No. 4) [2007] FCA 963, it was alleged that Citigroup infringed s912A(1)(aa) by failing to have appropriate arrangements in place to deal with the conflict that arose when one of its proprietary traders purchased a significant number of Patrick shares at a time when its corporate advisory team was advising Toll in relation to a takeover bid for Patrick. The court found in favour of Citigroup, holding in effect that the alleged conflict was a category 3 conflict and therefore fell outside of s912A(1)(aa). Proprietary trading (dealing in shares on one's own account) is not a financial service (CA s766C(3)) and the type of advice being given by Citigroup's corporate advisory team was an exempt service under CR r7.1.29(3)(c).

For other publications on managing conflicts of interest, see ASIC Regulatory Guide 79 - Managing conflicts of interest: an ASIC guide for research report providers, SIA/SDIA Best Practice Guidelines for Research Integrity and the Financial Planning Association's Principles for Managing Conflicts of Interest.

The concept of a conflict of interest comes to us from the law applicable to fiduciaries. This begs the question whether it is necessary for there to be a fiduciary relationship between the licensee and the client for a conflict to exist. In ASIC v Citigroup Global Markets Australia Pty Limited (No. 4), supra, counsel for ASIC made a critical and fatal concession (at para 26):

"ASIC does not concede that, as a matter of statutory construction, s912A(1)(aa) applies only where a licensee and its client are in a fiduciary relationship. However, Mr Walker SC, for ASIC, did concede that for the purposes of the present case, ASIC’s contention that Citigroup contravened s912A(1)(aa) depends upon the success of ASIC’s submission that the parties were in a fiduciary relationship."

The court found that this submission failed at the outset because the letter of engagement under which Toll retained Citigroup as its adviser specifically excluded the existence of a fiduciary relationship.

There was nothing in the explanatory memorandum for the Corporate Law Economic Reform Program (Audit Reform and Corporate Disclosure) Bill to suggest that the existence of a fiduciary duty is a pre-requisite to the application of s912A(1)(aa). Indeed, a number of the examples of conflicts cited in explanatory memorandum involve roles that would not generally be regarded as fiduciary (eg market making, proprietary trading, corporate lending and query also publication of equities research (as distinct from the giving of specific investment advice)). Further, even where a licensee is in a fiduciary relationship (eg as agent acting for a principal), the duties that are in conflict are often contractual or tortious duties rather than fiduciary duties (eg the duty of a broker acting for both a buyer and a seller to get the best price for each client).

In ASIC v Citigroup Global Markets Australia Pty Limited (No. 4), even though the court found that s912A(1)(aa) was not applicable, it went on to deal with whether Citigroup's arrangements for dealing with conflicts were adequate for the purposes of that section. The court said (at para 442-6):

"ASIC’s case was that without Toll’s explicit permission to engage in proprietary trading in Patrick shares, Citigroup had no arrangements, "still less adequate ones", for dealing with conflicts which may arise from the purchase of Patrick shares.

The essence of ASIC’s case therefore was that "adequate management" required the elimination of unauthorised conflicts by obtaining express consent. I reject that submission because it seems to me to be inconsistent with the plain meaning of s912A(1)(aa).

First, the subsection uses the words "management of conflicts of interest". I do not see that "management" requires elimination of a possible conflict, although of course it would be open to a licensee to take that further step if it chooses to do so.

Second, the phrase "management of conflicts of interest" assumes that there will be potential conflicts which must be managed by adequate arrangements rather than totally eliminated.

Thus, in my view, whether particular arrangements are adequate is to be determined as a question of fact."

The court found that Citigroup's arrangements were adequate for the purposes of s912A(1)(aa) and, in particular, that they met the tests laid down by Lord Millett in Bolkiah (see below).

