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Appendix 1

Answers to questions on notice   

Received from the Australian Securities and Investments Commission on 18 December:

Question on Notice #1

Page 17

Mr FLETCHER: Mr Savundra, you said that you had referred the matter to the AFP. When did that happen?

Mr Savundra: I cannot recall the date precisely but it certainly occurred after the parliamentary report was delivered. We had had requests for information via the AFP prior to that time but certainly—

Senator BOYCE: You had made requests or they had requested you

Mr Savundra: We had made international requests for information through the AFP. Prior to the report we had not sought to formally refer the matter to the AFP for investigation.

Mr FLETCHER: And the Crime Commission?

Mr Savundra: I will take that on notice, if that is okay.

ANSWER

The Australian Securities and Investments Commission (ASIC) referred material concerning Trio Capital Limited (in liquidation) and Jack Flader Jr to the Australian Federal Police (AFP) on 22 June 2012. ASIC initially approached the Police about this referral on 15 June 2012.

In respect of the Australian Crime Commission after initial contact a meeting was held between ASIC and the Commission on 20 June 2012.

We have reviewed our records and have confirmed that a number of Interpol requests have been made through the AFP since October 2009. These requests were made to assist ASIC with our Trio investigation.

 

Question on Notice #2

Page 18

Senator BOYCE: Are you able to give the costs of the Storm case, including that of the forensic accountant?

Mr Medcraft: I will take that on notice.

Senator BOYCE: If we could have a breakdown of the costs of the case to ASIC.

Ms Gibson: I think we would probably prefer not to provide that in a public forum, just because at some stage there will need to be some discussion about outcomes of the case and costs.

Senator BOYCE: That was going to be my next question: have costs been awarded or not awarded?

Mr Medcraft: In the case of Storm it is still in court at the moment, but we can confidentially give you the number.

Ms Gibson: I am not sure.

Mr Medcraft: We will take it on notice.

ANSWER

In view of the pending litigation in which ASIC is involved arising from the collapse of Storm Financial, ASIC does not consider it appropriate to comment on the cost of the Storm case at this point in time.

 

Question on Notice #3

Page 25

Banksia debentures

Mr FLETCHER: Is debenture secured over specific assets?

Mr Price: Yes, a floating charge.

Mr FLETCHER: Is it mainly commercial property or residential property or a mix?

Mr Price: I might take that question on notice. It is a bit of a mix, but I think it is mainly commercial property, just from memory.

Mr FLETCHER: The other aspect to that question, on notice, is what is the proportion of established property and property under development?

Mr Price: Again, I will take that on notice.

ANSWER

The Banksia Securities Limited loans by underlying security type (based on value):

• 22% was commercial property,

• 46% was residential property,

• 9% was industrial property,

• 18% was rural property and

• 5% was other property.

The Cherry Fund Limited (CFL) loans by underlying security type (based on value):

• 36% was commercial property,

• 21% was residential property,

• 6% was industrial property,

• 34% was rural property and

• 4% was other property.

(Source 7.3.2 on Pg 19 of Receivers' Report dated 7 December 2012)

There are 128 Banksia Securities Limited loans with an aggregate value of $147 million with internal loan classifications which incorporate a development element of “construction”, “land bank” and “vacant land”. This equates to approximately 28% of the Banksia loans by value as possible property development.

There are no CFL loans classified “construction”, “land bank” or “vacant land” indicating there are no development loans.

 

Question on Notice #4

Page 26

Banksia investors

Mr Price: It is an important point generally. One of the other things that the task force is doing is to consider if there are any breaches of the law. Obviously if we do find anything we will seek to hold people to account.

Mr Medcraft: We will look at directors; we will look at auditors; we will look at trustees. Basically we will look at all the gatekeepers, as we always do, including financial advisers.

CHAIR: So what are the consequences for—

Mr Medcraft: Sorry; the sad thing was—how much superannuation money was in—

Mr Price: A little over $100 million, off the top of my head, in superannuation money was—

Senator BOYCE: How many people?

Mr Price: I will need to take that on notice.

ANSWER

There are 843 different Super Funds (SMSFs) with investments totalling $112 million as at the date of appointment on 25 October 2012. (Source Receivers Profiling Sheet dated 27 October 2012)

This equates to 17.26% of the total $652 million investors funds by value.

