Australia: Citigroup Ruling – Implications For Letters Of Engagement And Insider Trading

Last Updated: 2 August 2007
Article by Marianne Robinson

The much anticipated Australian Federal Court decision handed down on 28 June cleared one of the world’s leading banks of insider trading and conflict of interest charges and in doing so clarified the approach that Australian courts will take when considering whether or not a fiduciary duty exists between two commercial entities.


Citibank Global Markets Australia Pty Ltd (Citigroup) is the Australian arm of the global financial company Citigroup Inc. Because its Australian business includes both investment banking and equities trading, Citigroup had established ‘Chinese walls’ to restrict the information flowing between its various departments. The existence of such Chinese walls is acceptable under Australian law as a means of preventing the flow of information across the different divisions of companies.

In 2005, after lengthy negotiations, Citigroup’s Investment Banking Division entered into a letter of engagement with Toll Holdings Ltd (Toll) in relation to a proposed takeover bid for Patrick Corporation Limited (Patrick). On the last trading day before Toll announced its AU$6 billion bid for Patrick, an employee in the equities trading part of Citigroup purchased one million Patrick shares on behalf of Citigroup which helped push up the share price. Later that day the trader’s supervisor invited him to join him for a cigarette outside, where he told the trader to stop buying Patrick shares. When he returned to the office, the trader sold 193,000 Patrick shares before trading closed.

The Australian Securities and Investments Commission (ASIC) alleged that there was insider trading as well as a breach of a fiduciary duty owed by Citigroup to Toll which arose because Citigroup had failed to have adequate arrangements in place for the management of conflicts of interests.

Letter of engagement

The relationship between an investment bank and its financial advisory clients is usually one that involves giving advice on strategic transactions including on mergers and takeovers. The services to be provided to the client are formalised in a letter of engagement which sets out the contractual relationship between the parties and the basis of payment for these services. The relationship between the client, the investment bank and the legal advisors for the client are based on strict confidentiality and trust as the parties work closely together to achieve the client’s goal. The nature of the advisory services provided by investment banks in these circumstances can vary from valuations, evaluations, advising on financing and alternative strategies. Accordingly, the terms of engagement setting out the basis on which the bank is retained and the mandates given to it vary from transaction to transaction.

Relationships that are fiduciary in character demand a very high standard of propriety and loyalty. ASIC’s case was based on the premise that as an advisor to Toll, engaged to advise on a takeover, Citigroup was in a fiduciary relationship with Toll which it breached by trading in Patrick shares without the express consent of Toll.

Justice Peter Jacobson noted that Australian courts had refrained from developing a general test for fiduciary relationships preferring instead to look at the actual circumstances and what one party is in fact entitled to expect of the other party. The scope of the obligations and whether or not they are fiduciary will be determined by Australian courts by the character of the venture and the terms of the agreement and the course of dealing between the parties.

In Australia, a person in a fiduciary position is absolved from any liability for what would otherwise be a breach of fiduciary duty if there is fully informed consent for their action. Whether or not such consent exists will be a question of fact. Whether the disclosure is sufficient will depend on the sophistication and intelligence of the recipient of the disclosure.

In August 2005, Toll and Citigroup entered into a written letter of engagement which retained Citigroup’s Investment Banking Division to provide advisory services in connection with a possible takeover. The terms of this letter were critical to the judge finding that there was no fiduciary relationship between Toll and Citigroup.

The letter of engagement referred to in the decision as the ‘mandate letter’ clearly stated that Citigroup was retained as an advisor of Toll as an independent contractor and not in any other capacity, including as a fiduciary. While the pre contract dealings between Citigroup and Toll strongly pointed to the existence of a fiduciary relationship, there was a clear contractual acknowledgement that there was no such relationship.

The judge found that Toll’s experiences in the area of mergers and acquisitions meant that it was aware that Citigroup was a large financial conglomerate with a proprietary trading desk and that it did not act exclusively for Toll. It followed then that:

‘In my opinion, there is nothing in the relationship of investment banker/financial advisor and client which requires a conclusion that it is an inherent part of the business of investment banking for a banker to engage in trading in its client’s target shares. But, in my opinion, in the particular circumstances of this case, for the reasons given above, Toll had sufficient knowledge of the real possibility of proprietary trading by Citigroup to amount to informed consent.’

Having found that no fiduciary relationship existed between Citigroup and Toll it followed that the ASIC claims based on misleading and deceptive conduct and unconscionable conduct also failed as each of these relied on the existence of such a duty.

Conflicts of interest and duty

While Justice Jacobson decided that there was a contractual exclusion of any fiduciary duty between the parties, he addressed each of the alleged conflicts raised by ASIC to show that the case would have been unsuccessful even if a fiduciary duty did exist. His reasons include the following:

  1. Australian law does not recognise a duty of a fiduciary to make full disclosure to the fiduciary’s client of all relevant knowledge in its possession. Citigroup did not have a duty to provide Toll with details of the Citigroup’s purchase of Patrick shares on the basis that it may be relevant to a bid price based on the closing price of the shares on the night before the bid. The evidence before the court was that even if Citigroup had told Toll about its trading it would have made no difference to the decisions of Toll on the day.
  2. There must be a real conflict of duty and not some theoretical or rhetorical conflict.
  3. ASIC failed to prove that even if Citigroup had owed a fiduciary duty, that trading in the shares gave rise to any conflict of interest.

