CHAPTER 25
SECURITIES DEALING
TABLE OF CONTENTS
25.1 SCOPE, PURPOSE AND BACKGROUND OBSERVATIONS
25.1.1 SCOPE AND PURPOSE
25.1.2 THE RISKS ASSOCIATED WITH SHARE DEALING BY THE BANK
25.1.3 SECURITIES DEALINGS - INSIDER TRADING PROVISIONS
25.2 THE DECISION TO DEAL: OBJECTIVES AND APPROVAL AUTHORITY
25.3 EQUITIES AND UNDERWRITING GROUP
25.4 THE BANK'S TREASURY CODE OF CONDUCT PROPOSAL
25.5 FINDINGS AND CONCLUSIONS
25.6 REPORT IN ACCORDANCE WITH TERMS OF APPOINTMENT
25.6.1 TERMS OF APPOINTMENT A
25.6.2 TERM OF APPOINTMENT C
25.1 SCOPE, PURPOSE AND BACKGROUND OBSERVATIONS
25.1.1 SCOPE AND PURPOSE
In the course of the Investigation, an examination has been made of the Bank's acquisition and disposal of shares in companies listed on the Australian Stock Exchange. These activities were undertaken as part of the Bank's commercial banking operations.
The examination of the Bank's dealings in shares is relevant to my Investigation in that:
(a) First, some of the transactions have resulted in losses to the Bank. These losses, have been calculated at approximately $1.8M.
(b) Second, in the course of examining the Bank's dealing in shares, I formed the opinion that having regard to the administrative arrangements that applied within the Bank, there may have been conduct in respect of the share dealings which fell within the matters referred to in my Terms of Appointment.
The focus of my examination of these share dealings has been upon the adequacy of the the administrative procedures adopted within the Bank, and supervision, direction and control exercised over share dealings.
25.1.2 THE RISKS ASSOCIATED WITH SHARE DEALING BY THE BANK
In examining the Bank's share dealings, I have been mindful that there are three particular risks associated with such dealings. They are:
(a) First, the risk of losses. My examination has disclosed that the losses realised as a result of the Bank's share dealings were, in the context of the Bank's total losses, not extensive, but nevertheless important.
(b) Second, share dealing by the Bank can involve the risk of a loss of objectivity in the conduct of the Bank's lending to those companies in which it has acquired shares.
(c) Third, and importantly, share dealing by the Bank involves the risk that, where the shares traded are those of a borrower from the Bank, the Bank may if appropriate procedures are not in place, breach the insider trading provisions of the Securities Industry Code. In this respect, I have not examined whether the Bank, as an instrumentality of the Crown, would be entitled to Crown immunity from prosecution for breach of those provisions. I have taken the view that, in the conduct of its operations, the Bank would at all times seek to comply with the law.
25.1.3 SECURITIES DEALINGS - INSIDER TRADING PROVISIONS
The Securities Industry Code which regulates the South Australian securities industry contains a number of provisions in relation to securities trading. These provisions regulate all dealings in securities prior to 1 January 1991.
In particular, Section 128(1) of the Securities Industry Code states that:
"A person who is, or at any time in the preceding 6 months has been, connected with a body corporate shall not deal in any securities of that body corporate if by reason of his so being, or having been, connected with that body corporate he is in possession of information that is not generally available but, if it were, would be likely materially to affect the price of those securities."
A person connected with a body corporate is defined by Section 128(8)(c) of the Securities Code to include a natural person who:
"... occupies a position that may reasonably be expected to give him access to information of a kind to which sub-sections (1) and (2) apply by virtue of -
(i) any professional or business relationship existing between himself (or his employer or a body corporate of which he is an officer) and that body corporate or a related body corporate ...".
Section 4(1) of the Securities Industry Code states that:
"... "dealing", in relation to securities, means (whether as principal or agent) acquiring, disposing of, subscribing for or underwriting the securities ...".