 

Question on Notice #5

Page 29

CP 189 – FOFA: Conflicted Remuneration

Mr FLETCHER: I want to go to the paper that you have recently put out, Consultation Paper 189 Future of Financial Advice: Conflicted remuneration. A concern has been raised with me that this is likely to apply to investment firms which operate for non-retail clients as well as retail clients. Is that ASIC's understanding of the scope of the paper and the scope of these remuneration arrangements?

Mr Kell: No. I will take it on notice to check on that but, no, that is not our understanding.

Mr FLETCHER: To expand on the concern, it has been put to me that this firm and other firms in the investment management market serving non-retail clients typically operate on the basis of a bonus structure as well as a base remuneration structure for their portfolio managers. A driver of bonus amongst other things is the amount of additional funds under management that they are able to secure. They are concerned that that remuneration structure will no longer be open to them if the arrangements in paper 189 come into effect.

Mr Kell: It is a little hard to provide a definitive answer on an example like that off the bat so we are happy to take it on notice and get back to you quickly. Generally, it is not intended to apply in a purely wholesale context.

Mr FLETCHER: Is that are concern that has been raised with you on the consultation process?

Mr Kell: Again, I could check on that. It certainly has not been prominent in the responses to the paper to date to my knowledge.

ANSWER

Under the Corporations Act, a benefit is only conflicted remuneration if:

• it is given to a financial services licensee, or a representative of a financial services licensee, who provides financial product advice to persons as retail clients; and

• it could reasonably be expected to influence the choice of financial product recommended to retail clients or the financial product advice given to retail clients.

The conflicted remuneration provisions do not apply in relation to services provided to wholesale clients. This position is reflected in our proposed regulatory guidance on the conflicted remuneration provisions.

From our consultations with industry, we consider that industry understand this.

 

Question on Notice #6

Page 31

Discretionary trusts

Senator BOYCE: Leading on from what you were just talking about, the issue has been raised that it may be possible to define a discretionary trust that operates a family business as a financial product. Has that issue ever been raised with you? If so, how?

Mr Tanzer: I have to take that on notice, Senator.

ANSWER

As you are aware, ASIC deals with particular matters as they arise, including considerations of whether something falls within the definition of a financial product under the Corporations Act 2001. While we are unable to comment on specific entities, I advise that it does not appear from our records that this issue has been raised with ASIC in any formal sense.

 

Question on Notice #7

Page 34

MF Global – client money

Mr FLETCHER: I want to ask some questions about MF Global. It is reported that a number of Australians have had their balances in accounts with that international broker frozen following its collapse in the US. How actively is ASIC involved in efforts to recover those moneys?

Ms Gibson: There are two positions. Firstly, the MF Global subsidiary in Australia is being wound up. I thought that there was some money in the course of being released from the local broker. I do not know about the position of Australians with funds in the US or UK fund directly. Some of the moneys that were invested here went through to London. There is some money frozen there. We are in constant dialogue with the receivers. The receivers are seeking to negotiate a situation with the US administrators to extract some money that is held in London.

ANSWER

The issues in these types of external administrations can be very complex, with a mix of competing interests, and often require court intercession as was the case with MF Global Australia Limited (MFGA). MFGA was one of the largest futures brokers and providers of contracts for difference (CFDs) in Australia. Due to significant financial difficulties faced by its US-based parent, administrators were appointed to MFGA on 1 November 2011. MFGA subsequently went into liquidation on 2 March 2012.

Since the collapse of MFGA, ASIC has continued to monitor and engage with the liquidators of MFGA, as appropriate, including;

• obtaining regular updates on the progress of the administration and liquidation of MFGA;

• monitoring the various court applications to access the legal and policy implications; and

• engaging with the liquidators on disclosure to clients and creditors, including on issues associated the liquidators’ remuneration and costs.

The liquidators of MFGA instituted representative proceedings to obtain court orders regarding the distribution of client monies and amounts recovered from clearing houses and counterparties. Representatives of various categories of claimants appeared in these proceedings. On 29 August 2012 Justice Black of the NSW Supreme Court handed down his decision in these proceedings.[1] Following the decision, the liquidators of MFGA commenced a first partial distribution to clients on 31 October 2012. To date approximately $201 million (or an average of 63 cents in the dollar) has been distributed to clients and a further distribution is expected after Christmas.

There had been a dispute between MFGA and MF Global UK Limited (in special administration) (MFGUK) over approximately $36 million held by the ASX. This had been the subject of separate proceedings in the Federal Court. On 14 December 2012 the liquidators of MFGA announced they had reached an agreement with the special administrators of MFGUK to settle this dispute.

