Compliance: Theory and Practice in the Financial Services Industry

November 2004 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:

(a)    15 of the questions in Part A (each question correctly answered is worth 2 marks, for a total of 30 marks); and
(b)    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, when is a financial services business taken to be carried on in Australia?
2.    Clause 4 of ASIC Pro Forma 209 is one of the justifications for a financial services licensee having a properly staffed compliance function. What does it require?
3.    List the products to which the Corporations Act prohibitions on insider trading apply.
4.    In what circumstances is a listed entity that becomes aware of information concerning it that a reasonable person would expect to have a material effect on the price or value of the entity’s securities, entitled to withhold that information from the Australian Stock Exchange?
5.    What is a “wash trade”? Under the Corporations Act, a person who engages in a wash trade is deemed to have done what?
6.    In what circumstances can a financial services licensee enter into a transaction on its own behalf with a non-licensee that relates to a financial product able to be traded on a licensed market?
7.    A person acquires a 20%+ shareholding in a listed foreign company. That foreign company has a 5% shareholding in a listed Australian company. What must the first mentioned person do in relation to the listed Australian company and by when must they do it? Why is that so?
8.    Generally speaking, when does a person hold a “substantial interest” in a corporation for the purposes of the Foreign Acquisitions and Takeovers Act (ignore for the purposes of your answer the acceleration and tracing rules in ss11, 12B and 12C)?
9.    For the purposes of the Trade Practices Act, what is an “exclusionary provision”?
10.   Under the Financial Transactions Reports Act, what must a cash dealer obtain in order to have a proper identification record for a signatory to an account?
11.   A new client telephones a financial services licensee requesting that they provide a financial service immediately. It is not reasonably practicable for the licensee to give a Financial Services Guide (“FSG”) to the client before the service is provided. What information must the licensee provide before providing the service (a reference to the relevant section numbers in the Corporations Act that specify the information will suffice)? When must the FSG be provided?
12.   A financial services licensee is approached by a new retail client to advise the client on how to invest a lump sum left to them in the will of a recently deceased relative. Having analysed the client’s personal circumstances and finding them to be particularly risk adverse and concerned mainly about preserving capital, the licensee recommends that the client buy an interest in a managed investment fund investing primarily in fixed interest products. What 3 disclosure obligations must the licensee satisfy in this fact scenario?
13.   One of the situations in which a regulated person must give a retail client a Product Disclosure Statement for a financial product is a “recommendation situation”. What is a “recommendation situation”?
14.   When is a financial services licensee entitled to keep the interest earned on a client trust account (ie an account maintained under section 981B of the Act)?
15.   Under the Corporations Act, the constitution of a managed investment scheme is required to make adequate provisions for 4 particular matters? What are they?
16.   If the responsible entity of a registered managed investment scheme is to have any rights to be paid fees out of scheme property, or to be indemnified out of scheme property for liabilities or expenses incurred in relation to the performance of its duties, what 2 conditions must be satisfied?
17.   ASX participants are required to include 3 general endorsements on all confirmations or to get an upfront acknowledgement from a client that the matters covered by those endorsements apply to the issue of all confirmations to the client. What are those endorsements?
18.   Under the Corporations Act, who is taken to be the “issuer” of a derivative (ignore for the purposes of your answer the special rules that apply to the wholesale markets referred to in Corporations Regulation r7.1.04D)?
19.   What sort of records must a participant on the Sydney Futures Exchange maintain in relation to trading errors?
20.   When is a general insurance product taken to be provided to a person as a retail client?


Part B

Compulsory Problem Question:

Analyse the following fact situation. What legal or regulatory breaches may have occurred? 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 Heartless and Pointless Stockbroking Pty Ltd (“HPS”), a trading and clearing participant of the Australian Stock Exchange (“ASX”). In that role you are responsible for handling customer complaints.

HPS is a wholly owned subsidiary of Heartless and Pointless Limited (“HPL”), a conglomerate financial services company whose shares are quoted and traded on the ASX. HPS has an AFSL that authorises it to advise on and deal in securities and derivatives and to operate managed discretionary accounts.

On your first day in the office, you receive a phone call from a client, Muhammad Ali (“Ali”), complaining about the performance of his HPS managed discretionary account. He says that he started the account with $1 million in 1999 and that it is now only worth $500,000. He says that the amount of brokerage he is being charged by HPS on the account is outrageous. He says that while he was a successfully sportsman, he was used to being gouged by his managers and advisers, but that now he is retired and on an invalid pension and the account is just about all that is left of his life savings, he can’t afford for this to go on.

