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Financial MarketsHistory of Stock ExchangesAIM OF THE ASXOctober 1990, ASX sought to restate its current role and that of its Listing Rules. “A stock exchange is first and foremost a market place for trading in securities of domestic and foreign issuers….The ASX’s role is to provide and maintain a fair, efficient, well-informed and internationally competitive market for trading securities, so as to secure the confidence of investors and companies in the conduct of the market”Produce a balance that avoids the excesses of over-regulation and complete laissez-fairelaissez-faire economy - an economy that relies chiefly on market forces to allocate goods and resources and to determine pricesFair, Orderly and Transparent (s792A)ASX wishes to achieve its ultimate goal of “Fair, Orderly & Transparent” by ensuring that it achieve “strong form efficiency” and ensure that all public and private information that is not generally available, is provided to the market place. Thus, insider traders will not be able to profit from the inside information as this information is already impacted in the price of securities. An orderly market is typically thought to exist when all bids, offers, and trades enter the market in the order in which they were originally placed and those bids, offers, and trades are not such that they are in conflict with each other i.e. a bid cannot remain in the market at a price higher than a offer, or a trade cannot take place below the current bid.Liquidity is not needed to ensure an orderly marketplace, it is likely that at any given time all markets suffer from periods of illiquidity, this does not mean that the market is un-orderly. Providing a liquid market is sensibly not a legislative requirement that the operators of an Australian financial marketplace need to comply with.Prior to the introduction of electronic trading Australia’s main futures exchange the Sydney Futures Exchange (‘SFE’) monitored and enforced the ‘orderly and fair’ market requirements with the assistance of pit bosses, surveillance cameras, and pit committees. The members of the SFE transacted business using the open outcry system, where traders shout their bids or offers into the pit, all bids and offers were required to be made in the pit and be sufficiently audible so that all traders in the pit were able to hear the relevant bid or offer.Electronic trading platforms can bring significant cost savings to the operators of a financial marketplace; however, in the case of the SFE this has been at the expense of an orderly marketplace. Transactions involving more than one type of contract are now transacted outside of the main trading market i.e. transactions involving multiple option contracts are now traded on a market named the ‘Custom Market’.A co-operative approach is needed with government oversight to ensure that the administration of discipline is handled correctly and proactively. Clear and frequent communication between the two bodies must exist to ensure that information is exchanged in regards to membership, disciplinary action and business activities as well as information that would ensure that “transparency” is being reflected by ASX.Market Efficiency – “General Market” InformationAllocation of ResourcesProfessor RR Officer, Queensland University – “Has a role to perform in the efficient allocation of resources. The stock markets role is to allocate capital…among public companies and between those companies and other assets….A company whose product is in demand can be expected to have a “high price” placed on its shares because of the expected future profits.”General Market InformationIn circumstances were information which is no generally available has price sensitive consequences, then a reasonable person must expect that such information would have a price effect on the value of the securities and inform ASIC immediately of the information otherwise criminal liability will arise where the failure to disclose this information arises under rmation is “generally available” where it consists of readily observable matter s676(2)(a) – which is further extended to information which must have been available in a manner which would, bring it to the attention of “those persons who commonly invest securities” in s676(2)(b). s677 provide that a reasonable person will be assumed to expect that information will have a “material effect” on the price or value of securities, if it is the case that the information would likely influence the decision to buy or sell such securities by “persons whom commonly invest in securities”.Semi-Strong MarketIn s677 outlines the “semi strong” form of efficient market hypothesis which suggests that all publicly available information is reflected in the price of the shares traded. Thus, s677 outlines that price effects the way trading decisions are made “is supportable as recognising the manner in which trading decisions of investors affect the market price of securities.”Concept of efficiency does not apply in a perfect market. It is the opportunity to capitalise on inefficiencies in the market that encourages investors to gather information. The utilization of this information promotes efficiency and assists in the optimal allocation of resources within the market. Even if the optimal allocation of resources within the market is still one of uncertainty, prices reflect expected returns and returns are not perfectively predictable in advance Semi-strong form efficiency in which all public information, such as company annual report data and historical price information, has been absorbed within the price of a corporations securities. The reliability of semi-strong form of the efficient capital market hypothesis depends ultimately upon the degree of monitoring which rational investment analysts make of various securities. Where such monitoring is lacking, the reliability of the hypothesis will suffer. The hypothesis depends upon there being their being a sufficient degree of turnover of trading in particular stocks. This is hypothesis is generally undermined in Australia by thin trading or by low turnover in many securities as there is only occasional secondary trading in the securities of the vast majority of listed companies and most securities market trading only involves the securities of the top 100 companies. Self-Regulation, Co-Regulation & External RegulationSelf-Regulation - Making certain yourself that you or your employees act according to the rules, rather than having this done by other people:Co-Regulation – Encompassing both self-regulation and regulation that is performed by an external agent or body to provide non-biased regulatory enforcementDemutualisation – REFER SFE for DefinitionCommon Laws between ASX and SFES792A(c)(i) – Handle conflicts of interest that arise between their commercial interests as listed companies and their regulatory and supervisory roles as market providers. Conflicts of interest arising over the running of the two AML as a business and ensuring that Fair, Orderly and Transparent occurs without over-balancing to the commercial interest as opposed to ensure that the supervision of the market is the first and foremostS792D(1) - In s792D, it establishes that ASX provides assistance to ASIC and that the Listing and Business Rules of the Exchange can be enforced through the court under s793C – which serves to bolster the inter-relationships between ASIC and the ASX. Both s792D and s793C strengthen the relationship between the two bodies in ensuring that compliance and the regulatory framework is clearly established.REFER ALSO POWERS OF ASIC BELOWS794C(1) – Aim to promote the efficiency of ASX and SFE whereby ASIC has the power to conduct an assessment of either of the two exchanges compliance obligations. This enables ASIC to comment on the exchange efficiencies as well as providing comment on improvements the exchange could make to increase its obligations and improve their effectiveness as frontline regulatorsS792F(1) – Aims to improve efficiency of ASX and SFE frontline regulation through annual compliance report which includes scrutiny of the exchanges compliance with their market obligations and a comparison of goals set from pervious years and general performanceDifferences in regulation of ASX and SFE - FunctionalRegulation unique to the stock exchange includes:Disclosure to ASIC about relisted companies s792C and Corps Regulations 7.2.05(01)Self-Listing companies – s798CNational Guarantee Fund Regulation unique to the futures industry includes:Money may be used for margins calls: s981D – Money may be used to meet margining, securing, transferring etc derivativess981D(2)(b) – Money is not allowed to be attached or taken in the executionASX Market Rules – 7.6, 7.15 & 7.17 are all different to SFEASX REUGLATIONS – MARKET REGULATIONASX supervisory arrangements are designed to maintain and enhance market integrity.Regulatory ControlASX is required to operate within this framework whereby regulatory control is divided between the relevant Commonwealth Minister (s794A), the Australian Securities and Investments Commission (s792C – s792D) and a Market Licensee (s791A).ASX AMLThe ASX holds an Australian market licence to operate a financial market (s792A). An Australian market licence is granted by the Minister (s798A), subject to there being adequate arrangements and resources to supervise and operate the market (s792A(d)). The ASX is required to fulfil a number of obligations as a market licensee (s792A) and the Minister is able to direct the ASX to comply with these obligations if he/she considers it necessary (s798A).Fair, Orderly and Transparent (REFER ABOVE)In summary, ASX market licence obligations require that the ASX do everythingpossible, within reason, to ensure a fair, orderly and transparent market (s792(a)).How does ASX Achieve this?To achieve this outcome, the Act states the ASX must establish and maintain adequate market supervision arrangements (s792A(c)). This includes arrangements to manage conflict, arrangements to monitor the conduct of its participants and arrangements to enforce compliance with its market rules and listing rules. These supervisory arrangements may involve a self-regulatory structure (the current ASX model) or may be outsourced to an independent person or related entity such as ASIC (s792C). Sufficient resources must also be available to operate the market properly and to enable adequate supervision (s792A(d)).Compliance/Managing RegulationThe Act requires the ASX to produce an annual report on the extent of compliance with its statutory obligations to ASIC (s792F).In addition, ASIC’s Policy Statement 172, requires the ASX to assess and analyse its performance against its stated compliance standards/outcomes and explain ways to address concerns raised ASIC is also required to assess ASX compliance on an annual basis. (Corps Regulation 7.2.06(c) and PS 172.114)Managing risk and complianceTo manage the risks associated with operating a financial market and to achievecompliance with its licence obligations, the ASX has developed a comprehensiveregulatory structure. How does it manage Compliance and Regulation?Operating units within this structure include:ASX SurveillanceInvestigations and Enforcement (I&E)Compliance ServicesRisk Management Unit and ASX Companies (ASXC)The National Adjudicatory Tribunal (NAT), a disciplinary tribunal comprised of Market Participants, is also relevant. Market/Listing RulesThe ASX imposes comprehensive operating rules on its Market Participants and listed entities. Rules regulating broker behaviour are called Market Rules Rules regulating the behaviour of listed entities are called Listing Rules. Collectively, these operating units and rules aim to ensure a fair, orderly and transparent market (s792A).ASX Surveillance (Self-Regulation)ASX Surveillance performs a pivotal role in the ASX supervisory framework. ASX Surveillance is responsible for the continuous monitoring of market activity in all listed securities. ASX Surveillance operates Surveillance of Market Activity (SOMA), a computer system that aids in the detection of unusual trading activity. SOMA continuously monitors the equity market in real time and generates alerts based on price, volume or unusual trading patterns. Information is also obtained from investors, brokers and the media. SOMA alerts and other information are examined by ASX Surveillance analysts. If the observed trading activity is unusual and is not explained by available market information, ASXC may be informed.In addition, activities that may indicate a breach of ASX Market Rules, suggest insider trading or suggest attempts to manipulate or interfere with the fair and orderly operation of the market, will be investigated further by ASX Surveillance. Depending on the nature of the unusual trading behaviour, this investigation may result in a detailed Referral to ASIC and/or I&E.ASIC & ASX Surveillance (Co-Regulation)Referrals from ASX Surveillance to ASIC, regarding alleged breaches of the Act, areinvestigated in accordance with the powers vested in ASIC under the Act.9 In removing undesirable restrictive market practices from an industry there must be some strong external market influence such as ASX Referrals Response Program – set up to investigate serious market irregularities. ASX sends notifications to ASIC about trading practices that have breached either s792B(2)(c) and 821B(2)(c) of the Act. ASX also notifies ASIC of any market manipulations such as insider trading or in matters that adversely effect the operation of a “fair, orderly and transparent market”.In s792D, it establishes that ASX provides assistance to ASIC and that the Listing and Business Rules of the Exchange can be enforced through the court under s793C – which serves to bolster the inter-relationships between ASIC and the ASX. Both s792D and s793C strengthen the relationship between the two bodies in ensuring that compliance and the regulatory framework is clearly established.Outline of Breaches ProcessA detailed analysis of ASIC and the civil and criminal penalty regime Referrals from ASX Surveillance to I&E, regarding alleged breaches of ASX Market Rules, are further investigated by I&E. If I&E conclude sufficient evidence exists to take action for breaches of ASX Market Rules, the matter is referred to the NAT. The NAT is a disciplinary panel that adjudicates matters concerning possible breaches of ASX Market Rules by Market Participants. The NAT has a variety of powers to impose penalties on parties found to have breached ASX Market Rules. Memorandum of Understanding (MOU) – REFER SFE AS WELLA Memorandum of Understanding (MOU) between ASIC and ASX formally sets outarrangements to facilitate the effective and efficient execution of their statutoryobligations. A regular meeting between ASIC and ASX is held to ensure effectivecommunication, and appropriate and timely responses to alleged market misconduct.Failures of ASX and move to no longer SELF-REGULATEThe market integrity debate, which to date has focused on ASX Listing Rules,corporate governance standards and recent corporate failures, fails to accuratelyacknowledge ASX regulatory responsibilities.Major FailingsThe ASX regulatory range does not extend beyond monitoring the conduct of Market Participants and listed entities to ensure compliance with its Market Rules and Listing Rules. It also fails to adequately deal with the perceived conflict that arises from being both market operator and regulator. Therefore, to advocate an end to all self-regulation based on incomplete arguments may not prove optimal for market integrity. The incentive of an exchange to regulate its own market needs to be further examined and a complete picture of self regulation presented. A central focus in the current market integrity debate is whether the ASX has the incentive to regulate the behaviour of its Market Participants and listed entities.Self-regulation and For-Profit-Company Media coverage is extensive in commenting on and assessing the ASX on this issue.One perception is that the ASX does not have the incentive to self-regulate as it is a for profit entity. This has prompted some, including The Australian Financial Review (AFR), to call for an end to self-regulation.” The Australian Financial Review has consistently argued that the ASX’s Surveillance and regulatory functions should be given to an independent body… It would be better to hand the entire market surveillance and listing rules supervision roles to ASIC…”Negative views Two diverse schools of thought exist on whether for-profit exchanges should self regulate. One argument proposes for-profit exchanges do not have the incentive to maintain fair, orderly and transparent markets given they generate their income from turnover. Proponents of this argument claim:vigilance of supervision will not be maintained as this is in conflict with the objective of a for-profit exchange to maximise turnover.Self-regulatory bodies may not be as extreme in correcting serious failings upon the part of their members as an outside body, such as ASIC, may be. Insufficient knowledge about ASX supervisory activities and especially supervisory outcomes may contribute to a narrow focus in the current market integrity debate and perceptions of a conflict of interest. Insufficient knowledge about ASX supervisory activities persists despite the fact that supervisory arrangements in place at the ASX are extensively documented and made transparent to the market. ASX supervisory outcomes are not always readily available. The operations and output of ASX Surveillance are necessarily confidential. To reveal detection methods would be counterproductive to the integrity of the market. Publicly available information may not present a complete picture of ASX Surveillance activities and may lead to inaccurate perceptions.In addition, maintaining trust and confidentiality with Market Participants is integral to supervisory success. This trust and confidentiality will encourage brokers, investors and listed entities to raise matters of concern with ASX Surveillance without fear of adverse exposure.Positive ViewsStrong arguments as to why a for-profit exchange will have the incentive to self-regulate effectively. The reasons why an exchange will have strong incentives to effectively self regulate its own market include:that insider trading and market manipulation will increase information asymmetry and will deter uninformed investors. This decrease in liquidity will:increase trading costs,reduce market efficiency reduce exchange income. In an increasingly competitive global equity market, liquidity will migrate to those markets where integrity and efficiency is high. Therefore, if integrity is poor, liquidity and exchange profits will suffer, and profits are a significant objective in the era of exchange demutualization. For these reasons, exchanges, especially for profit exchanges, have strong incentives to maintain high levels of market integrity.This enhances exchange competitiveness and maximises turnover.For example, ASIC must audit ASX supervisory activities. This motivates the ASX to ensure adequate supervisory performance.Further support for self-regulation was recently provided by ASIC. An audit by ASIC concluded ASX supervisory arrangements are adequate and the Australian equity market is fair, orderly and transparent (s792A). Development of self-regulatory codes and effective peer group controls is often a more subtle and effective mechanism of social control than the official regulatory structures, especially if self-regulatory intervention occurs early enough. Self-regulation has the advantage that a regulatory body, like the ASX, may be more closely attuned to the actions and practices of an industry than an external government regulatory agency such as ASIC. ASIC does not regulate itself and therefore if it took over the regulatory roles then who would regulate the ASIC ensuring that compliance of the ASX is still maintained.Market Obligations – BOTH ASX AND SFEGetting an AMLIn order to be granted an AML, an applicant must satisfy the Minister that it has “adequate operating rules and procedures to ensure as reasonably practical that the market will operate as mentioned in s792A(a)”. The content of the operating rules and procedures must deal with matters prescribed by the regulations s793A. The general procedure for applying an Australia market licence is found in s795A whereby it states that a body corporate may apply for a licence by lodging an application with ASIC which must include such information as required by the regulations of this section. Ministerial ApprovalApproval by the Minister is required for a licence to be granted and generally the Minister will grant a licence where the criteria provided for in s795B are met. The most subsections of this section include s795B(c), (d) and (e) which outline the appropriate “operating rules and procedures” (c), “adequate arrangements for supervising the market” (d) and finally ensure that the applicant has “adequate clearly and settlement arrangements for transaction effected through the market” – which is further defined under s768A as a “mechanism to meet obligations to parties arising under transaction relating to financial products” and Pt 7.3 of the Corps Act.Regulated Company - Operating Rules – s793A & 793BOperating rules of a financial market, or a proposed financial market, are widely defined by s761A which comprises of “any rules including the listing rules, that are made by the operator of the market or contained in the operators constitution and that govern:The activities or conduct of the marketThe activities or conduct of person in relation to the marketThe definition does not include any rules which relate to matters with respect to which written procedures are required under s793A(2) or to compensation rules within the meaning of Part 7.5 of the Corps Act.s793AThe body corporate seeking approval to operate as a stock exchange must also have made or adopted operating rules pursuant to s793A. s761A defines operating rules to include “any rules, including the markets listing rules, which deal with the activities or conduct of the market or activities or conduct of persons in relation to the market”. These operating rules must deal with the matters prescribed by the regulations with s793A. They must make satisfactory provision in regard to the conditions under which securities may be traded on the stock market of the exchange and must generally make satisfactory provision for the protection of the public. The stock exchange must also have sufficient funds in its fidelity fund (National Guarantee Fund) to make payments out of the fund as may reasonably be expected.s1115 of the Corps Act also prohibits the use of terms such as “stock exchange” or “stockbroker” or “sharebroker”. S1115(3) prohibits a body corporation that is not a stock exchange from making use of, or by inference, using the title of a stock exchange.S793Bs793B provides that the operating rules – as apposed to the listing rules – of a licensed market have effect of a contract between each participant in the market and between the licensee and each participant in the market. Amendments to rulesAny amendments to these operating rules must be notified in writing to ASIC under s793D and ASIC is required to send a copy of the amendment to the Minister as soon as possible s793E(2). The “operating rules” of a body corporate that conducts or proposes to conduct a financial market are defined in s761A as “any rules made by the operator of the facility..that deal with the activities or conduct of the facility or of a person in relation to that facility”Ministerial Approval of Body CorporateBefore a body corporate can receive ministerial approval as a stock exchange, its business rules need to comply with the provisions of s795B. This section provides approval as a stock exchange can only occur if the body corporate has made satisfactory provision for the matters set out there. This requires that provision can be made for a number of matters such as those discussed below.Failure of Operating RulesWhere a person has failed to comply with an obligation under these operating rules, an application may be made – by either ASIC, the licensee (ASX) the operator of the Clearly & Settlement Facility or the person aggrieved by the failure – before the court for directions s793C.Administration of ASX Listing RulesASX has “absolute discretion in administering the Listing Rules and in doing so looks to companies to comply with the spirit as well as the letter of those rules”. This has been supported by the legal courts of Australia for many decades.It was established in Kwikasair Industries v Sydney Stock Exchange in 1968 where it was resolved to remove the shares of a company from the list of the exchange and was argued that the Exchange did not have “unfettered power to take those securities of the list arbitrarily”. The court decided that “the members of the committee should be left free to exercise honestly their powers of entry on or removal from the official list unencumbered….by having to face litigious investigation.The powers…are intended to be exercised summarily and fearlessly in protecting the public interest”. This was furthered affirmed in Designbuild Australia Pty Ltd v Endeavour Resources If the ASX proposes to waive compliance with some aspect of the Listing rules, the nature of this waiver needs to be clearly stated as ruled in Devereaux Holdings Pty Ltd v Pelsart Resources. The principles of a “fair, efficient and well-informed and internationally competitive market” were described as:The listing and quotation principleAn entity must satisfy minimum standards of quality, size, operations and disclosure and must attract sufficient investor interestThe Market Information PrincipleMarket must be advised by timely disclosure of any information which may affect security values or influence investment decisions – REFER ASX OBJECTIONS POINTS 6 & 7The Regulatory PrincipleEvery listed entity must operate to the highest standards of integrity, accountability and responsibilityTrading and Settlement PrincipleAll market transaction in quoted securities of a listed entity must meet such requirements as give commercial certainty to fulfilment of the contractual obligations embodied in those transactions….to ensure trading…takes places in an orderly and efficient manner”.Obligations of a Market LicenceThe general obligations of a market licence are provided in s792A and this provides outlines that a licensee must “do all things necessary to ensure that the market operates in a way that promotes the objectiveness of fairness, orderliness and transparency to the extent that it is reasonably practicable to do so” and in particular that these objectives are consistent with one another. Definition of a Financial Markets767A defines a financial market, among other things, as a facility through which “offers to acquire or dispose of financial products are regularly made or accepted”. Certain conduct is deemed not to constitute a financial market for the purposes of s767A whereby such conduct includes the making or acceptance of offers or invitations to acquire or dispose shares on the person own behalf or on the behalf of one party to the transaction. Breaches and LimitsLimitsLimits are placed upon what are seen as unacceptable` control over the holder of a market licence or of an Australia Clearing and Settlement facility whereby Part 7.4 limits any one person holding up to 15% of the voting power in a body, unless a higher percentage is approved s850B.Enforcement of Listing/Business RulesThe enforcement of the Listing Rules and of the Business Rules is given a firm legal basis under s793C(1) whereby ASIC, the exchange or an “aggrieved” person may request that a court give directions to a person concerning compliance with or the enforcement of such rules. Where a body corporate fails to comply with or to enforce provisions of the corporate which are quoted on the securities exchange will be deemed to be a person who has been aggrieved by the failure to comply with the rules s793C(5). A body corporate which has agreed to allow its securities to be listed on the official list of the securities exchange is deemed to be under an obligation to comply with the listing rules or the business rules – s793C(2). Prohibited from Operating unless Holding AMLs791A prohibits a person from operating a financial market unless they hold an AML (Australian Market Licence). It also prohibits a person from assisting in the establishment or conduct of such a market or in holding out that the person conducts such a market. Powers of Courts to make orders under s1114The person is a holder of securities in the body corporate where that person is a holder of securities in the body corporate whose securities are quoted on the stock market of the stock exchange as per s1114(1A).REFER REST OF s1114 LISTED IN DOT POINTS.Persistent or continuing contravention of lawsRestrained from acquiring, disposing, dealing with securitiesAppoint of receiverContract in securities void or voidableDirect a person from doing a specific actMake ancillary orders Make interim orders pending the determination of an applications1114(1)(ca) gives the court the power to give directions to a person or to a corporation in regard to compliance with the enforcement of the Business Rules or with the Listing Rules of the Exchange. This includes requiring disclosure of information which is in the possession of a person or to order a person to publish various corrective advertisements with a view to making the required disclosure information available s1114(1)(ca)(ii). Court is prohibited under s1114(4) from making an order where it is satisfied that to do so would unfairly prejudice any person. Powers of ASICUnder s794D to prohibit trading on a stock market where it forms the opinion that it is necessary to give a direction in regard to trading in particular securities of a body corporate on a stock market in order to protect persons “dealing in a financial product or class of financial products”ASIC may give written notice to the securities exchange indicating that it has formed an opinion regarding the need to prohibit trading and setting out the reasons for that opinion. If the exchange fails to take action to prevent trading after receiving advice from ASIC, pursuant to s794D ASIC may issue a further notice setting out the reasons for making the direction.ASIC is required by s794D(5) to provide the corporation and the Minister with a copy of the direction and a statement of the reasons for the direction.Some protection from the abuse of the power to give directions regarding trading is found in s794D(6) which respectively allows a body corporate to request that ASIC refer the matter to the Minister and the Minister may require ASIC to revoke the notice. In Golden Bounty Resources NL v NCSC, the decision was referred to the Securities and Exchange Commission v Sloan whereby the US Supreme Court ruled that “the power to summarily suspend trading in a security