Section 128(6) of the Securities Industry Code states that:
"... subject to sub-sections (7) and (7A), a body corporate shall not deal in any securities at a time when any officer of that body corporate is precluded by sub-sections (1), (2) or (3) from dealing in those securities."
and further provides at Section 128(7) that:
"A body corporate is not precluded by sub-section (6) from entering into a transaction at any time by reason only of information in the possession of an officer of that body corporate if -
(a) the decision to enter into the transaction was taken on its behalf by a person other than the officer;
(b) it had in operation at that time arrangements to ensure that the information was not communicated to that person and that no advice with respect to the transaction was given to him by a person in possession of the information; and
(c) the information was not so communicated and such advice was not so given."
25.2 THE DECISION TO DEAL: OBJECTIVES AND APPROVAL AUTHORITY
The Bank was empowered to deal in securities by Section 19(3) of the Act, which provides that the Bank may, inter alia, "... issue, buy, sell and otherwise deal with securities ..." and that it may "... underwrite the issue of securities".
Section 19(7) of the Act prohibits the Bank from acquiring more than ten per cent of the issued shares of a company without the approval of the Treasurer.
In November 1984, the Board of Directors formalised dealings by the Bank in securities. A paper that was prepared by Mr G S Ottaway, Chief Manager, Finance department and submitted to the Board, set out policy guidelines for the purchase of equities.
This paper outlined a number of reasons why the Bank might invest in equities; investments for short term profit; as market support for South Australian businesses; as investment by way of loan (preference shares); and as a result of underwriting commitments.
Contained in this paper was a recommendation as to the process by which decisions to purchase equities, or to enter into underwriting commitments, should be made. It was proposed that all underwriting or investment opportunities be considered on the basis of individual merit. Further, it was proposed that the decision-making process which applied to lending decisions should also apply to decisions to purchase equities, and to enter into underwriting commitments.
The paper recommended that participation in underwriting activities and the purchasing of equities be subject to the following guidelines and restrictions:
(a) a purchase or commitment should not exceed ten per cent of the issued shares of the corporation concerned;
(b) no restriction (save general bankers' prudence) to apply to the purpose for which investment is made;
(c) investments may include speculative ventures of good promise where there is prospective longer term benefit to the Bank and to the State;
(d) discretionary authorities for the purchase approval of equities to be as shown hereunder:
Managing Director )
General Manager - Corporate and International ) $0.1M
General Manager - Retail Banking )
Lending Credit Committee $0.25M
with amounts in excess of $0.25M to be subject to Board approval;
(e) the Lending Credit Committee to have discretionary authority to approve underwriting commitments for amounts up to $1.0M and for underwriting commitments in excess of that, the proposal to be submitted to the Board with the recommendation of the Lending Credit Committee;
(f) monthly reporting to the Board of all new purchases or underwriting commitments and quarterly reporting of the total portfolio with associated performance data; and
(g) the aggregate amount invested in equities (excluding existing holdings in related companies as at 1 November 1984, and excluding acquisitions resulting from underwriting commitments) should not exceed $1.0M.
The Board of Directors resolved on 22 November 1984, that the Bank participate in the purchase of equities and the underwriting of equity issues subject to the guidelines and restrictions as presented in Mr Ottaway's paper as outlined above. The responsibility for day to day management, control and reporting of the Bank's equity portfolio was to lie with the Treasury division of the Finance department.
Subsequently, in August 1986, the Board approved amendments to the discretionary authorities as follows:
Managing Director )
Chief General Manager ) $0.3M (purchases)
(on recommendation of a General Manager) ) nil (underwriting)
Lending Credit Committee ) $0.75M (purchases)
) $2.0M (underwriting)
with amounts in excess of those limits to be subject to Board approval. The aggregate limit on new equities purchased was also increased to $3.0M.
In July 1985, the "Equities and Underwriting Group" was established within the Finance department. This was intended to be a discrete operation and had restricted limits on the amount which could be invested.()
The Investigation has been unable to locate in Bank files the document setting up the Equities and Underwriting Group on inception in 1985, but a memorandum of 10 April 1987 by Mr J Chamberlain, Manager, Profit Planning, sets out his understanding of its charter.
