Law of Investment and Financial Markets Assignment

Ignorant Hairdresser vs. Professional Consultant

Before we begin, it is understood that Norm is providing financial services in a financial services business: s 761A. Puala is considered as a consumer of financial services as the financial services are of a kind ordinarily acquired for personal, domestic or household use – ASIC Act, s 12 BC.

Hence she will be able to use the ASIC Act against Eastpoint and Norm. Assuming that Paula is in the retail category (s 761G (5)) and does not fall into the threshold of wholesale, Norm have more obligations towards Paula. As a professional financial consultant providing personal advice to a retail client, Norm is bound by Regulatory Guide 175 (RG 175) and he should act in the best interests of his client – Paula – and take a step further in understanding her financial situation and risk tolerance.

For further enforcement, does a contract[1] exist between the two parties? 1. Offer and Acceptance Paula approached Eastpoint to provide professional financial advice – an offer has been made by Paula to Eastpoint. Eastpoint accepted the offer by appointing Norm as their representative. Norm, as a financial consultant, is obligated to perform his duty towards Paula. 2. Consideration[2], with intention to create legal relationship The moment Paula paid Norm consultation fee, consideration has been established, with the intention to bind the two parties under contract law.

With the offer accepted, consideration and intention established, both Norm and Paula were bound to a legal contract. Hence, Norm must fulfil his fiduciary obligations.

Know Your Client

Under “Guidelines on Standard of Conduct for Financial Advisers” of the Financial Advisers Act (FAA), Norm should take reasonable steps to determine Paula’s financial objectives, risk tolerance, financial situation, investment experience and particular needs in order to understand her risk profile. Obviously, Paula desired income and capital growth from a portfolio of suitable investment products.

Norm, as her consultant, is obligated to adhere to the rules of “Know Your Client” and “Know Your Product” as mentioned in section 945 A of the Corporations act 2001, which requires the advisor not only to determine the investor’s relevant personal circumstances, but also actively acquire more knowledge to those personal circumstances. Norm had failed to understand Paula’s personal and financial situation and neglected to investigate her risk appetite. In this case under s 945A (1), Paula has the right to take necessary actions for loss or amaged caused by the non-compliance with the “know your client, know your product” rule. However Norm failed to do so. The obligations cannot be avoided by any disclaimer or warnings given to Paula.

Appropriate Advice based on Reason

Section 945A (1)(c) requires that personal advice must be “appropriate” to the client. According to RG 175. 115, advice is appropriate if it is fit for its purpose, i. e. satisfies client’s relevant personal circumstances. This section is crucial as the person’s objectives, financial situation and needs must be considered when making recommendations (s 761A).

Such conduct has violated the rules under FAA Code of Conduct – Reasonable Basis, where Norm should: ? “Ensure that its recommendations are suitable for the client… based on thorough analysis and take into account alternative investment options” and ? “Explain to the client the basis for its recommendation and why the investment product it is recommending is suitable for the client. ” Norm ignored Paula’s objectives, much less considered the client’s interest and based his actions on products with high commissions.

This brings out the issues on conflict of interest and Norm’s fiduciary duties towards Paula.

Fiduciary Duty and Conflict of Interests

A fiduciary relationship exists between Norm and Paula. With reference to Daly v Sydney Stock Exchange Ltd (1986) 160 CLR 371 at 37, fiduciary duties are applied unto him, as he has the “expertise in advising on investments is approached for advice on investments and undertakes to give it, in giving that adviser stands in a fiduciary relationship to the person whom he advises. ’ Norm breached his fiduciary duty towards Paula as she expected Norm to invest her funds according to his level of professionalism. Nevertheless, past precedence cases such as Rahmat Ali v Hartley Poyton Ltd, relates to Paula’s situation such that both plaintiffs are ill-equipped with necessary knowledge in investing. Norm took advantage of Paula’s incapabilities by working in his favour instead of his client in order to gain a hefty sum of remuneration. Norm had also given out a Financial Services Guide (FSG) that is not whole, thus being liable under the offence o provide a defective disclosure document: s 952D. This can be seen from the part that Norm, receiving a high commission, is not disclosed to Paula. Conflict of interest was also not taken care of. Eastpoint Money Managers Pte Ltd had failed to control, disclose and if not, avoid the conflict. For defective disclosure, Paula can return the product and receive a refund: s 1016F. However, this right can only be exercised during the period of one month from the issue of sale of the product – this issue had dragged on for two years.