without any notice, opportunity to be heard, or findings based upon a record – is an awesome power with potentially devastating impact on the issuer, its shareholders and other investors”.The lack of a time in which the minister is required to respond to a request under s794D(6) and that only the licensee, and not any other person who may be affected, may request that a matter referred to the Minister is a LARGE PROBLEM and that ASIC should only not be allowed to issue a new notice.SFE DemutualisationWhat is Demutualization?The process of changing a mutual or cooperative association into a public company by converting the interests of members into shareholdings, which can then be traded through a stock exchange. Their structure limits their activities to servicing their members and inhibits their ability to pursue profits and diversification as freely as companies. The main purposes of demutualising the Stock Exchange was to broaden its membership base to all users of its services, and to enable the Exchange to compete more effectively with other providers of like financial services.Why did SFE demutualise?ASIC has found some limitations in the legislative scheme in supervising ASX as a self listed entity despite the MOU. The law did not consider that possible conflicts of interest may arise from ASX securities being able to be traded on its own exchange. One such conflicts was between ASX's corporate objectives and business interests and those of other listed entities, not in relation to trading of shares in ASX. When the newly listed ASX made a bid for the Sydney Futures Exchange, a rival bid was made by Computershare Ltd. (a share registry and software firm). This gave rise to a conflict between ASX's interests as a bidder and an obligation to administer the listing rules in relation to Computershare Ltd. ASIC, ASX and Computershare Ltd. entered into an arrangement in order to address this problem.ASIC had to ask the question what arrangements needed to be put in place to ensure that the supervision of Computershare as a listed entity was not seen as tainted by the obvious conflict between ASX's role as a market supervisor and its interests as a potential commercial competitor?The attempt by the ASX and the Sydney Futures Exchange to merge was ultimatelyrejected by the ASIC as it persuaded both parties to enter into an agreement with them which provided that, until the issue of the rival bids was resolved, ASX as the market operator would not make any substantive decision about Computershare without first consulting with ASIC and acting in accordance with advice provided by ASIC. Subsequently Computershare Ltd withdrew its bid for commercial reasons. Sydney Futures Exchange has completed its demutualisation by court approved scheme of arrangement and its shares are traded on an exempt market established for the purpose.What were the main concerns about SFE Demutualisation?15% rule – Limits are placed upon what are seen as unacceptable` control over the holder of a market licence or of an Australia Clearing and Settlement facility whereby Part 7.4 limits any one person holding up to 15% of the voting power in a body, unless a higher percentage is approved s850B.Sections 792A(h) and 821A(g) require the body, if it or its holding company is a widely held market body, to take all reasonable steps to ensure that an unacceptable control position does not exist in relation to the body.SFE, the Exchange and SFE Clearing are "widely held market bodies" under s.850A, by virtue of Regulation 7.4.01. An "unacceptable control situation" exists if a person has more than 15% of the voting power of the entity. The Corporations Act (s.851B) requires Ministerial approval to be granted before an applicant can have greater than 15% voting power.Supervisory AspectsS792A(c) – CO-REGULATION – I.e BOTH ASX AND SFEASIC manages SFE arrangements for the supervision of its market in accordance with its obligations under s792A(c) of the Act. In accordance with s792A(d), SFE must have sufficient resources to operate the market properly and ensure the provision of the abovementioned supervisory arrangements. MOU – Memorandum of UnderstandingSFE maintained its close and constructive relationship with the Surveillance function of the Australian Stock Exchange (ASX), in accordance with the information-sharingMemorandum of Understanding in place between the two groups. This liaison and cooperation maintained the level of regulatory transparency and interaction between the two exchanges, and also contributed to a more consistent message of regulation to market participants, particularly around SPI200 expiry times.Regulation of SFESFE also participates in the Intermarket Surveillance Group (ISG), an internationalassociation of stock and derivatives exchanges which exchange information and co-ordinate activities in relation to market surveillance techniques, issues and developments.SFE introduced a self-reporting rule to bring SFE into line with other market regulatory environments, and to introduce a level-playing field amongst Participants by addressing the concerns of SFE’s senior supervisory committee – the Business Conduct Committee (BCC) - that some Participants may have been aware of significant internal Rule breaches but were not reporting them to SFE.From ASIC Report on SFESFE has delegated specific responsibilities to undertake rapid assessment and decision making in relation to matters that may impact on the provision of a fair, orderly or transparent market. SFE devotes substantial staffing and technological resources to operating and supervising its market. The infrastructure and operating system were upgraded during the period to improve levels of performance and redundancy of the SYCOM trading system. The high degree of system availability and pro-active testing identified in our previous report continued. The operating rules and guidance notes provide an adequate framework for a fair, orderly and transparent market. Supervisory areas have adequate policies & procedures in place that deal with: monitoring the conduct of participants and trading activity; educating participants on their obligations; investigating potential breaches of the operating rules or the Act; and making supervisory decisions and/or recommending disciplinary action. Conclusion of this Report 2004After making our assessment, ASIC concludes that SFE has adequate arrangements for the supervision of its market in accordance with its obligations under s792A(c) of the Act. Further, we conclude that in accordance with s792A(d), SFE has sufficient resources to operate the market properly and for the provision of the abovementioned supervisory arrangements. Power of ASIC to Govern REFER POWERS OF ASICParticipationThe SFE has several different types of membership depending on the type of business to be conducted. Full ParticipantFull Participants have direct access to the trading system and can trade in their own name or on behalf of clients. Associate ParticipantAssociate Participant status is for firms who wish to deal on behalf of clients but who do not require direct access to the trading system (they place orders via Full Participants). Local ParticipantLocal Participants have direct access to the trading system and trade on their own account, but may not deal for clients. Each membership type has net tangible asset, reporting and administrative requirements.Participant defined in s761A – “participant”Why SFE moved to the ASX?SFE chairman Rick Holliday-Smith expects the move to increase the group's profile among the investment community. “This move basically means anything we want to do, we can do easier,” Mr Holliday-Smith said. “We will have a currency in our shares which is a much more powerful currency. Shareholders will have more value.”Demutualisation is an important gateway opening up domestic markets to the “world”. In Australia, it has been a major factor for markets in shifting the focus from domestic market regulation to cross border issues – a further reason to improve exposure of the SFE by listing on the ASX and therefore getting a larger exposure to both domestic and international investing entities in an already fully established, functional and advertised exchange.Proposals for markets to operate across borders do not raise only market regulation issues. Regulation of cross border intermediary activity will often be involved, as will regulation of selling practices and disclosure and at administrative levels - effectively across national boundaries to protect consumers and ensure market integrity in all affected jurisdictions. Cross border activity will be two-way, and new entrants will want to enter the Australian market place which raises risks such as the extent to which global links will give rise to new forms of systemic risk, for example in global clearing and settlement arrangements. SFE FRONT-LINE REGULATION OF THE AUSTRALIAN MARKETSAustralian the business rules governing the SFE exchange, all serve to protect the stability and integrity of these markets. An illustration of how these combine to achieve this can be seen from the following examples:1. The licensing of a futures broker2. The licensing of a client adviser3. Risk disclosure and client agreement4. SFE Clearing structure5. Segregation of client funds and assets6. Trade documentation7. Compliance and surveillanceThe Licensing of a Futures Broker - A requirement of the Corporations Act is that a broker requires a license to deal on behalf of clients. A licence is obtained from ASIC after it is satisfied that the applicant has the necessary educational qualifications and experience to perform its duties as a futures broker. The Licensing of a Client Adviser - The SFE Business Rules stipulate that any representative of a futures broker who intends to provide advice to clients, solicit client orders or operate a discretionary futures account, must be a Registered Representative.Risk Disclosure Document / Client Agreement Form - Before a broker is able to transact business for a client, the broker is required to provide a number of documents to the client, which include:An explanation of the nature of futures and options contracts and the obligations of those who enter in such.A risk disclosure statement prescribed by the Corporations Law, which must be read and acknowledged by the client.A client agreement form setting out the contractual terms upon which the client and Participant will deal in accordance with SFE's Business Rules.SFE Clearing Structure - SFE Clearing has full responsibility for the registration, clearing guaranteeing and processing of all trades executed at SFE. Segregation of Client Funds / Assets - The Corporations Act stipulates that futures brokers who are entitled to hold client monies must place such monies in a clients’ segregated bank account. The rationale behind this requirement is to ensure that a Participant cannot use client monies for its own trading and that such monies so held, are protected from the general creditors of the broker in the case of insolvency.Trade Documentation - The Corporations Act prescribe that brokers must provide the client with the appropriate supporting documentation. This documentation includes the provision of contract notes and monthly pliance and Surveillance - Augmenting the client protection mechanisms contained in the Corporations Act is the SFE's Compliance and Surveillance function whose activities focus on ensuring that Participants comply with the provisions of the Corporations Act and SFE Business Rules. Where a Participant is viewed as having possibly contravened SFE's Business Rules, the matter is referred to the bodies outlined in the 'Hierarchy of Regulatory Supervision'.ASIC'S RESPONSIBILITIESAs the market operator, SFE occupies an intermediate position between the Australian Securities and Investments Commission (ASIC) and market participants. ASIC's oversight encompasses two overlapping responsibilities:Ensuring that SFE conducts a fair and orderly market - i.e. ensuring that SFE has appropriate supervisory procedures in placeTo monitor market activity, and in addition, that SFE has adequate disciplinary procedures to address breaches of relevant regulations.Ensuring that SFE complements ASIC's function of ensuring that licensed financial service providers act fairly, honestly and efficientlyEnsuring that SFE enforces its own requirements of market participants as to their 'fitness and propriety' to deal with clients.IS SFE CORPORATION SELF REGULATING?SFE Corporation's role as front-line regulator of market participants is continuing to evolve from its origins as a form of "self-regulation". "Self-regulation" is a term that no longer accurately describes the current regulatory structure for two reasons: To the extent that this expression connotes measures directed at ensuring the fitness of a market participant organisation as a whole (e.g. financial resources, training of staff, etc) whereas primary responsibility for this type of regulation is increasingly vested in government-appointed regulatory commissions. SFE Corporation's role in this type of ('fitness to deal with clients') regulation is necessarily confined to assisting the statutory regulator achieve its charter.To the extent that the term "self-regulation" connotes monitoring of actual trading activity and enforcement of rules specific to operation of the market, the notion of market participants regulating themselves (hence the term self-regulation) through the agency of "their" utility, the market operator, has become redundant. The emergence of demutualised market operators meeting mainstream corporate governance standards aligned with a focus on the interests of shareholders (including those who are not customers) has removed the last vestiges of "self" from the regulation in which market operators are involved.HIERARCHY OF REGULATORY SUPERVISIONSFE DemutualisationIn moving towards becoming a demutualised Market Operator SFE has not jettisoned its element of peer review that leverages the expertise of trading participants into the enforcement of market rules. Instead, this involvement has simply been retained at the ground level in a hierarchy of regulatory supervision involving less emphasison peer review as disciplinary powers escalate. Legislative amendments are also ushering in subtle changes which further emphasise the place of SFE's front-line regulation (particularly the 'fitness to deal with clients' component) as an adjunct to government-appointed regulators' over-arching responsibilities.ASIC Taking over SFEThe Financial Services Reform Bill 2001 that was passed in Parliament in mid 2001, and took effect from 11 March 2002. This reduces to a considerable extent the existing diffusion of responsibility between ASIC and SFE Corporation for supervising market participants as to matters that transcend their exchange traded derivatives business and go to the fitness of the market participant organisation as a whole. Going forward, it will more clearly be ASIC, rather than SFE Corporation, that has the primary responsibility for vetting market participants as to the adequacy of their staff training and other matters that go to their eligibility for a financial services providers licence. By contrast, under the previous law, SFE Corporation also shares some of this responsibility by virtue of the law precluding persons from being licensed to conduct futures business on behalf of clients unless they have first met the requirements imposed by SFE Corporation – as to staff training, financial integrity, etc - to be an exchange participant. SFE Corporation will maintain requirements to be an exchange participant. If any aspect were to become redundant because of increased involvement of ASIC in addressing the same issues in the course of its enforcement of licensing requirements, scope exists for those SFE requirements to be modified in consultation with ASIC. The same procedures apply to SFE Clearing. Its rule changes are potentially disallowable as a corollary of it having such a central role in the functioning of exchange traded markets. The SFE Business Conduct Committee performs the same function for SFE Clearing in relation to Clearing Participants as the Committee performs for SFE Corporation in relation to breaches of rules relating to the exchange. As from the commencement of the Financial Services Reform Act 2001 on 11 March 2002, the entirely of SFE Clearing's operations have become subject to supervision by both ASIC and the Reserve Bank of Australia (RBA). The Reserve Bank's focus will be on reducing systemic risks and the stability of the financial system. ASIC's focus will be ensuring that SFE Clearing's services are provided in a fair and effective way.Prior to the FSR Act commencing, the RBA had an involvement in a number of aspects of SFE Clearing's business. SFE Clearing, for example, is supervised by the RBA pursuant to operating an exchange settlement account with the RBA. Stockbrokers Administration SummaryDepartmentalisation is dependant on the size of the business, the volume of turnover and the areas of advice covered by the firm.Main objective of a stockbroking firm – provide advice to clients.Electronic traders (and internet sites) provide “execution only” Risks involved with internet trading include:~ Determing acceptable levels of risk~ Legal ramifications ~ System still has same settlement procedures (T+3) and governed by ASTCStockbrokersBuy/Sell shares on behalf of their clients on ASX. They charge a commission for this service.Their roles include:Advising clients on possible investments Take orders from clients to buy/sell financial instrumentsExecute Transactions through SEATS Ensure that shareholdings are available Ensure that the clients/brokers deliver valid transfer documentsEnsure payment is received from buying clientsEnsure all benefits from shares are received (i.e. dividends)Research and report on performance of listed companiesUnderwrite/Manage new issues of financial productsArbitage between MarketListed CompaniesStockmarket users split into two groups – Listed Companies and InvestorsListed companies use sharemarket to raise capital to fund their activities.InvestorsInstitutional Investors – Wide range of investment services. Main types are:Superannuation and pension fundsLife OfficesGeneral Insurance OfficesUnit Trusts and Mutual FundsCorporate investorsInternational InvestorsPrivate Investors – Main types are:RetireesSpeculators“Mums and Dads”Discretionary private client managementPrivate client investorsRegulators ASIC enforces and regulates company and financial services laws to protect consumers, investors and creditors. Responsibilities include:Consumer protection in relation to financial products and servicesCompanies – all aspects from reporting etcIssue and trading of listed and unlisted financial instrumentsTakeovers and mergersFinancial products industryFuture IndustryASIC investigates suspected contraventions of the law for which it has responsibility and takes actions where appropriate. These matters include:Insider TradingMarket ManipulationIllegal fund raisingInsolvent TradingIssuing false or misleading prospectuses or financial statementsMisleading and Deceptive ConductThey also have power to:Inspect books and recordsRequire person(s) to attend examination and answer questionsFacilitate an internationally competitive, fair and well-informed market for listed financial products and to ensure regulation of this market occurs.ASX OperationsExchange does not determine buying/selling prices of shares – these are determined by supply and demand of the industry.Promotes fair trading by collecting and supplying statistics and other information concerning matters with which it deals. Self-regulating organisation which is listed and therefore shareholdings in the ASX are restricted to 15%.ASX must at least match the standards of the major overseas stock exchanges in quality of its trading and settlement systems, the fairness and security of its market and the price of its services.DEFINITION OF FAIR MARKET Fully informed of all information necessary to asses the value of a financial productHave adequate liquidityHas brokers of the highest standards and ethics and integrityBy creating this market – it brings the buyers and sellers of products togetherOBJECTIVES OF THE ASX Maintain an electronic market for trading financial products that are of the highest world standard and that provides equal access for all states.Increase the speed and lower the cost of settlement procedures (achieve by introduction of a fully electronic transfer and settlement system)Provide the highest standards of protection for market participants by continuous monitoring and improvement of the effectiveness of its Rules for listed entities and participants, and its surveillance operations for detection of market malpractices by co-operation with ASIC in the enforcement of the ASIC act.The ASX market Rules, ACH Clearing Rules, ASTC Settlement Rules are a comprehensive set of rules of conduct and so forth. Enforcement of these rules is through 793C of the Corporations Act.ASX Listing RulesSeek to ensure investor protection is maintained and preserve the good reputation of the market. This is done by:Minimum standards of quality, size, operations and disclosure must be satisfiedInformation must be made available which may affect financial product values or influence investment decisionsPractices must be adopted and pursued which protect the interests of financial products holdersAll recognised by s793C of the corporations act. Adviser Competencies and Client RelationshipsFinancial Services Reform Act (FSRA)Aim is to pull together different rules and regulations that govern the financial products industry. Three main reforms are:Harmonised licensing, disclosure and conducting framework for all financial service providersA consistent and comparable framework for financial product disclosureA streamlined regulatory regime for financial markets and clearing and settlement facilities.Australian financial services licence (AFS)Sets minimum strandards regarding professionalism and transparency in the industrySections 911A – C forbid a person from carrying on the business of advising etc without holding a licence.A group of companies acting under a single AFS licenceCan have one license for an entire group business business but must disclose:Badging/Holding Out – Breach of Licence Conditions s 912A – Cancelling or suspending persons licence (s915C)Banning Order (s920A)Licensee and representative must give assistance to ASIC – s912E912D – licensee must notify ASIC in writing within three days after it becomes aware that it has breached a licence conditionObligations of licensees – ALL OBLIGATIONS Dispute Resolution systems – AFS licencee must have dispute systems in placeS 912A requires that resolution system must have:FICS – Deals with complaints about financial services providersPolicy Statement 146 – Training standards set out in Policy Statement 146 must be adhered to by representatives of a licensee and licensees themselves.Front Office Employees of a Stockbroking firm – Authorised representativesBack Office Employees – Settlements department staff and the receptionistFactual information and Financial Product Advice Factual information is truth and cannot be questioned. Fiancial Product Advice Definition – Statement of Advice (SOA ) & Statement of Additional Advice (SOAA)Provides information about the basis on which the advice is provided and it must be given to the client at the same time as the advice is being issued.PAGE 7 BOTTOMStatement of Additional Advice Conditions – Privacy Act – PAGE 8 BOTTOMDealers and their representatives must satisfy the National Privacy Principles (NPP)Fines of $30,000 for individuals; $150,000 for Business’sNPP covers all aspects of personal information A privacy statement must go with all documentation given to the clientAuthorised Representatives Representatives must hold written authorisation from a licensee. A person can be a corporate body, a natural person, a partnership or a trustee Must adhere to PS 146 and have knowledge and skills in relation to financial advice. (Page 9 Middle/Bottom)Financial Services and Financial ProductsPerson provides a financial service if they provide financial product advice or deal in a financial product.Financial services include Financial Product is a facility through which a person: Makes a financial investmentManages financial riskMakes a non-cash payment Advisers can only give advice according to their license – i.e. futures advisers cannot recommend on insurance Full, Limited and Execution Advice NEW SECURITY AND DERIVATIVE DEFINITIONS The Law of Contract and Agency Contract Law – When a promise is legally binding and generally not apply to third partiesBasis of contract is AGREEMENT – may be expressed orally or in writing. i.e. most contracts MUST be written Principal – Client Agent – BrokerAlways based on trustContract of Agency Formed when one person, the agent, is given authority to act on behalf of another person, the principal.Formed by the agreement of the principal and agent. Agreement can be EXPRESS – Stated orally or in writingAgreement can be IMPLIED – Unstated but taken for grantedIn STOCKBROKING, the contract of agency is the brokers promise to act on behalf of the client, and the clients agreement to pay the broker commission.Example Broker buys securities on the stock market for a client. Four contracts in place:The selling broker and the buying brokerBuying broker and the buyerThe selling broker and the sellerThe seller and the buyerContracts (ii) and (iii) are contracts of agency – The buying broker and the selling broker are agents of their principlesContract (i) is a contract for sale – Binds the two brokers to one another Advisers Role under the FSRA Holder of an AFS licence must uphold fiduciary obligations.Owes DUTY OF CARE to their clientsMAIN CONCEPTS include:Transparency of DealingsAvoid conflict of interestGive priority to client ordersS1017F(s) – Requires adviser to confirm a transaction “as soon as reasonably practicable”.Know your Client – Know your Product 945A of Corporations Act Representatives must not make recommendations to a person if they are expected to rely on it, if they don’t have reasonable basis for making their recommendation. (s945A)If an adviser contravenes this, then they are LIABLE. S 945A (2) provides defence for the adviser if they can provide their recommendation was appropriate in all circumstances.INTERNET TRADING places the onus of responsibility TOTALLY with the rmation gathered with a NEW CLIENT Financial Services Guide (FSG) – Provide at commencement of relationship and outlines what the client can expect from their dealing with the firm and from the individual broker as an agent.Client OBJECTIVES Client FINANCIAL SITUATION Client RISK PROFILE Assessing Clients INVESTMENT Needs Develop an awareness of the clients expectations (when client made contact, was it is based on (i.e. no advice, stock specific etc))Establish whether clients just wants to execute a deal or receive adviceAcquire relevant knowledge of the clients financial position and risk profile when a client is seeking portfolio advice.Ask polite questions about over financial position and correlate it to their risk and overall investment strategy.Portfolio/Stock Advice – Portfolio objectives may include: Cash Requirement – present and futureCapital growth versus income requirementsFully Franked or partially franked sharesAnalysis of Investments Information can come from prospectuses, ASX reports, Fund Managers reports etc.All must be evaluated for their effectiveness and relation to financial productLicence Holder Controls Licence must have sufficient controls in place to ensure that representative rstrict their advice to investments that have been fully researched.GIVING ADVICE FROM RECOMMENDATIONS Products that relation to insurance or superannuation are regulated by separate legislation and this must be told to the clients Chinese Walls If an adviser is in possession of information that is not generally known to the public, the adviser is prohibited from communicating that information to that part of the organisation that engages in dealing or advising in financial products.Underwriting departments receives sensitive information and to ensure that it is not leaked to dealing department – physical separation of two departments referred to as a CHINESE WALL.REASONS FOR CHINESE WALLS Discretionary accounts for clients Sums of money place with the broker and traded on clients behalfPrior written authorisation signed by the client must be obtained.Broker must not execute excessive number of transactions thereby earning large commission (churning)Quarterly reports to the client no later than 10 business days after the end of the quarter.Register must be maintained by the broker detailing:Date the account was openedName and address of the clientDate of the clients written authorisationThe clients account number or numbersAny qualifications, limitations or other client directionsWhere a broker is a listed company, shall not deal on behalf of any discretionary account or managed fund in any financial products of that member corporationDealing Procedures Dealer – To service the execution and advisory needs of clientsTrader – Describe a client who is an aggressive speculator – buying and seller securities within relative short time periods for the purpose of making a profit.House Trader – Handles the task of trading in the securities markets and arbitrating across physical and derivative markets as a source of profit for that firmFunctions of the operating and booking department To keep and record all clients instructions to buy or sell quoted securities and any amendments to those instructionsMaintain an up-to-date record of clients outstanding buy and sell instructions and to refer outstanding orders to the clients who placed them to confirm whether they should be amended, cancelled or remain unchangedTo record business transacted, allocate securities purchased or sold to the applicable client order, book the allocated transaction to the clients account and to issue confirmation notes to clients for securities brought or soTo advise other departments of special instructions received from clients in relation to their ordersReceipt and record of orders Only representatives an be allowed to accept orders from clients, and orders placed by a representative can only be accepted by the department and committed to the records.Records received by representatives must contain the followingOutstanding Orders Orders should be kept current otherwise they need to be referred to the client for “re-instruction” because the stock may have changed etc.Orders affected by special announcement, such as a increase or decrease in dividend, be referred immediately to the client.Ex-rights or ex bonus, must be referred to the client to allow them to consider the price variations and to give them any additional instructions regarding the entitlements.Orders for purchase or sale of RIGHTS Allocation and booking functionsOnce clients order has been executed by an operator and the securities bought/sold have been allocated to the clients order, the purchase or sale must be posted or booked to the clients account. This is done by a BOOKING CLERK.METHODS OF COMMUNICATION for placing and reporting of ORDERSTERMS OF ORDER ASX Trading systemsSEATS (Stock Exchange Automated Trading System)WHAT IS A SECURITY?