Plaintiff v Defendants

Mr D Grieve QC with Mr A G Melick SC, Mr R Gordon and Ms D Coulton

1 Berndale Securities Ltd ("Berndale") is a member of the Merrill Lynch group of companies. It commenced this proceeding to recover from the defendants, How Trading Pty Ltd ("How Trading") and David Charles Waterhouse, the balance of an account recording the indebtedness of How Trading to Berndale under a Derivatives Client Agreement dated 24 May 2006. The indebtedness arose in part as a consequence of options trading undertaken by How Trading, and in part as a consequence of action taken by Berndale when unwinding or liquidating the portfolio following default by How Trading. Mr Waterhouse controlled How Trading and guaranteed its obligations to Berndale.

2 Berndale was not How Trading's broker for the purpose of placing orders or giving advice. How Trading bought and sold options through Norris Smith Stockbroking Pty Ltd. In order to trade in options it was necessary for a clearing participant, authorised by Australian Clearing House Pty Ltd (the "ACH"), to assume liability as principal to the ACH on each transaction. Norris Smith was a trading participant under the ASX Market Rules, but not a clearing participant. Berndale was a general participant under the ACH Clearing Rules and a general settlement participant under the ASX Settlement Rules. Berndale provided third party clearing services to Norris Smith and How Trading.

3 The sole business of How Trading was to trade options in shares listed on the ASX. Mr Waterhouse was an experienced options trader through various entities. At different times in his career he had been a bookmaker and professional punter. He commenced to engage in the business of options trading in about late 1998 or early 1999.

4 Mr Waterhouse approached options trading as a gamble, trusting his judgment that the stock market would move in a particular direction. He traded options without owning the underlying stocks in which options were bought or sold. He regarded hedging as an unnecessary cost. His trading practices had the potential to yield substantial profits if the market moved as Mr Waterhouse predicted; but also exposed How Trading to the risk of substantial losses should the market move against him.

5 The market had fallen rapidly during the last quarter of 2007 exposing How Trading to potential losses reflected in margin calls made by the ACH on Berndale and passed on to How Trading. The margin, required by the ACH and Berndale, was calculated by reference to a sophisticated risk analysis undertaken by the ACH. The ACH acted as counterparty to seller and buyer under contracts. Berndale was not required to accept the margin calculation made by ACH but did so for the purpose of making margin calls on How Trading.

6 Until early November 2007, How Trading continued to meet its obligations under margin calls which were satisfied in cash by a direct debit made to an account at Westpac Bank. The ACH held some cash as security and was beneficiary under a bank guarantee, issued by Westpac, in the amount of $1 million. Berndale was not a beneficiary under that guarantee which was, in any event, due to expire on 31 December 2007.

7 Berndale had been concerned about the level of its exposure under the How Trading portfolio from as early as about February 2007, although it did not appear to take any step to challenge the trading strategy of Mr Waterhouse, nor to obtain security from him or How Trading until after Westpac had dishonoured a margin call made on 9 November 2007 in the sum of $3,784,733.01. On 21 November 2007, the bank dishonoured another margin call of $2,323,753.70. A further call for $2,456,127.76, made on 22 November 2007, was also dishonoured.

8 On 26 November 2007, Berndale notified How Trading that its failure to meet the margin calls constituted a default under the agreement and demanded that How Trading comply with its obligations. How Trading did not comply. Negotiations between Mr Waterhouse and representatives of Berndale followed, resulting in the execution of a letter agreement on 5 December 2007 amending the Derivatives Client Agreement. Under the December agreement, Berndale permitted How Trading to retain control of its portfolio on condition that the margin was maintained within specified limits and How Trading agreed to procure Westpac to issue a bank guarantee in favour of the ACH and Berndale to the value of $4 million. Mr Waterhouse agreed to provide his personal guarantee to further secure the indebtedness of How Trading to Berndale.

9 While How Trading was to retain control of the portfolio, its trading activity was limited to risk reduction trades. Such trades might have included the purchase of opposite positions to those which exposed How Trading and Berndale to the risk of financial loss. Risk reduction trades might also have involved a cost - the purchase price of opposite positions. While the intended consequence of authorised trading was to reduce the margin, there was no guarantee that this would occur. Market volatility could result in an escalation of the risk component in the margin calculation and erode the value of any reduction achieved through a buy back.

10 There was a sense of great urgency in the negotiations leading up to the December agreement. In the absence of agreement, Berndale proposed to exercise its default powers with the consequence that How Trading would lose control of the portfolio and account. The urgency was compounded by the fact that the Waterhouse family was about to fly to Aspen for a holiday. They were scheduled to depart on the afternoon of 5 December. As for Berndale, it was already exposed to financial loss which would crystallise if it took over and liquidated the account. It held no security from How Trading or the Waterhouse family.

11 Following the December agreement a dispute arose concerning the source of credit to fund buy backs. The dispute came to a head in late December 2007 when Berndale took steps to prevent How Trading from closing out positions without contributing its own cash to pay the premium. In response, How Trading commenced a proceeding in the Supreme Court of New South Wales to enforce an alleged agreement with Berndale under which How Trading was permitted to use the available margin, limited by the agreed cap, as if an overdraft facility to fund the required premium. The dispute was resolved by terms recorded in a letter agreement, dated 3 January 2008. The January agreement also amended the Derivatives Client Agreement.

12 The January agreement enabled How Trading to retain control of its account. However, by the close of business on 9 January 2008, the ACH margin exceeded the agreed cap of $6.5 million. Under the January agreement, How Trading had 48 hours within which to reduce the margin below the cap. It failed to do so. On 14 January, the following Monday, Berndale notified How Trading that it proposed to take control of the portfolio and exercise its default powers.

13 As at the close of business on Friday 11 January, the ACH had calculated the net market value of the portfolio at -$5,724,945.99. The defendants relied on the ACH valuation as the indicative cost at which open positions could and should have been closed by Berndale had it acted immediately. Berndale made no attempt to close out the portfolio as the defendants alleged should have occurred.

14 When Berndale took control of the portfolio on 14 January 2008, it comprised 18,269 open contracts. Most of the contracts were "sold put options" for which How Trading had derived premium income. The portfolio was large by industry standards for a private trader. One measure of its size was the number of open contracts. Another measure was the notional value of the underlying stock which was more than $545 million.

15 Berndale claimed the sum of $9,960,858.44 including interest calculated to 5 August 2009, and interest thereafter until judgment. That claim was in addition to $4 million already recovered by Berndale under a bank guarantee issued to it by Westpac at the request of Mrs Waterhouse. Berndale's calculation of its claim took account of the cost of closing out some positions and of trading profits and losses made in the course of hedging the portfolio, as well as the cost of finally disposing of the portfolio at auction on 5 March 2008.

16 The defendants initially defended the claim by alleging breaches of the Derivatives Client Agreement, a breach of fiduciary duty and a breach of the duty to mitigate. The alleged breaches related to the way in which Berndale purported to exercise its default powers. As the proceeding advanced, that part of the defendants' case underwent some change. The defendants ultimately alleged that the persons responsible for exercising Berndale's default powers were incompetent, with no real appreciation of their function. They alleged that Berndale should have, but did not, liquidate the portfolio on and within a few days of 14 January 2008. It was the defendants' case that had Berndale done so and closed out certain hedging contracts on 22 January 2008, Berndale would not have been entitled to call upon the bank guarantee. That line of reasoning would have the defendants' benefit from the conduct they alleged was unreasonably undertaken by Berndale in breach of contract.

17 A very substantial change was made to the defendants' case in March 2009. They amended their defence and counterclaim to allege that Berndale had engaged in conduct in contravention of s 12DA of the Australian Securities and Investment Commission Act 2001 (Cth) ("the Act"). The defendants alleged that How Trading was induced by oral representations and silence to agree to the terms of the December agreement under which the bank guarantee for the sum of $4 million and the personal guarantee of Mr Waterhouse were provided.

18 The conduct complained of by the defendants took place at meetings between representatives of Berndale and Mr Waterhouse on 5 December 2007, shortly prior to the execution of the December agreement and delivery of the guarantees. The Berndale representatives involved in the meetings with Mr Waterhouse were John Norman Laws, managing director of equity financing at Merrill Lynch; Robert John Forbes, a director of Berndale; and Michael Charles Horrax, general counsel for Merrill Lynch.

19 The alleged representations were to the effect that Berndale would fund premium required by How Trading to undertake risk reduction trades permitted under the December agreement; and that neither Berndale nor Merrill Lynch would trade on their own account for the purpose of reducing their own exposure to the How Trading portfolio. The defendants alleged that the representations were untrue because at the time they were made Berndale had no intention of funding the risk reduction trading; and because Merrill Lynch had already undertaken risk mitigation trading on its own account and intended to continue to do so. The risk mitigation transactions became known as the Merrill Lynch house trades. The conduct by silence relied upon by the defendants was Berndale's failure to inform them that Merrill Lynch had already undertaken risk mitigation trading.

20 How Trading also alleged that in reliance upon the contravening conduct of Berndale it agreed to indemnify Mrs Waterhouse for any amount for which she became liable to Westpac under the bank guarantee granted at her request. It counterclaimed for damages or restitution in amounts calculated by reference to the amount paid under the bank guarantee. The evidence supports such an agreement and, insofar as it may be relevant, I find that there was an agreement by How Trading to indemnify Mrs Waterhouse.

21 The parties divided the case into two parts. Chapter 1 concerned the defendants' misrepresentation case. Chapter 2 concerned the defendants' challenge to Berndale's exercise of the default powers.

22 The defendants' Chapter 1 case depended substantially upon the court accepting the evidence of Mr Waterhouse about his conversations with the representatives of Berndale on 5 December 2007 prior to executing the December agreement. The Chapter 2 case involved an analysis of Berndale's contractual and other duties owed to How Trading when purporting to exercise default powers, whether Berndale breached any of those duties and if so, with what consequence.

23 Mr Waterhouse prepared and filed a lengthy, detailed and at times self-serving witness statement. He presented as an intelligent and astute businessman and witness. It was apparent that he had spent a great deal of time in preparation for giving his evidence. The account given by Mr Waterhouse of the important events and conversations on which the defendants' misrepresentation case was based was challenged by Berndale.

24 The evidence of Berndale's witnesses, Messrs Laws, Forbes and Horrax, was generally unsatisfactory. It was imprecise, vague and defensive. That said, I am not persuaded that the representations alleged by the defendants were in fact made. Much of the evidence given by Mr Waterhouse in support of the misrepresentations and reliance was implausible. The background circumstances, objectively ascertained, made his evidence improbable.

25 Berndale went further and submitted that much of the evidence given by Mr Waterhouse about the relevant conversations was a recent invention and contrived. I have found that the defendants' misrepresentation case was opportunistically constructed around known facts and circumstances to make it appear plausible. The oral evidence of Mr Waterhouse exposed a house of straw. I reject the defendants' misrepresentation case. I have also found that Berndale's failure to inform How Trading of the Merrill Lynch house trades was not misleading or deceptive.

26 The defendants' Chapter 2 case involved allegations of breach of contract and fiduciary duty. The breach of contract case ultimately advanced by the defendants virtually ignored the pleadings. Berndale claimed that when exercising its default powers it was unfettered by any obligation of good faith to act reasonably (in an objective sense) or to have regard to the interests of its client. Its fall-back position was that it was required to act as a reasonably prudent broker protecting its personal obligations.[1]

27 The defendants submitted that Berndale owed to How Trading a positive duty to act reasonably when exercising the default power. That duty, they submitted, was an incident of an obligation of good faith arising under the contract. They alleged that Berndale breached the duty through the incompetent handling of the How Trading portfolio. They alleged that instead of taking the simplest and most straightforward course available - to close out all positions immediately - Berndale engaged in risky and expensive trading, changing the nature of the portfolio into a hedged package of positions for auction.

28 The defendants submitted that, by reason of its breach, Berndale was not entitled to claim the amount stated in the account, which had been inflated by its own improper conduct. Instead, Berndale should be confined to the value of the portfolio at the time it took control, on 14 January 2008 or the value at which the portfolio could have been realised in the market had Berndale closed out all positions immediately. The defendants alleged that had Berndale taken that course they could have done so at a cost which approximated the ACH valuation made as at the close of business on 11 January 2008.

29 The defendants argued that their account with Berndale should also be credited with the amount of the profits that would have been made by Berndale from the short sale of stock and trading in XJO put options, on the basis that those contracts should have been closed out on 22 January 2008. Alternatively, they claimed a credit for the actual profits made. The defendants claimed the notional or actual profits on the basis that, when exercising its default powers, Berndale was acting as agent for How Trading and breached a corresponding fiduciary duty to minimise its loss. They alleged that a proper accounting would have resulted in a reduction of How Trading's liability to nil or thereabouts, denying Berndale any right to draw down on the whole or most of the bank guarantee.

30 The defendants argued that Berndale was liable in damages to How Trading to the extent to which the amount recovered under the bank guarantee exceeded the correctly adjusted indebtedness of How Trading to Berndale. They claimed in the alternative that Berndale was unjustly enriched at the expense of How Trading by recovering under the bank guarantee.

31 Through its Merrill Lynch witnesses, Jason Kieran Ryan and Paul Lindsay Craft, Berndale advanced its strategy to unwind the portfolio and sought to explain and justify the strategy. Mr Ryan was head of equity risk and derivatives trading in Australia at Merrill Lynch. Mr Craft was a derivatives trader at Merrill Lynch. Their stated purpose was to prepare the portfolio for auction. They said that this necessitated very significant hedging in order to make the portfolio more attractive to potential bidders. Almost two months elapsed from the time Berndale took control of the portfolio until auction.

32 Messrs Ryan and Craft ridiculed the defendants' reliance on the ACH valuation as a measure of what could have been achieved in the market had Berndale closed out the positions on and within a few days of 14 January 2008. They said they never relied on the ACH valuation. They justified their auction strategy by asserting that it would have been impossible to close out positions immediately at a reasonable price, although they did not explore the market to ascertain what was possible or at what price. They refused to be drawn on what a reasonable price might have been.

33 After completion of the evidence and final submissions, but before judgment was delivered, the defendants made application to reopen their case and adduce further evidence. I have acceded to their application. The new evidence concerned the liquidation of the Lift Capital options portfolio about a month after the How Trading portfolio had been sold at auction. It was a portfolio of similar size to the How Trading portfolio. Messrs Ryan and Craft were also involved in that liquidation, which was completed within a few days of Merrill Lynch assuming control of the portfolio. No mention was made by Mr Ryan or Mr Craft at the trial of their involvement with the liquidation of the Lift Capital portfolio. It was not in dispute that the defendants were unaware of the relevant events until early February of this year.

34 While Berndale valiantly tried to distinguish the portfolios, I regard the evidence given about the Lift Capital portfolio as highly relevant at a number of levels and I have taken into account the relevant and admissible evidence adduced on the defendants application to re-open the trial. I was surprised and disappointed, to use a neutral phrase, that the role of Merrill Lynch in the liquidation of the Lift Capital portfolio was not disclosed by Berndale prior to or during the trial. Berndale could not have overlooked the potential impact of that evidence on the defendants' case and on its case in response.

35 On their own evidence Messrs Ryan and Craft did not explore the possibility of closing out all positions in the How Trading portfolio as quickly as possible. They said that to close out all positions in the market at that time would have been imprudent. They said that it would not have been possible to buy back positions at a reasonable price. Mr Ryan said that he decided upon an auction strategy as early as December 2007.

36 I have found that the rationale advanced by Messrs Ryan and Craft at trial for not immediately closing out all positions to be the product of reconstruction and an opportunistic invention. I have rejected the defendants' case against Berndale for breach of a fiduciary duty owed to How Trading, although I have found that Berndale owed a duty of good faith to How Trading when exercising the default powers. Berndale was required to have regard to the interests of How Trading and to act honestly and reasonably. Such duties are entirely consistent with the powers contained in cl 6.4 of the Derivatives Client Agreement, including Berndale's right to protect its own position.

37 I do not accept the evidence of Messrs Ryan and Craft in which they sought to explain why they could not, and thus did not, close out all positions on and within a few days of 14 January 2008. That evidence was accompanied by an equally implausible, but necessary, assertion that it was always their purpose to prepare the portfolio for auction.

38 On about 6 February 2008 Berndale commenced to make arrangements to conduct an ASX approved auction. It is not clear precisely when that decision was made, but I am satisfied that it was not made when Mr Ryan said it was. It was not made prior to Berndale taking control of the portfolio and cannot be employed by Berndale as a justification for the "strategy" implemented over the week commencing 14 January.

39 Contrary to the evidence of Messrs Ryan and Craft, I have found that there was, in the week commencing on 14 January 2008, a market in which the How Trading option positions could have been closed out. It was a reasonably liquid market and would, if tested, have resulted in transactions at prices close to the ACH valuations. A reasonable broker, looking to protect its own interests, would have at least tested the market. Mr Craft summed up the position when he said,

If I could have sold all of the options in the How Trading [portfolio] on the open market for reasonable prices on Day 1 [14 January 2008] or within several days of Day 1, I would have. If there had have been such a market at a fair price, selling the options on the market would have been the right thing to do. There was no incentive for us not to close down the portfolio in the least expensive and in the shortest time possible. However, there was no market for the number of options positions contained in the How Trading portfolio.

40 If the evidence of Mr Ryan, to the effect that he had decided to auction the How Trading portfolio as early as December 2007, is to be accepted, he made that decision without regard to the market as it existed in the week commencing 14 January 2008. Berndale did not seek ASX approval for an auction until early February 2008. Mr Ryan also said, contradicting other evidence given by him, that the How Trading portfolio had to be auctioned because Merrill Lynch had exhausted what liquidity they could find so that "we had to go down the route of the OTC auction for the How portfolio, there was no other choice. No other choice." In my opinion the decision to auction the portfolio was probably made in late January or early February 2008. Thus, an early decision to auction does not support or explain the short sales, hedging activity and delay in liquidation.

41 Whenever the decision to auction the portfolio was made, whether "very early in the equation" as Mr Ryan insisted, or in late January or early February, the fact remains that Berndale converted the How Trading portfolio, which Mr Ryan described as "toxic", into a fully hedged parcel of positions. In my opinion Berndale was not authorised to turn a pumpkin into a golden carriage at How Trading's expense. When exercising default powers under cl 6.4 it was entitled to deal with the portfolio to reduce its own exposure and consequently the exposure of How Trading. It was not entitled to create a new and more attractive product to offer to potential institutional bidders, if that was it's purpose.

42 In the absence of a credible explanation by Messrs Ryan and Craft for their management of the portfolio from the outset their purpose is elusive. What then was their purpose if not to prepare the portfolio for auction? What other explanation might there be for the short sales, the expensive hedging and delay in liquidation? Does the absence of a credible explanation establish the defendants case?

43 Contemporaneous correspondence revealed other possible explanations as to why Berndale might have chosen not to immediately close out the whole of the portfolio. In the week commencing 14 January 2008 Mr Waterhouse was attempting to secure additional finance to enable him to resume control of the portfolio and take it to another broker. By the following week it became obvious that his efforts would not succeed. It was only then that Berndale called upon the bank guarantee. That explanation was not, however, explored in evidence or advanced by Berndale.

44 Another possible explanation involved the defendants allegation that Berndale had made short sales of stock in the week commencing 14 January in an attempt to profit from knowledge of the imminent publication by Merrill Lynch of adverse trading results. A substantial profit, made from short sales, might have had the effect of eliminating the whole of Berndale's loss. Messrs Ryan and Craft explained the transaction as a hedge. Their explanation of the transaction was not ultimately challenged by the defendants.

45 A further possible explanation is that Berndale, treating the portfolio as it's own, wished to create a risk free hedged portfolio awaiting a final decision as to the best way to liquidate in an orderly manner. Such an objective may have been consistent with the letter of instruction from Ms Harkness, although Berndale advanced a different case.

46 The absence of a satisfactory explanation by a broker for its management of a portfolio in the exercise of its default powers, does not necessarily translate into a finding that it had acted unreasonably or in breach of its duty of good faith. This was not, however, a case involving the mere absence of a satisfactory explanation. Berndale had advanced a contrived and unconvincing explanation for remodelling or reworking the portfolio into a risk free, fully hedged, portfolio. I have the explanation. Berndale was not authorised under the Derivatives Client Agreement to restructure the portfolio at the expense of How Trading. In the absence of a credible explanation for remodelling the portfolio, when the most straightforward, simple and available course was to close out all positions, Berndale's conduct was inexplicable and unreasonably. It was also unauthorised.

47 Berndale also breached its duty to act reasonably by failing to have regard to the available market within which to close out the portfolio as soon as possible with the object of limiting its own liability and consequently the liability of the defendants. A reasonably prudent broker in the position of Berndale, acting to protect its own interests, and mindful of the interests of it's client, would have considered closing down the portfolio as soon as possible and tested the market for liquidity. Had Berndale done so, in the market that existed on and within a few days of 14 January, I have no doubt it would have found the necessary liquidity at prices at or near ACH valuations. In the circumstances a reasonable and prudent broker could and would have liquidated the portfolio by closing out all positions within the week of 14 January 2008.

48 Berndale's claim for payment of the account is made under cl 6.4 of the Derivatives Client Agreement. It was not authorised to recover the cost of transforming or remodelling the portfolio. Further, having breached its obligations to How Trading in the exercise of those powers, Berndale was not entitled to debit the How Trading account with the cost incurred when purporting to exercise the default powers. Berndale is not, however, required to bring to account the profits made during that process. Berndale's dealings with the account on and after 14 January 2008 were entirely at its own risk.

49 As a consequence, Berndale's claim against How Trading must be confined to the value of its exposure under the contracts in the portfolio it took over on 14 January 2008. The value may be arrived at in a number of ways. One possibility is the ACH valuation as at the commencement of business on 14 January 2008. The value of the portfolio at that time was ―$5,724,945.99. Another possibility is to assume that Berndale "did the right thing", as Mr Craft put it, closing out all positions within the week of 14 January 2008. Doing the best I can, but without any assistance from Berndale in having relevantly tested the market at that time, I would attribute the same value to the portfolio as the ACH valuation. I am fortified in that view by the evidence relating to the Lift Capital portfolio. From that amount must, of course, be deducted the sum recovered by Berndale from Westpac under the guarantee.

50 The counterclaim is dismissed. I will give the parties an opportunity to formulate proposed orders reflecting these reasons and will hear them on the question of costs.

51 Options trading may be well understood by many. What follows is a brief outline of those features of options trading in the relevant market which will assist an understanding of the issues in this case.[2]

52 Options are a form of derivative traded over the ASX 'deriving' their value from the underlying security on which they are traded. Options are most commonly traded over stocks but may be tracked over other types of securities such as an index. Options may either be bought (taken) or sold (written).

53 An option is a contract between two parties giving the taker (buyer) the right, but not the obligation, to buy or sell the underlying security at a pre-determined price (strike price) on or before an expiry date. To acquire this right the taker pays a premium to the writer (seller) of the contract.

54 Three features of options contracts have been standardised by the ASX; (1) the underlying security; (2) the expiry date and (3) the exercise or strike price. Each options contract is standardised to include 1,000 underlying securities, usually shares.

55 The expiry date is the last day of trading for a contract series. Options over shares usually expire on the Thursday before the last business Friday of the month. Index options expire on the third Friday of the contract month. Option contracts are usually listed with an expiry date for the next three months of a quarterly expiry cycle. For example, options would be available with expiry dates in January, April and July. In addition to quarterly expiry cycles, a current or "spot" month is also available. These options expire at the end of the current month.

56 There are two forms of options; call options and put options. Call options give the buyer/taker the right, but not the obligation, to buy the underlying shares at a predetermined price on or before a predetermined date. For this right the buyer/taker pays a premium as determined by the market, to the writer/seller of the options. Premiums are quoted on a cents per share basis. As each option contract provides for 1,000 shares, the premium as quoted, is multiplied by 1,000 to convert it to a dollar sum. On the other side of the transaction, a writer/seller of a call option is obliged to sell the underlying shares to the buyer/taker, if they exercise the option at the strike price. The writer is paid and keeps the premium regardless of whether the option is exercised.

57 Put options give the buyer/taker the right but not the obligation to sell the underlying shares at a predetermined price (strike price) on or before the expiry date. That is, the buyer/taker is only required to sell (deliver the underlying shares) if they choose to exercise the option. Again the taker/buyer pays a premium to the person writing/selling the put option. The writer or person selling the put option is obliged to buy the underlying shares at the strike price as agreed.

58 Options are commonly referred to as either "American" or "European". An American option (most options on the ASX) may be exercised at any time prior to the expiry date, whereas a European option may only be exercised on the expiry date.

59 The price of an option premium is influenced by two components; (1) the price of the underlying share or intrinsic value; and (2) the time left until expiry or time value.

60 An option may have intrinsic value when the exercise/strike price differs from the price of underlying stock. In the case of a call option (where the taker/buyer has a right to buy), the option will have intrinsic value, when the strike price is below the market price of the share. For example, a July $30 CBA call option has intrinsic value if CBA is trading at above $30. Options with intrinsic value are said to be "in the money". A trader will buy call options if they think the share price will go up and sell call options if they think the share price will go down.

61 In the example, if CBA shares were trading at less than $30, the call option would have no intrinsic value, because it only provides the right to buy the shares at a price higher than the market price. Needless to say, if the share price is below the strike price, it is better to buy the shares on the share market and let the option expire worthless. In this case, the option is said to be "out of the money".

62 Put options are the opposite of calls. If the strike price is greater than the market price, the taker may exercise the option to sell the shares at that price. Consequently, if, in the July $30 CBA example, CBA is trading at less than $30, the put option will be in the money. A put option will be out of the money if the stock price is higher than the strike price. In such a case, the option would not usually be exercised and would expire worthless.

63 Time value represents the period of time remaining until expiry of the option. This is affected by several factors including: (a) time till expiry; (b) volatility; (c) interest rates; (d) dividend payments; and (e) market expectations. As a general rule, the following holds true. The longer the time to expiry, the greater the time value of the option. The more volatile the price of the underlying stock, the higher the premium will be. This is due to the wider range over which the stock can potentially move. A rise in interest rates will usually push call option premiums up and put option premiums down. If a dividend is payable on underlying shares during the life of an option it will usually reduce the premium of a call option and increase the premium of a put option higher. Holders of options contracts who do not own the underlying securities are not eligible for dividends payouts. Ultimately, supply and demand will determine the market value of all options. During times of strong demand premiums will be higher.

64 The premium paid by the taker represents an assessment of the maximum loss possible on the option. This is because the taker is under no obligation to exercise their right under the option contract. The taker of a put option and the seller of a call option is not required to own the underlying security. If the writer of a call option does not own the shares, they would be obliged to buy the shares at market price in order to sell at the strike price under the option if expressed. Such options are known as "uncovered" or "naked". The writer of put options is obliged to buy shares from the option holder at the strike price and is thereafter exposed in a falling market. In such circumstances, in theory, the writer of put options would be obliged to buy shares from the option holder at above market. To avoid that risk, the writer will usually choose to "close out" a position prior to expiry.

65 An option may be "closed out" by obtaining a corresponding option in the same contract series. For example, if a put option is written/sold, it may be liquidated or closed out by buying/taking an identical put option from another party. Each contract effectively cancels the other out, and the seller/writer under the first contract is discharged from its obligation. A loss may be incurred, if when closing out a written put option, the premium paid is higher than the premium received under the original written/sold options contract. On average, less than 15 per cent of options are exercised. The remaining 85 per cent are closed out or expire unexercised.

66 The options market in Australia is operated by the ASX. The ACH administers the clearing facility for the ASX options market. Clearing is the process by which a "clearing participant", authorised by the ACH, trade and settle option contracts on their own and on behalf of other brokers. Options registered with the ACH are contracts between the clearing participant and ACH on a principal to principal basis. Under the Clearing Rules the ACH becomes central counter-party to both the buying and the selling broker. To ensure the obligations of the options writer, who is exposed to risk in the underlying stock price, the ACH requires the payment of margins as security. ACH calls the margin from a broker or clearing participant, who then calls the margin from the client. This means that the buying and selling brokers only deal with the ACH in the settlement of option contracts and neither broker has to rely on the other to perform under the contract.

67 When calculating its margin requirements the ACH uses the Theoretical Intermarket Margining System ("TIMS"). The margin so calculated has two components:

(1) The premium margin is the market value of the position at the close of business each day. It represents the amount that would be required to close out the options positions;

(2) The risk margin covers the potential change in price of the option contracts assuming the maximum probable intra-day movement (daily volatility) in the price of the underlying security. The daily volatility figure, expressed as a percentage, is known as the margin interval.

68 The TIMS is designed to evaluate the risks associated with an entire options portfolio and calculate the total margin payable, taking into account the volatility of the underlying stock. Volatility refers to the size and frequencies of price fluctuations. In times of increased volatility, the margin is likely to increase. It is important to note that the clearing participant, as principal, is initially liable to pay the margin. The clearing participant may require additional margins from a client to further secure its liability to the ACH. Brokers, clearing participants and the ACH may use different margining standards and the resulting margin may be different. When a clearing participant makes a margin, say from the client, it must generally be paid within 24 hours. If payment is not forthcoming the account is in default and the clearing participant is entitled to take prescribed action in relation to the client account and portfolio.

Brokers, market participants and clearing participants

69 Brokers provide a range of services to their clients. A "full service broker" offers both trading and clearing services. Norris Smith offered only trading services, contracting with Berndale to provide clearing services. For that purpose Norris Smith entered into an agreement with Berndale. How Trading, a client of Norris Smith, also entered into an agreement with Berndale as clearing participant.

70 Market makers provide liquidity in the market by providing quotes in certain options series. Under the ASX rules, each market maker is assigned one or more securities in which they must meet certain obligations. Market makers may be required to make a market on a continuous basis only, to quote requests only, or both. Continuous operators are obliged to make a market on a continuous basis, providing orders continuously in a designated number of series for specified underlying securities. Each order must be for a minimum quantity and at or within the designated maximum spread requirements.

71 A market maker assigned to respond to quote requests must provide orders on request for a certain percentage of the time for designated series, for the minimum designated quantity and within the maximum designated spread. The category of the security determines the maximum spread (the difference between the bid and the price) the designated market maker may quote when making a market and the minimum number of contracts for which the market maker must quote a price.

72 Thus, while market makers are intended to provide liquidity there is no guarantee that at any one time all series will have prices displayed. In the present case there was no suggestion that there was no available market on and from 14 January 2008 to enable Berndale to close out the How Trading positions. The question was price.

73 Traders often apply mathematical modelling, colloquially known as "the Greeks" to assess the risk within an options portfolio and where that risk lies. The "Greeks", commonly referred to as Delta, Gamma, Vega and Theta, are derived from the Black Scholes option pricing formula. The professional market uses the Greeks to measure how much hedging is needed to balance a portfolio.

74 Delta represents the change in value of an option (that is the change in premium) due to a change in price of the underlying securities. It is generally measured in a dollar amount. For example, an option with a delta of 0.5 will move half a cent for every one cent movement in the underlying stock. In a portfolio of 100 options the Delta multiplied by 100 is the number of shares required to create a neutral hedge. That is, to create a portfolio that would be worth roughly the same whether the stock price rose by a small amount or fell by a small amount. A "delta neutral" portfolio is intended to ensure that a change in the value of the options held due to a change in the underlying share price would be almost exactly offset by a corresponding change in the value of the options.

75 Gamma is the measure of the change in delta for a change in the value of the underlying stock price. Gamma-1 is the rate of change for delta when the market has fallen 1 per cent. The rate of change from gamma-1 to gamma-5 is not linear even though gamma-5 measures the rate of change when the market has fallen 5 per cent. A large gamma measurement will reflect a high level of exposure to change in the underlying stock. It is generally employed as a trigger for hedging or hedging adjustments. Gamma is an indication of the stability of a portfolio. The smaller the gamma the less often a delta hedge needs adjustment to maintain a delta neutral position.

76 Vega measures the change in option price given a change in volatility of the underlying stock. Theta is the change in option price given a one-day change in time to expiration. It is also referred to as time decay. Volatility is a measure of the precast or expected change in the price of underlying stock over a period of time.

77 Trading in options may involve up to four parties. Under the Market Rules a broker must be admitted as a "market participant" to execute trades on the financial market, whether for clients or as principal. Section 3 of the Market Rules provides for the admission of market participants by the ASX. The broker or market participant may permit a client or "authorised person" to place "orders". Orders are defined as instructions to enter into a derivatives market transaction or cancel a prior instruction.

78 A market participant may be granted "trading permission" by the ASX in respect of one or more financial products on the "trading platform" under section 12 of the Market Rules. The trading platform is made available by the ASX to trading participants for the entry of trading messages, the matching of orders, the advertisement of invitations to trade and the reporting of transactions. Trading messages are those messages submitted into a trading platform relating to trading functions, such as orders, amendment or cancellation of orders and the reporting or cancellation of market transactions.

79 All options trades executed on the ASX financial market are cleared through the ACH as central counterparty. To be eligible to clear trades through the ACH, an entity must be admitted as a "clearing participant" under section 3.1 of the Clearing Rules. ACH may admit an applicant as either a direct participant or general participant. A direct participant is authorised to clear a category of market transaction for itself and its clients. A general participant is admitted to clear a category of market transactions for itself, its own clients, other participants and their clients, and market participants and their clients. When trading in derivatives is undertaken the ACH requires participants to deposit 'margins' as a form of security to support the obligations under open contracts.

80 Each trading participant is given trading permission to submit trading messages and matching of orders in a trading platform. Once a client instructs its broker to buy or sell a contract, the trading participant enters the buy or sell order into the trading platform and the trading platform matches the order with a corresponding sell order entered into the trading platform by another trading participant. Under market rules, upon the matching of orders in the trading platform, a contract is formed between the trading participants whose trading messages are matched. The terms of the contract are defined by the relevant series, price and volume. Where the transaction is cleared by a clearing participant, such as Berndale, the rights and obligations of the trading participant (here, Norris Smith) are assumed by the clearing participant as principal.

81 Upon registration of a contract, ACH will novate the two corresponding contracts which are replaced by two "Derivatives CCP Contracts" with the following effect: (a) obligations owed by the seller to a buyer are replaced by obligations in the same terms owed by the seller to ACH and by obligations owed by ACH to the seller; (b) obligations owed by a buyer to a seller are replaced by obligations in the same terms owed by the buyer to ACH and ACH to the buyer. In this way the ACH acts as the central counterparty to both sides of the contract and the participants have corresponding obligations to ACH.

82 The proceeding commenced by Berndale was a claim for a debt with an alternative claim for damages. Prior to March 2009, the defendants' defence and counterclaim did not include a Chapter 1 case in which relief was sought on the basis of misleading or deceptive conduct. Mr Waterhouse said that he did not discover the facts revealing the falsity of the representation concerning "buying protection" until he had reviewed Berndale's discovery in February 2009. He said that it was only then that he realised the significance and falsity of the related representations. Mr Waterhouse conceded that he was not dependent upon his review of discovered documents to reveal the significance of the representation concerning the funding of buy backs after 4 December 2007.

83 In the defendants Chapter 1 case, the credit of Mr Waterhouse was crucial. The plaintiff challenged his evidence as unreliable and in material respects deliberately false and contrived. It submitted that the evidence of Mr Waterhouse in relation to his conversations and dealings with representatives of Berndale on 5 December 2007 was a contrivance, invented after he realised that his Chapter 2 case was fatally flawed.

84 In March 2009 the defendants were given leave to file and serve an amended defence and counterclaim in which they relied for the first time on contraventions of s 12DA of the Act. The conduct relied upon was comprised of two promissory representations alleged to have been made on behalf of the plaintiff and a failure to inform. The promissory representations alleged to have been made were as follows:

(a) Berndale would provide the funds necessary to permit How Trading to buy back put option positions which it had sold so as to reduce its liability to Berndale under the Agreement; and

(b) that Berndale would not enter into any transaction to hedge or otherwise buy protection in relation to How Trading's account under the Agreement.

85 In a subsequent amendment, the defendants expanded the scope of the second representation by including a reference to the Merrill Lynch group of companies so that the alleged representation was that "neither Berndale nor any other member of the Merrill Lynch group of companies would..." In addition to the promissory representations, the defendants relied upon Berndale's failure to disclose the fact that from late November 2007 Merrill Lynch had entered into hedging transactions, on its own account, designed to protect the group from any loss the group might suffer by reason of its exposure to the How Trading portfolio. It is common ground that from about 30 November 2007 Merrill Lynch began trading index put options, futures and stock on its house account for the purpose of protecting the group from its potential loss on the How Trading portfolio. These transactions became known as the Merrill Lynch house trades.

86 Thus the conduct relied upon by the defendants as misleading and deceptive in contravention of s 12DA of the Act fell into two broad categories. The categories were:

The conduct in relation to the Merrill Lynch house trades had three components. There was the promissory representation, a representation (unpleaded) of a present fact and a failure to inform.

87 A proper analysis of the defendants' case of misleading and deceptive conduct in contravention of s 12DA of the Act necessitates a review of the background to and the course of the evidence. The starting point is the defendants' allegations as pleaded. The relevant allegations are set out below.

2E On 4 and 5 December 2007 Berndale by its servants John Norman Laws, Robert Forbes and Michael Horrax orally represented to the second defendant that if How Trading provided security to Berndale for the payment of all money for which How Trading was then or may thereafter have become indebted to Berndale under the Agreement in the form of a Dual Beneficiary Guarantee to be issued by Westpac in the sum of $4 million with currency and effect from 7 December 2007 until 6 December 2008 ("the Dual Beneficiary Guarantee") and if the second defendant provided the Guarantee referred to in paragraph 10 of the amended statement of claim, Berndale would provide funds to permit How Trading to buy back put options which it had sold so as to reduce its liability to Berndale under the Agreement and, further, that neither Berndale nor any other member of the Merrill Lynch group of companies would enter into any transaction in order to hedge or otherwise buy protection in relation to How Trading's account under the Agreement.

2F The representations referred to in paragraph 2E above were reiterated in a letter dated 5 December 2007 written by Berndale and delivered to How Trading on that day.

2G The representations referred to in paragraph [2E] and [2F] above were made by Berndale in trade or commerce and constituted conduct in relation to financial services within the meaning of section 12DA of the Australian Securities and Investments Commission Act 2001 ("the ASIC Act").

2H At the time of making the representations referred to in paragraphs [2E] and [2F] above at Berndale's direction or on its behalf Merrill Lynch (Australia) Futures Limited ("Merrill Lynch Futures") had entered into certain transactions to hedge or otherwise buy protection in relation to How Trading's account under the Agreement by trading in index put options, futures and stock and Merrill Lynch Futures continued to do so on and after 5 December 2007.

2I At the time of making the representations referred to in paragraphs [2E] and [2F] above Berndale intended not to provide funds to How Trading to permit it to buy back put options which it had sold which intention it carried into effect on and after 20 December 2007 by refusing to finance purchase orders then placed by How Trading with Norris Smith which orders, if executed, would have substantially reduced How Trading's liability to Berndale under the Agreement.

2J By reason of the facts stated in paragraphs 2H and 2I above the representations referred to in paragraphs 2E and 2F above were misleading or deceptive or likely to mislead or deceive in contravention of section 12DA of the ASIC Act.

2K The representations referred to in paragraphs 2E and 2F above were about future matters and in light of the facts stated in paragraphs 2H and 2I above Berndale did not have reasonable grounds for making those representations.

2L By reason of the facts stated in paragraph 2K above and by section 12BB and the ASIC Act, the representations referred to in paragraphs 2E and 2F above are taken to be misleading.

2LA Further, at no time prior to the second defendant's execution of the Guarantee referred to in paragraph 10 of the amended statement of claim and How Trading's entry into the agreement referred to in paragraph 2P below did Berndale disclose to the defendant or either of them that on and following 4 December 2007 Merrill Lynch Futures had entered into the transactions referred to in paragraph 2H above.

2LB Berndale's failure to disclose to the defendants the fact that on and following 4 December 2007 Merrill Lynch Futures had entered into the transactions referred to in paragraph 2H above constituted conduct that was misleading or deceptive or likely to mislead or deceive in contravention of section 12DA of the ASIC Act.

2M In reliance on the representations referred to in paragraphs 2E and 2F above the second defendant executed the Guarantee referred to in paragraph 10 of the amended statement of claim.

2N If Berndale had not made the representations referred to in paragraphs 2E and 2F above, or if it had disclosed the fact that on and following 4 December 2007 Merrill Lynch Futures had entered into the transactions referred to in paragraph 2H above, the second defendant would not have executed the Guarantee referred to in paragraph 10 of the amended statement of claim.

2O If the second defendant knew of the facts stated in paragraphs 2H and 2I above before he signed the Guarantee referred to in paragraph 10 of the amended statement of claim, he would not have executed that Guarantee.

2P In reliance on the representations referred to in paragraphs 2E and 2F above How Trading entered into an agreement with Janette Mary Waterhouse ("Mrs Waterhouse") on or about 10 December 2007 by which in consideration of her entry into an agreement with Westpac as set out in paragraph 7 of the counterclaim it agreed to pay to her an amount equal to whatever sum or sums for which she may become liable to Westpac under her agreement with it.

2Q If Berndale had not made the representations referred to in paragraphs 2E and 2F above or if it had disclosed the fact that on and following 4 December 2007 Merrill Lynch Futures had entered into the transactions referred to in paragraph 2H above How Trading would not have entered into the agreement with Mrs Waterhouse referred to in paragraph 2P above.

2R If How Trading knew of the facts stated in paragraphs 2H and 2I above before it entered into the agreement referred to in paragraph 2P it would not have entered into that agreement.[3]

88 When requested to give particulars of the conversations alleged in paragraph 2E the defendants provided the following:

The conversations took place during the course of a meeting in Berndale's Sydney office on 5 December 2007 between Mr David Waterhouse (representing How Trading), Mr John Laws, Mr Robert Forbes and Mr Michael Horrax (representing Berndale). The substance of what was said by Mr Laws with the concurrence of Mr Forbes and Mr Horrax was that if How Trading provided Mr Waterhouse's personal guarantee and the Dual Beneficiary Guarantee for $4 million Berndale would fund How Trading's buybacks and would not buy protection in relation to How Trading's account if it kept the account within the margins set out in the letter of 5 December 2007.[4]

89 At one point during a pre-trial hearing Berndale proposed that the course of evidence should permit its witnesses to give evidence in response to the evidence of Mr Waterhouse concerning the alleged representations. It was conceded by Berndale that, because of the challenge made to the exercise by it of the default powers, it would at least be necessary for its Chapter 2 witnesses to give their evidence as part of its case in support of its claim. The defendants took the contrary position, pressing for a direction that would require the whole of Berndale's evidence to be adduced before the defendants' witnesses gave their evidence.

90 Notwithstanding the highly contentious nature of the Chapter 1 case, I required Berndale to call all of its evidence first and to close its case before the defendants were required to call their witnesses. One consequence of that direction was that the defendants would be required to cross-examine Berndale's witnesses who participated in the relevant meetings on 5 December 2007, at which the alleged oral representations were made, before Mr Waterhouse gave his evidence.

91 In preparation for trial a direction was made to the effect that the evidence-in-chief of each witness was to be given by witness statement, although the evidence of and concerning the representations would be given orally. A separate outline of the evidence of each witness in relation to the contentious conversations was to be prepared and exchanged. Notwithstanding those directions, Mr Waterhouse filed a witness statement in which he set out in conversational style a detailed version of the representations allegedly made by Messrs Laws, Horrax and Forbes at the office of Merrill Lynch and Berndale on 5 December 2007. His evidence about those discussions was contained in paragraphs 101 to 111 inclusive of his witness statement.

