In Justice Yates’ judgement in the Whitebox matter, there are several clarifications of key legal concepts in securities law, including clarifications about the meaning of the terms “likely”, “market”, “transactions” and “acts” for the purposes of s1041B(1)(b) of the Corporations Act (Cth). This note highlights these new judicial interpretations explained in the judgement at: https://www.judgments.fedcourt.gov.au/judgments/Judgments/fca/single/2019/2019fca0849.
The Australian Securities and Investments Commission (ASIC) sought to prove that, over five successive Serial Expiry Days in 2012, Whitebox Trading Pty Ltd (Whitebox) and its principal engaged in a deliberate strategy to manipulate the prices of all 200 individual securities comprising the XJO Index on the Australian Stock Exchange (ASX) in the Opening Single Price Auction (OSPA) for the sole or dominant purpose:
- of achieving a more favourable Basis (the mispricing between the traded price of SPI Futures and their Fair Price); and
- profiting from the index arbitrage positions that Whitebox traded on each day in SPI Futures and XJO Securities.
ASIC described a strategy predicated on placing very large orders or order amendments for XJO Securities late in the Pre-Open Phase. It was later accepted that the Defendants could have had no reasonable expectation they could trade in the OSPA. These orders were cancelled or reduced in volume shortly before the Rotation in the OSPA in which the securities were due to trade.
ASIC contended this was done intentionally to manipulate the Opening Prices of the securities in the OSPA and thereby affect the “Basis” (defined as a measure of mispricing which may give rise to an arbitrage opportunity between the share price index and the futures contract over the share price index). ASIC further contended that no orders or order amendments represented genuine supply or demand for XJO Securities.
In Justice Yates’ view the case turned on whether ASIC could establish, on the balance of probabilities, that the Defendants acted with the intention alleged by ASIC.
Given that the case brought by ASIC was one of intentional conduct and there was little direct evidence about the Defendants’ intentions, it was left to the Court to draw inferences from established facts and ASIC bore the onus of establishing the inferences it contended.
The Court accepted there was no scientific or reliable method to recreate the market place to identify what the Opening Prices would have been absent Whitebox’s orders, which considerably weakened the reliability of the evidence that ASIC adduced on the question. It accepted the argument that proving the allegations required an evidentiary basis stronger than unsubstantiated rules of thumb, as Dr Aitken a Court expert pointed out, explaining that he had been asked to consider and address opinions and rules of thumb about price effects in the market for XJO Securities rather than “surveillance protocol evidence”.
Notwithstanding that ASIC’s case failed, Justice Yates’ decision is a well drafted explanation of securities index arbitrage trading that brings clarification about four important terms. First, the meaning to be given to the word “likely” in the phrase “has or is likely to have the effect” in s1041B(1)(b). Justice Yates accepted ASIC’s contention it means “a real and not remote chance” of an outcome being achieved, as opposed to “more probable than not”.
Second, the meaning of “artificial price”, or a price that does not reflect a genuine expression of an intention to buy or sell securities under the order submitted (at paragraph 269). The Defendants’ argument challenged ASIC’s contention that “genuine supply and demand” is formed by forces created in a market by buyers whose purpose is to acquire at the lowest possible price and sellers whose purpose is to sell at the highest realisable price. This approach was presented as “simplistic because it ignored the inherently contingent nature of orders in the Pre-Open Phase and thus divorced the statutory language of s 1041B(1)(b) from its relevant context for this limb of ASIC’s case.” A better approach needed to appreciate what a reasonable observer of, or participant in, the Pre-Open Phase would understand from the placement or amendment of an order. This led the Court to consider “the assumptions on which those participating in the Pre-Open Phase operate, because it is only conduct that falsifies those assumptions that gives rise to a false or misleading appearance with respect to “the market” in which the securities are traded”. In other words, it required an understanding of the workings of the Pre-Open Phase leading up to the OSPA conducted by the ASX, as opposed to unsubstantiated rules of thumb or mere academic discussion. Justice Yates accepted that orders placed in the Pre-Open Phase are distinguished from orders placed in the Open Phase (or Normal Trading) and “reasonably informed observers or market participants understand the contingent nature of orders placed in the Pre-Open Phase and that it certainly does not follow from an order placed in the Pre-Open Phase that the order will remain in the Order Book until the commencement of the OSPA.” These particular characteristics of the Pre-Open Phase needed to be taken into account when applying s1041B(1)(b) meaning that “the paradigm of “forces of supply and demand” discussed in JM cannot be directly applied to orders, amendments and cancellations in this phase” and “the placement or amendment of an order in the Pre-Open Phase conveys only that the person placing the order or amendment is, at that time, pursuing some ordinary or legitimate commercial strategy or behaviour… and … does not convey anything more than a contingent intention to allow the order or amendment to execute at market opening.” (at paragraph 541)
The third clarification concerns the meaning of “market” in the phrase “false or misleading appearance … with respect to the market” as used in s1041B(1)(b), and whether the market is limited to the period of Normal Trading because only then can securities be bought and sold and the forces of actual supply and demand engage with each other. In other words, the Pre-Open Phase might not be a “market”. Justice Yates opined that it is, stating that a “market” is “a broad notion that contemplates potential as well as actual transactions”. For the purposes of s1041B(1)(b) therefore, the Pre-Open Phase is a “market” notwithstanding the conditional nature of an order since, in that phase, no order can execute until the Rotations in the OSPA for the securities concerned actually commence (Rotations are the stages of the opening algorithm; see paragraph 27).
Fourthly, the decision clarifies whether there is a distinction under the Corporations Act (Cth) between the words “transactions” and “acts”. ASIC submitted there was no relevant distinction between the two terms. Accordingly, “transactions”, as used in s1041A, was a hypernym that encompassed “acts”. Justice Yates did not agree, pointing out that “… in the context of s1041A, the word “transaction” is not a hypernym that encompasses unilateral acts, such as making an on-market offer (i.e., placing a bid or an ask) but, rather, acts that have been consummated by acceptance. If an on-market offer is not, relevantly, a “transaction”, there is no reason to think that the word has a different or extended statutory meaning in the Pre-Open Phase to include an order placed, amended or cancelled. This suggests that the textual differences between s1041B(1) (“act”) and s1041A (“transaction”) are not accidental and … had it been necessary for me to decide the question, I would have felt constrained to conclude that placing the Buy Orders and Cancellations (19 April 2012), and placing the Amended Sell Orders and Reductions (other Serial Expiry Days), do not constitute “transactions” for the purposes of s1041A.”
Besides these useful clarifications about the meaning of the terms “likely”, “market”, “transactions” and “acts” for the purposes of s1041B(1)(b) of the Corporations Act (Cth), this decision is a very useful step in our collective understanding of the complexities of index arbitrage trading on the ASX and the appropriate evidentiary basis for allegations of contraventions to the market manipulation provisions of the Corporations Act (Cth).
The author would like to thank Michael Hains for comments on an earlier version of the article.