(s 9, s 92)debentures, stocks or bonds issued or proposed to be issued by a governmentshares in, or debentures of, a bodyinterest in a managed investment schemeunits of such sharesTHINGS THAT COME UNDER THE DEFINITION OF A MANAGED INVESTMENT SCHEME (c):Time-shares - YES(INCLUDED in the definition of a managed investment scheme)(are a scheme, undertaking, enterprise, whether in Australia or elsewhere)(where participants are, or become, entitled to used, occupy or posses for 2 or more periods during the period for which the scheme, undertaking or enterprise is to operate, property to which the scheme, undertaking or enterprise related)(operate for a period NOT < 3 years)Franchises - NO(not included in the definition of a managed investment scheme)Partnership Interests - NO(if >20 members but NO NEED to be incorporated or formed under an Australian Law because of regulations made for the purposes of (ss 115(2))Retirement villages – NO(operating within or outside Australia)(where participants are provided, or are to be provided, with residential accommodation within a retirement village)(whether or not the entitlement of a participant to be provided with accommodation derives from a proprietary interest held by the participant in the premises where the accommodation is, or is to be provided)(if NOT a time share)Superannuation – NO(technically not a security rather an investment)(s 761A)A security means:A share in a body; orA debenture of a body; orA legal or equitable right or interest in a security covered by para (a) or (b); orAn option to acquire, by way of issued, a security covered by para (a), (b) or (c)DOES NOT include an excluded securityDOES include a managed investment product (part 7.11)WHAT IS A DERIVATIVE? (s 761D)Is an arrangement in relation to which the following conditions are satisfied:provide some future time consideration of a particular kind that future time is not less than the number of days, prescribed by regulations the amount of the consideration, or the value of the arrangement, is ultimately determined, derived from something else including, for example one or more of the following:an asset (ie futures on shares)a rate (including an interest rate or exchange rate) (futures on AUD or USD $)an index (SPI - share price index futures)a commodity (on rule and cattle - per cents per kg)(ie) – Locking in a future [price and/or protects against currency changes]Payment in the futureWhere the amount paid is dependence on the value of something else, such as an asset, rate, index or commodityA derivative is a financial product, where its value is determined by the value of another financial product. Examples include: Warrants, Options and FuturesEg the option of a BHP is derived from the actual BHP share.LEPO’sLow exercise price options contracts (LEPO’s) are low exercise price option contracts (usually about 1 cent). Allow investors to profit from movements in the price of the underlying security without having to pay the full amount of the option premium upfrontHEYN – High Yield Equity NotesHigh Yield Equity Notes are securities that provide the note holder with a cash flow stream that comprises a fixed yield and a short position in a European put option on the shares of an Australian company.FuturesA “future” must be defined as a financial product according to Corporations Act 2001 s1042A Division 3 Financial Product. According to s761D(1)(a) under “Meaning of Derivative” it states that “a party to the arrangement must, or may be required to provide at some future time consideration of a particular kind or kinds to someone” and that s761D(1)(c) “the value of arrangement, is ultimately determined, derived from or varies by reference to the value or amount of something else including an asset” which therefore implies that futures contracts brought on the SFE are derivative products according to s761D(1) and therefore they are also within the definition of s1042A which includes “derivatives” as Division 3 financial products. Futures RegulationThe purpose of regulation of derivative markets are set in the CASAC report as:Market stabilityMarket symmetry and regulatory simplificationAppropriate intermediary-client arrangementsRetail participant protectionTrading IntegrityWhy Regulate Futures Markets?One feature of derivative transactions is that they can involve enormous risk and the risk can develop quickly. “Overseas experience has indicated that market participants may be exposed to excessive financial risks….The OTC market could be serious established by the financial failure of one or more large OTC market makers” and the failure of an individual market participant could not only jeopardize the liquidity and the stability of the derivative market, but further extend to the entire financial system. Thus, the CASAC report recommended that appropriate Risk Management (Recommendation 26) and Risk Disclosure (Recommendation 29) be implemented to ensure that stability of the financial system does not hinge on a few market transactions. This also mitigates the risk that a market participant is exposed, and limits the risk under the risk management system.What is the Purpose of AFSL?IOSCO – para 12.8Investment advisers are those principally engaged in the business of advising others regarding the value of securities or the advisability of investing in, purchasing or selling securities.If an investment adviser deals on behalf of customers, the capital and other operational controls discussed above as applicable to other market intermediaries also should apply to the adviser. If the adviser does not deal, but is permitted to have custody of client assets, regulations should provide for the protection of client assets including segregation and periodic inspections.The regulator should place emphasis on the substantive licensing criteria, and the capital and other requirements recommended for the regulation of other market intermediaries. The minimum requirements recommended by IOSCO include:A licensing regime that is sufficient to establish authorisation to act as an investment adviser and to ensure access to an up to date list of authorized advisers;Bars against the licensing of persons who have violated securities or similar financial laws;Record keeping requirementsClear and detailed requirement setting out the disclosures to be made by the advisers to potential clients, including:Descriptions of the advisers educational qualifications, Relevant industry experience, Disciplinary history, Investment strategies,Fee structure and other client charges, Potential conflicts of interest and Past investment performance.Updated material and disclosure information.CLERPOverall role is to facilitate investor confidence in the market, and each of the preceding factors contribute to this to ultimately ensure investors are making informed investment decisions, and allow the most efficient use of resources.Promote Market Integrity – Reflected in the general requirement for licence holders to act fairly, honestly and transparently.Risk management & protection of client assets – The protection if investors and stability of financial systems are increased by an adequate supervision of ongoing capital standards. Adequate systems will protect assets against excessive exposure to risk and reduce the possibility of default.Sufficient & Informed Disclosure – Part 7.7 of the Corporations Act states that retail clients of financial products and services must receive prescribed disclosure requirements. This ensures that retail investors can appropriately make comparisons across financial instruments and understand all the risks involved to enable them to make an informed investment decision. Broker have competence, skills and experience to provide relevant services – Investors can now be confident that brokers have appropriate skills, experience and qualifications to satisfy their investment needs and goals relevant to the level of risk they want to be exposed to.Adequate training and supervision of licensed employees and agents – Licensees may authorise a person to be a representative and provide financial services on its behalf. Individual agents are not required to be licensed, However, the AFS licensee must have appropriate mechanisms in place to train, supervise and control their employees effectively, otherwise the licensee will be liable to compensate for any loss suffered by the plaints and Dispute Resolution – Retail financial intermediaries should maintain adequate international systems to deal with complaints by retail investors, and should also maintain appropriate indemnity insurance arrangements.Powers of ASIC/Powers of CourtsPowers of CourtsThe person is a holder of securities in the body corporate where that person is a holder of securities in the body corporate whose securities are quoted on the stock market of the stock exchange as per s1114(1A).REFER PAGE 319 FOR REST OF s1114 LISTED IN DOT POINTS.Persistent or continuing contravention of lawsRestrained from acquiring, disposing, dealing with securitiesAppoint of receiverContract in securities void or voidableDirect a person from doing a specific actMake ancillary orders Make interim orders pending the determination of an applications1114(1)(ca) gives the court the power to give directions to a person or to a corporation in regard to compliance with the enforcement of the Business Rules or with the Listing Rules of the Exchange. This includes requiring disclosure of information which is in the possession of a person or to order a person to publish various corrective advertisements with a view to making the required disclosure information available s1114(1)(ca)(ii). Court is prohibited under s1114(4) from making an order where it is satisfied that to do so would unfairly prejudice any person. Powers of ASICUnder s794D to prohibit trading on a stock market where it forms the opinion that it is necessary to give a direction in regard to trading in particular securities of a body corporate on a stock market in order to protect persons “dealing in a financial product or class of financial products”ASIC may give written notice to the securities exchange indicating that it has formed an opinion regarding the need to prohibit trading and setting out the reasons for that opinion. If the exchange fails to take action to prevent trading after receiving advice from ASIC, pursuant to s794D ASIC may issue a further notice setting out the reasons for making the direction.ASIC is required by s794D(5) to provide the corporation and the Minister with a copy of the direction and a statement of the reasons for the direction.Some protection from the abuse of the power to give directions regarding trading is found in s794D(6) which respectively allows a body corporate to request that ASIC refer the matter to the Minister and the Minister may require ASIC to revoke the notice. In Golden Bounty Resources NL v NCSC, the decision was referred to the Securities and Exchange Commission v Sloan whereby the US Supreme Court ruled that “the power to summarily suspend trading in a security without any notice, opportunity to be heard, or findings based upon a record – is an awesome power with potentially devastating impact on the issuer, its shareholders and other investors”.The lack of a time in which the minister is required to respond to a request under s794D(6) and that only the licensee, and not any other person who may be affected, may request that a matter referred to the Minister is a LARGE PROBLEM and that ASIC should only not be allowed to issue a new notice.WHEN DO YOU NEED AN AFSL? - (REFER KYC)s 911A - “A person who carries on a financial services business in this jurisdiction must hold an Australian financial services licence covering the provision of the financial services”What is a person?Can be a person, entity or co personGenerally includes a partner (s 761F, s 9)What is to carry on? (means to satisfy the business test):Regular course of conduct (ie. more than once)Look for what type of work is being done to determineWhere a person provides a financial service with system, repetition and continuityA one off transaction is unlikely to be deemed as “carrying on”No requirement for a profit motive (explanatory Memorandum to the FSR Bill 2001)s761C which implies, pursuant with s21(1), “a body corporate that has a place of business in Australia...carries on that business in Australia...as the case may be”What is Financial services business?A business of providing financial services (s 761A)What is Financial services?“provide financial product advice” (s 766A(1))What is Financial Product Advice? (s 766B(1))A recommendation or a statement of opinion, or a report of either is FPA if:it is intended to influence a person(s) in making a decision or to interest a person in relation to a particular financial product, or could be reasonably regarded as being intended to have such an munication which is EXEMPT from being FPA (s 766B):advice given by a lawyer set out of (s 877B(5)(a) or (b))advice given by a registered tax agent set out in (s 766B(5)(c))a quote relating to the cost of financial product or the rate of return on a financial product set out in (s 766B(6) or (7)What is a Financial Product? (s 763A)A facility though which, or though the acquisition of which, a person does the following:makes a financial investment (s 763B)manages financial risk (s 763C)makes non-cash payments (s 763D)What is does dealing in financial products mean? (s 766C)apply for or acquiring a financial productissuing a financial productin relation to securities/managed investment interest - the underwriting of securities or interestvarying a financial productdisposing of a financial productDealing = arranging of the above (s 766C(2)) – (ie negotiations)NOT dealing – if person deals on their OWN behalfWhat if the service is incidental? (s 763)No need for an AFSL if the financial product is incidentalWhat are the Licence Conditions? (s 914A)s 914A(1)ASIC may at any time (by written notice):impose conditions, or additional conditions, on the licensevary or revoke conditionss 914A(3)ASIC can impose, vary or add conditions only after giving the licensee an opportunityto appear, or be represented, at a hearing before ASIC that takes place in privateto make submissions to ASIC in relation to the matterWhat are the Obligations of a licensee? (s 912A)must do all things necessary to ensure that the financial service covered by the licence are provided EFFICIENTLY, HONESTLY and FAIRLY******comply with AFSL conditionstake reasonable care that your reps are complying with financial services lawshave available adequate resourcesmaintain the competence to provide the financial servicesmust adequately train your reps to ensure that they are competent to provide the financial servicesmust have a dispute resolution system which satisfied s 912A(2) where financial services are provided to retail clientsmust have adequate risk management systemsmust have compensation arrangements where financial services are provided to retail clientsWhat is a FSG? (REFER KNOW YOUR CLIENT)Financial services guide is design to ensure that prospective RETAIL CLIENTS are able to make an informed decision whether to acquire a financial service that is offered. Information includes remuneration of providers, its relationships with issuers etcWhat is a SOA? (REFER KNOW YOUR CLIENT)Statement of AdviceBased on a consideration of one or more of the clients objectives, financial situation and needs, and must make sure the advice is appropriate to the client.Benefits that might reasonably be expected to be capable of influencing the service provider must be disclosed. Disclose various amounts associated with the financial product such as costs, benefits, interests and service provider remuneration.What is a PDS? (REFER KNOW YOUR CLIENT)Product Disclosure Statements purpose is to provide a means of comparing a range of products and to provide consumers with sufficient information to make informed decisions about buying financial products. Information must be provided about significant benefits and risks associated with holding a product, entry and exit fee’s commissions and ongoing management charges.5 Classes of InvestorsConsumer ClientHousehold, Personal or Domestic use ?Yes – TPANo – WholesaleUnconscionable Conduct exists in Fin Reg and TPADuties of Care and SkillMisleading & Deceptive Conduct – Has no consumer pre-rec i.e. don’t need to be a consumerAny thing that is Misleading & Deceptive applies to all sectorsInvestor Theory is Mum & Dad based mainly because of their:Lack of Educational KnowledgeWillingness to invest in “anything”Oligospoloy – Small number of buyersRetail Client – under $500,000FSR – Financial Services ReformFSG – Financial Services GuideSOA – Statement of AdvicePDS – Product Disclosure StatementKYC – Know your ClientWholesale Client – Any investor, that is not a retail investori.e. >$500,000 etcDon’t get FSRSophisticated Investor - $500,000 + Primary Market – Direct Offer without the need for a prospectusCost benefit as they do not need itUnsolicitated offersNo need or a prospectusProfessional Investor - $10,000,000 +Also Sophisticated InvestorAlso Wholesale ClientManaged FundsSuperannuation FundsStockbrokers/Institutional Banking ClientsNo ProspectusNo FSR reformProblems with AFSLs & the Licensing System Licensing is too difficult – FSR has made it much harder for smaller and less well resourced companies to enter the financial services industry. The requirements set out an order to & apply for an AFSL are both costly and difficult to understand.Lack of understanding of ASIC requirements has resulted in AFSL applications being submitted poorly or perhaps far too long.RecommendationsShorter applications and better explanations of what information is required to enable ASIC to assess the applicationFSR has involved a lot of time, money and effortThere is no apparent increase in investor protection for the amount of time and money which has gone into the system.RecommendationsSimpler licence applications which take less time to apply and assess are neededASIC should put more resources into dealing with complaints, surveillance, investigations, infoline and improve their computer network.ASIC has always been under-resourced in dealing with the FSRBoth the difficultly of the regulatory requirements and the number of persons ASIC has to regulate is underestimated.This has created inherent problems with ensuring all that licensing, disclosure and dispute resolution issues are well documented and resolved appropriately.RecommendationsNeeds to be more realistic understanding of the number of persons ASIC regulates so that ASIC can obtain more funding Licence applications need to ask for an estimate of the number of representatives so that it is possible to extract this data from the ASIC database.FSR has not created greater confidence in the regulatory systemFSR has not created greater confidence in the regulatory system because of the lack of certainty about the application of licensing requirements to companies which do not fit into the traditional financial services panies with unusual operations may have concerns about Risk of adverse regulatory action.RecommendationsASIC should allocate some resources to deal with the non-traditional type of licence applications to reduce cost and uncertainty.ASIC could issue non-action letters to companies offering innovative products while it considers the licensing and fundraising implications to encourage companies to be entrepreneurial and to make enquiries where there is uncertainty.FSR has added regulatory burdensFSR has added regulatory burdens from ASIC that are unclear or inconsistent with other policies – particularly through ASICs issue of policy statements with are confusing and unclear. Many of these policies apply to different licence’s and its entirely confusing.RecommendationsImprove policy statement releases and the guide to obtaining a AFSL.Issue licences with relevant financial conditions which are automatically linked to the type of authorisations required.FSR has added huge costsCompanies have to lodge separate forms for changes to ASIC’s database of companies and ASICs database of licensees – an ongoing problem.RecommendationsImprove and modify the ASIC databases so that their is linkage between the company and the license registers and only one form has to be lodged for a change in particulars relating to a corporate licensee.Elitism has evolved as a result of FSRFSR has given rise to an elitist system and it is confusing for less resourced participants who cannot attend seminars or functions.RecommendationsASIC should place more information on their websites and in the monthly FSR updates.ASIC should improve the search capability of the FAQs section to enable easy information dissemination.FSR encourages form over substanceFSR has given rise to the vie that regulators focus on form over substance and narrow interpretations of the law.This has resulted in a decrease of protection of consumers.A strict adherence to the law means that ASIC does not adopt a practical approach in dealing with some matters, where a commonsense approach would prevail.RecommendationsSetup a complaints assessment panel with external practitioners, who would sign confidentiality statements who ASIC could on to provide a commercial viewpoint or different perspective on regulatory matters on a no names supplied basis.Dispute resolution under FSR is open to manipulationFSR has given rise to a dispute resolution system which appears to be capable of being manipulated. Financial planners who put their investors into products which were unsuitable for their needs then assist these investors to make vexatious complaints against product issuers.There are dispute resolution firms that are not registered with ASIC who purport they can help investors with claims when they may not be able to.RecommendationsASIC or the external dispute resolution scheme should give more assistance to investors with their complaints by giving them simple explanatory booklets with some basic questions to answer.Perhaps the regulator should check whether all private complaint agencies are bona fide organisations or whether they are just another mechanism for getting business.The regulators approachASIC takes the following approach:To take a commonsense approach to administering the law in the spirit intended;Focus on areas of greatest risk;Target outcomes through intervention, andAim to deal with issues early, flexibly and simply.It is uncertain if the public views ASIC in this manner in light of FinCorp etc.RecommendationsASIC needs to consider the various facets of a matter as a whole and take a commonsense approach instead of taking a high legalistic approach.ASIC should consult with a full range of stakeholders in the industry before taking action.ASIC targets for surveillance should be those financial planners/advisers who promote high yield, high risk products.Internet Portal Operators –ps162An internet portal operator is generally NOT providing financial product advice and is therefore NOT required to hold a licence or authorisation (merely a conduit (channel)) HOWEVER the investment advisers, brokers and fund managers who place the communications on the website WILL be providing financial product adviceWHEN WILL an internet portal operator need a licence/authorisation?If there is a feature where users complete a questionnaire about their objectives, financial situation and needs, and on the basis of their answers, they are given information and advice about selected financial productsOR if the operator uses data mining techniques to determine what types of product the user is interested in, and subsequently gives the user information about those specific types of productsTHEY WILL NOT require an AML if the company is not operating a financial market: the facility operated by the company is not one through which offers or invitations are made THE WILL require an AML if it is not the situation above(ie they are operating a financial market where offers or invitations ARE made)PS 162 – Internet Discussion Sites (IDS)Any person who conducts an investment advice business must have a licence including IDS’s that allow people to “disseminate information, opinions and advice about securities”Exceptions for IDS’s to operate without a licence include:The IDS is operated to enable people who are not securities market professionals to exchange information that may include opinions and advice about securities.Posting on the IDS are clearly identified and kept separate from commercial material on the site; andPeople who use the IDS receive adequate disclosures and warnings including that the material posted on the IDS is not professional investment advice.What is Investment Advice?S77(1) of the Corps Act 2001defines investment advice as “a business of advising other people about securities, or a business in the course of which a person publishes securities reports”. If an IDS posts information, opinions and advice about securities, and it is made available to the public – then the IDS operator will require an AFSL. How to draw the line?Principles that ASIC adopt must be in line with IOSCO principles as the internet is global and information can be accessed from anywhere.Draw consistencies with other legislation around the world for IDS’s – i.e. operate an Australian IDS from the United States/Russia/UK etc – how to regulate this ?ExampleTo illustrate the importance of solidifying online securities law – the following examples were publish in the in late March which highlights the importance of increased IDS regulation: They heard it through the grapevineTraders who took the advice of one of the regular contributors to .au made a fortune when controversial mining company Cudeco had its huge run last year.“A Cap Resources”, a mining explorer with programs in Botswana, China and Australia was the discussed on .au. Its share price is up more than 400 per cent in the past six months, creating a tidy return for those who acted on the early tips from these online discussions.Problems that stem from these examplesASIC and the ASX claim they monitor online forums regularly for misuse – but how effective is their management? It is enormously difficult to stop false rumours, optimistic reports, inaccurate takeover assumptions, insider trading and other misinformation.i.e. I work for CitiBank representing Toll Holdings – I login to an IDS from an Internet Cafe so I cannot be traced, post insider information and leave. How can ASIC/ASX stop this?Without major investigations, it is also impossible to stop it because information can easily be contributed anonymously and easily.Forums are unregulated and there is no guarantee that information is accurate. Unless people report suspicious information or information which is likely to mislead investors – ASIC and ASX are almost powerless to stop it.The main issue for IDS’s is that postings are anonymous and all that is required to sign up is a username and an email address.This means it is possible to have multiple memberships, and post multiple messages about the same company creating widespread assumption’s that positive speculation is widespread.What’s being done to stop it?Some prosecution cases have risen out of IDS’s speculation and misleading information.Example’sIn 2005, the Victorian director of a small listed company, Adelong Capital, received a hefty fine and suspended sentence after being convicted of making false statements which were published on a German internet site, but which were picked up locally and caused the share price to rise.In 2001, a Queensland man received a suspended sentence after being convicted of making false claims about a Nasdaq-listed company called Rentech in emails and in investor forums.ASIC’s Financial Website – .au attempts to provide information regarding internet scams but relies predominately on “the user” to submit scams.Improvements to IDS’s regulationsStronger enforcement and regulation of IDS’s is the only way to realistically stop information dissemination. A taskforce group from ASIC/ASX needs to be created to monitor ID’s exclusively as the internet becomes more a popular discussion medium.Increased regulation through Internet Service Providers/Search Engines to look at access logs of these sites.Improved sign-up regulation such as personal addresses, Internet Protocol Addresses (unique identifiers assigned by your Internet Service Provider) and the like.Increased advertising/restrictions in regards to regulation’s of IDS’s requiring disclosure statements such as:Online investment forums are not licensed or regulated by rmation about the website owners, place of business etcMany Posts and Discussions on IDS’s are false, rumour or market speculation.Posting false or misleading information in relation to corporate entities will reside in possible prosecution. ASIC and ASX monitor this discussion forum for misleading, deceptive and/or false market information and representations.Please report any suspicious information to website administration.PS 141 – Offers of securities on the internetThis PS seeks to provide certainty for people who use the internet and are exposed to commercial transactions in regards to offers, invitations and advertisements of securities that can be accessed through the internet in Australia.The ultimate aim is to provide certainty for users of the internet and ensure they do not to engage in illegal or unlicensed securities offers.Requirements of Securities Offerings on the Internet in AustraliaAs with all securities offerings in Australia, a prospectus is required when an offer or invitation is made for securities in Australia as per s1018(1) of the Corps Act. The internet is no different.The Corps Act also places major restrictions of the advertisement of securities in Australia according to s1025, s0126 and s1078 – all of which apply to securities offerings on the internet.PS 141 states that ASIC is “generally concerned with the effect of an offer on the internet” and whether the offer has a “significant effect on consumers or markets in Australia”. A “Significant effect” is determined by:The amount of enquiries that an issuer receives from investors in Australia about the offering;The amount investors in Australia to whom securities are actually issued;The amount of complaints ASIC receives from investors in Australia.Offers of securities outside AustraliaFor an offer to be considered as “not targeting persons in Australia” it must satisfy the following requirements:“Take reasonable precautions to exclude subscriptions being accepted from persons in Australia, and to regulate the number of applications received from Australia”“The offering of material or advertisements must not be