The objectives of the Group, as proposed and approved by the Managing Director, were:
". To develop the understanding and skills of group members in share investment, trading and underwriting;
. to provide a forum for consideration of equity investments by the Bank;
. to provide a forum for consideration of share underwriting proposals; and
. to broaden the scope of Treasury investments and the potential for enhanced return on funds through portfolio trading." ()
The general approach taken was to purchase and trade stocks for relatively short term capital profits in preference to long term holdings.
It is not clear from the Bank's records where responsibility for the management of the equities portfolio was placed in the early years of its operation. The equities portfolio held by the Bank included shares/securities that were acquired for long term strategic investment as well as shares that were acquired for short term trading purposes. Both the Planning department and the Finance department performed management responsibilities in this matter. In a memorandum of 27 July 1988 presented by Mr K S Matthews to the Executive Committee on the topic of "Equities Portfolios" the following comment is made:
"The Bank has a number of equity holdings in various forms. There is a lack of clarity in some areas as to where responsibility lies for the control of these various investments ...".
In September 1988, it was clear that with respect to the `Long Term Equity Portfolio', management responsibility was to be exercised by the Corporate Banking division and that the Planning and Finance departments would cease to have a responsibility in this area.
The Corporate Banking division was at various times involved in supporting South Australian companies by investing in their shares. Some of these companies were existing clients of the Bank. These investments were of a long term nature and the motive for investment was to show the Bank's support for South Australian based organisations with a view to fostering or cementing a banking relationship with them.
As to the matter of whether the decision to purchase shares was made after referring to information obtained from current Bank loan files, I have received potentially conflicting responses from Bank officers and, in the circumstances, I do not record any firm opinion. To my mind, the important matter is to identify the need for the Bank to ensure that adequate procedures are in place.
A random check of the minutes of the Lending Credit Committee shows that banking facilities were granted or extended by that Committee to listed companies that were customers of the Bank at a time when the Equities and Underwriting Group were trading or traded shortly thereafter in the securities of those companies. At the time that this trading took place, there were no established procedures within the Bank to satisfy the requirements of Section 128(7) of the Securities Industry Code.
25.3 EQUITIES AND UNDERWRITING GROUP
Mr Chamberlain's April 1987 memo states that in July 1986 following a restructure of the Finance department, equity trading was no longer considered to be a Treasury function and became a "low key part of Finance department". The recommendation by Mr Chamberlain was that a formal Equities and Underwriting Group be re-established to provide an educational base for the Bank to develop expertise in the area of equity investments.
The recommendation that the Group be re-established was approved by Mr Matthews, Chief General Manager on 28 April 1987. Its members were to comprise the following:
(a) Chief General Manager (Chairman);
(b) Two representatives from Finance and Planning department;
(c) Two representatives from Corporate Banking division; and
(d) General Manager, Corporate and International Banking (ex officio).
There is no evidence available to satisfy me that any regard was had to the Securities Industry Code requirements, and even if this Code, as a matter of law, did not apply to the share dealing activities of the Bank, I would nevertheless, have expected that the matter be raised for consideration.
At a meeting of the Equities and Underwriting Group on 22 May 1987 the Authorities/Limits were set as:
(a) $0.1M in any one company;
(b) Chief General Manager: $50,000 on recommendation of one other member of the Group; and
(c) Secretary: $25,000 per stock for trading purposes only.
In my opinion, the setting of an amount of "$25,000 per stock for trading purposes only" for the Secretary of the Equities and Underwriting Committee was outside of the authority of that Committee. Any equities trading should only have been undertaken in accordance with the Board approvals of 1984 as amended in 1986, or in accordance with a delegation from the Managing Director pursuant to Section 18(2) of the Act.