92 Mr Waterhouse made his statement available to the media prior to trial. In it he recited in great detail many conversations with representatives of Berndale and Norris Smith, with Mr Tighe (his wife's financial advisor), and with his wife. He also recited a course of discussions with Mr Ritchie, a Merrill Lynch executive, in which he alleged he was told by Mr Ritchie of his intention to short sell shares in knowledge of an imminent adverse report to be published by Merrill Lynch in the United States. The witness statement was comprised of 257 paragraphs, over 50 pages. Many of the conversations recited in the statement contained assertions of what had been said in another conversation. Much of the proposed evidence appeared to be self-serving.

93 By filing a witness statement in which the contentious conversations were recorded in such detail, Mr Waterhouse provided Berndale, the court and the media with a very precise recitation of his version of conversations against which his oral testimony might be compared if the relevant passages were to become part of the evidence. As might be expected, Berndale filed and served a list of objections to the witness statement of Mr Waterhouse. It objected to the whole or part of 165 of the 257 paragraphs. Rulings were made in respect of some objections, although it was apparent that much of that to which objection was made might be canvassed in cross-examination. In order to resolve some objections it would be necessary to make findings of fact which may be uninformed and premature if made for the purpose of the ruling. It was apparent that credit would be an important issue and so it was very likely that many of the passages to which objection was made would probably be employed in cross-examination. The defendants submitted that final determination of the objections should be deferred until the end of the evidence. Against that background, I declined to rule on many of the objections, insofar as they were pressed requiring Berndale to revisit the objections in its closing submissions. By then it would be possible to discern what, if any, objections were pressed and how the defendants might justify the inclusion of material which at the outset appeared to be self-serving, irrelevant or otherwise inadmissible.

94 The oral testimony concerning the conversations overtook the precise formulation by Mr Waterhouse of the conversations found in his witness statement. Also, as might be expected, Berndale cross-examined Mr Waterhouse so as to rely upon much of what was previously objected to in order to establish inconsistency and bolster its case of contrivance. This experience provides an example of where there may sometimes be a lack of utility in addressing objections at an early point in a trial when it is apparent that the course of cross-examination is very likely to traverse relevant passages.

95 The precise narrative prepared by Mr Waterhouse remained part of his witness statement when adopted by him as his evidence-in-chief. They were not deleted, although Mr Waterhouse was required to give oral evidence of the conversations. He was cross-examined on the content of some of the relevant paragraphs in his witness statement and the defendants' counsel put to Berndale's witnesses the precise content of much of them. Set out below are paragraphs 101 to 111, inclusive, of the witness statement dealing with the critical meetings:

1. I attended the office of Merrill Lynch at around 9am on Wednesday 5 December 2007 to sign agreements, the meeting lasted 20-30 minutes. At the meeting, John Laws, Robert Forbes and Michael Horrax, being persons who I understand were all employees of Berndale or Merrill Lynch at the time, were present throughout. This was the first time I had met any of those people in person. I had only spoken by telephone to Laws on a few occasions and only to Forbes once and Horrax never. At the outset of the meeting Horrax tabled a draft letter setting out certain conditions upon which Berndale proposed that the Agreement be varied. One of the terms of Berndale's letter was that my wife should provide it with a release in respect of any claims that she may have against it. An understanding was reached to the effect that she would do so in a separate document.
2. At that meeting there was extensive discussion about the terms upon which security in the form of the $4 million bank guarantee was to be provided. I said "I'm disappointed Dan Ritchie could not make it and confirm in person, however my wife's adviser Tony Tighe, who also cannot make it this morning, as he is also travelling overseas in a few hours as well, wants to make it clear that the guarantee will only be provided on the understanding that Merrill Lynch will have no input in any trading of the account nor will they buy any protection against any positions of the account. In other words they are to treat the account as it was before, as if it is not in default. You have not been trading or buying protection against the positions since the account has been in default?" Laws replied "No", Horrax and Forbes shook their heads with a confused or bewildered look as if to say no. I then said "This agreement confirms that you cannot do anything that is to How's detriment on these positions or take opposite trades in relation to anything on the How Account. Janette and Berndale are now both sharing the risks, Janette more than Berndale, as she is putting up $4 million and Berndale are carrying How for around $1 million less than the $250,000 which we have in cash in the How account. That may increase up to two and half million dollars if the margins increase over the next three weeks. Tony Tighe has made it very clear, as per his letter which I sent to you on Monday".
3. Laws said, "The margin is $6 million made up of $4.5 million in short-term market value and one and a half million dollars in ACH risk premium. David, we understand what you and your wife's adviser mean. Time is against us. It's all covered in this letter". I said "Tony Tighe just wanted me to make it very clear to everyone in the room, when I sign the agreement".
4. The final topic of discussion at that meeting concerned the possibility that market conditions could operate to force the How account above the margin limits which had been the subject of discussion in the emails which had passed between me and Laws. This was the subject of specific reference in point 1 and 2 of an email sent by him to me at 4:15 p.m. on 3 December 2007, a copy of which is at page 034-035 of the exhibit.
5. Laws said: "Now that we have reached an understanding as to how we are to proceed, we will expect you to comply very strictly with the terms of that understanding." I said: "Have no fear, John. As soon as the account goes over these limits, I will be aggressively buying back, as I will have 48 hours within which to bring the account under the limits." Laws said: "That's great. As long as you understand that. David we would like you to reduce the risk margins by buying back positions during the course of the next few months." I said: "John I worked out we only have about $250,000 left in the account, which I will spend on buybacks." Laws said: "Yes, now that we've done this agreement, you are no longer in default and when you have used up the $250,000 we will keep on funding the buybacks, as we have before, at 10% rate, which has been reduced from 15% because you are no longer in default."
6. The meeting concluded within 20 to 30 minutes on the basis that the draft letter, which Mr Horrax had tabled, would be modified to accommodate the various understandings that had been reached. I was to return later that morning with the signed letters and agreements. I also took the forms of release, which had been prepared for execution by my wife and myself, both personally and on the behalf of How.
7. I arrived home and my wife said "David, what happened with Berndale?" I replied "Janette, they acknowledge everything Tony requested" Janette replied "Ok, if Tony says its ok, on the understanding you have to explain to Tony how you will buy back the positions without the guarantee being called up. I must say I am very against it. Why am I doing this, there is no advantage or upside to me and very little to you, this will seriously strain my financial position if they call on the guarantee, just to keep your good reputation".
8. I then returned to Merrill Lynch's office later that morning and then had a quick meeting with Mr Laws, Mr Forbes and Mr Horrax when I had the releases, which had been signed by my wife, myself personally and on behalf of How... I said, "The agreements are signed on the understanding of this morning's conversation" Laws said, "As promised, we will treat the account pre last month, before you got into trouble. David, How Trading is no longer in default. Time is working against us David; it's a trust thing. We have carried you for over the last three weeks. If we wanted to do anything against your interests, we would have taken over the account on day one. Our word should be good enough, our reputation is one of the highest in the world of world-class banks, and our interests are aligned. The last thing we would want is to take a set against your positions, which could cause us to take control of the account. We want you to work through this yourself. However we expect you to maintain control of the positions. What happened in the last few weeks was very embarrassing for us with the ASX on the whole. We just want you to get through this. "
9. I would not have signed the 5th of December agreement, nor given my guarantee or requested or induced my wife to give a $4m guarantee if Laws, Forbes and Horrax had not assured me that I could buy back positions with funding from Merrill Lynch, and that they would not buy protection on positions on the How Trading option account. Furthermore, I relied on their reputation of honesty when Laws said with Horrax and Forbes both nodding and agreeing that they had not engaged in buy protection on the position prior to that meeting. If I had known they were in fact buying protection (as they were) I would have not signed the letter. I wanted to maintain my good name, but I expected them to honour their promises and not trade against these positions before or after signing that agreement. Had I known that they had already acted and intended to act in the way that they in fact did, I would never have entered into the agreement of the 5th of December with them.
10. I said to Laws, "Tony Tighe wants you rooting for How. He wants you to still be sharing the risk. It's great that you have confirmed that. The bank said they would have the guarantee ready for you in the next 2 days. I will certainly be pushing my hardest to get it done ASAP" Laws said "David, now you have signed this agreement, please just push hard to get the guarantee from Westpac". I said "John, as you know I could have walked away and left you with the shell of How, however I value my reputation, that is why I want to do the proper thing here".
11. Then Horrax asked me for the signed guarantee and Janette's signed release. I then said to Horrax as I handed them to him "I have them here". Laws said, "David, from the list of your assets, this guarantee is not worth the paper it is written on. However it gives us credibility in New York." I then left.[5]

96 In his oral evidence-in-chief Mr Waterhouse said that he attended a meeting at the offices of Merrill Lynch in Sydney at around 9 am on Wednesday 5 December 2007. After identifying himself to a security guard he was given access to a floor of the building on which the offices of Merrill Lynch were located. He met Mr Laws in the lift area and was taken to a meeting room where he was introduced to Mr Horrax and Mr Forbes. The four men sat around a large table. Mr Waterhouse said he had not met any of Mr Laws, Mr Forbes or Mr Horrax before that meeting, although he had spoken with Mr Forbes once and with Mr Laws three or four times. He said that each attendee had a copy of the draft agreement that had been circulated the previous night.

97 According to Mr Waterhouse he made a complaint about the paragraph numbered 8 on page 2 of the document. That paragraph related to a dispute over brokerage and commissions paid by How Trading on its option account for the period 1 September 2006 to 5 December 2007. The issue had been previously raised by Mr Waterhouse in his communications with Berndale leading to the preparation of the draft agreement. Mr Waterhouse gave evidence of his complaint in the following terms:

John, I am not very happy with number 8. I have been trying to get the commissions or, sorry, the interest off Norris and for the last year, and I don't see how just an email from Norris would result in the commissions going back to How.[6]

98 The complaint by Mr Waterhouse concerning brokerage and commissions was apparently resolved. His evidence continued:

John Laws said words to the effect - something like "It's not a deal breaker. We will put this in a separate document. This is the interest from OCH, we will put this in a separate document and Forbes will work out the actual interest moneys owed." And re the commission that my wife had requested, he said "We will do a separate document for that as well. And we will ensure that you get those funds credited back to How Trading."

1. Very well. Now, was anything else said on that particular topic of interest and commissions that you can recall?---
2. He said "You have been in default to us for the last two weeks or so, and we will be charging you 15 per cent on the default. However, once we do this agreement," or he could have said "bank guarantee comes into our possession" - I don't know which word he used - "the interest rate will drop from 15 down to 10."

Q. Very well. That covered that topic as far as you can recall, did it?---

A. That's right, yes.

99 Mr Waterhouse was asked what else he could recall as having been said during the course of that meeting about the draft agreement. He responded:

Horrax said "I'll get your - the new agreement changed and emailed up."

Q. Yes?---

1. And I believe Horrax went to a phone in the room and spoke to someone and discussed some of the changes.

Q. Did you have a laptop computer with you?---

A. Yes, I did.

1. And was something emailed to you on that computer during the course of the meeting?---
2. Near the end of the meeting, yes. It wasn't emailed automatically, of course, it was emailed 10 or 15 minutes later after that.
3. Very well. Leaving that to one side, what else was said at the meeting about the terms of the letter that you have before you being - or the draft, rather - being MCH1.13 to Mr Horrax's statement?---

A. Were you referring to changes to this agreement?

1. No, I am not talking about any specific changes, I am just talking about the agreement generally, what was proposed, was anything said to your recollection about the content of the letter?---
2. Yes, I said to Mr Laws "I am very disappointed that Dan Ritchie can't make it here today. However, Tony Tighe, Janette's financial adviser, who has been advising her on this situation, also can't make it here this day as he is travelling overseas in a couple of hours' time, but he wants me to make it very clear that the guarantee is only given on the proviso that you don't buy back positions or trade against those positions on the account.

Q. Yes. Was anything else said by you at this point?---

1. I then said to Laws, "Have you been trading against the positions on the account?" And he looked at me and said "No". And I also looked at Horrax, and I looked at Forbes, and they looked at me with not - not understand them, like they weren't understanding what I was saying and shook their heads as though to say we don't know what you are talking about.

1. I said "Tony Tighe wants to make it very clear that he wants Merrill Lynch to carry on the account as it was before and do nothing to its detriment, not buy opposite positions to the actual How positions on the statement, on the actual account statement, and basically wants to make sure that Merrill Lynch still continue to share the risks, now Janette has come aboard, with her. She is putting up 4 million and you have got approximately $1 million at risk, and wants the risk to be shared."
2. Very well. What, if anything, did Mr Laws or any other Berndale representatives say in response to that?---
3. He said "We understand. There's a risk margin of 4.5 million - there's a margin of 4.5 with a risk margin of 1.5 making it 6 million today. He said there was a margin of 6 million which comprises of a margin of 4.5 of ACH margin and a risk margin of 1.5. And if the margin increases, then obviously Berndale's risk also increases, and may increase up to $2 million or thereabouts.

Q. Yes?---

A. Actually it would have been 3, words to that effect anyway.

1. Very well. Now, was anything else said about the proposed agreement and how it was to be carried into effect at that point?---
2. He said "We want you to chase up the bank," and I think I rang the bank at that stage to see what the likelihood of getting the agreement ready by Friday. He said that "We expect you to control the account in better terms than you have in the past, and hence we expect you to - if the margins increase we expect you to buy back positions during the - that time." He said - - -

1. He said "If the margin goes above 7.5 you have got a 48 hour window to buy back and bring the margin back under the agreed limits, and we will fund those at 10 per cent once this agreement is signed," or he may have said "once this agreement bank guarantee is passed over."
2. I see. Was anything else said by you or by anyone else who was present during the remainder of the meeting, as you presently recall?---
3. Michael Horrax then said "We have a separate agreement for Janette as per your instructions that you don't want her - or her lawyer does not want her to be in the agreement, and here is also your guarantee to your release, can you bring them back after they are signed."

Q. Yes. Now, did you then leave the premises at that point?---

A. Yes.

Q. And where did you go?---

A. I returned back to Elizabeth Bay.[7]

100 In relation to the second meeting between Mr Waterhouse and representatives of Berndale took place later the same morning, Mr Waterhouse said in oral evidence that he met with Mr Laws, Mr Forbes and Mr Horrax in the same board room:

1. And after you had been back to your home at Elizabeth Bay, did you then return again during the course of the 5 December 2007 to the offices of Merrill Lynch in Sydney?---

A. Yes, I did.

Q. About what time did you return there?---

A. It was approximately 1 to 2 hours after the first meeting.

1. I see. And were you in contact with anyone there when you returned?---

A. Again I was met by John Laws at the reception area.

Q. All right. And did you meet with him and anyone else?---

1. Yes, again Rob Forbes and Michael Horrax, we went back to the same boardroom.

Q. Right. Did you have a conversation with those three men?---

A. Yes, I did.

1. What did you say to them and what did they say to you as best you recall it?---
2. I think there could have been some discussion, Horrax could have shown me the changes also as per the email. I am not 100 per cent sure as I'm sitting here now. And I said "This guarantee from my wife and my" - sorry, "My guarantee and my wife's future proposed guarantee is given on the conditions as per this morning."
3. And having said that, did one or other of the Merrill Lynch or Berndale representatives respond?---
4. He said "David" - John Laws said "David, we totally understand, and we expect you to - we hope that you get out of this trouble, we are totally supporting you, we have been supporting you for the last few weeks. Our interests are aligned, and we certainly don't want to do anything which is detrimental to you."

Q. Was anything else said, to your recollection?---

1. I said "Tony Tighe wants you rooting for How Trading," he said "Of course." And he then - Horrax then said "Do you have the releases and the guarantees?" Which I gave him. And actually just before that he asked me to sign the agreement.

Q. Yes?---

A. Which I did.

Q. Yes?---

1. And I just remembered this during the court case, I actually asked John Laws if I could change the date from the 7th to the 8th to give me the weekend on the agreement on page - - -

...

Q. When was that done?---

A. That was done at the second meeting.

Q. I see. And how did that alteration come about, who said what?--

1. I said to John "I would like to have the weekend in case there's a hiccup with Westpac, do you mind if I make this this Saturday which will give me until the Monday?"

Q. Yes?---

A. And he said "No, that's fine."

Q. I see. And was it then that the alteration was made?---

A. That's right.

...

1. Right. Now, can you recall anything else being said on that occasion?---

1. I said "I am taken to understand I could have left you with the shell of How, and yet I want to see this through and I want to support it with my guarantee and my proposed wife's guarantee." And at that stage I handed the guarantee to Horrax. And at that stage John Laws said "According to the answers you gave Norris last Friday, this guarantee is not worth the paper it's written on. However it's given us credibility in New York."

Q. Can you recall anything else being said?---

A. No, I think that's about - - -[8]

101 The credibility of Mr Waterhouse and Messrs Laws, Horrax and Forbes, insofar as their evidence bears upon the Chapter 1 issues, cannot be properly analysed without a review of the context and background to the meetings.

102 The chronology of events leading up to the meetings on 5 December 2007 is not contentious and, for the most part, involves a review of email correspondence. The emails are mostly set out in full. A summary would not do justice to the picture that emerges from the exchanges. Many of the emails contain typographical errors, abbreviations or cryptic expressions. Those remain in the reproduced text.

103 The relevance or significance of some of the content of the emails may not be apparent without a summary of my conclusions in relation to the Chapter 1 issues. Berndale submitted that a close analysis of the events leading up to the 5 December meeting is sufficient to expose the defendants' Chapter 1 case as a contrivance, constructed after the events. I am of the view that an examination of those events and in particular the communications, clearly demonstrates the improbability of the defendants' Chapter 1 case. Insofar as Messrs Laws, Horrax and Forbes denied the critical conversations of which Mr Waterhouse gave evidence, their evidence was far from satisfactory. They sought to downplay the concern that Berndale and Merrill Lynch must have had about its unprotected exposure to the How Trading account in November and early December 2007. In the rush to reach agreement on 5 December 2007, they overlooked the significance of some terms of the December agreement and sought to defend or explain terms and negotiating positions in a defensive and unconvincing manner. Mr Forbes and Mr Laws had allowed the How Trading account to expose Berndale and Merrill Lynch to a significant financial risk. They sought to distance themselves from responsibility. Mr Horrax sought, unsuccessfully, to explain away his oversight of an ambiguity in the December agreement which led to proceedings in the Supreme Court of New South Wales in late December 2007. Ultimately, however, the denials by Messrs Forbes, Laws and Horrax are consistent with the objective evidence of surrounding circumstances that made the defendants' Chapter 1 case inherently improbable. I accept their denials.

104 I do not accept the evidence of Mr Waterhouse concerning the critical parts of the conversations upon which he relied to support the representations. Much of the evidence given by Mr Waterhouse about the meetings was reconstructed to take advantage of his discovery, in about February 2009, of the Merrill Lynch house trades. I am not persuaded that representations to the effect alleged by the defendants were ever made, including the unpleaded representation concerning the Merrill Lynch house trades.

105 In 2001, How Trading and Mr Waterhouse were trading in options using Rivkin Discount Stockbrokers ("Rivkins"). Some time in May 2006, Mr Waterhouse was approached by an employee of Rivkins to open an account with Norris Smith. The principal of that firm, Mr Norris Smith, had previously been employed as a manager at Rivkins. Norris Smith engaged Berndale to provide third party clearing services for their clients. A Derivatives Clearing Agreement between Norris Smith and Berndale is dated 8 February 2006.

106 In April 2006, Mr Smith emailed Mr Forbes to set up a clearing account for How Trading. Mr Smith asked whether Berndale was prepared to share the risk on the account. Mr Forbes replied that Berndale would not share the risk as it was 'not a business that Merrill is in'.

107 Berndale opened two accounts in the name of How Trading:

(1) an options account for transacting options identified as "NOR00016" (Options Account); and

(2) an account for transacting equities and clearing cash balances identified as "9000016" (Equities Account).

108 The Options Account recorded the margin calls made by the ACH. Each day Berndale's computer system automatically generated a statement, showing all transactions and open positions, as well as the cash position and any margin requirements. A copy of the statement was sent by email to How Trading. In times of increased volatility or a downward movement in the market for underlying stocks, the ACH would often call on Berndale for additional margin. Berndale would subsequently call on How Trading for additional margin and the amount would be debited from How Trading's bank account and reflected in the Equities Account.

109 To secure its obligations under the Derivatives Client Agreement, How Trading had procured Westpac to issue a AUD$1 million single beneficiary guarantee in favour of the ACH. The guarantee, issued on 10 January 2007, was to expire on 31 December 2007.

110 On Friday 16 February 2007, Samantha Hettihewa, acting risk manager at the ASX, emailed Mr Forbes raising concerns about the level of risk on the How Trading portfolio. She wrote:

In accordance with the Financial Stability Standards, ACH have comprehensive risk controls in place to provide a high degree of confidence that in the event of extreme volatility, ACH will be able to settle all of its obligations in a timely manner, and will be able to settle its obligations in the event the participant with the largest obligations is unable to meet them. The risk control arrangements ACH have in place include a stress test scenario which is calculated daily and provides ACH with a summary of the participant with the largest exposure...

Berndale's stress loss exposure $124m, $24m over ACH internal limit of $110m:

• As I mentioned in my call to you, Berndale has exceeded the RRR of $110m today. The stress loss exposure is calculated for both the cash and derivatives markets, however the increase for Berndale predominantly results from the derivatives portfolio.
• The potential stress loss for Berndale has increased by over $61m in the last 4 days, this is larger than any increase we have observed for the CP in the last year.
• The derivatives market exposure is concentrated in one account - How Trading. The current contribution by this account is 90% representing a potential loss of $90m in an extreme but plausible market fall scenario. This is a highly concentrated exposure in one account.
• The account comprises mainly short put positions with a significant concentration in financial stocks, notably options over CBA.
• These puts are susceptible to high volatility and given the fact that implieds in financials have increased lately, the market risk from this account increases further.

111 Ms Hettihewa went on to request that Berndale provide information regarding the increased risk on the account. During a telephone conversation on 16 February 2007, Mr Forbes informed Ms Hettihewa that he would speak to Mr Smith about reducing the risk but that Berndale considered the risk was acceptable, provided How Trading met its margin calls. Mr Forbes also responded to Ms Hettihewa's written questions by email. The questions and answers were as follows:

1. What is the reason for the trading activity that has caused this increase in exposure?
2. The reason for the increased exposure was from increased trading of CBA after the profit announcement. The client has mainly Feb calls and puts written. The highest strike price for Feb puts is 4950 and the lowest call price is 5100.
3. Was there an increase in trading related to upcoming results announcements?
4. Yes. Mainly CBA's result as mentioned above.
5. Is this trading related to arbitrage activity?
6. No, with exception the in the money Feb calls for CBA are covered by stock.
7. Who is Berndale's trading participant?
8. Norris Smith Stockbroking.
9. What is the nature of the How Trading account i.e. retail/institutional, local/foreign?
10. The company is a registered entity with ASIC.
11. Can you provide more detail on this account?
12. Norris Smith can provide additional detail
13. Are you aware of the highly concentrated risk exposure in How Trading and are you comfortable with its size (90% of exposure) ?
14. The exposure will reduce greatly after CBA go ex-div and about 80% of the exposure across all stocks will disappear on the Feb expiry. This particular client tends to trade more towards the end of an expiry month. We are continuing to review client exposures and are comfortable with the exposures at the current level.
15. Do you expect the exposure to increase further and if so, how long before we see the exposure reduce?
16. The exposure will not increase and as above most of it will go on the Feb expiry.
17. Are you aware of the concentrated risks posed by this account in the event that the market turns bearish and how will you manage this?
18. We are continuing to review client exposures and are managing the associated risks.
19. Are you aware of the further risks posed by this account by increasing volatility and how will you manage this given stock volatilities are increasing across the board?
20. We are continuing to review client exposures and are managing the associated risks.

112 On Wednesday 9 May 2007, David Seare, manager of clearing risk operations, ASX, sent to Berndale an email with further questions to which Berndale responded as follows:

1. Was the increase in exposure due mainly to new trades and/or market conditions effecting existing positions?
2. The main increase is due to both new positions and increased volatility
3. Could you provide some background into how you are risk managing the client. Has any extra collateral been requested or have you instigated closing out of any positions? Also, do you perform any stress testing on the accounts?
4. We do keep a very close eye on this account, and ensure that the risk is constantly monitored.
5. How long do you expect the increased exposure to remain for? In addition, do you expect it to grow any further?
6. The client will not take on any new positions until the May expiry. We also expect a large proportion of the exposure to expire in May.
7. Do you have any particular concerns about the client?
8. We have no particular concerns about the client.
9. I guess you still have the direct debit access to the client's bank account
10. Yes we have direct access to the clients banking. The client has had significant margin calls and we have never had a single failure.

113 On Sunday 2 September 2007 Mr Waterhouse complained to Mr Smith that he had not received interest on funds at the ACH which he claimed had been agreed. The following email exchange took place;

DW Norris, I have just done the interest bill for August - its $6,325 (My bank interest is double that) - its been a horrible month, but it was $3,300 for July. The way to get around you wearing all this interest yourself would be to give no commission trades starting at the beginning of the month until this is squared out-in other words the first ever days are nil up until $6,325 has been spent. Otherwise the interest bill is going to mount up till never never. The normal time (like May or June) of lost commission of only a few days. On something else how much would it cost to get auto emails on trades - if it was not too much I would pay it myself, as last Thursday I lost $50,000 on ANZ, I thought I had taken off the $29,00 puts - then I received Steve email after market telling me for the first time I have written 100 of the $29 puts - I left sick. So if its no too expensive I would pay for this service myself.

NS G'day, I'm sorry, but I can't keep doing business on this basis, I think you should be dealing elsewhere and transfer the positions. If Merrills won't pay me I'm not going to keep doing business for nothing. I'm getting Al to chase it up but I just can't do it.

DW Norris, As you know, I can not transfer the positions - why would any one take them. You have guarantee the interest on the account, on that basis I have traded for the last 15 months - what are you saying now, you did not guarantee that? I will call you at lunch.

NS I'm not interested, you were also not supposed to get your margins up where they are. You put a bank guarantee in place so we wouldn't have to go through this yet you keep increasing them.

114 On 3 and 4 September 2007, the discussion over interest continued between Steven Calland, an employee of Norris Smith, and Mr Waterhouse.

SC We have been told by Al who has spoken to Rob Forbes at Merrills and they have said they will pay the interest so you can deal if you wish

DW Steve, When Norris wrote what he wrote, I know is like me loses he's temper, so I know now he did not mean what he wrote - even before the phone call. However can he confirm by email that I will receive the interest, not withstanding his previous emails.

SC He's gone for the day. I'll try and get confirmation tomorrow and possibly something in writing from Merrills.

SC Norris said we have official confirmation Merrills will now pay interest. Norris said e would pay $2000 into your a/c today.

DW ok - thanks Steve, So I understand - Merrill's will pay all previous interest ($23,600) up till Monday 3rd Sep or will they start paying interest from now on & Norris will keep on paying $2,00 per month till 1/05/08 & $1,600 on 01/06/08? No big deal either way - just like to be clear on things on this hot issue. Can I trade or just roll - please note for the future - I can not transfer positions to another broker down the track - I just want to be clear on that.

115 By September, Mr Waterhouse was becoming frustrated about the lack of regular and timely information concerning this trading. He informed Mr Calland of his concern, who in turn contacted Scott Anderson at Merrill Lynch. Mr Calland sent Mr Waterhouse the following exchange of emails with Mr Anderson:

SC By the way mate, is there any way we can get automatic emails sent to this client as soon as a trade is executed. We used to be able to do this at Avcol and it saved a lot of time. At the moment I have to send reportings manually, when I get busy sometimes I just can't send them at all which can be very frustrating for the client in a busy market. Surely we have the infrastructure to do this, please advise.

SA Unfortunately we are unable to do this. Apologies.

SC Okay but can we maybe work towards doing this someday, if some small brokers as well as large ones can do it surely the largest broker in the world can.

SC Dave, below is a record of correspondence I had with Merrills concerning automatic emails. It seems too hard for them. I can't do anything else except manual emails and in busy periods they will be late or non existent.

116 By October 2007, Mr Waterhouse had not received the interest payment he claimed he had been promised by Mr Smith. He described the issue as a "hot topic". It remained hot for some time, resulting in further email exchanges between Mr Waterhouse and representatives of Norris Smith.

117 On Thursday 8 November 2007, Mr Seare again contacted Mr Forbes expressing concern at the level of risk in relation to the How Trading account. He sent questions by email to which Mr Forbes responded as follows:

1. Are you as the ASX participant comfortable with almost all of your exposure coming from the single client spread across positions in mainly four equities?
2. We are comfortable with ours exposure and risk management practises. The client has bought back a large part of the positions today.
3. Has the client indicated whether they are likely to be increasing this position?
4. The position has been reduced today.
5. Was the increase in exposure due mainly to new trades and/or market conditions effecting existing positions?
6. Both.
7. Has any extra collateral been requested or have you instigated closing out of any positions? Also, do you perform any stress testing on the accounts?
8. The position has been reduced today.
9. How long do you expect the increased exposure to remain for?
10. As above.
11. Do you have any concerns of the client's ability to meet daily margin payments?
12. No. We closely monitor this account and have no concerns about the client making margin calls.

118 At the time these responses were given the market was falling. It was a period of relatively high volatility. How Trading's unhedged portfolio was exposed to heavy losses if the trend continued. Margin calls would increase and Berndale held no security. In the circumstances, the response by Berndale seemed arrogant and uninformative. Berndale told the ASX, in effect, to mind its own business. The response was the more astonishing when one considers an email of the same day from Mr Forbes to Mr Smith. The following exchange took place:

RF Norris, ASX have called about the level of risk in How Trading options positions. Is he stock covered? Are his positions getting wound down? How can we get the risk down a bit?

NS I have bt back shit loads of puts today, I reckon over 1,000 contracts.

119 A statement issued by Berndale to How Trading on 8 November 2007 revealed a margin requirement of $11,998,483.43. The increase in the margin was caused, according to Mr Waterhouse, by an increase in the number of contracts written by How Trading and by volatility in the market. To combat the rising margin, Mr Waterhouse had commenced to buy back positions.

120 On Monday 12 November 2007, there was an exchange of emails between Mr Smith and Mr Waterhouse in which Mr Smith relayed Berndale's concerns:

1. The ASX is going in to Merrills today to have a look. We have to get it down today or we'll be in serious trouble

On the following day Mr Forbes wrote to Mr Smith alerting him to the margin.

The total margin for How Trading has only been reduced by 640K today and is still over 11 million. Despite the large number of positions bought back yesterday, the account has not made any significant change in margin position. Can you urgently advise how this is going to be fixed. We have the ASX coming in today and they've specifically request and answer on this account.

G'day, I spoke to the client, we are closing out a lot more today, he sent an email to say he is going to get the margin down to well under $4m.

121 At around 9.14am on 13 November 2007, a direct debit margin call of $3,784,733.01, made on How Trading's bank account on 9 November 2007, was dishonoured. This excited a string of emails between Mr Forbes and Mr Smith.

1. The account is in debit for this 3.8 million plus a further 1.9 million due today. How am I getting the 5.7 million?
2. I just spoke to him, you can put through the margin call today of $1,877,819.99
3. What about the 3.8 million?
4. As he owns 60,000 RIO I'm going to see if we can send the short RIO calls to Opes, which will relieve a far bit of margin
5. If you close all the positions down, then the margin will come back. Credit have advised me to ask you for security to cover the exposure if it's not brought back into line.
6. Can't promise but we might be getting $1m from Opes
7. I can see a position of

CBA 10,074 Puts You are buying back 600

WBC 5667 Puts You are buying back 1302

BHP 4118 Puts You are buying back 754

What about the rest of the CBA, WBC and BHP, or is all the risk concentrated in these positions?

1. CBA there are just under 3,000 with a strike under 4700, I'm going through the rest now. The puts I'm buying back are where the risk margins are, we are buying back puts that are within 20% of the stock price. If we do this it reduces the margins heaps. When these are done we work back covering the ones more than 20% out of the money.
2. Let me know when you start executing so I can report to credit.
3. We have already started, Steve just told the client to get a shit load done by 1pm as we have to report to you with an update, which we will do

Bought back 1229 so far, and sold another 300.

The 300 we sold was to close, he was long 11/2650s and short 11/2600s

Joe (a/c 67) rang back, putting $600k today

122 On the same day Mr Waterhouse procured a loan of $1 million from Opes Prime and a further loan of $1 million from his wife, using those funds to reduce How Trading's indebtedness to Berndale. At about the same time Mrs Waterhouse registered a charge over the assets of How Trading to the value of $4 million, being the total amount she had by then advanced. Later that day Mr Smith wrote to Mr Forbes explaining the progress on the account.

1. I haven't gone through the whole lot but we didn't buy back as much as in my early email but we have bought back most if not all of the positions within 10-15% of the market. I think the position will improve by about $2m tomorrow morning with todays buys and the market up in the stocks he has positions in. Tomorrow we will work on CBA, the highest put strike there is $54 10% out of the money. In BHP the highest put strike is $33 which is 20% away from the money.
2. It's not enough. The client has short positions of 55,000 and has only bought back 1400. I understand that we need to buy back in an orderly manner, but the client is in default to us, and unless the position is rectified tomorrow, we will never be able to deal with this client again. Further, there doesn't seem to have been any real effort to make a significant dent into reducing the overall positions. This single client is seriously jeopardising the Berndale/Norris Smith Stockbroking relationship, as we cannot carry anywhere near this level of risk. I am under massive pressure to resolve this, and tomorrow will be the fourth day of the client promising to reduce the margin to an acceptable level. I need to know urgently exactly which positions will be bought back tomorrow. If the margin level is not below about 4 million, we will need to arrange the buying back of positions ourselves and will have to look for additional security from you for any further business.[9]
3. I understand. We'll fix tomorrow.

123 On 9 November 2007, How Trading had commenced to buy back and closed out a large number of open contracts in an attempt to reduce the margin and continued until 15 November 2007. Mr Waterhouse maintained that Berndale wholly funded the premiums required to buy back the positions. The margin on 8 November 2007 was $11,998,483.43. On 9 November 2007, How Trading spent $1,141,567.20 to close out positions but only reduced the margin to $11,715,656.04. On 12 November 2007, How Trading spent $2,517,660.08 but only reduced the margin to $11,074,942.87. On 13 November 2007, How Trading spent $417,565.00 and reduced the margin to $8,884,711.24. On 14 November 2007, How Trading spent $335,110.58 and reduced the margin to $8,386,490.43. Finally, on 15 November 2007, How Trading spent $141,699.60 to buy back positions, reducing the margin to $7,606,345.77.

124 The significance of these transactions is two-fold. First, the source of the funding to buy back positions became a contentious issue. Mr Waterhouse sought to employ the circumstances in support of the defendants' case that Berndale had agreed to fund buy backs at the meeting on 5 December 2007. Second, it provides an example of the lack of any precise synchrony between the cost of buying back or closing out positions and a reduction in the margin. Sometimes the reduction in the margin exceeded the expenditure when, for example, by closing out contracts there was a greater reduction in the value attributed to risk component of the margin than the cost. It was also possible for the cost to be outweighed by an increasing risk component due to volatility or deteriorating market conditions.

125 On 20 November 2007, Berndale issued a statement to How Trading. The margin requirement on that day was $9,351,643.88; the cash balance held by ACH was $4,027,890.18 and the security on deposit at the ACH was $3,000,000. Berndale made a margin call of $2,323,753.70 which was automatically debited to the How Trading bank account on the following day. That debit was dishonoured on 23 November 2007. On 21 November 2007, Berndale made a further margin call in the sum of $2,456,127.76. The automatic debit was dishonoured on 26 November 2007.

126 At 9.01am on Friday 23 November 2007, Mr Waterhouse sent an email to Mr Smith expressing his concerns. This email is significant because it reveals an allegation made by Mr and Mrs Waterhouse to the effect that the problem had been caused by Berndale in its failure to control or limit trading by Mr Waterhouse. The allegation, in which Mr Waterhouse relied upon his own inability to manage his trading and the account, is revealing and arresting. The allegation was later repeated to Berndale who required deeds of waiver and release from Mr and Mrs Waterhouse as part of the December agreement. It should have, and probably did, ring very loud warning bells at Berndale.

Norris,

Unfortunately the bank will not increase any further borrowing on my account - in the short term anyway - they were surprised when giving me additional loan last week - the account was hit with 2 (now 3) lots of $2m withdraws this week.

I need some short term support from Berndale; we have had a profitable dealing for 18th months, when the account was conducted properly, up until the last few months. I'm very sorry it has got to this, I have tried to do with right thing - I have brought back over $10m worth of options in the last few weeks - getting my bank to fund that & more, I wish they (Berndale or OCH) had reined me in every time the margin got to $4m, like they have previously had, when it had gone over that amount - looking at my position's earlier this month and last month, I was still writing positions when the margin got up to near the $10m mark - why didn't they say something then?

Janette, who I told of my position for the first time yesterday, as she has to guarantee the new bank loan, is so upset & can not believe they allowed the margin to get so big. The account was so manageable when it traded up to $3m or $4m on expiry and then fell off. As I said last week, buying back out of the money positions does not bring margins down - it increases them, because the fictional prices (that pushes up the margin) caused by this huge volatility becomes fact, when you actually pay that price for them. I will still buy back today - I have no choice, but one example is the CBA Dec $53 put - I sold some for 30c on 9th of Oct when the stock was $57.75 - more than 6 weeks of time decay have passed, less than 4 weeks to go, in theory because of the time factor & the stock is the exact same price now, the price of the option should be 40% of the price I received being 12c - I was paying 75c yesterday - 6 & a half times -that's 650% more than it should be worth - this is what I was explaining last week with buying back "way of the money positions" - totally different to "in the money positions", where you pay a closer intrinsic amount.

Today with further buying back - you saw yesterday what I was up against, no one would make markets in NAB or WBC. If you look at the positions, without November, as expiry 4 trading day away after today - the lowest strike after further buy back's today will be 15% in December - which is a short 3 weeks expiry, positions after that, will be well out of the money by more than 25% of their strike price.

If the market settles down for just 1 week, then the margins will crumble, I'm asking Berndale to carry me over this period, going through the positions, not only puts have gone up an of average 500% over all - but calls have also gone over 150%. Calls that I was selling a month ago on CBA when the stock was $4 higher & have since lost 20% time decay have gone up a further 20% on the price I sold them - bizarre.

I got into trouble because of Coles & Rio - the same thing happened back in August 2003 with AMP - Avcol carried me for over $1m for just over one month - this time its $6m (on last nights margin - which will come down by $2m or $3m tonight as the Spi here & UK markets are both up) - with expiry next Thursday, my margin should be less than $2m in debit to Berndale & over the short 3 weeks December expiry I would think the margin could be back to nil debit to Berndale - but, any sign of trouble in the market, I will be buying back full stop. Even if the margin does not come down as much as it should, I have a few irons in the fire for cash flow, like in the last 12 months, there were T3 Ipo and Rinker takeover - both these netted over $1.5m each. BT (BTT) Ipo-it will listed on December 14th, is the hottest Ipo since BNB listed in Oct 2004, it should list at a 20-30% premium & will net close to that $1.5m - these funds will go to Berndale.[10]

127 At 10.49am on 23 November 2007, Mr Forbes and Mr Smith exchanged emails about the risk in the How Trading portfolio. It is surprising that Mr Forbes was not better informed about the matters raised with Mr Smith.

1. ASX have called our management again about this. I need to advise them by 3. (1) Where is the key exposure - short term, medium term, long term; (2) How is the exposure being secured; (3) What is the strategy to close this account. This account is causing us enormous embarrassment at the ASX, and Merrill credit want Norris Smith Stockbroking to secure the debt, and I need it all clearing. Let me know how you go with the client.
2. The client has a meeting with his bank on Monday to get a new line of credit. He owes about $11m on his house which is worth $30m. He is trying everything he can. He is closing out some more today. The key exposure is in the following November positions: I have checked the vol that ASX using and that is what is causing the problem as can be see below.

CBA 126 11/5450 p 5.5% from current price

CBA 212 11/5400 p

CBA 100 11/5350 p

CBA 200 11/5300 p

CBA 200 11/5250 p

CBA 255 11/5200 p

CBA 200 11/5100 p

CBA 100 11/5050 p

CBA 209 11/5000 p

Total 1602

Using ASX figures they have CBA on annual vol of 19%, with a margin interval of 4%, and I checked a few of the Nov puts and they are quoted at 43% and above.

NAB 174 11/3800 p 5.5% from current price

NAB 68 11/3750 p

NAB 30 11/3700 p

NAB 108 11/3650 p

NAB 196 11/3600 p

NAB 212 11/3500 p

NAB 78 11/3400 p

NAB 99 11/3150 p

NAB 262 11/3100 p

NAB 79 11/3000 p

Total 1306

ASX have NAB on 17% annual vol and margin interval of 5.5% but the same as CBA the Nov positions are at +43% with some at 48%. These are the bulk of the positions where the risk margin is. He has closed out over 6,000 positions in the last week and because the ASX has marked the vol up, so the risk margin increases dramatically on the positions. These positions were not a problem until the risk margin was increased.

128 Mr Forbes then wrote to Andrew Stutchbury, chief administrative officer of Merrill Lynch, Mr Laws and Mr Anderson attaching the account summary provided by Mr Smith.

This is the summary of where the account is at from Norris. I've also attached a list of all open positions. There are 47,852 short contracts. Of these 11,893 will expire on 29 November. A further 15,066 will expire in December. I've asked for a strategy of how the account will be closed down.

129 During this period, Mr Waterhouse continued to buy back positions with mixed success. He emailed Mr Smith at 1.22pm on Friday 23 November 2007:

Norris, As I said I am doing everything possible. On Monday I am going with Chris Murphy to his bank CBA Private-with either transferring my account to them or a separate loan. My Accountant Tony Tighe will be working here at home on the weekend to do a Statement of Positions re the Option account, to take to CBA Private meeting, he will be trying incorporate these position's in the new loan/facility. The sole purpose of establishing the difference between Premium Margin (buyback) & Risk Margin (extra security for OCH)-along with the fact the positions are around 20% out of the money. Also I'm as seeing Leverage Equities after CBA's meeting on Monday to further ask for a higher lending ratio from 80% to 90%. As you see the vol is around 49%-on Thursday night, 4 trading day's to go, the position's which are causing the margin to blowout-will expire, these way out of the money position will fall off & in turn bring down the margin by around 20%. As you know I'm also buying back anything remotely close to the money-like 10 or 15%-it's very hard as no traders want to participant.[11]

130 An issue arose in the proceeding concerning the liquidity of the market on and after 14 January 2008 when Berndale was in control of the account. Berndale witnesses maintained that in times of high volatility it was difficult to buy back positions. In the end it was common ground that there was a market - the issue was at what price. The concern expressed by Mr Waterhouse about his difficulty in buying back positions during a period of high volatility were later echoed by Berndale.

131 At 5.16pm on 23 November 2007, Mr Laws sent an email to Mr Smith concerning a potential margin call.

Norris,

Are you able to confirm you will have recourse to the house, or the stocks with LE, in the event of default.

The market, and banks in particular, are trending badly, and he's likely to be further in call tonight.

If we had to crystallize the losses on Monday, and he reacted badly, have you verified the assets are in his name?

132 At 5.44pm that evening Mr Laws wrote to Mr Stutchbury and Mr Forbes outlining the position.

We are in the process of confirming that our client, Norris Smith, has recourse to his clients assets. Verbally, he believes his client has net assets of approx $48mill. His client's accountant is working to update his financial position over the weekend and he will be approaching his current bankers and margin lenders for new financing lines on Monday.