published, distributed or made available in ways or locations which are constructed to draw attention of persons in Australia”“The offering material or advertisement must not contain material which is specifically relevant to persons in Australia”.When will ASIC take action?ASIC will only that action “if we (ASIC) believe that an Internet Offer, Invitation or advertisement has had a significant effect on consumers or markets in Australia, then we will take appropriate regulatory action on the basis that the offeror may not have complied with the requirements.”Is this enough?Realistically, this approach does not necessarily assist individual investors that are scammed by local or overseas internet securities fraud.While the younger generation tends to be more internet “savvy” – the older generation is not educated enough in the risks and danger’s of investing in online securities offerings. It is ASIC’s/ASX obligation to more accurately promote some basic principles of reviewing online investment offerings etc.IG Index Plc v New South Wales [2006]Plaintiff argued that according to the constitution, it already fell in the Gambling Provision and needed not comply with the Corporations Act 2001 as then it would be doubly regulated.Court affirmed that the company did do the derivatives and needed to comply wit the Corporations Act 2001.The court laid down the rule that spread betting involves dealing in ‘derivatives’ as that term is defined in s761D.Spread betting is a term used to describe various types of wagering on the outcome of an event, where the payoff is based on the precision of the wager, rather than a simple binary outcome. A bet is made against a ‘spread’ – or index – on whether the outcome will be above or below the spread.Specific Answers to DO I NEED AN AFSL?What about the Authorisation of Representatives?This has been a major DEREGULATION as representatives of securities dealers and investment advisers no longer need to be licensed by ASIC (s 916A-s 916F, s 912A(1)(ca). Before 1989 each rep was required by law to hold an AFSL. It is an offence for a person to act as a representative where the principal is NOT licensed and where the rep does NOT hold proper authority from the licensed person to be a representative (s 911B)The licensee MUST notify ASIC of any person(s) authorized to be reps under (s 916F)This notice must provide the following:name and address of repdetails of the authoritiesdetails of each other financial service licensee on behalf of whom the reps are authorised repsLicensee holds power over Representative?A licensed person is treated as a principal in relation to conduct by the representative affecting a third person (s 917A). This is NOT a strict principal and agency relationship (Siu v Brich Securities)BUT the representative MAY yet have actual or ostensible authority to receive funds on behalf of the principal (Claton Robard management v Siu)The principal is liable for the acts of rep in connection with the securities or investment business, whether or not the rep acts within the scope of their proper authority (s 917B)The principal is NOT liable if the agent’s lack of authority is disclosed to the client, which acts as a limitation under (s 917D)A principal cannot contract out of a liable for the actions of a rep (s 917F(5))If a rep is acting for >1 principal, principals will be jointly and severally liable for the actions of the rep (s 917F)When can ASIC Suspend /cancel a license, & Co-Regulation?ASIC can suspend or cancel a licence (this takes immediate effect)ASIC must give written notice to the related party.WITH hearing (s 915B)ceases to carry on the financial services businessbecomes an insolvent under administrationis convicted of serious fraudbecomes incapable of managing their affairs because of mental or physical incapacitylodges with ASIC an application for ASIC to do so, which is accompanied by the documents (if any), required by regulations made for the purposes of this paragraphWITHOUT a hearing (after hearing has been offered)(s 915C)the licensee has not complied with their obligations under (s 912A)aa) ASIC has reason to believe a licensee cannot comply with their obligationsASIC is no longer satisfied of the matter in which (s 913B(2) or (3)) was applied at the time the licence was granted (good game and character)A banning order or disqualification has been madeA banning order or disqualification has been made against a rep, and ASIC considered the licensee’s financial services will significantly impair the licensee’s ability to meet its obligationsREFER HEARINGS SECTION IF HEARING APPLIESCo-regulation of AFS licenseesA holder of an AFSL must give assistance to ASIC, or any other authorised person by ASIC, if there is a request in relation to the AFSL holders complying with their licensee obligations (ie surveillance checks – s 912E)An AFSL must co-operate with ASIC under (s 914A)Cannot give false information (s 1309) or obstruct or hinder ASIC (s 1310)ASIC has powers over ASX and SFE and their personnel under the ASIC act.When can ASIC Ban a person?Hearing requirements are set out in (s 915C(4))ASIC’s guidelines on the identification of licensees are listed in Practice Note 18A failure to comply with the guidelines may lead to ASIC to use it powers under (s 915C) and (s 920A)Under (s 915C) ASIC may suspend or cancel a licence after a hearingthe applicant for the licence contained false or materially misleading matterif a material matter was omitted from the licence applicationif the licensee has contravened a securities lawif a condition of a licence has been contravenedif the commission has reason to believe that a licensed natural person is not of good fame and characterwhere the licensee is a body corporate, if the commission is satisfied that the educational qualifications and experience of an officer of a corporation are inadequate, or if that person was not an officer at the time that the licence application was madeif an officer of the licensed body corporate performs different duties from those which the Commission assumed that the officer was qualified to performwhere a banning order is made against a director, secretary or executive officer of the corporation or where a licence held by such an officer is suspended or revokedif there is reason for the Commissioner to believe that a licensee has NOT performed the duties of a dealer efficiently, honestly or fairlyif there is a reason for the Commissioner to believe that a licensee will not perform the duties of a dealer efficiently, honestly or fairly. Banning orders may be made by ASIC in various circumstances where a licence is cancelled or suspended (s 920A)Hearing – s 920A(2)NO hearing – s 920A(3)Banning orders CAN ALSO be made against UNLICENSED persons (s 920A(1))Cases of this includeASC v Kippe (1996)Vinton Smith Dougall v ASC (1997)McLachlan v ASIC (1999)Donald v ASIC (2000)Time period of banning order – Permanent or Specified period of time (s 920B)A contravention of a banning order is an offence (s 920C)If ASIC makes an order to revoke/suspend a licence or to ban a person from the securities industry, a notice to this effect must be published in the Gazette (s 920E(2))Licensing provisions – (s 912A)A licensee must “do all things necessary to ensure that the financial services covered by the licence are provided carefully and honestly”ASIC Hearings Before ASIC can make decisions under Pt 7.6EgRefuse a licenceImpose conditions or to vary conditions in a licenceCancel or suspend a licence (s 915C)Make a banning order (s 920A)ASIC must give the person affect an opportunity to appear before ASIC and make submissions and to give evidence to ASIC in relation to the matter (s 915C(4), s 920D(3))Imposing the natural justice requirements under Pt 7.6What is the ASIC hearing manual?As a matter of ASIC’s general principle, they must apply the rules of due process and of natural justice in giving people who may be affected by decisions of ASIC the opportunity to be heard.What are hearings?Conducted informally and as quickly as possible (effectively, efficiently and fairly) to make a decision which is both correct and proper in a timely manner. Where a hearing is approached in a process based on (inquisitional v adversary) rather than the traditional legal court system of (prosecution v defence) as it is NOT a context between you and ASIC.Case: Nam Bee v Corporate Affairs CommissionLee J noted that:“The hearing…is not to be conducted with formality as in a court or even as in a tribunal, its purpose being to ensure that the applicant has the opportunity to put before the commission submissions and evidence on the matters which he chooses, which are relevant to the application. The hearing is not to be conducted as an appeal against a contemplated refusal of the commission of the application. It is not to be conducted as if it were a contest between the commission and the applicant”7 Principles for conducting administrative hearingsThe Eilison Report (review this) – did ASIC abuse power etc? Concluded that they do and needed changes Principle 1 – The opportunity to be heardThis gives the person in question the right and opportunity to be heard before a decision is made by ASIC. Under this principle a person may present evidence or submissions (written or oral) which will address the issues of particular concern to ASIC.Principle 2 – Your entitlement to a noticeASIC cannot make a decision until the person in question has been given sufficient notice. They will be given notice as to the subject matter or reason for the hearing and the issues the hearing wishes to address. ASIC will also outline why they have brought you before a hearing and will also let you have sufficient time to prepare a response.Principle 3 – Your right to an impartial decision makerIf you believe a there is a conflict of interest, or there appears to be a bias member amongst the current hearing committee, you have the right to have your hearing to be heard by a person who has an open mind on the decision that should be made Principle 4 – Finding of facts to made on sound basisIf ASIC are to find against your favor it must occur on proper proof and be based on material that is relevant credible and probative (provable), BUT the rules of evidence do not apply (i.e. you do not need evidence written or otherwise)Principle 5 – There is no onus of proofASIC is only interested in finding out the truth on the matter in question (ie fact)Generally no burden of proof, but sometimes material must be presented in support of your situation. Principle 6 – Court practice does not applyThe hearings procedure is not a formal situation like a court room (ie legal/technical)RATHER it is more a business/administration approach, BUT the opportunity to present evidence and to make submission still applies.Principle 7 – Applying policy and precedentsASIC are not bound by policy and precedents, they have the choice to both use or not to use them in an administrative hearing. (vague, but ASIC usually follow them)What ASIC Notice WILL SAYWhat the notice will say:Outline which provision of the Corporations Regulations ASIC or Corps Act we are conducting the hearing uponThe purpose of the hearingDate, time and place and estimated duration of hearingIf you do NOT want to appear, you may make a written submissionWhat happens if you do not respond to the notice (ASIC will make a decision on the basis of the information available)The issues of concern to ASIC or if it is in relation to the application for What happens if you have an agreement with an UNLICENSED person?Rescinding the ContractIf an unlicensed person(s) engages in the dealing or the giving of advice or reports on securities, these agreements with the client may be rescinded (s 925A)The client may give notice to the unlicensed person(s) if he wishes to rescind the agreement, however this must be done within a reasonable period after the client becomes aware of the fact that the other party to the agreement is unlicensed (s 925A(2))Informing client of UNLICENSED PRATICEIf within a reasonable time, the unlicensed persons informs the client he did not hold a license (or it has been suspended), the client is unable to rescind the agreement with the unlicensed person (s 925A(4) & (5))This right of rescinding the contract can also be done under (Div 11 of Pt 7.3)This notice given to the unlicensed person in question has the effect of rescinding the agreement with the person (s 925B).However, recession will not be possible if it will prejudice a bona fide (Something that is in good faith, not a fraud, the real thing) purchaser for value with no notice of the rights of the client to give notice under this section (s 925B)If a court orders, then partial rescission may be possible (s 925C)Enforcement of an Agreement by UNLICENSED PRACTICEAn unlicensed person is NOT entitled to seek enforcement of an agreement where a client who is entitled to give notice (under s 925A) having the effect of rescinding the agreement (under s 925B) where the unlicensed person applied to enforce the agreement after it has been rescinded (s 925E).If a commission has been paid by the client, he may recover this amount paid as commission as a debt (s 925F) (also means that an unlicensed person cannot recover any commission that has been enforced due to such an agreement)What are the WORD restrictions (6 words controlled by SXD)?s 923AA person contravenes this section if they carry on financial services business or provide a financial service.Not a contravention if the person does not receive commissions, any form of remuneration or any other gifts or benefits from the issuer of the financial product which may be reasonably expected to influence the person. IndependentImpartialUnbiaseds 923BStockbrokerSharebrokerFutures brokerASIC can authorise the use of these words by imposing a condition on an AFSL in the following circumstances:Can, under the licence, provide a financial service relating to the securitiesis a participant in a licensed marked whose licence covers dealings in securitiess1115 of the Corps Act also prohibits the use of terms such as “stock exchange” or “stockbroker” or “sharebroker”. S1115(3) prohibits a body corporation that is not a stock exchange from making use of, or by inference, using the title of a stock exchange.Market Rules – Changes in WORDSUsed to be called a “member” of ASX, is now referred to as a “participant”Applicant for a participant must hold an AFSL with authorises the applicant to carry on its business as a Market Participant. The requirement DOES NOT apply if the applicant will ONLY be a Principal Trader.Licence costs about $250,000 (plus $25,000 GST)Outline for process and requirements of being a participant under the (market rules s3)SFE – there is no charge (but many tests and constant surveillance must be completed)Retirement and TimeshareThe definition of “interest” in the Companies Act 1961 (Victoria) did not include a specific reference to a “timesharing scheme” and thus a separate reference to “timesharing scheme” has now been incorporated in the definition of “managed investment scheme” in section 9 of the current Corporations Act 2001 (“Act”). The only reason why a timesharing scheme is a managed investment scheme under the Act is because of limb s9 (b) of the definition of “managed investment scheme” which specifically includes it within that definition a timesharing scheme. The definition of “managed investment scheme” specifically excludes a franchise and also a retirement village scheme, each of which expressions are defined in section 9 of the Act. S9(f) and s9(L) specifically exclude franchises and retirement villages were s9 of the act defines franchise under “managed investment scheme”:arrangement under which a person earns profits or income by exploiting a right in connection with the supply of goods or services.And retirements villages as:Operating within or outside AustraliaWhere participants are provided, or are to be provided, with residential accommodation within a retirement villageWhether or not the entitlement of a participant to be provided with accommodation derives from a proprietary interest held by the participant in the premises where the accommodation is, or is to be providedPrior to the introduction of the Managed Investments Act 1998 timeshare schemes were prescribed interest schemes (ASIC’s Policy Statement (PS 66)). This Policy statement (PS 66) set out ASIC’s previous policy in regard to prescribed interest timeshare schemes. Since the commencement of the ASIC Act in 2001, ASIC has replaced PS 66 with Summary Policy Statement 160 Time-sharing schemes (PS 160). PS 160.1 says that if you promote or operate time-sharing schemes which are required to be registered by the Corporations Law (Law) you must comply with the managed investment provisions (Chapter 5C) and the fundraising provisions (Chapter 6D) of the Law.Under Australian laws timeshare interests are interests in a managed investment scheme and so are financial products. ASIC is considering updating PS 160 to reflect recent changes in financial services laws. It is also reconsidering the industry supervisory body concept set out in its policy. This is largely due to the fact that, to date, no industry supervisory body has been approved by ASIC for these interests. Generally speaking, other timeshare schemes that are registered managed investment schemes have to comply with all of the relevant ASIC, provisions of the Act. However, some technical relief is available recognizing the particular nature of timeshare schemes schemesThe cooperative companies’ legislation and the establishment of the NCSC (what is now ASIC) addressed this problem by issue of the NCSC policy statement providing a range of exemptions for a timesharing schemes This approach has continued with the NCSC policy statement being replaced by Policy Statement 66 and now by Policy Statement 160 - which still regulates timesharing schemes under the Act.A franchise and an interest in a retirement village scheme were considered to be “interests” for the purposes of the companies and securities legislation. Each of these two types of interest are specifically exempted from the managed investment definition and are regulated by – franchising, under the Trade Practices Act (ACCC) - and in the case of retirement village schemes, on a State and Territory basis. This may be in recognition of the fact that franchising crosses State borders whereas retirement villages are generally State or Territory specific. [It was recognised many years ago that regulation of franchising and retirement village interests under companies or securitieslegislation was entirely inappropriate and led to a number of unintended consequencesboth for the regulator and the consumer.] For timesharing to be regulated under the Trade Practices Act by the ACCC an entirely new part would need to be introduced into that legislation which provides for at least licensing, product training, constituent documents, disclosure and a compliance regime. It appears a pointless exercise to create the infrastructure which already exists under the Corporations Act relating to these fundamental elements, particular when the thrust of the Trade Practices Act is to avoid misleading and deceptive conduct. For consistency of application, it would certainly assist if the matters which are currently addressed to the State Offices of Fair Trading were instead addressed to the ACCC or to ASIC under Parts 2 and 3 of the ASIC act. Disclosure – LicensingCLERPCLERP 6 has stated that “it is highly desirable that a consistent and comparable disclosure regime for all financial instruments be developed..to assist investors to make comparisons across all financial instruments, so they can make informed investment decisions. The disclosure document must address specific issues in order to increase comparability”Financial Product DisclosureInitial Disclosure – Disclosure to a person’s considering whether to buy a financial product.Prospectuses – A prospectus must contain all the information that investors and their professional advisers reasonably require in order to make an informed assessment about:The rights attaching to the securities; andThe assets and liabilities, financial position and performance, profits and losses and prospects of the company. Directors – Directors may be personally liable if there prospectus is ‘defective’ such that there is an omission of material information or if the prospectus contains any false or misleading statement.They can rely on a ‘due diligence’ defence if they make reasonable inquiries and, after doing so, believe on reasonable grounds that the prospectus is not defective. On Going Disclosure – Disclosure to the existing investors and the marketplace generally about a financial product.Continuous Disclosure – The listing rules require listed companies to disclose to ASX any matter that may materially affect the price of shares expect in limited circumstances i.e. Trade Secrets and the like.Failing to Disclose - If a company fails to disclose price-sensitive information when it is required to do so:Trading in the shares may be suspended or the company may be de-listed by the ASX;Court order seeking enforcement of the ASX Rules may be sought under s793C or 1101BASIC may seek various remedies e.g. criminal penalties, civil penalties (up to $200K for an individual and $1 million for a company) & administrative penaltiesInvestors may seek compensation orders if they have suffered loss.Periodic Disclosure – Must include, for example, a directors report and an auditors report.Listed companies must state whether they have complied with the ASX corporate Governance Principles and, if they haven’t, they must explain why.Financial Services DisclosureInitial Disclosure – Disclosure when consumer is considering whether to acquire financial services. E.g. advisory or dealing services.PDS - Product Disclosure Statements purpose is to provide a means of comparing a range of products and to provide consumers with sufficient information to make informed decisions about buying financial products. Information must be provided about significant benefits and risks associated with holding a product, entry and exit fee’s commissions and ongoing management charges.FSG - Financial services guide is design to ensure that prospective RETAIL CLIENTS are able to make an informed decision whether to acquire a financial service that is offered. Information includes remuneration of providers, its relationships with issuers etcInitial Disclosure – Disclosure when consumer is considering whether to acquire financial services. E.g. advisory or dealing services.SOA – Statement of AdviceBased on a consideration of one or more of the clients objectives, financial situation and needs, and must make sure the advice is appropriate to the client.Benefits that might reasonably be expected to be capable of influencing the service provider must be disclosed. Disclose various amounts associated with the financial product such as costs, benefits, interests and service providerInsider TradingIOSCOThe first statement under para 4.2.1 of the IOSCO Principles states that “Investors should be protected from misleading, manipulative or fraudulent practices including insider trading, front running or trading ahead of customers and the misuse of clients assets”.4.2.2 states that “fairness of the markets is closely linked protection and, in particular, to the prevention of improper trading practices”.Is insider trading ethical?*******Refer to the Securities Attachment 4-15General Insider Trading WordsIconoclastic – stirrer, destroying icons, destroying accepted truthPersonal advice - pursuant to s766 (B) (3) and s945A (1) “Personal advice” – s766B (3) - is advice where “the provider of the advice has considered one or more of the persons objectives”.Arranged the deal - according to s766C (1) and s766 (2)General advice – The meaning of “general advice” is defined by s761A, pursuant to s766B (4), which states that “general advice is financial product advice that is not personal advice”.Insider Trading PenaltiesRefer to Page 71 of NotesIs the Person in possession of Inside Information?A person as specified in s1043A may be in possession of inside information, whether or not the person is an employee or has a fiduciary relationship with the company of which the information is possessed. For a person to possess inside information, the information must not be generally available pursuant to s1042C (1) (a) which states that “information is generally available if it consists of readily observable matter”. If “A” has provided “B” with information which is not “generally available” then “B” can be assumed to have been provided with inside information and therefore breached s1043A because “B” is a person that holds inside information as defined in s1042A. In addition to the breach of insider trading provisions outlined in s1043A, s182 also states that an “officer or employee of a corporation must not improperly use their position to gain advantage for themselves or someone else or cause detriment to the corporation”. Despite the prohibition against insider trading listed in s1043A, s182 implies “B” has clearly used its position “to gain advantage for them” and “to cause detriment to the corporation”. Case: R v Hannes – Generally available informationConsider the manner of the phrase “generally available”. Under s1042C(1)(a) & (b) it is not necessary that the information consists of a specific item of information as information will be generally available if it consists of “deductions, conclusions or inferences” drawn from readily observable matter or from the information made known to those who commonly invest in securities s1042C(2).It should be noted that “information” has now been defined in s1042C(1) as including matters of supposition and other matters which are not sufficiently definite to warrant being made known to the public as well as matters which relate to a persons intentions or likely intentions. When read in conjunction with s1042C(2) this is an extremely wide definition of information and covers a lot of situations.Is there a “CHINESE WALL” in place and what does this mean?In accordance with ASX Market Rule 7.18.1 which states that having a “Chinese Wall in place”, is “whereby information known to persons included in one part of the business of the Market Participant is not available (directly or indirectly) to those in another part of the business of the Market Participant and it is accepted that in each of the parts of the business of the Market Participant so divided decisions will be taken without reference to any interest which any other such part or any person in another other such part of the business of the Market Participant have in the matter” – s761A which defines “participant” as “a person who is allowed to directly participate in the market under the markets operating rules”. Therefore pursuant to s1043F, a corporation won’t be liable for insider trading assuming there is no communication of information between one “part of the business” and “another”. Where a broker has a Chinese Wall in place, that will be deemed not to be in position of inside information held by another person in the brokers organisation. This provision parallels the defence found in s1043F of the Corp Act whereby a broker that manages a discretionary account upon behalf of a client, churning or the resort to an excessive number of securities transactions for the client by the broker, the broker may be regard as having acted in a prohibited manner under Market Rule 3.3.2 and Market Rule 3.4.2 This provision is aimed at monitoring the income of the broker which is gained from commissions. Thus, it can be determined if this has been breached because there has been excessive trading which on the situation and the relative circumstances. Has Insider Trading actually occurred?In developing whether a party has committed insider trading it is useful to begin at s1042B which questions the “application of division” of the insider trading legislation and whether it is applicable to this security. Since securities are a financial product pursuant to s1042A under “Division 3 financial Products means: (a) securities” which are defined in s 761A (a) under security where it states that a security is “a share in a body...or legal or equitable right or interest in a security”; we can assume that any holdings are securities and thus financial products. Therefore, s1042B (a) applies since it “applies to acts or omissions…to Division 3 financial products (regardless of where…issuer carries on a business)”. Since “a person whom is working within a company” information satisfies the definition of 1042A inside information because it was “not generally available” and it would “have a material effect on the price or value” of the security - pursuant with 1042C’s definition of “generally available” and 1042D’s “material effect” definition – then clearly in combination with s1043A(b), “a person whom is working within a company” has knowledge that is defined as inside information. Example with Chinese Wall in Place – (if no Chinese Wall, B is outside party)Since “a person whom is working within a company” has told B about the information that has been established to be inside information, and as per s1043A (2) which implies “a person whom is working within a company” should have “ought reasonably to (have) know(n), that the other person (B) would have or would likely....enter into an agreement to apply for, acquire, or dispose of relevant Division 3 financial products” then “a person whom is working within a company” has breached insider trading laws. The Merchant bank with which both A and B work will also be liable, as it has breached the both ASX Market Rule 7.18.1 and Corporation Act 2001 s1043F due to its inability to stop the passing of inside “information known to persons included in one part of the business of the Market Participant” being made “available (directly or indirectly) to those in another part of the business”. Does Insider Trading include FUTURES?A “future” must be defined as a financial product according to Corporations Act 2001 s1042A Division 3 Financial Product. According to s761D(1)(a) under “Meaning of Derivative” it states that “a party to the arrangement must, or may be required to provide at some future time consideration of a particular kind or kinds to someone” and that s761D(1)(c) “the value of arrangement, is ultimately determined, derived from or varies by reference to the value or amount of something else including an asset” which therefore implies that futures contracts brought on the SFE are derivative products according to s761D(1) and therefore they are also within the definition of s1042A which includes “derivatives” as Division 3 financial products. Can Insider Trading apply to SFE?It has been established that “a person” has purchased products that are defined within s1042A Division 3 Financial Products, then it must again be established if s1042B can apply to this derivative purchase. Corporation Act 2001 s1042B (a) applies since it “applies to acts or omissions…to Division 