The Australian regulatory environment surrounding financial institutions, in particular financial intermediaries, has been significantly influenced by recent events in the United States, and there is currently considerable focus on conflicts of interest affecting such institutions.
In Australia, the conduct of financial intermediaries is regulated by the general law, including equitable principles, and by statutory obligations under the Corporations Act 2001 (Cth) (Corporations Act), in particular the requirements as to financial services licensees contained in Part 7.6 and as to conduct of business contained in Part 7.8. The Australian Securities & Investments Commission (ASIC) has responsibility for the regulation of financial services, including enforcing the provisions of the Corporations Act concerned with the conduct of transactions in financial products. Australian Stock Exchange Limited (ASX) also undertakes regulatory functions in relation to the market for listed equities and other listed financial products and Sydney Futures Exchange Limited (SFE) conducts regulatory functions in respect of the futures market.
Australian financial institutions and particularly financial intermediaries are similarly structured to such institutions in the United Kingdom and the United States. Australian financial intermediaries commonly perform multiple functions, including the provision of broking and research services to clients; proprietary trading; underwriting of public offerings and private placements; and the provision of investment banking services, including advice to corporate clients. Commission-based remuneration structures are relatively common amongst Australian financial intermediaries, giving rise to a conflict between an institution’s or individual employee’s incentive to maximise their commission income by undertaking volume trading, and the client’s interest in maximising returns on investments and minimising transaction costs. The recognition of this conflict has prompted a move away from commission-based arrangements in financial intermediaries which primarily service institutional clients.
It is common in Australia for research to be provided by analysts employed by financial intermediaries to clients of those intermediaries, and for the costs of that research to be recouped through trading commissions rather than being separately charged to the clients. Therefore, an analyst’s recommendation which results in increased trading in a financial product could tend to increase the commission revenues of the relevant intermediary, and an analyst’s adverse report could adversely affect the intermediary’s investment banking activities. Consequently, there is scope within the Australian market for the types of conflict of interest that have generated recent controversies in the United States.
In November 2001 the Securities Institute of Australia and the Securities and Derivatives Industry Association released Best Practice Guidelines for Research Integrity, which is intended to assist analysts and financial intermediaries manage conflicts of interest that might affect the integrity of research. The rule changes made by the National Association of Securities Dealers and New York Stock Exchange in May 2002 prohibiting certain research practices and strengthening disclosure obligations for analysts and firms have also had an impact in Australia, since a number of Australian intermediaries are subsidiaries of US entities and adopted the practices required by the US rules. ASIC in turn has published a surveillance report dealing with research analyst independence on 22 August 2003, which did not identify any contraventions of the Corporations Act, but indicated ASIC’s view that there was “an unacceptable level of reliance, in some entities, on staff integrity to avoid and manage conflicts of interest”. IOSCO, of which ASIC is a member, also published a Statement of Principles for Addressing Sell-Side Securities Analyst Conflicts of Interests and a report on analyst conflicts of interest in September 2003.
General law fiduciary principles
Under Australian law, the relationship between a financial intermediary and its financial advisory clients is not necessarily fiduciary in character. An intermediary which holds itself out as having expertise in advising on investments and undertakes to give advice to its client may owe a fiduciary duty to that client: Daly v Sydney Stock Exchange (1986) 160 CLR 371 at 385, per Brennan J; Aequitas Pty Ltd v Sparad No 100 Ltd (formerly Australian European Finance Corp Ltd) (2001) 19 ACLC 1006, [2001] NSWSC 14. In particular, a stockbroking firm which acts as agent for a client will owe a fiduciary duty to that client, arising from the agency relationship: Daly v Sydney Stock Exchange, above.