Making False Representations as to returns – Misrepresentation

To prove misrepresentation, there must be false statements which was relied upon by the representee – Paula – and had induced the contract as mentioned in the case of Koh Keow Neo & Others v Chee Johnny & Others.

Fraudulent Misrepresentation

According to the FAA, advice should be clear, adequate and not false or misleading[5]. Norm advised Paula to directly invest her funds into Dragon Developers that directly invest into residential apartments being built in Singapore and promising her that she can expect investment growth rate of 15% p. . , which lured Paula to follow his recommendations. Paula was misled. Fraudulent misrepresentation arises when the false statement is made by the representor knowing that there is falsity. Norm had not disclosed to Paula that he is remunerated one-fifth of the invested sum for every client he obtains for Dragon and dishonestly told Paula that her funds would be injections into building projects, which ended up being used to cover existing debts faced by the company, which is similar to the case of Lim Geok Hian v Lim Guan Chin.

Is Paula able to claim in negligence under tort?

To prove that Norm had made negligent misstatements, she has to prove the Norm owes her duty of care; Hedley Byrne & Co Pte Ltd v Heller & Partners Ltd (1964). In other words, there has to be “proximity” between adviser and the advisee.

Factors determining existence of a special relationship and duty of care:

1. Paid advice? “Payment for information or advice is very good evidence that it [the advice] is being relied on and that the informer or adviser knows that it is. – Lord Devlin in Hedley Byrne.
2. Is adviser – Norm – carrying on business of providing advice? ? In this case, Paula approached Norm for consultation, where both parties are aware of the reason why Paula approached Eastpoint for financial advice.
3. Does Norm know that Paula would rely on his advice? ? Norm ought to know that Paula is likely to rely upon his advice and that it is generally reasonable for the latter to do so: United Project Consultants Pte Ltd v Leong Kwok Onn (2005)
4. Disclaimer? Had Norm provided a disclaimer to limit his liability for his recommendations, it could have relieved him of his duty of care towards Paula. However, the disclaimer has to be reasonable under the Unfair Contract Terms Act; Smith v Eric S Bush (1989), not forgetting that both parties enter the contract with goodwill.

Nevertheless, due to the fact that he had committed the dishonest act of withholding complete information from his client, any disclaimer made by Eastpoint or Norm should be ignored. Yes, Norm owes Paula a duty of care. Next, did Norm breach this duty?

According to Lanphier v Phipos (1838), “Every person who enters into a learned profession undertakes to bring to the exercise of it a reasonable degree of care and skill. ” Paula had earlier indicated that she wanted to invest in a portfolio of investment products, implying that she wanted a mix of financial products, not investing all her “available funds” into a single property developing company. She wanted income and capital growth, which generally places her as a balanced investor who looks for stable income stream and steady capital growth in her capital.

With her money “directly invested into residential apartments”, Paula is unable to meet her objective of deriving “income” from her investment – she will not expect any income for the first few years of making this investment. In this case, Norm had neglected Paula’s wishes and inevitably raised the level of portfolio risk – property investments are perceived as risky. When Norm skipped informing Paula about his reception of commission upon recommendation of Dragon Developers, it was an act of neglecting to disclose commission details, as mentioned in Rule 106[6] of the Rules of Professional Conduct.

Failing to adhere to Rule 106, there is the possibility that Norm had violated Rule 101 – General Conduct[7]; such that he had omitted information with the intent to deceive Paula. There is also the possibility that upon recommending Paula the property investment plan, he had not made a clear picture for her with regards to the level of risk Paula would be taking if she had acted upon his recommendation, as well as the financial position of the Dragon in which it is burdened with liabilities and debts. Hence Norm could have gone against Rule 111[8].

Not only that, even though Paula’s investor category suggests that she is able to accept fluctuations in her income and capital, she suffered a great financial loss as a result of Norm’s supposed irresponsible (and most probably fraudulent) recommendation, and also due to the contravention of s 945A (requirement to have a reasonable basis for advice) and s 949B (disclosure requirements imposed by regulations) in Pt 7. 7. This loss was not mitigated by Norm – he did not take all reasonable steps available to him: British Westinghouse Electric & Manufactury Co v Underground Electric Railway Co of London (1912).

With the above-mentioned issues, it is obvious that there was a situation of negligence on Norm’s side, should it be contract or tort.

