Compliance: Theory and Practice in the Financial Services Industry

November 2003 Exam Paper

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This examination is an open book examination. You may bring into the examination room and refer to any written materials that you think may be helpful in answering the questions below.

The examination is divided into 2 sections and is worth 60% of your assessment. You must answer:


15 of the questions in Part A (each question correctly answered is worth 2 marks, for a total of 30 marks); and


the question in Part B (30 marks).

You will have 20 minutes reading time and 2 hours to complete the examination. Good luck!


Part A

Short Answers:

Answer 15 out of the following 20 questions. Your answers should be brief (no more than 2 sentences). Please identify clearly the number of the question you are answering.

1.    Under the Corporations Act, there are 5 categories of “financial services”. What are they?
2.    What is the difference between personal advice and general advice?
3.    A licensed financial planner wants to describe itself in its marketing materials as providing objective and independent financial planning advice. What conditions must it satisfy in order to lawfully do this?
4.    In ACCC v Rural Press Ltd [2001] ATPR ¶41-833, Mansfield J made 3 core observations about the Australian Standard on Compliance Programs AS 3806-1998. What were they?
5.    When is information “generally available” for the purposes of the Corporations Act provisions regulating insider trading?
6.    What requirements must a Trading Participant’s “Chinese wall” arrangements satisfy in order to meet the definition of that term in the ASX Business Rules?
7.    A stockbroker wishes to short sell securities for a client relying on the exception for short sales made in accordance with the rules of a licensed exchange. What 3 conditions must the broker satisfy under the Corporations Act to effect the short sale without breaching section 1020B(2)?
8.    What disclosures must an ASX Trading Participant make if they sell securities as principal to a client who is not itself a Trading Participant or a member of a recognised stock exchange?
9.    When does a person have a “substantial holding” in a body corporate under the Corporations Act?
10.   A person receives a direction from a listed company under section 672A of the Corporations Act requiring them to give information about their shareholdings in that company. By when do they have to respond?
11.   Under the Trade Practices Act provisions regulating competition, there are 4 “per se” offences (ie offences where it is not necessary to show any material adverse effect on competition) of which firms competing in the financial services sector need to particularly conscious. What are they?
12.   Case law establishes the proposition that an expression of opinion which is honestly held and which is based on reasonable grounds is not necessarily misleading just because it turns out to be wrong. When might an expression of opinion be misleading?
13.   Under the Financial Transactions Reports Act, “cash dealers” are subject to 3 separate reporting obligations. What are they?
14.   Paraphrasing the Corporations Act, a financial services licensee or authorised representative (“adviser”) giving personal advice to a retail client must only provide the advice to the client if they have a reasonable basis for the advice. What enquiries must the adviser make, and other steps must the adviser take, in order to have a reasonable basis for giving personal advice to a retail client?
15.   A financial services licensee is approached by a new retail client to advise the client on how to invest money the client has won in a lottery. Having analysed the client’s personal circumstances, the licensee recommends that the client buy interests in a particular managed investment scheme giving the client a balanced exposure to a number of different markets. What 3 disclosure obligations must the licensee satisfy in this fact scenario?
16.   Tournier v National Provincial and Union Bank of England [1924] 1 KB 461 is usually cited as the main authority about the duties of confidentiality owed by bankers to their customers. What was the main statement of legal principle the court applied in that case?
17.   What are the 3 defining characteristics of a managed investment scheme (ignore time-sharing schemes for the purposes of your answer)?
18.   An ASX Trading Participant receives an order from a client to buy shares. When must it make a record of that order and for how long must it keep that record?
19.   An SFE Participant operates a discretionary account on behalf of a client. What sort of records must it maintain and for how long?
20.   What must an insured disclose before a contract of insurance is entered into in order to satisfy their duty of disclosure under section 21(1) of the Insurance Contracts Act?


Part B

Compulsory Problem Question:

Analyse the following fact situation. What legal or regulatory breaches may have been committed by the named parties (CSFB, BS, JM, JM Nominees and V Dodgy)? What other compliance issues are involved? What additional matters would you consider looking into over and above those enquiries referred to below?

You are a compliance officer who has just started working at Cheddar Swiss Feta Brie (“CSFB”), a trading and clearing participant of the Australian Stock Exchange (“ASX”). In that role you are responsible for handling customer complaints.

On your first day in the office, you receive a phone call from a wealthy investor, Joe Millionaire (“JM”), complaining about dealings he has had with CSFB. JM is a retired Australian investment banker living in Monaco.

JM tells you that at about 8.30 am on the morning of 15 October 2003 he telephoned Brian Smart (“BS”), one of the institutional dealers at CSFB, saying that he had been given his name by an investment banking colleague as a person who specialised in small cap stocks and who would be able to help fill a particular order. JM then asked BS to buy up to 20 million shares in XYZ Limited (“XYZ”), a listed company trading on the ASX, at 50˘. He said that the order was placed in the name of the trustee company for his self-managed superannuation fund, JM Nominees Pty Limited (“JM Nominees”).

JM explains that the order was for just under 20% of XYZ’s issued share capital, because he wanted to buy the maximum amount of XYZ shares he could without having to make a takeover bid. He said that XYZ’s shares had closed the previous evening on the ASX at bid 50˘/offer 52˘. He mentioned that trading in XYZ’s shares had been depressed for some time prior to the period in question because it was generally known to the market that XYZ’s major shareholder, who held about 18% of XYZ’s issued shares, was in financial difficulties and was keen to sell its XYZ shares and this was causing a major overhang in the market.