Under Australian law, a fiduciary relationship gives rise to two proscriptive obligations, namely that a fiduciary may not have a conflicting personal interest or conflicting duty owed to a third party (the “no conflict” rule) and may not profit from its fiduciary position without the beneficiary’s consent (the “no profit” rule): Breen v Williams (1996) 186 CLR 71, 138 ALR 259; Pilmer v Duke Group Ltd (2001) 207 CLR 165, 180 ALR 249; Aequitas v Sparad No 100 Ltd, above. For example, a stockbroker which is in a fiduciary relationship with its client is under a duty not to compete with its client in trading on its own account: Hewson v Sydney Stock Exchange (1968) 2 NSWR 224; Bonds & Securities (Trading) Pty Ltd v Glomex Mines NL [1971] 1 NSWLR 879; Daly v Sydney Stock Exchange Ltd, above. However, Australian law does not treat a fiduciary relationship as giving rise to positive duties to protect the principal’s interests, disclose information or provide advice. Furthermore, the extent of any fiduciary duty may be narrowed by the scope of the contract between the fiduciary and beneficiary which gave rise to the relationship: Hospital Products Ltd v United States Surgical Corporation (1986) 156 CLR 41 at 97.
The statutory efficiently, honestly and fairly standard
Australian financial intermediaries (and offshore intermediaries dealing in the Australian market, in certain circumstances) are required to hold an Australian financial services licence. A financial services licensee is required to do all things necessary to ensure that the financial services covered by its licence are provided “efficiently, honestly and fairly”: Corporations Act s 912A(1)(a). Action taken by a licensee in conflict of interest may well breach that standard, leading to revocation of its financial services licence: R J Elrington Nominees Pty Ltd v Corporate Affairs Commission (1989) 1 ACSR 93.
The statutory obligation to manage conflicts of interest
The Corporate Law Economic Reform Program (Audit Reform and Corporate Disclosure) Act 2003 introduced s 912A(1)(aa) into the Corporations Act which requires a financial services licensee to have in place adequate arrangements for managing conflicts of interest that arise wholly, or partly, in its financial services business. That section took effect from 1 January 2005. The Explanatory Memorandum to this amendment noted that the amendment was prompted, in part, by international experience with conflicts of interest and particularly issues arising in respect of securities analysts in the United States in 2002; and that the intent of s 912A(1)(aa) was to require licensees to adequately disclose conflicts to investors, and to have internal policies and procedures for preventing and addressing potential conflicts of interest.
ASIC Policy Statement 181 – Licensing: Managing conflicts of interest
ASIC Policy Statement 181 (30 August 2004) indicates ASIC’s view that arrangements to manage conflicts of interest, in compliance with s 912A(1)(aa) of the Corporations Act, need to include arrangements to control, avoid and disclose conflicts of interest as appropriate. That Policy Statement defines a conflict of interest as “circumstances where some or all of the interests of people (clients) to whom a licensee (or its representatives) provides financial services are inconsistent with, or diverge from, some or all of the interests of the licensee or its representatives” and notes that this includes actual, apparent and potential conflicts of interest (PS 181.15). The Policy Statement acknowledges that, notwithstanding the existence of a conflict of interest, a licensee may still provide financial services if it takes proper steps to manage that conflict. In particular, the Policy Statement notes that:
“The conflicts management obligation does not prohibit all conflicts of
interest. It does not provide that a licensee can never provide financial
services if a conflict of interest exists. Rather, the conflicts management
obligation requires that all conflicts of interest be adequately managed” (PS
181.27).
Policy Statement 181 indicates that the conflicts management obligation requires that a licensee ensure that the quality of its financial services “is not significantly compromised by conflicts of interest” and those services are not “of materially lesser quality than the licensee would have been likely to provide if they were not subject to the relevant conflict of interest” (PS 181.14). That Policy Statement indicates that, to control a conflict of interest, a licensee must identify relevant conflicts; assess and evaluate those conflicts; and decide upon and implement an appropriate response to them (PS 181.29). The Policy Statement identifies conflict management arrangements as including measures such as meetings with affected staff or clients; periodic reviews of business operations by an internal or external auditor or other independent person; or periodic review of client files and records of services provided (PS 181.32).