Chinese walls and adequate arrangements to manage conflicts

Chinese walls play an important role in the management of conflicts of interests as they protect clients from misuse or abuse of financial information which comes into the possession of an advisor because of the fiduciary relationship in place with the client.

The Australian Corporations Act requires financial services licensees such as Citigroup to have in place adequate arrangements for the management of potential conflicts of interest. ASIC argued that the terms of the legislation required the elimination of unauthorised conflicts by the obtaining of express consent from Toll before Citigroup could trade in Patrick shares. This view was rejected by the judge on the basis that requiring the elimination of all conflict was not consistent with the plain meanings of the word ‘manage’ which was used in the legislation.

The Chinese walls used by Citigroup to manage potential conflicts of interest included:

  1. The physical separation of departments
  2. Educational programs
  3. Procedures for dealing with crossing the wall
  4. Monitoring by compliance officers
  5. Disciplinary sanctions
  6. Written policies and procedures for the identification and management of conflicts.

ASIC did not challenge the evidence as to the adequacy of the arrangements and so the judge found that they were adequate for the purposes of the Corporations Act.

Warning about Chinese walls and compliance

Justice Jacobson noted a warning given by judges in earlier cases that it is not always realistic to place reliance on arrangements comprising Chinese walls.

‘Adequate arrangements require more that a raft of written policies and procedures. They require a thorough understanding of the procedures by all employees and a willingness and ability to apply them to a host of possible conflicts.’

Insider trading claims

In addition to the claims of a breach of fiduciary duty, ASIC alleged that the trader’s actions in selling the shares after being informed not to buy shares was evidence of insider trading and that all of his trading that day was undertaken with the knowledge that there was a substantial likelihood that the Toll takeover bid for Patrick was imminent.

To succeed in this claim ASIC had to prove that the trader was in possession of information not generally known to the public and that a reasonable person in possession of such information would expect it to have a material effect on the price or value of the shares. A company is said to be in possession of such information if it is in the possession of an officer of the company.

The Australian Corporations Act defines an officer of a company in terms that include their involvement in the policy and decision making or management of the company and their ability to affect its financial standing. While the trader had a daily trading mandate up to AU$10 million this was not of itself sufficient to qualify him as someone who had the capacity to affect Citigroup’s financial standing within the meaning of the legislation. The judge noted that a loans officer at a large bank branch had authority to made loans of such amounts and so found that the trader was not an officer of Citigroup merely because of the size of his trading mandate. The judge further found that even if the trader were an officer of Citigroup there was no evidence that he had made the supposition that Citigroup was acting for Toll in the takeover of Patrick when he bought or sold the shares. Evidence to support this view was the fact that he sold the shares because he believed that there was an overexposure to Patrick shares.

Although the judge decided that the trader was not an officer of the company, he did comment on whether or not the ASIC case would have succeeded if this had not been the case. To do this he had to consider the Chinese walls defence available under the Corporations Act which applies in situations of alleged insider trading.

The judge found that the arrangements required to satisfy the Chinese walls test did not require a person to demonstrate a standard of absolute perfection. The Citigroup arrangements were sufficient to establish the defence even if they did not anticipate the express situation that had arisen because they did lay down the general principles of how to deal with such matters.

‘Nevertheless the events which took place within Citigroup during the afternoon and evening of 19 August 2005 show that Chinese walls may not be as solid as the name implies.’


The ASIC conflict of interest case did not succeed because ASIC failed to establish the existence of a fiduciary duty between Toll and Citigroup. There is no Australian law that prevents an investment bank from contracting out of its fiduciary relationship. Many companies may now look more closely at their letters of engagement to determine the precise nature of their relationship with their investment bankers. If an investment bank wishes to reserve the right to continue to buy and sell shares in a client company, then it should ensure that the letter of engagement clearly excludes any fiduciary relationship between the parties or it will require clear and express consent for its ability to trade in this way. How clients react to such requests from their advisors is likely to impact on the future relationships between advisors and clients. While this case involved two sophisticated commercial entities, the case opens the door to all fiduciaries contracting out of their fiduciary duty even if there is a lack of sophistication of one party in comparison to that of the other party.

This case also highlights the different roles played by Chinese walls. Citigroup’s Chinese walls were considered from the perspective of managing potential conflicts as well as in the context of a defence against insider trading.

The insider trading case failed because of the existence of well documented Chinese walls which provided a defence for the purposes of the legislation. The existence of a fully integrated compliance program was held to be an effective defence despite the court’s warnings about the inability to identify and eliminate all forms of risk of information leakage across the structural barriers. The case should serve as a warning to service providers using Chinese walls that if there is a need to rely on them as a defence to litigation, then the physical separation of the various departments, the processes, procedures and education programs will all need to withstand significant scrutiny.

The Federal Court found Citigroup did not engage in insider trading, conflict of interest or a lapse in fiduciary duty. ASIC was ordered to pay the legal costs of both parties which according to various commentators could exceed AU$10 million.

Phillips Fox has changed its name to DLA Phillips Fox because the firm entered into an exclusive alliance with DLA Piper, one of the largest legal services organisations in the world. We will retain our offices in every major commercial centre in Australia and New Zealand, with no operational change to your relationship with the firm. DLA Phillips Fox can now take your business one step further − by connecting you to a global network of legal experience, talent and knowledge.

This publication is intended as a first point of reference and should not be relied on as a substitute for professional advice. Specialist legal advice should always be sought in relation to any particular circumstances and no liability will be accepted for any losses incurred by those relying solely on this publication.

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