In the course of the review of transactions by the Equities and Underwriting Group there were several instances that indicated that the Bank's internal administrative procedures were deficient. In this context, I refer to the inability of the Bank to locate documentation confirming that certain investments had been made in accordance with approval authorities that had been established. With the exception of the Case Study in relation to Celtainer Ltd (in liquidation) reported in detail in Chapter 10 of this Report, I have not detailed these matters in order that the affairs of clients of the Bank are protected. Reference should be made to the case study on Celtainer Limited for a discussion of the credit management processes that may be compromised in circumstances where the Bank is both an equity investor and a lender to the same entity. It is, in my opinion, not necessary to detail the cases to establish the point that procedural arrangements in these matters are important and in the case of the Bank were seriously defective.
25.4 THE BANK'S TREASURY CODE OF CONDUCT PROPOSAL
As its meeting on 26 July 1990, the Board Minutes record that the Board considered a paper presented by Mr G D Abbott, General Manager, Group Human Resources, on the topic "Treasury Code of Conduct". The purpose of this paper was to place before the Board certain recommendations regarding a `Code of Conduct' to be promulgated to the staff of the Bank involved in Treasury operations.
A number of separate matters were examined in this paper. One matter dealt with in the paper related to "Inside Information - Inside Trading". The Directors at their meeting of July 1990 noted that the Treasury Code of Conduct was a basis for providing appropriate ethical standards for those working within the Treasury area of the Bank, although, it could not be said from the Minutes, that the Board had "laid down" a Code of Conduct at this meeting. The Directors noted that it was necessary to clarify matters associated with "conflict of interest" which was another matter dealt with in the paper. In particular, the minutes record a notation by the Directors that "a distinction" was to be drawn between staff merely having an investment in shares in a company, as opposed to an interest as a Director, or at a management level.
I requested from the Bank all files relating to the matter of share trading. Apart from this memorandum on the "Treasury Code of Conduct" there is no other documentation that has been made available to me on this matter of procedures to be adopted by staff in any area of the Bank in conducting share trading activities. It will be noted that by the date of this paper to the Board, ie July 1990, the share trading activities of the Bank had abated.
25.5 FINDINGS AND CONCLUSIONS
The operations, affairs and transactions of the Bank in the matter of dealing in shares of companies has resulted in losses and, in my opinion, were not adequately supervised, directed and controlled by the officers and employees of the Bank who had administrative responsibilities in this matter. In particular:
(a) On all the evidence available to me, I am of the opinion that there was, at least up to July 1990, no effective system put in place to ensure that the Bank met the requirements of Section 128(7) of the Securities Industry Code. The risk that the insider trading provisions might be breached, inadvertently or otherwise, in those cases where the corporate banking department was carrying on share dealing activities, should have been obvious. Despite this, no effective systems were put in place to mitigate that risk.
(b) The objective of share dealing, - inter alia, to improve the Bank staff's knowledge and skills in respect of the equities market - were inappropriate. The material losses incurred are witness to that. If it was thought that training was important, staff should have been seconded to a subsidiary of the Bank, such as it's stockbroking subsidiary, where training would have been on a professional basis, better supervised, and would not involve the attendant risk of breach of the insider trading provisions of the Securities Industry Code.
(c) The documentation of approvals of share purchases, made available to me was inadequate in that it was not possible to determine whether all share transactions were properly authorised.
(d) Although the share dealing by the Bank involved the risk of breach of the Securities Industry Code provisions, it is my opinion, following my examination of some of these dealings, that the matter does not warrant further investigation. Nonetheless, appropriate procedures should be implemented within the Bank to deal with the issues raised in this Chapter.
25.6 REPORT IN ACCORDANCE WITH TERMS OF APPOINTMENT
25.6.1 TERMS OF APPOINTMENT A
For the reasons stated in this Chapter, I am of the opinion that the procedures for the dealing in securities by the Bank were inadequate.
25.6.2 TERM OF APPOINTMENT C
For the reasons stated in this Chapter, I am of the opinion that the trading in securities by the Bank was not adequately supervised, directed, or controlled, by the officers and employees of the Bank.