Policy Statement 181 also indicates the need to make appropriate disclosures to the client as part of arrangements to manage conflicts of interest. The Policy Statement notes that “adequate disclosure means providing enough detail in a clear, concise and effective form to allow clients to make an informed decision about how the conflict may affect the service provided to them” (PS 181.50). The Policy Statement expresses the view that generic disclosures are unlikely to satisfy the conflicts management obligation (PS 181.53), and gives examples of specific matters which would generally need to be disclosed to a client at the time of providing financial product advice, namely:
product and the product issuer. The Policy Statement also acknowledges that disclosure obligations may be qualified by Chinese walls, noting that “where the relevant people do not have actual or constructive knowledge about a given matter owing to the operation of effective information barriers, the conflicts management obligation will not necessarily require them to make disclosures about the matter” (PS 181.62).
ASIC also notes that some conflicts of interest are such that the only way to manage them will be to avoid them, so that disclosure and the imposition of internal controls would not be adequate. ASIC gives several examples of such conflicts:
conflict of interest in a particular product (PS 181.42). Policy Statement 181 also expresses the view that conflict management arrangements are unlikely to be adequate unless compliance monitoring records are kept; and indicates that ASIC expects licensees to keep, for at least seven years, records of conflicts identified and actions taken, any reports given to the licensee’s owners or senior management about conflict of interest matters and copies of written conflict of interest disclosures given to clients or to the public as a whole.
Steps to avoid or mitigate conflicts of interest
Steps which may be available to mitigate conflicts of interest include limiting the scope of a financial institution’s retainer by agreement with the client; obtaining the client’s consent to the conflict after making full disclosure of material facts; introducing mechanisms for independent oversight or decision-making, where those employees who might otherwise make the decision are conflicted; and reconstituting boards and committees so as to ensure that their members are not conflicted. Chinese walls may also be used as a means to avoid or mitigate conflicts of interest, by avoiding the inappropriate flow of information between business areas. Chinese wall arrangements are already relatively common in Australian financial institutions, since there is an exception to the prohibition on insider trading under Australian law where trading is undertaken by a person who does not possess non-public price-sensitive information by reason of a Chinese wall arrangement within a financial intermediary.
Market participants on ASX also typically maintain Chinese walls in order to rely on an exception to Market Rule 7.18, which would otherwise prohibit a market participant which is in possession of non-public market-sensitive information, as a result of its relationship to a client, from giving advice to another client of a nature that would damage the interest of either of those clients. Under ASX’s Guidance Note Prohibition of Advice to Clients (reissued on 11 March 2004), ASX market participants which maintain Chinese walls must have a written policy statement which forbids the communication of non-public information to staff members who offer financial products advice or dealing services, which must be distributed to and reviewed by all staff. ASX also requires market participants which maintain Chinese walls to impose physical access restrictions to isolate staff and documents that may have or contain non-public market-sensitive information, including separate management or supervision, and to limit upon staff transfers between areas to limit the risk of the Chinese walls being breached.
Research report providers
ASIC has also published a guide titled Managing Conflicts of Interest: An ASIC Guide for Research Report Providers in November 2004. That guide identifies steps which should be taken by research providers in developing and implementing arrangements for controlling and avoiding conflicts of interest. In particular:
product issuer, including any other services it provides to the product issuer; and any assistance given by the product issuer in preparing the report; and should also disclose the date the research report was written and who took responsibility for it, and the reasons for the opinions and recommendations in that report (paras [3.7]–[3.13]). ASIC also notes that it would be inadequate to make a generic statement that the research provider may from time to time have interests in the financial products that are the subject of the research (para [3.8]).
Further disclosure obligations
Part 7.7 of the Corporations Act also imposes further disclosure obligations as to conflicts of interest on financial services licensees who provide services to retail clients. In particular, a financial services licensee and its authorised representative must give a Financial Services Guide (FSG) to a retail client to which it provides financial services: Corporations Act ss 941A–941B. That FSG must disclose all remuneration, commissions and other benefits attributable to the provision of the relevant services and any associations or relationships with the issuers of financial products that might be capable of influencing the relevant advice: ss 942B–942C. A financial services licensee must also give a Statement of Advice (SoA) to a retail client to which it provides advice: s 946A(1). That SoA must disclose remuneration, commissions and other benefits, any other interests and any associations and relationships with issuers of any financial product that might be capable of influencing the advice or any other authorised services, in the level of detail which a retail client would reasonably require for the purpose of deciding whether to act on the advice: ss 947B–947C.