JM tells you that BS had said to him that he would need to get management approval before he could take on such a large order from a person for whom CSFB had not previously acted and that he would get back to him with their requirements. About 10 minutes later, BS telephoned JM and said that his Credit Department would need a contact name at a local Australian Bank to whom they could speak to confirm that JM Nominees had sufficient funds to pay for the purchase. JM obliged with the name of his Australian bank manager. BS told JM that he could not start filling the order until he had Credit Department approval but in the meantime he would start ringing around various institutions and brokers to identify any sellers of XYZ.

BS then telephoned JM shortly after 10 am saying that his Credit Department had given the OK to take JM Nominees on as a client and that he had identified a parcel of 18 million shares in XYZ that was available for purchase at 51˘. JM said that he would amend his order to 51˘ and take the lot. BS then told JM that in the course of trying to find sellers at volume he had received orders from other buyers and that JM would have to share in the execution with those clients. When JM complained about this, BS told him this was standard practice with institutional clients and that they had put in orders at 51˘ ahead of his.

JM said that of the 18 million shares available at 51˘, he was only allocated 9 million shares. He tells you that he is disgusted with the shabby treatment he has received at the hands of CSFB. He says that since 15 October, the shares in XYZ have traded upwards to more than $1.00 and that if he had received the entire 18 million shares available on 15 October, as he should have, he would have doubled his money on the transaction. He says that he wants CSFB to supply the missing 9 million shares that he should have received on 15 October at 51˘.

You tell JM that you will look into the matter and get back to him.

After the telephone conversation, you call up the trading chart for XYZ shares on the ASX website and you note that its share price for some weeks prior to 15 October had traded in a narrow band around the 50˘ mark on low volumes. After the crossing of the 18 million shares on the morning of 15 October, the price quickly traded up to 60˘, although again on low volumes. However, on 21 October, the price suddenly spiked from 60˘ to around $1.00. You then look at the corporate announcements on the ASX website and see that there was an announcement by XYZ after the close of trading on 20 October that XYZ had successfully re‑negotiated a major supply agreement and this was expected to have a significant impact on its profitability. XYZ’s shares have continued to trade since then at prices in excess of $1.00. There are no other announcements relating to XYZ on the ASX website in the period in question.

You check CSFB’s computer trading records and you note that BS placed the following trades in XYZ shares:

Date/Time Client Bought Sold Price (˘)
10.10 am
V Dodgy 50,000 - 50.0
10.15 am
“VAR” 18,000,000 - 51.0
3.00 pm
V Dodgy - 50,000 60.0

The “VAR” code indicates that the purchase of the 18 million shares, which was effected as a special crossing on the ASX, was done for various clients of CSFB. CSFB’s trading records confirm that this transaction has been allocated as to 9,000,000 shares to JM Nominees, 8,000,000 shares to Client A, 500,000 shares to Client B and 500,000 shares to Client C.

You check CSFB’s order records. You note that order forms were completed for the orders for JM Nominees and Clients A, B and C after the close of trading at around 4.30 pm on 15 October. They show the orders all at 51˘ and the times that the orders were received as 10.05 am, 9.30 am, 9.35 am and 9.40 am respectively. When you query BS about this, he says that he usually writes up his orders at the end of the trading day from the information in his trading diary.

You ask BS to show you his trading diary for 15 October. The writing in it is very messy and all over the page but there is a scribbled note that confirms that BS received an order from JM by telephone for 20 million shares at 8.30 am at 50˘. There is a line through the time and price with an entry underneath saying “10.05 am 51˘”. There are also notes that indicate orders from Client A for 20 million XYZ shares, from Client B for 2 million XYZ shares and Client C for 2 million XYZ shares. There is no time marked for Client A’s order but the times for the orders for Clients B and C are shown as 9.35 am and 9.40 am respectively.

While CSFB tapes the phone lines of its retail brokers, it does not tape the phone lines of its institutional brokers. There are no tapes therefore that you can review to confirm the information that BS has given to you about the time of receipt of the orders.

You do some calculations and show BS that he allocated the 18 million purchase as follows:

Client Original Order Allocation % of
% of
Original Order
JM Nominees 20,000,000 9,000,000 50.0% 45.0%
Client A 20,000,000 8,000,000 44.4% 40.0%
Client B 2,000,000 500,000 2.8% 25.0%
Client C 2,000,000 500,000 2.8% 25.0%

You ask BS to explain why the trade was allocated in that way. He says that JM Nominees was given a slightly larger allocation than Client A because JM’s original order at 50˘ was first in time and it was that order that flushed out the seller at 51˘ and BS therefore felt it was fair and equitable for JM Nominees to get a bigger share of the order. He says that Clients B and C had much smaller orders and therefore only deserved smaller allocations.

You ask BS when he contacted the seller of the 18 million shares in XYZ. He says he can’t quite recall but that it would have been somewhere between 8.30 am and 9.30 am.

You check CSFB’s client file for JM Nominees and there is only a note prepared by BS with JM’s name, his postal address in Monaco, the name, address and ABN of JM Nominees, details of its Australian bank account and the name of the manager at the bank branch where that account is maintained. When you query BS about this and why there isn’t a client agreement on the file, BS tells you that this is standard practice for institutional clients at CSFB. He adds that if you knew anything about stockbroking, you would know that institutional clients never sign client agreements.

You ask BS what other information he knows about JM and why he placed such a large order for XYZ. BS tells you that the appropriate credit checks had been undertaken by CSFB’s credit department and once he knew JM Nominees had the cash to pay for the shares, that was all he needed to know.

You mention to BS that JM is very unhappy about the way in which the 18 million trade was allocated. He responds by saying “What’s he complaining about. He actually got a larger allocation than we normally would have given to an institutional client. We usually allocate on a pro rata basis, based on the respective size of the orders received. If we had done that in this case, he would have got less than the 9 million shares we gave him.”

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