Over the week he has reduced his position significantly. The attached spreadsheet details a total of 280 trades over the week, a net 83 trades buying back his short option positions. (current market value position shows a net positive amount of $1.8mill (this is likely to be reduced today) and a shortfall of $2.3mill on total margin requirement. From my conversation with our client, both he and his client are highly sensitized to the seriousness of the situation. We have both agreed that we will be working this end client down and closing the account entirely within a reasonable timeframe.[12]

133 The tenor of the exchanges between Berndale and Norris Smith revealed a view, held by Mr Forbes at least, that security arrangements in relation to How Trading were a matter for Norris Smith, not Berndale. Presumably Mr Forbes was alarmed to discover that Mr Smith lacked detail about the financial position of Mr Waterhouse.

134 On 26 November 2007 Mr Laws wrote to Mr Smith at 1.40pm.

Norris, I believe we are in agreement we want this client to reduce his positions to zero with both of us. We will be writing a letter to Waterhouse notifying him of being in default under our derivative agreement with him. We will reserve our rights to your firm in this regard also. You should act accordingly with your client similarly. We also intend to double margin the account via yourselves, until it is resolved. I would expect to see risk-reducing trades taking place each day, and I think its best for you client to execute these trades, rather than us. We'll be tracking this daily for progress. With the uncertainty in the market, this is a serious matter, and I trust you will work with us to resolve your clients situation.[13]

135 On Monday 26 November 2007, the following email exchanges took place between Mr Forbes, Mr Smith and Mr Laws.

1. Do you have any update this morning? He has received a credit back of 600K from Friday, so is still in default for about 4.2 million.
2. Better than I expected assuming the banks are up today he'll get back, loads more tomorrow.
3. Any update on him paying the outstanding cash. Credit will not allow us to "sit and wait" until Friday. We need some personal guarantees from either the client, or NSS. We are also likely to change the margin policy for this client, until all positions are closed. Will advise later. Can you send me over latest financials for NSS.
4. We will know more tomorrow morning, Waterhouse has been in meetings half the day to try and get some cash as quickly as possible. I've stressed the point to him that this needs to be fixed now. Talk to you tomorrow, if you or John need to talk to me today, I'll be here until 5.30.
5. We're going to have to move to double margining on this account from next week in order to keep up the pressure and ensure the positions are closed. We need to see some significant movement in positions daily. Even today he only did a total of about 80 lots. He needs to be closing positions, especially the longer dated stuff that's not expiring in November and December.
6. As well as below which is a good idea, I'm going to see if he can transfer some of the positions to another broker (I'm not holding my breath). I'm having a discussion with him tomorrow about getting the whole thing cleaned up and that we don't want any more new positions ever.
7. Norris, You should make it clear to him that we can start closing out positions any time now, but we are hoping he will do so as he can prob control better. If speed of play lags, then we will step in.[14]

136 At 4.34pm the same day Mr Forbes formally advised How Trading that it was in default under the agreement.

Berndale has issued you with two margin call notices dated 22 November 2007 and 23 November 2007, respectively ("Margin Notices"). You were required to deliver the margin set out in the Margin Notices within 24 hours of the Margin Notices. This 24 hour period has now passed in respect of both Margin Notices and Berndale has not received the margin payments required to be made by you.

This constitutes a default under the Agreement.

We hereby demand that you comply with the Margin Notices by close of business today. Should you fail to comply, Berndale may exercise its rights under the Agreement in respect of your default.

This letter is without prejudice to our rights under the Agreement and any other rights we have against you. This letter does not constitute a variation or waiver of any provision of the Agreement nor a consent to any departure from it.

137 At 12 noon on 27 November 2007 Mr Waterhouse replied to Mr Forbes.

Dear Robert, I acknowledge receipt of this letter. As you know I am working with Norris Smith to manage the margins in the accordance with my understanding of the agreement & having daily communications with Norris Smith. Could you please forward me a copy of the agreement for my records & I will continual to work this through with the best interest of all parties involved. As you know I'm in discussions for further borrowing, with the idea of closing positions in a timely manner.[15]

138 The following email exchanges took place between Mr Smith and Mr Forbes, commencing later that day.

1. G'day, I'm going to have to work on him tomorrow to come up with $4m. If closed out today it would be close to line ball, if closed out end of Dec there will be surplus and so on. I'm working on $3m cash $3m bank guarantee. I'll talk to you in the morning.
2. If he can't get the cash from the bank, he needs to liquidate his stock portfolio at LE.
3. I'll be going through all that with him tomorrow, I'll sell his bloody kids if I have to.
4. If the market tanks overnight he's going to have another 2 million margin call and we will be almost certain to shut down all his positions for him. The longer this drags the worse for all of us, and waiting until Thursdays expiry is obviously not going to provide any relief.[16]

139 Mr Forbes apparently responded to the request from Mr Waterhouse and at 6.30pm on Tuesday 27 November 2007, Mr Waterhouse again wrote to Mr Forbes.

Thanks Rob, As mentioned in previous emails, myself and my accountant have been discussing and meeting many of our financial backers with a view of fully refinancing How Trading Pty Limited Options Account to an agreed level in the short term.

As you know all of which takes time, and meanwhile the company's margin has continued to be placed in a manageable position to allow both of these undertakings to occur.

Along with other solutions, including How Trading seeking other brokers to take over Berndale's position, How Trading is confident of obtaining a further $2m to add to the present Bank Bills of $3m held by Berndale. These Bank Bills will continue to be held against How's Account for the next 12 mths (as when these Bank Bills expire) at which stage How Trading would be willing to hold future Bank Bills equal to the Margin plus a buffer of $1m until expiry. This proposal will require any excess greater than $5m Bank Bills which is presently held in cash to be repaid to How Trading Westpac account which needs to be in receipt of these excess funds to allow How Trading to manage its debt to its bankers.

This was the latest proposal verbally communicated to Norris Smith today after market. It is one of the many solutions proposed to Berndale for consideration. Of course How Trading will not write any further positions until we are advised by Berndale of its consent to do so.

How Trading current book continues to expect that its Margin will come down to no more that $4m by the end of December 2007 and $3m by the end February 2008 and in 12 mths time $1m.[17]

140 By this time, the How Trading account position was attracting the attention of the risk management group at Merrill Lynch. At 3.20pm on Monday 26 November 2007, Donald Ellett wrote to Denis Kelliher in Hong Kong informing him of Berndale's option exposure.

Denis, To keep you informed.

The particular client that brought managing risk exposure to our attention is currently in margin call default with 2 days unpaid margins worth appx AUD5m. (Total margin requested of appx AUD10m).

The account is currently in 500k NE given the AUD5m call was covered by Berndale to the exchange. The client is selling premium, puts and calls, with generally cash (from premium) used as margin collateral (plus a AUD 3m bank guarantee) EOD position is not out today, however the market was up over 2% and the broker (Norris Smith) believes there will be about AUD3m benefit, giving about AUD2.5m excess. ASX stress tests have been showing a margin call of up to AUD40m at 15% equity shock. We have sent a letter today (How Trading Default Notice) and will push for double the exchange margin to be posted (today was AUD10m).

We are also stressing the importance of unwinding (given default) in addition to the fact that about 25% of positions will expire this Thursday.

The client has been told by the broker they will not be allowed to trade again in the future.

I am trying to get a full list of positions, so I can run my own RBH style margining, and also assess on market liquidity in the Exchange Traded Options (ETO) market on the 30 odd underliers.

Is there anything else you wish to add? Or like me to explain?[18]

141 By late November 2007, Merrill Lynch was examining the possibility of winding up the portfolio. Due to its liability to the ACH, Merrill Lynch became concerned to protect itself from the risk in the How Trading portfolio. On November 27 at 11.34pm, Mr Tomo Kodama, Managing Director, of Global Markets Financing & Services at Merrill Lynch ("GMFS") in New York, wrote to senior managers of Merrill Lynch around the world.

We have served a default notice to How Trading (a Berndale Australia client), who owes approximately AUD 5mm in margin. They have not paid since Friday, and we believe that the client has significant negative gamma exposure (many of his positions may expire on Thursday). The exchange margin is 8.5mm (we post the margin on behalf of the client to the exchange), vol dispersion and RBH risk numbers are in the 19mm range. For perspective, after Thursday (front contract expiration) total risk is expected to drop to roughly 12 mm.

While this is not a prime brokerage client, FF&O in Asia rolls into Mel Ford's organization. It is unclear whether PB risk should be looking at the position, but given the circumstances Denis and his team will address. We are working to get a better handle no the exposure (we need a better way to judge the short optionality) and will continue to work with the client to cut down the risk.

142 On 27 November 2007, two Merrill Lynch traders were recruited to assist in protecting Merrill Lynch against its exposure to the How Trading portfolio. They were Jason Ryan and Paul Craft. Both gave evidence. They said that they developed and implemented the unwind or liquidation strategy after Berndale took control of the account on 14 January 2008. Late on 27 November 2007 the following email exchange took place between Mr Stutchbury and Mr Laws.

1. You should engage Jason Ryan asap on his recommendations on how best to extract Berndale from this situation. My concern is the client remains in call after today's decline, the US declines again overnight, pushing the Aussie bank market down and creating a greater margin call. Its two days of further inaction that you can't afford.
2. Don and I have been talking with Crafty. He's getting a sense of market price vs previous ASX marks.

143 That evening, at 7.15pm Mr Laws wrote to Mr Waterhouse.

David,

Berndale's view here is that the market is unstable and we are not in a position to leave ourselves vulnerable to further market deterioration. Norris has kept us abreast of your plans but they fall short of our expectations in having you meet your obligations to us.

We need you to aggressively begin to close out positions and we would expect you to work to release equity in your margin lending positions. The Westpac loan will be very helpful so plead inform us when that will get deposited.

We have effective control over your account at this stage, but I presume you are best placed to close out positions quickly to optimize the value of the positions. We will begin to work with Norris to close out positions tomorrow if progress is not being made in the morning and the market levels deteriorate further. We are also concerned that the release of margin with expiry of the is not as great as initially estimated. We appreciate your efforts to date but since you remain in margin call we have little choice but to act to protect ourselves.[19]

144 Mr Waterhouse wrote back on 8.28am on Wednesday morning, 28 November 2007.

John,

I disagree re the November expiry-I believe the margin will come down from $8m to around $6m or less. However I do agree the market has been very unstable which has cause the very high volatile & it turn, has caused the margins to blow out to extreme, around 3 times the normal rate, hence the bizarre overblown margins on the account over the last 10 trading days-this is confirmed with margins falling off last night when the market finish down, as the volatile keeps coming down in the next few days, this in turn brings margins back down quickly. Since this has happen, How Trading have brought back over $8m worth of positions & have funded the account with a further injection of $7m. I am working to bring down margin much further, which will bring the account back within the previous operating range that is acceptable by all parties. I expect the funds from Westpac early next week.[20]

145 Later that morning, the following email exchange took place between Mr Smith and Mr Waterhouse commencing at 11.18am.

1. G'day David, This has to be resolved immediately and back in credit or we will have no choice but to close all positions out. Berndale and I cannot keep running the risk of default indefinitely. You are going to have to get the cash to cover margins by Friday at the latest. If you've got margins loans at LE I urge you to realise some cash from there and settle the margins with us.
2. Norris, I think I have the green light from Westpac. They know the pressure of time-late Friday or first thing Monday morning I will be signing.
3. G'day, As far as personal guarantee Berndale want a summary of assets and liabilities, this part looks hopeful. Let me know. Also nobody from Berndale or Merrills has spoken to Opes.[21]

Having regard to the unwind strategy apparently employed by Merrill Lynch on and after 14 January 2008, it is interesting to note that Mr Smith proposed (in the event that the account was not returned to credit) that all positions would be closed out. Mr Laws had proposed similar action. This is, in effect, what the defendants contend should have occurred on and within a few days of 14 January 2008. The significance of the request for a summary of assets is that it confirms the prior absence of financial information produced to Norris Smith or Berndale by Mr Waterhouse.

146 The risk to Berndale on the How Trading portfolio continued to cause it concern. On Wednesday 28 November 2007 at 6.45pm, James Indge head of compliance at Merrill Lynch, sent an email to Ruby Kwong at the Merrill Lynch control group in Japan, concerning the potential unwinding of the How Trading account. Messrs Ryan and Craft were "wall crossed", an expression used to describe the creation of a "Chinese wall" to prevent a conflict of interest.

Berndale Securities Limited has a client which is in default (unable to meet its margin call). Berndale has sought advice from Paul Craft (a derivatives trader who resides in MLAF) to get an idea of the client's portfolio and its value at risk. Legal and Compliance met with Paul Craft a short while ago to discuss the client's positions. His analysis is that 80% of the portfolio's market risk is concentrated in three ASX listed stocks, being Commonwealth Bank of Australia (CBA), National Australia Bank Ltd (NAB) and Westpac Banking Corporation (WBC). As the risk lies in long-dated options for the 3 banks (basically the client is short long dated put options) and unwinding the positions would have a material impact on the price of the long dated options please can you arrange for Paul Craft to be Wall crossed immediately so he cannot trade the options for CBA, NAB & WBC. As I understand it, the unwinding of the positions in the options would not be material to the underlying share price of the three stocks and therefore we do not need to restrict Paul in the headstock of each bank.

147 At 6.52pm on Wednesday 28 November 2007, Mr Indge wrote to Messrs Laws and Forbes informing them of the 'wall crossing'.

John/Rob

As you will see from below, we have Wall Crossed Paul Craft as a result of your client's portfolio, which is in default.

You are reminded, that you must not discuss your client's portfolio with any of the traders in MLEA and MLAF without first checking with OGC.

Many thanks for your co-operation.

148 Meanwhile, Mr Smith and Mr Waterhouse were discussing the provision of security to Berndale. The proposal under consideration, and ultimately communicated to Berndale, involved a bank guarantee and a margin cap. What was paramount to Mr Waterhouse was that he retain control of the account. On 29 and 30 November 2007 and 1 December 2007, the following email exchange took place between Messrs Smith, Laws and Waterhouse commencing at 12.19pm on 29 November:

1. G'day, I just spoke to David, we have come up with the following.
   1. Take the bank guarantee for $2m and agree that if the margin is under $7m we take no action on the a/c
   2. By end of December we take no action while a/c is in credit.
   3. Any surplus funds have to go back to WBC

4. Payment of interest.

David has also said that when funds start going back to WBC we would also be able to withdraw funds to cover margins if necessary.

He has a meeting with Opes tomorrow and they have indicated by email to him that they will take over the ac/s first week of Jan 08.

I think the above is a very good solution for everybody. With CBA and NAB covered down 18% and 13% respectively.

1. Thanks Norris. As you see I'm trying to do everything to solve this problem & down the track repay Westpac. The funds that Berndale/Norris Smith will hold will not fall below $5m until expiry of every option-this cover could be 300% (margin $1.5m v $5m security) within 4 months. Further Opes have said they will take the account after December expiry.
2. David/Norris,

Do you know more specifically what form of undertaking Westpac will require? Could it be a straightforward phrase undertaking to pay funds from the account directly to a nominated Westpac Account? Pls advise, with language if possible.

I think point form and keep it clear and simple.

1. We will not close out positions as long as margin is under $7m up until Friday 20th Dec, day after expiry.
2. We will not close any positions after Dec expiry as long as a/c is in credit.
3. We will remit any surplus margin to WBC when a/c goes into credit.
4. Payment of interest on a/c.

1. John, also no extra margins by Berndale/NSS to be placed on the account-normal OCH margin only. I have total control over the account. The amount of funds to flow from the margin to Westpac would be around $1.5m-this is when the margin if $5m or less. Please send a draft letter & I will get it fine tuned.
2. David,

We have a lot of internal discussion to go on this. In the meantime, can you send across your accountant's financial statement of your position and a draft form of your personal guarantee.

I would like to receive your letter first-saying that I have ask my account to prepare both, which will be ready by Monday.

1. We are going to need to do this simultaneously. Our lawyers are drafting something but risk won't proceed to signing it until they see something that supports your net worth. I assumed you would have this handy for you own Westpac discussions. As I said we will need to confer further internally before this arrangement is agreed but it will save time if we can share draft info as its ready.
2. John,

I'm not suggesting a signed letter-I need a draft to take to my lawyers. Once I receive that I will furnish you with the Guarantee, along with asset & liability statement. I'm trying to be as helpful as possible, my only interest in seeing this through, therefore I'm allowing myself to support this with guarantee & funds of $2m.

We will furnish you a draft today but you have to accept you still owe us $3.6 mill today, even after the Nov expiry. This fact makes it very hard to negotiate. We need to see the substance of your personal g'tee. You should be selling down your margin lending position. If you have assets away from us we could take them as collateral. We are planning to trade freely on the account to reduce risk if the account is not back in credit by Monday If you provide the g'tee and statement of your financial position, we can work with you to manage the position. If the ASX margin req't deteriorates further that creates further problems we can discuss.

1. John, confirming the following.
   1. The bank will get you a bank guarantee for the $2m that comes due tomorrow. This will be ready on late Monday afternoon or first thing Tuesday morning-I will keep on top of this. On the other matter.
   2. Berndale on receipt of another bank guarantee of $2m ($5m in total bank guarantee along cash of apx $400,000) they are holding will allow the margin to increase up to $7.5m without being in default-Berndale will waive any previous default (inc the notice of 26/11/07) by How Trading as per the signed agreement of 25/5/06.
   3. Berndale will release fund back to Westpac as the margin decreases.
   4. Berndale will pay previous interest owe to How Trading.
   5. David Waterhouse will guarantee How Trading account with Berndale.
2. David, I thought I would lay out the commercial arrangement in my language also. This is still subject to our legal and risk approval and subject to satisfactory documentation:-

1. understood
2. we will ask again for the additional $1.6mill (David you need to consider other unencumbered bonds or stocks you can transfer to us as collateral)
3. we discussed this before, I can not
4. full legal personal guarantee (ensuring access to real estate - this many mean adding a spouse to the g'tee. We can make this determination when we see the statement of assets).
5. We discussed this before, I can not.
6. provide latest financials for How Trading
7. possible
8. you will only be able to do risk reducing trades
9. agreed
10. ASX margins must remain under A$7.5mill until Friday 20th Dec (margin is currently A$7.1mill)
11. agreed
12. if margin moves above A$7.4mill before Dec 20 we will be able to close positions
13. agreed
14. after 20 Dec, if the client is within normal ASX margin reg't, we will not close positions
15. can you extend this to 8th of Jan
16. after Dec 20 expiry, and if account is within reg't, the client will be required to transfer all remaining positions to other brokers by Jan 8th
17. this is new, I understood the positions could stay until expiry.
18. If the margin returns to credit, this will be paid to Westpac directly (Westpac's facility needs to provide for us to redraw funds to meet margin debits
19. agreed
20. continue to work, like today, to reduce risk in dated option positions
21. not agreed, I would want to have control over the account & would look to close if a position became a bit dangerous.
22. ensure existing bank g'tees are renewed to our satisfaction
23. agreed, please note I was the one who first mention this last Tuesday, no one from Berndale was interested until yesterday.
24. notwithstanding this arrangement, we cannot withdraw our default notice while you still owe us margin
25. yes you can, just reissue them if the account goes into default as per the new agreement
26. Let's discuss again on Monday.
27. Please do remember I have done & will keep on trying to do everything to sort this out, however you are getting a further $2m plus a personal guarantee, the account has no risk whatsoever left on it, just time decay
28. David, the point on the g'tee requires attention (and the How Trading financial). Norris and I can't understand why you are avoiding providing a list of your assets. We don't know your net worth at all unless you show us something. And we never discussed adding your spouse before, but if that is where your assets are, we would want that. Surely, you have just given Westpac an updated schedule. Can you send something across tomorrow?
29. John, This is unacceptable. I will get an offer off to you this afternoon.[22]

149 While corresponding with Mr Waterhouse, Mr Laws kept Berndale management informed of developments. On Thursday 29 November 2007 at 3.07pm, he forwarded a summary prepared by Mr Ellett to the management team.

Background:

How Trading trades a short strangle strategy by generally selling single stock ETO puts and a few calls, with no downside risk protection. How executes through Norris Smith Stockbroking, a small broker who clears through Berndale Securities.

FF&O post margins to the Exchange daily and request funds from Berndale who in turn request funds from How Trading directly. On Wed 21 Nov How failed to meet the first margin call.

How has continued to fail to meet margin calls to date, and other than some margin release (buy back of short puts) and small cash flows continues to fail and still currently owes AUD4.4m. The account as at this morning showed approximately AUD4m in cash equivalents posted with the Exchange versus a short market value of AUD5.5m based on ASX price. (as below this figure realistically could be higher) The account is in negative equity AUD1.5m based on yesterday close prices.

Margining:

The Exchange charge a margin of AUD8.2m against this options portfolio of 33 names and over 300 open positions using a excel version of the RBH (Risk Based Haircut) or Vol Dispersion calculators approximately AUD 20m would be margined in PB using a simple 15% beta adjusted P&L slide. We have discussed with Norris an inevitable remargining at least double potentially next week.

The ASX using a 150% vol shock plus 15% P&L slide have been alerted to this particular portfolio and preliminary stress margin call figures were around AUD150m, although this figure would have substantially reduced as the open positions have reduced from 60,000 contracts to approx, 45,000 in the last few weeks since notified, capturing the closer to and ATM positions. We have not been given any more figures from the ASX on their stresses.

Raising Cash:

How has requested a AUD2m facility be set up in the form of a bank guarantee from Westpac, however there were some conditions that may impede ML receiving the guarantee. It is expected next week, although the bank could be sensitive to whilst How reportedly has AUD40m net worth, it appears he is unable to raise additional cash. He wishes to provide a personal guarantee, which give a floating charge over assets (but does not stop others also doing so).

Other known wealth:

Home worth AUD30m and AUD11m mortgage... 80% of stocks geared - a request to gear at 90% was declined (The Stockbroker is thinly capitalised and look through to the client is required)

The Portfolio:

Roughly 80% of the portfolio risk is in 3 Banking stocks, although there are a total of 33 names. I have approached the Derivative desk (Paul Craft), who have loaded all open positions on these 3 stocks into excel using RAM to calculate Greeks and theoretical prices Nov options have been excluded due to their expiry tomorrow. Carved out portfolio metrics:

Premium (value): (5.3m)

Delta$ 18.8m

Gamma$1 (5.0m)

Vega (718.8m)

Notional 612.7m

Paul's comments: all of these figures are very large, the notional is massive.

Buy back well out of the money puts in Dec and Jan, as they are cheap now. If the market loses 10% these options will pose an even greater problem and will not be able to be bought back. Dec and Jan positions could be closed for a theoretical price of about AUD550k (probably cost AUD1m).

40% of the notional exposure could be closed out. Over 40% of gamma would disappear. Only about 11% of Vega would be reduced. Dec and Jan positions appears relatively delta neutral due to short calls and puts, as well as a few long puts. Norris has purchased a few puts back and bought some near to the money long puts to reduce some exposure, but to the extent of 100's of contracts, not 1,000's of contracts as we wish - there were about 500-600 contracts bought today according to FF&O. Delta has reduced AUD 10m over the last week.

How has approached another broker, Opes Prime Stock Broking who happens to be a PB client and clears through Berndale. Whilst this would not solve the issue of portfolio risk on our books, Opes Prime are a much larger broker with an expected AUD 500m worth of free collateral held with ANZ that might support a loss.

Whilst this is not our recommended solution, due to Chinese walls are unable to mention such propositions, only request if such a portfolio did get transferred, Opes would be required to post a much larger margin - this is effect would be requested of the client, which as I understand is an impossibility.

We will make suggestions on how to unwind and work together with Norris Smith Trading on a daily basis. I assume we will also have a daily conference calls and an EOD summary (from myself)

150 On 30 November 2007 at 8.55am, Mr Laws wrote to Messrs Craft and Ryan.

We appreciate your help to date with this account. We are now at a stage of delicate balance between taking charge of the account and managing it down immediately, or having to raise $2mill from Westpac and provide a personal g'tee which is potentially very valuable. Overriding this is that he still owes us $4mill. One of the main tensions is the Dec positions. On one hand, the client thinks he is 'protected' from getting exercised with a 10-15% price cushion. Leaving these to run off is key to him, as Westpac don't want him to spend anymore premium on these. On the other is the negative gamma and vol risk in the book.

Ultimately the firm wants to minimise its loss. I appreciate the time drain and Chinese Wall factor, but we will continue to need Paul's expertise in managing our exposure.

151 At 2.00pm on Friday 30 November 2007, Mr Laws wrote again to senior management at Merrill Lynch:

As of lunchtime Syd time Friday, and following the conference call at 11.30am Syd time, we have not been able to contact How Trading direct. By email I have strongly reiterated our demand for him to meet his margin call or relinquish control of the account.

We agreed on the call to tell How, if he provided a personal guarantee (estimated net worth of A$30mill), we would work with him (in his office) to reduce risk in the book and manage to the best outcome. Allowing this call, Paul Masi and Nigel Beattie discussed the matter, reviewing our options in total.

The option outlines above is unlikely to be accepted by the client, as they will not accept releasing control of the book. The client would then, unlikely provide a g'tee and we would be in a position of taking over the portfolio. It is estimated that existing the portfolio would cost approximately USD3-5million and in this options our likely course of action would be to sue How Trading.

An alternative option which we believe might leave us in a stronger position, would be to try and obtain as much new margin as possible and a personal guarantee, while at the same time agreeing to various conditions set by the client and setting some additional considerations to limit our risk. The added collateral received would strengthen our position in a probable litigation event, notwithstanding we may have incurred a higher loss. Key here is validating the support of his personal guarantee. We'd like the team to consider the following proposal:

• Request the client to provide the $2mill loan from Westpac
• We will ask again for the additional $1.6mill
• Full legal personal guarantee (ensuring access to his real estate)
• Client will only be able to do risk reducing trades
• ASX margins must remain under A$7.5mill until Friday 20th Dec (margin is currently A$7.1mill). if margin moves above A$7.5mill before Dec 20 we will be able to close positions.
• After Dec 20 expiry, if the client is within normal ASX margin req't, we will not close positions
• After Dec 20 expiry, and if account is within margin req't, the client will be required to transfer all remaining positions to other brokers by Jan 8th
• If the margin returns to credit, this will be paid to Westpac directly (this is Westpac's condition)

We would also consider buying on our own account some downside protection. Client has continued to buy back 265 contracts this morning in Jan and Mar positions closer to the money than his existing shorts but tapping into more liquidity.[23]

This email foreshadowed the Merrill Lynch house trades which, when exposed in discovery to the defendants, resulted in the introduction of the Chapter 1 case in early 2009.

152 Throughout Friday 30 November 2007, Mr Waterhouse was in contact with Scott Skene of Westpac to procure a loan of $2m on behalf of How Trading. Late that day Mr Skene sent the following email to Mr Waterhouse:

David, Further to our conversation, please find attached the Business Finance Request which will be completed under How Trading. Could you please sign on pages 4, 5 & 8.

I will also have the loan documents for the formal increase of $2m on Monday. Could I arrange a time to come on Tuesday morning to complete with Janette and yourself.

I have also received approval for an additional $2m until the 21/12/07 subject to the following;

• Confirmation from Janette of the transaction and security against home.
• All accounts are to operate in credit at all times. Funds will be required to be in the account to cover transactions prior to presentation otherwise drawing will be returned to bring accounts into order as required.
• This is the peak of our assistance on this basis.

• Mr Ryan recommended that Merrill Lynch take preventative measures on Merrill Lynch's own account, by purchasing index options as general protection against a market decline. Presumably he so instructed Mr Craft who advised by email that trades had been effected. At 5.07pm, Craft emailed Ryan and said,

153 At 5.40pm on 30 November 2007, Mr Waterhouse sent an email to Mr Smith outlining his financial position.

As you know I own & sole director of over 600 Companies which control many assets.

I have in my own name;

Property Nil

Liabilities Nil

Other Assets is :

* Goodwill $5m ( represent the ability to make $5.m pa)

* Shares in Priv Comp $500K

* Cash $100k

* Artwork $300K

154 Berndale was apparently unaware that Mr Waterhouse did not own any real estate and that other "assets" were of uncertain value except for cash. It continued to push for a personal guarantee from Mr Waterhouse as well as more tangible security. Mr Laws emailed Mr Waterhouse at 7.18pm on Saturday 1 December 2007 and said:

David, the point on the g'tee requires attention (and the How Trading financial). Norris and I can't understand why you are avoiding providing a list of your assets. We don't know your net worth at all unless you show us something. And we never discussed adding your spouse before, but if that is where your assets are, we would want that. Surely, you have just given Westpac an updated schedule. Can you send something across tomorrow?

155 Mr Laws emailed Merrill Lynch management at 10.53am on Monday 3 December 2007 regarding the provision of the bank guarantee.

We agree entirely that we have given enough time for there to be a more meaningful response from the client. We have given our client, Norris Smith a 4pm deadline to:

- ensure the expiring $2mill Westpac g'tee is renewed (we have rec'd an email from Westpac anticipating the renewal will take place)

- source the additional $2mill Westpac loan

- provide visibility to the assets of both How Trading and him personally to support the personal g'tee

We believe there is flight risk from Westpac if we act aggressively on the account this morning. However, this time today will also be used by OGC to advise procedures for managing the account (eg, how we interact on the account, whether we 'buy' the account onto GELP's books etc). We sent a default notice last Monday protecting our rights, so our broad rights over claiming the account are not in question.

We have called the end client and left a message. He said he would call back asap, but will communicate as above.[24]

156 At 12.00 pm on Monday 3 December 2007, Mr Laws wrote to Waterhouse enquiring about the progress of the bank guarantee.

David, thanks for coming back... a couple of things:

- we're simply trying to understand your financial positions. How have your discussions with Westpac gone today?

- on the expiring g'tee, we believe we need to give you a new g'tee to get signed - Norris should be chasing you on this also - where are you so we can deliver this to you or the bank directly for their signature?

- on the basis we get the two bank matters and the g'tee in place today, we can enable a better discussion to take place around the underlying conditions below... we aren't that far apart.

When can you have a conversation about this?[25]

157 At 12.31pm on Monday 3 December 2007, Mr Waterhouse replied. The text of this email was prepared by Mr Tighe. It was the genesis of the December agreement and called in aid by Mr Waterhouse to explain his understanding of the terms of the December agreement made a few days later.

John, Having given your recent correspondence further consideration I am of the view that the conditions which you have requested on the last 2 emails being 7.50pm Friday 30 November 2007 and 7.18pm Saturday 01 December are quite unreasonable and I therefore reject them. In view of the expiry of Westpac's guarantee on 1 December 2007, I am prepared to put the following proposal for your consideration.

- My wife, Janette Waterhouse, will provide a guarantee to How Tradings for liability limited to $4 million for the life of the options subject to the following conditions:

• If the margin requirement exceed $7.5 million from more than two days otherwise than as a result of any activity on the part of Berndale or Norris Smith Stockbroking, the guarantee will become enforceable;
• For so long as How Trading maintains the margin requirement at less than $7.5 million, or in excess of that sum to no longer than 48 hours, Berndale and/or Norris Smith Stock broking will have no right to trade or close out How Tradings position or buy protection in respect of that position and if either does so, the guarantee will automatically be avoided.

Please note that my wife is the sole proprietor of her residence which is presently worth $25-30 million and is subject to a mortgage of $6 million. She has advanced $7 million to How Trading and holds a fixed and floating charge over its assets and undertaking to secure those advances.

Please note further that the OCH margin requirement stands today at $6.948 million and the longest dated option is June 2010. You presently hold cash security of $1.3 million and owe approximately $60,000 in unpaid interest. It is my intention that the options will expire either worthless or I will buyback positions that become difficult. The margin requirement will therefore decrease daily. Any surplus funds after expiry in June 2010 is be remitted to How Trading.[26]

158 In his witness statement Mr Laws said that he understood the reference to "buying protection" in this email to mean that Merrill Lynch could not trade on the How Trading account. He distinguished the Merrill Lynch house trades. He said that when he read the email it did not occur to him that the proposed condition that Merrill Lynch not "buy protection" would have any connection with the Merrill Lynch house trades as there was no possibility that they would contaminate the How Trading account.

159 At 12.54pm on Monday 3 December 2007, Mr Laws wrote to Mr Waterhouse enquiring about the progress of the Westpac bank guarantee. At 4.15pm he forwarded an email, drafted by Mr Horrax, to Mr Waterhouse.

In order to confirm in writing the position that we discussed this afternoon and provide additional clarity on specifics we would be prepared to accept the following conditions:

1. if the margin requirement exceeds $7.5 million from more than 48 hours otherwise than as a result of any activity on the part of Berndale we will make immediate demand under the guarantee set out below, and
2. for so long as How Trading maintains the margin requirement at less than $7.5 million, or in excess of that sum to no longer than 48 hours, Berndale will not trade or close out How Tradings positions.

On the basis that your wife guarantees the obligations of How Trading to Berndale secured by way of second mortgage over her residential property at 97 Elizabeth Bay Road in respect of the balance of the equity in the property provided that:

1. Westpac advances are limited to the current level of $6,644,000 and
2. a valuation of the property to our satisfaction in all respects is received by us.

It would also be a requirement that all trading would be the purposes of risk reduction.

Unless you accept these conditions prior to the start of trading Tues 4 Dec, or if we have not heard from you by then, we will begin closing positions and will begin legal proceedings against How Trading.[27]

160 At 4.34pm the same day Mr Craft sent an email to Mr Ryan setting out the list of index put options he had bought that day for GMFS.

Trade for GMFS

Dec 07 5750put (88%)

Bought 200 @ 7.255

Dec 07 6100put (93%)

Bought 266 @ 26.12218

Total for today

USD 67m Notional

Premium USD 185k

Mr Craft explained the transactions. He said that he bought 200 December 2007 5,750 ASX200 puts (88 per cent) @ $7.255 and 266 December 2007 6,100 ASX200 puts (93 per cent) @ $26.12218 on the SFE. The trades were booked in the name of Merrill Lynch.

161 Later that day (3 December) at 5.51pm, Mr Laws wrote to management.

Waterhouse just called me. He says there is no way his wife could get legal advice to consent to a full value g'tee/mortgage.

Westpac have taken the maturing g'tee and paid down their loan. The only way they give it back is if margin is less than $6million.

He'd like to come in for a meeting. He was certainly more contrite, but no more cashed up. Earliest he can do is noon. I told him I'd put it to the group, but he'd need a much better plan abt how to pay us back. And that we would have already begun closing positions.

I'm sure its more of the same, but without Westpac. The only diff would be getting the mortgage in our favour rather than How Trading (but still with a $4mill limit). I don't see much positive in a meeting. Any one have other thoughts?

162 At 10.57pm the same night, Mr Laws again wrote to management, outlining the process to commence unwinding the How Trading portfolio.

Fyi, an outline below of the process we will use to begin unwinding How Trading (David Waterhouse) positions tomorrow morning. Some of the key numbers from Don's risk summary, and to add to Dan Ritchie's overview earlier:

Cash/G'tee provided: A$1.3mill

Margin call missed: A$5.6mill

Total ASX margin req't: A$6.9mill

Margin req't represented by:

Options value: A$5.2mill

ASX initial margin: A$1.7mill

Total index put protection (abt 90% strike) bought by GELP: A$163mill notional at a cost of abt A$400k. The bank g'tee matter has turned out. Westpac have acted in their interests and allowed the $2mill g'tee to lapse, placing the burden on Berndale. It transpires there are 2 forms of standard g'tee, and FF&O accepted the form some years ago that only provides for the ASX to be protected, and not the Firm. This is the only account that have bank g'tees in place.

How advised he is unable to provide a spousal g'tee to the value of the house (a 3rd party g'tee of this nature requires evidence of external legal advice, and no lawyer would approve). He has asked for a meeting in our offices tomorrow, although I've told him we would being unwinding positions and initiating legal proceedings first thing. He is unlikely to have anything material to add, especially given Westpac's reversal.

He will likely request us to accept a $4mill 2nd mortgage on his spouses house, which she has rec'd verbal legal advice on, as a settlement, against on the condition we only exercise this if the ASX margin increases above $7.5mill.

We don't know the current financial status of How Trading. This is the only Waterhouse related entity we will have recourse to unless we can pierce the corporate veil based on any illegal activity or misrepresentations we can identify.[28]

163 On the morning of 4 December 2007, commencing at 7.34am, the following email exchanges took place between Mr Waterhouse and Mr Laws.

After our phone call-I telephoned Westpac & then I had a meeting with my wife & her accountant last night. I think I can offer you the following offer-if certain concessions are meet by Berndale/Norris Smith.

1. Westpac will give you a duel guarantee for $4 for 12 months-at the end of the 12month period, Westpac will issue a new guarantee matching the 5th of December 2008 margin with plus 10%-in exchange for that, Berndale will release the previous $4m guarantee that will expire that day. 2. The margin can not exceed $7.5m until 21st December 2007 and $6.5m until 25th of January 2008 & forwards the account must decrease. 3. All excess monies over the bank bill of $4m must flow back into How Trading Westpac account, including the present bank bill of $1m held by OCH-likewise margins must be meet by How Trading from 25th of January 2008-if margins are not meet within a 48 hour period Berndale can take control of the How Trading option account. 4. As long as the account is maintain in the above conditions - Berndale/Norris Smith will have no rights to trade, close out positions or buy protection on the How Trading account. 5. Berndale must pay all interest owed on the account from 01/09/06 until present-this is over $60,000. 6. Norris Smith/Berndale must remit all brokage they have derived on the How Trading account between 01 September 2007 until 30 November 2007-is this a sticky point from my wife as her accountant & her totally blames Berndale/Norris Smith allowing the account to blow out from a workable margin of $3m to $8m without any sort of control and accountability on the their roll of a stockbroker. The commission in September was $22,900,October $48,240 & November was $28,900-total $100,000

John-this is the final offer as my wife leaves on a 3pm fight tomorrow (5th of December) to America-I can email the E ticket if you want confirmation, but after that nothing can happen until 2nd of January 2008 when she returns. There is no chance of anything more like the open ended mortgage you requested, as even if she wanted too-she wont, she would never find a lawyer to sign off on it.$4m is the maximum amount she & her legal adviser will allow her to go to

The margin is now $6.4m, $500,000 came off last night as the volatility is coming down as we are getting to Christmas-this means you will be carry How Trading for only $1m for between 2 to 7 weeks-you did agree the margins will fall away after December expiry.

I hope is acceptable, if not, I know I have done everything possible on my part, in the position the account has found it self in to resolve this.

JL David, I just want to clarify.

- In addition to points 1 through 6, your wife will still provide a $4mill personal g'tee?

- The $4mill Westpac duel beneficiary guarantee will be effective when? Today? (to be exact, the duel g'tee will be in favor of Berndale and the OCH and will be exercisable by Berndale)

I'll revert when I canvas the group.

DW John,

Of course not-she will provide the guarantee to Westpac who will inturn provide the $4m bank guarantee to Berndale-not both.

Tomorrow, docts will be signed today by my wife at the bank, there is a normal 3 day turn around, which the bank could bust everyone to get it out by tomorrow.

JL David - we need to talk.

We are agreed in principle. We need you to begin the doc process immediately. We completely refute any suggestion we are responsible for your loss. And negotiating out of commission earned is up to Norris. Remember also we have the right to levy default interest on you which would offset some of the interest you claim (which we have never agreed to). However this is noise which we can negotiate out of. The main thing is we want this in place asap, and would welcome the opportunity to talk with Westpac with yourself to ascertain likely finalisation. Where can I call you?

1. David, just to reiterate also, we will want to constrain you to only risk reducing trades.
2. Of course.

Westpac are ok to talk to you re the irreversible $4 million bank guarantee-they would want some sort of matching letter from you release/or making no claim the previous bank guarantee of $1m-so they no trouble when collecting it.

1. David, will call you soon. Westpac agreement and communication is key, as this is all subject to satisfactory legal documentation_._

She will not sign anything unless we have a watertight confidentiality agreement.

We are seeing the bank at 1pm, however she & the bank will not sign until we have that agreement finalized & signed. Can you send you draft doct

Drafting now...will be with you soon. Much the same as we discussed.[29]

164 On the same day Merrill Lynch short sold stock on its own account for the purpose of creating a hedge against its potential loss. The following table shows the stock traded by Merrill Lynch on 4 December 2007, which was the bulk of stock sold as part of its risk mitigation strategy. The far right column represents these trades as a percentage of the total volume of stocks traded on the ASX that day.

165 At 1.04pm on 4 December 2007, Mr Waterhouse received an email from Mr Tighe. The communication was unusually formal in nature but said nothing of the important conditions Mr Waterhouse claimed in evidence that Mr Tighe required.

Good Afternoon David,

In response to your recent request for further funding from Janette Waterhouse on behalf of your company How Trading Pty Limited, Janette considers the request however she reminds you of some the conditions and views given her current secured facilities:

- Janette has a registered secured charge over the assets of the company that represents the shareholder loans since before 30 June 2006

- We remind you that as a director, any creditor during these times requesting a change in trading terms or any abnormal payments, would be reviewed under scrutiny, and could be seen, as a possible preference payments by Janette.

- Any advances that Janette may consider would most likely be made, as previous, through How Trading Pty Limited. Janette has not and will not currently consider financing directly to any creditor, therefore not providing direct guarantees to any of How's service providers.

- Janette reserves the rights to approve any other guarantees offered by the company,

- Janette would consider any reduction of her current facility in light of providing a further guarantee to How.

We conclude this communication in saying that Janette as a financier to How will work with its director to achieve the best commercial result available depending upon the market conditions prevailing and the risks to her as a financier. We look forward to be made aware of any trade creditors requests during these times. Should there be any queries please address any concerns to the writer on behalf of Janette

166 At 2.29 pm on Tuesday 4 December 2007, Mr Horrax sent a without prejudice draft letter setting out the terms as discussed between the parties. Some terms had been modified by Mr Horrax. The conditional prohibition on Berndale's actions in relation to the portfolio and account had been modified when compared with his initial draft sent to Mr Waterhouse by Mr Laws at 4.15pm on 3 December 2007. Mr Horrax substantially incorporated the words drafted by Mr Waterhouse in his email sent to Mr Laws at 7.34am on 4 December 2007 - "No right to trade, close out positions or buy protection on the How Trading account".[30] The 48 hour period available to remedy a default had been deleted.

Dear Mr Waterhouse,

Confirmation of Conditions

We refer to the Agreement between Berndale Securities Limited ABN 63 006 687 467 (Berndale) and How Trading Pty Limited ABN 36 101 185 979 (How Trading) dated 24 May 2006 (Agreement) and to your account number NOR00016 (Account), held at Berndale.

Subject to satisfactory completion of each of the conditions set out below, as determined by Berndale in its sole discretion, Berndale agrees not to close out any positions in the Account or buy protection on the Account:

1. Westpac Banking Corporation ABN 33 007 457 141 (Westpac) provides an executed bank guarantee in favour of the Australian Clearing House (ACH) and Berndale in the form of the Ach Bank Guarantee - Dual Beneficiary in an amount of AUD$4,000,000 with effective from 5 December 2007 for a term of 12 months (Dual Beneficiary Guarantee);
2. Westpac provides written confirmation to How Trading with a copy to Berndale that Westpac will issue a new guarantee in favour of ACH and Berndale in the form of the ACH Bank Guarantee - Dual Beneficiary with effect from 5 December 2008 in an amount corresponding to the ACH margin requirement in respect of the Account as at 5 December 2008 plus 10% of the ACH margin requirement;
3. The ACH margin requirements on the Account do not exceed the amounts set out below:
   • (a) from 5 December 2007 to 21 December 2007 - AUD$7,500,000
   • (b) from 22 December 2007 until 25 January 2008 - AUD$6,500,000
   • (c) from 26 January 2008 until 28 March 2008 - AUD $6,000,000
4. From 29 March 2008 and thereafter How Trading fully satisfies all margin requirements in accordance with the Agreement and the ACH Rules;
5. How Trading will only enter into transactions which effectively reduce the risk in the Account;
6. Berndale will transfer any credit balance in the Account (as determined by Berndale in its sole discretion) to a Westpac account as directed by How Trading when the credit balance of the Account is [AUD$10,000] or more, up to a maximum aggregate amount of [AUD$]
7. Berndale agrees to negotiate with How Trading regarding interest payable on the Account;
8. Berndale will facilitate discussions between How Trading and Norris Smith Stockbroking Pty Limited with respect to commissions paid for the period 1 September 2006 to 5 December 2007;
9. David Waterhouse provides a personal guarantee with effect from 5 December 2007 in favour of Berndale in respect of all obligations of How Trading owing to Berndale, including without limitation the obligations in respect of the Account; and
10. Janette Mary Waterhouse agrees in writing to waive any claims, rights and proceedings which she, or any of her related entities or related persons may have against Berndale, its directors and employees and any of their respective affiliates.