Allocation conflicts
Recent events in the United States have also included allegations that investment banks allocated shares in initial public offerings which were likely to trade at a premium to the issue price (“hot IPOs”) to directors and officers of clients in exchange for continuing investment banking relationships, or in circumstances that those clients were paying higher commissions for trading services provided to the client. That conduct may also involve a conflict between the interests of the issuer and the interests of the financial intermediary, if it involves underpricing of securities issued by the issuer, to facilitate the issue of securities to corporate executives who intend to sell out at a profit immediately following the issue (“flipping”). That conduct may also give rise to a conflict between the corporate executive’s interest and his or her employer’s interests when a decision is made as to the allocation of future business. There is less evidence of such conduct in Australia, possibly because of the widespread use of bookbuilding to determine allocations in Australian initial public offerings. At least if such conduct involves underpricing of securities, it could be characterised, since 1 January 2005, as a contravention of s 912A(1)(aa) requiring the licensee to maintain adequate arrangements to manage conflicts of interest.
Trading conflicts
There are also specific provisions in the Corporations Act dealing with conflicts of interest in trading activities of financial services licensees. If a financial services licensee is fiduciary to its client, or acts as agent for its client, it is under a duty not to enter the market and trade in competition with that client: Hewson v Sydney Stock Exchange Ltd [1968] 2 NSWR 224 at 231. Section 991B of the Corporations Act also applies if a client has instructed a financial services licensee to buy or sell financial products of a particular class that are able to be traded on a licensed market, and the licensee has not executed the transaction. In that situation, the licensee must not (except as permitted by limited exceptions) enter into or instruct another person to enter into a transaction of purchase or sale of financial products of that class on its own behalf or on behalf of an associate of the licensee: s 991B(2). However, the prohibition in s 991B(2) does not apply to transactions entered into by a participant in a licensed market in accordance with the operating rules of the licensed market: reg 7.8.17. Rule 7.5 of the ASX Market Rules deals with client order priority in transactions on ASX, and therefore excludes the operation of s 991B. That rule requires a market participant to deal fairly and in due turn with client orders and with a client order and an order on its own account.
Soft dollar arrangements
“Soft dollar” arrangements are another area of potential conflict of interest in Australia. Soft dollar benefits include benefits received by financial advisers and financial intermediaries if they recommend certain products, other than by way of fees paid by the client for their advice or commissions payable by the product issuer. A similar issue arises from the practice by which part of the brokerage fee payable by a fund manager to a financial intermediary is then paid by that intermediary to a third party on the fund manager’s direction. If undisclosed, such arrangements can conceal the full charges made by fund managers to investors, by presenting payments which are ultimately received by the manager or applied for its benefit as third-party commissions.
At general law, a fiduciary obligation owed by a financial services licensee or adviser to its client would require disclosure of such soft dollar benefits to the client, or alternatively that the adviser or licensee account to the client for those benefits. The Corporations Act also requires that soft dollar benefits received by a fund manager should be disclosed in the FSG and SoA provided to retail clients: Corporations Act ss 942B–942C, 947B–947C. The disclosure of such arrangements is also required under codes of ethics adopted by self-regulatory organisations, such as Rule 106 of the Code of Ethics of the Financial Planning Association. The licensee’s obligation to manage conflicts of interest under s 912A(1)(aa) of the Corporations Act would also require the licensee to disclose such benefits to its clients.
The Secret Commissions Act 1905 (Cth) also prohibits anyone from offering to an agent (including an employee), and prohibits an agent from accepting, a gift or inducement likely to influence the agent to do or refrain from doing any act on behalf of the principal. That prohibition is not limited to a bribe offered to a government or public official, and also extends to a bribe offered to an employee or agent of a company. If the Secret Commissions Act applies, a commission or inducement may not be accepted by a financial intermediary without the “full knowledge and consent” of the client. The statutory criminal law of the Australian states and territories also impose prohibitions similar to those imposed under the Secret Commissions Act (Cth).