Ali mentions that he complained about these matters to your predecessor over 4 months ago but that all he got was a letter acknowledging receipt of his complaint. Since then he has heard nothing from HPS.

Ali says that he thinks HPS is acting in contumelious disregard of his rights as a client. You tell Ali you will look into the matter and get back to him.

Immediately after the call, you look up the meaning of “contumelious” in your dictionary (“insolent; reproachful; disgraceful”) and then have a vague recollection of a judge using that expression repeatedly in a case. You think to yourself it is no wonder that the judiciary has a reputation for being aloof and remote when it uses these sorts of obscure and antiquated expressions. Your mind then returns to the business at hand and you set about dealing with the complaint.

You examine HPS’s client records and see that Ali has indeed held an account with HPS for 5 years and that throughout that period Dean Martin (“Martin”), one of HPS’s institutional stockbrokers, has been the adviser responsible for the account. That examination also reveals:

•     There has been an extraordinary number of trades on the account over the 5 year period, generating very significant commission for HPS and Martin personally. Many of these are short term trades, with mixed success (some of them have yielded profits, but just as many have yielded losses).
•     Recently there has been an increasing number of trades involving options, warrants and other highly leveraged derivative products. In one or two cases, these have been spectacularly successful but a number have also been spectacularly unsuccessful, resulting in large losses.
•     In particular, you note that there has been a lot of same day trading in warrant products issued by HPS. You recognise that these trades just happen to co-incide with the launch date of the warrant products in question. You notice that the trades invariably take the form of a number of purchases in the morning and one or more sales late in the afternoon, reversing out the position. You also notice that where the sales have resulted in a loss, an amount has been transferred from the HPS error account to make good that loss.
•     You note that over the 5 year period there have been regular purchases and sales of HPL shares in Ali’s account. You know that HPS’s standard discretionary account agreement contains an express authorisation to deal in HPL shares but you can’t find a copy of a signed account agreement in Ali’s client file. In fact, the only things that you do find on Ali’s client file are:
  •     a copy of the letter your predecessor wrote to Ali acknowledging receipt of his complaint, which refers to HPL’s corporate values statement that “HPL and its employees comply with the spirit and letter of the various Acts, rules and regulations that govern its operations and at all times strive to act with honesty and integrity”, and assures him that his complaint will be handled in accordance with that commitment, but says nothing else;
  •     a certificate from a firm of suburban accountants dated 1 October 1999 confirming that Ali had assets in excess of $2.5 million. The letterhead of the firm did not indicate to which, if any, professional accounting body the firm belonged; and
  •     copies of quarterly statements sent to Ali in relation to the account.
•     You also note that a large number of shares in XYZ were purchased for Ali’s account in May 2004 (which you calculate to be 4.9% of the issued shares in XYZ). These were accepted into a takeover bid made by another client of the firm, ABC Limited (“ABC”), in July 2004 at a substantial profit. ABC already had a 19.9% shareholding in XYZ at the time it launched its takeover bid. You know that HPL’s corporate advisory arm acted on the takeover bid for ABC.

You interview Martin. You ask him about his trading strategy for the account. He says that he doesn’t really have one – he just looks for opportunities to make money for his client.

When you quiz Martin about the whereabouts of Ali’s discretionary account agreement, Martin tells you that he wouldn’t have a clue. He says it is possible that Ali never signed one because he is an institutional client and “insto’s never sign client agreements”.

You query whether Ali really is an institutional client and Martin tells you that he distinctly remembers Compliance clearing him as a wholesale client when the account was opened. Otherwise he would not have been able to act as the adviser on the account (retail clients get handled by a different division at HPS).

When you quiz Martin about the same day trading in HPS-issued warrants and why the losses from that trading have been made good from the error account, he tells you that since these trades were in HPS products, if any of them resulted in a loss, he felt it only right that HPS should make good that loss. He says he has cleared this arrangement with the head of the Warrants Desk.

You then interview Martin’s boss, Jerry Lewis (“Lewis”), and he tells you to “go easy” on Martin. He says that Martin is one of HPS’s most profitable traders and is responsible for a large number of client accounts. He says that Martin has been most unhappy lately, especially since your predecessor in Compliance had “given him a hard time about 6 months ago over trading in some other customer account”, and it would be a disaster if Martin left the firm.

When you ask Lewis what he knows about the trading in Ali’s account, Lewis tells you that he does spot checks on discretionary accounts from time to time, but that he doesn’t recall ever reviewing Ali’s account.

When you ask Lewis what he knows about the trading in Martin’s other managed discretionary accounts, he evades the question, saying that he has had to “cut Martin some slack lately” and “treat him with kid gloves” because he has been so unhappy and the firm can’t afford to lose him.

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