Berndale acknowledges that Westpac has provided a single beneficiary guarantee in favour of the ACH in the ACH standard form Bank Guarantee - Standard in an amount of AUD$1,000,000 (Single Guarantee) and that this Single Guarantee lapses on 31 December 2007. Upon the Single Guarantee lapsing Berndale confirms that it has no right or claim against Westpac or any other party in relation to the lapsed Single Guarantee.

If at any time, How Trading breaches any of the above conditions, Berndale may, without notice to How Trading, immediately exercise its rights under the Client Agreement, the ACH Clearing Rules and any other rights it has, including without limitation its right to make demand under the Dual Beneficiary Guarantee and to close out any transactions in the Account.

If any of conditions, 1, 2, 8 or 9 are not satisfied by How Trading, as determined by Berndale in its sole discretion, by 5.00pm Sydney time on 5 December 2007, this letter shall cease to have any force and effect.

This letter is governed by the laws in force in Victoria.[31]

167 Notwithstanding the advanced stage of the negotiations, Mr Gupta at Merrill Lynch, who was aware of the negotiations, instructed Messrs Ryan and Craft to 'Pls carry on your hedging'

Regardless of the negotiations with the client. We will let you know when to stop.

168 On or about 4 December 2007, Mr Ryan told Mr Craft to set up a mirror of How Trading's positions into a "RAM" book described as the "AEP Book". RAM was an internal Merrill Lynch computer system used to analyse and measure risk. By entering the positions in the AEP book Merrill Lynch was able to undertake a more detailed analysis of the portfolio and plan its protective trades. All Merrill Lynch risk mitigation trades were to be recorded in the same book as well as any positions bought by How Trading.

169 Mr Waterhouse replied to Mr Horrax' draft terms and conditions at 3.35pm on 4 December 2007, with some minor amendments relating to confidentiality, and he proposed that documents be executed that afternoon.

170 At 3.54 pm, Mr Waterhouse sent to Mr Horrax a draft release to be signed by Mrs Janette Waterhouse and himself. The release had been required by Berndale following the allegation that it had permitted How Trading to continue to trade to its detriment.

171 Mr Horrax replied at 6.39pm attaching draft documents, including the letter agreement which was to be further modified the following morning at the first of two meetings that took place at Berndale's offices.

David,

Attached are the current versions of the documents. The primary documents is the Agreement. There are small number of amendments to the Agreement which have resulted from our internal discussions and external advice. Two of those amendments which I will highlight are as follows:

(1) The clause relating to facilitating negotiations on commissions has been removed as you should have already received comfort in relation to this matter directly from Norris Smith. At a legal level issues in relation to commission relate to How Tradings relationship with Norris Smith and issues in relation to interest relate to the relationship How Trading has with Berndale. This structure is therefore now reflected in the Agreement.

(2) We have now included a reference in the Agreement to three Release documents (which are attached) as although we remain firmly of the view that Berndale is not responsible for the situation the account is in as this issue has been raised earlier today by your wife via you we wish to clarify there will be no debate in relation to such points going forward with respect to any party.

A marked up version of your draft of the Release is attached along with three final versions. In essence we have looked to amend this document in order put it into a deed format which removes the need for consideration.

Also attached is the letter addressed to How Trading which we understand you will pass to Westpac. This letter at essentially extracts the two relevant elements from the Agreement in relation to Westpac as per your request.

Finally a personal guarantee document is attached together with an acknowledgment of legal advice form both of which we understand to be relatively standard documents.

I understand that this is a considerable amount of documentation and if you have any queries please do not hesitate to contact me.[32]

Michael,

I will call John first thing tomorrow-I hope it has not change too much.

David,

I think overall no points of principle have really changed. However I'm happy to explain with John tomorrow morning if that helps.

The draft letter agreement prepared by Mr Horrax was in a marked up version of the draft sent earlier that day. The words limiting Berndale's ability to deal with the account remained the same.

174 On the evening of Tuesday 4 December 2007, the following email exchange took place between Messrs Waterhouse, Laws and Horrax commencing at 7.03pm.

Can we get a letter from Norris Smith first thing in the morning re the $100k in commission repayment- otherwise Janette (who fly's out to USA at 3.15pm) will not be signing.

I just talked with Norris and he's left for the day. Don't you think his email is sufficient? We have discussed also with Norris and there is no impediment to this point_._

JL I've no doubt he would provide a letter but we asked him to send that email and he complied. Just want to be cognizant that time is of the essence.

175 At 7.38pm the same evening, Mr Laws sent an email to management within Merrill Lynch attaching a draft of the letter agreement between Berndale and How Trading.

All,

We reached an agreement with How trading, copy of the draft letter attached. Essentially:-

- We will receive a $4mill g'tee from Westpac and a personal g'tee from the client

- He will only engage in risk reducing trades

- The ASX margin needs to stay within A$7.5mill up to end of Dec expiry, within A$6.5mill from 21 Dec '07, within A$6mill from 25 Jan '08 until 28 Mar '08, and thereafter within normal ASX margin (ie no margin call outstanding)

If the margin rises above these limits we will exercise our rights, claim the $4mill g'tee, proceed litigation against him personally, and begin closing positions (per procedures agreed with OGC)

We anticipate this agreement being signed by the client tomorrow morning and believe that Westpac will deliver the g'tee Thursday. I am in dialogue with the clients Westpac contact so will be able to track their progress. If it looks like Westpac get stuck along their approval process, our agreement is voided.

In addition, OGC have sent a note to our broker client, Norris Smith, preserving our rights against him when/if an eventual loss is established on the How Trading account.

We believe this leaves us with more valuable recourse to collateral from Westpac and the client, that we would not have had access to as of last night, and we have limited our risk to measurable parameters based on ASX measured margin requirements. We don't believe litigating How Trading alone would have resulted in any recovery.

Asian markets a bit mixed today, with the ASX virtually flat.

We have slightly increased our index bought put position from notional A$163mill to approx A$182mill and have short net A$10mill single stocks and futures as a partial delta hedge. Jason Ryan will forward more detailed email. GELP and GMF&S Risk will continue to analyse the positions and advise on further risk mitigation.

176 Emails passed between Mr Waterhouse and Messrs Laws and Horrax well into the evening and the following day prior to the meeting on the morning of 5 December. The significance of the exchanges leading up to the meeting is in the attention given by Mr Waterhouse and his advisors to detail. Issues were being identified, explained, agreed, rejected or discussed. There was a flow on from some of the discussion at the first meeting on the following day - in relation to recording agreement by Mrs Waterhouse, the provision of a bank guarantee, interest and commission. The emails are also important for what they do not contain. There was no attempt by Mr Waterhouse or his advisors to extend the prohibition on Berndale's trading "on the account" to prohibit Merrill Lynch trading on its own account to reduce its risk. Nor was there any discussion about funding buy backs.

John,

Talked to Janette's lawyer-he has not read the new inclusions, only heard from me reading. His thoughts were

First look Janette waiver looks ok.

However he does not like the Westpac $1m letter.

Also does not like the following inclusions in the main letter-

1. wants the date to match the date of Westpac handing over the bank guarantee-maybe as late as 7th Dec
2. wants 8th Dec 2008 -as the 5th is a Friday-8th is a Monday
3. wants original-this is too messy
4. wants his original-too open ended
5. does not want Janette to agree to anything in this doct.(esp. as she is not a signatory to this doct.)-accepts that Janette will sign separate waiver

Wants Berndale to waive its right to the old $1m as soon as it takes collection the new guarantee of $4m Everything else looks ok-wants a letter from Norris however This doct's must be signed by 10am-as she will be leaving to go to the airport by 11am(4 hours before flight).[33]

178 Commencing at 10.27pm that evening Messrs Horrax and Laws wrote, to Mr Waterhouse,

1/2 - we will need to discuss internally as these are business issues.

6/7 - I will check tomorrow as I don't have access to all my folders at home but will revert asap.

9 - Happy to remove the references to "agree" but we will need reference to the provision of the signed Releases as these are needed from our perspective and it is intended that the letter be overarching i.e. cover all points relevant to deal i.e. we wouldn't be comfortable to cover the Releases separately as we looking at this as a complete package. I think this shouldn't be contentious.

On the old guarantee I don't get the impression that you intend that Westpac would be released early or that it would no longer be used as collateral. Therefore from our perspective we took the view that nothing was changing with respect to the terms of the old guarantee i.e. we just accept that it expiries on 31 Dec and agree to take no action in respect of any potential renewal - which we are happy to do - so I am not sure of the point here - I guess this is the same point in respect of the Westpac letter as it is designed to be consistent with the main letter. I am happy to talk to the lawyer direct if that would help.

We are very conscious of the timing and will turn this around as quickly as we can.

1. Points 1/2 we can accept. David, you need to fire up Westpac. Friday is unreasonable. We are turning this around in a day and they are letting you down.

Points 6 - this is the point abt paying Westpac any credit balance. I think our language is clear. Your email wasn't that clear to me and some colleagues struggled with it also. Point is we will pay to Westpac any credit over the ACH margin, and they should pay it back if margin moves against them the next day.

7. Norris has agreed to rebate commission, we don't know exact number. We have agreed to credit interest, we haven't agreed to an exact calculation. You need to accept our right to charge default interest on the margin calls, we haven't agreed an exact number. We need to have some good faith here David. As I've said this is noise that neither of us should let be a showstopper.

As Michael says the old g'tee is absolutely useless to us and we should never have accepted it. The ONLY situation Westpac gets called on it is if Berndale entirely default to the ACH. So we are arguing abt not exercising on something we can exercise. I think our language is clear on that.

179 On the morning of Wednesday 5 December 2007, at 7.09am, the following exchange of emails took place between Mr Waterhouse and Mr Laws:

Good news - the margin is coming down with the vol coming off - this morning its $6m.

First thing can you established the exact amount the account is in debit.

The way I see it there will be $160k excess fund in interest & Norris redbait vs. default interest of a lesser amount.

What is the default interest rate - too make it easier, Norris must pay these funds of exactly $100,000 (you can confirm in 5 sec that is the exact amount by looking at previous Sep, Oct & Nov end of month statements) to Berndale to cover default interest up until 29th of March, excess funds after that day are to be credited to How - this way Norris (which is messy) is out of the picture. We have no control of Norris repaying - Berndale does.

6. Sole discretion? - we just want it to revert to normal credits & debits.

1. negotiate - we need confirmation.
2. I have covered this above - Norris has sent 40 previous email with the promise to pay interest in a few days to within a month, not one promise has been kept from sep 2006 - Norris will not pay this unless you (Berndale have a commitment from him) - I would have no chance of collecting, my wife was concerned for him - losing his business/house, but she also blames him as well for not controlling the account & believes he should not profit by it.
3. Her lawyer said he does not want her name in the doct. full stop - I will have in my hand her separate release from her - I can not see why this is so important to have her in the doct?

This is a matter from Westpac - again I can not see what your problem is here, once you receive the $4m from Westpac, then you must accept you have no rights whatsoever to the previous $1m--Westpac will not advance the $4m without this is acceptance by Berndale - this is 100% deal breaker, as they believe you can and will.

Re a matter of trust - I trust you, however I'm not the man with the chq book - my wife is, she unfortunately has lost a lot of respect in my judgment in the last month, she is putting up her own property which she brought 4 years ago with her own independent funds, nothing to do with me, so she decide to seek independent advice-she got it-she is using it, I think trust should come from your side as she is putting up the $4m-with no being to her, which speaks plenty about her.

Are you able to come in and park yourself in our offices while we sort this out. Again we are not far apart but time is of the essence. I'll have a room ready at 8.30am... L38 Governor Philip Tower

180 Also on the morning of 5 December 2007, Mr Ryan sent an email to Mr Fujiwara in which a strategy was presented to avoid the Merrill Lynch house trades breaching the proposed prohibition on Berndale under the draft December agreement.

Hi Fuji,

The situation changed during the day. I was under the impression that you were aware of that. I will increase the number of calls into Ajay to prevent this re-happening, but I'm not on the non-risk Client related calls. I can ask to go on them if you wish.

The current status with the Client is that the draft Client agreement states "Berndale agrees not to close out any positions in the Account or buy protection on the Account". Therefore, all trades (including the index puts) are ML's. I avoid calling them GMF&S / FF&O / Gelp / Equity Mgt's as I think we all see this as a ML issue.[34]

181 The anticipated meeting took place at the office of Merrill Lynch. In attendance were Mr Waterhouse, Mr Forbes, Mr Laws and Mr Horrax. The draft letter agreement was tabled and discussed. It was amended and eventually signed at a second meeting shortly prior to midday. Also signed that day were deeds of waiver and release, a side letter confirming Berndale's agreement to remit interest and which concerned interest charges and the personal guarantee given by Mr Waterhouse, together with an acknowledgment of legal advice. As a result, How Trading was no longer in default. The terms of the letter agreement, ultimately signed by Mr Waterhouse on 5 December 2007, were as follows:

Dear Mr Waterhouse,

Confirmation of Conditions

We refer to the Agreement between Berndale Securities Limited ABN 63 006 687 467 (Berndale) and How Trading Pty Limited ABN 36 101 185 979 (How Trading) dated 24 May 2006 (Agreement) and to your account number NOR00016 (Account), held at Berndale.

Subject to satisfactory completion of and ongoing compliance with each of the conditions set out below, as determined by Berndale in its sole discretion, Berndale agrees not to close out any positions in the Account or buy protection on the Account:

1. Westpac Banking Corporation ABN 33 007 457 141 (Westpac) provides an executed bank guarantee in favour of the Australian Clearing House (ACH) and Berndale in the form of the ACH Bank Guarantee - Dual Beneficiary in an amount of AUD$4,000,000 with effective from 7 December 2007 for a term of 12 months (Dual Beneficiary Guarantee);
2. Westpac provides written confirmation to How Trading with a copy to Berndale that Westpac will issue a new guarantee in favour of ACH and Berndale in the form of the ACH Bank Guarantee - Dual Beneficiary with effect from 7 December 2008 in an amount corresponding to the ACH margin requirement in respect of the Account as at 8 December 2008 plus 10% of the ACH margin requirement;
3. The ACH margin requirements on the Account do not exceed the amounts set out below:
   • (a) from 5 December 2007 to 21 December 2007 - AUD$7,500,000
   • (b) from 22 December 2007 until 25 January 2008 - AUD$6,500,000
   • (c) from 26 January 2008 until 28 March 2008 - AUD $6,000,000
4. From 29 March 2008 and thereafter How Trading fully satisfies all margin requirements in accordance with the Agreement and the ACH Rules;
5. How Trading will only enter into transactions which effectively reduce the risk in the Account;
6. Berndale will transfer any credit balance in the Account to a Westpac account as directed by How Trading when the credit balance of the Account is AUD$10,000 or more, up to a maximum aggregate amount of AUD$4,000,000
7. [Intentionally Omitted]
8. David Waterhouse provides a personal guarantee with effect from 5 December 2007 in favour of Berndale in respect of all obligations of How Trading owing to Berndale, including without limitation the obligations in respect of the Account; and
9. Each of How Trading and David Waterhouse agrees in writing to waive any claims, rights and proceedings which she, or any of her related entities or related persons may have against Berndale, its directors and employees and any of their respective affiliates.

Berndale acknowledges that Westpac has provided a single beneficiary guarantee in favour of the ACH in the ACH standard form Bank Guarantee - Standard in an amount of AUD$1,000,000 (Single Guarantee) and that this Single Guarantee lapses on 31 December 2007. Berndale confirms that it has no interest in or claim over the Single Guarantee and it will take no action in an attempt to extend the Single Guarantee beyond 31 December 2007, provided that How Trading confirms the Single Guarantee may be treated as collateral for the Account until 31 December 2007.

If at any time, How Trading breaches any of the above conditions, Berndale may, without notice to How Trading, immediately exercise its rights under the Client Agreement, the ACH Clearing Rules and any other rights it has, including without limitation its right to make demand under the Dual Beneficiary Guarantee and to close out any transactions in the Account.

If any of conditions, 1, 2, 8 or 9 are not satisfied by How Trading, as determined by Berndale in its sole discretion, by 5.00pm Sydney time on 7 December 2007, this letter shall cease to have any force and effect.

This letter is governed by the laws in force in Victoria.

182 Later the same morning, Mr Ryan sent an email to staff updating the How Trading position.

Hi Guys,

Today the Client has been in the office to sign the documents (which he has done), and has taken some papers away and will return this morning with his wife's signature on. John will put a call into Westpac this afternoon to verify that the guarantee is happening as it should.

Paul [Masi] has broadly agreed to the following:

Should either of the above events fail to materialise we will maintain (and slightly increase) our stock delta hedge (to 100%). Should we receive positive results from the above (wife signing and Westpac) we will look to reduce the stock delta hedge to around 50%.

The index options will be delta hedged while we have a stock hedge on, and while the agreement with the Client looks promising.

The Client has just returned to the office again as I write.

183 Mr Waterhouse and his family flew to Aspen on the afternoon of 5 December 2007. The holiday had apparently been planned for some time. Mr Tighe was to make the same journey. At the airport Mr Waterhouse met Mr Tighe. Mr Tighe was travelling on a different flight and agreed to meet with Mr Waterhouse in the United States to discuss the strategy for buying back positions. Mr Tighe said that when he met Mr Waterhouse at Sydney Airport, Mr Waterhouse showed him a copy of the letter agreement. What passed between them concerning the letter agreement, if anything, was not revealed in evidence or explored.

184 Upon his arrival in Aspen, Mr Waterhouse received an email from Mr Laws complaining that Westpac would not have the guarantee ready until the following Monday. Mr Waterhouse agreed to intervene to assist the expedition of the guarantee.

185 On 7 December 2007 at 11.01am Mr Waterhouse sent an email to Mr Laws.

John

Scott Skene from Westpac has been told by he's legal people because of the "Dual Beneficiary format of the guarantee, will delay the issue-I have just asked him for a certain day (more certain than the last time, when he said Friday at the latest)-he is coming back to me within 15min- you are welcome to call him yourself to see what the problem is-on 92265893.

What will this do to our agreement?

Is it possible you change the no.2 to the 11th December?

The margin is now deflating to the low $5m market.

I will call you as soon as he calls me-I'm very disappointed in Westpac for this bizarre delay.

186 Later that morning, there were further email exchanges between Mr Waterhouse and Mr Laws concerning the delay and a proposal by Mr Laws for a substitute bank cheque for $4 million to be held in escrow by Berndale until the guarantee was prepared and delivered. Mr Waterhouse eventually agreed.

187 As a consequence Mr Forbes arranged for a facsimile to be sent to Mr Waterhouse in Aspen, attaching the Draft Dual Beneficiary Guarantee.

David,

Per our phone call and emails, we confirm:

On the basis Westpac issue a A$4 million bank cheque in favour of Berndale Securities Ltd, we will:

1. effectively extend the date on Point 1 in our letter dated 5th December 2007 to be effective on receipt of a A$4 million 'Dual Beneficiary' Westpac guarantee
2. hold the bank cheque without cashing it until the guarantee is delivered to us
3. return the bank cheque to Westpac in exchange of the guarantee at Westpac offices (7/275 Kent St, Sydney)
4. pay How Trading interest if the bank cheque is cashed (ACH rate - 50 bps)

A second fax appears to have been sent around this time by Berndale.

David

We refer to the letter agreement between How Trading Pty Limited (How Trading) and Berndale Securities Limited (Berndale) dated 5 December 2007 (Letter Agreement) and to your account number NOR00016 (Account)

Provided that Berndale receives a bank cheque from Westpac Banking Corporation (Westpac) made out to Berndale Securities Limited in the amount of AUD$4,000,000 (Bank Cheque) by 5pm today 7 December 2007, Berndale agrees to the terms set out in this letter.

Berndale will hold the Bank Cheque in escrow until 4pm Sydney time on 15 December 2007 or such earlier time as agreed between How Trading and Berndale (Exchange Time) on the following conditions:

(a) At the Exchange Time Westpac will provide a bank guarantee in the form of the ACH Bank Guarantee - Dual Beneficiary in favour of Berndale and the Australian Clearing House (ACH) in the amount of AUD$4,000,000 with effect from the Exchange Time for a term of 12 months (Dual Guarantee). For this purpose Berndale will attend the office of Scott Skene of Westpac at Level 7, 275 Kent Street, Sydney at the Exchange Time or at such other meeting as agreed with Berndale;

(b) If Westpac does not provide the Dual Guarantee at the Exchange Time Berndale will release the Bank cheque from escrow and will be immediately entitled to deposit the Bank Cheque.

If Westpac does not provide the Dual Guarantee at the Exchange Time, upon Berndale banking the Bank Cheque, Berndale agrees that the Letter Agreement is amended as follows:

(1) Condition 1 is waived;

(2) Conditions 2 is waived;

(3) Berndale will pay interest to How Trading on the credit balance of the Account at the ACH rate less 50 basis points;

(4) The reference to "AUD$4,000,000" in Condition 6 is replaced with "AUD4,400,000

For the avoidance of doubt the personal guarantee of David Waterhouse provided under condition 8 of the Letter Agreement and the waivers provided under condition 9 of the Letter Agreement will remain in full force and effect.

Except as provided in this letter, the terms and conditions set out in the Letter Agreement remain in full force and effect.

This letter is governed by the laws in force in Victoria.

The bank cheque for $4,000,000 was held in escrow by Merrill Lynch and subsequently exchanged for the Westpac Dual Beneficiary Guarantee on Monday 10 December 2007.

188 On 7 December 2007 at 6.36pm, Ryan sent an email to Merrill Lynch management.

Hi All,

Given the status of the Westpac guarantee we have unwound all delta hedges on the AEP book. Total P&L from these stocks and future trades is USD 2,784 (only).

The downside index puts remain in place (unhedged). Their purchase prices was totally ~USD 560k (details of those are below). The cost of reversing all the index trades at current (EOD) spot would be ~USD300k.

ATM vols have declined this week. 6mth vol on banking stocks is down about 2 points. The Vega of the Client's position is currently USD880k and this vol decrease has accounted for most of the reduction in potential unwind cost which would now be close to USD8 for 1/3 of the position, plus a buffer of 1-2 vol for the entire position.[35]

189 Mr Laws wrote to Mr Smith at 11.13pm on Monday 10 December 2007.

Norris,

Rob may have mentioned to you today, on David's we can only accept trades that buy back existing positions. If you want to buy higher strike puts as a hedge, or any other risk reducing trade, can you ensure you talk to us first.[36]

190 On Tuesday 11 December 2007 at 9.49am, Andrew Stutchbury sent an email to Ed Moriarty, chief risk officer, Robert McDonough of Corporate Credit in New York and Salvatore Petrancosta of Global Credit and Commitments in Hong Kong about the 'How Trading - Game Plan'

Managing How Trading

Client currently out of call with A$4mm bank cheque (12 mth gtee from Westpac expected to arrive today). With no ability to add new positions client exploring transferring positions to another broker. While exchange margin is below A$7.5m, Berndale can not close out positions, this amount reduces down to A$6mm out in March 2008. Client can only enter into risk reducing trades. I don't believe the business will remove the hedges all be it they are incurring a loss. Those hedges are there to cover some of the risk if the market completely tanks.[37]

The hedges under discussion were Merrill Lynch house trades designed to protect its position against a loss on the portfolio.

191 On Tuesday 11 December 2007 at 9.27am, Melvyn Ford in Hong Kong wrote to Sylvan Chackman, copying in other Merrill Lynch staff, including Mr Laws, outlining the strategy for dealing with Mr Waterhouse and the How Trading account. One issue that was clear to the writer was the difficulty Mr Waterhouse might have funding buy backs.

Syl

We discussed this at length in the region today with Paul Masi, Fuji and the other key players in our respective teams. The client is not currently reducing risk, in fact he is out of Australia through the Christmas period. We will be very strongly encouraging him to reduce risk on the book, one of the issues around it is his capability to spend money to reduce risk. We will make sure that Denis and Jason Ryan (GELP) are pro-active in speaking to the client when risk reducing opportunities arise. This will definitely have to be led by us, given what we know about the client. Note that under the agreement he can only do risk reducing trades and we have appropriate control in place via Norris (broker)

We are taking the following steps:

(1) We are preparing some relevant scenario analysis to take Norris (broker) through to indicate the level of risk still embedded in the portfolio and the approximate level of moves required in the underlying equities to hit the agreed ASX margin triggers under the recently signed agreement.

(2) We will strongly encourage Norris and How to reduce risk and/or move the portfolio away given the above scenarios, naturally we strongly favour moving the portfolio away, Masi and Denis will discuss Norris.

(3) If the client meets the requirements of the recent agreement (expiring in March 08), then we have the right to apply PB margin above exchange requirement and where he fails to pay we can re-take control of the portfolio.

Margins have reduced and the market is relatively stable. Dec crash hedges remain in place.[38]

192 On Monday 17 December 2007, the Australian market was down 3.5 per cent, prompting Mr Ritchie to email Mr Fujiwara in Japan and Mr Beattie in Hong Kong at 5.54pm;

Heads Up, Aussie market down 3.5% today which is a huge move for us. How Trading will be close to the $7.5m limit on margin triggering collapse of agreement and us taking control of portfolio. Report from Don Ellett to come.

193 Mr Fujiwara circulated an updated summary of the situations at 6.30pm to Mr Ford, Mr Ritchie and others.

On the back of the Australian market plunge today, we get together to follow up How situation. We do not know exactly the exchange margin number but we expect that is very likely to close to 7.5mm very soon.

Actions:

(1) Dan Ritchie to reach the account and give them a head-up of the situation.

(2) Jason Ryan to confirm and coordinate with the local OGC that we can release the notice as soon as the margin number is confirmed. (to target establishing a systematic process to be ready).

(3) Ajay, Jason and Denis will focus on trading hedging strategies focusing on delta and gamma first crossing new year. (we decided to trade out of their account).

(4) Melvyn to connect up with necessary GMFS team globally.

From Ajay, I would like to have loss estimate based of a few market scenario (considering a market liquidity during the year end), which is an update of what we have done few weeks ago.[39]

194 During Monday 17 December 2007, the following email exchange took place between Mr Forbes and Mr Anderson

1. Can you get the How numbers out as early as possible tomorrow to everyone. The market move is pushing him close to the point where we will step back in and take it over.
2. Is that my birthday present from you?
3. Yes

The defendants submitted that Berndale or Merrill Lynch was anxious to take over the portfolio and exhibited some exhilaration at the prospect. Mr Anderson did not give evidence. His comment might equally be interpreted as a facetious remark. As settlement participant for the transactions, Berndale was exposed under the contract but unable to control the account because of its agreement made on 5 December 2007. It would not be surprising if Berndale and Merrill Lynch were anxious to have control of an account which exposed the group to financial loss.

195 On Tuesday 18 December 2007 at 9.59pm, Mr Kelliher sent out a summary to Merrill Lynch management.

Synopsis: ASX Margin requirement starting today was $6.1mm vs current Trigger level of $7.5mm. ASX fell sharply at open (-3.0%). but recovered to close down (.5%). We estimate that for COB today the ASX margin requirement will be approximately flat (+/-$400k), meaning we expect How Trading to remain within current triggers for tomorrow.

Actions today:

- How Trading executed some (small) risk reduction trades in their account today incl $15mm buying back Bank OTM existing strike puts

- After a local conf call the desk executed for ML, some additional (gamma) hedges for our own protection - $19mm Jan 17 puts, delta hedged at a premium cost of approx $200k

- Continued to work through key exposures/strikes and discern appropriate hedges should default event occur

196 On 18 December 2007, the account margin was $5,979,706 and How Trading spent $355,612 in buying back positions. On the following day Mr Anderson wrote to Messrs Laws, Forbes, Ellett and Stutchbury.

Initial Margin has reduced by $108,000k. Client bought back positions yesterday for $355,000 debit premium, creating a further $247,551 margin call on his account today.

An additional margin call by the ACH would be first covered by Berndale. How Trading had no agreement with the ACH in relation to margins. This email suggests that by 18 December, Merrill Lynch and Berndale were aware that How Trading was utilising the agreed margin cap as an upper credit limit within which it could fund buy backs.

197 The buy back on 18 December was on an agenda for a management meeting planned for the following day.

How paid approx $350k in "risk reduction trades yesterday". I noticed effectively, ML are funding his ability to buy back... our deficit to him is increasing. He is not using "new cash" to do these trades. This has possible implications I believe that need to discuss soon.

Points of note

(1) This perhaps was not our intention under "risk reducing trades"- We may have expected any premium would be funded by himself.

(2) This does potentially give him the means to effectively trade his way out of hitting the ASX trigger levels, albeit doing trades we would concur with.

Given the account status and time pressure I prefer we discuss on a call than elaborate more - I don't want to inadvertently overstate or understate the concern at this point.

198 On the morning of Wednesday 19 December, the margin on the account was approximately $6 million against the default trigger of $7.5 million. Berndale expected the margin to increase during the day. By the end of the day the margin had increased to nearly $6.5 million. Berndale anticipated a default by Friday of that week. The following exchange took place between Mr Anderson and Mr Forbes.

1. Margin has increased by $505,700.64 to $6,485,407.06. Teetering on the edge for Friday.
2. Thank God
3. Well I think he is in trouble anyway don't you? Only 15k to go and one day. Its like ASX's very own movis script. Are you pokering?
4. Market's going to rally tomorrow. Markets crapped twice in a week and he's still under for next month. Just have to sit and hope. Poker will be later.

This email gave traction to the defendants' allegation that Berndale was excited at the prospect that the account would fall into default. While some at Berndale and Merrill Lynch might have been looking forward to the prospect of taking over the portfolio the assumption of control by Berndale or Merrill Lynch would at least provide some opportunity to contain its exposure.

199 Insofar as the defendants persisted in their allegation that Merrill Lynch was improperly attempting to take control of the account, the following email is inconsistent with any such motive. Mr Kelliher wrote to Mr Ryan at 10.43am on 19 December 2007,

Basically thinking, if he's going to buy back, lets see if we can point him in the right directions, right names, right strikes that we think give most "bang for buck"

So in my view the strikes on the bank yesterday were good, westfiled given the prop sector issues prob good...

200 Late on 19 December 2007, Mr Smith raised the funding issue directly with Mr Waterhouse. At 5.59 pm, he wrote,

G'day

What do we do to get the cash for premium from positions you are buying back. I think you have now used all surplus cash and any premium that is bought back is not covered by margin collateral?

201 Mr Laws wrote to Mr Smith at 6.48pm on 19 December informing him that Berndale required Mr Waterhouse to fund premiums.

Norris, after further discussion we believe you should decline further trades unless he prefunds the premium. Essentially, he can reduce the margin amount to less than the trigger, by crystallizing the loss. Let us know the clients response.

202 On the morning of Thursday 20 December 2007 at 9.38am, Mr Smith wrote back to Mr Laws about the funding of the premium and there followed a brief exchange.

1. John, he hasn't gotten back to me from email last night. I'll wait for him to ring in today (if he does) and talk to him about it, I'd ring him but he's still away.

I don't think we should push pre payment if he agrees to pay for what he buys, as he doesn't know what he's going to be doing from day to day.

I'm not reading anything into lack of reply but he could be reassessing the situation.

1. Norris, On with our legal now. We are very uncomfortable with allowing How to trade without funding his premium as the default amount from him could increase and the ASX margin could be held under the trigger. We will reject all trades put on, unless the premium is prefunded.

NS He wants to buy 50 NAB 3/3200 puts @ 46, order is not on.

He says if he can't reduce liability he's stuck. He thinks under your agreement with him he can reduce liability.

203 When the market opened on 20 December 2007, Waterhouse decided to close 35 NAB December $37 puts. This introduced a credit of $17,500.00, after expenses, into the account and a corresponding reduction in the margin and risk. Almost immediately there occurred the following email exchange between Mr Anderson, Mr Laws, Mr Forbes, Mr Kelliher and Mr Ellett:

1. How Trading has Sold 35 NAB Dec07 37.00 Puts @ .50c to close down his existing long position. This will crystallise premium of $17,500 on his account tomorrow.
2. Just got off w Indy. Need to talk
3. What?? I know its Dec 07 but
4. Talk now?
5. The position has fallen into the money, so this is a good thing otherwise we have to go through the mechanics of a physically delivery. Outside of the fact he is realising cash at a time when he doesn't have any

204 Mr Laws said that he was concerned that How Trading was manipulating the agreed margin triggers by buying back positions without pre-funding the premium, thereby increasing How Trading's indebtedness to Berndale. If there was a market downturn and the price of the sold put options increased, How Trading could buy back the sold put options in order to keep the ACH margin requirement below the agreed margin triggers. The consequential reduction in margin would keep it below the trigger point but the cost would be debited to the equities account, resulting in How Trading's indebtedness to Berndale increasing. Under this scenario, How Trading would be able to remain within the margin triggers but simultaneously increase its indebtedness to Berndale. He said that Berndale's indebtedness was potentially unlimited if the market moved adversely to How Trading's positions. That realisation might explain the apparent enthusiasm for the account to reach the trigger so that Berndale's exposure would be controlled by it rather than Mr Waterhouse.

205 On 20 December 2007 at 1.39 pm and following, Mr Smith and Mr Laws had the following email exchange:

NS John

I would be sending him an email today telling him what is going to drop off in the way of DEC margin tonight. It puts him in the position of knowing exactly where he will be at end of today in relation to the DEC margin and he then can't complain he doesn't know what's going on, which I reckon could be an issue. On that I would also tell him what his margins are for JAN, FEB and MARCH in relation to CBA, NAB and ANZ and if you can JUNE in NAB. I would like to know these myself.

As far as buying stuff back I don't think I would let him buy back any bank positions cum the next div, NAB 3/3200 puts are 12.3% out of the money at the moment. The big pos in Jan are the 3100 which are 15% away today. The other 2 big pos in NAB are 6/3000 (17.8% away) and 6/2900 and 12/3000.

1. Thanks. I think we may want to suggest some trades that we are prepared to fund - will discuss with NY overnight. Will see if we can provide some insight per below and revert

NS John

What you might want to do is suggest some trades to Waterhouse (let him fund them). If these were my positions I'd be selling some NAB June or July (probably July) call spreads and using that to buy some protection in JUNE. Eg, sell 400 times a 50 cent call spread for 25 cents and buy 100 NAB 6/3200 puts, should be about cash neutral and covers NAB ex div in JUNE down to 2900. On the upside he loses $100,000 but all the puts become worthless. The current premium margin for the JUNE puts is $407,000. The end result would only cost him $100,000 at most. If you use the NAB ex div price of $35.00 that gives a 17% buffer.

Norris,

We are contemplating suggesting a few trades we may fund that David could do. In the meantime, we want to be clear that we are not offering an unlimited overdraft for David to buy premium. Out internal lawyer is drafting a note to you to be clear on this. We will revert if we have interest to allow risk reducing trades without David providing any new funds. If the market continues to move down, we aren't able to let David buy unlimited premium to close trades.[40]

207 As part of his daily update Mr Kelliher wrote to Merrill Lynch management on 20 December 2007.

Synopsis: ASX Margin requirement starting today was $6.5mm vs current Trigger level of $7.5mm. On the 7th consecutive down day in the Index, bank stocks were down 1-2% as concerns over bad debt exposure and slowing loan growth continues to weigh on sentiment. We estimate that for COB today this will have a negative impact on ASX margin, unable to estimate accurately at this point, will get confirmation later this evening Syd time. Should the main exposures remain around current levels or weaken further it is increasingly probably we will breach the next trigger level of $6.5mm (refer below

Actions today:

- ML Funding of bought option premium - How Trading responded to yesterdays developments by pointing to the agreement that states he can "do risk reducing trades". I involved OGC at that point who drafted a response for Norris and How Trading, and pointed out appropriate conditions in the ASX Client agreement. Discussions around this were held with Norris who will pass on to How. Further discussions to be held with NY mgmt tonight on this topic

- Client traded a small option today that has possible ramifications. Call me to discuss further, although I will discuss on the management call tonight.

- I have reviewed the language in the Client Agreement with OGC today and our understanding is that the $6.5mm Trigger level will be effective based off the ASX Margin Statement for Monday COB 24th which, with holidays will mean we would have control effective market open on Thursday the 27th. Call me to discuss further.

208 The margin on Thursday 20 December 2007 increased by a further $511,821 bringing the total margin to $6,997,228.

209 The disagreement regarding the pre-funding of premium became a confrontation on Friday 21 December 2007, when Mr Waterhouse communicated his intention to seek an injunction restraining Merrill Lynch from departing from the terms of the December agreement. At that time Mr Waterhouse was still in the United States. He returned home on the following day. In his daily update Mr Kelliher wrote:

Key point of note: Client indicated his intention (this morning) to serve Berndale with a legal injunction. For further information pls call OGC or myself

Synopsis: ASX Margin requirement starting today was $7mm vs current Trigger level of $7.5mm. Banks exhibited a strong rally today, up between 1 and 3.5%. This will decrease the amount of ASX margin we estimate to around $6.5mm, i.e. around the trigger level effective on Monday COB. Actual amount to be confirmed later.

Actions today

- Focused on the Key point of note as per above

- Agreed a list of procedures and contacts over the holiday period should the trigger be breached. I sent this out locally today.

- Desk spent $100k on additional puts which was agreed today by Fujiwara san. This was less than yesterdays indicated spend. Current 10% parallel shock down is for total $3mm pl approx

- Local Finance starting to look for a loss provision estimate, discussions will probably move through into next week.

210 Following his return to Sydney Mr Waterhouse immediately wrote to Mr Laws trying to resolve the funding of buy-backs.

John, Please call me I'm back in Sydney & going to a meeting at Henry Davis York Solicitors at 3pm in regards of seeking an injunction on Monday morning in the Supreme Court-Julia Ward of Mallesons who was retained by my QC Don Grieve on Friday has suggested we should talk-as she has found out she can not act in the matter as Berndale have a retainer with her firm.

211 In his evidence, Mr Waterhouse said that at the close of trading on 21 December 2007 the margin was $6 million and the net market value of the portfolio was ―$4.3 million. He claimed that had he been allowed to buy back positions on 20 and 21 December, he would have reduced the portfolio to a point where there was a margin of only a few hundred thousand dollars.

212 Following a conversation between Mr Waterhouse and Mr Laws on Saturday afternoon, in which an attempt was made to negotiate a resolution of the dispute, Mr Laws emailed Mr Waterhouse.

David,

Here are my thoughts on our conversation. Subject to my mgt and NY approval, we would accept a 'deposit' of $500,000 from you which you could draw on to buy back and close existing option positions. We would keep these funds separate from the main account, which is currently in margin call approx $2mill, and these funds would not be commingled and they would earn interest at the agreed credit interest.

This will provide you with the flexibility you require to close down positions. Given this, and your ability to manage your ASX margin vs the triggers established in our side letter, we are not in a position to amend any other terms at this point. Trading with other brokers would potentially introduce confusion. We would only accept trades on T+1 free of cash. In other words you would be required to pay initial margin and premium to the other broker. The plan above contains the issue to ourselves.

On another matter, when we accepted the personal gtt, we had discussed receiving a statement of assets from you and of HOW Trading. We still want these documents please. Let's discuss tomorrow.

John,

That is not acceptable.

I read that you are offering nothing what you agreed to at the meeting of the 5th & before - further you are asking for more - I will hold you to the agreement of the 5th that you fund "buyback's in reduction of risk of the account at 10%P/A" - further the 48 hours (2 trading days) which was offered & agreed to in our previous emails, yet for some reason misplaced from the document on the morning of signing of that agreement, we will also asking the Supreme Court to reinstate this important part of the agreement - I had no idea that this had been left out until I read the document upon my return yesterday - I feel very cheated on that point, what you have done by leaving this out is to have sudden death. I'm very disappointed in you on your deceptive action.

I had a meeting with the solicitor & QC for 2 hours yesterday - they are preparing my affidavit in support of their request off an injunction, along with my wife (who will fly back tomorrow) also to sware an affidavit re her giving the guarantee of the $4m on these conditions - the ball has started - on Monday a letter from Henry Davis York to you informing of the court action. Thursday we will be in front of acting judge of Commercial Division of the Supreme Court seeking that injunction along with relief.[42]

214 On Monday 24 December 2007, Henry Davis York, solicitors for How Trading, sent the following letter to Berndale.

We act for How Trading Pty Ltd ABN 36 101 185 979 with relation to its Agreement dated 24 May 2006 with your company which was the subject of variation on 5 December 2007.

As you know, the variation was agreed to at a meeting on that day between your Mr John Laws, Mr Robert Forbes and Mr Michael Horrax, on the one hand, and Mr David Waterhouse representing our client, on the other. We have been provided with a copy of your letter of 5 December 2007 and the emails which led to it.

That letters omits one of the terms of the agreement reached at the meeting namely that your company would finance (at 10%) all transactions entered into by How Trading to reduce the risk in its margins account. It also omits another term which had been the subject of common understanding throughout the negotiations preceding the meeting namely that for so long as How Trading maintains the margin requirement at less than the limits referred to in condition 3 of the letter, or in excess of those limits for not longer than 48 hours (i.e. two trading days) your company will not trade or otherwise close out How Trading's positions: see Mr Law's email of 3 December 2007 (4.15pm)

On 20 December 2007 our client placed an order with the broker, Norris Smith, to purchase 50 NAB March 2008 $32 put options for 46c for the purpose of reducing the level of risk but your company refused to finance that transaction. It seems apparent that your company has no intention of abiding by its contractual commitments unless compelled by the Court to do so. We are instructed to take whatever proceedings may prove necessary to that end.

In the interest of averting litigation, however, we are instructed to request that you provide the following written undertakings by 5 pm today:

- That your company will honour its commitment to finance all transactions entered into by our client in accordance with condition 5 of the letter of 5 December at 10% interest; and

- That your company will honour its commitment not to trade or close out our client's positions for so long as it maintains the margin limits stipulated in condition 3 of the letter 5 December 2007 or in excess of those limits for no longer than 48 hours (i.e. two trading days).

If those undertakings are not provided by the time stipulated our instructions are to sue for appropriate injunctive relief without further notice.[43]

215 Berndale instructed Blake Dawson to reply, which it did by letter dated 24 December 2007.

We act for Berndale Securities Limited (Berndale) and are instructed to respond to your letter of 24 December 2007.

Our client denies that it agreed to the term your client alleges. Further, our client denies the common understanding or assumption your client alleges. Our client has and will continue to honour its obligations.

Your client breached its obligations under paragraph 5 of the letter dated 5 December 2007 by selling options on 20 December 2007. Our client reserves all of its rights in relation to that breach and generally.

In the circumstances, our client will not give the undertakings requested.

We are further instructed that any proceeding that your client files, including for injunctive relief, will be opposed. We have instructions to accept service on behalf of Berndale.

Would you please ensure that we are given proper notice by fax and email of any application for injunctive relief.