In Bolkiah v KPMG, the House of Lords had to consider whether, and if so in what circumstances, a firm of accountants which had provided litigation support services to a former client and in consequence had in its possession information which was confidential to him, could undertake work for another client with an adverse interest. Delivering the judgment of the House, Lord Millet said:

"Chinese Walls are widely used by financial institutions in the City of London and elsewhere. They are the favoured technique for managing the conflicts of interest which arise when financial business is carried on by a conglomerate. The Core Conduct of Business Rules published by the Financial Services Authority recognise the effectiveness of Chinese Walls as a means of restricting the movement of information between different departments of the same organisation. They contemplate the existence of established organisational arrangements which preclude the passing of information in the possession of one part of the business to other parts of the business. In their Consultation Paper on Fiduciary Duties and Regulatory Rules the Law Commission (1992) (Law. Com. No. 124) describe Chinese Walls as normally involving some combination of the following organisational arrangements:

(v)  

disciplinary sanctions where there has been a breach of the wall.

KPMG insist that, like other large firms of accountants, they are accustomed to maintaining client confidentiality not just within the firm but also within a particular team. They stress that it is common for a large firm of accountants to provide a comprehensive range of professional services including audit, corporate finance advice, corporate tax advice and management consultancy to clients with competing commercial interests. Such firms are very experienced in the erection and operation of information barriers to protect the confidential information of each client, and staff are constantly instructed in the importance of respecting client confidentiality. This is, KPMG assert, part of the professional culture in which staff work and becomes second nature to them. Forensic projects are treated as exceptionally confidential and are usually given code names. In the present case KPMG engaged different people, different servers, and ensured that the work was done in a secure office in a different building. KPMG maintain that these arrangements satisfy the most stringent test, and that there is no risk that information obtained by KPMG in the course of Project Lucy has or will become available to anyone engaged on Project Gemma.

I am not persuaded that this is so. Even in the financial services industry, good practice requires there to be established institutional arrangements designed to prevent the flow of information between separate departments. Where effective arrangements are in place, they produce a modern equivalent of the circumstances which prevailed in Rakusen's case [1912] 1 Ch. 831. The Chinese Walls which feature in the present case, however, were established ad hoc and were erected within a single department. When the number of personnel involved is taken into account, together with the fact that the teams engaged on Project Lucy and Project Gemma each had a rotating membership, involving far more personnel than were working on the project at any one time, so that individuals may have joined from and returned to other projects, the difficulty of enforcing confidentiality or preventing the unwitting disclosure of information is very great. It is one thing, for example, to separate the insolvency, audit, taxation and forensic departments from one another and erect Chinese Walls between them. Such departments often work from different offices and there may be relatively little movement of personnel between them. But it is quite another to attempt to place an information barrier between members all of whom are drawn from the same department and have been accustomed to work with each other. I would expect this to be particularly difficult where the department concerned is engaged in the provision of litigation support services, and there is evidence to confirm this. Forensic accountancy is said to be an area in which new and unusual problems frequently arise and partners and managers are accustomed to share information and expertise. Furthermore, there is evidence that physical segregation is not necessarily adequate, especially where it is erected within a single department.

There have been some interesting examples in recent years of financial services organisations incurring significant liabilities for failing to properly manage or disclose conflicts of interest.

We looked at the recent $1.5b settlement in the US involving research analysts in Lecture 3. This was specifically cited in the explanatory memorandum for the Corporate Law Economic Reform Program (Audit Reform and Corporate Disclosure) Bill as one of the reasons for the introduction of s912A(1)(aa) (at 5.593-6):

"International experience with conflicts of interest - particularly that of the United States ... in 2002 with respect to analysts - led the Australian Government to consider its own regulatory framework for managing conflicts of interest.

In August 2003 ASIC completed its Research Report into Analyst Independence. The Report concluded that while ASIC did not identify any actual contraventions of the Corporations Act 2001, there was in its view, an unacceptable level of reliance, in some entities, on staff integrity to avoid and manage conflicts of interest. This, together with international experience, confirms a general unease in Australia about analyst independence and the management of conflicts of interest when providing financial services.

Under the current regulatory regime financial services licensees are required to ensure that financial services covered by their licence are provided `efficiently, honestly, and fairly'. While industry has widely accepted that this would include managing conflicts of interest, the duty was not express in its application to conflicts of interest.