As noted above, the issue of conflict of interest has been a focus of attention by Australian industry and regulatory bodies for several years, and Australian practice has been influenced by developments in the United States during 2002. Part 7.7 of the Corporations Act imposes disclosure obligations as to conflicts of interest on financial services licensees who provide services to retail clients; the amendments made by the Corporate Law Economic Reform Program (Audit Reform and Corporate Disclosure) Act 2003 introduce the further requirement for a financial services licensee to have in place adequate arrangements for managing conflicts of interest; and ASIC Policy Statement 181 outlines ASIC’s expectations in that area. It is unlikely that there will be significant legislative developments in the regulation of conflict of interest in respect of financial institutions in Australia in the immediate future, given the recent legislative change. It is also unlikely that there will be extensive regulatory activity in the area, since it is generally thought that the more egregious practices identified in the United States had not occurred, or had only rarely occurred, in Australia.
As to regulation of conflicts of interest, see J Moutsopoulos, Finance Industry has Duty to Manage Conflicts (2005) IFLR 41; and ASIC Policy Statement 181 and ASIC’s guide titled Managing Conflicts of Interest: An ASIC Guide for Research Report Providers, which are available on ASIC’s website at www.asic.gov.au.
Conflicts of interests affecting auditors, and particularly the question of auditor independence, have also been an area of recent regulatory development in Australia. The Corporate Law Economic Reform Program (Audit Reform and Corporate Disclosure) Act 2003 introduced detailed provisions dealing with auditor independence into the Corporations Act. Auditor independence is also regulated by auditing standards promulgated by the Auditing and Assurance Standards Board of the Australian Accounting Research Foundation as well as professional ethical rules of CPA Australia, the Institute of Chartered Accountants in Australia and the National Institute of Accountants.
Auditor independence has come under further scrutiny in Australia partly as a result of local events and partly as a result of international developments. A number of Australian listed companies failed, including One.Tel and HIH Insurance Limited, at about the same time as the Enron and WorldCom failures in the United States. In at least one of those failures, that of HIH Insurance, the extent of relationships between management and the audit firm, Arthur Andersen, came under particular scrutiny. In August 2001, the Commonwealth Minister for Financial Services commissioned a report on auditor independence, which was released in October 2001. The Corporate Law Economic Reform Program (Audit Reform and Corporate Disclosure) Act 2003 introduced statutory requirements as to auditor independence, with effect from 1 July 2004. A number of major Australian companies also have securities listed in the United States and are therefore also required to comply with certain requirements of the Sarbanes-Oxley legislation, particularly in relation to the scope of permissible non-audit services.
General requirement for auditor independence
The Corporations Act establishes the statutory framework within which audits take place. A company must appoint an auditor to audit its annual financial reports, and either audit or review its half-year financial reports, and prepare an auditor’s report to company members: Corporations Act ss 301, 302(b).
The Corporate Law Economic Reform Program (Audit Reform and Corporate Disclosure) Act 2003 introduced a general requirement for auditor independence into the Corporations Act. Sections 324CA–324CC of the Corporations Act prohibits an auditor, audit firm or audit company from engaging in audit activity in relation to an audited body if a “conflict of interest situation”, as defined, exists in relation to that audited body at the relevant time. An individual auditor, audit company, member of an audit firm or director of an audit company contravenes the Corporations Act if, if he, she or it:
A member of an audit firm or director of an audit company also contravenes the Corporations Act if:
director of that company would have been aware of that conflict if that firm or company had in place a quality control system reasonably capable of making him, her or it aware of that conflict (Corporations Act ss 324CB(6), 324CC(6)).
These sections can impose liability on a member of an audit firm or director of an audit company not only if he or she is aware of the conflict, but also if he or she lacked that knowledge because the firm did not have adequate control systems in place. Those sections might be contravened, for example, if the auditor’s independence is compromised by a relationship between the auditor or an individual member of the audit team and the audited company, a current or former director of the company, or current or former management of the company. A defence is available to an offence arising from a contravention of s 324CA(2) by an individual auditor or audit company, or a contravention of s 324CB(2) or (4) by a member of an audit firm or of s 324CC(2) or (4) by a director of an audit company, if the individual auditor, audit company, member of the audit firm, or audit company director had reasonable grounds to believe that the individual auditor, audit firm or audit company respectively had a quality control system in place at the time that provided reasonable assurance (taking into account the size and nature of the individual auditor’s practice, the audit firm or audit company) that the individual auditor, firm, audit company and their employees complied with the relevant requirements: Corporations Act ss 324CA(4)–(5), 324CB(6), 324CC(6).