216 In light of Berndale's response, How Trading issued proceeding No 6232/07 in the Supreme Court of New South Wales on 27 December 2007. The summons claimed the following relief

1. A declaration that the Agreement ('The Agreement') made by and between the plaintiff and the defendant on 24 May 2006 was varied by them;

(i) By a letter dated 5 December 2007 written by the defendant to the plaintiff ("the letter")

(ii) By an oral agreement made on 5 December 2007 by David Waterhouse on behalf of the plaintiff and by John Laws; Robert Forbes and Michael Horrax on behalf of the defendant by which;

(a) the defendant undertook to finance all trading by the plaintiff under the Agreement by lending to it the funds necessary to purchase all derivatives acquired by the plaintiff on terms that the same would be repaid with interest at 10% on the sale of such derivatives; and

(b) the defendant undertook that it would not take any action under clause 6.4 of the Agreement if the ACH margin requirement of the plaintiff's account exceeded the limits set out in condition 3 of the letter for any period not exceeding 48 hours; and

(iii) By a letter dated 7 December 2007 written by the plaintiff to the defendant

1. An order that the Agreement as so varied by specifically performed.
2. An Order pending suit that the defendant be restrained from acting otherwise than in accordance with the Agreement as so varied.
3. Such further or other Order as the Court deems fit.
4. Costs.[44]

217 An application for interlocutory relief was to be made the same day but was deferred to the next day after the following email exchange between Mr Waterhouse and Mr Laws.

In light of avoiding going off to Court today - I would make the following "Without Prejudice" offer. To get around this sudden death, no 48 hours, I have asked the bank yesterday if they would allow the funds of $1m Bank guarantee that is due to lapse on Monday, to be extended until 28th of March. These funds would remain on deposit with OCH earning 5%. Part 3 (b) of our agreement would change from $6.5m to $7.5m & Part 3(c) would change from $6m to $7m - this would allow freedom to me of this extra $1m in lieu of the 48 hours & would give Berndale an extra $1m for 90 days

As well as this I would place on deposit at 5% the $500,000 to be used in buying back positions-, Your suggestion that I was in breach of our agreement by closing 35 of the $37 NAB Dec 07 calls last Thursday is bizarre, I would told by Norris Smith that day, that Berndale would not allow any equity traded whatsoever on How Trading account including exercise that was due that day- the result of closing the position was to bring the margin down by $17,500-therefore reducing the risk on the account.

1. David, just letting you know I've read this and am considering... will revert shortly.
2. Without prejudice

I am trying to reach my colleagues. Can you confirm you will defer court action for 24hrs until we can fully discuss your proposal.

218 Shortly before Christmas 2007, Mr Ryan informed Mr Craft that a new RAM book called "AGM" was being created by Merrill Lynch's finance department for the purpose of recording its house trades. On or about 27 December 2007, Mr Craft transferred all of the house trades he had made on the management account up to that point from the "AEP" book into the new "AGM" book. Unlike the "AEP" book, which was described as a "dummy" book, the "AGM" book was linked to the Merrill Lynch reconciliation and finance systems. Thereafter, all house trades were recorded in the "AGM" book.

219 At the close of business on Thursday 27 December 2007, Mr Ellett circulated his daily update to management.

How wishes to negotiate a new deal were the ASX margin cut off rises from AUD6.5m back to AUD7.5m, and AUD1m cash or dual guarantee is offered to Berndale Securities, plus an additional AUD500k is placed into a trading account with Norris/Berndale to be used for the sole purpose of buying back short put positions. The offer is under discussion.[45]

220 On Friday 28 December 2007, Mr Waterhouse arranged to spend $500,000 to buy back positions. He provided Norris Smith with cash to facilitate the transactions.

221 At 1.57pm, Mr Laws sent a 'Without Prejudice' Letter of offer to Mr Waterhouse. Mr Waterhouse accepted the offer which was subsequently modified and signed by the parties. The letter agreement was signed on 3 January 2008. The key elements of the January agreement were the clarification of How Trading's obligation to fund the premium, payment of a $500,000 sum to Berndale, an obligation by How Trading to seek to procure an additional bank guarantee in the sum of $1 million, and a two day period in which to remedy defaults. Set out below is the full text of the January agreement.

Reference is made herein to the Derivatives Client Agreement between Berndale Securities Limited ABN 63 006 687 467 (Berndale) and How Trading Pty Limited ABN 36 101 185 979 (How Trading) dated 24 May 2006 (Derivatives Client Agreement) and to your account number NOR00016 held at Berndale (Account).

Reference is further made herein to the letter agreement dated 5 December 2007 between Berndale and How Trading entitled Confirmation of Conditions (December Agreement) and the facsimile from Berndale to How Trading of 7 December 2007 (Facsimile).

This letter agreement supersedes and replaces the December Agreement and the Facsimile, each of which shall, immediately upon the execution of this letter agreement, cease to have any force or effect.

1. Immediate Obligations of How Trading

Immediately upon execution of this letter agreement by the parties hereto, How Trading shall:

(a) deposit AUD$500,000 (Deposit) with Berndale in cleared funds which will be held by Berndale in a secondary account (Secondary Account) separate from the Account;

(b) only enter into transactions in respect of the Account which effectively reduce the risk in the Account, as determined by Berndale (Risk Reducing Transactions);

(c) fund all Risk Reducing Transactions from the credit balance of the Secondary Account. Should the funds in the Secondary Account be exhausted How Trading must pre-fund the Secondary Account prior to placing an order for any Risk Reducing Transactions, in at least the amount required to pay for such Risk Reducing Transactions;

(d) only use funds in the Secondary Account (whether consisting of the Deposit or additional funds deposited therein) to fund Risk Reducing Transactions in the Account; and

(e) not use any funds in the Secondary Account (whether consisting of the Deposit or any additional funds deposited therein) for any purpose other than that permitted in (d) above, or withdraw any such funds from the Secondary Account.

In addition to (a)-(e) above, (f) and (g) below shall be satisfied at all times:

(f) The AUD$4,000,000 bank guarantee issued by Westpac Banking Corporation ABN 33 007 457 141 (Westpac) pursuant to the December Agreement shall remain in full force and effect throughout the term thereof; and

(g) The personal guarantee provided by David Waterhouse in favour of Berndale in respect of all obligations of How Trading owing to Berndale dated 5 December 2007 and the Deed of Waiver and Release of each of David Waterhouse and How Trading each dated 5 December 2007 shall remain in full force and effect (as such items were delivered in accordance with the December Agreement).

As long as How Trading is in compliance with its obligations under this letter agreement and all terms and conditions of the Derivatives Client Agreement, Berndale will not, during the term of this letter agreement, make a margin call under the Derivatives Client Agreement unless the ACH margin requirement in respect of the Account exceeds the following margin triggers (Margin Triggers):

(a) from open of business on 27 December 2007 until close of business on 25 January 2008, AUD$6,500,000; provided however, following receipt by Berndale of the Bank Guarantee (defined below), the margin trigger for the above dates shall be AUD$7,500,000; and

(b) from open of business on 26 January 2008 until close of business on 28 March 2008, AUD$6,000,000, provided however, following receipt by Berndale of the Bank Guarantee (defined below), the margin trigger for the above dates shall be AUD$7,000,000.

As used herein, the term Bank Guarantee means an executed bank guarantee in respect of the Account in favour of the Australian Clearing House (ACH) and Berndale issued by Westpac in the form of the ACH Bank Guarantee - Dual Beneficiary form and in an amount of AUD$1,000,000, and having a term not ending prior to 15 April 2008.

To the extent How Trading (a) has not breached any of its obligations under this letter agreement, including without limitation, its obligations under Section 1 hereof, or any of its obligations under the Derivatives Client Agreement, (b) Berndale has acknowledged receipt of evidence, satisfactory to Berndale in its sole discretion, that How Trading has requested the Bank Guarantee from Westpac and is working with Westpac in good faith to obtain such Bank Guarantee, and (c) Berndale has not received any indication, as determined in its sole discretion, that Westpac will not actually provide the Bank Guarantee prior to the Initial Deadline (defined below), How Trading shall have the Cure Period (as defined below) to cure any breach of the Margin Triggers (Cure Right), solely to the extent such breach occurs prior to 5:00 p.m. (Sydney, Australia time) on 14 January 2008 (Initial Deadline); provided however, to the extent the Bank Guarantee is actually received by Berndale in a form acceptable to Berndale in its sole discretion prior to the Initial Deadline and (a) above continues to be satisfied, the Cure Right shall continue to apply to any breach of the Margin Triggers occurring prior to 5:00 p.m. (Sydney, Australia time) on 24 January 2008. How Trading hereby acknowledges that the Cure Right is expressly conditioned on (a)-(c) above and agrees to immediately notify Berndale if How Trading knows or has reason to know that Westpac will not provide the Bank Guarantee prior to the Initial Deadline. Further, the Cure Period relates only to the breach of the Margin Triggers and no other breach of any other term under the Derivatives Client Agreement, this letter agreement or any other agreement between the parties will provide for said Cure Right.

For the purposes of this letter agreement the ACH margin requirement in respect of each day will be the margin requirement notified to Berndale by the ACH on that day. If the ACH margin requirement on any day exceeds the applicable Margin Trigger for that day (Relevant Day), How Trading will have until 4.00pm (Sydney, Australia time) on the second trading day immediately following the Relevant Day to correct such breach (Cure Period).

As long as How Trading is in compliance with its obligations under this letter agreement and all terms and conditions of the Derivatives Client Agreement, Berndale will, during the term of this letter agreement:

(a) acknowledge the Margin Triggers set forth in Section 2 of this letter agreement and not close out any positions in the Account or buy protection in the Account on behalf of How Trading; provided however, nothing in this letter agreement shall prevent Berndale or any of its affiliates from taking any action deemed necessary or desirable by Berndale or any such affiliate to hedge the exposure of Berndale and/or any such affiliates to How Trading and/or the Account;

(b) pay interest on the credit balance of the Secondary Account at the ACH Cash Rate less 0.50% per annum. As used herein, the term ACH Cash Rate means the interest rate determined by the ACH under Procedure 10.2.5 of the ACH Clearing Rule Procedures less the ACH administration fee applied under Procedure 10.2.5; and

(c) if How Trading has no outstanding obligations to Berndale in respect of the Account or the Derivatives Client Agreement, as determined by Berndale in its sole discretion, and Berndale determines that the Account is in credit as at 31 March 2008, repay any credit balance that remains in the Secondary Account to How Trading.

1. Additional Agreements and Acknowledgements by How Trading

(a) If, as at 31 March 2008, How Trading has outstanding obligations to Berndale in respect of the Account or the Derivatives Client Agreement, including, without limitation, pursuant to a deficit in the Account, Berndale may apply any credit balance that remains in the Secondary Account to such deficit or other amount owing to Berndale.

(b) If at any time, How Trading breaches any term or condition of this letter agreement, as determined by Berndale in its sale discretion, Berndale shall, immediately upon such breach, have no further obligations under this letter agreement and Berndale may immediately, without notice to How Trading, (i) exercise all of its rights existing under the Derivatives Client Agreement, the ACH Clearing Rules or otherwise, without any limitation or restriction whatsoever, including, without limitation, any limitation or restriction which may exist under the terms of this letter agreement, (ii) exercise any other rights it has, including without limitation its right to make demand under the Bank Guarantee, the items described in Sections 1 (f)-(g) hereof, or any other documentation delivered to Berndale pursuant to this letter agreement or the December Agreement (iii) apply any credit balance that remains in the Secondary Account to any deficit in the Account or other amount owing to Berndale, and (iv) take any other action as Berndale determines necessary or desirable to satisfy all obligations owing by How Trading to Berndale, including, without limitation, amounts owing in connection with the Account and the Derivatives Client Agreement.

(c) How Trading hereby agrees not to take any actions which could reasonably result in an increase in the obligations owed to Berndale or its affiliates, including, without limitation, any increase in the deficit in the Account, any other amount owed to Berndale or its affiliates or any other exposure of Berndale or its affiliates to How Trading and/or the Account.

Nothing in this letter agreement is intended to amend the Derivatives Client Agreement in any manner other than to prescribe the Margin Triggers described herein (which shall only apply to the extent How Trading is in compliance with its obligations under this letter agreement and all terms and conditions of the Derivatives Client Agreement, and for the limited time periods set forth herein), and the parties hereto expressly agree and acknowledge that Berndale retains all of its rights under the Derivatives Client Agreement (including without limitation its rights with respect to, any other past or future default or breach by How Trading, and any amounts owing to Berndale by How Trading, under the Derivatives Client Agreement or otherwise in respect of the Account) and each of its other agreements, if any, with How Trading.

At the close of business on 28 March 2008 Berndale's obligations under this letter agreement shall automatically expire without further action on the part of any party hereto, and all obligations of the parties with respect to the Account shall be determined solely in accordance with the Derivatives Client Agreement, the ACH Clearing Rules and any other means permitted therein, including, without limitation, obligations of How Trading to deliver margin which shall be determined by Berndale in its sole discretion pursuant to the terms of the Derivatives Client Agreement, the ACH Clearing Rules and the other means permitted therein, and without any further reference to the Margin Triggers created under this letter agreement

This letter agreement is governed by the laws in force in Victoria.

222 On Friday 4 January 2008, Mr Waterhouse hand delivered a cheque for $250,000 to cover the remainder of the $500,000 required under the January agreement. On Monday 7 January 2008, Mr Waterhouse over spent the amount held to fund buy backs by $10,000. The additional sum was paid to Berndale. On the following day, Mr Waterhouse hand delivered to Berndale a further cheque for $250,000 to fund buy backs. At the close of business that day the margin was $6,272,461 after Mr Waterhouse had spent $259,022 on buy backs.

223 The margin trigger was $6.5 million. By providing an additional bank guarantee, contemplated under the January agreement, Mr Waterhouse could have increased the trigger point to $7.5 million. He was apparently unable to do so. At the close of business on 9 January 2008, the margin exceeded the trigger. Mr Waterhouse continued to pursue extra funding from Westpac. On Thursday 10 January 2008, he met with Anne Jones at Westpac to discuss increasing the amount secured under the guarantee. He sought to persuade Berndale to give more time. He wrote to Messrs Laws and Forbes at 7.39pm that night.

John, Robert

I have just had a meeting with the head of Westpac Private bank-very good news. Re the extra $1m they will have approval by tomorrow afternoon or first thing Monday Morning. However what they have suggested what I'm doing is putting a bank-aid on a broken leg. After reviewing the option position and seeing how much the positions are since early December, Westpac have offered they would be prepared to increase the Guarantee from an extra $1m that I requested by up to $4m on 2 conditions being met by Berndale.

1. They would raise the guarantee from $4m to $8m-provided Berndale keep their extra margin of $2m on the account for an extra 3 months-March now extended till 27/06/08-this would raise the margin cover up to $10m.
2. If the margin increased over $10m during that period Berndale would allow the 2 day grace to continual until 27/06/08 and 1 day's grace thereafter until expiry.

If these 2 conditions are agreed to they would leave the $8m until expiry of all positions-30th of July 2010. A further condition they would want me over the next few months to buy back and close a further $1,000,000 more of positions.

They believe the market could lose more in the short term & I would be in default very quickly, they believe with the extra $4m (instead of only $1m) guarantee and buying back of the extra $1m, I would weather the short term volatility and ride this out within the next six months-after that these positions would die a natural death. As they say, if you could get the shares at the put prices that I have written, I would be earning over 9% grossed up yield. All in all Berndale positions would be much safer, as the bigger the guarantee the less it is exposed for as around 30% risk margin is carry in the overall margin-the $8m guarantee would be in place until the last position fell off. If Berndale would do this, I'm sure with this large amount of $8m security, I could take the account to another broker like UBS, once the margin came down below half the guarantee-under the $4m mark.

224 How Trading had two trading days to cure the default. It was unable to do so. At the close of business on Friday 11 January 2008, the margin was $7,137,752 and How Trading remained in default of the January agreement.

225 Mr Laws contacted Mr Waterhouse and arranged a meeting at the office of Merrill Lynch at 8.30am on Monday 14 January 2008. On that morning Mr Waterhouse met with Mr Ritchie, Mr Laws, Mr Horrax and Mr Forbes. This was the first occasion on which Mr Waterhouse had met with Mr Ritchie. It was the occasion of the private conversation between Mr Waterhouse and Mr Ritchie in which Mr Waterhouse claims he was told that he should take advantage of the imminent publication of an adverse report from Merrill Lynch concerning its financial position. More will be said about the meeting in Chapter 2.

226 Following the meeting, Mr Horrax sent an email to Mr Waterhouse formally notifying him that Berndale was taking control over the account. He wrote,

Reference is made to the Agreement between Berndale Securities Limited ABN 63 006 687 467 (Berndale) and How Trading Pty Limited ABN 36 101 185 979 (How Trading) dated 24 May 2006 (Agreement) and to your account number NOR00016 held at Berndale (Account).

Reference is further made to the letter agreement dated 3 January 2008 between Berndale and How Trading entitled How Trading Account NOR00016 (Side Letter).

Capitalised terms used in this letter not otherwise defined herein have the meaning given to them in the Side Letter.

On 9 January 2007, the Australian Clearing House (ACH) margin requirement in respect of the Account exceeded the applicable Margin Trigger. The Cure Period in respect of that Margin Trigger breach expired at 4.00pm on 11 January 2008 (Cure Expiry). As at the Cure Expiry, the ACH margin requirement in respect of the Account remained in excess of the applicable Margin Trigger.

As a result, How Trading is now in breach of the conditions of the Side Letter. Berndale hereby notifies How Trading that it will exercise its rights in respect of such breach from the date of this letter, including without limitation Berndale's right under clause 6.4 of the Client Agreement to enter into or close out derivative transactions in the Account.

You are further notified that Berndale has exercised its rights under clause 4.6 of the Derivatives Clearing Agreement between Berndale and Norris Smith Stockbroking Pty Limited ABN 98 113 959 596 (Norris Smith) dated 8 February 2006 to direct Norris Smith not to accept or execute any orders from How Trading in respect of the Account.

This letter and any action referred to herein is without prejudice to all rights of Berndale under the Client Agreement, the ACH Clearing Rules or otherwise.

Dear Berndale,

I note that following our meeting this morning, Berndale have blocked How Trading Pty Limited from acting on its account with your company (effective of trade commencement this morning), until such time as Berndale agree for control to be returned back to How Trading Pty Limited.[46]

While Mr Waterhouse said that he asked Mr Ritchie not to undertake the proposed short sales, he did not propose that How Trading's positions be closed out. Instead, he continued to pursue avenues to regain control of the account.

228 The defendants' case in relation to the funding promise is based upon a statement alleged to have been made by Mr Laws during the first meeting on Monday morning, 5 December 2007, at the offices of Merrill Lynch. The December agreement was silent as to any funding obligation on the part of Berndale or Merrill Lynch. The negotiations leading to the December agreement were equally silent on the topic.

229 A funding promise was alleged by How Trading in proceeding 6232 of 2007 issued in the Equity Division of the Supreme Court of New South Wales on 27 December 2007. In that proceeding, How Trading sought a declaration that the Derivatives Client Agreement had been varied by the December agreement and an oral agreement made the same day between David Waterhouse and Messrs Laws, Forbes and Horrax by which:

the defendant undertook to finance all trading by the plaintiff under the agreement by lending to it the funds necessary to purchase all derivatives acquired by the plaintiff on terms that the same would be repaid with interest at 10% on the sale of such derivatives...

That proceeding was compromised by the January agreement. Berndale submitted that the terms of the deeds of waiver and release executed by the defendants on 5 December 2007 were broad enough, in terms, to discharge Berndale from any liability it might otherwise have in relation to the claims now made in this proceeding. Those deeds of waiver and release were specifically acknowledged by the January agreement to "remain in full force and effect". The full terms of each deed of waiver and release, given by Mr and Mrs Waterhouse, were as follows:

Deed of Waiver and Release

DATE: 5 December 2007

PARTIES:

Berndale Securities Limited ABN 63 006 687 476

Level 39, 120 Collins Street

Melbourne, Victoria

How Trading Pty Ltd ABN 36 101 185 979

PO Box 5520

West Chatswood NSW 1515

OPERATIVE PROVISIONS:

In consideration of Berndale Securities Limited (Berndale) entering into an agreement with How Trading Pty Limited (How Trading) upon the terms of the attached draft and your compliance with conditions 1-8 set out in that agreement, How Trading agrees to waive, release and forever discharge Berndale its directors and employees and any of their respective affiliates (each, a Released Person) from any claims, rights, expenses, costs, liabilities, and proceedings which How Trading and any person or entity related to How Trading has or may have against a Released Person in relation to any of the matters the subject of that agreement or the Derivatives Client Agreement between Berndale and How Trading dated 24 May 2006.

230 Berndale did not contend that, by reason of the January agreement, the defendants were estopped from maintaining this proceeding insofar as it included a claim based upon the funding promise, or that to maintain such a claim was an abuse of process. It's case in this respect was confined to an allegation that the terms of the deeds of waiver and release had the effect of releasing and discharging Berndale from the claims made in the counterclaim, and that any liability of Berndale in respect to those claims was absolutely barred.

231 The matter in contemplation by the parties at the time the deeds of waiver and release were prepared and executed at Berndale's insistence, followed allegations made by Mr and Mrs Waterhouse to Norris Smith and Berndale that they had allowed the How Trading account margin to "blow out from a workable margin of $3m to $8m without any sort of control and accountability on their role as a stockbroker". It was from that allegation that Berndale sought the protection of the release and waiver. There is no justification to extend the deeds of waiver and release beyond their intended operation.[47] Furthermore, if the December agreement and guarantees were induced by misrepresentations, so were the deeds of waiver and release.

232 On 22 and 23 November 2007, Berndale had made margin calls on How Trading for sums in excess of $2 million. How Trading had failed to meet the margin calls. On 26 November 2007, Berndale issued a default notice in which it required How Trading to comply with the margin calls by the close of business that day, otherwise Berndale would exercise its rights under the agreement. Those rights are relevantly found in cl 6.4 of the agreement.

233 Berndale had threatened to exercise its default powers under cl 6.4 of the agreement. Had they done so, Mr Waterhouse would have lost control of the How Trading account and How Trading would, in all probability, have been placed in liquidation. The financial support given by Mrs Waterhouse, through Westpac, would also crystallise into an irrecoverable debt. Mr Waterhouse regarded his reputation as being on the line. He pleaded with Mr Tighe for his support, telling him, "My reputation is on the line, without that I am nothing". For the Waterhouse family there was a lot at stake. There was also much at stake for Berndale. It was unsecured. Berndale and the Waterhouse family found themselves in difficult circumstances.

234 Mr Waterhouse conceded in cross-examination that his primary objective in reaching accommodation with Berndale on 5 December 2007 was to maintain control of the How Trading account.

1. Your singular objective in the period post-default on 22 November 2007 was to maintain control the How Trading account?
2. Yes.

Those responsible for the management of the How Trading account at Berndale were equally anxious to ensure a satisfactory outcome from their employer's point of view. In late November 2007, in response to its exposure to the How Trading account, Merrill Lynch had commenced to make the protective house trades.

235 Mr Waterhouse interpreted the latitude given to How Trading in the month of November, in particular the period surrounding his failure to meet margin calls, as funding accommodation given by Berndale to enable How Trading to buy back positions and thus reduce the margin and the corresponding exposure of Berndale. At one point, Mr Waterhouse suggested that in the week of 26 November Mr Laws told him that Berndale would fund buy backs, although his position quickly changed. He conceded that Mr Laws did not use those actual words but nevertheless made it clear that they would fund buy backs because he conveyed an expectation that How Trading should aggressively buy back positions. Mr Waterhouse contrasted his assumption with what he claimed was a statement to that effect by Mr Laws at the meetings on 5 December 2007.

236 Berndale witnesses denied that any such statement was made by Mr Laws. It submitted that the evidence of Mr Waterhouse in this regard should be rejected. It made a broad attack on the credit of Mr Waterhouse as a whole and submitted that his evidence concerning the representations was a contrivance.

237 Having heard and reread the evidence given by Mr Waterhouse, Mr Horrax, Mr Laws and Mr Forbes, and reviewed that evidence against the background circumstances, substantially recorded in the numerous emails passing between Mr Waterhouse and Berndale and within the Merrill Lynch group, I reject the defendants' case on the funding promise based on assurance alleged to have been given by Mr Laws on 5 December 2007. I reject the evidence of Mr Waterhouse that Mr Laws gave any such assurance.

238 In my opinion it was inherently unlikely that Berndale would have exposed itself to additional liability by giving such an assurance to Mr Waterhouse. Had the topic of funding been under contemplation, let alone discussion, I have no doubt that Berndale would have expressly included within the December agreement, a requirement that How Trading fund buy back premium with its own funds. Berndale was attempting to limit and eventually eliminate its exposure to How Trading.

239 Funding of buy backs was not a topic under consideration in the negotiations leading up to the December agreement. When it did emerge as an issue sometime later in December it was clear that Berndale and Merrill Lynch were taken by surprise by what they saw as an opportunistic strategy employed by Mr Waterhouse.

240 On 18 December, Mr Laws was informed by Mr Anderson at Merrill Lynch that How Trading had bought back positions in circumstances which increased the margin exposure on the account. Mr Laws responded by requiring Norris Smith to decline further trades unless premiums were pre-funded. This communication and the internal correspondence passing between Merrill Lynch management demonstrates surprise at the strategy being employed by How Trading.

241 In hindsight it is not difficult to see how the terms of the December agreement might have been construed to provide such an opportunity for How Trading. Agreement on margin caps turned the relationship between broker and client on its head. Ordinarily margins were to be paid and eliminated. The December agreement operated only as between How Trading and Berndale. It did not avoid Berndale's liability to the ACH. As such it had features of an overdraft facility if only because of the fluctuation in liability that would occur within the permitted cap. If treated in that way Berndale would appear to be acting as surety for How Trading up to the margin limit. In my opinion that characteristic was overlooked by the officers of Berndale when negotiating the terms of the December agreement. Had Mr Waterhouse said anything at any meeting on 5 December to indicate his intention to employ the margin, as he did later that month, I have little doubt that his proposal would have been absolutely rejected by Berndale. It is inconceivable, in the circumstances, that Mr Laws would have volunteered any such financial accommodation to Mr Waterhouse.

242 While I do not regard the evidence given by Messrs Forbes, Horrax and Laws as satisfactory in every respect, I accept the general tenor of their evidence to the effect that no such representations were made by Mr Laws to Mr Waterhouse. Mr Laws denied that he told Mr Waterhouse at the first meeting on 5 December 2007 that Berndale would keep on funding buy backs as it had before. Mr Horrax denied that any such thing was said by Mr Laws, and Mr Forbes had no recollection of any discussion about buy backs. Mr Laws was cross-examined at length about the funding promise. He refused to accept that Berndale had, in effect, funded How Trading's buy backs in November 2007. He also refused to accept that he understood that the effect of creating a margin cap was to enable How Trading to buy back positions within the cap. Mr Laws and Mr Horrax ought to have recognised that possibility, but I accept that Mr Laws did not give any positive assurances to Mr Waterhouse that Berndale would provide funding.

243 It is possible that on 5 December 2007, Mr Waterhouse recognised the funding opportunity provided by the margin cap, although I am inclined to the view that even he did not appreciate the potential until sometime later. His pursuit of additional funding to buy back positions is inconsistent with an intention to rely upon the margin caps.

244 Mr Waterhouse agreed that he had discussed How Trading's ability to fund buy backs with Mr Tighe on about 3 December 2007. If that is correct, he was alive to the importance of funding arrangements. There is nothing found in the written exchanges during negotiations to indicate any intention on the part of Mr Waterhouse to buy means other than funds secured from third party sources.

245 After arriving in the United States, there were discussions between Mr Tighe and Mr Waterhouse concerning the method by which How Trading would buy back positions and avoid a guarantee from Westpac being called upon. Mr Tighe gave evidence to similar effect. He said that Mr Waterhouse tried to demonstrate to him how he could buy back positions and avoid a call on the guarantee. Mr Tighe estimated the buy back cost at more than $3 million. He was told by Mr Waterhouse that he was expecting approximately $3 million before the end of December 2007 from a position held by How Trading in the float of BT. Mr Tighe agreed in cross-examination that he expected those funds to become available to How Trading to fund buy back. Had Mr Waterhouse received the funding assurance from Mr Laws on 5 December 2007, the course of the discussion concerning buy backs, about which Mr Tighe gave evidence, would have been quite different. The relevance to funding of using the margin caps as if an overdraft limit would have been vigorously called in aid by Mr Waterhouse and would have been a matter of significance to Mr Tighe when considering the exposure of his client, Mrs Waterhouse. Instead, the focus of attention was on the anticipated volatility of the market and the expectation that How Trading would come into the necessary funds before the end of December.

246 In the course of negotiations over the terms of the letter agreement of 5 December 2007, there was a shift in the words employed to describe the conditional prohibition on trading by Berndale. The primary objective of Mr Waterhouse was to retain control of the How Trading account. That was imperative. By doing so he hoped that he could trade out of the crisis caused by the falling market in late 2007 which had caused ever increasing margin calls from the ACH and thus Berndale. Mr Waterhouse was of the opinion that the market would rally before Christmas enabling him to close out positions and thus reduce the exposure of How Trading.

247 Mr Waterhouse had been in discussion with Mr Tighe about possible solutions since the events of default in November. Various possibilities were canvassed, including additional finance and new broking arrangements. On 30 November 2007, Mr Laws emailed Mr Waterhouse with a proposal that incorporated many of the elements of the final agreement. Berndale wanted a guarantee from Westpac, additional security or cash, a personal guarantee from Mr Waterhouse and a margin cap trigger of $7.5 million. Mr Waterhouse responded with a proposal on 3 December 2007, drafted by Mr Tighe.[48]

248 Mr Tighe said that prior to dictating the email sent by Mr Waterhouse he was concerned that Berndale might "take the guarantee and then start trading on the account and forcing [How Trading] to be in default again". He said to Mr Waterhouse, "Haven't you heard of all the short selling by institutions in the market at the moment?"

249 Mr Tighe was not challenged about this evidence. I have no doubt that he was concerned to avoid a situation where Mr Waterhouse lost control of the account. He was also concerned about the potential for very significant losses to Mrs Waterhouse.

250 The defendants attached a great deal of significance to the second dot point in Mr Tighe's email to contend that it was his intention, and the intention of Mr Waterhouse, to convey to Berndale that, as a condition of providing guarantees, Berndale would be prohibited from undertaking trades on its own account to mitigate against its risk of loss as a result of its exposure to the How Trading account. The second dot point provided:

• For so long as How Trading maintains the margin requirement at less than $7.5 million, or in excess of that sum to no longer than 48 hours, Berndale and/or Norris Smith Stockbroking will have no right to trade or close out How Trading's position or buy protection in respect of that position and if either does so, the guarantee will automatically be avoided.[49]

251 I do not accept that the email was intended to convey any such limitation. In my view it was intended by Mr Tighe and Mr Waterhouse to convey, in the strongest terms, the paramount condition that Mr Waterhouse was to retain total control over the account without any right on the part of Berndale to interfere in the management of the account. The How Trading account was largely unprotected by any hedging. Hedging was inconsistent with the strategy adopted by Mr Waterhouse and was expensive. Berndale had previously required How Trading to effect protective trades, and Mr Waterhouse and Mr Tighe wanted to avoid any such interference in the future.

252 The words "or buy protection in respect of that position" are ambiguous, although at this time Mr Waterhouse maintains he was unaware of the Merrill Lynch house trades. I do not accept that the words were intended by Mr Waterhouse or Mr Tighe to avoid the possibility that Berndale or Merrill Lynch might engage in internal hedging in order to protect itself against exposure to the portfolio.

253 On 28 November 2007, Norris Smith had caused How Trading to buy CBA and NAB put options as a hedge. Mr Waterhouse agreed that the expression "to buy protection" included the purchase of an opposite position to one already held. The transactions entered on 28 November had that character. It is most probable that the words employed in the second dot point of the email of 3 December were intended to prevent just such a transaction.

254 Those words were also consistent with the anxiety expressed by Mr Tighe concerning the risk that Berndale would "take the guarantee and then start trading on the account". It was a question of control. In any event, negotiations between Mr Waterhouse and Berndale had only just begun. A proposal sent to Mr Waterhouse by Mr Laws, drafted by Mr Horrax, contained the following paragraph 2:

1. for so long as How Trading maintains the margin requirement at less than $7.5 million, or in excess of that sum to no longer than 48 hours, Berndale will not trade or close out How Trading's positions.[50]

255 Mr Waterhouse responded on the morning of 4 December 2007. In paragraph 4 he proposed a modified form of conditional prohibition.

1. As long as the account is maintain in the above conditions - Berndale/Norris Smith will have no rights to trade, close out positions or buy protection on the How Trading account.[51]

These words had apparently been formulated by Mr Waterhouse after discussions with his wife and Mr Tighe. This formulation is consistent with an attempt to more explicitly avoid a repeat of what occurred in late November. The words were substantially adopted by Mr Horrax and incorporated into the December agreement which provided,

Subject to satisfactory completion of and on going compliance with each of the conditions set out below, as determined by Berndale in its sole discretion, Berndale agrees not to close out any positions in the account or buy protection on the Account.[52]

256 Messrs Laws, Horrax and Forbes were cross-examined about the "buying protection" representation before Mr Waterhouse had given his oral testimony, although by then he had filed a witness statement in which he set out in detail the course of the relevant conversations that took place at the meetings on 5 December 2007. Their cross-examination included counsel for the defendants putting to each of them the version of events given by Mr Waterhouse in paragraphs 101 to 111 of his witness statement. Mr Horrax gave evidence first. He denied that Mr Laws had said anything in the course of the meeting on 5 December 2007 to the effect that Berndale agreed not to close out any positions in the How Trading account or buy protection. He was cross-examined.

1. And he went on to say that Mr Tighe, or his wife's adviser, wanted to make it clear "the guarantee will only be provided on the understanding that Merrill Lynch would have no input in any trading on the account, nor will they buy protection against any positions on the account," he said words to that effect, didn't he?---
2. No.
3. And he said words to the effect "In other words, they, Merrill Lynch, are to treat the account as it was before, as if it was not in default," he said words to that effect, didn't he?---
4. Words to the effect of he retains control were mentioned.
5. Yes. And you understood as a result of what he said that Merrill Lynch was to treat the account as if it was not in default, that's right, isn't it?---
6. Provided - practically speaking, provided he complied we would not take control.
7. Yes. And he expressly said words to the effect "You have not been trading or buying protection against the position since the account has been in default, have you"?---
8. No.
9. Didn't he?---
10. No.
11. And Laws replied to that question by saying "no", didn't he?---
12. There was no such question.
13. And you and Forbes, to your observation, shook your heads as if in agreement with what Laws had said, didn't you?---
14. No such conversation took place.

257 Mr Laws denied any recollection of Mr Waterhouse saying anything about buying protection. He said that if Mr Waterhouse had asked Berndale to agree not to buy protection against the risk of its exposure to the How Trading account he would have told him that Berndale or Merrill Lynch would have bought protection in respect of the account. He added that he would not have been authorised to agree that Berndale would not do so. When Mr Laws was cross-examined on that topic he gave the following evidence:[53]

1. And he went on to say, I suggest to you, after the passage that I have read, which I will re-read, "My wife's adviser, Tony Tighe, who also can't make it this morning as he is travelling overseas in a few hours, wants to make it clear that the guarantee will only be provided on the understanding that Merrill Lynch will have no input in any trading on the account, nor will they buy protection against any positions on the account." He said that or words to that effect, didn't he?---
2. No, I deny that.
3. You on your oath, having as you have admitted no more than a hazy recollection of this meeting, deny in unqualified terms that Mr Waterhouse said something to the effect that I have just put to you at that meeting, do you?---
4. I do.
5. I see. He went on to say, I suggest, "In other words, they are to treat the account as it was before, as if it was not in default." He said words to that effect, did he not?---
6. He may have said words to that effect.
7. Yes. By the way, you say that he appeared to read the letter or the draft letter carefully. Is it your evidence that when he had done so he said absolutely nothing at all about the deletion of the 48 hour moratorium provision?---
8. I don't recall him saying that.[54]

1. He went on to say, did he not, immediately after that, "You have not been trading or buying protection against the positions since the account has been in default, have you?" He asked that question, didn't he?---
2. I don't believe he did.
3. You don't deny he did, do you?---
4. Look, can I restate it in some way?
5. My question, and it's a yes or no question, Mr Laws, as you would appreciate?---
6. Yes.
7. You do not deny that Mr Waterhouse said words to the effect "You have not been buying - you have not been trading or buying protection against the positions since the account has been in default, have you?" You don't deny that he said words to that effect, do you?---
8. I don't deny it, but I would like to just clarify it, if I could?
9. Well, by all means, what do you want to say in addition to what you have said?---
10. Your question is a little vague, because if he had asked me was Merrill Lynch buying protection or trading on their own account in lieu of the How Trading positions, I would have been happy to answer that.
11. And - - - ?---In the affirmative. And you say that you would have answered that question in the affirmative?---
12. I would have.
13. I see. But in truth he said this: "You have not been trading or buying protection against the positions since the account has been in default, have you?" And you replied "No", didn't you?---
14. I don't recollect it, but could I clarify again?
15. You don't deny that interchange, do you?---
16. I don't deny it, but could I clarify?

1. Well, if I'd heard the question that he was asking whether we had done any trades or bought any protection if the How Trading account that was ultimately going to come back to him to be accounted for to his credit or debit, then I would have said no.

Q: But what in fact passed between you was in these terms: "You have not been trading or buying protection against the positions since the account has been in default, have you?" And you responded "No", didn't you?---

1. I don't recollect it. I may not deny it if it was voiced in that way that I have just mentioned a moment ago.
2. And to your knowledge and recollection, both Horrax and Forbes who were there, shook their heads when you said what you said as if in agreement with your statement, or your denial, that's true, is it not?---
3. I don't have any recollection of any gestures, signs - - -
4. Once again, you don't deny that occurrence, do you?---
5. I wouldn't have been looking at them to judge.
6. I see. And Mr Waterhouse proceeded to say "This agreement confirms that you cannot do anything that is to How's detriment on these positions," he said words to that effect, didn't he?---
7. I have no recollection of that.
8. Again you don't deny it, I take it?---
9. I do deny that there was much elaborate - any real discussion around there point.
10. Is that denial made on the footing that you are inviting his Honour to conclude that this period of between at least 15 minutes and 25 minutes was occupied by the four of you by the interchange of no more than 100 words or so?---
11. It was likely there was more conversation, yes.
12. Yes, indeed. Mr Waterhouse was anxious to state his position, wasn't he?---
13. I don't recollect that he was anxious.
14. Well, the words that he said at the meeting were, to your observation, designed to avoid any possible misunderstanding as to the parties' contractual rights and obligations, that's right, is it not?---
15. I don't necessarily believe so. I think the document was the final record of what we were about to agree.
16. And he said "This agreement confirms that you cannot do anything that is to How's detriment on these positions, or trade opposite trades in relation to anything on the How account." Do you recall that?---
17. I deny that he would have said that. I deny that.
18. And he went on to say "Janette and Berndale are both sharing risks. Janette more than Berndale, as she is putting up $4 million and Berndale are carrying How for around a million, less the $250,000 we have in cash in the How account." He said words to that effect, did he not?---
19. I don't recollect, but maybe don't deny that.
20. All right. And he went on to say "That may increase up to $2.5 million if the margins increase over the next few weeks," didn't he?---
21. Again, I'm sorry, I just don't recollect.
22. But you don't deny it either, do you?---
23. That's right, correct.[55]

258 The evidence of Mr Forbes was to the effect that he had no recollection of the statements allegedly made by Mr Waterhouse or the alleged responses.

1. But was it not your understanding that the intent of the agreement was that Mr Waterhouse was to retain control of the account, subject to the conditions that we have discussed, as if his company had not fallen into default?---
2. Yes.
3. Right. And Mr Waterhouse said, I suggest, words to this effect, "You have not been trading or buying protection against the positions since the account has been in default, have you?" Do you remember him saying that?---
4. No, I don't.
5. But you don't deny it, though, do you?---
6. I don't recall it so I can't deny it.
7. To that Mr Laws replied "No", did he not?---
8. I don't recall that conversation.
9. And you and Mr Horrax at the time that Laws said "No", shook your heads as if in agreement with what Laws had said, that's right, isn't it?---
10. I don't recall the conversation.
11. And Mr Waterhouse went on to say words to this effect, "The agreement confirms that you cannot do anything that is to How's detriment on these positions, or take opposite trades in relation to anything on the How account." Do you recall that?---
12. I don't recall Mr Waterhouse saying that.
13. And may I take it that you therefore don't deny it?---
14. I don't recall it so I can't deny it.
15. And then he went on to say "Janette and Berndale are both sharing risks, Janette more than Berndale as she is putting up $4 million, and Berndale are carrying How for around a million less the 250,000 we have in cash in the How account." Do you remember him saying words to that effect?---
16. No, I don't.
17. And again you don't deny it?---
18. I don't recall it so I can't deny it.
19. He went on to say "That," referring to the - I'm sorry, I will withdraw that. He went on to say "That may increase up to $2.5 million if the margins increase over the next three weeks. Tony Tighe has made it clear as per his letter which I sent to you on Monday." Do you remember him saying that?---
20. No, I don't.
21. Again you don't deny it?---
22. I don't recall it, I don't deny it.
23. And Laws said "The margin is $6 million made up of 4.5 million in short term market value, and 1.5 million in ACH risk premium." Do you remember him saying that?---
24. No, I don't.
25. Again, you don't deny it?---
26. I don't recall it, I don't deny it.
27. David, we understand what you and your wife's adviser mean. Time is against us, it's all covered in this letter." Do you recall words to that effect being spoken?---
28. No, I don't.
29. Again, you wouldn't deny it, I take it?---
30. I don't recall it so I can't deny it.
31. Mr Waterhouse said, "Tony Tighe just wanted me to make it very clear to everyone in the room when I signed the agreement.[56]

259 There was an apparent sensitivity on the part of Mr Laws and Mr Horrax to the Merrill Lynch house trades. Mr Laws accepted in cross-examination that Mr Waterhouse attributed a meaning to the words "buying protection" other than merely a reference to "no right to trade" and "no right to close out positions", although such a concession does not advance the defendants' case very far.

260 When Mr Horrax was asked in his evidence-in-chief whether at any point in the course of the meeting on 5 December 2007 Mr Laws said anything to the effect that Berndale agreed not to close out any positions in the account or buy protection on the account, Mr Horrax answered, "No". The following exchange then took place:

1. Now, Mr Horrax, if Mr Waterhouse had asked you at the meeting on 5 December to agree that neither Berndale or other entities in the Merrill Lynch group were to buy protection on and for their own account in respect of the risk posed by the How Trading portfolio, what would you have said?---
2. I would have said that had not been proposed. It's not something that we would have had the authority to agree to. And we would have had to have independently discussed without Mr Waterhouse's presence.[57]

261 In his witness statement, Mr Horrax had said of the prohibition on trading,[58]

I did not want there to be any other changes and certainly nothing that had the effect of impinging upon Merrill Lynch's ability to trade on its own account for the purpose of hedging its own risk.

Mr Horrax accepted in cross-examination that he had composed his email to Mr Waterhouse on 3 December to avoid the possibility that Berndale or Merrill Lynch might be restricted in its ability to hedge its own exposure under the How Trading account.

1. And the paragraph firstly numbered 2 in the email which reads "For so long as How Trading maintains the margin requirement at less than $7.5 million, or in excess of that sum to no longer than 48 hours, Berndale will not trade or close out How Trading's positions," that was carefully composed by you in consultation with Mr Laws on the afternoon of 3 December 2007 as a response to the second sub bullet point in Mr Waterhouse's email of 3 December 2007 at 12.45 pm, that's right, isn't it?---
2. It was composed by me, yes.
3. And it was composed by you in response to that second sub bullet point, wasn't it?---
4. Yes.
5. And you quite deliberately deleted the words "or buy protection in respect of that position" from the email that you or Mr Laws, rather, sent to Mr Waterhouse at 4.15 pm, didn't you?---
6. Yes.
7. And you did that deliberately to give accommodation to the concern which you have said that you had in paragraph 30, namely, that you didn't want there to be other changes and certainly nothing that had the effect of impinging upon Merrill Lynch's ability to trade on its own account for the purpose of hedging its own risk, that's so, isn't it?---
8. In terms of making sure there were no other changes, that was my intention at the time.
9. Yes. And you deliberately deleted the words "or buy protection in respect of that position" to accommodate that concern, didn't you?---
10. I don't believe I did.[59]

...