It was considered that any new provision should not be limited in application to analysts, but should also provide for financial services licensees more generally, as the potential for conflicts of interest to arise are not limited in application."

In August 2003, the US Securities and Exchange Commission charged Deutsche Asset Management, Inc. (DeAM), the investment advisory unit of Deutsche Bank AG, for failing to disclose a material conflict of interest in its voting of client proxies for the 2002 merger between Hewlett-Packard Company (HP) and Compaq Computer Corporation. The SEC found that, unbeknownst to DeAM's advisory clients, Deutsche Bank's investment banking division was working for HP on the merger and had intervened in DeAM's proxy voting process on behalf of HP. This created a material conflict of interest for DeAM, which had a fiduciary duty to act solely in the best interests of its advisory clients. It further found that DeAM violated this duty by voting the proxies on the HP stock owned by its advisory clients, without first disclosing the conflict. The SEC made an order censuring DeAM, directing it to cease and desist from further violations, and imposing a civil penalty of US$750,000. DeAM consented to the issuance of the order without admitting or denying its findings. For details, see: http://www.sec.gov/news/press/2003-100.htm.

In September 2004, NY Attorney General Eliot Spitzer announced a $450 million settlement with two prominent US mutual fund management companies, Invesco Funds Group and AIM Advisors, to resolve charges that the companies permitted illegal market timing trades (short-term investing in mutual fund shares and/or the exploitation of pricing inefficiencies in mutual fund share pricing) and late trades (obtaining a given day's mutual fund share price for orders to buy, sell or exchange shares that were placed after the close of the market on that day) in shares in their funds. For details, see: http://www.oag.state.ny.us/media_center/2004/sep/sep7c_04.html and the Invesco Assurance of Discontinuance and AIM Assurance of Discontinuance.

In October 2004, NY Attorney General Eliot Spitzer announced that he was suing the leading US insurance brokerage firm, Marsh & McLennan, alleging that it steered unsuspecting clients to insurers with whom it had lucrative payoff agreements and that the firm solicited rigged bids for insurance contracts (see http://www.oag.state.ny.us/media_center/2004/oct/oct14a_04.html and http://www.oag.state.ny.us/media_center/2004/oct/oct14a_04_attach1.pdf). The accompanying civil complaint alleged that for years Marsh received special payments from insurance companies that were above and beyond normal sales commissions. These payments, known as "contingent commissions", were characterized as compensation for "market services" but were, in fact, rewards for the business that Marsh and its independent brokers steered and allocated to the insurance companies. The complaint also alleged that Marsh occasionally solicited fake bids to deceive its customers into thinking that true competition had taken place for their insurance business. The complaint culminated in a settlement agreement under which Marsh & McLennan agreed to pay US$850 million in restitution to its policyholders, to adopt a new business model designed to avoid conflicts of interest and to issue a public statement apologising for "unlawful" and "shameful" conduct (see http://www.oag.state.ny.us/media_center/2005/jan/marshsettlement_pr.pdf).

In ASIC v Citigroup Global Markets Australia Pty Limited (No. 4), the court went to great lengths to expound its finding that none of the 5 conflicts alleged by ASIC was in fact a meaningful conflict (see paragraphs 369-420). In my view, the court took an unnecessarily narrow and legalistic view of what constitutes a conflict. Most market participants would, I think, regard Citigroup's proprietary trading in that case as being in clear conflict with the interests of Toll. The fact that Citigroup itself took steps to stop the trading when it became known is ample evidence of that. I think this aspect of the decision has to be seriously questioned. It would have been much better, in my view, if the court had left the analysis of what constitutes a conflict to another day and rested its decision on the fact that the conflicts in question were "category 3" conflicts outside the reach of s912A(1)(aa) and/or that Citigroup had appropriate arrangements for managing those conflicts for the purposes of s912A(1)(aa).

