Australian Securities and Investments Commission v Davidof

B THE RELEVANT PRODUCT AND ITS CHARACTERISTICS 7 The products that were the subject of the alleged contraventions were three types of MINI warrants issued by Credit Suisse Investment Services (Australia) Limited (CSISAL) by reference to the Product Disclosure Statement (PDS) issued by CSISAL for MINI warrants on 21 January 2013. The PDS explained the features of the MINI warrants. 8 As is well known, a warrant is a type of financial instrument that derives its value from an underlying instrument (also known as the "reference asset") such as a share, or a group or index of shares. A MINI warrant is a particular type of warrant that offers leveraged exposure to an underlying instrument. The exposure is "leveraged" (and warrants often have similarities to call options) because while a MINI warrant holder pays an amount struck by reference to a small proportion of the value of the underlying instrument, the holder gains exposure to the full price movement of that underlying instrument. In this case, one of the three relevant MINI warrants issued by CSISAL had an underlying instrument being shares in Atlas Iron Limited; for the other two MINI warrants, the reference asset was the ASX SPI 200 Index Futures contracts. 9 MINI warrants take the form of a "MINI Long" or a "MINI Short" and, as the description implies, the former allows the holder to benefit from the underlying instrument or reference asset increasing in price, while the latter allows the holder to benefit from any price decreases. However, unlike other types of warrants, MINI warrants are cash settled, meaning that they only allow investors to trade the underlying instrument's movements and cannot be exercised (like an option) to obtain the underlying instrument itself. 10 Moreover, importantly for present purposes, MINI warrants are "open-ended" contracts with no set expiry date. Despite being open-ended in this sense, the PDS addresses the question of when a MINI warrant can be exercised by the holder or may be terminated. As to termination, section 2.8 of the PDS, lists the following possible circumstances: (a) on the Settlement Date following nomination by the Issuer of an Extraordinary Event; (b) on the Settlement Date following a Stop Loss Event (which occurs when the price of the reference asset is equal to or less than the Stop Loss Level (for a MINI Long) or equal to or greater than the Stop Loss Level (for a MINI Short)); (c) on the Issuer Call Date, following an Issuer Call; (d) on the Settlement Date following exercise in accordance with clause 5 of the Terms; (e) if compulsory acquisition of the Reference Assets is begun; or (f) on the Settlement Date following a Termination Date. 11 To understand these circumstances, it is necessary to know that the "Terms" to which section 2.8 of the PDS refers are those set out in section 7 of the PDS. It is also necessary to know that the "Settlement Date", which is the date upon which the obligation arises on the part of CSISAL to pay to the holder the Termination Amount or the Stop Loss Value (see cl 8.4 - 8.5 of the Terms), is defined as follows (emphasis added): Settlement Date means 10 business days after an Issuer Call Date, Exercise Date, the end of the Stop Loss Valuation Period or Termination Date, or such other date as determined by the Issuer in its discretion as is reasonably necessary for the Issuer to fulfil its obligations under these Terms. 12 Hence, although, as Mr Davidof submits, it is "open ended" in the sense of having no set expiry date, the terms of the MINI warrants specified that CSISAL, as the Issuer, may be required to provide consideration by paying to the holder the Termination Amount (upon valid exercise of a MINI warrant, or following an Issuer Call or Extraordinary Event) and the Stop Loss Value (if any) upon the occurrence of a Stop Loss Event.

C THE RESPONDENT'S ALLEGED CONDUCT 13 At relevant times, Mr Davidof was employed as a private client adviser with Macquarie Bank Limited and a representative of Macquarie Equities Limited (MEL) who was entitled to provide financial services under MEL's Australian financial services licence. He was also a Level 2 Accredited Derivatives Adviser, which authorised him to provide personal advice to clients in relation to financial products, including derivatives. 14 The banning order arose in circumstances where ASIC relied on six transactions by which ASIC found Mr Davidof had contravened s 1041A, each of which related to the trading, on the Australian Securities Exchange, of the MINI warrants. This buying and selling of MINI warrants was said to be pursuant to a prior arrangement with two Credit Suisse employees working on the "warrants desk" whereby the trades netted off a profit obtained, or a loss incurred, in other trading that was carried out on Credit Suisse's account, through the warrants desk. In this way, it was said engaging in the impugned conduct involved setting an artificial price for the MINI warrants and contravention of s 1041A of the Act.