Resulting Remedies

Should this be concluded as fraudulent misrepresentation, there should be rescission of the contract between Paula and Eastpoint, together with monetary compensation of less than or equivalent to $60,000. Not forgetting that under civil liability, she may recover the amount of the loss or damage by action against a liable person being, under Pt 7. 7.

Should Eastpoint be held responsible for the unprofessional conduct of Norm?

For an employer to be liable, the employee is to commit a tort in the course of employment. Hence as Norm’s employer, Eastpoint is no doubt, responsible in compensating Paula’s loss. In conclusion, Paula has the cause of action against Norm and Eastpoint Managers Pte Ltd.

The Madoff affair Con of the century

From The Economist print edition There are no heroes in the Madoff story; only villains and suckers BERNARD MADOFF worked as a lifeguard to earn enough money to start his own securities firm. Almost half a century later, the colossal Ponzi scheme into which it mutated has proved impossible to keep afloat—unlike Mr Madoff’s 55-foot fishing boat, “Bull”. The $17. 1 billion that Mr Madoff claimed to have under management earlier this year is all but gone. His alleged confession that the fraud could top $50 billion looks increasingly plausible: clients have admitted to exposures amounting to more than half that.

On December 16th the head of the Securities Investor Protection Corporation, which is recovering what it can for investors, said the multiple sets of accounts kept by the 70-year-old were in “complete disarray” and could take six months to sort out. It is hard to imagine a more apt end to Wall Street’s worst year in decades. The known list of victims grows longer and more star-studded by the day. Among them are prominent billionaires, including Steven Spielberg; the owner f the New York Mets baseball team; Carl Shapiro, a nonagenarian clothing magnate who may have lost $545m; thousands of wealthy retirees; and a cluster of mostly Jewish charities, some of which face closure. Dozens of supposedly sophisticated financial firms were caught out too, including banks such as Santander and HSBC, and Fairfield Greenwich, an alternative-investment specialist that had funnelled no less than $7. 5 billion to Mr Madoff. Though his operation resembled a hedge-fund shop, he was in fact managing client money in brokerage accounts within his firm, seemingly as Merrill Lynch or Smith Barney would.

A lot of this came from funds of funds, which invest in pools of hedge funds, and was channelled to Mr Madoff via “feeder funds” with which he had special relationships. Some banks, such as the Dutch arm of Fortis, lent heavily to funds of funds that wanted to invest. On the face of it, the attractions were clear. Mr Madoff’s pedigree was top-notch: a pioneering marketmaker, he had chaired NASDAQ, had advised the government on market issues and was a noted philanthropist. Turning away some investors and telling those he accepted not to talk to outsiders produced a sense of exclusivity.

He generated returns to match: in the vicinity of 10% a year, through thick and thin. Charming, but far too smooth That last attraction should also have served as a warning; the results were suspiciously smooth. Mr Madoff barely ever suffered a down month, even in choppy markets (he was up in November, as the S&P index tumbled 7. 5%). He allegedly has now confessed that this was achieved by creating a pyramid scheme in which existing clients’ returns were topped up, as needed, with money from new investors. He claimed to be employing an investment strategy known as “split-strike conversion”.

This is a fairly common approach that entails buying and selling different sorts of options to reduce volatility. But those who bothered to look closely had doubts. Aksia, an advisory firm, concluded that the S&P 100 options market that Mr Madoff claimed to trade was far too small to handle a portfolio of his size. It advised its clients not to invest. So did MPI, a quantitative-research firm, after an analysis in 2006 failed to find a legitimate strategy that matched his returns—though they were closely correlated with those of Bayou, a fraudulent hedge fund that had collapsed a year earlier.

This was not the only danger signal. Stock holdings were liquidated every quarter, presumably to avoid reporting big positions. For a godfather of electronic trading, Mr Madoff ran the business along antediluvian lines: clients and feeder-fund managers were denied online access to their accounts. Even more worryingly, he cleared his own trades, with no external custodian. They were audited, of course, but by a tiny firm with three employees, one of whom was a secretary and another an 80-year-old based in Florida.

Perhaps the biggest warning sign was the secrecy with which the investment business was conducted. It was a black box, run by a tiny team at a very long arm’s length from the group’s much bigger broker-dealer. Clients too were kept in the dark. They seemed not to mind as long as the returns remained strong, accepting that to ask Bernie to reveal his strategy would be as crass as demanding to see Coca-Cola’s magic formula. Mr Madoff reinforced the message by occasionally ejecting a client who asked awkward questions.