My strong recommendation to financial services organisations would be not to rely on a court taking as sanguine a view of conflicts in future cases and to bolster their positions contractually by including in corporate advisory mandates a provision along the following lines:

"The XYZ group carries on a range of businesses, including providing stockbroking, futures broking, market making, banking, corporate advisory, investment advisory, investment management and custodial services to clients, as well as sales and trading activities on their own account. It is possible that the various members of the XYZ group which provide these services or engage in these activities may:

(a)  

hold long or short positions in securities of companies involved in the transaction;

(b)  

effect transactions in those securities for their own account or for the account of their clients; and/or

(c)  

be advising on, or otherwise involved in, a transaction that could materially affect the price or value of those securities.

The XYZ group maintains "Chinese walls" to manage the potential conflicts of interest that might arise from its various activities and to safeguard confidential information. It is critical to us and to all of our clients that these Chinese walls are effective. Accordingly, you agree that:

(a)  

we will provide advisory services to you in relation to the transaction solely on the basis of the information that is known to, and able to be disclosed by, the particular personnel involved in the transaction;

(b)  

we are not obliged to disclose to you any information that is not known to, or not able to be disclosed by, the personnel involved in the transaction because of the maintenance of these Chinese walls or to have regard to any such information when advising you in relation to the transaction; and

(c)  

in certain extraordinary circumstances, the personnel involved in the transaction may have to withdraw from their involvement and they may be unable to disclose the reason for this."

This clause should be supplemented by the one suggested above dealing with confidentiality obligations.

Similarly, I would recommend that brokers include in their client agreements a provision along the following lines:

"The XYZ group carries on a range of businesses, including providing stockbroking, futures broking, market making, banking, corporate advisory, investment advisory, investment management and custodial services to clients, as well as sales and trading activities on their own account. It is possible that the various members of the XYZ group which provide these services or engage in these activities may:

(a)  

hold long or short positions in financial products that you hold or are interested in;

(b)  

effect transactions in those financial products for their own account or for the account of their clients; and/or

(c)  

be advising on, or otherwise involved in, a transaction that could materially affect the price or value of those financial products.

The XYZ group maintains "Chinese walls" to manage the potential conflicts of interest that might arise from its various activities and to safeguard confidential information. It is critical to us and to all of our clients that these Chinese walls are effective. Accordingly, you agree that:

(a)  

we will provide services to you from time to time under these [Terms of Business] solely on the basis of the information that is known to, and able to be disclosed by, the particular personnel involved in any transaction on your account;

(b)  

we are not obliged to disclose to you any information that is not known to, or not able to be disclosed by, the personnel involved in any transaction on your account because of the maintenance of these Chinese walls or to have regard to any such information when effecting a transaction on your account; and

(c)  

in certain extraordinary circumstances, the personnel who normally handle your affairs may be precluded from acting on your behalf, either generally or in relation to particular financial products, and they may be unable to disclose the reason for this."

Per Lord Denning MR, at p7:

In Tournier's case, T was a customer of the National Provincial and Union Bank. He had run up an overdraft of 9l.8s.6d. and, when pressed for payment, had agreed to pay off the overdraft at 1l per week. He made only 3 payments. Shortly thereafter he obtained 3 months’ employment as a travelling salesman. The bank received for clearance a cheque for £45 in his favour from another customer of the same branch, which he had not deposited but instead had endorsed over to a bookmaker. The bank manager took umbrage at that and telephoned his employer trying to track down his current address. In the course of the conversation, the bank manager mentioned that T was indebted to the bank but had not been responding to its letters. He also mentioned that T must be getting money from somewhere and referred to the cheque in favour of the bookmaker. The employer decided not to renew T’s contract of employment after the 3 months had expired. T alleged it was because the bank manager had created the impression with his employer that he was a gambler and did not honour his debts. He sued the bank for slander and for breach of confidence. Held that the bank had breach its implied duty of confidentiality and was liable to T in damages.