3 financial products (regardless of where…issuer carries on a business)”. Although “a person” has purchased the shares on the Sydney Futures Exchange, s1042B (a) implies that the purchase place is irrelevant in determining insider trading provisions. Since in the previous question it was established that “a person whom is working within a company” information satisfies the definition of inside information because it was “not generally available” and it would have had “a material effect on the price or value” of the Division 3 Financial Product – it must be determined whether or not B has breached insider trading provisions by purchasing a parcel of futures as a result of this inside information.FROM HERE GOTO CHINESE WALL EXAMPLEDefences to Insider Trading - Exceptions to s1043AUnderwritersExemption for underwriters in s1043C(2) and Corps Reg 9.12.01(c) Whereby s1043C(2) states that s1042A(2) does not apply where:communication of information is solely for underwriting agreementscommunication of information is solely for underwriting agreementsfor purposes of entering into sub-underwriting agreements Legal RequirementsExceptions to s1043A are also provided for purchases of securities which are undertaken pursuant to a legal requirement – s1043D, s1043E, Corps Reg 9.12.01(d)Including: (i) Deceased Person (ii) Liquidator (iii) Trustee in charge of Bankruptcy in the sale of mortgages or documents of titleChinese Walls – Refer AboveWe have also seen that s1043F and s1043G provide defences to an action under s1043A where a body corporate or a partnership has in place a Chinese Wall which “could reasonably be expected to ensure that information was not communicated”, provided that the information was not communication to another person in the organisation or partnership who made a decision and provided that no advice was given in respect of a transaction by the person was in possession of the information. The Chinese Wall defence has now clearly been broadened with the introduction of the “could reasonably be expected to ensure” standard in s 1043F and 1043G.Trades on the Basis of their KnowledgePersonA knowledge of a natural persons own intentions in relation to a dealing in securities is also expected from the operations of s1043A by s1043H. CompanyA similar defence is made available for bodies corporate in s1043I. Trade on Behalf of another personA further exception is provided in s1043J for a person who enters in to a transaction upon behalf of a body corporate in relation securities of another body. Such a person will not breach s1043A merely because he or she is aware that he first mentioned corporation proposes to enter in to or has previously entered into a transaction or agreement in relation to the securities of the other body corporate.Generally Available Information DefencesS1042C, s1043M, s1043NIt is a defence to an action under s1043A(1) if the court is satisfied that the information came into the possession of the person as a result of being made available to persons whom commonly invest in securities in accordance with s1042C(1)(b)(i) and if the other persons to the transaction knew (or ought to have known) of the information prior to entering into the agreement or transaction. IT CASESR v Evans and Doyle [1999] [Mt Kersy]OutlineASIC alleged that Evans and Doyle were guilty of insider trading in that they had breached section s1043A(1)(b) and (c) of the Corporations Law by entering into an agreement to purchase shares in Mt Kersey Mining NL. At the time, Doyle worked as a dealer for the stock broker J B Were and Evans was finance director of MPI Pty Ltd, a company engaged in the business of exploring for minerals, including nickel.Alleged that the inside information possessed by Doyle and Evans was that MPI Pty Ltd had discovered high grade nickel sulphide on one of its mining leases in Western Australia. Doyle knew or ought reasonably to have known that the information possessed by him was not generally available. The critical issue was whether, when the two telephone conversations between Doyle and Evans occurred at 2.00 pm and 2.07 pm, there was an "agreement" to purchase shares as required by section s1043A(2)(a). The question was critical because if the agreement was held to take place when the purchase of shares occurred on the Exchange, then at this stage there was an argument that the information was generally available and therefore not confidential.DecisionMcDonald J quoted from Bell Group Ltd v Herald and Weekly Times Ltd [1985] VR buying/selling shares involves the creation of two separate contracts. The first is one of agency between the client and the broker for the sale or purchase of shares and can be referred to as an agency contract. The second contract is one for the sale and purchase of the shares, being made by the broker, in the performance of the agency contract. The conclusion of McDonald J was that where a person authorises, or instructs a broker to purchase securities in a company whose securities are quoted on the Exchange and thereby enters into an agreement with the broker to purchase such securities, there is not entered into an agreement to purchase those securities within the meaning of section s1043A(2) of the Corporations Law. The agreement to purchase the securities is entered into by the buying broker on behalf of the client when the agreement is concluded with the selling broker. In other words, it is only if and when a trade or agreement to purchase the securities has been achieved by the broker that the broker enters into an agreement to purchase securities causing the principal also to enter into an agreement to purchase securities.Consequently, the conversations at 2.00 pm and 2.07 pm which amounted to an instruction from Evans to Doyle to purchase shares in Mt Kersey, although constituting an agency contract or agreement between these two, did not constitute an agreement for the purposes of section s1043A(2).Simon HannesOutlineMr Hannes was convicted on an insider trading charge that related to him (using the name 'Mark Booth') acquiring 5,000 TNT $2 call options in September 1996 through Ord Minnett Limited, when he had knowledge that TNT was likely to be the subject of a takeover bid.The ASIC investigation of 'Mark Booth's' trading started within 24 hours of the announcement of a takeover by Dutch company Royal PTT Nederland NV (KPN) at $2.45 on 2 October 1996. Within two days, ASIC obtained court orders freezing the $2 million profit from 'Mark Booth's' trading, and this profit was ultimately returned to the people who had sold the call options. DecisionASIC's investigation into the circumstances surrounding 'Mark Booth's' purchase of call options was conducted in collaboration with the Australian Federal Police and the Australian Stock Exchange. Using sophisticated investigation techniques, ASIC was able to identify Mr Hannes as the person who had bought the TNT $2 call options. During the trial, the Crown led forensic evidence from a handwriting expert and forensic computer expert and he was convicted of breaching s1043A of the Corporations Act.The Financial Transactions Reports Act charges relate to Mr Hannes making six cash withdrawals in one day from different bank branches and then using the cash to acquire nine bank cheques, again from various bank branches.R v Rene RivkinOutlineASIC alleged that Mr Rivkin contravened the insider trading provisions of the Corporations Act when, on 24 April 2001, he purchased 50,000 Qantas shares. The shares were purchased in the name of Rivkin Investments Pty Ltd, a company of which Mr Rivkin is the sole director.The charge followed an investigation by ASIC into the circumstances surrounding trading in Qantas shares shortly before Qantas announced that it would take over the operations of Impulse Airlines.DecisionMr Rivkin was sentenced to nine months imprisonment, to be served by way of periodic detention, and was fined $30,000.On 30 April 2003 Mr Rivkin was found guilty by jury on one count of insider trading in contravention of section 1002G(2) of the Corporations Act, following a 21-day trial in the NSW Supreme Court before Justice Whealy.Chairman of ASIC David Knott said:“Insider trading is a serious offence that undermines the fairness and integrity of our stock market. Mr Rivkin has sought to trivialise these proceedings from the time they were first instituted. In doing so he mocks every investor who expects fair dealing and proper disclosure in share markets transactions”Question 5A and B work for a merchant bank but are located on different floors with a “Chinese Wall” between them. One of A’s clients is considering a takeover offer for shares in Monash Ltd, a company listed on ASX. Towards the end of the end-of-year staff party, when spirits are high, A tells B about the possible takeover. As a result of this “leak”, B decides to buy Monash shares on the ASX.Has A breached insider trading laws?In accordance with ASX Market Rule 7.18.1 which states that having a “Chinese Wall in place”, is “whereby information known to persons included in one part of the business of the Market Participant is not available (directly or indirectly) to those in another part of the business of the Market Participant and it is accepted that in each of the parts of the business of the Market Participant so divided decisions will be taken without reference to any interest which any other such part or any person in another other such part of the business of the Market Participant have in the matter” – s761A which defines “participant” as “a person who is allowed to directly participate in the market under the markets operating rules”. Therefore pursuant to s1043F, a corporation won’t be liable for insider trading assuming there is no communication of information between one “part of the business” and “another”. In developing whether party A has committed insider trading it is useful to begin at s1042B which questions the “application of division” of the insider trading legislation and whether it is applicable to this security. Since Monash Ltd securities are a financial product pursuant to s1042A under “Division 3 financial Products means: (a) securities” which are defined in s 761A (a) under security where it states that a security is “a share in a body...or legal or equitable right or interest in a security”; we can assume that Monash Ltd shares are securities and thus financial products. Therefore, s1042B (a) applies since it “applies to acts or omissions…to Division 3 financial products (regardless of where…issuer carries on a business)”. Since A’s information satisfies the definition of 1042A inside information because it was “not generally available” and it would “have a material effect on the price or value” of the security - pursuant with 1042C’s definition of “generally available” and 1042D’s “material effect” definition – then clearly in combination with s1043A(b), A has knowledge that is defined as inside information. Since A has told B about the information that has been established to be inside information, and as per s1043A (2) which implies A should have “ought reasonably to (have) know(n), that the other person (B) would have or would likely....enter into an agreement to apply for, acquire, or dispose of relevant Division 3 financial products” then A has breached insider trading laws. The Merchant bank with which both A and B work will also be liable, as it has breached the both ASX Market Rule 7.18.1 and Corporation Act 2001 s1043F due to its inability to stop the passing of inside “information known to persons included in one part of the business of the Market Participant” being made “available (directly or indirectly) to those in another part of the business”. If B brought futures contract over Monash Shares on SFE, would B infringe the insider trading provisions?In establishing if B has infringed insider trading provisions by purchasing futures contracts over the Sydney Futures Exchange, a “future” must be defined as a financial product according to Corporations Act 2001 s1042A Division 3 Financial Product. According to s761D(1)(a) under “Meaning of Derivative” it states that “a party to the arrangement must, or may be required to provide at some future time consideration of a particular kind or kinds to someone” and that s761D(1)(c) “the value of arrangement, is ultimately determined, derived from or varies by reference to the value or amount of something else including an asset” which therefore implies that futures contracts brought over Monash Shares on SFE are derivative products according to s761D(1) and therefore they are also within the definition of s1042A which includes “derivatives” as Division 3 financial products. It has been established that B has purchased products that are defined within s1042A Division 3 Financial Products, then it must again be established if s1042B can apply to this derivative purchase. Corporation Act 2001 s1042B (a) applies since it “applies to acts or omissions…to Division 3 financial products (regardless of where…issuer carries on a business)”. Although B has purchased the shares on the Sydney Futures Exchange, s1042B (a) implies that the purchase place is irrelevant in determining insider trading provisions. Since in the previous question it was established that A’s information satisfies the definition of inside information because it was “not generally available” and it would have had “a material effect on the price or value” of the Division 3 Financial Product – it must be determined whether or not B has breached insider trading provisions by purchasing a parcel of futures as a result of this inside information.A person as specified in s1043A may be in possession of inside information, whether or not the person is an employee or has a fiduciary relationship with the company of which the information is possessed. For a person to possess inside information, the information must not be generally available pursuant to s1042C (1) which states that “information is generally available if it consists of readily observable matter”. Since A has provided B with information which is not “generally available” then B can be assumed to have been provided with inside information and therefore breached s1043A because B is a person that holds inside information as defined in s1042A. In addition to the breach of insider trading provisions outlined in s1043A, s182 also states that an “officer or employee of a corporation must not improperly use their position to gain advantage for themselves or someone else or cause detriment to the corporation”. Despite the prohibition against insider trading listed in s1043A, s182 implies B has clearly used its position “to gain advantage for them” and “to cause detriment to the corporation”. KNOW YOUR CLIENT RULES – SOA, FSG & PDSIOSCOIOSCO – para 12.8Investment advisers are those principally engaged in the business of advising others regarding the value of securities or the advisability of investing in, purchasing or selling securities.If an investment adviser deals on behalf of customers, the capital and other operational controls discussed above as applicable to other market intermediaries also should apply to the adviser. If the adviser does not deal, but is permitted to have custody of client assets, regulations should provide for the protection of client assets including segregation and periodic inspections.The regulator should place emphasis on the substantive licensing criteria, and the capital and other requirements recommended for the regulation of other market intermediaries. The minimum requirements recommended by IOSCO include:A licensing regime that is sufficient to establish authorisation to act as an investment adviser and to ensure access to an up to date list of authorized advisers;Bars against the licensing of persons who have violated securities or similar financial laws;Record keeping requirementsClear and detailed requirement setting out the disclosures to be made by the advisers to potential clients, including:Descriptions of the advisers educational qualifications, Relevant industry experience, Disciplinary history, Investment strategies,Fee structure and other client charges, Potential conflicts of interest and Past investment performance.Updated material and disclosure information.Clients Money and SharesClient Accountss981A and s981B in accordance with s982B and 982D and Market Rule 7.11.1 and 7.12.1 require that the broker keeps separate client accounts and pays any monies associated to the client into the respective account on the day it is received or the next business day (Mention Thornley v Tilleys Case whereby profits were made by not holding separate accounts)Other Client Money and Shares are on PAGE 22 What is a Financial Service? What is carrying on of mean?The “carrying on” of a “financial services business” is defined within s761C which implies, pursuant with s21(1), “a body corporate that has a place of business in Australia...carries on that business in Australia...as the case may be”. A “financial service” is defined within s761A, pursuant with s766A(1), which states that a “person provides a financial service if they provide financial product advice” whereby “financial product advice” is defined within s766B(1) as “a recommendation or statement of opinion…that is intended to influence a person(s) in making a decision in relation to a particular financial product”. Furthermore, a “financial product” as defined in s761A and s764A (1) which refers to “a person” making a “financial investment” – defined by s763B (a) as “the investor gives money (contribution)…to another person and the other person uses the contribution to generate a financial return, or benefit for the investor”What type of advice is being given?Personal advice - pursuant to s766 (B) (3) and s945A (1) Personal advice” – s766B (3) - is advice where “the provider of the advice has considered one or more of the persons objectives”.Arranged the deal - according to s766C (1) and s766 (2)General advice – The meaning of “general advice” is defined by s761A, pursuant to s766B (4), which states that “general advice is financial product advice that is not personal advice”.FSGDo I need a Financial Services Guide (FSG)?FSGAn “AFSL LICENCEE” must provide appropriate disclosure requirements for “THE RELEVEANT PERSON” in relation to the “personal advice” given. s941A (1) states that a financial services licensee “must give a Financial Services Guide…if the providing entity provides a financial service to the person as a retail client”. Since it has been established that “AFSL LICENCEE” has provided financial advice, it must be determined whether “THE RELEVEANT PERSON” is a retail client. s761A under retail client- pursuant with S761G (1), s761G (2) and s761G(7) which refers to Corporation Regulation 7.1.18(2) - gives direct indication that “THE RELEVEANT PERSON” is a retail client and therefore must be provided with a FSG in accordance with s941A(1). Note: S761G (1), s761G (2) and s761G(7), Corps Regs 7.1.18(2) – Refer to amounts up to $500K for a retail client.When must a FSG be given?s941D(1) states that a FSG “must be given to the client as soon as….it becomes apparent…that the financial service will...provided to the client, and must…be given to the client before the financial service is provided”. Since none of s941C applies, then “AFSL LICENCEE” should have provided “THE RELEVEANT PERSON” with a FSG pursuant with the contents of the guide in s942B (2) – including all relevant commissions in accordance with s942B(2)(e) and Corps Regulations 7.7.04(2) AND any connections in accordance with s942B(2)(f) - before any advice was executed.Note: s941C - Indicates that were FSG has already been given or is only EXECUTION TELEPHONE advice then it is not needed.S941D – Indicates timing of giving the guide and if client wants it straight-away has the right to get it within a “reasonable time”Not Providing FSG and the ConsequencesAs “AFSL LICENCEE” did not even provide a FSG, she has contravened the Corporations Act 2001 and therefore can have both civil and criminal offences taken against her as defined in s1311. “AFSL LICENCEE” has breached s952C (3) whereby s952B (a) defines a “disclosure document” as a FSG. Since “AFSL LICENCEE” has breached compliance of the Corporations Act 2001 for failing to provide a FSG the “AFSL LICENCEE” is liable for criminal damages pursuant to s1311 Schedule 3 penalties which are $100,000 or 2 Years imprisonment (or both) and s953B(2)(a) for civil actions.Note: Misleading or Deceptive Conduct – 12DA(1) and s1041H(3) If the “AFSL LICENCEE” took reasonable steps under s953B(6) that to make it not defective then NOT LIABLE.*****IMPORTANT *****Market Rule 7.3.2 and the Broker (Market Participant) must disclose to the client that it will be acting on their behalf s991E(1)(c) and have obtained the consent of the client in accordance with s991E(1)(d).If the broker fails to make the required disclosure, the client is not bound by the contract and may have it set aside in accordance with s991(E)(4) and s991E(5). SOADo I need a Statement of Advice (SOA)?Since “AFSL LICENCEE” has given personal advice - pursuant to s766(B)(3), s944A and s945A(1) to “THE RELEVEANT PERSON” – she must also give “THE RELEVEANT PERSON” a Statement of Advice in accordance with s946A which states that Australian Financial Services Licensee has an “obligation to give (a) client a statement of advice”. When must a SOA be given & what must it contain?The contents that “AFSL LICENCEE” must include in this SOA are outlined in s947B (2) including the commissions s947B(2)(d) – and the relevant connections s947B(2)(e) - as well as the relevant warnings if the advice is based on incomplete or inaccurate information in accordance with s945B and that the advice does not take into account the clients objectives, financial situation or needs – s949A(2)(a).The timing of the advice is outlined in s946C (1) which states that a “Statement of Advice must be given to the client when…the advice is provided and….before the providing entity provides the client with any further financial service”. Since there are no limitations for the advice – in accordance with 946A (3) and s946B (2) – then “AFSL LICENCEE” should have provided “THE RELEVEANT PERSON” an SOA in relation to the advice given for “P’s $50,000” as the “RELEVEANT PERSON” is a retail client under S761G (1), s761G (2) and s761G(7) and Corps Regs 7.1.18(2).If the client is wishing to replace one financial product with another then included in the SOA must be all relevant information about charges for the replacement of the products – s947D(2)(a)(i) – and also any other significant information about the consequences of the clients actions – s947D(2)(b).Note: S761G (1), s761G (2) and s761G(7), Corps Regs 7.1.18(2) – Refer to amounts of $500K for a retail client.s946B(1)(g) - Indicates that were SOA has already been given or is only EXECUTION TELEPHONE advice then it is not needed.Not Providing SOA and the Consequences“AFSL LICENCEE” ’s failure to adhere to s946A(1) - and therefore 952C(3) - to provide “THE RELEVEANT PERSON” with a Statement of Advice means that she can have both civil and criminal offences taken against her as defined in s1311. As “AFSL LICENCEE” has breach the Corporations Act 2001 in failing to provide an SOA to her client, she liable to s1311 Schedule 3 penalties which are $100,000 or 2 years imprisonment (or both) and s953B(2)(a) for civil actions. Note: Misleading or Deceptive Conduct – 12DA(1) and s1041H(3) If the “AFSL LICENCEE” took reasonable steps under s953B(6) that to make it not defective then NOT LIABLE.*****IMPORTANT *****Market Rule 7.3.2 and the Broker (Market Participant) must disclose to the client that it will be acting on their behalf s991E(1)(c) and have obtained the consent of the client in accordance with s991E(1)(d).If the broker fails to make the required disclosure, the client is not bound by the contract and may have it set aside in accordance with s991(E)(4) and s991E(5). Question 8What licence under the Corporations Act (if any) should Lisa Hold?In accordance with s911A(1) of the Corporations Act 2001, a “person who carries on a financial services business in this jurisdiction must hold an Australia financial services licence covering the provision of the financial services”. Therefore, it must be established whether or not Lisa must have a licence within this s911A (1) definition. Since Lisa “carries on accounting partnership”, she is defined as a “person” within s761F (1) (a) dealing with the meaning of person in the context of partnerships. The “carrying on” of a “financial services business” is defined within s761C which implies, pursuant with s21(1), “a body corporate that has a place of business in Australia...carries on that business in Australia...as the case may be”. A “financial service” is defined within s761A, pursuant with s766A(1), which states that a “person provides a financial service if they provide financial product advice” whereby “financial product advice” is defined within s766B(1) as “a recommendation or statement of opinion…that is intended to influence a person(s) in making a decision in relation to a particular financial product”. Furthermore, a “financial product” as defined in s761A and s764A (1) which refers to “a person” making a “financial investment” – defined by s763B (a) as “the investor gives money (contribution)…to another person and the other person uses the contribution to generate a financial return, or benefit for the investor” – ultimately implying that Lisa needs to hold a Australia Financial Services Licence in accordance with the Corporations Act 2001.Does Maggie require a Corporations Act licence before she can write her regular business column in the newspaper?As defined in the previous question, s911A (1) defines what is needed for an Australia Financial Services Licensee. However, in accordance with s911A (2) “a person is exempt from the requirement to hold an Australia financial services licence if they provide”, s911A (2) (ea) then goes on to state “the service is the provision of general advice” whereby “the advice is provided in a newspaper or periodical”, the “newspaper is generally available to the public” and finally the main purpose of the “newspaper or periodical is not the provision of financial advice”. The meaning of “general advice” is defined by s761A, pursuant to s766B (4), which states that “general advice is financial product advice that is not personal advice”. “Personal advice” – s766B (3) - is advice where “the provider of the advice has considered one or more of the persons objectives”. Therefore, the advice being provided by Maggie can be considered to be general advice and therefore pursuant to s911A (2) (ea) is advice that is “exempt” from the need to hold an “Australia Financial Services Licence”.Does Bart need a Corporations Act Licence to work in the office?Bart is in charge of “reception desk and minor administrative matters in the office” and in accordance with s766A (3) he does not require a Corporations Act Licence because his work is the “kind ordinarily done by clerks or cashiers” and he does not provide a “financial service” as previously defined in both s761A and s766A(1).Has Lisa breached any of the provisions of the Corporations Act dealing with client disclosure, and is so, what is the penalty for the breaches?It has been established that Lisa holds an Australia Financial Services Licence according to s911A (1) and she has given personal advice - pursuant to s766 (B) (3) and s944A (1) - to “P”. Since “P” invested the money in shares “On Lisa’s Recommendation”, Lisa consequently is deemed to have “arranged the deal” according to s766C (1) and s766 (2) and has consequently provided a “financial service” through “dealing in a financial product” with respect to s766A (1) (b).FSGLisa must provide appropriate disclosure requirements for “P” in relation to the “personal advice” given. s941A (1) states that a financial services licensee “must give a Financial Services Guide…if the providing entity provides a financial service to the person as a retail client”. Since it has been established that Lisa has provided financial advice, it must be determined whether “P” is a retail client. s761A under retail client- pursuant with S761G (1), s761G (2) and s761G(7) which refers to Corporation Regulation 7.1.18(2) - gives direct indication that “P” is a retail client and therefore must be provided with a FSG in accordance with s941A(1). s941D(1) states that a FSG “must be given to the client as soon as….it becomes apparent…that the financial service will...provided to the client, and must…be given to the client before the financial service is provided”. Since none of s941C applies, then Lisa should have provided “P” with a FSG pursuant with the contents of the guide in s942B (2), and before any advice was executed.As Lisa did not even provide a FSG, she has contravened the Corporations Act 2001 and therefore can have both civil and criminal offences taken against her as defined in s1311. Lisa has breached s952C (3) whereby s952B (a) defines a “disclosure document” as a FSG. Since Lisa has breached compliance of the Corporations Act 2001 for failing to provide a FSG and she is liable for criminal damages pursuant to s1311 Schedule 3 penalties which are $100,000 or 2 Years imprisonment (or both) and s953B(2)(a) for civil actions.SOASince Lisa has given personal advice - pursuant to s766(B)(3), s944A and s945A(1) to “P” – she must also give “P” a Statement of Advice in accordance with s946A which states that Australian Financial Services Licensee has an “obligation to give (a) client a statement of advice”. The contents that Lisa must include in this SOA are outlined in s947B (2) and the timing of the advice is outlined in s946C (1) which states that a “Statement of Advice must be given to the client when…the advice is provided and….before the providing entity provides the client with any further financial service”. Since there are no limitations for the advice – in accordance with 946A (3) and s946B (2) – then Lisa should have provided “P” an SOA in relation to the advice given for “P’s $50,000”. Lisa’s failure to adhere to s946A(1) - and therefore 952C(3) - to provide “P” with a Statement of Advice means that she can have both civil and criminal offences taken against her as defined in s1311. As Lisa has breach the Corporations Act 2001 in failing to provide an SOA to her client, she liable to s1311 Schedule 3 penalties which are $100,000 or 2 years imprisonment (or both) and s953B(2)(a) for civil actions. Has Lisa breach any of the provisions of the Corporations Act dealing with market misconduct, and if so, what is the penalty for the breach(es)?In establishing whether or not Lisa has engaged in Market Misconduct, s1041A “prohibits conduct” that relates to “tak(ing) part in, or carry(ing) out a transaction that” is going to influence a financial product and/or market. Since Lisa has “recommended” a financial product that has “turned out to be worthless” because she inflated “the price” – she is deemed to have breached s941A and engaged in Market Misconduct. It must now