Dastards

Guambat has spewed his stew before about the tendency of this government to make new laws where the old ones ought to work (for instance creating a law of terrorism where murder would do). Now I do understand that it is a primary principle of criminal law that crimes must be specifically drawn and narrowly interpreted to avoid being vague and ambiguous. And so, for instance, new terror laws are enacted so that one person who takes money from a terrorist organisation can get convicted but it could be that another person who is involved with channeling millions of dollars to a terror state cannot be convicted on terrorism charges.

And with that little aside aside, I'll go into what led me through that thought process. In a prior post I alluded to the dastardly deeds of market manipulation and insider trading as two of the possible "infringements" that might be applicable to the Citigroup case being pursued by ASIC. But Malcolm Maiden sets me straight on that with his column in today's Herald. His take is that the (alleged) dastardly deed more technically arises from a failure to manage a basic conflict of interest:

The Australian Securities and Investments Commission finds itself in this quixotic position after copping a hospital pass from the Howard Government in 2004, when it passed the Corporation Law Economic Reform Program 9.

CLERP 9 was one of Australia's regulatory acts of contrition for the excesses of the dotcom boom and coincidental debacles such as HIH, and one of the things it did was require financial market players such as the investment banks to "have in place adequate arrangements for the management of conflicts of interest that may arise …"

A fine sentiment, with which we all agree. But on the subject of what constituted a conflict and what arrangements should be put in place, CLERP was mute. It was up to Lucy's mob to work out what it all meant and they must have known at the outset that the job had the potential to take them to some exciting places.

And so it has. The case against Citi challenges one of the fundamental assumptions behind a thoroughly modern investment bank: that conflicts of interests raised by an investment bank being adviser, marketer, analyst and trader on a deal can be either managed or sterilised without the need to actually shut the activity down.

Brokers and investment banks were once pure agents, buying and selling shares on behalf of their clients: it was thought that a firm would be hopelessly in conflict with its clients if it traded in its own right.

But that started to change in the 1980s, along with other antiquated notions, including the compartmentalisation of the markets for equity and debt. The big players now all trade actively for themselves, in shares, bonds, you name it, through their proprietary trading divisions.

ASIC's case is complicated by its most sensational aspect, an allegation of insider trading that hangs in turn from a claim that bankers sitting behind the Toll-Patrick bid advice wall noticed that the proprietary desk was trading Patrick shares, took action that resulted in the trader concerned being told to stop, and did so when rumours were flying that Toll was about to attack Patrick, leading the trader to make the "supposition" that Citi was working with Toll on a bid (the proprietary desk subsequently sold some Patrick shares, ASIC alleges).

But the key claim is that Citi's conflict management system failed.

The regulator wants the court to order Citi to create a formal conflict management structure for the proprietary trading desk that will "bring any such conflict of interest to an end once detected", a structure that would shut down much of the proprietary trading that currently takes place.

And this is what makes me wonder, what (besides the fact that as written and regulated, market manipulation and insider trading is almost too difficult a case to win) point is there in bringing the charges under a conflict of interest characterisation? Remember, the conflict of interest arises because the trading desk was buying Patrick when in was in the interest of Toll, whom the advising group represented, that the price go down. If the advising desk had simply seen the trading desk selling and told them "hey, that's a good idea, do a whole heap of it", there would have been no conflict with its clients interests.

But wouldn't it still be market manipulation or at least insider trading if the advising group got the trading desk to sell the stock with a view to driving the price lower to enhance the takeover in advance of the announcement? My very generalist legal background doesn't have a legal opinion on that but would raise the topic in an issue spotting exam paper.

Meanwhile, the Herald also points out that this is an inopportune time for Citigroup to get caught, once again, in a regulatory spotlight:

Citigroup believes it has wrongly been singled out for participating in the industry-wide practice of proprietary trading and has vowed to vigorously fight the charges.

Although the damages ASIC is seeking against the world's biggest bank are small in financial terms, the case is a blow to Citigroup at an inopportune time.

The US Federal Reserve last year barred Citigroup from making any new acquisitions until it improved internal controls following the bank's involvement with the Enron and WorldCom scandals in the US and other fiascos in Europe and Japan.

The bank last week emerged as one of the leading bidders for Turkey's Finansbank, in a deal that could be worth between $US5 billion and $US6 billion ($7 million to $8.4 million).

The Federal Reserve has not publicly stated whether the restrictions have been lifted but in December Citigroup indicated most of the regulatory problems had been settled.

But after the ASIC case was announced, US commentators indicated the deal could be in jeopardy.

"This would be too blatant to ignore by the Fed," New York University business professor Robert Lamb told Dow Jones MarketWatch. "This is going to make it much harder for them" to pursue deals like the Turkish acquisition.

One more aside: Malcolm Maiden, in the column cited above, makes one of the most qualified bullish comments I've heard since, say, 2000: "This market is high but it is not yet repulsively expensive."