The trading business was hardly pristine either. It had been probed for front-running (trading for its own account before filling client orders) and separately found guilty of technical violations. Some clients reportedly suspected that Mr Madoff was engaged in wrongdoing, but not the sort that would endanger their money. They thought he might be trading illegally for their benefit on information gleaned by his marketmaking arm. This failure of due diligence by so many funds of funds will deal the industry a blow.

They are paid to screen managers, to pick the best and to diversify clients’ holdings—none of which they did properly in this case. Some investors are understandably irate that their funds—including one run by the chairman of GMAC, a troubled car-loan firm—charged above-average fees, only to plonk the bulk of their cash in Mr Madoff’s lap. This is the last thing hedge funds need, plagued as they are by a wave of redemption requests. Financial firms that dealt with Mr Madoff are bracing themselves for a wave of litigation as individual victims go after those with deep pockets.

Hedge funds will also face pressure to accept further oversight. But the affair shows the need for the government to enforce its rules better, rather than write new ones, argues Robert Van Grover of Seward & Kissel, a law firm. Mr Madoff’s investment business was overseen by the Securities and Exchange Commission (SEC), but it failed to carry out any examinations despite receiving complaints from investors and rivals since as long ago as the late 1990s. As a Wall Street fixture, Mr Madoff was close to several SEC officials.

His niece, the firm’s compliance lawyer, even married a former member of the team that had inspected the marketmaking division’s books in 2003—though there is no evidence of impropriety. In a rare mea culpa, Christopher Cox, the SEC’s chairman, has called its handling of the case “deeply troubling” and promised an investigation of its “multiple failures”. Having already been lambasted for fiddling while investment banks burned, the commission is now likelier than ever to be restructured, or perhaps even dismantled, in the regulatory overhaul expected under Barack Obama.

As The Economist went to press Mr Obama was expected to name Mary Schapiro, an experienced brokerage regulator, to replace Mr Cox. The rules themselves will need changing, too. All investment managers, not just mutual funds, could now be forced to use external clearing agents to ensure third-party scrutiny, says Larry Harris of the University of Southern California’s Marshall School of Business. Regulation of financial firms’ accountants may also need tightening. And more could be done to encourage whistle-blowing. Mr Madoff claims to have acted alone.

But given the huge amount of paperwork required to keep his scam going, it seems unlikely that no one else knew about it. Above all, however, investors need to help themselves. This pyramid scheme may have been unprecedented, but the lessons are old ones: spread your eggs around and, as Mr Harris puts it, “investigate your good stories as well as your bad ones. ” This is particularly true of money managers who work deep in the shadows or seem beyond reproach—even more so during booms, when the temptation to swindle grows along with the propensity to speculate.

There will always be “sheep to be shorn”, as Charles Kindleberger memorably wrote in “Manias, Panics and Crashes”. Let us hope they never again line up in such numbers.

In Other Words…

Bernard L. Madoff had admitted to having swindled close half a trillion from unsuspecting investors and had left a mess for the Securities Investor Protection Corporation (SIPC) to clear. These unsuspecting investors ranged from the rich to the knowledgeable. Behind the appearance of transacting hedge funds, Madoff kept the funds circulating within his organisation.

Whatever reasons which lured investors into Madoff’s trap, they included his influential status in the financial world while giving returns to match promises. However, the high “returns” were generated from a pyramid scheme. There were also suspicious activities such as stock liquidations, denial of access to accounts, and clearing trades without external custodians. But the most suspicious point was how the investment process was kept secretive, especially from clients. Still, blame falls upon fund managers, financial institutions and the Securities & Exchange Commission (SEC) for falling short of diligent supervision.

Violation: Statements of law

Corporations Act 2001(Cth) 1. Obligations of Licensees: s 912A(1) 2. Disclosure & Conduct of Business Rules: s 945A 3. Regulatory Guide 168. 103 (documentary disclosure) 4. Defective disclosure documents: ss 1021D & 1021E (PDS) 5. Disclosure of possible or actual conflicts of interest: s 942B & 942C Regulatory Guide 181 6. No avoidance of conflicts of interest: [RG 181. 49 – 181. 63] ASIC Act 7. Loss of credibility on SEC: s 12A 8. Misleading & Deceptive Conduct: s 12DA 9. Implied warranty to render financial services with due skill & care: s 12ED Others 10.