Relevantly, the dispute has been settled on the basis that:

• MFGUK will receive an amount of GB£400,000 (approximately AU$592,680); and

• MFGA will receive the balance of the disputed funds, being approximately AU$35.2 million.

The liquidators of MFGA anticipate receiving the funds from ASX shortly and will look to make a

further distribution to clients (specifically, futures clients) as soon as practicable.

Mr FLETCHER: It is reported that, although the clients were told that their moneys were going into a so-called client segregated account, they actually went into a pooled account and, when the firm collapsed, that became part of the pool of assets that creditors tried to recover against. Is that right?

Ms Gibson: I had thought that when the money was frozen that this was the subject of much discussion, although I might have to come back to you on notice about this. It has been to court and tested before Justice Black. He gave quite a long judgment in working out how the moneys that are available are to be divided up between the various classes of investor. Whether money is in a client segregated account is one of the criteria.

ANSWER

At the time of its collapse, MFGA held a substantial amount of funds in client segregated accounts. As an Australian financial services licensee and market participant MFGA was required to keep 'client money' in a client segregated account, separate from its own funds. Under the Corporations Act, moneys held in client segregated accounts are held in trust. However, the Corporations Act does not require a licensee to maintain a separate account for each client. Additional funds were subsequently able to be recovered from clearing houses and counterparties with which MFGA had open positions. Justice Black found the client segregated accounts maintained by MFGA should be grouped into four pools, representing the four product lines of MFGA (namely, futures, CFDs, online FX and margin FX). In addition, his Honour found that amounts recovered from clearing houses and counterparties were, on receipt by MFGA, to be held on trust under Chapter 7.8 of the Corporations Act. Accordingly, the funds recovered from counterparties are only available for distribution to the relevant client pool and not for general distribution to other creditors.

Mr FLETCHER: I am interested in understanding whether clients of MF Global are in a different position to clients of an Australian broker that they used to transact on the ASX or whether they are in exactly the same position.

Ms Gibson: We would need to take that on notice to give you a fully correct answer.

ANSWER

Under the ASIC market integrity rules, brokers holding client funds to trade on Australian futures markets are required to place those funds into a segregated account. As a market participant, MFGA adhered to this requirement. The clearing of MFGA futures trades was conducted by MFGUK. Clearing is a capital intensive business and it is common for one entity in a group, with a large capital base, to be a clearer in multiple markets for number of trading participants in the group. There had been a dispute between MFGA and MFGUK over the funds held by the ASX at the time of MFGA’s collapse, however this dispute has now been settled.

>>>>>>>>.

Mr FLETCHER: There was a suggestion in one of the press reports that a particular difficulty was that ASIC had granted an exemption to MF Global to allow it to use its British business as the market participant in Australia. Is that right or not?

Ms Gibson: I would need to take that on notice. I am not sure whether we or the ASX would have done that. If the problem was clearing participants, then probably the ASX would have done that.

ANSWER

MFGUK, an entity regulated by the UK Financial Services Authority, had been granted an exemption by ASIC from the requirement to hold an Australian financial services licence for certain financial services it provided to wholesale clients. The Corporations Act contemplates the granting of such exemptions.

The decision was made by the ASX to allow MFGUK to be a Clearing Participant.

Mr FLETCHER: All right. That was all I had.

.

.

 

Question on Notice #8

Page 34

Financial advice and the super cap

Senator BOYCE: I have had a couple of people complain to me about not receiving the best advice from their financial service providers or advisers, which has caused them to go over the cap on superannuation. Has that issue been raised with you? If so, what is ASIC thinking about that?

Mr Kell: We are aware of the issue and the fact that the change in the level of the cap means that advisers should be revisiting the strategies and arrangements that were put in place prior to July this year. First and foremost, it is an issue about which the ATO has been providing educational material and information to investors. That material talks about the cap and how they can manage that. We have not been receiving a significant number of complaints about this, but I will take it on notice to check whether we have had any. I will also check on whether we have referred any of those to the Financial Ombudsman Service for them to look at the quality of the advice that has been provided. At this stage, it has not been a big issue in terms of complaints that have come to us. We are aware of it. We think that it is the sort of issue that, as a matter of course, should be captured in knowledge d skills updates for financial advisers. We would like to see it incorporated into the training that advisers get.