be determined what sections of Market Misconduct she has breached.False trading and Market Rigging s1041B(1) states that a person must not do an act that “is likely, to have the effect of creating, or causing the creation of, a false or misleading appearance of active trading in financial products on a financial market operated in jurisdiction”. A “false or misleading appearance” is defined in s1041B(2) which states a “person is taken to have created a false or misleading statement if” they “enter into or carry out….any transaction of acquisition or disposal of any…financial products that does not involve any change in the beneficial ownership”. Since the shares that were brought by “P” were subsequently discovered to be “owned by Lisa” and she was trading with other members of the firm – Lisa has therefore engaged in false and misleading statements.s1041C(1) implies that any engagement in “fictitious or artificial transactions” in relation to “the price for trading in financial products on a financial market….being maintained, inflated or depressed” is prohibited. As Lisa was found to have “inflated” the price when initially expressed her “recommendation to P” and that she was trading with other members of the firm – she has also breached s1041C(1) of the act.False or Misleading StatementsLisa has clearly engaged in “false or misleading statements” in accordance with s1041E (1) which states that a “person must not make a statement, or disseminate information if the statement or information is false” and therefore leads to a “person….applying for financial products”. Clearly, Lisa’s statements previously mentioned have induced “P” to purchase the shares and therefore she has breached s1041E (1) of the act. Inducing persons to Deal, Dishonest Conduct & Misleading or Deceptive ConductLisa’s recommendation to “P” that the company has a “great potential for capital growth” ultimately “induced” “P” to invest. s1041F(1) states that a persons must not “induce another person to deal in financial products by making or publishing a statement…if the person knows…the statement is misleading, false or deceptive” where s766C defines “dealing” as “applying for or acquiring a financial product”. Lisa has also consequently breached s1041F (1) of the Corporations Act. s1041G(1) also implies that Lisa has engaged “in dishonest conduct in relation to financial product” whereby “dishonest” is defined as “according to the standards of ordinary people”. Therefore, Lisa has also breached this section. Lisa has also breached s1041H (1) as she has engaged in conduct “in relation to a financial product” and a “financial service, that is misleading (and) deceptive” in accordance with s761A and s764A.Penalties on BreachesPursuant to s1311 (1) which states that “a person who does an act or thing that the person is forbidden to do by or under a provision of this act is guilty of an offence by virtue of this subsection” and therefore is liable to Sch 3 which states that each offence in s1041 is $200,000 or 5 years imprisonment or both for each breach committed .The relevant civil penalties defined in the Corporations Regulation 9.4B and s1041 (1) may apply for “loss or damaged by conduct” in relation to s1041E, s1041F, s1041G and 1041H. s1041 (1) may be limited by s1044B where “liability arising under a law of the State” may be restricted. Lisa may also be liable for penalties under s1317G (1), pursuant to 1317E (1), which gives a “pecuniary penalty of up to $200,000” for “contravention of” s1041A, s1041B and s1041D - and she may also be ordered to pay compensation...for damage suffered by another person” - pursuant to s1317HA – because of the breach of each section. Relationship of Client & BrokerBroker – Corps Regulations 7.11.01 A “participant” – s761AA “participating market licensee” – Corps Regulations 7.5.01A “financial services licensee” – s761A, s911A, s913BBasic UnderstandingBroker enters into a contract to buy or sell securities as agent of the client. The terms of the contract must be clearly stated and further terms may be implied from the customs and usage of the exchange. The contract will be subject to the ASX Market Rules Part 7.7 (below)The duties of the broker will be determined by the nature of the contract which has been entered into between the client and the broker, so that a mere buy or sell order in relation to a particular security may not bring with it a duty to provide investment advice.The contract will still be binding upon the client even through the principal was not disclosed, provided that the client had given the broker the authority to enter the contract. Case – Bell Group Ltd v Herald and Weekly Times Ltd (REFER MARKET MISCONDUCT AS WELL FOR THIS CASE)OutlineClient sought to avoid the jurisdiction of a dispute committee of the Stock Exchange by arguing that the articles and rules of the exchange did not apply to the client and only applied to the brokers.DecisionRejected because Judge said that there are two contracts in course of broker-client relationship:The contract that broker enters into with another broker to buy or sell the securities – the “agency contract”The contract between each broker which derives from the fact that brokers buy or sell securities as principles.The last contract is between the buyer and seller that derives from the fact that brokers enter into the securities contracts as agent for an undisclosed principal. Note: Brokers are made personally liable for a securities contract as it deems the broker to be acting as principals and requires them to deliver valid documents of title and settlement and to pay the amount agreed between them. If the selling broker sells the securities and then goes into liquidation after receiving a payment for securities, but before the proceeds of the sale are paid to the client, the client would still be required to claim the securities and the selling broker will be deemed to have authority from the client to receive payment for the sale.Duties and Responsibilities of BrokersOutlineThe relationship between brokers and their clients is governed by the general law, by the provision of Part 7.7 of the Corporations Regs and by the Market Rule 7. Brokers have a general fiduciary duty to their clients which include:Brokers fiduciary relationship with the clientRelationship of special trust and confidence between two parties. To owe particular duties to their principal in the fulfilment of certain obligations specified through their legal relationship. These values are of special importance to the financial framework as they are the underlying source of all business and professional relationships agreements.These obligations arise as soon as the relationship between the adviser and the client is established through a dealing or transaction involving securities, futures or investment advice.This relationship carriers with it a preparedness by the first individual to expose themselves to risks in reliance upon the actions and conduct of the second individual with whom the trust has been established.A measure of confidence must exist between the two parties as it carries with it a sense of security and safety. This implies an important feature to relationships of confidence whereby individuals can be open, honest and frank with the person whom shares their confidence.Duty to make a valid contract and the best bargain possibleWith reference to Market Rule 7.5, it appears that there is an implied undertaking for the broker to obtain the best execution and therefore the best possible price with reference to 7.5.4(b) & (c). Thus, if the broker can purchase at a lower price than that stipulated by the client and, if necessary, sell at a higher price than that specified then it should do so.Where the dealer exercises a power of sale in relation to the securities, provided that the dealer acts in good faith, the dealer need not secure the best price possible such as where a loss would be suffered due to the decline in the value of the securities. This is consistent with the exercise of a power of sale by a receiver and manager under s420A(2)(3) Duty to obey instructions The broker is required to carry out the clients instructions to the letter and if the broker departs from the clients instructions, it does so at its own risk even though, at the time, it may have seemed like a desirable course of action that was in the clients interests as per Market Rule 7.4.If the broker conforms exactly to the client’s instructions, and even if with the benefit of hindsight the client’s decision is a poor one, then the client has no legal remedy. If the circumstances change between the time of taking the instructions and the time of the broker acting – a prudent broker will go back to the client and review the instructions.Where the broker has undertaken a transaction contrary to the instructions of the client, the broker will lose the right to be indemnified by the client MR 7.4.1(a) This Market Rule was considered in Mercantile Credits Ltd v Jarden Morgan Australia Ltd whereby the Full Court in Mercantile Credits approved the principle from Majeau Carrying Co Pty v Coastal Rultile, that a sharebroker had a common law claim to keep shares until all claims had been paid. The Full Court accepted that the making of the contract with the client gave the broker the right to exercise a general claim over the securities.Duty not to compete with the clientMarket Rule 7.5, Reg 7.8.17, Reg 7.8.18, s991B and s991C of the Corporations Act provide that a broker is not to trade in securities on the brokers own account while the broker still holds an unexecuted order from a client to deal in the same class of securities on the same terms. Duty to inform client when acting as principalBroker is engaged to act for the benefit of the client and is not permitted to meet a clients order by buying securities on its own account from a client or selling securities on its own account to a client, without informing the client that it is acting as a PRINCIPAL.Market Rule 7.3.2 and the Broker (Market Participant) must disclose to the client that it will be acting on their behalf s991E(1)(c) and have obtained the consent of the client in accordance with s991E(1)(d).If the broker fails to make the required disclosure, the client is not bound by the contract and may have it set aside in accordance with s991(E)(4) and s991E(5). Duty to exercise skill, care and diligence A broker is required to use due skill, care and diligence when carrying out its duties and must observe high standards of integrity and fair dealing.s945A & s945B provide that where personal advice is provided to a retail client by the financial services licensee or its representative, the provider of the advice must ascertain the clients objectives, their financial situation and needs, investigate and consider the options available to the client and the base on which that advice is given.Duty to provide ConfirmationA broker is required to inform the client to transaction for the sale and purchase of securities/futures entered into on its behalf by providing the client – according to Market Rule 7.9.1 - as soon as reasonably practicable after completion of the sale or purchase of securities, a confirmation recording the essential details of the transactions. Duty to Maintain ConfidentiallyThe broker has a statutory and fiduciary duty to ensure that it maintains confidentially whereby the existence of a duty of a broker to keep the affairs of its clients in confidence is a consequence of the fiduciary relationship. Note: This duty is OVERRIDDEN whereby the broker is bound by law to disclose the information concerning its clients affairs to ASIC, ASX, AXSF or SFE.Duty to restrict dealings with EMPLOYEES & Maintain separate Client AccountsClient Accountss981A and s981B in accordance with s982B and 982D and Market Rule 7.11.1 and 7.12.1 require that the broker keeps separate client accounts and pays any monies associated to the client into the respective account on the day it is received or the next business day (Mention Thornley v Tilleys case whereby profits were traded and made by not holding separate accounts –Dealings with Employeess991F prohibits brokers from making joint purchases of securities with employees or from extending credit to employees to enable them to purchase securities. Regulation 7.8.21 and Market Rule 7.8.1 are unless they are approved undertakings under Market Rule 7.8.2(a) and 7.8.2(b) (for example). Duties and Responsibilities of ClientsOutlineThe client also has a number of duties that it must give to the broker.Right to indemnity/remunerationIf the client defaults on an order then the broker can:“Selling Out” where a buy order is not paid, a broker can sell the clients shares to make up the short fall in according with Market Rule 7.14.2“Buying In” a broker can buy in to fill a sell order for a clientWhere a client fails to complete a contract with a dealer, such as by failing to pay the prices of the securities which have been purchased on behalf of the client, BR 7.14.2 provides various options to the dealer such as the sale of the securities at the expense of the client. The dealer MUST allow the client the appropriate time to complete the transaction as ruled in Utz v Javor. (2) Right to a lien (right to take over the shares) The broker has a right to a lien under s984A and s984B whereby the “property” may be “used for the purpose of meeting obligations incurred by the licensee”. Where the broker has undertaken a transaction contrary to the instructions of the client, the broker will lose the right to be indemnified by the client MR 7.4.1(a) This Market Rule was considered in Mercantile Credits Ltd v Jarden Morgan Australia Ltd whereby the Full Court in Mercantile Credits approved the principle from Majeau Carrying Co Pty v Coastal Rultile, that a sharebroker had a common law claim to keep shares until all claims had been paid. The Full Court accepted that the making of the contract with the client gave the broker the right to exercise a general claim over the securities.Right to undertake crossingsCrossings - A situation in which a broker acts as agent on both sides of a given transaction. If the broker has a buy order and an equivalent sell order, he/she can "cross" the orders. This is common in the case of large orders, but is legal only if the broker first offers the securities to the public at a price higher than the bid price.A broker is allowed to do this under Market Rules 7.7.1 and 7.17, 7.18, 7.22Right to exclude information not generally availableUnder Market Rule 7.18.2 a broker has the right to exclude information that is generally NOT available to the public.Under Market Rule 7.18.1 and 7.18.3 where CHINESE WALLS ARE IN PLACE.(refer insider trading) Disclosure - InformationIOSCO – Section 10 (page 168)Para 10.1 – Principles for Issuers There should be full, accurate and timely disclosure of financial results and other information which is material to investors decisions.Holders of securities in a company should be treated in a fair and equitable manner.Accounting and auditing standards should be of a high and internationally accept quality.Para 10.3 – Timely Disclosure of Information Disclosure requirements extend beyond the issuer to include others, such as directors and senior officers of the company, participating underwriters, and material shareholders.Investors should be provided with all information necessary to make informed investment decisions on an ongoing basis. The principle of full, timely and accurate disclosure of current and reliable information material to investment decisions is directly related to the objectives of investor protection and fair, efficient and transparent markets.Para 10.4 – Shows when disclosure is required (IMPORTANT)The IOSCO Principles provide a standardised benchmark for information which is considered more price sensitive and relevant to investors. According to s10.4 this includes information directly related to:Offering of securities for public sale;Content and distribution of prospectuses or other offering documents;Advertising in connection with securities;Information about those who have a significant interest in a listed company;Information about those who seek control of a company;Information material to the price or value of a listed security;Periodic financial reporting;Shareholder voting decisions.Investors should be provided with all information necessary to make informed investment decisions on an ongoing basis. The principle of full, timely and accurate disclosure of current and reliable information material to investment decisions is directly related to the objectives of investor protection and fair, efficient and transparent markets.Disclosure should be clear, reasonably specific and timely. Specific disclosure requirements should be augmented by a general disclosure requirement. Such a general disclosure requirement can provide that disclosure is required of all material that is relevant to a particular investment decision.Regulation should ensure the sufficiency and accuracy of information. This will involve sanctions or liabilities on the issuer company and those responsible persons who fail to exercise due diligence in the gathering and provision of information. Regulators also need to give careful consideration to the circumstances in which it may be necessary to the proper functioning of the market to allow something less than full disclosure – i.e. trade secrets of incomplete negotiations.Para 10.5 – Information about Corporate ControlThe level at which disclosure is required varies from jurisdiction to jurisdiction, but is generally set at a level well below that which would be characterized as a controlling interest.The nature of disclosure required also varies but full public disclosure is generally thought to best meet the underlying policy rational of disclosure where a change in control of a company has occurred or is contemplated.Regulation should ensure:The timeliness and relevance of the information provided to investors and potential investorsAn appropriate mechanism for the setting of quality standards and to ensure that where there is some dispute or uncertainty, standards can be the subject of authoritative and timely interpretation that is consistently applied.Independent verification of financial records.Para 11.6Provide investors with sufficient information to evaluate whether and to what extent their investment is an appropriate investment vehicle for them.Why Firms Disclose Bad News?Management accountability – Managers may be sued by stockholders if there is a large stock price disparity following an earnings announcement based on stockholders alleging that management failed to disclosure adverse earnings news swiftly enough. Thus, management seek to release bad news in 2 ways:Disclose it early and voluntarily, then it is difficult for the shareholder to sue as it is difficult to argue that the manager withheld information.Disclosing early limits the period of non-disclosure, thereby reducing the damages a shareholder could claim and/or the overall number of shareholders concerned.Douglas Skinner Concluded – 70% of annual disclosures conveyed good news, 67% of quarterly disclosures involved bad news. Correspondingly, these results indicated that quarterly disclosures tended to convey bad news, while annual disclosures tended to associate with good news. Research indicated that managers voluntarily disclose earnings information for two mutually exclusive reasons. First, when firms are doing relatively well managers make good news disclosures to distinguish their firms from less well performing organizations. Secondly, managers will make pre-emptive bad news disclosures to avoid or negate any legal liability actions or reputational concerns.REFER TO ESSAY WRITTEN – note this is now available at .au/papers/ CHESS sponsorship agreementsHolding Uncertificated Shares & getting on CHESSTo hold uncertificated shares under a broker sponsorship, client enters into a sponsorship agreement with a CHESS participant – usually a broker.The agreement between the client and the broker must be in place before the holdings can be established on CHESS. The broker notifies CHESS that an agreement is in place between the two parties by sending an electronic message that contains the clients registration details. CHESS validates the message, and if accepted, returns a message to the broker which includes the clients HIN as provided by CHESS. CHESS notifies the sponsored client that they are registered on this system by sending them a “New Sponsorship Notification” advice form which contains the clients HIN, registration details, PID (Personal Identifier Code).The agreement authorises the sponsor to deal with the shareholdings on the holders behalf, subject to explicit conditions.Note: A client may elect to terminate the agreement at any time by giving the sponsoring party written notification. The instructions to terminate the agreement may include their wish to become issuer-sponsored or to transfer their CHESS holdings to another participant.How many sponsors can a client have?The client can be sponsored by as many participants as they wish but each particular holding of shares can only have the one sponsor. ExampleIf you hold 1,000 BHP shares 500 of those can be sponsored by one broker and 500 by another.HOWEVER, these holdings will be recorded under separate HIN on the CHESS subregister and the shareholder would be required to sign separate sponsorship agreements.Conversion of Certificated and issuer-sponsored holdings on CHESSOnce the client has been allocated a HIN, the broker can proceed to convert the clients issuer-sponsored holdings into CHESS holdings if instructed by the client:This will require the client to surrender holding statements, supplying their SRNs to the broker – who will issue a receipt for the financial products which are being converted.The broker converts these holdings by extracting the market information such as the clients SRNCHESS validates that the message is in the prescribed format and in turn notifies the relevant share registryShare registry validates the message and moves the shareholding from the issuer-sponsored subregister to the CHESS subregister.Process is completed by the share registry notifying CHESS of the movement and CHESS in turn notifying the broker. Client will receive a CHESS Holding Statement at the end of the month upon conversion of these holdings, for each company in which the shares are held. Key Similarities & differences between Issuer-sponsored and CHESSThe key similarity between the CHESS and issuer-sponsored subregisters is the fact that:They are both uncertificated (or the securities are held in an electronic format).Both use the ‘name on register’ approach ie. shareholders can register their shareholdings in their own name.Movements on both subregisters are primarily though electronic meansBoth receive holding statements (albeit from different sources).The key differences between the CHESS and issuer-sponsored subregisters are:CHESS subregister is maintained by CHESS and controlled by the sponsoring broker, whereas the issuer-sponsored subregister is maintained by the share registryCHESS holders receive a HIN to identify their holdings, whereas issuer sponsored holders receive an SRNCHESS holders receive one HIN per broker they are sponsored with, and can hold all securities on that HIN. Issuer-sponsored holders receive an individual SRN for each company in which they hold securities.CHESS holding statements are issued by CHESS and are identical in format and content per stock, whereas issuer sponsored holding statements are issued by the company share registry and can be different from company to companyChanges to name and address details for CHESS holders require only a signed written request (with supporting documentation re name change) to the sponsoring broker, and this change affects all securities under that HIN. Changes to name and address details for issuer- sponsored holders requires the shareholder to make this request with each company for each security held under the SRN.CHESS Settlement ConceptsBroker/Broker TradesCHESS minimises the number of delivery obligations for broker/broker trades for each T+3 settlement cycle by netting similar trades overnight.This is made possible through novation, whereby for each single broker/broker trade executed on SEATS, two new contracts are created. These two new contracts are:between the selling broker and the ACHbetween the ACH and the buyer brokerThe settlement of the new contract has two components:Settlement of funds – between the original selling and buying brokers of the SEATS tradeDelivery of the financial products – As directed by ACH as a result of the netting process.Broker as net deliverer or net receiver in T+3 cycleCHESS routinely nets buy and sell broker/broker trades with the same settlement date and broker PID into a single net obligation. As a result of this process, a broker will only ever be a net deliverer or receiver of the same financial products in any T+3 settlement cycle.CHESS creates net obligations and schedules them for settlement on the due date. On T+2, CHESS notifies brokers of their scheduled obligations. BlockingA selling broker, by agreement with the counterparty, can exclude a trade from netting. This facility is know as “blocking”. Requests to block or unblock a trade from netting process must be submitted to CHESSS by end of T+1.T+3 Settlement PeriodWhat is T+3?ASX has a fixed settlement cycle of “Trade Date + 3 business days”.T+3 settlement means that most ASX transaction between ASX brokers will be due for delivery by selling brokers on the 3rd business day following the of sale – if a Monday is sale date, Thursday is settlement date.Unless early delivery has been agreed between the parties, buying brokers are entitled to reject any delivery made prior to the T+3 date.Failure of T+3A selling broker not fully delivering those financial products due for settlement on T+3 is deemed to have “failed”.ASX then:ASX reschedules that portion which was not delivered on T+3 for the following settlement day and imposes a fine on the selling broker.If the settlement obligation remains undelivered, ASX will continue to reschedule and fine the broker daily until the line is fully delivered.The selling broker will, if possible, borrow the financial products from the financial product lending market or other means to close outstanding obligations.The selling broker is entitled to pass the fail fee onto the selling client if the situation is warranted.Fail fees commence at $50.00 per transaction or 0.1% pf consideration whichever is the greater amount. This is a maximum failure fee of $2K per transaction per day. CHESS Overview T+3 SettlementTASX broker/broker trades for T notified to the ACHT+1Notification by counterparties, derived from day T broker/broker trades and day T broker crossings, between ASX brokers and institutional participantsin the ACHT+2Clearance & pre-settlement processing for day T+3 settlementT+3ACH settlement of day T broker/broker trades and corresponding contracts between brokers and institutional partnersDelivery v PaymentCHESS effects settlement of transaction between ASX brokers on a delivery versus payment (DvP) basis. DvP is the irrevocable and simultaneous exchange of unconditional financial products for same day cleared funds to settle an obligation.CHESS achieves DvP because it is supported by two main principles:the ACH has direct control over a subregister which records the legal ownership of the issuers financial productsthe ACH has the ability to effect irrevocable transfer of a participants funds through the banking system.DvP settlement occurs in CHESS when financial products are transferred between holdings on the CHESS subregister controlled by participants and when CHESS instructs the banks through electronic messages to effect payment, both occurring simultaneously. Payment FacilitiesEach broker taking part in DvP settlement must establish at least one payment facility for the payment or receipt of funds in the CHESS environment.The broker makes an arrangement with a single bank that is a CHESS participant to have its payment facility authorised. The bank will associate the brokers payment facility identifier with the brokers accounts that are to be debited or credit to enable financial settlement of payment obligations in CHESS. Brokers Receiving funds – Must have these funds credited to their trust accounts.Brokers Making Payments – Must make these payments from their general bank accounts.Market MisconductSecurities market misconduct is deal with under the provision of the Corps Act as well as the ASX Market Rules.IT IS ALL ABOUT FOT (fair orderly and transparent)Market misconduct creates the followingUndermines confidence in the marketUneconomical use of resourcesCorruption and money launderingWhite collar crimeCase: ASIC v AdlerOutlineRodney Adler was the director of the company HIHTo support HIH he used company money to buy shares in his own nameDecisionThis created an artificial price which was holding the market up3 charges of manipulating the stock market 2 charges of making false or misleading statements in relation to securities.There was proof beyond all reasonable doubt of his market misconductThe principal forms of securities misconduct are dealt with under Pt 7.1 of the Corps Act:Misleading or deceptive conduct (securities) (s 1041H)Dishonest conduct (s 1041G)Dissemination of information about illegal transactions (s 1041D)Making false or misleading statements or omissions in a prospectus or in relation to securities (s 1041E)Stock market manipulation (s 1041A)False trading and market rigging (s 1041(B) & (C))Fraudulently inducing persons to deal in securities (s 1041F)Insider trading (s 1043A)Mislead or deceptive conduct - s 1041H – (REFER ASIC ACT)What is it?The integrity of a securities market depends upon the non-corruption of information about securities that is available in the market, the principal provision which is aimed at ensuring this integrity is (s 1041H).S 1041H makes the general prohibition of M or D in connection with any dealing in securities or of conduct which is “likely to” mislead or deceive (based on s 52(1) of TPA)Cases which have been held as M or D under s 52 of the TPA can be used in assistance as indicated by The Explanatory memorandum to the Corporations Bill 1988.The phrase “likely to” has been interpreted by the TPA in situations where it is found that “there is a real or not remote chance or possibility regardless of whether it is less or more than 50%”. Case: Global Sportsman v Mirror NewspapersWhen does it arise?M or D can arise in relation to a financial product or servicein the allotment or issue of a financial productin the publication of a notice in relation to a financial productin the making, or making an evaluation of, an offer under a takeover bid or recommendation relating to such an offerin carrying on negotiations, making arrangements or doing any other act, preparatory to, or in any way related to, the aboveA contravention of s 670A, s 728 or conduct