D THE TRIBUNAL'S REASONING 15 I noted above that in setting aside the banning order, the Tribunal considered that the MINI warrants were not a "derivative" and hence not a "financial product". Having reached this conclusion, the Tribunal did not need to evaluate other arguments about Mr Davidof's trading and the banning order that had been raised by him in his Application for Review of Decision (Individual), which was before the Tribunal on the hearing. 16 This can be seen in the key reasoning of the Tribunal member revealed in the reasons for decision at [26] -[27]: CSISAL issued a Product Disclosure Statement (PDS) for MINIs on 21 January 2013. At 2.1, the PDS lists key features that apply to all MINIs. One such feature is 'the open-ended nature of a MINI'. At 2.8, the PDS sets out when a MINI terminates. The Tribunal also takes into account the description in Annexure A to the reviewable decision set out above that MINI's (sic) have no set expiry date. The Tribunal finds that the MINIs issued by CSISAL and traded by the applicant did not satisfy s 761D(1)(b) of the Act or reg 7.1.04 of the Corporations Regulations 2001. MINIs are not a derivative under the Act. ASIC put to the Tribunal no other basis on which the transactions undertaken by the applicant fell with the definition of financial product. The Tribunal finds that the applicant was not taking part in or carrying out a transaction or transactions that fall within either s 1041A or s 1041B of the Act, because the transactions in which he was engaged were not trading in financial products. Given that conclusion, it is unnecessary for the Tribunal to consider the other issues in the case. 17 Accordingly, put another way, the reasoning of the Tribunal had the following components: (a) the MINI warrants did not have a set expiry date so as to be able to satisfy the criterion in s 761D(1)(b) or reg 7.1.04(1) of the Corporations Regulations 2001 (Cth) (Regulations); (b) because the Tribunal found that the MINI warrants were not a "derivative", they were therefore not a "financial product"; and (c) because in trading the MINI warrants Mr Davidof could not have been taking part in, or carrying out, a transaction or transactions involving a "financial product", there could be no contravening s 1041A of the Act.

The Issues of Law 18 Having stated the reasoning, it can be seen the appeal, pursuant to s 44 of the Administrative Appeals Tribunal Act 1975 (Cth), is quite narrow. The questions of law raised by the appeal for the purposes of s 44 (see May v Military Rehabilitation and Compensation [2015] FCAFC 93; (2015) 233 FCR 397 at [191] and [194]), and the answers for which ASIC contends, are as follows: (a) On the terms of the PDS that CSISAL issued in relation to the MINI warrants, are the MINI warrants a "financial product" within the meaning of s 761D read with reg 7.1.04 of the Regulations, properly construed? Answer: Yes. (b) In order to satisfy s 761D(1)(b) of the Act and reg 7.1.04(1), or s 761D(2) and reg 7.1.04(2) of the Regulations, is it necessary to establish that the "future time" to which those provisions refer is a specific date fixed in advance? Answer: No. (c) Was it open on the evidence before the Tribunal for it to conclude that the MINI warrants issued by CSISAL, and in issue in these proceedings, did not satisfy any or all of: (i) the definition of "derivative" in s 761D(1) of the Act, read with reg 7.1.04(1) of the Regulations; and (ii) the definition of "derivative" in s 761D(2) of the Act, read with reg 7.1.04(2) of the Regulations? Answer: No.

The relevant provisions of the Act and Regulations 19 Section 764A(1)(c) of the Act provides that for the purposes of Chapter 7 of the Act (which includes s 920A and s 1041A), a "derivative" is a "financial product". Section 761D of the Act defines the term "derivative" for the purposes of the Chapter. Obviously enough, for reasons that have been explained, subs 761D(1) and (2) are of critical significance to the appeal. They are as follows: (1) For the purposes of this Chapter, subject to subsections (2), (3) and (4), a derivative is an arrangement in relation to which the following conditions are satisfied: (a) under the arrangement, 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 (b) that future time is not less than the number of days, prescribed by regulations made for the purposes of this paragraph, after the day on which the arrangement is entered into; and (c) the amount of the consideration, or the value of the arrangement, is ultimately determined, derived from or varies by reference to (wholly or in part) the value or amount of something else (of any nature whatsoever and whether or not deliverable), including, for example, one or more of the following: (i) an asset; (ii) a rate (including an interest rate or exchange rate); (iii) an index; (iv) a commodity. (2) Without limiting subsection (1), anything declared by the regulations to be a derivative for the purposes of this section is a derivative for the purposes of this Chapter. A thing so declared is a derivative despite anything in subsections (3) and (4). 20 The relevant provisions of the Regulations for the purposes of s 761D(1) and (2), are regs 7.1.04(1) and (2), which relevantly provide (emphasis added): (1) For paragraph 761D(1)(b) of the Act, the prescribed period is: (a) for a foreign exchange contract-- 3 business days; and (b) in any other case--1 business day. (2) For subsection 761D(2) of the Act, and subject to this regulation, an arrangement is declared to be a derivative if the following conditions are satisfied in relation to the arrangement: (a) the arrangement is not a foreign exchange contract; (b) under the arrangement, a party to the arrangement must, or may be required to, provide at some future time (which may be less than 1 day after the arrangement is entered into) consideration of a particular kind or kinds to someone; (c) the amount of the consideration, or the value of the arrangement, is ultimately determined, derived from or varies by reference to (wholly or in part) the value or amount of something else (of any nature whatsoever and whether or not deliverable), including, for example, one or more of the following: (i) an asset; (ii) a rate (including an interest rate or exchange rate); (iii) an index; (iv) a commodity. 21 What can immediately be seen is that apart from the italicised part of reg 7.1.04(2)(b), which allows that the "future time" may be "less than 1 day after the arrangement is entered into", reg 7.1.04(2) is drafted in substantially similar terms to s 761D(1). It follows, as ASIC submits, that if an arrangement otherwise satisfies s 761D(1) but involves, or may require, the provision of consideration of a particular kind or kinds to someone at a time that is less than one business day, it can still meet the definition of "derivative".