Breach of fiduciary duties (relationship with stockbroker. ) 11. Tort of negligence 12. Fraudulent Misrepresentation: Misrepresentation Act Section 4 of South Australian consolidated acts

Relevance between “Con of the Century” and Investment Law

Generally, Madoff had not act in the best interest of his clients – breaching an important aspect of investment law. As a fiduciary, it is crucial to use reasonable diligence, due care and skill – Daly v Sydney Stock Exchange Ltd. He is also required to act selflessly, and selfishness is absolutely prohibited, with reference to Kumagai-Zenecon Construction Pte Ltd v Low Hua Kin.

He violated the implicit warranty to render financial services with due skill and care: s12ED of ASIC Act. From the article[9], no practice of transparency existed between investors and financial firms. Madoff had failed to comply with the obligations of licensees under the Corporation Act 2001, s912A(1). This is proven by the fact that he denied investors’ rights to access to their online accounts. Madoff had violated the disclosure and conduct of business rules, and did not fulfil the Documentary Disclosure under Chapter 7 of the Corporations Act 2001.

He managed his firm with secrecy and kept his clients in the dark with regards to profits dealings. The impression of restrictedness applies to him and his business. He could have given defective disclosure documents to his clients. Besides, it is proven that he cleared his dealings without the assistance of qualified external custodians, thus failed to disclose actual conflicts of interest, with relevance from Yeo Geok Seng v Public Prosecutor. When applying the ASIC Act (s12DA), Madoff can be charged for misleading and deceptive conduct as he swindled his clients under the facade of a hedge-fund-shop”, when monies were actually managed within his firm’s brokerage accounts. Madoff could be charged for fraudulent misrepresentation in the course of business. With reference to Panatron Pte Ltd v Lee Cheow Lee and another, fraudulent misrepresentation is present when it is made knowingly, or without belief in its truth, or recklessly, careless whether it be true or false. SEC had failed to carry out detailed investigations on Madoff’s schemes, proving that they were not credible as supposed under s12A of the ASIC’s (equivalent to SEC) Act.

They were unable to protect the vulnerable investors and had misplaced the trust that investors bestowed upon them. In a nutshell, ‘Con of the Century’ had projected many issues relevant to investment law.

Commentary on the “Con of the Century”

In my opinion, although the media’s portrayal of Bernard Madoff as dictator of this Ponzi scheme, it is not an established fact and still remains as a hypothesis. SEC has shown that its regulation is hopelessly inefficient. Why were there no thorough investigations on Madoff even though they had received credible and specific allegations regarding his financial wrongdoing years ago?

The fact that Madoff did not sue these people for defamation should have been another warning sign. As far as I understand, SEC held enormous subpoena records and access to trading records. Instead of using this power, why did they only rely on information provided voluntarily by Madoff? Perhaps that was how Madoff was able to receive a clean bill of financial health years ago, leading to more people victimized by him. The failure of due diligence by the investment advisers should also be noted.

As mentioned in the article, if Aksia and MPI bothered to take a deeper look into what Madoff offered and sense that something was amiss thereby deciding against investing in him, then why not the investment advisors from top banks from the rest of the world do the same? Or is it that they were too engrossed with the juicy commissions dangling before them, hence throwing caution to the wind? Perhaps the victims of this fraud were also to blame. If they paid more attention towards what they were investing in and exercised their due care and diligence, they would have second thoughts about putting their funds with Madoff.

In addition, Madoff basically dealt with those with millions and billions, who should have had the basic financial knowledge to know that investments with high returns are accompanied by high risks and that his operations cannot be always outperforming markets. Although Madoff claimed he acted alone, it is unbelievable. Surely there was a conspirator. Moreover, this was actually a family business. Suspicious indeed. In the end, Madoff was reported by his son. However, there is something amiss. Which son will give his father away? Unless he held a grudge against the parent or he did it for society.

Perhaps Madoff was noble enough to shoulder the blame to protect his family. But who knows? If Madoff keeps his silence and divulges nothing, the ones who were involved will run scot-free. All in all, no one can really stand up and pinpoint out that Madoff was totally at fault. Rather, it was the combined “weaknesses” of the people involved that allowed Madoff to use these “weaknesses” to his advantage, thus bringing a whole new scale a Ponzi scheme can reach.

Bibliography

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