in relation to a disclosure statement or document within the meaning of s 953A or s 1022A is NOT a contravention of s 1041HCase: Henjo Investments v Collins Marrickville - TPA“M or D conduct generally consist of representations, whether express or by silence, but it is erroneous to approach s 52 on the assumption that its application is confined to the circumstances which constitute some form or representation”Case: Concrete Constructions v NelsonAlthough limits to the section have been set, these limits are by no means preciseIt is a question of fact in all the circumstances of a case whether conduct will be misleading or deceptive, BUT there must be some misrepresentation before the conduct will be classed as M or D. TEST FOR ESTABLISHING MISLEAD OR DECEPTIVETaco Co of Australia v Taco BellThe Full Court laid some test which needed to be satisfied in applying the “M or D” test under s 52 of the TPA (analogy in s 1041H):Necessary to identify the relevant section of the public…by reference to whom the question of whether or conduct is, or likely to be, M or D falls to be testedOnce the relevant section of the public is established, the matter is to be considered by reference to all who come within itEvidence that some person has in fact formed an erroneous conclusion is admissible and may be persuasive but it is no essential (such evidence DOES NOT itself establish that M or D exists or is likely to M or D)Necessary to inquire why a proven misconception has ariseThe FUNDAMENTAL importance of this principle is that it is only by this investigation that evidence of those who are shown to have been led into error can be evaluated and it can be determined whether they are confused because do f M or D conduct o the part of the respondent.Industrial Equity v North Broken Hill HoldingsInvolved in the trading of securities, IE made a takeover offer for NBH.NBH issued various ads which sought to persuade its shares NOT to accept this offerThese statements IE claimed as being M or DCourt HELD that these were merely states of opinion by NBH directorsShort of evidence to the contrary, s 52 should NOT be interpreted so that argumentative opinions expressed in a debate should constitute M or D conduct.ASIC ImplicationsASIC has considered the implications of M or D in the context of S 1041H(2) in a variety of releases such as:Practice Note 12 (1991) – ASIC on circumstances in which silence or half-truths in relation to material matter would constitute a misrepresentation”“in appropriate circumstances silence may constitute M or D where a duty to disclose is established, the duty may arise due to the existence of a special relationship which of itself requires the disclosure of certain information”Under the TPA an omission or refusal to act (MUST BE DELIBERATE)NO SUCH QUALIFICATION under (s 1041H(3))In the ASIC Practice Note 18 (1992)The effect of CORPORATIONS ACT s 1041H - “covers every aspect of dealing in securities or advising in relation to securities offerings (whereby) full disclosure of all info relevant to the identity of the representative and licensee concerned, presented in a manner which is not mislead, is essential for investor protection”.Hornsby Building information Centre v Sydney Building Information CentreNOT necessary to prove that the defendant intended to engage in M or D conduction in relations to the securities A contravention of s 1041H is NOT a criminal offence. A breach may create a civil liability under s 1041H, provided that an action for damages is brought within 6 years of the day of which the cause of action aroses 1041 allows “any person involved in the contravention, whether or not the other person or any person involved in the contravention has been convicted of an offence in respect of the contravention”. ASIC v Tweed – IMPORTANT RELEVANT CASEIt is a legislative response to the conduct of Mr David Tweed and his company, National Exchange Corporation Pty Ltd. Mr Tweed offered to purchase shares from small shareholders well below the market price of the shares. He did not disclose to shareholders that the offer price was below market price. As a result shareholders lost a large amount of money in agreeing to sell shares to Mr Tweed.Mr Tweed relied upon the self dealing provisions in the Corporations Act to avoid having to hold an AFSL and hence having to comply with the product disclosure obligations in the Act (due to him being a principal trade = no need for AFSL) Regulations were made in April 2003 which provided that unsolicited offers in the nature of Mr Tweeds, needed to be accompanied by information regarding the market price of the product. However since that time Mr Tweed has continued to offer to purchase shares below market price without disclosing this fact due to loopholes in the regulationsDissemination (spreading) of information about illegal transactions - s 1041D – (REFER ASIC ACT)It is an offence to circulate or disseminate any information or statement to the effect that the price of a security will rise or fall because of a transaction which is a breach of (s 1041 A, B, C, E, F) under (s 1041D)An offence will occur if the person making the statement or disseminating the information has entered into any such transaction or done any such act or thing, or alternatively if the person expects to receive or has received a benefit in doing so.DamagesIf a natural person contravenes s 1041D, a penalty of 5 years imprisonment or a fine of $20,000, or both will apply (Sch 3) If by a corporation it is a fine of $100,000 (s 1312)May also lead to civil action being taken for loss or damage suffered as a result of the circulation or dissemination of the info about the illegal transaction.DefensesDefense to this civil action is if it is by way of advertisement which is published in the ordinary course of business, provided that the person who published the advertisement had no reason to suspect, and did NOT known, the publication would contravene a provision in Pt 7.1Making false or misleading statements or omissions in a prospectus or in relation to securities - s 1041E – (REFER ASIC ACT)OutlineS 1041E proscribes the making of a state, or the dissemination of information, which is materially false or misleading, where such a statement in relation to securities is made in specified circumstancesCivil and criminal actions for false and misleading statements in relation to securities may also be brought for a contravention of (s 1041E)Civil actions for loss or damages need to be brought under (s 1041I) while criminal charges can be brought directly under (s 1041E).DamagesIf convicted for a breach a max penalty of up to $20,000 or 5 years imprisonment or both may be imposed (s 1311(1))What is a false or misleading statement?The making of a statement or the dissemination of information which is “false in a material particular or materially misleading” in the following circumstances:is likely to induce another person to buy or sell financial productsis likely to induce other persons to dispose or acquire financial productswhere the statement or information is such that it is likely to have the effect of increasing, reducing, maintaining or stabilizing the price for trading in financial products on a financial marketFor a statement to be “likely”, it must have the probably effect of inducing a purchase in accordance with the test laid down by the High Court in R v Boughney which requires that this probable effect had to be proved beyond reasonable doubt As was in the case of: Macleod v ASCCase: NCSC v Monarch Petroleum NL & CoDelivery of a forged letter containing false statements to the Perth Stock Exchange (which led to an increase in the price and volume of trading in various securities before trading was suspended as the announcement was broadcasted over the loud speaker.HELD as a clear breach of (s 1041E and 1041F)Case: Richard Lew and Carl Davis of Estate MortgageOutlineLew and Davis had authorized the issue of a # of TV adds which suggested that investment in the EM trust was subject to a low risk, as it only invested in prime income-producing real estate. $500 million was raised from the public before the trust collapsed. The adds were found to be false in many respects, and the money had been raised as part of a “sophisticated advertising campaign…to alter the perception of the investing public” and that it was “no appropriate to ignore the fact that vast amounts of money were raised by these campaigns”.DecisionBoth pleaded guilty of various charges based upon breaches of now (s 1041E)Terms of imprisonment 8 and 12 monthsCase: CAC v WalkerOutlineWalker was alleged to have made statements to a financial journalist that some of the PBB operations would be acquired by a large international pharmaceutical company which had also purchased a large # of shares in the company.This statement was in fact FALSE in material was as allegedly made to induce a person to deal in the securities of PBB.DecisionPeter Arthur Walker was charged under (s 1041E) where he sought to exploit public concerns about blood contamination under the establishment of the so-called Private Blood Bank (PBB).HELD “the material before the court appears to indicate that he made a # of statement which he knew would be published in the press of a kind which would cause the price of the shares in PBB to rise. It appears that some of these statements may NOT have been true.”Stock market manipulation (s 1041A) – (REFER ASIC ACT)OutlineThis problem has long been frowned upon due to its effect upon the reputation of stock markets and the loss which may be caused to those affected by fluctuations in the price or volume of securities.Stock market manipulation includes such practices as “ramping” and other price manipulations, “churning”, “pools” and the creation of false rumors or reports, where each were seen to have in common that they are “designed to stimulate artificially market turnover and share prices for the purpose of profiting, at the general public’s expense, from the distortions inflicted on the market”. (REFER SECURITES NOTES FOR FURTHER DEFINITIONS)Such manipulation can cause collapses in listed companies, or has tended to follow booms in the market. An example of this can be seen in the Australian miner boom int late 1960’s early 1970’s.What are the effects?(s 1041A) 2 circumstancesProhibits a person from entering into 2 or more transactions in securities of a particular body corporate in circumstances where these transactions have or are likely to have the effect of creating an artificial price for trading in financial products on a financial marketProhibits a person from making 2 or more transactions that have the effect of artificially maintaining a price for trading on a financial market. Such transactions must be entered into with the intention of inducing other person to buy or subscribe for securities of the body corporate or of a related body corporate. SSuch transactions must are entered into with the intention of inducing other persons to buy or subscribe for securities of the body corporate or of a related body corporate.R v De Berenger (1814)This is a classic illustration of stock market manipulation, apparently aimed at increase the price of securities. De Berenger and 7 other associates circulated false rumors and false reports.The principal prohibitions of market manipulation, are now found in the provisions of (s 1041A and 1041B), although M or D and IT are also examples of market manipulationWhat is a Pool, Corner, Churning? (Covered also by s1041B)PoolA “pool” (Rae Committee in relation to the mineral boom of 60’s - 70’s)Were organized by groups of >4 wealthy investors They would successively pool their funds and would sell the stock between one another This would raise the price of the shares and provide the opportunity for members of the pool to sell their shares at a profit. CornerIs another form of market manipulation possibly coming within (s 1041A)This practice is a response to short selling and involves the purchase of more securities than is available in the market with a view to dictate the price at which shorts sales of such securities are the be completed. Golden Bounty Resources NL (1993). ASIC alleged the existence of stock market manipulation where 4 million of the shares in GBR were held to be in relation to the dictating of the share price with a series of short sales. A price rise of 3 cents to 35 cents, which the court held as a ramping of the share price.Bruce Emerton Miles He pleaded guilty for placing instructions to buy and sell options in Moage Ltd with 9 separate stockbrokers, which he used to make bogus inflated bids for Moage shares leading to an increase the price of each option from 1-9 cents over a 5 day periods. Was held to 12 month suspended sentence and ordered to compensate the brokers who had lost $36,454 as a result of these transactionsChurningTrader acquires a parcel of shares and places buying and selling orders for them, usually at about the same price or at slight rising prices to BOOST the turnover.RunsInvolved groups of people creating activity in a share, either by their own buying, or by the dissemination of rumors in order to bring about SHARP price increases. This would attract buyers in at these high prices which allowed the organizers of the run to sell their shares for a quick profit.False trading, market rigging (s 1041B) – (REFER ASIC ACT)Outlines1041B deals with the creation of false or misleading appearance.Has 2 limbsProscribes the creation, or doing of anything, which is intended or which is likely to create a false or misleading appearance of active trading “in financial products” on a financial marketsProscribes the creation, or doing of anything, which is intended or which is likely to create a false or misleading appearance “with respect to the market for, or the price for trading in, financial products on a financial market”A person will be deemed to have created a false or misleading appearance of active trading in particular securities if ANY of the 3 tests set out in (s 1041B(2)) are satisfied:If a person carries out or enters a transaction of buying or selling securities in circumstances where there is no change in the beneficial ownership of those securities (s 1041B(2)(a).Can be made directly or indirectly Includes the making of an offer to buy or sell securities and the making of an initiation which expressly or impliedly invites a person to offer to buy or sell securities (s 1041B(4))A purchase or sale is NOT a change in beneficial ownership if the person who had a beneficial interest in the securities before the transaction, continues to have an interest in the securities after the transaction (s 1041B(3))If a person offers to sell securities at a specific price, and that persons has also made, or proposes to make, an offer to buy substantially the same # of securities at a price which is the same as his asking price (s 1041B(2)(b))Vice versa to point 2 (ie buy shares a specific price and sell the same # at a specific priceCase: Norths v Marra developmentsOutlineA broker (North) claimed compensation, who had undertaken false trading upon behalf of a client who refused to reimburse the broker for its servicesRespondent claimed in defense that the appellant’s claim should fail as the transaction in question was illegal both under statue and at common law.North established a market which increased the share price to $16.50 as Marra believed its low share price left if vulnerable to a take-over.DecisionHigh Court rejected the claim by North as the work that it had undertaken for Marr was in breach of (s 1041B) as the action was “intended to create, a false or misleading appearance of active trading” “The objective of the section is to protect the market for securities against activities which will result in artificial or managed manipulation. The section seeks to ensure that the market reflects the forces of genuine supple and demand” Real or genuine transactions are able to create a false or misleading appearance, and both types are seen to be in breach of the legislation. “It is enough to breach the section that the activities are intended or calculated to create a false or misleading appearance (NOT necessary that they do INFACT create that appearance”The decision from Marra developments was applied similarly to the following:Fame Decorator Agencies v Jeffries industriesR v LloydCase: ASIC v Nomura International – IMPORTANT IMPORTANTNomura devised an international strategy aimed at securing an arbitrage advantage for itself by actively placing sale and bid orders for a security thought a number of brokersNomura had sought to influence the price of securities by placing these orders through towards the end of a trading day.Also held a futures position which almost perfectly weighted arbitrage positionThey had 4 strategiesThe Bid BasketThrough its broker it bought all of the same securities it had soldThey would buyer cheaper (to force down price but not too much)Was a profit motive involved in selling to itselfThe Ask BasketDecided to place a further set of sell ordersBUT these orders were above the previous days closing priceAimed to “confuse” none of which were accepted (itself or 3rd party)The London bid side sell ordersEach sale occurred to be the last trade of the dayThe purpose was to ensure the closing price was lower and secondly to guard against the price of those securities rebounding after Nomura has sold its securities in the March orderLondon offer side sell orderUsed to prevent a round in the price of securities at the close of trading, Nomura’s brokers sold a substantial volume of each of the top 10 securities in (All Ords)CONCLUSION OF NOMURA:It was a cross border contract aimed at creating a false or misleading appearance of trading in securities in contravention of (s 1041B)“Nomura was not simply using accepted or standard market to achieve legitimate commercial objectives, Nomura engaged in deliberately misleading conduct as part of strategies designed to achieve illegitimate ends”.They were deliberately trying to lower the price of the securities included in the ALL ORDS at the close of 29 Mar 1996, which would increase the profits to be made on their subsequent holding of SPI futures upon expirationCommentsSecurities regulation laws aim to promote the confident and informed participation of investors and consumers in the financial system and the Nomura decision is clearly in line with earlier Australian and comparative authorities which aim to maintain market credibility. The Nomura case reflects the problems of the international market place and the international regulatory response.If investors lack confidence in the market, they will place their investments elsewhere. Without the investments of institutional and retail investors, there is no market to transfer funds from savers to users for use and investment.Fraudulently inducing persons to deal in securities - s 1041F(REFER ASIC ACT)s 1041F prohibits a person from inducing or attempting to induce another person to deal in securities where this is done by any of 3 methods:Making or publishing a forecast or promise which is known to the person making it to be “misleading, false or deceptive”a dishonest concealment of material factsRecording or storing by mechanical, electronic or other means information which the person knows to be false or misleading in a material, where a person has reasonable grounds to suspect that it would be available to the other person.DefensesIs a DEFENCE if it can be proved that when the information was so recorded, the defendant had no reasonable grounds for expecting that the info would be available to any other personCase: NCSC v Monarch Petroleum NL & CoOutlineDelivery of a forged letter containing false statements to the Perth Stock Exchange (which led to an increase in the price and volume of trading in various securities before trading was suspended)Decision“The false statements were clearly designed to induce persons to deal in securities, namely shares of companies in the Magnet group thus constituting the offence of inducing or attempting to induce persons to deal in securities (s 104F)”Case: Story v NSCSASIC is empowered by s 50 of the ASIC Act to initiate civil actions under s 1005 for the loss or damage suffered by a person as a result of a contravention of (s 1041E or s 1041F)IF in relation to a takeover, “ASIC will take into consideration any undertakings whereby the offeror has agreed to compensate persons who sold shares on market in reliance upon a statement that there would be no increase in the offer price”“Such civil compensation or undertakings will not prevent ASIC from investigating or persecuting any offence which appears to have been committed”ASIC ACT The ASIC act does will more consumer protection (ie broker/client)The Corps act deals with market misconductConsumer – 12BC –“Consumer” is defined with 12BC(1) if the dealing or undertaking:If the price less than the prescribed amount of $40,000 (12BC(3))If the price exceed the prescribed amount – the services were of kind ordinarily acquire for personal, domestic or household useSmall business – (REFER page 80)M or D – s 12DAA person must not, in trade or commerce, engage in conduct in relation to financial services that is misleading or deceptive or is likely to mislead or deceiveThis means that anything NOT in trade on commerce CANNOT = M or D(ie if outside business, as in the case of Hedley Byrne v Heller)Example if advice was given at a BBQ then cannot be M or DM or D DOES NOT apply to disclosure documents (due diligence)s 12DA (1A) – FSGs 12DA (1A)(b) – SOAs 12DA (1A)(c) – PDSFalse or, misleading representations (s 12DB)A person must not, in trade or commerce, in connection with the supply or possible supply of financial services, or in connection with the promotion by any means of the supply or use of financial services:falsely represent that services are of a particular standard, quality, value or gradefalsely represent that a particular person has agreed to acquire servicesrepresent that services have sponsorship, approval, performance characteristics, uses or benefits they do not haverepresent that services has a sponsorship, approval or affiliation it does NOT havemakes a false or misleading representation with respect to the price of servicesmakes a false or misleading representation concerning the need for any servicesmakes a false or misleading representation concerning the existence, exclusion or effect of any condition, warranty, guarantee, right or remedyMisleading conduct in relation to financial services (s 12DF)A person must not, in trade or commerce, engage in conduct that is liable to mislead the public as to the nature, the characteristics, and the suitability for their purpose or the quantity of any financial servicesDefenses (s 12GI)The contravention is respect of which the proceeding was instituted was toreasonable mistakereasonable reliance on information supplied by another personthat:the act or default of another person, to an accident or to some other cause beyond the defendant’s controlthe defendant took reasonable precautions and exercised due diligence to avoid the contraventionWhere “another person” does NOT includean employee or agent of the defendantin the case of a defendant being a body corporate, a director, employee or agent of the defendantRemedies/Injunctions (s 12GD)If a person has engaged in the following:a contravention of a provision of this divisionsattempting to contravene such a provisionaiding, abetting, counseling or procuring a person to contravenes a provisioninducing, or attempting to induce, whether by threats, promises or otherwise, a person to contravene such a provisionbeing in any way, directly or indirectly, knowingly concerned in, or party to, the contravention by a person of such a provisionconspiring with others to contravene such a provisionTHEN A COURT MAY GRANT AN INJUCTIONCivil liability for damages (s 12GF) – REFER ASSIGNMENT FOR CIVIL AMNTSA person who suffers loss or damage by conduct of another person that contravenes a provision may recover the amount of the loss or damages by action against that other person or against any person involved in the contravention (within 6 years)Court order to disclose information (s 12GLA, s 12GLB)s 12GLA (non punitive (punishing) orders)The orders which a court may make are:a community service ordera probation order for a period of no longer than 3 yearsan order requiring the person to disclose information he possess’ or has access toan order requiring the person to publish at the person’s expense and in the way specified in the order, an advertisement in the terms specified in, or determined in accordance with, the orders 12GLB (punitive orders requiring adverse publicity)requires the person to disclose, in the way to 3rd parties specified in the order, such information he possess’ or has access torequires the person to publish at the person’s expense and in the way specified in the order, an advertisement in the terms specified in, or determined in accordance with, the orderEnforceable undertakings to ASIC (s 93AA)93AA(1) ASIC may accept a written undertaking given by a person in connection with a matter in relation to which ASIC has a function or power under this act(ie the person will try to fix the problem/undertaking)93AA(2) The person may withdraw or vary the undertaking at any time, but only with ASIC’s consent(ie in fixing the problem, the undertaking shall be removed by ASIC)93AA(3) If ASIC considers that the person has breached any of its terms ASIC may apply to the Court for an order(ie if the person has still not rectified the problem, ASIC will apply for a Court order)93AA(4) If ASIC is satisfied that the person has breached a term, the court may make all or any of the following ordersorder to comply with that term of the undertakingorder person to pay the Cth an amount that is of any financial benefit that the person has obtained and that is reasonable attributable to the breachorder to compensate any other person who has suffered loss/damage due to breachany other order that the Court considers appropriatePublishers have a defense for market misconduct under (s 1044A)If the defendant, was at the time, a person whose business it was to publish or arrange for the publication of advertisements; andThey received the advertisement for publication in the ordinary course of that business and did not known, and had no reason to believe, that its publications would amount to an offence against that provision(ie. the newspaper is cleared from liability, and the court may will relieve wholly or partly from liability if it appears to the court that the circumstances above apply)Short SellingWhat is Short selling?A short sale is “The sale of a security that the investor does not own in order to take advantage of an anticipated decline in the price of the security”. In order to sell short, the investor must borrow the security from their broker in order to make delivery to the buyer - the short seller will have to buy the security back in order to return it to the broker with the hope it has fallen in price in order to make a profitWHEN is short selling legal?Options contracts on ASXCorporations Regulation 7.9.79(1)(a), where it “does not have effect in relation to a sale of financial products that is done by the giving or writing of an option registered with: (a) an Options Clearing House Proprietary Limited”.s 1020B(2), which states, “a presently exercisable and unconditional right to vest the products”. Here, the Act is referring to a situation whereby a sequence of short sales would be deemed legal if it is executed under an options contractOptions over futures contracts on SFECorporations Regulation 7.9.79(1)(b), where it “does not have effect in relation to a sale of financial products that is done by the giving or writing of an option registered with: (b) a SFE clearing Corporation Pty Ltd”.s 1020B(2), which states, “a presently exercisable and unconditional right to vest the products”. Here, the Act is referring to a situation whereby a sequence of short sales would be deemed legal if it is executed under an options contractArbitrageArbitrage transaction pursuant to s1020B (4)(b) & ASX Market Rule 19.2 which permits arbitrage transactions to occur as long as the Trading “Participant” – s761A which defines this as “a person who is allowed to directly participate in the market under the markets operating rules” – “is a registered arbitrageur” & sells the products on “bona fide (in good faith) arbitrage account on another market”. Therefore, in the above sequence of short sales the arbitrageur will buy a stock on a foreign exchange which hasn’t adjusted for the exchange rate. The arbitrageur will purchase the undervalued stock and short sell the overvalued stock, thus profiting from the difference.Offsetting contract to buy – unfulfilled conditions (s 1020B(4)(c))“before the time of sale has entered into a contract to buy those products and who has the right to have those products vested in the person” Where payment, receipt by the person of a proper instrument of transfer and the documents of title are presentThis situation will arise when a trader already has a contract to buy (ie go long) on a particular stockThe short sale will subsequently counter balance the contract to buy with the contract for the quantity to go short.Tick testRefer to Materials pg 31Restrictions on when a short sale may be executed. Tick-test rules dictate that a short sale can be made only in two situations: 1. When the price of the particular stock is higher than the last trade price (an uptick). 