In Winterton Constructions Pty Ltd v Hambros Australia Ltd, a builder brought a s52 action against Hambros, when it withdrew finance for a construction project with the effect that the developer was no longer able to pay the builder. The builder tried to argue that as someone who stood to benefit from the completion of the building, Hambros had a duty to the builder to inform the builder if it intended to stop credit. The claim was rejected. In the course of his decision, Hill J stated (at p40,888):

"… Hambros is not a banker in the ordinary sense of the word. Hambros is what is commonly referred to as a merchant bank. However, there is much to be said for the view that a merchant bank has likewise a contractual duty of confidence to its clients, that duty being an implied term in the relationship between them. …[And then later] Even in the case of a financier not being a bank, a borrower is entitled to expect (even if it not an implied term of the contractual arrangement) that his financier will keep confidential matters concerning the borrower’s financial affairs."

In Libyan Arab Foreign Bank v Bankers Trust Co, shortly before the US President signed a decree in 1986 freezing all Libyan assets held with US institutions, a senior executive of Bankers Trust rang the Federal Reserve Board and told them that "the Libyans" were taking their money out of the various accounts they had with BT. The Libyan Bank sued alleging a breach of confidentiality. The court was prepared to reach a tentative conclusion that the disclosure was justified by a higher public duty and that, in any event, the breach of confidence had not resulted in any loss to the customer as it had no effect on the timing of the Presidential decree.

In Brown & Co v Bank of NSW, the plaintiff sued, amongst others, a bank which had given a favourable credit reference about one of its customer companies to the plaintiff’s bank. The plaintiff had agreed to sell wool to the company on deferred payment and suffered loss when the company went into receivership within a few weeks of the reference having been issued. The reference had been stamped: "This opinion is confidential and for your private use and without responsibility on the part of this bank or its officers". That disclaimer was held to be sufficient to defeat any claim in negligence. However, in this case, the reference had been given with knowledge of its falsity or with reckless disregard of the truth and so a claim for fraudulent misrepresentation was upheld. Virtue SPJ had this to say (at p213):

"There is, of course, a conflict of duties which can arise in cases of this kind. On the one hand, there is the duty of a banker to maintain secrecy regarding a customer’s affairs; on the other, there is a the duty owed to a person to whom he supplies information or an opinion as to a client’s affairs or credit, at least to give an honest opinion, or where a duty of care arises to give a report that observes that duty. It is suggested in Paget on Banking …, in reliance on Tournier v National Provincial & Union Bank of England Ltd … that a bank should not answer an inquiry of this description even from another bank without the consent of its client. Certainly the bank is not bound to give any opinion whether with its customer’s consent or not.

This definition has been read down by the courts so that it only applies where the interception is committed by a third party who is not party to the communication. In R v Evans & Doyle, the defendants challenged on voir dire the use of taped conversations between the broker (Doyle) and his client (Evans) in an insider trading prosecution. It was held that the tape recordings were admissible. The mischief that s6(1) was directed to was the interception by third parties of a communication or conversation happening over the phone lines. The Act did not stop the parties to the conversation from recording the conversation. In response to a submission from defendant’s counsel that the broker's employer (JB Were) was a third party to the conversation between Evans and Doyle, the court said that the tapes were recordings by the employer of conversations that one of its employees had had in the course of his employment. JB Were could only act through its servants and agents. JB Were was to be regarded as a party to the conversation and therefore any recording by it of the conversation was not an interception.

The court also found that, in any event, the client knew that his phone conversation was being recorded and that also prevented the recording from being an interception for the purposes of the TIAA. The court said:

"The pip tone generator forming part of the recording equipment installed at Weres and by which its operation recorded the telephone conversations, … was, by its design and by its operation, such that when a telephone conversation to or from an attached extension was being recorded, a pip or beep was transmitted to the line at each end, that is to the line of the person speaking and listening at the recording end and also at the other end. …

I am satisfied to the necessary degree that the bips or tone pips were transmitted to [the client’s] end of the line during the conversation, they were present to be heard, and were heard, and by reason of his previous knowledge of the presence of the meaning of such beeps I am satisfied that he knew that his telephone conversations with [the broker] were being recorded at the relevant time."