F CONSIDERATION 22 Returning to s 761D, the focus becomes whether the "arrangement" (to use the statutory word) is one that satisfies the conditions set out. Although the Tribunal found the only condition to be wanting was that in s 761D(1)(b) or reg 7.1.04(1) (by reason of the fact that the MINI warrants did not have a set expiry date), it is well to go through each of the three conditions specified. 23 In the circumstances of this case, ASIC submits, and it may be accepted, that this task can be assayed by directing oneself to asking three questions: (a) Does the arrangement make provision whereby a party to the arrangement must, or may be required to, provide consideration of a particular kind or kinds to someone at some future time (s 761D(1)(a))? One should pause here to note that the use of the words "must, or may be required to" (and, in particular, the disjunctive) accepts that the arrangement is not necessarily required to lead to the provision of consideration of a particular kind or kinds, although the possibility must exist. (b) Pursuant to the arrangement, is the "future time" to which question (a) refers not less than the number of days prescribed by the regulations (s 761D(1)(b))? (c) Is the amount of the consideration, or the value of the arrangement, ultimately determined or derived from, or does it vary by reference to (wholly or in part), the value or amount of something else, such as an asset or index (s 761D(1)(c))? 24 Returning to the characteristics of the MINI warrants identified above and taking the questions out of order: (a) As to question (c): the amount of the consideration, or the value of the arrangement, is plainly ultimately determined or derived from the value or amount of something else, being shares in Atlas Iron Limited or the ASX SPI 200 Index Futures contracts; (b) As to question (a): the arrangement does make provision whereby a party to the arrangement may be required to provide consideration of a particular kind or kinds to someone at some future time because each MINI warrant imposed on CSISAL an obligation to pay to the holder the Termination Amount in certain circumstances (see [12] above) calculated in accordance with section 8 of the PDS, depending on the MINI type (Long or Short) and notwithstanding that the definition expressly contemplates that the result of the calculation may be that no payment is required to be made. 25 This leaves question (b). ASIC initially submitted that the "future time" is not less than one business day (reg 7.1.04(1)(b)) after the day on which the arrangement is entered into. This condition was satisfied, it was said, because the future time at which the obligation on the part of CSISAL to provide consideration may arise is satisfied by reason of the reference, in the definition of Settlement Date, to "10 business days" after the happening of specified event: see [11] above. 26 The definition of Settlement Date must, however, be read in full. The Settlement Date could include "such other date as determined by the Issuer in its discretion as is reasonably necessary for the Issuer to fulfil its obligations under these Terms". It follows, at the very least as a matter of logic, that it could be less than 10 days. I have previously referred to the characteristics of s 761D as allowing for declaration by regulation of derivatives (s 761D(2)). As noted above, reg 7.1.04(2) relevantly provides that under the arrangement, a party to the arrangement may be required to provide consideration at a future time which may be less than one day after the arrangement is entered into. Despite the lack of precision caused by the words "such other date as determined by the Issuer in its discretion", the date upon which the obligation arises on the part of CSISAL to pay to the holder the Termination Amount or the Stop Loss Value must logically be at a future time within the meaning of the regulation. 27 It follows that all the necessary characteristics of a derivative are satisfied in the circumstances of the MINI warrants. 28 What can be seen is that the Tribunal, in reaching its conclusion at [26] of its reasons, focussed on the description in the PDS as to "the open-ended nature of a MINI" and the description of MINI warrants, in Annexure A to ASIC's decision, as having no set expiry date. With respect, this approach diverted attention away from the analysis of the "arrangement", as is required by s 761D(1). In fairness to the Tribunal, it does not seem, given what I have seen of the record below, that the textual and contextual analysis conducted on appeal was gone into in any detail at the hearing, perhaps for understandable reasons, given the primary focus of the proceedings before the Tribunal. 29 Accordingly, the appeal ought to be allowed and the decision made by the Tribunal on 20 January 2017 should be set aside. It is necessary that the matter be remitted for redetermination according to law.

G ADDENDUM 30 What is set out above constitutes a record of my ex tempore reasons for allowing the appeal. Subsequent to the making of orders and oral delivery of my reasons, I became aware of a communication by Mr Davidof to the NSW Appeals Registry of the Court, early on the morning of the hearing, expressing his concern that the appeal book did not contain a complete copy of the reasons of the Tribunal. Mr Davidof was correct to point to this discrepancy. For completeness I should record that I did, however, on the appeal, have access to the record below and was in possession (and took account) of a complete copy of the reasons of the Tribunal in determining the appeal. I certify that the preceding thirty (30) numbered paragraphs are a true copy of the Reasons for Judgment herein of the Honourable Justice Lee.