Q: You have agreed with me, have you not, that in the reply to Mr Waterhouse's email which you composed in consultation with Mr Laws on the afternoon of 3 December 2007, you have deleted from the first sub condition (2) the words that appeared in Mr Waterhouse's email "or buy protection in respect of that position", haven't you?---

1. I have deleted, yes.
2. And you did that deliberately, didn't you?---
3. Yes.
4. And you did it deliberately to avoid any possibility that Mr Waterhouse may have understood that the agreement committed Berndale not to exercise its rights or powers under clause 7.6 of the Agreement, didn't you?---
5. I can't recall exactly why I deleted that wording.
6. That's not a truthful answer, is it, Mr Horrax?---
7. It is.[60]

...

Q: Certainly. As the author of Mr Laws' email sent to Mr Waterhouse at 4.15 pm in response to the latter's email received by you at 12.45 pm, you deliberately deleted from that response the words "or buy protection in respect of that position" to avoid any possibility that Mr Waterhouse may have understood the variation agreement eventually made to operate on the footing that as a term of it Berndale had undertaken that it would not, for so long as the conditions of the agreement were satisfied, exercise any rights conferred on it under clause 7.6 of the Agreement, that's right, is it not?---

1. I think the answer is no.
2. I see. And your evidence is that you have no idea why you deliberately deleted those words, is that what you tell his Honour?---
3. My intention at the time was simply to make it clear.
4. What clear? Make what clear?---
5. That provided the account was compliant with the trigger levels, that we would not take control. Yes.
6. In other words you had in mind that the only clauses that would be varied were 4.1 and 6.4, is that right?---
7. Yes.
8. And yet at the time you were concerned, as you have told us in paragraph 30, that there should be no change that had the effect of impinging upon Merrill Lynch's ability to trade on its own account for the purpose of hedging its own risk, is that right?---
9. I've said that in my statement. I said that probably with reflection.
10. What you are saying, Mr Horrax, is this, isn't it: you now realise that you have trapped yourself and that the statement that you have made in paragraph 30, "I didn't want there to be other changes and certainly nothing that had the effect of impinging upon Merrill Lynch's ability to trade on its own account for the purpose of hedging its own risk," is a statement that exposes your knowledge at the time, or appreciation at the time, that the phrase or buy protection of the account" or "in respect of the account", could well have meant that Berndale was not to exercise its powers under clause 7.6, that's the fact of the matter, isn't it?---
11. No.[61]

262 There is no doubt that Mr Horrax deleted the words "or by protection in respect of that position", but Mr Waterhouse reintroduced the words in his proposal to Mr Laws on the morning of 4 December 2007. Mr Horrax substantially adopted that terminology in his final draft of the December agreement.

263 The apparent sensitivity of Mr Horrax to the concept of buying protection was revealed again in the January agreement, which was prepared and executed as part of the resolution of the proceeding commenced by How Trading in the Supreme Court of New South Wales in late December 2007. In that agreement he added a proviso:

... provided however, nothing in this letter agreement shall prevent Berndale or any of its affiliates from taking any action deemed necessary or desirable by Berndale or any such affiliate to hedge the exposure of Berndale and/or any such affiliates to How Trading and/or the Account;

264 The defendants challenge the evidence of Messrs Laws, Horrax and Forbes as unreliable. They relied upon the apparent sensitivity of Mr Horrax to the position of Berndale and Merrill Lynch in relation to buying protection and his negotiations with Mr Waterhouse prior to 5 December 2007. Both Mr Horrax and Mr Laws were criticised for "an attitude bereft of commercial morality" in relation to the exition of the 48 hour moratorium term which they acknowledge had been introduced by Mr Waterhouse.

265 The manner in which Mr Horrax and Mr Laws conducted themselves in their negotiation with Mr Waterhouse may be criticised for its lack of frankness in relation to the "48 hour" issue, although it must be recognised that they were dealing with a sophisticated businessman whom they knew had access to a financial advisor and a solicitor during the course of the negotiation. Even if their conduct were to be characterised as "bereft of commercial morality" (and I do not so find) it does not impugn their credit on the important matter of their evidence concerning the conversations with Mr Waterhouse on 5 December 2007.

266 Berndale drew a comparison between the witness statement of Mr Waterhouse and his oral evidence to support its attack on the credit of Mr Waterhouse. While there are differences, some of which are material, the oral evidence given by Mr Waterhouse in relation to the alleged representation concerning the prohibition on protective trading by Berndale was largely consistent with his witness statement on that topic. That was to be expected. He was well prepared and rehearsed in his evidence. I have no doubt he had spent a great deal of time in preparation.

267 In his witness statement, Mr Waterhouse said that Mr Tighe wanted to make it clear,

that the guarantee will only be provided on the understanding that Merrill Lynch will have no input in any trading of the account nor will they buy any protection against any positions of the account.[62]

The reference to Merrill Lynch is curious. As initially pleaded the alleged representation was to the effect that "Berndale would not enter into any transaction..." By a subsequent amendment, the scope of the representation was expanded to include a reference to Merrill Lynch.

268 In his witness statement, Mr Waterhouse went on to interpolate.

In other words they are to treat the account as it was before, as if it is not in default. [63]

By his interpolation Mr Waterhouse might be taken to have conveyed no more than that he was to remain in control of the account and that Berndale would not exercise any of its default powers. I note that the first of the specific default powers under cl 6.4 of the Derivatives Client Agreement authorises Berndale to,

Enter into one or more transactions to effect the close out of one or more Derivatives Contracts...

269 The interpolation by Mr Waterhouse found in his witness statement was followed by a question which elicited an answer from Mr Laws relied upon by the defendants as the unpleaded representation concerning the buying of protection. Mr Waterhouse claims to have said,

You have not been trading or buying protection against the positions since the account has been in default?

To which Mr Laws is said to have replied, "No". Mr Waterhouse went on to say that Mr Horrax and Mr Forbes shook their heads with a confused or bewildered look as if to say no.

270 Mr Waterhouse continued in his witness statement to confirm the terms of the agreement. He claims to have said,

This agreement confirms that you cannot do anything that is to How's detriment on these positions or take opposite trades in relation to anything on the How account. Janet and Berndale are now both sharing the risks...[64]

The significance of this confirmation, according to the defendants, was to further qualify the prohibition by reference to risk. In other words, Berndale was not permitted to itself take steps to mitigate its potential loss should How Trading default.

271 The concept underlying the evidence given by Mr Waterhouse in his witness statement, to the effect that Berndale (or Merrill Lynch) was not entitled to take protective measures against the potential loss, if conveyed to Messrs Horrax, Laws and Forbes, would have presented as so extraordinary and commercially unsound at the time as to produce an immediate reaction to the notion of any such limitation. In my opinion that would have been so even if Merrill Lynch had not by then engaged in such protective activity.

272 The account given by Mr Waterhouse in his oral evidence commenced with a similar recitation of Mr Tighe's expectation. Mr Waterhouse said,

Tony Tighe, Janet's financial adviser, who has been advising her on this situation, also can't make it here this day as he is travelling overseas in a couple of hours time, but he wants me to make it very clear that the guarantee is only given on the proviso that you don't buy back positions or trade against those positions on the account.[65]

273 The requirement of Mr Tighe, as stated by Mr Waterhouse, is in similar terms to the words of the agreement. Mr Waterhouse next gave evidence of a question directed to Mr Laws:

I then said to Mr Laws, "Have you been trading against the positions on the account?" And he looked at me and said, "No." And I also looked at Horrax, and I looked at Forbes, and they looked at me with not - not understanding them, like weren't understanding what I was saying and shook their heads as though to say we don't know what you're talking about.[66]

While the question formulated by Mr Waterhouse is slightly different the substance of what he said in oral evidence is the same as in his witness statement. Mr Waterhouse continued:

Tony Tighe wants to make it very clear that he wants Merrill Lynch to carry on the account as it was before and do nothing to its detriment, not by opposite positions to the actual How positions on the statement, on the actual account statement, and basically wants to make sure that Merrill Lynch still continues to share the risks, now Janet has come aboard, with her.[67]

In his oral evidence, Mr Waterhouse attributed the limitation solely to Merrill Lynch. This is consistent with his witness statement but inconsistent with the way in which the representation was initially pleaded. The relevant term of the December agreement only mentions Berndale. The only other party mentioned in negotiations in relation to that restriction was Norris Smith. That grouping lends further weight to the conclusion that Mr Waterhouse was seeking to avoid a repetition of the 28 November hedging experience. On the other hand, the introduction of Merrill Lynch as the active party in the evidence of Mr Waterhouse, lends weight to the submission that his evidence about the alleged prohibition on protective trades found its origin in his discovery of the Merrill Lynch house trades in early 2009.

274 As part of its broader attack on the credit of Mr Waterhouse, Berndale submitted that in his witness statement Mr Waterhouse said that he was the person who made reference to a period of 48 hours within which to bring How Trading's account into order, in his oral evidence that reference was attributed to Mr Laws. It submitted that Mr Waterhouse gave evidence that, in his mind, the two key issues that needed to be resolved at the meeting were the rebate of commission from Norris Smith and the payment of interest on credit balances. Berndale submitted that these matters were of principal concern to Mr Waterhouse, and occupying a substantial amount of the discussion at the meeting, but were conspicuously absent from the very detailed account given by Mr Waterhouse in his pre-prepared witness statement. What is perhaps more important, as a factor militating against the credibility of the version of events given by Mr Waterhouse, is that the two issues, commission and interest, were topics discussed in the negotiations and recorded in the pre-agreement emails, whereas the alleged representations were not.

275 The challenge by Berndale to the credibility of Mr Waterhouse does not start and stop with a comparison between his witness statement and oral evidence in connection with the important meetings of 5 December 2007. Berndale submitted that when giving his evidence Mr Waterhouse was firm and certain when it suited his case. He was adroit in answering questions that he perceived would advance his interests and sought, on many occasions, to buttress his evidence by reference to a document or other evidence. He was obviously well prepared. When asked, however, to answer difficult questions Mr Waterhouse became evasive and non-responsive, changing his evidence and reconstructing. Berndale gave the example of evidence given by Mr Waterhouse concerning communications he said he had with Mr Forbes on 28 December 2007 in connection with the proceeding commenced in the Supreme Court of New South Wales. In his witness statement Mr Waterhouse gave a detailed account of a conversation he claims to have had with Mr Forbes. He said:

That day at Court, outside the Courtrooms I was talking to Robert Forbes, who said:

"David, I'm sorry it has come to this. You notice that I did not get involved. I think you have been treated unfairly. Anyway I think we will resolve this before we go inside (meaning back into the Courtrooms) Jade just told me as much (pointing to someone across the hall) ".

I replied: "Well, I can not understand Laws. Everyone including you was saying, buyback, buyback. Then Laws/Ritchie said no, we want the account, we will freeze you, and so we take control. Anyway, I just want to close out the positions and get away from you people as I bet you want to get away from me. I just wish that you had not stopped me, 8 days ago. I would have closed the positions but now we are into the holiday trade, which is terrible".

Forbes "As I said, I did not go on affidavit. I just work here. I'm just happy to have a job. No hard feeling I hope".

I replied "No, thanks for that, Norris said you were good mates with him".

276 When it was first put to Mr Waterhouse that the conversation did not occur, he maintained that it had. When reminded of the evidence of Mr Forbes and Mr Laws to the effect that Mr Forbes was not at court that day, Mr Waterhouse first said that his belief was that Mr Forbes was at court but then said that he may have been confused between the statements he attributed to Mr Forbes outside court on 28 December 2007 and a conversation he said he had with Mr Forbes on 31 December 2007. Mr Waterhouse then sought to reconstruct the events in the witness box by attributing the statements made outside court to Mr Horrax, by reference to an email sent to him by Mr Horrax on 3 January 2008. Mr Waterhouse then retreated from that position once it became evident that the only Berndale representatives present at court on 28 December 2007 were Mr Laws and Ms Harkness.

277 Berndale further submitted that another factor which undermined Mr Waterhouse's credit was the fact that he had been prepared to falsely accuse Mr Laws of having made, on a previous occasion, essentially the same representation he alleged Mr Laws made to him at the meeting on 5 December 2007 regarding Berndale funding the premium for the buy backs, only to change his evidence and concede that he had made an assumption to that effect. It is true that at times the evidence of Mr Waterhouse gave the appearance of having being made up on the run.

278 Another matter said to be adverse to Mr Waterhouse's credit was the evidence given by him in relation to the second of the two meetings that took place on 5 December 2007. On his version of events, Mr Waterhouse said that at the second meeting with Messrs Horrax, Forbes and Laws on 5 December 2007 he sought, and obtained, from Mr Laws, a verbal assurance that the documents were signed "on the understanding of this morning's conversation". He relied on his account of what took place at the second meeting to reaffirm his version of the discussion that took place at the first meeting.

279 Berndale submitted that the weight of the evidence supported a finding that Mr Laws was not present at the second meeting. Mr Waterhouse was the only witness to place Mr Laws at the second meeting. Mr Laws denied he was present. Mr Laws said that he learnt that the documents had been executed when told by Mr Forbes. Mr Horrax also denied that Mr Laws was present. Mr Forbes' testimony was that the second meeting was brief. His evidence was that he and Mr Horrax were certainly present, but he had no clear recollection of Mr Laws being present.

280 Berndale also relied upon the improbability of the position adopted by Mr Waterhouse. It submitted that a shrewd and experienced businessman such as Mr Waterhouse would not have been satisfied with verbal assurances. Negotiations had been in writing and the bargain was reduced to writing. Mr Waterhouse had negotiated and reviewed the drafts over a number of days. If the terms of the written agreement had not accurately reflected his understanding of the bargain, Mr Waterhouse would have insisted on amendments being made, even at the last minute, to protect his position. This was the approach he had adopted on the matters of commission rebate and interest.

281 Berndale submitted[68] that Mr Waterhouse had a clear motive to lie. He had a direct interest in the outcome of the litigation. If the Court were to accept that Berndale made the representations alleged, the personal guarantee given by Mr Waterhouse in respect of How Trading's indebtedness to Berndale was liable to be set aside.

282 Finally, Berndale submitted that the evidence given by Mr Waterhouse, even if accepted, did not support his case of misrepresentation. I agree. The representation as pleaded is different. It is as to the future. It is difficult to discern a promissory representation of the kind alleged from the oral evidence given by Mr Waterhouse. It is only by interpolating his oral evidence concerning the expectation of Mr Tighe, to the effect that the guarantee was only given on the proviso that "you don't buy back positions or trade against those positions on the account", that it becomes possible to discern a promissory representation. But that formulation of the representation does no more than restate the substance of the relevant words in the December agreement.

283 The words in the December agreement were, in my view, intended by the parties to ensure that control of the portfolio remained with Mr Waterhouse and that Berndale would not exercise any of its default powers or insist on How Trading buying hedging positions as had occurred, to the displeasure of Mr Waterhouse, towards the end of November 2007. Mr Waterhouse would decide what positions were to be closed out and when and would not incur the cost of hedging.

284 I find that there was no representation by Mr Laws or anyone else to the effect that Berndale or Merrill Lynch had not been undertaking the Merrill Lynch house trades or that they would not undertake protective house trades. I do not accept that the representation as pleaded was made.

285 As a matter of common sense, it was improbable that Mr Waterhouse would have required such confirmation and assurances, when the conditions under which the guarantee would be provided had been negotiated and reduced to writing. The words employed, "or buy protection on the account", were substantially the same as those used by Mr Waterhouse in his email sent at 7.34 am on 4 December 2007. That being so, why would Mr Waterhouse have considered it necessary to further question the Berndale representatives further concerning that topic? I find that he did not.

286 There was substance in Berndale's challenge to the credit of Mr Waterhouse. He was an evasive and opportunistic witness. I do not accept that Mr Waterhouse sought or was given the confirmation and assurance at the meeting on 5 December in relation to buying protection as he claims.

287 The defendants contended that the failure of Berndale or Merrill Lynch to inform Mr Waterhouse of the Merrill Lynch house trades was misleading and deceptive conduct in contravention of s 12DA of the Act. They contended that had Berndale disclosed the fact of the house trades to Mr Waterhouse, How Trading would not have entered into the 5 December agreement and Mr Waterhouse would not have given his personal guarantee.

288 While there is no general duty of disclosure in commercial dealings, silence may be relied upon to demonstrate a contravention of s 52 of the Trade Practices Act 1974 (Cth) and by analogy, s 12DA of the Act. In Demagogue Pty Ltd v Ramensky,[69] Black CJ said,

Silence is to be assessed as a circumstance like any other. To say this is certainly not to impose any general duty of disclosure; the question is simply whether, having regard to all the relevant circumstances, there has been conduct that is misleading or deceptive or that is likely to mislead or deceive. To speak of "mere silence" or of a duty of disclosure can divert attention from that primary question. Although "mere silence" is a convenient way of describing some fact situations, there is in truth no such thing as "mere silence" because the significance of silence always falls to be considered in the context in which it occurs. That context may or may not include facts giving rise to a reasonable expectation, in the circumstances of the case, that if particular matters exist they will be disclosed.

289 The context in which the failure to disclose arose does not, in my view, lead to the conclusion that Berndale's silence constituted misleading or deceptive conduct. The defendants submitted that the absence of any material impact, adverse to them, of the Merrill Lynch house trades was irrelevant to the significance of the plaintiff's representations that it would not "buy protection". They argued that if it be accepted that Mr Waterhouse would not have entered into the 5 December agreement or given his personal guarantee if he knew that such trades had been undertaken, the mere fact that the trades were undertaken was sufficient.

290 The likelihood that the Merrill Lynch house trades might adversely affect the defendants' position would be a relevant part of the context giving rise to a reasonable expectation that, in the circumstances, the trades would have been disclosed. It would hardly be the case that a failure to disclose an immaterial fact, no matter how subjectively important to Mr Waterhouse, would constitute misleading or deceptive conduct. Mr Ryan gave evidence that the Merrill Lynch hedging activity did not have any measurable impact on the price of the relevant stocks in the market and therefore the price of related options. For example, on 4 December 2007 Merrill Lynch sold 250,000 NAB shares. On the same day, 8.17 million NAB shares were traded on the exchange. The Merrill Lynch sale represented 3 per cent of the volume. Mr Ryan expressed the opinion that it was not until a trade represented over 10 per cent of the total market volume that some degree of impact on price from that trading event may be discernable. He also said that, in his opinion, the purchase of the index options and futures did not have any measurable effect because the number of index options and futures that Merrill Lynch traded were so small that there was nowhere near the volume required to have any effect. Mr Craft gave similar evidence. Mr Gibson, one of the plaintiff's expert witnesses, gave evidence to similar effect, as did Mr Woolley.

291 The defendants adduced no evidence concerning the capacity of any of the Merrill Lynch house trades to adversely affect the How Trading portfolio. There was no cross-examination directed to the issue. The evidence given by Messrs Ryan, Craft, Gibson and Woolley on this issue was unchallenged.

292 I accept Berndale's submission that the steps taken by Merrill Lynch to protect its exposure to the How Trading account were not inimical to the interests of How Trading. There are other contextual factors which militate against any reasonable expectation of disclosure. The significance of the Merrill Lynch house trades reached its high point in the evidence of Mr Waterhouse at paragraphs 79 and 80 of his witness statement:

1. Tony Tighe telephoned the next day, being Sunday 2 December 2007, and said "I am concerned that they could buy protection, on the account, after Janette gave them any guarantee, which would be detrimental to How's position straight away, by them taking or playing the opposite side to How". I said "Tony, I have been insistent with Laws that Berndale agree that the account and the trading on the account would be exactly the same as before it fell into default and that How could trade its way out of this predicament". Tony replied, "David, you may find they cannot agree to that because you are still in default. I'll think about it and come over to the house and write out what I think should be done. It's very important I get it right, short but tight". He also said "David, I need you to fully explain to me the way that How can buy back its positions without the guarantee being called on". I said "Tony, I will explain the method by which How can buy back its positions before the guarantee is handed over so that you will be totally satisfied that the guarantee will not be called against Janette". Both Tony and I (with my family) were about to travel to Aspen in the United States for a holiday with 4 other families. I suggested, as he was to stay at the same hotel, and we were on the same flight from Los Angeles to Aspen via Denver, that we would sit down and he would do a due diligence either in transit or on the first night in Aspen. Tony Tighe sent an email that day. At page 304 of the exhibit is a copy of that email.
2. On the morning of Monday 3 December 2007 Tony Tighe arrived at Elizabeth Bay and said "David, I will settle a letter that you can send to Berndale. However Berndale and Norris Smith have to agree to another thing I want. That is they have to agree to this extra clause, which is very simple but important. Berndale or Norris Smith have no right to trade or close out How Trading's position. They cannot buy protection in respect of that position, and if it does either, the guarantee will automatically be void. Do you understand that David? " I said, "Yes, I understand, but why do you want it Tony?" Tony said, "David, they could bet against you and you would not know it. Your account is in default and has been for a long time. They must be sick of you and they may just decide to push you and the account over the edge by taking hedge or protection against your positions, which you would not know about and could cause your margins to increase. We do not want them betting against you, they must keep sharing the risk or the guarantee that Janette may give will be void. I will make it short, but if they don't agree then there will be no $4m guarantee from Janette. And I want you to promise me if that is the case, that you will not give a personal guarantee. If they break this condition, then the guarantee for $4m will be voided". Tony then dictated to me a letter to Berndale, which requested certain conditions, which I sent by email on Monday, 3 December 2007 to John Laws. At page 310-316 of the exhibit is a copy of that email.[70]

293 That version of events depended upon an explanation given by Mr Tighe for his concern about a proposed guarantee to be given by Mrs Waterhouse. According to Mr Waterhouse, Mr Tighe expressed concern that Berndale "could buy protection on the account" by "taking or playing the opposite side to How"; and "they could bet against you and you would not know it"; and "we do not want them betting against you, they must keep sharing the risk".

294 When Mr Tighe gave evidence he said that he composed the paragraph in the email of Mr Waterhouse, sent to Mr Laws at 12.31 pm on Monday 3 December 2007, which contains the words,

Berndale and/or Norris Smith Stockbroking will have no right to trade or close out How Trading positions or buy protection in respect of that position and if either does so, the guarantee will automatically be avoided.

295 Mr Tighe said at paragraph 31 of his witness statement that he told Mr Waterhouse,

the immediate risk is not in you keeping control, the immediate risk is them saying one thing and doing another. That is, take the guarantee and then start trading on the account and forcing you to be in default again. Haven't you heard of all of the short selling by institutions in the market at the moment?[71]

296 The evidence of Mr Tighe was not challenged. Perhaps that is understandable in a context where he quite obviously did not explain the concept of "buying protection" in the same terms as those attributed to him by Mr Waterhouse. The risk, explained by Mr Tighe in his witness statement, was that Berndale could not be trusted. He said that "the immediate risk is them saying one thing and doing another". Mr Tighe explained what he meant by that. He said, "That is, take the guarantee and then start trading on the account and forcing you to be in default again." The reference to "short selling by institutions" appears to be no more than a reference to institutional short selling as a risk to How Trading, presumably because with a sufficient volume the market may be depressed.

297 There is nothing in the evidence of Mr Tighe which indicated that his concern, as expressed to Mr Waterhouse and his requirement included in the email of 3 December 2007, were directed to anything more than that Mr Waterhouse should retain control of the account and that Berndale or Norris Smith should not be in a position to require How Trading to close out positions or buy protection in relation to those positions. The evidence given on this topic by Mr Tighe, in which he expressed his concern that Berndale could not be trusted, is consistent with the experience of Mr Waterhouse on 28 November when he was required to undertake risk mitigation trades on the account. Mr Tighe spoke of the risk that Berndale would "then start trading on the account". In other words, undermine the options trading strategy implemented by Mr Waterhouse. The risk identified and explained by Mr Tighe was not concerned with in-house risk mitigation trades of the kind undertaken by Merrill Lynch.

298 Mr Tighe said in his witness statement that on Wednesday 5 December 2007, Mr Waterhouse telephoned him with the news that agreement had been reached and that he would meet Mr Tighe at the airport with a copy of the agreement. Mr Tighe included in his witness statement the content of a conversation he had with Mr Waterhouse in which he was told of the events that had just taken place. To that extent the evidence of Mr Tighe is inadmissible hearsay. He was not cross-examined about the passage or the topic and I do not propose to rely upon it. If admissible, however, I do not regard the evidence as supporting the defendants' case.

299 Mr Waterhouse met Mr Tighe at Sydney Airport. They were about to depart for the United States, although Mr Tighe was on a different flight. Mr Tighe said that Mr Waterhouse showed him a copy of the December agreement. Given the significance of the agreement to the future of How Trading and the potential risk to Mrs Waterhouse, it might be expected that Mr Tighe would have read it carefully. Westpac had not yet given its guarantee. If Mr Tighe was not satisfied that the terms and conditions or if the letter did not sufficiently record his instructions apparently given to Mr Waterhouse on behalf of Mrs Waterhouse, there was an opportunity to intervene to protect his client. Mr Tighe did not elaborate and was not cross-examined about the terms of the December agreement.

300 I do not accept the evidence of Mr Waterhouse in which he embellished the expressions of concern by Mr Tighe in an attempt to elevate his concern about "buying protection" into one which might embrace risk protection trades undertaken by Merrill Lynch on its own account. Mr Tighe's attention was focused on the risk that Berndale would breach its agreement to leave Mr Waterhouse in control of the account. Mr Waterhouse's paramount concern was to retain total control of the account. The words employed in the 5 December 2007 letter agreement captured the intention and addressed the real concerns of Mr Tighe and Mr Waterhouse. It was not intended to go further and prohibit Merrill Lynch from undertaking risk protection trades on its own account.

301 Had Messrs Laws, Horrax or Forbes informed Mr Waterhouse that Merrill Lynch was itself engaged in hedging its risk to the account, it would not have deflected Mr Waterhouse from the urgent need to retain control. Time was not on his side. He and his family were about to travel to Aspen for a holiday in the midst of a crisis concerning a threatened loss of control. By any objective standard the risk mitigation trades, if disclosed, would not have caused Mr Waterhouse to refuse the deal then offered to him and walk away from How Trading. He was confident, as he explained to Mr Tighe, that he could recover the position and salvage the fortunes of How Trading. In the circumstances, I am not satisfied that the failure of Berndale to disclose the Merrill Lynch house trades was misleading or deceptive conduct. I am satisfied that had Berndale or Merrill Lynch disclosed the Merrill Lynch house trades to Mr Waterhouse, the December agreement would have been signed and the guarantees provided.

302 Berndale's claim was for $9,960,858.44 together with interest calculated to 5 August 2009. Its claim was put in two ways. First, Berndale claimed the amount recorded in the account of How Trading as due to it following How Trading's default and the eventual liquidation of its portfolio. Alternatively, Berndale claimed damages for breach of the Derivatives Client Agreement. The breach alleged by Berndale is How Trading's failure to pay the amount due on the account together with interest.

303 The amount claimed was calculated after Berndale had brought to account the cost consequences of its dealings with and in relation to the portfolio following its assumption of control on 14 January 2008, and its purported exercise of default powers under cl 6.4 of the Derivatives Client Agreement. Control of the portfolio and the exercise of default powers followed a breach by How Trading of its contractual obligation to maintain the margin calculated by the ACH within an agreed limit. Berndale alleged that in breach of the Derivatives Client Agreement How Trading failed or refused to cure the breach of the margin trigger. That was the event relied upon by Berndale to justify its exercise of the default powers.

304 The defendants argued that whichever way Berndale put its claim it could not avoid a duty to mitigate its loss. The employment of the phrase, "duty to mitigate" was confusing. That phrase is commonly understood to refer to a duty imposed on a claimant for damages to take reasonable measures to minimise loss flowing from another's wrong. Berndale accepted that in relation to its alternative claim for damages it was under a duty to mitigate its loss. It distinguished the claim made for the balance due under the account, although its claim for damages was for How Trading's failure to pay the very same amount. Although it was not expressed in such terms, Berndale's concession that it was under a duty to mitigate assumed that the duty was defined by the default powers in cl 6.4. In the circumstances of this case, the distinction made by Berndale seems to be without substance.

305 The defendants' allegation of a failure to mitigate was not directed at Berndale's conduct following How Trading's failure to pay the balance of the account - relying upon Berndale's claim for damages as a springboard to impose upon it a conventional duty to mitigate. That part of the defendants' case was a complaint that, when exercising its contractual right to deal with the portfolio, Berndale owed How Trading a duty of good faith which required Berndale to act honestly and reasonably.

306 The defendants alleged that Berndale breached that duty and accordingly was not entitled to impose upon How Trading the costs and losses incurred by Berndale beyond the negative value of the portfolio at the time Berndale assumed control of the portfolio, or the cost of closing down the portfolio on and within a few days of 14 January 2008.

307 While the defendants accepted that Berndale purported to exercise its contractual powers they maintained that it failed in that attempt. They argued:

(1) The Agreement did not authorise the trading in futures by Merrill Lynch as part of the liquidation process and, at all events, the account in which those transactions were purportedly conducted was irregularly constituted.

(2) The liability of How Trading under cl 6.4 "for any deficiency" in its account with Berndale and the liability of How Trading under cl 6.5 "to pay to Berndale any amount owing" do not support a claim for money so as to obviate the duty of mitigation. Berndale must take reasonable steps to mitigate its loss.

(3) The power under cl 6.4 to take action in the event of default must be qualified by reference to action that "a reasonably prudent broker would take in the circumstances to protect the personal obligation of Berndale incurred when dealing on behalf of the client".

(4) In any event, Berndale owed How Trading a fiduciary obligation to take all reasonable steps to minimise the loss in the account.

(5) The hedging strategy adopted by Berndale on and after 14 January 2008 was not reasonable - it was inept and misconceived. Berndale ought to have closed out of the portfolio on and within a few days of 14 January 2008. Had it done so, the maximum liability of How Trading would have approximated the "net market value" of the portfolio as calculated by the ASH at the close of business on 11 January 2008.

308 The structure of the defence and counterclaim was not as clear at trial as it might have been. There were allegations of breach of contract, an allegation that Berndale failed to discharge its duty to mitigate its loss and breach of fiduciary duty. The lack of clarity arose in part because the defendants initially failed to clarify precisely what they meant by the "duty to mitigate". As the trial progressed the defendants effectively abandoned their pleaded case for breach of contract, falling back on a duty which required Berndale to act reasonably, as a by-product of duty of good faith, in the exercise of the default powers. The defendants' case was significantly clarified during submissions made on its application to reopen.

309 The conduct of Berndale under analysis commenced when Berndale took control of the How Trading portfolio on 14 January 2008. Having regard to the nature of Berndale's default powers and the circumstances in which they were to be exercised - upon default - it is not difficult to draw a parallel between the "event of default" as pleaded by Berndale and a defendants' "wrong", which will give rise to a conventional duty to mitigate. The confusion over terminology evaporated when the defendants' clarified their case by alleging that Berndale owed to How Trading a duty to act reasonably as an incident of a duty of good faith. A duty to act reasonably was expressly pleaded in paragraph 6A of the defendants' defence. Thus, I interpret the defendants' reliance on a duty to mitigate as no more than a contention that in the exercise of its default powers Berndale was under a positive duty to act reasonably.

310 The allegation of breach of fiduciary duty has two important aspects. First, the defendants relied upon Berndale's position of power, coupled with the risk to which How Trading was exposed by the short sales of stock and the purchase of XJO puts (allegedly undertaken as agent for How Trading) to establish a duty owed by Berndale to close out those transactions so as to derive the maximum profit. The duty was also said to be supported by the contractual obligations. How Trading argued that, had the transactions been closed out on 22 January 2008, Berndale would have derived substantial profits and it was required to give full credit to How Trading for those hypothetical profits. Taking those credits into account the liability of How Trading to Berndale would have been substantially diminished. How Trading claimed in the alternative to be entitled to a credit for the profit actually realised on the short sales and XJO put transactions.

311 On that basis the defendants alleged that Berndale was only entitled to draw down on the bank guarantee to the extent of How Trading's indebtedness, calculated at only $2,724. How Trading alleged an agreement to indemnify Mrs Waterhouse for any loss she sustained by facilitating the financial accommodation. Each of these elements feature in the formulation by How Trading of its counterclaims and the calculation of its loss.

312 Set out below are the alternative claims for damages or restitution by How Trading.

(3) Quantum of counterclaim (alternative) (adjusted for loss on futures trades and WES cash break)

(4) Quantum of counterclaim as pleaded (adjusted for loss on futures trades and WES cash break)

313 Calculations (3) and (4) include adjustments made for what was described as a "cash break" or mistake made by Berndale in overlooking a transaction when finalising its liquidation of the portfolio and for losses made by it in the course of futures trades, which the defendants contend were unauthorised.

314 The structure of the defendants' calculations commenced with a value attributed to the portfolio on the assumption that the indebtedness of How Trading to Berndale on 14 January 2008 was only $5,668,000. That was the amount Berndale's expert witness, Mr Semple, said should have been the overall cost of liquidating or closing out the portfolio on and within a few days of 14 January 2008. The defendants calculations of damages rejects any entitlement of Berndale to more than $5,668,000. No attempt was made to claim a set off against Berndale's claim by reference to damages suffered by How Trading as a consequence of a breach of contract by Berndale. The defendants' broad notion of a failure to mitigate, in the sense mentioned above, became a primary element of their Chapter 2 case.

315 An important feature of the defendants' counterclaim was the allegation by How Trading that it was entitled to bring to account its liability to Mrs Waterhouse who facilitated a bank guarantee drawn down by Berndale in late January 2008. How Trading alleged an agreement with Mrs Waterhouse made on or about 10 December 2007, in which she agreed to procure Westpac to provide a Dual Beneficiary Guarantee in favour of Berndale in the sum of $4 million. How Trading alleged that, in consideration of her doing so, it agreed that should the guarantee be called upon it would pay to her an amount equal to her liability together with interest. That sum is calculated at $4,340,275 as at 31 January 2009, and thereafter at the rate of $600 per day.

316 The defendants' breach of contract case, as pleaded, depended upon a construction of cl 6.4 which imposed upon Berndale a positive obligation to exercise the default powers "with the intent (on its part) and with the effect (as a matter of objective fact or probability) of reducing the risk to Berndale" and thus How Trading's liability to it. In their defence and counterclaim the defendants alleged -

1. By clause 6.4 of the Agreement, in the event that How Trading committed any one or more of the defaults prescribed in sub-clauses 6.4(a)-(i), Berndale was entitled without giving prior notice to How Trading to take any action, or refrain from taking action, which it considered reasonable in the circumstances in connection with Derivatives Contracts registered in the Client Account or otherwise entered into for the account of How Trading.
2. Upon the proper construction of clause 6.4 of the Agreement, the powers conferred on Berndale by that clause could only be exercised with the intent (on its part) and with the effect (as a matter of objective fact or probability) of reducing the risk to Berndale in relation to How Trading's Client Account and How Trading's liability to it upon that Account.
3. Alternatively, it was an implied term of the Agreement that the powers conferred on Berndale by clause 6.4 of that agreement could only be exercised with the intent (on its part) and with the effect (as a matter of objective fact or probability) of reducing the risk to Berndale in relation to How Trading's Client Account and How Trading's liability to it upon that Account.

6A. Further, on the following 14 January 2008 Berndale was under a duty to take all such action as was reasonable and appropriate to mitigate its loss under the Agreement.

1. Berndale's purported exercise of the powers conferred on its by clause 6.4 of the Agreement on and following 14 January 2008 was not in accordance with the conditions referred to in paragraphs 4 and 5 above or the term referred to in paragraph 6 above and was therefore in breach of contract.
2. The sums claimed by Berndale are claimed in consequence of its breaches of the Agreement and are therefore irrecoverable by it.

9(a) On or within several days of 14 January 2008, in the proper exercise of the powers conferred on it by clause 6.4 of the Agreement and in discharge of the duty referred to it in paragraph 6A above, Berndale could, and should, have liquidated all of How Trading's put and call options on the open market for their then net market value namely minus five million six hundred thousand dollars ($5,668,000) or thereabouts by purchasing an equal number of put and call options (in relation to the same stocks and on the same terms as to strike prices and expiry dates) as How Trading had sold prior to 14 January 2008 at aggregate cost of $5,668,000 or thereabouts.

9(b) In the event that Berndale had acted in the manner set out in subparagraph (a) above it would have reduced How Trading's liability to it to one million six hundred and sixty-eight thousand dollars ($1,668,000) or thereabouts (after taking the Dual Beneficiary Guarantee referred to in paragraph 12 of the further amended statement of claim into account), being an amount substantially less than the profit derived by How Trading upon the share trading transactions effected on its behalf by Berndale as set out in schedule A to the further amended statement of claim.

1. In breach of the conditions referred to in paragraphs 4 and 5 above or of the term referred to in paragraph 6 above and of the duty referred to in paragraph 6A above, Berndale failed and neglected to act in the manner stated in paragraph 9 above.
2. On 14 January 2008, in purported exercise of the power conferred on it by clause 6.4 of the Agreement, Berndale short sold in the name of How Trading and as its agent the following shares at the undermentioned prices:

1. On 15 January 2008, in purported exercise of the power conferred on it by clause 6.4 of the Agreement, Berndale purchased in the name of How Trading and as its agent 500 put options in the ASX/S & P 200 index at 5400 for the price of $.93 per unit, in aggregate $465,000.00 ('the XJO puts').
2. On 17 January 2008, in purported exercise of the power conferred on it by clause 6.4 of the Agreement, Berndale short sold in the name of How Trading and as its agent the following shares at the undermentioned price:

1. The transactions referred to in paragraphs 11 and 13 above exposed How Trading to the risk of very substantial losses in the event that the price of the shares short sold by Berndale in the name of How Trading and as its agent increased in value after 14 and 17 January 2008 respectively.
2. In the premises:
   1. By reason of the matter stated in paragraph 14 above and consistently with the conditions referred to in paragraphs 4 and 5 above or the term referred to in paragraph 6 above and the duty referred to in paragraph 6A above, on and following 14 January 2008 Berndale was obliged to monitor the movements in the prices of the shares which it had short sold in the name of How Trading and as its agent very carefully and to close out all of the transactions referred to in paragraphs 11 and 13 by purchasing shares equal in number to the shares which it had short sold when the prices of such shares had fallen sufficiently to enable How Trading to derive the maximum profit which could have prudently been derived from the short sales;
   2. Consistently with the conditions referred to in paragraphs 4 and 5 above or the term referred to in paragraph 6 above and the duty referred to in paragraph 6A above, on and following 15 January 2008 Berndale was obliged to monitor the movement in the ASX/S & P 200 Index very carefully in order to sell the XJO puts at a time and for a price most prudently advantageous to How Trading.
3. In purported exercise of the power conferred on it by clause 6.4 of the Agreement but in breach of the conditions referred to in paragraphs 4 and 5 above or the term referred to in paragraph 6 above and in breach of the obligation referred to in paragraph 15(a) above, on the dates stated below Berndale closed certain of the short sales referred to in paragraph 11 above by purchasing the following shares at the under mentioned prices:

1. The transactions referred to in paragraph 16 above (with the exception of the purchase of 16,000 shares in CBA on 18 January 2008) resulted in losses totalling (net) $144,417.
2. Berndale asserts that How Trading's indebtedness to it increased by the amount of a net loss of $144,417 which assertion is denied by the defendants because of the facts that the transactions referred to in paragraph 16 above were effected by Berndale in breach of the conditions referred to in paragraphs 4 and 5 above or the term referred to in paragraph 6 above and in breach of the duty referred to in paragraph 6A above and the obligation referred to in paragraph 15(a) above.
3. Further, in breach of the conditions referred to in paragraph 4 and 5 above or the term referred to in paragraph 6 above and in breach of the duty referred to in paragraph 6A above and the obligation referred to in paragraph 15(a) above, Berndale failed and neglected to close the short sales referred to in paragraphs 11 and 13 above by purchasing, on 22 January 2008, the following shares which were for sale on that day at the under mentioned prices (being the prices at which How Trading would have prudently derived the maximum profit to be derived from those short sales, after allowing for the ill-advised and wrongful purchases referred to in paragraph 16 above):

1. In the event that Berndale had not acted in the manner set out in paragraph 16 above, it could and should, in conformity with and in discharge of the conditions referred to in paragraphs 4 and 5 above or the term referred to in paragraph 6 above, the duty referred to in paragraph 6A above and the obligation referred to in paragraph 15(a) above, have closed those of the short sales made on 14 January 2008 which were partially closed before 22 January by the purchases set out in the table in paragraph 16 above by purchasing the following shares at the undermentioned prices on 22 January 2008:

1. In the event that Berndale had purchased the shares set out in paragraphs 19 and 20 above on 22 January 2008 How Trading would have derived a profit of $4,267,775.00 and would have substantially reduced the totality of its indebtedness to Berndale.
2. On 22 January 2008 Berndale could and should, in conformity with and in discharge of the conditions referred to in paragraphs 4 and 5 above or the term referred to in paragraph 6 above, the duty referred to in paragraph 6A above and the obligation referred to in paragraph 15(b) above, have sold XJO puts for their then market value of $1,862,500 so deriving a profit of $1,397,500 and reducing How Trading's indebtedness to it in that amount.

22A. By reason of Berndale's breaches of the duty referred to in paragraph 6A above (as stated in paragraphs 10, 16, 18, 19, 20 and 22 above) Berndale is not entitled to recover the sum claimed by it.

317 As the trial progressed, the defendants shifted emphasis from the construction (and implied term) contended for in paragraph 5 and 6, and instead sought to qualify Berndale's default powers by reference to a "reasonably prudent broker" test derived from an express default power in cl 6.4(l) of the Derivatives Client Agreement. To some extent the defendants shift is explicable because Berndale seemed to accept that it was bound by such a duty, although the parties provided little assistance in giving content to the duty. The position adopted by the parties underwent further change and clarification when further submissions were directed to the content of the duty in the course of the defendants' application to reopen the trial.

318 Berndale submitted that when exercising the default power it was free to choose its course of action, provided that it considered that course to be reasonable. It was a wholly subjective test which, once satisfied, became impregnable to attack. Berndale accepted, however, that its choice must be made bona fide for the purpose of exercising the power. It conceded that it would not be permissible to act for an ulterior, dishonest, arbitrary or capricious purpose. Berndale submitted that its choice of action was not fettered by any obligation to act reasonably - presumably on an objective basis - and that it was not under any duty to consider alternative courses of action. Berndale rejected the proposition that it owed How Trading a duty of care when exercising its default powers, or that it owed How Trading any implied obligation of good faith.

319 The defendants' submissions on the nature and content of the duty owed to How Trading, made in the course of its application to reopen the trial, also clarified their position. The defendants argued that a duty of good faith should be implied which obliged Berndale to engage in conduct that was objectively reasonable.