In Gooley v Westpac, the applicant, a senior employee in Westpac’s corporate advisory area, sent a legal summary on limited partnerships and details of some limited partnership financing structures the bank had been involved in that were "in trouble" and were good candidates for restructure to an outside party with whom the employee had a prior involvement and who was active in property investment. Westpac summarily dismissed him for serious misconduct, namely, passing on confidential information concerning the Bank's relationship with clients and breaching a declaration of secrecy he had signed and the Westpac Code of Conduct. The employee applied to the Industrial Relations Court for damages for breach of award on the basis that his dismissal was harsh, unjust and unreasonable (this was before the remuneration cap for claims in this jurisdiction was introduced). The Court said that it was not convinced that the information was in fact confidential, or that its release would have or had harmed the bank. The employee’s motive in sending the material was in pursuit of the bank’s interests (trying to find a purchaser for the properties in question). Accordingly, his misconduct was not "serious" and therefore his dismissal was harsh, unjust and unreasonable.

In Ramage v Challenge Bank, Ramage was an employee working in the loan approval section of Challenge Bank. He had been looking for a property to purchase. He found a property he was interested in and used Challenge Bank resources to obtain a property search. That search revealed that the property was financed by, and subject to a mortgage in favour of, Challenge Bank. He pulled the client’s file and obtained a copy of a valuation report on the property which valued it at somewhat less than the purchase price being asked for by the vendors. He mentioned that in passing to the estate agent handling the sale who passed the comment on to his client, the vendors. They wrote a letter of complaint to Challenge Bank. Ramage was summoned to a meeting with his boss and with HR, told that this was a serious matter and given until the following morning to provide a response. He wrote out his version of what had happened. The following morning he attended another meeting with the same people and gave them his statement. He was asked some further questions and then asked to leave the room. After an interlude, he was invited back and told that the bank had no alternative - either it had to sack him or he could resign voluntarily. He chose to resign. Subsequently, he sought to be reinstated on the basis that he had been constructively dismissed and that this was harsh, unjust or unreasonable.

The Court, after noting the references to an obligation not to mis-use information in Ramage's written employment contract and a clause in the Challenge Bank Credit Manual about the confidentiality of customer information, stated:

"I do not accept the arguments put forward on behalf of the applicant. Mr Ramage clearly acted improperly when he went to the vendors' confidential file to look at the valuation. Mr Ramage had no business going to that file. He did it purely for his own purposes. The information he gained from the valuation on the client file could have been used by Mr Ramage as a bargaining tool in his dealings on the property. The banking industry is very sensitive and its employees, particularly those in professional positions, have a duty to behave responsibly. I find that there was a valid reason for the termination and that the termination was not harsh, unjust or unreasonable. Accordingly, the application must be dismissed."

In Santos Limited v Smith, Smith was employed as a petroleum geologist by Santos. He was dismissed for purchasing Santos share options while allegedly in possession of price sensitive information about an oil discovery. Before the purchase he had discussed it openly in his workplace. He made no secret of the transaction. The transaction came to the attention of senior management some two days later. The worker admitted the transaction to the Manager of the Petroleum Division, explaining that he believed he had not done anything wrong and that he was unaware of any prohibition on the ownership or trading of Santos shares or options by its employees. The worker was asked to resign but declined. He was subsequently suspended from his employment while a full investigation was carried out. As a result of this, he was dismissed.

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Fourth, the scale of the transaction was a relatively small one. He made only $1,200 profit on his investment.

The Commissioner was not satisfied that the respondent had committed an act of gross misconduct and thereby breached his contract of employment. The basis for the dismissal therefore disappeared and, in those circumstances, the Commissioner concluded that the dismissal was harsh and unjust.

where a person refuses to participate in, or cooperate fully with, an alcohol or drug test, the person will be counselled and encouraged to participate. If the person continues to refuse without legitimate cause, they will be deemed unfit for work and the incident will be treated as returning a positive result.

because Worley acted inconsistently with its contractual obligations in relation to the test, the dismissal was harsh and unreasonable.