ANSWER

ASIC has not received a significant number of complaints from consumers who have received advice that has caused them to exceed the concessional contributions cap. ASIC has, in fact, received 1 complaint and 2 breach notifications regarding excessive contributions to date in the 2012 calendar year. Both breach notifications were in respect of the conduct of one financial adviser.

One of these matters is being considered at the Superannuation Complaints Tribunal and the other two were managed through the relevant Australian financial services licensee's dispute resolution framework.

Received from the Australian Securities Exchange on 18 December:

ASX Further Response to Questions from the PJC

Question 1

“Would it be possible to get, on notice – I do not necessarily want to know the days – the meetings and the topic that is discussed at those meetings?”

 

Answer 1

Regular monthly meetings are held between ASX and ASIC representatives on:

a) Business Development, Operations and Technology matters discussion topics cover current business, technology and operational issues, including:

• ASX Business initiatives
• ASIC initiatives and regulatory issues
• Matters relating to the operation of the markets and clearing and settlement facilities
• ASX participants
• ASX and ASIC technology
• Changes to the operating rules and
• Consultations and submissions

b) Compliance related matters discussion of current compliance related issues, including:

• Run off case management
• Information requests
• Rule overlap or other rule issues
• Referrals
• Participant co-ordination and
• Participant capital monitoring

Question 2

“The MOU with ASIC – has it got a term to it?  Does it have to be renegotiated?”

Answer 2

There is no term. The MOU is ongoing.

 

Question 3

 “The memorandum of understanding that you have reached indicates that ASIC has capacity to advise the Australian Securities Exchange of a potential breach of the ASX operating rules, but it is limited by the Privacy Act and section 127 of the ASIC Act. Does the ASX receive from ASIC sufficient information to address breaches of its operating rules? Given the transfer of responsibility for supervision of the stock market from ASX to ASIC, should section 127 of the ASIC Act be reviewed to consider the ASX among entities which ASIC may provide confidential information to?”

Answer 3

The regular meetings outlined in Question 1 (above) together with daily discussions between ASX Compliance and ASIC staff and specific meetings/discussions relating to particular incidents/events/issues provide forums for ASX to obtain any relevant information from ASIC that ASX does not otherwise obtain itself through its operational or compliance activities.  Also, ASIC has this year released information to ASX pursuant to section 127 to enable ASX to pursue enforcement action against ASX participants.

 In relation to the question about section 127 of the ASIC Act being reviewed, we believe this is not necessary for ASX Group licensees. However, it could be helpful if the Securities Exchanges Guarantee Corporation (the trustee of the National Guarantee Fund) was included in the list of bodies corporate in Part 1 of Schedule 3. SEGC has statutory powers under section 892D to require production of documents or statements to assist it in determining a claim for compensation in respect of a broker, but these powers do not apply to ASIC. The inclusion of SEGC in the list in Part 1 of Schedule 3 will facilitate cooperation between SEGC and ASIC in relation to the sharing of information. This is particularly important now that broker supervision functions have been transferred to ASIC.

 

Question 4

“Could you provide on notice some examples from the US market where the level of high frequency trading and dark pools activity has had very negative outcomes of the kind we are seeking to prevent?”

Answer 4

Below are reports/extracts of high frequency trading and dark pool activity:

The US flash crash date and summary of what occurred

On May 6, 2010, the prices of many U.S.-based equity products experienced an extraordinarily rapid decline and recovery. That afternoon, major equity indices in both the futures and securities markets, each already down over 4% from their prior-day close, suddenly plummeted a further 5-6% in a matter of minutes before rebounding almost as quickly.

Many of the almost 8,000 individual equity securities and exchange traded funds (“ETFs”) traded that day suffered similar price declines and reversals within a short period of time, falling 5%, 10% or even 15% before recovering most, if not all, of their losses. However, some equities experienced even more severe price moves, both up and down. Over 20,000 trades across more than 300 securities were executed at prices more than 60% away from their values just moments before. Moreover, many of these trades were executed at prices of a penny or less, or as high as $100,000, before prices of those securities returned to their “pre-crash” levels.

By the end of the day, major futures and equities indices “recovered” to close at losses of about 3% from the prior day.

http://www.sec.gov/news/studies/2010/marketevents-report.pdf

The BATs and Facebook IPOs dates and summary of what occurred

BATS experienced a serious technical failure on Friday, March 23, 2012 which caused it to withdraw its own IPO.