320 By paragraphs 5 and 6 of their defence and counterclaim, the defendants alleged a construction of the agreement or an implied term that sought to limit the scope of Berndale's default powers by requiring that Berndale exercise the powers with the intention and with the effect, as a matter of objective fact or probability, of reducing its risk under the How Trading account. The content of the limitation as pleaded was, however, so vague and uncertain as to be meaningless unless informed by specific allegations of what Berndale ought to have done and did not. For example, the defendants alleged that in the proper exercise of the powers Berndale should have liquidated its portfolio by immediately closing out all put and call options on the open market at a cost of $5,668,000 or thereabouts. This allegation, if correct, would impose on Berndale an obligation to adopt a particular approach to liquidating the portfolio within a defined period of time. Next, the defendants alleged that having short sold stock and purchased XJO puts, Berndale exposed How Trading to a risk of very substantial losses. They alleged that by reason of its contractual obligations and the duty to mitigate Berndale was obliged, as How Trading's agent, to carefully monitor the movement in the prices and to close out all transactions when the share prices had fallen sufficiently to enable How Trading to derive the maximum profit which could have been prudently derived from the short sales and to carefully sell the XJO puts to similar effect. This allegation imposed on Berndale a positive obligation to maximum profits by selling at a particular time. Berndale's failure to close the short sales on 22 January 2008, being the day upon which the maximum profit could have been derived, was pleaded as a breach of the terms alleged in paragraphs 5 and 6 of the defence and counterclaim.

321 The defendants alleged that as a consequence of Berndale's breach of cl 6.4,

(1) the amounts claimed by Berndale were irrecoverable; and/or

(2) Berndale breached its duty to mitigate its loss and is therefore not entitled to recover the sum claimed by it.

322 Thus, the primary issues for determination in this part of the case were:

(a) whether the construction contended for by the defendants in paragraph 6 or the implied term in paragraph 7 is sustainable;

(b) what was the nature and content of any duty owed by Berndale to How Trading in the exercise of default powers;

(c) was there any breach by Berndale of any such duty; and

(d) if there was a breach, what was the consequence.

323 Following Berndale's notification to How Trading that it was taking control of the portfolio, Ms Harkness, a Merrill Lynch lawyer, sent a memorandum to Mr Ryan and Mr Craft outlining the procedures to be followed:

Subject: Berndale Securities Limited - How Trading Account NOR00016

Berndale Securities Limited (Berndale) has the right under the Agreement between Berndale and How Trading Pty Limited (How Trading) to take over the How Trading Account NOR00016 (Account) in certain circumstances. If Berndale exercises this right, this memorandum sets out guidelines for traders on behalf of Berndale to trade the positions in the Account.

- All transactions to be executed on behalf of Berndale only by Jason Ryan, Paul Craft, Denis Kelliher or such other trader as approved by OGC.

- For so long as Paul Craft is trading positions in the Account for Berndale, he will not execute orders or otherwise provide any services on behalf of Merrill Lynch Equities (Australia) Limited (MLEA). This direction will remain in force until notice by OGC.

- Each trader operating the Berndale account to be wall crossed and prohibited from trading options over NAB, CBA, Westpac and any other securities in respect of which there are material positions in the Account. This restriction will remain in place until such time as the positions in the Account are no longer material (such determination to be made by risk and OGC and notified to traders in accordance with OGC procedures).

- Berndale to operate the Account as a prudent broker and as if the positions are for the account of Berndale. Due to Berndale's legal position under the Client Agreement, in trading the positions in the Account, the interest of How Trading and Berndale should coincide.

- Where possible, and if it will result in greater proceeds, Berndale to itemise the transactions in the Account and seek offers for selected transactions from time to time, rather than selling the Account wholesale.

- Berndale to take steps to hedge, as would a reasonable broker. It is noted that Berndale may not be able to obtain a direct hedging position in all circumstances. Accordingly, hedges may encompass risk reducing trades which may or may not match underlying, strike and maturity.

- Preference to trade in the market and not to take any trades in house. Traders to obtain OGC approval before entering into a trade with any Merrill Lynch desk; Allow reasonable time (in accordance with standard trading protocols) for bids_I_offers to be received.

- Berndale traders may either (i) enter ETOs or OTC trades through a third party broker or (ii) enter ETOs directly by entering a bid/offer to the screen. In general, if using a third party broker Berndale will instruct Merrill Lynch Australia (Futures) Limited to execute transactions on Berndale's behalf. MLAF will pass on any commission on a direct costs basis to Berndale for the Account.

- Berndale to seek multiple bids where appropriate in respect of each transaction or group of transactions and to attempt to seek interest from a variety of counterparties. If using a third party broker this can be by way of the broker seeking bids from multiple counterparties. If using the ETO market directly, in accordance with normal trading practices involving request for quote.

- Traders to prepare a file note at the end of each day regarding trading on that day, including the rationale for each trade and where possible a log of when bids/offers received and how many bids/offers. A general overview of the market, as relevant to the Account also to be included.

These procedures are by way of guidance only and Berndale traders retain discretion to take a price where they consider it is the most reasonable price possible in the circumstances.[72]

324 The instructions approved hedging of the portfolio and favoured individual transactions against "selling the Account wholesale".

325 Mr Ryan said he wanted to remove as much risk from the portfolio as soon as possible. He said that "the only feasible way to execute this delta-neutralising strategy was to short sell stock". Delta exposure is hedged by trading the opposing delta amount of the underlying stock of the option. Thus, if the price of the underlying stock moves by a small amount, the change in the value of the option was offset or hedged by the corresponding change in the value of the stock. For short put positions, the effect of delta may be negated by selling or shorting stock. Short selling occurred when the investor borrowed a stock and then sold it, hoping to buy it back for a lesser price in order to make a profit. As sold put options were susceptible to downward movements in the market for the underlying stock, short selling might be employed as a mechanism to offset any loss in value of the option against the profit made from the short sale.

326 Mr Ryan said that on 14 January 2008 he instructed Mr Craft to "flatten the delta" by short selling stock and to commence "gamma hedging" the positions which had the greatest negative gamma. The following table outlines the short selling of stocks conducted by Merrill Lynch on 14 January 2008.

327 At the end of the day Mr Ryan sent an email to Mr Fujiwara, Mr Kelliher and others, outlining the day's trading:

To reduce the risk of this option account we have:

Flattened all book deltas. Larger deltas were worked over the day. Smaller ones in the morning session. Flatten / Reduce selected gamma positions. Selection on the basis of gamma (size), maturity and strike. We targeted a CBA and a NAB position today. (10% of the CBA gamma1, and 15% of the NAB gamma1). Details in email attached.

Flattening the account's gamma is the immediate priority over the next week, and we will focus on vega post that.

328 At about 8.30am on 14 January, Mr Waterhouse and Mr Tighe attended at the offices of Merrill Lynch. Mr Waterhouse gave evidence of a meeting with Mr Ritchie, Mr Laws, Mr Horrax and Mr Forbes during which he complained about the terms of the 3 January 2008 letter agreement and later, alone with Mr Ritchie, the attitude of Berndale to funding buy backs in late December. It was during this later conversation, so Mr Waterhouse alleges, that Mr Ritchie told him of the imminent Merrill Lynch report that would make the market fall, inviting Mr Waterhouse to use the information and opportunity to "do yourself a favour". Mr Waterhouse said that Mr Ritchie told him that Merrill Lynch intended to "short the hell out of stocks in the market that you have option positions on, maybe up $100m, which will more than match your open positions, it's a great opportunity for you, that we know what is coming this week".

329 Mr Waterhouse said that he was concerned that what was proposed was not legal and that the market may not react as Mr Ritchie had forecast. Mr Waterhouse said he pleaded with Mr Ritchie not to undertake such trades. He said that Mr Ritchie agreed and said, "David, this news will be bad, but don't worry, we will not be buying protection on the account, nor shorting stock if that's what you want".

330 Early in the trial, Berndale objected to the whole of the evidence of the private conversation between Mr Waterhouse and Mr Ritchie. The basis for the objection was relevance. Berndale announced that, subject to resolution of their objections, Mr Ritchie would give evidence in which he would emphatically deny making the alleged statements. The objection to the evidence was argued and determined. The defendants did not rely upon the short sales by alleging that they were unreasonable or imprudent because they were made illegally. In the course of the trial the defendants did not challenge the explanation for the short sales given by Berndale. Mr Waterhouse was permitted to give evidence of the conversations with Mr Ritchie because they were part of the course of communications he said took place between the parties in relation to the How Trading account. I concluded the ruling on evidence as follows:

Mr Waterhouse's evidence can be tested, as I am sure it will be. Mr Ritchie may or may not be called to give evidence. That is a matter for the plaintiff. The truth or otherwise of what Mr Waterhouse alleges he was told by Mr Ritchie about the intention of Merrill Lynch to use the information about to be published is, in my view, quite irrelevant in this proceeding. I do not propose to make any findings that are unnecessary to decide the real issues. As presently advised I do not even consider it necessary to decide whether the particular conversations took place, unless it is submitted that I should do so for the purpose of assessing the credit of a witness.

331 Apart from his evidence-in-chief, in the form of a witness statement, reciting the alleged conversations with Mr Ritchie, nothing more was said of them. Mr Ritchie was not called to give evidence. Mr Waterhouse was not cross-examined on that topic; nor was Mr Tighe. It was not submitted that I should make anything of the conversations and I do not propose to do so. There followed, however, other communications between Mr Waterhouse and representatives of Berndale which form part of the chronology of events that occurred during the liquidation of the portfolio. These events are included within the chronology because the communications were relied upon as relevant to the question whether, in all of the circumstances, Berndale discharged its contractual and other duties.

332 After the meeting on 14 January 2008, Mr Waterhouse sent an email to Mr Horrax in which he noted that Berndale had taken control of the account "until such time as Berndale agree for control to be returned back to How Trading Pty Ltd." On the same day Mr Kelliher sent an email to numerous Merrill Lynch executives informing them that How Trading was looking for solutions. Mr Ritchie sent a short message to Mr Laws on the morning of 15 January,

Still thinks he can get us a 4m bank check on Thursday.

Jason spent abt $300k yesterday and would look to spend more today. If it were to work, I think we'd need to keep the spend on our side to around the $1mill mark including the loss on the stock hedge. That way we can say that you have spent what you are going to any way and will just get the $4mill gtee and take the $1mill into the account as its already spent... makes sense? But we still have a tough time selling it... You'd need to get Masi to push it I think...

Can Waterhouse see the stock hedges we have on.

335 Whether or not Mr Waterhouse could see the stock hedges - presumably on his screen - he received contract notes in due course. He complained to Mr Smith who emailed Mr Forbes to enquire who placed the order. Mr Smith had assumed that negotiations between Berndale and Mr Waterhouse were ongoing. He asked,

Does this mean that all negotiations are finished.

336 According to Mr Ryan and Mr Craft, it took four weeks, between 14 January and 13 February 2008, to prepare the portfolio for auction on 5 March 2008. Mr Craft monitored the portfolio using the RAM system. He said he dealt with the How Trading account as if it was a house account held by Merrill Lynch, in which risk needed to be reduced at the least cost to the account. Mr Craft kept a notebook in which he made entries recording trades executed on each day. He had been instructed by Ms Harkness to keep proper records.

337 It was common ground that hedging was a conventional methodology to minimise risk in an options portfolio, although it was not part of How Trading's strategy to hedge. It was common ground that if a portfolio was not to be closed down immediately, hedging was an appropriate strategy. The defendants' experts did not contend that the hedging transactions that were undertaken were ineptly carried out. The defendants' case was that hedging at all was completely unnecessary.

338 Mr Craft's first entry was on 14 January 2008 in which he recorded the purchase of 265 NAB March 2008 $32 put options, 260 CBA June 2008 $41 put options and 86 NAB January $31 put options. These transactions were, he said, targeted at reducing gamma. They were positions that How Trading had sold and were closest to the money. On the same day, in order to reduce the delta risk, Merrill Lynch had made the short sales of stock. Mr Craft purchased 56,250 NAB shares and 10,969 CBA shares. He did so because "buying the put options created a short delta on the portfolio. I bought stock in the underlying shares for the purpose of hedging this delta exposure". How Trading had longer dated NAB put options, some extending as far out as June 2010. Some CBA put options matured in January, March and July 2010.

339 Mr Craft, responding to the defendants' case that Berndale should have closed out all of the How Trading portfolio within several days of 14 January said,

If I could have sold all the options in the How Trading on the open market for reasonable prices on Day 1 or within several days of Day 1, I would have. If there had have been such a market at a fair price, selling the options on the market would have been the right thing to do. There was no incentive for us not to close down the portfolio in the least expensive and in the shortest time possible. However, there was no market for the number of options positions contained in the How Trading portfolio.[73]

340 This evidence by Mr Craft is important because of his concession concerning "the right thing to do" if there was a market for the number of option positions contained in the How Trading portfolio "at a fair price". It remained a mystery as to what a fair price might have been. There was a market. Merrill Lynch did not consider or explore the possibility of immediately closing down the portfolio. An issue arises as to whether its failure to do so was unreasonable and a breach of a duty owed to How Trading.

341 The complexity of the unwinding process undertaken by Merrill Lynch becomes immediately apparent from the trading on 14 January. Berndale commenced to transform an unhedged into an hedged portfolio. This is consistent with the evidence given by Mr Ryan when he said,

I did not consider selling all of How Trading's put and call options on the open market or within several days of 14 January, because to do so would have been impossible at a fair price. If that course of action had been suggested to me at the time, I would have rejected it.

From this evidence, it was apparent that he did not consider going to the market for the purpose of closing out all positions. He said in later evidence that he first decided to auction the How Trading portfolio in late December 2007, or early January 2008. If that is correct, the decision was made prior to How Trading's default without regard to the market conditions at the time.

342 On 15 January, Mr Craft said he focussed on reducing the gamma in the portfolio. He said that the options that had the most amount of gamma were those whose strike price was closest to the current spot price, and wherever possible he tried to buy back the exact position where the portfolio was short. He said that his object was to reduce the number of positions in the portfolio, thus making it easier for third parties to price at auction. He identified a lack of liquidity for shorter dated put options and decided, in consultation with Mr Ryan, that the best way to reduce the gamma quickly was to buy short dated index put options (XJO put options). One reason for purchasing the XJO put options was that they "provided the portfolio with broad crash market protection". If he was anticipating a crash in the market, he did not elaborate. Much of what was being done might have been explained on that basis but it was not. On the same day, Mr Craft bought WBC March 2008 $22.50 put options on screen and 230 BHP July 2008 $24 put options. He also bought 17,600 NAB shares to hedge the option positions that he had bought that day. He said that other "buy trades" were undertaken for the purpose of rehedging the portfolio to get it delta neutral because the delta of the stocks had changed as a result of market movement.

343 Mr Waterhouse sent an email to Mr Ritchie at 5.21pm on 15 January in which he referred to a telephone conversation concerning the hedging activity undertaken by Merrill Lynch. He said that he had no interest in settling the short sale trades. Mr Ritchie responded that the orders were placed with a view to reducing the risk in the account. Mr Ritchie said, somewhat curiously:

To clarify when you called yesterday afternoon I explained that Berndale had control of the account and was placing orders with a view to reducing the risk in the account. Although we would very much like you to settle your obligations with us immediately we understand from you that you are currently not in a position to do so.

However this does not detract from the fact that responsibility for settlement of any trade within the account with Berndale is the responsibility of How Trading and that ultimately How Trading will be responsible for the net balance of the account.[74]

344 Mr Craft said that on 16 January he focussed on unwinding the CBA and BHP option positions, but found it difficult to trade in bank options at reasonable prices. He did not say that there was no market or explain what would have been reasonable prices.

345 In response to a further complaint by Mr Waterhouse, sent by email at 12.25pm on 16 January, to the effect that Berndale was not complying with a previous agreement not to short sell stock and "hold off until Friday before doing further on the account", Mr Ritchie said, at 5.20pm the same day:

Upon Berndale taking control it is quite clear that Berndale may do whatever we consider reasonable in the circumstances. We are of the view that we are complying with the agreement in this respect.

I am not going to be drawn into specific transaction or strategy discussions but in any event I believe that nothing we have done is inconsistent with what we previously discussed.[75]

346 The alleged agreement to hold off until Friday was not explored in evidence. It was inconsistent with the defendants' case and not pursued. Nor was it advanced by Berndale as an explanation for hedging and delay in liquidation by auction or otherwise. The communications that followed are consistent with a conclusion that Berndale may have decided to hold off liquidation to give Mr Waterhouse an opportunity to retake control of the portfolio. As no party advanced such a case, I make no finding in that regard.

347 In a summary, circulated within Merrill Lynch by Mr Kelliher at 7.30pm on 16 January, he noted that if the account had not been hedged with the trades already executed by Merrill Lynch, the loss that day would have been in excess of $1m. Presumably, his reference was to an increased exposure in the account. Mr Kelliher also reminded "people" that "unwind" will take several weeks to reduce gamma and then vega to a "de minimus" level.

348 Also on 16 January, Mr Anderson provided more information to Merrill Lynch executives in an email sent at 12.17pm. Having explained a little of the background to the account and the fact that the market had remained volatile and "the margin number has escalated beyond the client's capability to meet them", he continued:

On this basis Merrill Lynch has assumed ownership of the account and are working to reduce the risk on the account with a hedging and closing strategy. The final account default will not be known until either the client sends in additional funding or his account is fully liquidated by Merrill and we start legal proceedings to recover our loss.[76]

349 On 17 January, Mr Craft focussed on unwinding further bank options as well as BHP and Woolworths options. The RAM reports informed him that these were the highest risk positions with the largest gamma. As a consequence, he bought 40,000 NAB shares for the purpose of delta hedging the portfolio. He also short sold 80,786 CBA shares. He said that he made that short sale for the purpose of rehedging the portfolio.

350 On 17 and 18 January, in emails to Merrill Lynch personnel, Mr Ryan justified the hedging strategy by comparing the increase in the margin had the hedging not been undertaken.

351 On Friday 18 January, Mr Craft continued in his efforts to unwind the same options as on the previous day. He bought ANZ, NAB, CBA and WBC shares. He said that these purchases were done for the purpose of rehedging the portfolio to get it delta neutral. He spoke with brokers asking for offers in bank options but was unable to get "reasonably priced" options. It was not clear what was meant by reasonably priced options. In any event, it was from this point that Mr Craft decided to execute buy orders directly on the listed market (from his screen) rather than go directly to brokers as a source of options.

352 On Saturday 19 January, Mr Waterhouse sent an email to Mr Laws in which he complained about short selling and the lack of information provided to him. The email made reference to attempts being made by Mr Waterhouse to obtain finance through Westpac to provide an extra guarantee, and a bank cheque in the interim, for $4,000,000 to enable him to regain control.

John,

I had a call from Westpac on late Friday afternoon.

They told me they may be in a position to grant the request 'that they give a bank Chq for $4m early next week until the extra guarantee comes in place' - the same deal as the 7th of Dec, you hold & do not bank the chq until the guarantee will come in place.

However they have ask again about the state of affairs with the How Trading account - one, the present margin - two, the indebtedness of How Trading to Berndale above the margin. They want to be comfortable that this money is going to cover margin only & the debt is not a large amount over the stated margin - the main reason, is the guarantee being called on if the account is not overmargin & the account some time in the near future going across to another broker, say within the next 6-12 months with the minimal of fuss.

I note Berndale, under no instruction from me, have on the How account brought back $831k of positions before yesterday & $554k yesterday - I again find this latest buybacks unacceptable, being notified over 24 hours later, after the purchase & with the stocks were all about $1 higher (I was only then informed), why the wait, if the stocks had fallen were they going to keep these in the house account, to say I feel like a mushroom is a understatement, when ever I placed an order with Norris Smith I would receive an email within 5 min's of that order been hit.

The margin has now fallen to $6.1m - what is Berndale position on the account, as its under the $6.5m agreement. Also I feel very uneasy re these non-recourseable $45m shorts & march 5400 spi you did in How's name (without authorisation/notifying me or even Norris Smith of these huge trades until they were executed).

I have asked since early December to get an exact figure for the How Account - which Rob has promised, yet for some strange reason, unwilling to provide.

All in all, I can not see Westpac (that is my wife) doing this facility with all this subterfuge going on. I'm trying to do, as always the right thing to Berndale/Norris Smith - I think you are trying to help me but I feel very uneasy with Berndale's action in this last week.[77]

353 Mr Waterhouse said that following his email to Mr Laws he received an email from Mr Ritchie inviting him to a meeting at the office of Merrill Lynch on the following Monday. He attended a meeting on Monday morning with Messrs Ritchie, Forbes and Laws and gave an account of apparent confusion about the state of the How Trading account. He said that on 24 January he made another request for a meeting, this time with his wife's solicitor, Mr Horton and Mr Tighe. His request was refused by Mr Horrax on 25 January 2008.

354 The efforts by Mr Waterhouse to arrange additional funding from Westpac were well known to Berndale. Berndale did not initially reject his proposal that he have an opportunity to seek additional financial support from Westpac. Mr Horrax gave him the option on Monday morning, 21 January, of providing a total of $8 million by way of Westpac guarantee and once again taking control of the account (and moving it to UBS) or, in the event the margin did not fall as contemplated, Berndale would continue on "its current path of managing the account".

355 Mr Craft said that in the week commencing 21 January, he focussed on unwinding option positions in ANZ, CBA, BHP and Woolworths. He bought ANZ, NAB, CBA and WBC shares for the purpose of rehedging the portfolio to get it delta neutral. Mr Ryan instructed him to start reducing the vega in the portfolio. Mr Craft said that the best way to reduce vega was to buy back long dated options. He said there was also an issue of liquidity, although the nature and extent of the issue was unexplained.

356 Mr Craft said that on 22 January 2008, it was "near impossible" to purchase options. He short sold stock to get the portfolio back to a delta neutral position. On 23 January, Mr Craft bought back positions in BHP and ANZ. On 24 January, he bought back positions in Woolworths, WBC, CBA and NAB, thus "reducing vega". On 25 January, he bought back positions in CBA, NAB and WBC. He also sold SPI March 2008 futures for the purpose of rehedging the portfolio.

357 During the so-called "unwind" process undertaken by Mr Craft, on instructions from Mr Ryan, his stated purpose was to try "to get the portfolio into a state where it was able to be auctioned as soon as possible". He said that he had reduced the delta, gamma and vega to make the portfolios suitable to be auctioned to the market.

I was confident that, at these levels, traders would be willing to take on the risk contained in the portfolio at competitive prices.

358 Mr Ryan said that he had decided on an auction strategy as early as December 2007. Although that evidence was not challenged by the defendants, I am not satisfied that he did. Such a proposal does not seem to have been mentioned in correspondence until shortly before an application for approval was made to the ASX, and was not mentioned in the initial instructions or guidelines from Ms Harkness. Her instructions contradict any such purpose.

359 On 25 January 2008, Mr Horrax advised Mr Waterhouse of Berndale's intention to call upon the guarantee. On 25 January Mr Horrax wrote:

David,

Dan has passed me your e-mail as he is at the office today. We have discussed your request and the current positions.

We don't believe it is necessary or appropriate for us to proceed with the meeting requested. It is quite within your power to release the underlying agreements that together with Berndale statement which quite clearly set out the position of the account.

On Monday morning we came to a conclusion that there were essentially two options:

1. Dependent on Westpac providing a $8 million guarantee and the ACH margin requirement falling to $4 million you would be able to move the account to UBS and operate the account under their rules.
2. Should the margin not fall Berndale would continue on its current path of managing the account.

Unfortunately I understand that the margin is well in excess of $9 million. Therefore it does not appear realistically possible to proceed with the first option.

We have therefore come to the conclusion that we have no choice but to move to liquidate the current $4 million guarantee.

360 This letter from Mr Horrax proceeds on the basis that the decision to liquidate was made at that time. It is inconsistent with a pre-planned auction.

361 Mr Waterhouse replied to Mr Horrax and Mr Ritchie at 4.25 pm:

Michael,

Just got a call from Westpac - Merrill's have asked for the $4m. The market rebounded today 300 points, 100 points higher than it was last Monday, when the margin was $6m - if the margin has come down to around the $4m can we still do the deal with UBS? If not, please call and I will try & assist you getting the $4m bank cheque on the guarantee as quickly as possible - Westpac have told me there could be a lot of red tape involved, which I will try & shorten.

362 Mr Ryan mentioned an auction on 6 February 2008 in an internal email. A few days later Mr Indge, equity business manager at Merrill Lynch, had discussions with the ASX concerning an off-market sale. The portfolio was sold at auction on 5 March 2008.

363 The ACH Clearing Rules provided for minimum terms for client agreements of the kind entered into by How Trading and Berndale. Many of the terms found in the Derivatives Client Agreement merely recite the minimum terms prescribed by the Rules. The Rules do, however, accommodate some variation and relevantly, an extension of default powers. Clause 6.4 is one such example. While the minimum provisions are included in cl 6.4, it is more extensive, identifying additional events of default and additional powers.

364 The purpose of the clearing facility provided by Berndale was explained in the Rules. In summary, the facility offered by Berndale was to remove direct transaction counterparty risk through novation and registration of the counterparty obligations by the ACH. The clearing arrangement is described in cl 2 of the Derivatives Client Agreement:

1. CLEARING ARRANGEMENTS AND RELATIONSHIP WITH ASX AND ACH

2.1 Clearing Agreement between the Broker and Berndale

The Broker is a Market Participant of ASX and is a party to a Clearing Agreement with Berndale for the purposes of the ASX Market Rules and the ACH Clearing Rules.

Berndale is a Clearing Participant of ASX and a General Participant of ACH.

2.2 Nature of Berndale's obligations [ACH Minimum Term 4]

The Client acknowledges that:

(a) notwithstanding that Berndale (or the Broker) may act in accordance with the instructions of, or for the benefit of, the Client, any Derivatives Contract arising from any order submitted to ASX is entered into by the Broker as principal; and

(b) upon registration of a Derivatives Contract with ACH in the name of Berndale, Berndale incurs obligations to ACH as principal, even though the Derivatives Contract may have been entered into on the Client's instructions.

2.3 Obligations of Client owed to Berndale

On execution of a transaction in an ASX Derivative Product by the Broker on behalf of the Client, the Client owes obligations to Berndale in relation to that ASX Derivative Product including the obligations set out in this agreement.

Where the client owes an obligation to deliver funds, security or information to Berndale that obligations will not be satisfied by delivery to the Broker.

2.4 Rights of Client [ACH Minimum Term 4]

The Client acknowledges that any benefit or right obtained by Berndale upon registration of a Derivatives Contract with ACH by novation of a contract under the ACH Clearing Rules or any other legal result of registration is personal to Berndale and the benefit of that benefit, right or legal result does not pass to the Client. The Client has no rights, whether by way of subrogation or otherwise, against ASX or ACH in relation to any transactions by Berndale (or the Broker or any other Participant of ASX Group) in any Derivatives Contract.

2.5 ...

365 Under cl 3 of the agreement, How Trading and Berndale agreed that the terms of the relationship and any dealings between them concerning derivatives contracts were subject to, and they agreed to be bound by, the Corporations Act 2001 (Cth), the ASX Market Rules, the ACH Clearing Rules and the procedures, customs and practices of the ASX and ACH.

366 Clause 4.1 authorised Berndale to call for payment of money or provision of security which it considered, in its absolute discretion, appropriate in connection with the obligations incurred by it in respect of derivative contracts entered into for the account of How Trading. The time by which How Trading was required to pay any amount or provide security was of the essence. How Trading was required to pay the amounts or provide the security within 24 hours of the call for payment.

367 The default powers are to be found in cl 6.4 which provided:

If:

(a) the Client fails to pay, or provide security for, amounts payable to Berndale or fails to perform any obligation arising pursuant to the exercise or settlement of a derivatives Contract;

...

Berndale may, in addition to any other rights which it may have against the Client, without giving prior notice to the Client, take any action, or refrain from taking action, which it considers reasonable in the circumstances in connection with Derivatives Contracts registered in the Client Account or otherwise entered into for the account of the Client (including, without limitation, Derivative Contracts arising from those contracts) and, without limitation, Berndale may:

(j) enter into one or more transactions to effect the close out of one or more Derivatives Contracts in accordance with the ACH Clearing Rules;

(k) exercise one or more Derivatives Contracts in accordance with the ACH Clearing Rules;

(l) take such other action as a reasonably prudent broker would take in the circumstances to protect the personal obligation of Berndale incurred when dealing on behalf of the Client;

(m) sell or cause to be sold:

(i) any or all of the Client's property, including any security lodged with Berndale (whether the property or security had been lodged with Berndale in connection with this agreement or for any other reason) or held by Berndale or its related bodies corporate on behalf of the Client; and

(ii) any financial products held by Berndale in an account for the Client or otherwise held;

(n) exercise any other power, right or remedy which Berndale may have under this agreement or in law or equity;

(o) exercise or cause to be exercised any other rights conferred by the ASX Market Rules, the ACH Clearing Rules or this agreement or perform any other obligations arising under the ASX Market Rules, the ACH Clearing Rules or this agreement in respect of any Derivatives Contracts or Derivatives Transactions;

(p) charge an administration fee calculated by reference to the additional cost which may be incurred by Berndale as a result of the default;

(q) levy a default charge on the amount of up to 15% per annum;

(r) apply any cash held by Berndale or the Broker on the Client's account or to which they have access, or payments received from the Client or in reduction of the Client's liability to Berndale; or

(s) instruct the Broker to cancel any of the Client's unexecuted orders,

and the Client must account to Berndale as if those actions were taken on the instructions of the Client and, without limitation, is liable for any deficiency and is entitled to any surplus which may result.

In relation to any of the rights exercisable for the benefit of Berndale in the event of a default, the Client authorises Berndale and each of its directors and employees as the Client's attorney to give instructions on behalf of the Client in respect of the Client's holdings of financial products sponsored on behalf of the Client in respect of the Client's holdings of financial products sponsored by Berndale or the Broker in CHESS, or held by their related bodies corporate in nominee holdings, and in respect of call deposit facilities or cash management trust accounts on which they are authorised to give instructions, to enable Berndale to realise those financial products or funds and apply the proceeds in reduction of the Client's liability to Berndale and to recover Berndale's costs in so acting.

The Client must pay or reimburse Berndale any such administration fees and default charges (together with any GST payable on those amounts) immediately upon demand or at Berndale's option it may deduct such administration fees and default charges (and any GST) from any proceeds of sale, or proceeds from the close out or exercise of rights in relation to a Derivatives Contract, or other amounts otherwise payable to the Client.[78]

368 Under cl 11, How Trading agreed to indemnify Berndale from all claims, losses, liabilities, damages and costs (including legal costs on a solicitor and client basis) whatever and however arising, suffered or incurred by Berndale directly or indirectly arising out of, or in connection with:

(b) any failure by [How Trading] to strictly comply with this agreement; or

369 Under cl 12 How Trading and Berndale were entitled to terminate the agreement at any time by giving notice in writing to the other. Termination was effective upon receipt of the notice by the other party. As to the effect of termination, cl 12.2 provided:

Termination does not affect the existing rights and obligations of the Client or Berndale at or prior to termination. Upon termination of this agreement, Berndale will close out all Derivatives Contracts held by Berndale for the account of the Client, unless, in accordance with a direction from the Client, the registration of those contracts are transferred to another Participation in accordance with the ASX Market Rules or ACH Clearing Rules.

370 The applicable principles of construction of agreements are well understood. They were not in dispute. The agreement must be construed as a whole. In the present case, the agreement incorporates an obligation to be bound by the Corporations Act, Market Rules, Clearing Rules and the procedures, customs and practices of the ASX and ACH. When construing the agreement the court should consider what a reasonable person would understand by the language of the agreement, having regard to the text of the document as a whole, the surrounding circumstances known to the parties and the purpose and object of the transaction.[79] The court should have regard to all the words used in the agreement "so as to render them all harmonious with one another"[80] and to ensure the "congruent operation of the various components as a whole".[81] Commercial agreements should be given a commercially sensible construction.[82] A common sense, non-technical approach is to be adopted in the construction of commercial contracts. There is also a presumption that the parties do not intend the agreement to achieve an unreasonable outcome.

371 The principles applicable to the implication of a term into a contract were not in dispute. In BP Refinery (Westernport) Pty Ltd v Shire of Hastings,[83] the Privy Council identified the following conditions which must be satisfied if a term is to be implied into a contract:

(1) It must be reasonable and equitable; (2) It must be necessary to give business efficacy to the contract, so that no term will be implied if the contract is effective without it; (3) It must be so obvious that "it goes without saying"; (4) It must be capable of clear expression; (5) It must not contradict any express term of the contract.

372 The defendants do not allege a breach of a duty of care sounding in damages. A contractual duty to act reasonably is only expressly mentioned in cl 6.4(l). If an obligation of good faith was to be imposed on Berndale, it arises from the contractual relationship between the parties.

373 The learned authors of Contract Law in Australia[84] express the view that the implication of an independent term requiring good faith is unnecessary. They have argued that Australian contract law is rapidly moving towards three propositions.

(1) In most contracts (perhaps all contracts) a requirement of good faith must be implied, at least in connection with termination pursuant to an express term of the contract, but perhaps more generally.

(2) Where it is present, the source of the implied requirement of good faith is an implied term of the contract.

(3) The implied requirement of good faith is satisfied by a party who has acted honestly and reasonably.[85]

Our view is that good faith is not an independent concept so much as something which is inherent in contract law itself and therefore a concept which must be taken into account when interpreting a contract, determining the scope of contractual rights and so on. Good faith informs all of contract law and if a particular rule or principle is not producing results which are consistent with our current understanding of good faith, then there is something wrong with the rule or principle.

The most important device for ensuring that god faith considerations are upheld in the application of contract rules and principles to particular contracts is "commercial construction". The recent cases rely heavily on the implication of a term of good faith, but in our view the better approach is to give effect to the intention of the parties. Properly applied, commercial construction will achieve a result which is consistent with the underlying requirement of good faith. It is, moreover, a technique that has been in use for some time. It usually makes recourse to term implication quite unnecessary. Although this is not simply a disagreement with methodology, the fact that the wrong methodology has been employed has led to the implication of a requirement of good faith having a content which is far too onerous and is, indeed, inconsistent with key features of contract itself.

Every aspect of contract law is, or should be, consistent with good faith because good faith is the essence of contract. On that basis, illustrations of good faith in contract are infinite. One criticism of the recent cases is their failure to acknowledge the good faith element of contract rules. Although it has sometimes been recognised that many rules of contract law give expression to ideas that can only be explained in terms of good faith, the implications of this may not have been fully understood or appreciated in the recent Australian cases.[86]

375 The defendants submitted that the default powers in cl 6.4 and the circumstances in which they may be exercised, imposed a duty of good faith on Berndale to exercise those powers honestly and reasonably. That duty required conduct that was objectively reasonable.

376 Berndale relied on the judgment of Buchanan JA, with whom Warren CJ and Osborn AJA agreed, in Esso Australia Resources Pty Ltd v Southern Pacific Petroleum NL[87] where his Honour said,

Counsel for Esso submitted that SPP was bound to exercise good faith in assigning its interest in the joint venture agreement because "an additional term implied by law into commercial contracts is a term requiring the exercise of good faith in the performance of the contract".[88] The argument appeared to run that as this was a commercial contract, an obligation of good faith attended the exercise of every right and power conferred by the contract, including the power of assignment contained in article 24.01(a).

Esso's case was advanced on the basis that an obligation of good faith qualified the power or right of assignment conferred by article 24.01(a), so that "cynical resort to the black letter"[89] of the contractual provision was necessarily a breach of contract. At trial Esso contended that the linking of SPP and SPV as related corporations for the sole purpose of denying Esso the power of vetoing the assignment of SPP's interest in the joint venture displayed a want of good faith. In my view the abandonment of that approach was correct. It is difficult to discern a want of good faith in the exercise of a power which can serve only the interests of the party upon whom the power is conferred. The ostensible purpose of the exercise of such a power will almost invariably be its true purpose. The power may be contrasted with a power expressed in general terms in a contract, such as a partnership agreement, which is concerned with co-operation to produce a result beneficial to all the parties to the agreement.[90]

In Metropolitan Life Insurance Co. v. RPR Nabisco Inc.[91] Judge Walker said:

"In other words, the implied covenant will only aid and further the explicit terms of the agreement and will never impose an obligation which would be inconsistent with other terms of the contractual relationship .... Viewed another way, the implied covenant of good faith is breached only when one party seeks to prevent the contract's performance or to withhold its benefits .... As a result, it thus ensures that parties to a contract perform the substantive, bargained-for terms of their agreement."

If a contractual right or power, which is intended to advance only the interests of the party on whom it is conferred, is fettered by an implied obligation of good faith, resort to the duty may become an obstacle to the promotion of that party's legitimate interests.[92]

I am reluctant to conclude that commercial contracts are a class of contracts carrying an implied term of good faith as a legal incident[93], so that an obligation of good faith applies indiscriminately to all the rights and power conferred by a commercial contract. It may, however, be appropriate in a particular case to import such an obligation to protect a vulnerable party from exploitive conduct which subverts the original purpose for which the contract was made. Implication in this fashion is perhaps ad hoc implication meeting the tests laid down in BP Refinery (Westernport) Pty. Ltd. v. Shire of Hastings[94], rather than implication as a matter of law creating a legal incident of contracts of a certain type.

377 The Chief Justice added the following observation,[95]

There has also been consideration of the capacity of a contractual party to look after itself and its own interests rather than turn to concepts of good faith for relief.[96] These approaches, more aptly described as judicial reticence, regarding the application of the doctrine of good faith, may be construed as hesitation at the courts' involvement in contractual performance. If a duty of good faith exists, it really means that there is a standard of contractual conduct that should be met. The difficulty is that the standard is nebulous. Therefore, the current reticence attending the application and recognition of a duty of good faith probably lies as much with the vagueness and imprecision inherent in defining commercial morality. The modern law of contract has developed on the premise of achieving certainty in commerce. If good faith is not readily capable of definition then that certainty is undermined. It might be that a duty of good faith is no more than a duty to act reasonably in performance and enforcement, a long established duty.[97] Of course, some commentators have regarded the duty to act reasonably as properly subsumed within the duty of good faith.[98]

378 Berndale emphasised the reluctance of the court to imply a term of good faith. The court in Esso Australia acknowledged, however, that in a particular case it may be appropriate to import such an obligation to protect a vulnerable party. In my opinion the particular relationship created by the Derivatives Client Agreement creates such an obligation when Berndale is exercising its default powers.

379 Norris Smith was How Trading's broker, not Berndale. Berndale had contracted to provide a clearing facility under which it would earn a fee by fulfilling the clearing function. Berndale became liable as principal under each contract. It did not receive instructions from How Trading or Mr Waterhouse, but was a necessary participant in the trading activity undertaken by Norris Smith on instructions from Mr Waterhouse. It was only when a client terminated the agreement or upon an event of default that a clearing participant had occasion to deal with the client's account or individual contracts. In the absence of some instruction to Norris Smith refusing to deal in or limit dealings in contracts for How Trading, Berndale's clearing role, while essential, was at arms length from How Trading. The nature of the contractual or other duties imposed on a broker or clearing participant, when exercising default powers, will necessarily be informed by the circumstances and the manner in which the power may be exercised, as well as the possible outcomes.

380 In some respects the default power may be likened to a mortgagee's power of sale. There are, however, material differences. The mortgagee of land exercising a power of sale will ordinarily sell land encumbered by secured advances. The land may be worth far more than the debt. There are established practices when it comes to selling land of a particular type, including accepted marketing strategies.[99] The market for land is relatively stable. The item for sale is real property involving a conveyance of title and commanding a price. The sale of securities by a mortgagee will involve different considerations, as will the sale of a futures contract by a broker following default by a client. An important feature of the analysis of this case is the nature of the thing to be dealt with under the default power.

381 The defendants adopted the language of "liquidation" when advancing their case as to what should have been done with the How Trading portfolio following default on 11 January 2008. Liquidation, as a description, is apt only if it is understood that the portfolio did not contain assets or things which could readily be sold to repay the creditor. The account was comprised of open contracts under which, for the most part, third parties had rights to require the ACH to settle the purchase of designated stock in the future at a strike price. In a falling market, the prospect of sold put options being "in the money" increased. That is, it became more likely that the strike price would exceed the market price for the stock, thus exposing the ACH, as counter party, to the theoretical risk that it would be required to settle the purchase of stock at above market prices. To liquidate the portfolio would involve a cost. The only question was how much.

382 I was told that the possibility of a put option being exercised was remote because the exposure would almost certainly be closed out by the purchase of a corresponding and opposite position. The anticipated loss would be crystallised in the price paid for the opposite position. An assessment of the likely cost (if there was a cost) of closing out or neutralising positions was an important element of the assessment made by the ACH of the value of the portfolio, its margin requirements and consequentially, the margin call by Berndale on How Trading.

383 Ordinarily, a trader such as How Trading would arrange for a credit facility and/or provide security to the clearing participant, such as Berndale and the ACH or both to satisfy margin calls. An unusual feature of this case was that until the guarantees were provided pursuant to the December agreement, Berndale had nothing by way of security. Even after 5 December 2007, Berndale's security fell short of margin requirements.

384 If a trader, such as How Trading, defaulted under its margin obligations, a clearing participant, such as Berndale, might take control of the account with the object of reducing the margin to within an acceptable level, whereupon control might revert to a client. The relationship between the parties might even resume normality. Another possibility is the liquidation of the portfolio in its entirety by closing out all positions in the market or arranging for an auction of the portfolio. That would have the effect of eliminating all exposure of the clearing participant under each contract. That is what the defendants meant by "liquidation" and it was so understood by Berndale.

385 Under cl 6.4 of the agreement, Berndale was provided with a range of broad powers to deal with the contracts in the account. The general power is worth repeating -

Berndale may, in addition to any other rights which it may have against the Client, without giving prior notice to the Client, take any action, or refrain from taking action, which it considers reasonable in the circumstances in connection with Derivatives Contracts registered in the Client Account or otherwise entered into for the account of the Client (including, without limitation, Derivatives Contracts arising from those contracts) and, without limitation, Berndale may...[100]

386 The default powers do not expressly require agreement or consultation with the client. There is no time period stipulated within which action must be taken. There is no prescribed process that must be undertaken. The general power might be interpreted as an attempt to give Berndale significant freedom and flexibility to act in its own interests to reduce its personal exposure under the contracts. So stated, the scope of the power may seem a natural reflection of Berndale's personal liability, a defaulting client, the fact that the contracts are negotiated in a frequently volatile market and the coincidence between Berndale's interest in reducing its own exposure and the client's interest in reducing the consequential liability.

387 It was not submitted by Berndale that the general power was entirely unfettered, although it denied any obligation to exercise the power in good faith. While the defendants did not expressly allege an absence of good faith, they did allege an incident of such a duty - to act reasonably. The defendants also contended for a construction that required Berndale to close out contracts at a particular time so as to minimise cost and maximise profit.

388 As a matter of construction, I do not regard the general introductory words as intended by the parties to prescribe the manner in which Berndale was to undertake liquidation actions. For example, having decided to close out transactions or to "take such other action", was Berndale at liberty to close out at any price or in any manner or at any time of its choosing; or if having decided to auction a portfolio, was Berndale at liberty to do anything it liked with the portfolio in order to make it most attractive to potential bidders?

389 The general words authorise the taking of action. A range of contemplated actions and powers is set out in paragraphs (j) to (s) and includes liquidation actions [(j) - (l), (o) and (s)]; security realisation actions [(m)]; the charging of fees and interest and the application of funds [(p), (q) and (r)] and a miscellaneous power [(n)]. The range of actions and powers is so specific and complete as to leave little or no work for the general introductory words.

390 I do not regard the general words as having been intended to qualify any limitations inherent in the prescribed powers, such as in cl 6.4(l), by eliminating the requirement of objective reasonableness; or so as to permit Berndale to charge more than 15 per cent interest. Furthermore, while the general words speak of "taking any action", the specific range of actions and powers extends beyond the concept of actions. There is a conceptual mismatch which also leads to the conclusion that the general words should not override or have the effect of removing any limitation embedded with a specific power.

391 In any event, the contract has conferred specific powers to cancel transactions, close out positions, exercise contracts and "take such other action as a reasonably prudent broker would take". Thus, it is not necessary, for the purposes of this case, to look beyond that range of actions.