2. In a case where there is no change in the last trade price. The previous trade price must be higher than the trade price that preceded it (a zero uptick or zero plus tick) This rule is intended to prevent investors from destabilizing the price of a stock when it's falling. Also known as the short sale ruleExample$6.70, $6.80, $7.20, $7.00, $7.10YESYESYESNOYESI.e. THE ENDING PRICE > STARTING PRICE is LEGAL THE ENDING PRICE < STARTING PRICE is NOT LEGALApproved short sale productsUnder [s 1020B(4)(e)] the legal notion of short selling is permitted if (i) “the products are included in a class of products in relation to which there is in force a declaration, made by the operator of a licensed market as provided by the operation rules of the market, to the effect that the class is a class of products to which this paragraph applies; and (ii) made as provided by the operating rules of the market; and (iii) at the time of sale, neither the person who sold the products, nor any person on behalf of whom the first-mentioned person sold the products, was an associate, in relation to the sale, of the body corporate that issued the productsMarket RulesThe issue of the “operating rules of the market” in relation to the shares in question would need to be classed under Section 19 of the ASX Market Rules: Short Selling -Traded products19.3-19.7 highlights the “permitted short selling of approved short sale products and public securities”. However, it is under the rules of 19.7.1 which short selling is most relevant Here, it states, “ASX may designate a Traded Product to be an Approved Short Sale if (a) 50 million Traded Products of the class have been issued; (b) the market capitalisation of the Traded Products of the class on issue is not less than $100million”. Thus, if this series of short sales satisfies s 1020B(4)(e) in conjunction with section 19 of the ASX Market Rules, it shall be deemed legal.REFER SAMPLE QUESTIONSWhat is short selling trying to achieve?The regulation of short selling attempts to achieve three main outcomes;the possibility of trading on a falling market,the possibility to provide demand to stop further market decline and the possibility to improve the markets overall efficiency & liquidity. Under the first outcome, regulation has made it possible for people to trade in a falling which is often referred to in finance as a “bear market”. This allows an investor the ability to sell a desired quantity of a security, which he/she does not own. The investor will in theory, borrow stock from a holder, (usually a brokerage firm) which they consequently sell. To profit from such a practice, the investor must rely on the falling price of the stock, which, eventually on settlement will allow the investor to buy back the stock at a lower price in order to close the trade. Whilst this method of trading can prove beneficial in a falling market, if the stock were to rise, the investor would be forced to buy the stock back at a higher price and subsequently suffer a loss. This follows on to the second objective and reason behind the regulation of short selling. Once a person decides to embark upon a short position, he must at some point close out, and buy back the stock to settle. Therefore, when a market is falling and sellers outnumber the amount of buyers for any particular stock an investor holding a short position must then buy back the stock from a seller, which would subsequently increase the buying side of the stock and ultimately add demand to stop the market from further decline. The third object of short selling is to improve market efficiency and liquidity. When a stock has risen to levels which seem higher than expected (often referred to as overbought) where the bulls in the market have pushed the price to a figure which the market believes is overvalued, investors may short this stock to bring down the price to a level which the market finds more acceptable.It is through these reasons why short selling is regulated and permitted, and can therefore achieve a positive result within the various markets which adopt itEXAMPLEShort selling in AntimonyAbout 15 brokers who shorted the 20 cent stock of Antimony Nickel in February 1971. Gordon Barton held 18% after the float, and started buying heavily. Soon he owned 105% of the stock, thanks to the short selling. He promptly stuck the price up to $3. Alas, the Sydney Stock Exchange suspended the stock, claiming there was not an orderly market. Sykes claims seven of the 10 firms on the SSE committee were short sellers. This case is an example of a “corner” where the short sellers were squeezed out as the stock was a small company and not very liquid, no-one was selling any of the stock.The self-reg, in those days protected the brokers - “mates”, and never faced the music.Short Selling to speculate The most obvious reason to short is to profit from an overpriced stock or market. Probably the most famous example of this was when George Soros "broke the Bank of England" in 1992. He risked $10 billion that the British pound would fall and he was right. The following night, Soros made $1 billion from the trade. His profit eventually reached almost $2 billion.How does short selling ‘practically’ work?Short selling is effectively - selling what you don’t own - to engage in short selling you need to find a person who owns shares and believes that the share is going to rise. In undertaking short selling, you do think that the?price?is going to fall. You are effectively “betting against” people who think its going to rise.Well firstly, we have to clarify the difference between?naked short selling?and?covered short selling. Typical short selling is referred to as covered short selling - the practice whereby a?trader?sells a?security?that they do not own with the expectation that the value of the securities will decrease allowing them to sell the securities at current market prices and then buy the securities back when they fall in value. With enough value drop, the?trader?can purchase the securities and ‘cover’ their position for less than they received for selling them earlier. Of course, if the?price?increases then the?trader?is required to cover the increase and they lose money. The difference between a ‘covered’ short selling and a naked one is that a naked short sell is selling a stock?without borrowing the shares. This creates a position when the?seller?does not obtain the shares within a specified time?period?and subsequently fails to deliver on their obligation. This type of short selling typically incites more negative sentiment in a stock.The following example should help to illustrate Fred approaches his stock?broker?and says “I want to short sell NAB at current market rate of $20.00The stock?broker?would approach a large investor who has gone “long” on NAB shares and thinks they are going to rise (i.e. the large investor holds a bunch of NAB shares and thinks that they are going to rise)The stock?broker?effectively “borrows” these shares from this investor and sells them at the current market rate - deriving a cash sum. The?broker?is now indebted to the investor for X? number of shares and holds cash for Fred.The stock then falls to $18 and Fred wants to cash out and tells his?broker.The?broker?then uses the money from the sale of the shares “borrowed” from the large investor, and buys them at a rate of $18.This costs $18 per share and the stock?broker?then gives the large investor the number of shares borrowed.Fred has made $2 and pays a premium to the stock?broker, who would have in turn been charged a premium from the large investor.So a proper illustrate in a practical sense:Fred “borrows” 1000 shares at $20 and immediately sells them at market?price earning $20,000Stock falls to $18Fred buys 1000 shares at $18KFred “returns” the “borrowed” shares to the “borrower”Fred keeps $2K profitFred’s $2K has a “premium borrowing” charge of 10% - so he has to pay this for “borrowing” the shares - $200 to the company.Fred Nets $2K - $200 = $1,800Short selling consequencesListed penalties under Schedule 3 – s1020B, 1020C – PAGE 1,410 ASIC powers:Licensing offences (ie suspend cancel or ban)Stop order (s 1020C)Stop trading (s 794D)Enforce Breach of Operation Rules (s 793C)Court order (s 1101B)Injunction (s 1324)Civil Damages (s 1324(10))Question 4Give two (2) situations where the following sequence of short sales in shares of Monash Ltd would be legal under the Corporations Act and/or ASX Business MR 19:69,68,72,70,71Corporations Act 2001 s1020B (1) (a) defines “securities” - with reference to s 761A under the definition of security - as “a share in a body...or legal or equitable right or interest in a security” therefore dictating that s1020B(1)(a) and the respective ASX 19.1.1 can apply to Monash Ltd shares. In order to establish two situations where short selling can apply in the Corporations Act and ASX Business MR 19, the principle of short selling must be defined. A short sale is “The sale of a security that the investor does not own in order to take advantage of an anticipated decline in the price of the security”. In order to sell short, the investor must borrow the security from their broker in order to make delivery to the buyer - the short seller will have to buy the security back in order to return it to the broker with the hope it has fallen in price in order to make a profit.One such situation where the previously mentioned sequence of short sales is legal under both legislations is through an option contracts on the ASX pursuant to s1020B (2) of the Corporations Act and Corporations Regulation 7.9.79(1). s1020B (2) states that “a presently exercisable and unconditional right to vest the products” which implies that this sequence of short sales is legal if implemented through an options contract. Corporations Regulation s7.9.79 further refines this s1020B(2) definition by stating that 1020B(2) “does not have effect in relation to a sale of financial products that is done by the giving or writing of an option registered with the (a) Option Clearing House Proprietary Limited; or (b) SFE Clearing Corporation Pty Limited”. This implies that options can also be written under s 7.9.79(a) and (b) of Corporations Regulation. Under a put options contract, the same results as short-selling are achieved. Puts are very similar to having a short position on a stock insofar as the buyer of the put contract hopes that the price of the stock will fall before the option expires. The main differences between short-selling and buying put options, is that put options have a have limited life as the option will expire if stock doesn’t goes down within the specified time limit, and the put option stock is owned by the purchaser. A premium is paid to buy a put option which protects against adverse stock movements and therefore limits loss as appose to short selling where the potential losses are infinite if the stock keeps increasing.Another instance where this progression of short sales would be legal is under Arbitrage transaction pursuant to s1020B (4) (b) and ASX Market Rule 19.2 which permits arbitrage transactions to occur as long as the Trading “Participant” – s761A which defines this as “a person who is allowed to directly participate in the market under the markets operating rules” – “is a registered arbitrageur” and sells the products on “bona fide (in good faith) arbitrage account on another market”. Therefore, in the above sequence of short sales the arbitrageur will buy a stock on a foreign exchange which hasn’t adjusted for the exchange rate. The arbitrageur will purchase the undervalued stock and short sell the overvalued stock, thus profiting from the difference.A short seller of shares can argue that shares can just as easily rise as fall. What is the regulation of short selling trying to achieve, and do you believe it achieves its purpose?Short selling typically only occurs in bear market, were the overall value of market shares is declining or expected to decline. While it is true that shares can “just as easily rise as fall”, a short seller would not seek to invest during a bull market or a rising period of market growth. A short seller typically limits its sales to a bear markets whereby the market condition is falling, therefore increasing its chance of capitalising on a market downturn. While the argument presented by the short seller in this question is theoretically valid – a short seller would not sell a short unless the security and/or market illustrated that a clear downturn was evident due to the infinite degree of loss available on a short transaction.Both Corporations Act s1020B and ASX Market Rule 19 seek to ensure that short selling does not push a market downward and influence a bear market, while equally seeking to limit investors from potential infinite loss. Short selling has been permitted in some situations by both the Corporations Act 2001 and ASX because it does provide some benefits to the overall operation of the market. It provides liquidity to market transactions, drives down overvalued securities and generally provides the market with more information about companies. Equally, short selling can influence a market to change rapidly if short traders capitalise highly during a bear market, further increasing the market downturn with another possibility being that short sellers seek to smear companies in order to reduce their market value and therefore gain large returns. These are some of the foremost reasons that short selling is so heavily regulated in the marketplace. The introduction of both the up-tick-rule - which prevents a short unless a stock is trading upwards pursuant to s1020B (4) (d) (iii) (A) - , and the zero-up-tick rule - A transaction at the same price as the preceding trade, but at a higher price than the last different trade s1020B (4) (d) (iii) (B) – ensure that it is more difficult for short sales to push a market downward. In combination with these rules, the Corporation Act s1020C gives ASIC powers to stop orders, s749D (1) allows ASIC to “suspend dealings in the financial product”, s793C (1) and s1101B (1) make “an application to the Court” for the “court to make certain orders” and therefore, pursuant to s1324 (10) issue “damages”. This spectrum of prohibited regulation deters investors from pursuing illegal short selling trades because of the high possibility of being prosecuted. This strict supervision in combination with a small quantity of legal short selling situations, entices the author to believe that there is suitable regulation of short selling in the marketplace to ensure that it remains “fair, orderly and transparent” (s792A (a)).Did Banning Short Selling in 2009 Make a difference?Any ban must be measured against the objective aims of what short selling is. Before, it was stated that the regulation of short selling attempts to achieve three main outcomes;the possibility of trading on a falling marketthe possibility to provide demand to stop further market decline and the possibility to improve the market’s overall efficiency & liquiditySo by banning short-selling we are effectively trying to ascertain whether these aims where achieved at a greater level. The question is where they?So on 19 September 2008, ASIC announced more measure to regulate short selling – these were banning naked short selling and requiring disclosure of covered short sales to ASX via brokers. There was a Senate Inquiry into ASICs reasoning before the passing of the Corporations Amendment (Short Selling) Bill 2008 – () where a number of submissions were received and ASICS justification wasThe issues that were concerning us were the lack of confidence in the market, with buyers staying out and short sellers using strategies to push down prices, and also allegations of false market rumours. We felt that we needed a circuit-breaker to come into line with what was happening internationally.ASICs key justification that...short selling coupled with rumours can actually depress prices further. In the case of financials, that is an extremely worrying issue. If the stock price of a financial gets to a particular level it runs a risk of being rerated for credit purposes, so it might drop from AA to something else. That, of course, is your worst nightmare because that then precipitates a further decline, and, of course if you are the short seller, you keep shorting the stock.There was also more justification regarding the effect that short selling ban had on market liquidity such that ASIC stated that the trading had decreased following the ban but that it was ‘difficult’ to correlate evidence between the ban and reduce trading with the overall market volatility regarding global financial turmoilASX's monthly activity report released for the November period revealed a decrease (9%) in trades during the period of the short selling ban when compared to the period from 1 July to the commencement of the ban on 22 September. Given the volatility in market activity internationally, we are unable to assess whether that decrease is directly related to the short selling ban.An examination of price levels, volatility and liquidity does not provide a clear view about the effect of the ban in Australia. However, none of these indicators suggest that ASIC should not have placed the bans. ASIC's action to ban covered short selling of all quoted stock was necessary when considering the aims it set out to achieve, that is, to act as a circuit breaker to assist in maintaining confidence in Australia's financial markets; as a response to bans imposed overseas; and to deal with high levels of rumourtrageOf course in December 2008 the government passed the Corporations Amendment (Short Selling) Bill through parliament and this is what ideally started the debate over the effectiveness of banning short selling on the market. In the authors opinion Short Selling is only as effective as the information dissemination that is flooding into the market. Large institutional investors, arguably, have faster information dissemination to act upon that smaller traders who tend to ‘piggy back’ on these larger traders. While it’s obvious that short selling increases market liquidity and essentially ‘true price discovery’ in the market – it seems quite clear that ASIC was more concerned about false rumour and insider trading spreading into the market and its inability to effectively manage this information flow as its primary justification for the ban. The entire market was essentially trading on information dissemination – due to the overall global volatility at the time - and reacting on this information as it flowed into the market. As the majority of the information disseminating into the market was negative, most traders swapped their positions to short selling to compound stock losses further - thereby making a greater profit and essentially – as warren buffet puts it – ‘riding on their coattails’ of institutional investors who were dumping large quantities onto the market driving prices even lower.So, perhaps, the real argument is not the banning of short selling – but rather the lack of adequate information distribution and ASICS current inability to effectively manage this in bear markets. The banning of short selling in the form ASIC implemented was an adequate ‘quick market fix’ for the torrid of selling happening in the market – but idealistically, it just exposed a greater problem that should have perhaps been managed more adequately – or more ‘proactively’ – in the bull market that was had up until the start of 2008. It seems an entirely reactionary approach in my mind when more proactiveness surrounding market disclosure should have been a larger part of ASICs strategy in ‘boom-times’.So if we turn our minds to efficiency of market information – we can see that an efficient capital market is a market in which all information is reflected in the underlying price of security as soon as it becomes available. This suggests that security prices are unbiased estimates of the future value of a security, and that they react immediately to the release of any new information. Thus, the efficient capital market theory concludes that there is almost no advantage gained by institutional investors spending time and energy on securities research and analysis as price will automatically encompass all relevant information. Consequently, this assumes that the information dissemination process occurs instantaneously and there is no time lag between the disclosure of the market information and its relevant interpretation of it. While it can be argued that this is not rationally achievable in real markets, proponents of the efficient market concept suggest that it is. They argue that there is no need for mandatory or voluntary disclosure regulations since there are adequate market incentives available to issuers to make accurate, complete and timely disclosures without breaching any of the relevant disclosure regulations.It is known in the market that unsophisticated investors tend to have a number of biases such as egotism, over confidence and an unwillingness to accept failure by holding a security even in a bear market. As concluded in the Gambotto v WCP Ltd, unsophisticated investors tend to ‘follow the herd’ and do not use any available information in their decision making process. This type of market behaviour causes extreme price volatility and is based on imperfect investor reasoning - a concept that the efficient market hypothesis failures to accurately explain. Thus, it is apparent that while investors do attempt to disseminate information in primary markets they tend to typically adopt a ‘herd mentality’ in secondary markets. This forms the reasonable conclusion that while the efficiency market hypothesis is a useful theoretical concept, it is not entirely sustainable in real markets. For more info – read (National Guarantee Fund)WHAT IS THE NGF?The National Guarantee Fund (NGF) is a compensation fund that is available to meet claims arising from dealings with stockbrokers including where: a stockbroker transfers securities without authority; or where the stockbroker becomes insolvent and fails to meet its obligations to a person who had previously entrusted property to it (in certain circumstances as set out in the Division 4 of Part 7.5 of the Corporations Act).The Fund is administered by the Securities Exchange Guarantee Corporation (SEGC) which acts as a trustee of the NGF, it is wholly owned but NOT controlled by the ASX. The SEGC is a subsidiary of ASX, but operates independently and in accordance with Div 4 Pt 7.5 of the Corps Act. SEGC is a non profit organization and does not trade in its own right.The NGF may be funded by levies on securities transactions, the ASX and ASX membersWhat was the purpose of the NGF?The purpose of the Australian Stock Exchange and National Guarantee Fund Bill 1986 ('the Bill') is twofold:to provide legislative support for a reorganisation of stock exchanges in Australia to establish a single national stock exchange, the Australian Stock Exchange Ltd ('ASX Ltd') with each of the 6 current capital city exchanges as subsidiaries of itto create a national guarantee fund ('NGF') consisting of the pooled assets of the existing fidelity funds operated by the separate capital city exchanges, which will provide greater protection to investors in respect of failure of contracting parties to meet their transaction obligations or in respect of dealer insolvency.Other facts on the NGFThe assets of the fidelity funds of each of the states were merged to form the fundThose assets have since been investedAt 30 Jun 2004 the value of the fund = $164.4 millionThe minimum amount which must be maintained by the NGF is $80million (s 899I)A levy is required to be paid under (s 889J by SEGC and s 899K by market operator)A failure to pay this is an officeAML condition (s 795B(1)(f))Neither ss 881D(2) nor 882A(2) (relating to compensation arrangements) requires the Minister to reject the applicationPayments FROM the fund may only be made in accordance with the legislation (s 889H)These include:Costs of investigating claimsCosts of settling claimsThe administrative costs of SEGCThe administrative costs of the Fund itselfHOW does the NGF contribute to market confidence?The NGF scheme contributes to market confidence in the ASX by providing three significant forms of investor protection:A mechanism for ensuring clearing guarantee for ASX markets and contract completion guarantee for clients;A mechanism for investors dealing through ASX member organisations (stockbrokers) to claim compensation for the default, fraud or insolvency of a stockbroker in the circumstances set out in the legislation; andFunding for significant systems development projects, through payments to the Securities Industry Development Account, which have had the effect of reducing transaction risk on the ASXWhere “Investor protection” on Australian Stock Exchange Ltd (ASX) is achieved through a combination of federal legislation, supervision by the ASIC and Department of Treasury, self-regulation by the ASX, stockbroker management practices, and the NGF.WHAT have been the major claims to date?The majority of past claims on the NGF resulted from the insolvency of seven stockbroking organisations following the 1987 market crash.NGF: 5,554 claims ($21.37?million paid and $13.37?million recovered) since 1988, mainly in 1988-91. Since 1993, one insolvency but more unauthorized transfer claims.WHAT CLAIMS CAN BE MADE?4 subdivisions of Div 4 Pt 7.5 of the Corps Regulations which set out the types of claims you can make on SEGC:Subdivision 4.37.5.20Provides for the completion of sales and purchases (& cash compensation of purchases in certain circumstances) of securities transactions entered into by a dealer on ASX’s equities and debt market where those transactions are required to be reported to ASX by the dealerExampleIf a Dealer has bought securities on your behalf and you have paid for them, but he has not provided them to you either within the time set out in the rules (or if no time specified then within a reasonable amount of time).If SEGC is satisfied with the claim they will transfer you securities of the same kind and number as those claimedIf no securities available then you will be paid an amount of money to compensate for the lossVice versa if dealer had sold securities on your behalfSubdivision 4.77.5.53Provides compensation for the loss that results if a dealer transfers securities WITHOUT authoritySubdivision 4.87.5.60Provides compensation for the loss that results if a dealer wrongly cancels or fails to cancel a certificate of title to securities(although this basis for claim is now UNLIKELY as all securities quoted on ASX since Feb 1999 are required by the ASX listing rules to be held in uncertificated formSubdivision 4.97.5.64Provides compensation for the loss that results if a dealer becomes INSOLVENT and fails to meet its obligations to a person who had previously entrust property to itThe MOST important is Subdivision 4.5:Allows ASX’s clearing houses to make a claim on SEGC if a dealer fails to meet a net payment obligation or net delivery obligations on a settlement day (7.5.40)Payment LimitsNO max amount that applies to an individual claimIf claim is for property entrusted to a Dealer under subdiv 4.5, the max amount available for any one insolvent dealer = 14% of the min amount of the fund as at the end of the day the dealer becomes insolvent (7.5.71)If total of all valid claims is NOT > than this amountThen claims will be settled in fullIf total IS > than this amountClaims are settled on a pro-rate basis: 30 Jun 2003 = $11.2millCan there be a reduction in compensation?SEGC may reduce the amount in certain circumstancesTo the extent that you were responsible for cause the lossIf you have received a benefit for assigning any rights or remedies in relation to the loss without SEGC’s written consentDaly v Sydney Stock ExchangeOutlineInvestment advice had been sought from Patrick Partners (firm of borkers) by Dr. Daly.Apr 1975 an employee from the brokers advised Daly it was NOT a good time to buy sahres, and suggested that he put his funds ain a 90-day call account with a high interest rate.Daily was assured that his money would be safe in the fundThe partners of PP knew that they were facing financial difficultyJun 1975 Daly’s deposit was subsequently assigned to the appellant, within this month PP also ceased trading due to insolvency.Daly claimed compensation from the fidelity fund but was rejected by both the Sydney Stock Exchange and the NSW Ctt of Appeal.DecisionHigh Court held that there was no contractive trust, Daly should only be regarded as a creditor of the insolvent firmDaly could NOT claim compensationThis would NOT happen now, as the NGF does not depend on proof of defalcation or fraud by a broker and a person DOES have the right to claim. Which can be calimed directly against the NGF in repespect of dealer insolvencyWhat are things NOT covered by NGF?Does NOT apply to OFF market transactionsIt is important to note that for transactions of this nature, they do not attract the protection of the NGF as the NGF generally only applies to transaction effected on the marketAnother reason where a claim cannot be made under NGF when there is an insufficient nexus with Australia (ie business was not carried on within Australia)SFE – Fidelity FUNDTo give clients dealing in the futures market additional protection, the Futures Law requires the SFE to operate a fidelity fund. This fund is intended to cover losses sustained by a client because of a defalcation or fraudulent misuse of money or other property by a Participant.What claims can be made?Claims on the fidelity fund can be made for up to a maximum of $A500,000 per Participant (including the reasonable costs related to the making and proof of the claim), less any benefit received from any other source which reduces the loss.‘Stress-testing’ has determined that the SFE’s $177 million guarantee fund, with the provision of a second level of commitment from Clearing participants of a further $30 million at the discretion of the Board, and is consistent with International practice.The structure of the current Clearing Guarantee Fund is:Available SFE Clearing capital $30 millionClearing Participant’s Commitments $67 millionInsurance cover $80 million$177 millionTYPES OF DEFAULTThe risk management and financial surveillance techniques of SFE Clearing are specifically designed to prevent a Clearing Participant from defaulting on its obligations. It is worth noting that there has never been an SFE Clearing Participant default on their obligations and as a consequence the $177 million guarantee has not been called upon. However the following summarizes the steps that would be taken were such an event ever to occur.House DefaultIf a Clearing Participant were unable to meet its financial obligation and the default occurred in its House Clearing account, SFEClearing may act immediately to:Attempt to transfer all segregated client positions and monies to another Clearing ParticipantTake control or liquidate the positions in the House Clearing Account or in both the House and Client Clearing AccountApply the Clearing Participant's commitment and House initial margin deposits to the defaulting Participant’s position and loss.Client assets (positions and/or monies) on deposit with or in the control of SFE Clearing or its participants may not be used or impaired by SFE Clearing in the case of a Clearing Participant default resulting from House activity.Client DefaultIf a Clearing Participant were unable to meet its financial obligation and the default occurred in its Client Clearing account, SFEClearing may act immediately to:Attempt to transfer non-involved client positions and monies to another Clearing Participant/sTake control of or liquidate Client and House positionsApply the Clearing Participant's commitment and Client and House initial margins of the defaulting Participant to the position or lossIt should be noted that SFE Clearing has the right to apply toward the default all Client initial margins in the defaulting Clearing Participant's account.Accordingly, initial margins deposited by Clients not causing the default are potentially at risk if there is a default in the Client account of their Clearing Participant.Should the defaulting Clearing Participant's obligation not be fully satisfied by the above steps, SFE Clearing would apply its available capital set aside specifically for this purpose, followed by the commitments of the non-defaulting Clearing Participants and finally the 3rd party insurance cover. ................
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