BATS experienced a system problem in our attempt to open the BATS ticker symbol for the first time on Friday morning. We failed to roll into continuous trading with our new BATS ticker immediately following the opening auction. In effect, our newly issued stock did not begin trading as it should and was halted before it ever started trading.

Technology implementations are prone to failures and unexpected outcomes, even after going through rigorous testing. Every market center and every trading participant has experienced technical issues in their history. Our historical reliability has been very strong, with 99.9% uptime on our primary BATS BZX Exchange over the last 3+ years. On Friday we were under the brightest spotlight imaginable ... opening our own stock on our own exchange for the first time ever. It doesn’t get much more public than that.

Our listing Exchange has an obligation to operate and maintain fair and orderly markets. In the ordinary course, when an exchange experiences a technical problem, normal trading in the affected securities resumes once the technical problem is resolved. This situation was unique, however, because the affected security was our own. After fixing the software module that failed, and rolling it back into production, we were faced with how the market would react to a re-opening of our stock after the failed first start. Had the delay been only a few minutes, the restart process would have possibly been manageable. But after 2 ½ hours had transpired, we determined that this was a material event that had eroded investor confidence in our own stock and made the timely resumption of fair and orderly trading unlikely. As a result, we pulled the IPO and unwound all auction executions.

http://www.batstrading.com/resources/newsletters/CEO_Newsletter_25Mar2012.pdf

Facebook

On May 18, 2012, Nasdaq experienced system difficulties during the Nasdaq Halt and Imbalance Cross Process (the “Cross”) for the FB IPO. These difficulties delayed the completion of the Cross from 11:05 a.m. until 11:30 a.m...

As a result of the system difficulties, however, certain orders for FB stock that were entered between 11:11:00 a.m. and 11:30:09 a.m. in the expectation of participating in the Cross

– and that were not cancelled prior to 11:30:09 – either did not execute or executed after 1:50 p.m. at prices other than the $42.00 price established by the Cross. (Other orders entered between 11:11:00 a.m. and 11:30:09 a.m., including cancellations, buy orders below $42.00, and sell orders above $42.00, were handled without incident.) System issues also delayed the dissemination of Cross transaction reports from 11:30 a.m. until 1:50 p.m. At 1:50 p.m., Nasdaq system difficulties were completely resolved...

As a result of these unique circumstances, Nasdaq is proposing to accommodate members for losses attributable to the system difficulties on May 18, 2012 in an amount not to exceed $62 million.

https://www.sec.gov/rules/sro/nasdaq/2012/34-67507.pdf

Knight Capital malfunction date and summary of what occurred

Knight Capital Group Provides Update Regarding August 1st Disruption To Routing In NYSE-listed Securities

As previously disclosed, Knight experienced a technology issue at the open of trading at the NYSE yesterday, August 1st. This issue was related to Knight's installation of trading software and resulted in Knight sending numerous erroneous orders in NYSE-listed securities into the market. This software has been removed from the company's systems.

Clients were not negatively affected by the erroneous orders, and the software issue was limited to the routing of certain listed stocks to NYSE.

Knight has traded out of its entire erroneous trade position, which has resulted in a realized pre-tax loss of approximately $440 million. Although the company's capital base has been severely impacted, the company's broker/dealer subsidiaries are in full compliance with their net capital requirements. Knight will continue its trading and market making activities at the commencement of trading today. The company is actively pursuing its strategic and financing alternatives to strengthen its capital base.

http://www.knight.com/investorRelations/pressReleases.asp?compid=105070&releaseID=1721599

Other issues or incidents in the US

Flash order controversy at Direct Edge. Direct Edge withdrew the practice of flashing customer orders to their liquidity providers before routing unfilled orders to other venue in 2011.

Number of dark pools operating in the US

According to Mary Schapiro there are 15 public exchanges, more than 30 dark pools, 3 electronic communication networks (ECNs), and more than 200 internalizing broker-dealer.s

Proportion of off market trading in the US

According to Fidessa, 32% in FY13.

Proportion of retail flow executed on lit exchanges

Internalisation is also thought to account for almost 100% of all retail marketable order flow. Retail internalization is driven by the purchase of order flow by wholesale OTC market makers from retail brokerage firms. This practice enables broker/dealers to “preference” those orders that are profitable to arbitrage and route unwanted orders to other market centers

Dark Pools, Internalization, and Equity Market Quality, CFA Institute 2012

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