392 Option Investments (Aust) Pty Ltd v Martin[101] provides some guidance as to what limitations might be imposed on the manner in which a broker takes default actions. In that case the plaintiff, a futures broker, became entitled to close out a client's positions following default. The broker delayed about four months in a falling market before closing out the positions. The client (defendant) alleged that upon default the broker became bound to sell forthwith, or at least came under a duty to exercise care to make a reasonable sale having regard to the client's interests. Lush J found no contractual obligation to sell forthwith. His Honour observed:

Against this background, the giving of authority to a broker to close out his client's open positions upon default in meeting a margins request appears clearly as a right in the nature of security given to the broker to protect himself against liability or loss. It is, in fact, a power of sale given as security to the broker as an actual or contingent creditor of the client.

... Evidence was led by the defence that the usual and "prudent" course for a broker to take when a margin call was not met was to close out the account immediately. This evidence was far from establishing a usage which could become a term of the contract, and it was not in fact led for that purpose, but rather in support of an allegation of negligence. No doubt in most situations it would be a prudent course for the broker to take in his own interests, but that is not to say that he is under an obligation to his client to take it.

The defence and counterclaim must therefore fail so far as they are based upon breach of contract.

This, however, does not end the matter. The exercise of a power of sale is subject to safeguards imposed by law, I am not aware of authorities which deal with situations comparable with the present, but I had myself occasion to consider authorities on sales by mortgagees in Henry Roach (Petroleum) Pty Ltd v Credit House (Vic) Pty Ltd [1976] VicRp 26; [1976] VR 309.

On principle_,_ the broker who closes out must be under a duty to sell in good faith: in most cases sale on an open exchange will satisfy this requirement. Since he sells for the protection of his own interest he is entitled to select the time of sale unless he is otherwise contractually bound. He is bound to have regard in making the sale to the client's interest and may be under a duty to exercise care for the protection of the client's interest. Both these concepts must be understood in the light of the fact that the broker has the power for the protection of his own interest. In any case I do not find it easy to give practical content to these last stated principles in a situation where the broker has the right to choose the time of sale and sells through an open exchange. This difficulty is in no way reduced by the consideration that, so far as I can see, the client can order the broker to sell in any interval between default in providing the margin and sale by the broker. This view seems to be consistent with what happened in Hogan v Shaw, supra, and while I can see for myself no reason why the client could not do so, I should add that the matter has not been argued in the present case.

Accordingly, in my opinion the defendant here cannot make a case of failure to regard his interest, or of negligence in the conduct of the sale, by reference to delay alone.[102]

393 The relationship between the client and broker in Option Investments had many of the same characteristics as the relationship between Berndale and How Trading, although it more closely resembled the relationship between How Trading and Norris Smith. Relevant similarities include the liability of Berndale as principal, the fact that the default power may require action in volatile market conditions, the existence of a broad general power of sale (or liquidation), a client in default and a presumption that the broker's interests coincide with the clients in minimising exposure and viability. There were, however, differences. Berndale was not the broker, took no instructions and provided no advice. It was introduced into the relationship as a necessary participant in the settlement of transactions required under the Rules. Berndale had, however, been an active participant in the composition of the portfolio. It was aware of the nature of the portfolio, each contract and the associated risks. It well knew that the portfolio was unhedged.

394 In Dalton v AML Finance Corporation Ltd[103] a broker made a call for payment of a margin which the client failed to meet whereupon the broker sold contracts at a loss. The relevant part of the proceeding concerned a counterclaim by the broker against the client based on a right of indemnity for the loss which it had sustained on selling the contracts. The client alleged that, by his having repudiated the contract between them, the broker became obliged to sell the contracts immediately. Presumably, if the contracts had then been sold the loss would have been less. Rogers J held that there was no implied obligation on the broker to sell futures contracts as soon as repudiation took place, nor did any such obligation arise as a matter of construction from the terms of the contract.

395 The material characteristics of the relationship in that case are essentially the same as in Option Investments. In relevant respects they are sufficiently similar to the facts of the present case to make the observations of Rogers J pertinent. His Honour said, after considering some English authorities in relation to the operation of the Cocoa Futures Market in London,

On any view, a broker on the Sydney Futures Exchange contracts a personal obligation. The necessary corollary is that he may have to take action in relation to his client to protect his own position. The Clearing House may at any time make a margin call on the broker, which he has to satisfy the same day. In order to safeguard his own position, he may have to make a call on his client, either in anticipation of a call being made on him by the Clearing House or after such a call was made. In the result, an adversary relationship may well arise between the broker and his client, which is somewhat unusual in a relationship of principal and agent. When one adds to these considerations the fact that the parties are dealing with an extremely volatile market, it must be self-evident that a broker must be given a great deal of freedom of movement in determining when and in what amount he should make a margin call, and whether or not upon failure to meet a margin call he should close out a contract then and there or whether his interests are better served by postponing the sale. In my view, similarly, he must have the same freedom of decision in determining whether to accept a repudiation of the contract entered into by the client and in effecting a sale of the futures contract as a result of any such repudiation.[104]

396 Rogers J adopted and applied the decision of Lush J in Option Investments. In conclusion, his Honour said:

I acknowledge that it is an unfortunate corollary of the view which I have expressed that if the broker makes the wrong decision as to the time to close out the contracts, the victim of the error of judgment will be the client. As matters stand, I consider that must be accepted as one of the risks of entering into futures contracts in the absence of additional rules governing the broker/client relationship.[105]

397 Insofar as the defendants' breach of contract case depended upon the construction contended for in paragraph 5 or the implied term contended for in paragraph 6, I reject the construction and the corresponding implied term. Such a construction or implied term seeks to impose on Berndale affirmative obligations to take particular action, and to take that action in a particular manner, at a particular time and with a particular outcome. In other words, Berndale was contractually obliged to make correct decisions advantageous to the client. Such obligations are inconsistent with the express terms of the contract; neither are they necessary to provide reasonable protection to How Trading when most vulnerable. There is no place for hindsight as a device to determine what should have been done and when, or to give content to a duty to act reasonably.

398 The introduction by the defendants of the notion of an overriding obligation to act reasonably was designed to reach the same outcome as the pleaded breaches, namely, that Berndale was disqualified from claiming more than the value of the portfolio on 14 January 2008. The defendants accepted that Berndale was entitled to act to protect its own interests. Clause 6.4(1) expressly so provides.

399 The formulation of the express power in cl 6.4(l) may resemble the test formulated by Lush J in Option Investments and applied in Dalton, if what is meant by "reasonably prudent broker" is one who is acting in good faith, having regard to the interests of the client, but who ultimately acts to protect its own interests. After all, a broker who acts reasonably to reduce or minimise its own exposure under contract will also protect the interests of the client. Such a duty does not presuppose that a broker is under an obligation to take any particular course of action. In a volatile market, reasonable brokers may differ as to the strategy to adopt to reduce their own exposure. The community of interests between client and broker, the volatility of the market in which they are both exposed and the premise to the exercise of the power - a defaulting client - justify a great deal of freedom in deciding how to deal with the portfolio.

400 There can be no doubt that the exercise of the default powers under the Derivatives Client Agreement may have a significant adverse impact on the client. At the very least it will crystallise their liability to the broker. The conduct of the broker may be extremely detrimental to the interests of the client. While the clients risk of loss following default may be an anticipated incident of the relationship, there is no reason in principle why a broker should be at liberty to disregard the interests of its client. The wholly subjective test advanced by Berndale rejects any obligation to act in good faith or reasonably.

401 The exercise of default powers, such as those under cl 6.4 of the Derivatives Client Agreement, is the very circumstance in which a duty of good faith will readily be imported into a contractual relationship. To recognise such an obligation does not subvert the original purpose for which the contract was made or the power conferred under cl 6.4, if the content of the obligation goes no further than to require Berndale to have regard to the interests of its client and to act honestly and reasonably. There is no inconsistency because the agreement does not attempt to define the manner in which the power may be exercised; nor was there any attempt to exclude any such obligation.

402 When the broker takes control of the portfolio, purporting to exercise default power, the client is entirely in the broker's hands. While their fortunes are connected, due to the primary liability of the broker, the parties to the contract must have intended that when exercising the default powers, Berndale would at least have regard to the interests of the client - while seeking to protect its own position - which readily translates into an obligation to act with honesty and objective reasonableness. The defendants did not allege that Berndale acted dishonestly. They submitted that Messrs Ryan and Craft were incompetent, engaging in needless and expensive hedging of the portfolio which delayed that which ought to have been achieved within a few days.

403 It will only be in the most unusual circumstances that a broker who liquidates a contract or portfolio in the market, will be found to have acted unreasonably. Such circumstances would almost certainly disclose a disregard of the interests of the client. To disregard a client's interests would almost certainly fall short of that expected of a reasonably prudent broker, acting in its own best interests. It might be described as aberrant or incompetent behaviour. It may even fall short of a subjective test of reasonableness.

404 The shift in the defendants' case, from its focus on an obligation to undertake defined action to concentrate on breach of the objective standard of reasonableness, redirected its attention to an attack on the conduct of Messrs Ryan and Craft as incompetent and out of their depth when purporting to exercise the default powers. The defendants submitted that the evidence disclosed that Messrs Ryan and Craft were entirely preoccupied with what they perceived to be the "risk" attaching to the How Trading account, and that preoccupation dictated their determination to expend substantial sums in endeavours to hedge that account, rather than getting on with the job of liquidating the portfolio. They submitted that the evidence demonstrated that neither Mr Ryan nor Mr Craft had any appreciation of what they should have done to bring about a timely and efficient liquidation. By their approach, the defendants recognised that, in the absence of fiduciary obligations or a general duty of care, it was necessary to explain why Berndale did not act in its own best interests.

405 Should it be found that Berndale breached its duty to How Trading because the action taken was not authorised or because Berndale acted unreasonably when taking action, Berndale should not be entitled to debit the account of How Trading with the cost of that action. The Derivatives Client Agreement does not contain any provision which requires How Trading to pay Berndale any amount Berndale may claim. The amount which Berndale might properly claim under cl 6.4 is an amount properly incurred. Put another way, if, in purported exercise of the default power, Berndale had breached its duty to How Trading, Berndale would not be entitled to look to How Trading for the loss Berndale might have sustained. If necessary, a term would be implied so as to limit Berndale's entitlement to call for payment to only so much of the account as represents costs and expenses incurred by it in the proper exercise of the default power. To the extent that Berndale was confined to a claim for damages, the component of its claim, represented by costs improperly incurred, could not be said to have been a loss caused by a breach of How Trading.

406 In addition to their allegation that Berndale's failure to close out the short sales and the XJO puts on 22 January 2008 were in breach of contract, How Trading alleged that Berndale was required, as How Trading's agent, to maximise profits and to account to How Trading for the maximum profit which How Trading would have prudently derived. The fiduciary duty case is not easily distinguished from the breach of contract case as pleaded. The fiduciary duty seems to depend upon the facts alleged in paragraphs 11 to 22 of the defence and counterclaim.

407 Having identified the hypothetical profits of $4,267,775 (the amount that ought to have been derived from closing out the short sales on 22 January 2008) and $1,397,500 (the amount that ought to have been derived from selling the XJO puts on the same day), the defendants allege,

1. Further, in its purported exercise of the rights conferred on it by clause 6.4 of the Agreement on and following 14 January 2008, Berndale has acted as the agent of How Trading and has thus owed fiduciary duties to it.
2. By reason of the matter stated in paragraph 23 above, in any determination of How Trading's liability to Berndale under the Agreement Berndale is obliged to provide full credit to How Trading for the maximum profit which How Trading would have prudently derived from the short sales effected by Berndale as its agent on 14 and 17 January 2008, being the profit stated in paragraph 21 above.

408 The hypothetical profits and the actual profits derived from the transactions are employed as part of the defendants' calculation to arrive at the quantum of damages under each alternative formulation set out above. In my opinion the relationship between Berndale and How Trading did not give rise to a fiduciary duty on the part of Berndale owed to How Trading. Nor do the facts alleged - principally the short sales and the purchase of XJO puts - change that position.

409 The critical features of a fiduciary relationship, as stated by Mason J in Hospital Products limited v United States Surgical Corporation & Ors[106] is that,

the fiduciary undertakes or agrees to act for or on behalf of or in the interests of another person in the exercise of a power or discretion which will affect the interest of that other person in a legal or practical sense. The relationship between the parties is therefore one which gives the fiduciary a special opportunity to exercise the power or discretion to the detriment of that other person who is accordingly vulnerable to abuse by the fiduciary of this position. The expression "for, "on behalf of", and "in the interests of" signify that the fiduciary acts in a "representative" character in the exercise of his responsibility...

That contractual and fiduciary relationships may co-exist between the same parties has never been doubted. Indeed, the existence of a basic contractual relationships has in many situations provided a foundation for the erection of a fiduciary relationship. In these situations it is the contractual foundation which is all important because it is the contract that regulates the basic rights and liabilities of the parties. The fiduciary relationship, if it is to exist at all, must accommodate itself to the terms of the contract so that it is consistent with, and conforms to, them. The fiduciary relationship cannot be superimposed upon the contract in such a way as to alter the operation which the contract was intended to have according to its true construction...

410 In Pilmer v Duke Group Ltd (in liq) McHugh, Gummow, Hayne and Callinan JJ highlighted the distinct character of a fiduciary obligation, which sets it apart from contract and tort. Quoting with approval from the judgment of McLachlin J in Norberg v Wynrib,[107] their Honours said,

The foundation and ambit of the fiduciary obligation are conceptually distinct from the foundation and ambit of contract and tort. Sometimes the doctrines may overlap in their application, but that does not destroy their conceptual and functional uniqueness. In negligence and contract the parties are taken to be independent and equal actors, concerned primarily with their own self-interest. Consequently, the law seeks a balance between enforcing obligations by awarding compensation when those obligations are breached, and preserving optimum freedom for those involved in the relationship in question. The essence of a fiduciary relationship, by contrast, is that one party exercises power on behalf of another and pledges himself or herself to act in the best interests of the other.

411 To attract fiduciary obligations, Berndale must have,

(1) bound itself in some way to protect or advance the interests of How Trading;

(2) in the exercise of a power or discretion which would affect How Trading's interests in a legal or practical sense;

(3) such that Berndale had a special opportunity to exercise the power or discretion to the detriment of How Trading who is accordingly vulnerable to abuse by Berndale of its position.

412 In the ordinary course of their relationship, Berndale acted as How Trading's agent for the purpose of clearing trades it had executed through Norris Smith. It is doubtful that in so doing it attracted any duty, fiduciary or otherwise, that might attach to a broker providing advice and effecting trades. Whatever may be the position during day to day trading, once How Trading had defaulted the relationship changed. While Berndale owed a duty of good faith - to have regard to the interests of How Trading and to act honestly and reasonably - it had no obligation to protect or advance the interests of How Trading over its own. Actions taken by it were not as agent for How Trading. The relationship had an adversarial quality. Berndale was entitled to act to protect its own interests.

413 The defendants relied on the agency relationship to also complain about the legality of the futures trading undertaken by Merrill Lynch after Berndale took control of the portfolio. They submitted that an account had been improperly opened when not authorised by How Trading. That submission exposed the fundamental flaw in this part of the defendants' case. Merrill Lynch was not purporting to act as agent for How Trading. It was acting in its own interests when trading on the account.

414 During pre-default day to day trading, all trades were initiated on the instructions of Mr Waterhouse to Norris Smith. As stated by Lush J in Option Investments,[108]

a broker's duty is to execute the order which his client gives him ... The relationship has fiduciary aspects relating to moneys and securities held by the broker, but otherwise the broker's duty is to execute orders. The content of the broker-client relationships may, of course, be added to or varied by special agreement.

Berndale was never How Trading's broker in the sense considered by Lush J. It was the clearing participant.

The liberty to make some business decisions by reference to its own interests... presents an overwhelming obstacle to the existence of the comprehensive fiduciary relationship. This is because [H.P.I's] capacity to make decision and take action in some matters by reference to its own interests is inconsistent with the existence of a general fiduciary relationship.[109]

416 The contractual default powers given to Berndale were intended to permit it to protect its own interests. The exercise of the default powers had the consequence that an "adversary relationship" arose.[110] It is the antithesis of a fiduciary relationship.

417 In any event, the particular duties the defendants assert arise from the agency relationship are positive legal obligations to close transactions at a particular time because it would be most beneficial to How Trading. There is an element of hindsight embedded in the obligation, feeding off the historical data concerning market conditions on 22 January 2008. Such an obligation is inconsistent with the exercise of default powers under the Derivatives Client Agreement. Moreover, in Breen v Williams[111] Gaudron and McHugh JJ said:

In this country, fiduciary obligations arise because a person has come under an obligation to act in another's interests. As a result, equity imposes on the fiduciary proscriptive obligations - not to obtain any unauthorised benefit from the relationship and not to be in a position of conflict. If these obligations are breached, the fiduciary must account for any profits and make good any losses arising from the breach. But the law of this country does not otherwise impose positive legal duties on the fiduciary to act in the interests of the person to whom the duty is owed.

418 The fiduciary duty alleged by the defendants and the corresponding obligation to account is coupled with the alleged contractual obligations to contend that Berndale's failure to close out the short sales and XJO futures on 22 January 2008 was in breach of the duties. I have already found that the construction and implied term contended for by the defendants are inconsistent with the powers actually conferred on Berndale under the contract. Berndale was not under any such duty to close out the short sales or the XJO contracts on 22 January 2008, and was not required to account to How Trading for any profit, actual or notional, by reason of a fiduciary obligation. Consequently, there was no occasion to include the hypothetical profits within a claim for damages.

419 It was not suggested by the defendants that Berndale should have allowed the options to expire or be exercised. It was common ground that on 14 January and in the following week there was a market in which the open contracts could have been closed out. While the defendants submitted that the portfolio should have been closed out on and within a few days of 14 January 2008, they did not argue that it should have been auctioned immediately.

420 An auction was available in approved circumstances to attract offers from bidders who might be in a position to profit from the premium paid by the seller to induce the buyer to accept the risk under the open contracts. The particular circumstances of a buyer would dictate the value to it of the portfolio. Much would depend upon the composition of any open positions offered by the buyer or other components of the portfolio of securities on offer.

421 Mr Ryan and Mr Craft claimed responsibility for designing and implementing the Merrill Lynch strategy to unwind the portfolio. They took control of the portfolio and dealt with it on and after 14 January 2008. While Berndale was the contracting party under the Derivatives Client Agreement, it was Merrill Lynch employees who exercised the default powers under cl 6.4. Berndale is a subsidiary of Merrill Lynch. The defendants did not suggest that there was any impediment to Merrill Lynch employees exercising the default powers under cl 6.4.

422 Mr Ryan's strategy was explained by him in the following terms:[112]

In my opinion the biggest risk of loss to the How Trading account came from the delta exposure. I wanted to remove as much risk from the account as soon as possible. In my opinion, the most prudent thing to do first was to hedge the delta exposure in the portfolio, which would have the effect of neutralising the delta. Once the delta was flattened or neutralised, and the gamma (which caused the large deltas) and vega reduced, the portfolio could then be auctioned. This was the strategy that I developed.

423 Mr Craft said that the strategy he developed in consultation with Mr Ryan was to flatten the delta in the portfolio by trading stocks; reduce the negative gamma of the portfolio by buying back the options with the biggest short gamma, as well as buying index options to offset the short gamma; reduce the Vega of the portfolio to a level which was small enough that Merrill Lynch could auction off the portfolio with minimal market impact; and auction off the remainder of the portfolio in a competitive tender process.

424 Berndale, through its witnesses Messrs Ryan and Craft, firmly committed to a case in which it sought to explain and justify its strategy in terms of the preparation of the portfolio for by auction. Mr Ryan said that he had decided that auction was the best course in late December 2007 or early January 2008, well before assuming control of the portfolio. They ridiculed the defendants' case that all positions should have been closed out immediately by claiming that it was impossible to do so at reasonable prices. Mr Ryan said the price would have been outrageous. The events of the first week were particularly important because it was the defendants' case that the portfolio should have been closed out before the end of that week.

425 Mr Ryan emphasised his objective when he said that he did not consider selling all of How Trading's options on the open market on, or within several days, of 14 January 2008 because to do so would have been impossible at a fair price. He said that if that course of action had have been suggested to him at the time he would have rejected it. Mr Craft also emphasised his purpose when he said that if he could have sold all of the options on the open market for reasonable prices on 14 January, or within several days, he would have. He said that had there been a market for the options at a fair price it would have been the right thing to do. He said that there was no incentive for Berndale not to close down the portfolio in the least expensive and shortest time possible. He said that there was no market for the number of option positions contained the How Trading portfolio.

426 Mr Ryan first became involved with the How Trading portfolio on about 30 November 2007 when he was involved in determining what measures should be taken on behalf of Merrill Lynch to protect its exposure to the portfolio. The measures implemented by him were the Merrill Lynch house trades. Prior to his involvement with the How Trading account, Mr Ryan had never undertaken the liquidation of such a large portfolio.

427 Messrs Ryan and Craft did not adopt the language of liquidation to explain what they did. They preferred the expression, "unwind". Berndale submitted that the liquidation actions of Messrs Ryan and Craft were those of a reasonably prudent broker. Mr Ryan said that he was kept informed about the How Trading account throughout December and into January 2008 prior to default on 11 January 2008. From the information available to him, he concluded that the portfolio was highly exposed to loss because a high proportion of the options had a strike price of 80 per cent, or less, of the spot price for the underlying stock. It was his opinion that the delta exposure was significant and required immediate hedging in an effort to neutralise the deltas before auction. He instructed Mr Craft to "flatten the delta". He worked closely with Mr Craft thereafter and arranged the auction of the portfolio.

428 Mr Craft also became acquainted with the How Trading portfolio in November 2007. He formed the opinion that it was "an incredibly high risk portfolio due to the large delta and negative gamma risks". Mr Craft had been instrumental in the Merrill Lynch house trades, acting on instructions from Mr Ryan. Both Mr Ryan and Mr Craft were poised to take control of the How Trading portfolio throughout December 2007. By reference to his trading note, Mr Craft gave a day-by-day account of his activity in hedging and liquidating option positions. While Mr Craft kept notes of his day to day management of the How Trading portfolio, it was not his usual custom to do so. He kept no such notes of his management of the Lift Capital portfolio.

429 In this part of their case the defendants relied primarily on expert testimony from Mr Semple and Mr Best, together with some evidence from Martin Otto Waterhouse, a cousin of David Waterhouse. The evidence of Martin Waterhouse was limited to his experience in closing out about 970 high priced, long dated put option contracts on 24 January 2008 at a time of high volatility in the market. Berndale relied upon their expert witness Simon John Gibson, in addition to the evidence of Messrs Ryan and Craft.

430 Mr Semple was the Managing Director of Andika Pty Ltd. He had a Bachelor of Applied Science from the University of Southern Queensland, a Bachelor of Commerce from Bond University. He was a Master of Stockbroking, a member of the Securities and Derivatives Industry Association and the Australian Institute of Company Directors. He had more than 10 years' experience as a client adviser with broking firms and was the author of a book, "Options Made Easy".

431 Mr Semple's thesis was that the portfolio could and should have been closed out on and within a few days of 14 January 2008 at an overall cost approximating the ACH valuation of $5,668,001.32. Mr Semple had some experience at liquidating portfolios, although not of the size of the How Trading's portfolio.

432 Mr Best was a principal, and portfolio manager, at KIS Capital Partners. He had obtained accreditation as a "click operator" and completed various other diplomas. He had been a click operator for Tricom Equities from 2003 until 2005.

433 Mr Best had previously provided trading assistance and advice to How Trading. He was critical of the auction process. He expressed the opinion that the portfolio "could and should have been closed down immediately by the buying back of those of the put options which had the most adverse impact on the margin as a first priority and, subsequently, by buying back the balance of the portfolio". He said that the stocks in which the options were written were liquid in mid-January 2008 and that "it should not have taken more than three days to liquidate How Trading's portfolio in this manner and (it) probably could have been achieved within a shorter period of time".

434 Mr Gibson gave evidence on behalf of Berndale. He was a Director of Risk Return Management Pty Ltd, an advisory and consultancy company established in 2006. He had been a derivatives adviser since 1988. He had previously held the position of joint head of equity derivatives with HSBC Securities and prior to that, ANZ McCaughan. He had also been a senior derivatives adviser with Goldman Sachs JBWere and its predecessor firm, JBWere.

435 The experts advanced by the parties, ostensibly to assist the Court according to the expert witness code of conduct, were all advocates in their clients' cause. They each had some previous association with their client although this did not explain the degree of enthusiasm with which Mr Semple and Mr Gibson in particular advanced the party line. They rigidly adhered to their respective theses to the point of absurdity.

436 While each expert made an important contribution to the evidence, Mr Semple and Mr Gibson overlooked any useful analysis of the actual market in the week commencing 14 January. Instead, they made generalisations and speculated about what might have been achieved and at what price.

437 Mr Best fell into a different category. Berndale made a general objection to his evidence. It submitted that his opinions, initially set out in three short witness statements, did not conform with established principles. Berndale submitted that Mr Best was not appropriately qualified, did not identify facts he was asked to assume, or distinguish his investigations from his conclusions and the basis for them.

438 It is true that the statements of Mr Best, adopted by him as his evidence during the trial, did not follow the usual form of identifying specific questions, assumptions and facts otherwise established. Nevertheless, I found his demeanour and evidence refreshingly frank. Although he lacked experience in some areas of options trading, he nevertheless made a number of helpful observations and provided data that went to the heart of an important issue namely, what a broker would have done if setting out to liquidate the How Trading portfolio.

439 The connection that Mr Best previously had with Mr Waterhouse in 2003, relied upon by Berndale to impugn his independence, also gave him an advantage. In late August 2003, he had assisted Mr Waterhouse to buy 30,000 call options positions in a rising market to reduce How Trading's margin from $8 million to $2 million.

440 The nature, content, and value of the portfolio on 14 January 2008 was an important issue in this part of the case. The concepts are obviously interrelated. The defendants' thesis depended upon an examination of those matters. So did Berndale's response. The characteristics of the portfolio were relevant to the defendants because they argued that it could and should have been closed out on and within a few days of 14 January 2008. The characteristics were also at the centre of Berndale's justification for having adopted an auction strategy, and when comparing the Lift Capital portfolio with the How Trading portfolio.

441 The experts were regarded as crucial by the parties on that issue. There was no dispute about the composition of the How Trading portfolio, but little or no common ground between the parties on the value of the portfolio or the availability of a market in which to close out positions. When the parties spoke of a "value" it was not always clear what they meant and whether they meant the same thing. To begin with, the portfolio did not have a positive value as an asset - it was a liability. Valuations were reflected in a negative sum which, to have any meaning, was the approximate cost of closing out the positions. Sometimes a witness spoke of liquidating a portfolio by sale while others assumed that the real transaction involved the purchase of opposite positions.

442 There was disagreement about the nature of the risks and the liquidity of some option positions. At the heart of Berndale's rationale for adopting the auction and hedging strategy, were expressions of concern about the possible, or even likely, behaviour of the market to liquidating such a large portfolio of options. There were differing predictions about volatility and liquidity. The defendants argued that volatility was factored into the ACH valuation. Berndale elevated the significance of volatility as a factor which had an impact on price and liquidity - which as a generalisation was not in dispute - and employed those market characteristics in an attempt to diminish the validity of the ACH valuation. With the exception of some evidence from Mr Gibson and Mr Craft, Berndale did not attempt to attribute any particular value to the portfolio over which it assumed control on 14 January 2008.

443 The How Trading portfolio was comprised of 18,269 open contracts with 116 positions. It was heavily focussed in financial stocks and therefore susceptible to adverse movement and volatility in those stocks. Most of the options were sold put options which exposed How Trading to risk of loss in the event of a price decline in underlying stocks. The portfolio was dissected by Mr Gibson and to some extent by Mr Best, who identified about 2,600 call option contracts which, in a falling market, would expire worthless. There were about 1,000 short dated sold put option contracts, in highly liquid stocks, which were so far out of the money as to be worthless. The balance, Mr Best said, were longer dated sold put options in highly liquid stocks. In his evidence given on the application to reopen, Mr Best went further. Mr Gibson and Mr Ryan had drawn particular attention to "out of the money" How Trading positions to explain the difficulty, if not impossibility, in finding market liquidity. Mr Best analysed what he described as the "problematic positions" to demonstrate that even those positions could have been closed out in the market at or around 14 January 2008, at a price at or around the ACH valuation.

444 The How Trading portfolio was unhedged with the exception of a few NAB option positions. It was not part of the strategy employed by Mr Waterhouse to hedge. Insofar as it is a relevant measure of size or exposure, the notional value of the portfolio in January 2008 was approximately $545 million. By this is meant that if every option was exercised, How Trading would be required to acquire those stocks. The defendants and their experts rejected the relevance of notional value as an indicator of the size or exposure of the portfolio. As a measure, notional value assumed that the options would not expire worthless. While it gives some indication of the size of the portfolio, the notional value is not very helpful. There was an alarmist quality in the way it was employed by Berndale.

445 Mr Gibson employed the notional value of the portfolio to analyse its composition. He said that financial stocks in the portfolio represented 77 per cent of the open positions, meaning that the portfolio was particularly exposed to volatility in the market for financial stocks. He said that about 41 per cent of the options in the portfolio had a duration greater than six months, and 31 per cent had a duration greater than nine months. He described these as longer dated options and observed that in general the market for longer dated options was less liquid. Mr Semple agreed that the market for long dated options more than 20 per cent out of the money often lacked liquidity, but maintained that there was always a market.

446 Mr Ryan described the portfolio on 14 January as comprised of mainly sold put options which were at 80 per cent strike or less. That is, the strike price was 80 per cent or less than the spot price for the underlying stock. He said that the market for such options was less liquid. He said that it would have been "impossible" to close out the positions in the How Trading portfolio, at or even close to, the ACH valuations. He went so far as to say that it was "absolutely impossible" to close out the positions even at a 30 per cent discount, which I interpolate to mean that the cost of buying opposite positions would have been more than 30 per cent over fair valuation. He did not, however, suggest that there was no market in which to acquire such options, although a fair reflection of his evidence was that the price required to buy the positions would be "outrageous". Mr Ryan considered that the biggest risk of loss to the account came from delta exposure. He described the portfolio as "toxic" because of its composition and lack of hedging.

447 It may be accepted that the opinions of reasonably prudent brokers may differ as to the most appropriate approach to the liquidation of a portfolio. But what was initially arresting about Berndale's case was its apparent failure to even consider, as a strategy, the rapid and structured closing out of all positions. Mr Ryan said,

I did not consider selling all of How Trading's put and call options on the open market on or within several days of 14 January2008, because to do so would have been impossible at a fair price. If that course of action had have been suggested to me at the time, I would have rejected it.

448 Mr Semple gave evidence of what, in his opinion, Berndale ought to have done to liquidate the portfolio. He said that he would have assembled a team of two or three click operators and segmented the portfolio into categories to assess the areas of greatest risk. With the market trending down, as it was in January 2008, Mr Semple would have isolated those positions which constituted the greatest risk. After making an assessment of volatility he would have instructed a task force to buy corresponding put options in particular stocks which were more volatile and thus placing greatest pressure on the margin. Mr Semple said that one of the invariable characteristics of the options market in Australia was that options could always be readily bought and sold in stocks that were liquid.

449 Mr Semple said that volatility was "slightly above average" in January 2008. He accepted that high volatility usually resulted in reduced levels of trading and thus liquidity. He said that the market was stable in relative terms in January and expressed the opinion that a task force would not have had difficulty buying back all positions. He said that his team could have bought back the option positions in relation to the more volatile stocks on 15 January at an overall cost of about $3,276,528, which corresponded with the valuation attributed to the positions by the ACH and Berndale on 11 January 2008. He would then liquidate (buy back) the balance of the positions on 16 January, resulting in a total cost of $5,668,001.32. Mr Semple concluded this part of his opinion by stating that:

The strategy which I have outlined above was entirely feasible and capable of implementation within two days in mid January 2008. For that reason, there was no necessity for Berndale to construct any hedges in relation to the How portfolio.

450 Mr Semple said that with one exception, the steps taken by Berndale to liquidate the portfolio were "unnecessary, ill advised and to the very significant financial detriment of How Trading". The one exception was the short sales of stock on 14 January. He had been asked to assume that Berndale had reason to expect the market to fall when the Merrill Lynch Group accounts would be published on 18 January. Mr Semple's approval of this step was based on the further assumption that Berndale should and would have closed out the short sales on 22 January, at the lowest point in the market, thus yielding a profit which would have been enough to reduce How Trading's indebtedness to nil without recourse to the bank guarantee. Thus, Mr Semple's approval of the short sales was predicated on the purpose as a profit-making strategy which was not the purpose advanced by Berndale. Berndale said the purpose was to reduce the market or delta risk. Mr Craft said,

As the market for stocks was liquid, selling stock to reduce the market exposure was the simplest and most obvious thing to do. It was something that could be done with very little if any market impact... In my opinion, reducing the delta risk was a prudent risk-reducing strategy.

Mr Ryan said that the short sale of stock was a hedge and not speculation.

451 The reasons given by Mr Semple for rejecting the Merrill Lynch strategy were as follows:

(1) There was no need to construct the hedges because the whole of the portfolio could have been liquidated within 48 hours;

(2) The only purpose of the hedges was to defer liquidation;

(3) Having constructed the hedges they were irrationally destroyed; and

(4) Immediate risk annihilation is better than hedging at a substantial cost while deferring the risk reduction.

452 Mr Semple's criticisms distil to a rejection of unnecessary hedging cost and delayed completion of the task which he said could and should have been completed within 48 hours. He did not suggest that the hedging strategies as such were misconceived or ineptly executed. Nor did he explain how the hedges had been "irrationally destroyed".

453 According to Mr Semple, Berndale did not act as a reasonably prudent broker because,

when a client is in the position of default, the first thing the broker should be looking to do is to minimise that risk going forward, and the only way to do that to is begin an orderly close out of the positions in question. And that's the basic process that any ASX participant member would look at when a client account is in default. In terms of how this process goes, it's fairly straightforward. All the reports are freely available through the broker. An open positions report of the previous trading day would be provided, that would list all the positions on the client's account. You could then get another report that would list all the margins per security. So for example there's BHP, there might be a lot of options for BHP, but there would be a summary that would say is the premium margin for BHP, and this is the risk margin for BHP, therefore the total margin for BHP would be X, and then that would be summarised for all the other stocks. That's important for the process of a close out because it identifies which position should be looked at first, because you go to the ones that have the biggest risk margin. What that means, Your Honour, is if you are about to close out, you want to start spending the money on where you are going to get the best bang for your buck. Ie, if you buy $100,000 worth of positions back and you manage to get 150,000 back from a risk margin, that's a better way of utilising funds initially to clean the account out. The process itself, on the day, I would probably get two click operators who - qualified operators to assist in the process to make sure we had sufficient time to do it. And based on where the market closed on the Friday, which from memory was about 5981, and from memory we were closed on the Monday, I think it was a one point difference, there wasn't a lot of high volatility in the market at that point in time. Liquidity in the actual options market in January '08 was fairly high, and I believe there's some statements verifying that from the ASX. And I know the volume in dollar terms during January '08 was around the $6.5 billion mark for the day.

454 When explaining why the hedges were not necessary or desirable he said,

Well, again, the first correct step would have been starting an orderly close out of the actual option positions in question. Now, the particular trading day was fairly flat in terms of the price movements of the market. As they started closing out positions they would be derisking the particular portfolio. The only conceivable reason to put into place that hedge would be if they hadn't sufficiently closed down enough positions on that day and they wanted to ensure themselves in case of an adverse price movement overnight. But because you are in play on that day, the session of that day is pretty obvious to everybody in terms of how the market is trading. We haven't had to wake up the next - we haven't had to come to work from the previous night in Wall Street if it dropped by 500 point, we know the next day in the market is going to be fairly difficult. But we had an orderly close on Friday, market again was 5981 from memory. It closed on Monday at 5980, so it was like a one point differential in terms of the market move. So, no, they did not need to go about that sort of short sale on the 14th.

455 Mr Best also expressed an opinion concerning the Merrill Lynch unwind strategy. It was while a principal click operator at Tricom Equities that he assisted How Trading, a client of Tricom, in 2003. He said that it was his invariable experience at Tricom to work with a client, who was unable to meet a margin call, to reduce the margin. The broker would execute orders to buy back the options which had the most adverse impact on the margin. Mr Best said that to his knowledge Tricom never hedged its position in relation to a client's account. Perhaps its clients had already hedged their portfolio or had provided better security. The issue was not explored.

456 Mr Best said that in his opinion the market had an ability to absorb a portfolio of the nature of that held by How Trading in mid January 2008. He said:

The options comprising the portfolio could and should have been closed down immediately by the buying back of those of the put options which had the most adverse impact on the margin as a first priority and, subsequently, by buying back the balance of the portfolio.

In that regard the opinion of Mr Best corresponds with that of Mr Semple. Mr Best does not, however, explain how he would have achieved that objective.

457 In his initial witness statement, Mr Best purported to express an opinion about the liquidity of the market in mid January by reference to his "recollection". That was an unsatisfactory basis for an opinion. In his second statement, however, he gave evidence of the large number of contracts traded on the market on 14, 15 and 16 January 2008. The nature of the contracts (whether puts or calls, bought or sold) and the underlying stocks was not explained. His evidence, in this regard, was not challenged and subject to its generality, provides some evidence of liquidity on those days. Mr Best's opinion evidence also extended to a criticism of the auction process undertaken by Berndale in March 2008. To the extent that his criticism meant no more than that the portfolio should have been closed out within days of 14 January, it adds nothing to his evidence. Insofar as his criticism was directed to the efficacy of the auction process, it was at odds with the defendants' case. They relied upon the similarity between the auction result and the ACH valuation to support the validity of the ACH valuation as a reliable measure of the cost of closing the portfolio in January 2008.

458 Berndale challenged Mr Semple's opinion to the effect that the portfolio could have been liquidated within two days at a cost close to the market value determined by the ACH. While Berndale's witnesses accepted that the portfolio could have been closed out or liquidated over that period, Berndale submitted that Mr Semple's core thesis depended upon three flawed assumptions. These were,

(a) volatility on 14 and 15 January 2008 was only slightly above average;

(b) the liquidation of the portfolio could be carried out over two days with the assistance of two or three click operators; and

(c) the portfolio could have been realised for the values that emanated from the ACH.

459 Berndale challenged Mr Semple's qualifications, submitting that he was not a professional derivatives trader and had never been employed to trade derivatives using his own discretion. It submitted that Mr Semple had never had day-to-day responsibility for trading a portfolio of derivatives on behalf of a house account for a financial institution. Mr Semple was essentially a private client advisor, but never had a mandate to exercise his own discretion on a client's behalf. Berndale submitted that the clients Mr Semple dealt with through Andika are all "mums and dads" investors. The biggest portfolio Mr Semple had been involved in unwinding had a margin value of about $1.2 million. Accordingly, Berndale argued, Mr Semple's experience and qualifications were limited and his evidence should be given less weight than the evidence given by professional derivatives traders such as Messrs Ryan, Craft and Gibson.

460 I am not persuaded that Mr Semple's lack of experience in liquidating a large portfolio was a disqualification. The process under consideration was closing out positions within a portfolio, not a sale or transfer of the whole portfolio by auction or some other means. What was important was knowledge of and experience in the relevant market, and an understanding of the impact of volatility on pricing and liquidity and strategies to close out a portfolio or positions within a portfolio at the best price.

461 Berndale also challenged Mr Semple's independence and credit. It submitted that a factor of critical relevance to Mr Semple's independence, and therefore his credit, was his failure to disclose any prior dealings with Mr Waterhouse in his expert report. Mr Semple had in fact given Mr Waterhouse advice in connection with options trading relating to an account operated for Mrs Waterhouse. When asked under cross-examination if it did not occur to him that he ought to disclose those things, Mr Semple answered "[i]t was ten years ago". He said he was told by counsel that the time difference was so long ago it wasn't important.

462 Another factor relied upon by Berndale, as going to Mr Semple's independence and credit, was the apparent extent of counsel's involvement in the drafting of his witness statement. Mr Semple admitted his statement was prepared with counsel's assistance. In his first report, Mr Semple said that the short sales were a means to delta-hedge the portfolio. That reference has been removed in his witness statement. In relation to the second statement, Mr Semple admitted to accepting and adopting a suggestion, first raised by the defendants' solicitors, that the short sales should have been closed out on 22 January 2008. Further, Mr Semple agreed that his witness statement was not responsive to the letter of instructions produced in response to the plaintiff's call.

463 Berndale also criticised Mr Semple's demeanour. It submitted he was defensive and at times unreasonably argumentative or assertive. It said he stubbornly clung to his view that the volatility on 14 and 15 January 2008 was only slightly above average, but was ultimately obliged to concede that it was not a view he could maintain. Berndale submitted that Mr Semple took a bewildering U-turn concerning the last sentence in paragraph 19 of his witness statement that read:

I have been asked to assume that when Berndale did so [made the short sales] it had good and substantial reason to expect, or predict, as virtually certain that the Share Price Index on the ASX would fall very significantly in the days immediately following 14 January 2008 because publication of the Merrill Lynch group's international accounts as at the year ended 31 December 2007 was to take place during those days.

Under cross-examination, Mr Semple refused to accept that he had been asked to make the assumption, describing his words as an independent conclusion he had reached because, amongst other things, "people trading the market were well aware of the events on the calendar". His evidence in this regard was illogical and unresponsive to the questions he was asked. There was an element of confusion in his response.

464 Other factors identified by Berndale, as relevant to the weight that ought be given to Mr Semple's evidence, included his failure to make any independent investigation of the data available concerning volatility in the equities market in January 2008; his failure to make any independent valuation of the How Trading portfolio as at 14 January 2008; the fact that he attributed ACH values to Berndale in his witness statement but knew that the valuations in fact emanated from the ACH, not Berndale; the fact that he expressed the opinion that options may always be readily bought and sold in liquid stocks yet he conceded in cross-examination that there was a substantial distinction between liquidity of stocks and options derived from those stocks; his assertion that Berndale "quite irrationally" destroyed the hedges, when under cross-examination he admitted they were maintained; and the fact that his instructions were given orally.

465 Berndale complained that Mr Semple's written instructions were suggestive of the conclusions he was asked to reach. For example, Mr Semple was advised that on 22 January 2008 Berndale could and should have closed all of the short sales which it made on 14 and 17 January 2008. Berndale submitted that Mr Semple was not told that many of the facts were disputed.

466 Berndale further submitted that Mr Semple made no meaningful and independent analysis of the How Trading portfolio, and that his report was simplistic, untutored and biased. It submitted that Mr Semple tailored his evidence to suit the defendants' case, and in that regard misunderstood his duties to the Court as an independent expert.

467 In relation to Mr Best, Berndale submitted that he did not have the qualifications to support his opinions. It submitted that he had never been involved in a professional role as an options trader in the sense of taking principal risk. Nor had he been involved in unwinding an account in the order of the magnitude of the How Trading account. There was also an objection to the evidence of Mr Best based upon the absence of structure commonly required of an expert opinion.

468 I found the evidence of Mr Semple and Mr Best given at trial of limited assistance. The evidence of Mr Best given in support of the defendants' application to reopen was of more assistance. His analysis of the "problematic" positions in the portfolio was only challenged by Berndale in relation to a few of the positions analysed by him. While there was an overarching challenge to the employment of ACH valuation data to establish a price at which positions might have been closed out in the market, the evidence of Mr Best did establish a close correlation between ACH valuations and market activity. That such a correlation should exist was not surprising.

469 Mr Semple provided a framework within which he said the portfolio could and should have been liquidated, although his methodology to assess the value at which that could have been achieved was not persuasive.