The Corporations Act also requires auditors to make an annual declaration that the auditor has complied with the auditor independence requirements of the Corporations Act and any applicable codes of professional conduct in relation to the relevant audit or review: Corporations Act s 307C.
Prohibited relationships between a company and its auditors
The Corporations Act also prohibits several financial and employment relationships between a company and its auditors.
An auditor or audit firm is prohibited from engaging in audit activity where specified relationships exist between persons specified in a table in ss 324CE(5), 324CF(5) or 324CG(9) and the audited body as specified in s 324CH(1): Corporations Act ss 324CE(1), 324CF(1) and 324CG(1). For example, an audit firm is prohibited from engaging in audit activity if it employs an officer or audit-critical employee of the audited company or provides remuneration to such a person or has various forms of financial relationship with the audited entity.
It is also an offence for a former partner of the audit firm to become an officer of an audited body (other than a small proprietary company) or (in the case of a listed entity) a related body corporate of the audited body before the expiry of two years after he or she leaves the firm: s 324CI. A similar prohibition applies to a former professional member of the audit team,1 other
1 The term “professional members of the audit team” is defined in s 324AE as any registered company auditor who participates in the company audit, any other person who participates in the audit in a manner that involves exercising professional judgment as to accounting and audit standards or provisions of the Corporations Act and any other
than a partner, who is also prohibited from becoming such an officer before the expiry of two years after he or she leaves the firm: s 324CJ. Except where the audited company is a small proprietary company, no more than one former partner of an audit firm may become a director of that company: s 324CK.
Rotation of members of audit team
The Corporations Act also requires rotation of key members of the audit team, and limits the period over which an individual may play a “significant role” (as defined in Corporations Act s 9) in the audit of a listed company or listed registered scheme.
An individual who plays a significant role in the audit of a listed company or listed registered scheme for five consecutive years may not then play a significant role in the audit of that company or scheme during a two-year “cooling off” period: s 324DA(1). An individual is also prohibited from playing a significant role in the audit of a listed company or scheme if he or she would thereby have played a significant role in the audit of that company or scheme for more than five out of seven successive financial years: s 324DA(2).
An audit firm must take necessary steps, as soon as possible after a partner becomes aware that an individual is not eligible to play a significant role in the audit of a listed company or listed registered scheme as lead or review auditor, either to ensure that the individual ceases to act as lead or review auditor in relation to the company or scheme or otherwise that the firm resigns as auditor: s 324DC.
Non-audit services
In principle, the extensive provision of non-audit services by an audit firm to its audit client can raise a potential conflict of interest, so far as the audit firm owes a duty only to the relevant company in respect of non-audit services, whereas its audit services are also directed to protecting the interests of shareholders and the investing public. In January 2002, ASIC released the results of a survey into the relationship between Australia’s 100 largest companies and their auditors, which found that non-audit fees accounted for nearly 50 per cent of total fees paid to the relevant audit firms. The extent of non-audit fees derived by audit firms from Australian listed entities suggested that the relationship between such listed entities and their auditors was exposed to the same risk identified by recent US experience, that auditors may be reluctant to confront clients as to the appropriateness of accounting policies and expose themselves to the risk of loss of lucrative non-audit fees.
The annual directors’ report of a listed company is required to include details of the amount paid to the auditor for non-audit services provided during the year; a statement that the directors are satisfied that the provision of non-audit services is compatible with the general standard of auditors’ independence imposed by the Corporations Act; and a statement of the
person in a position directly to influence the outcome of the audit. This definition is designed to cover the people in the audit firm or audit company who are most directly in a position to influence the audit (Explanatory Memorandum to the Corporate Law Economic Reform Program (Audit Reform and Corporate Disclosure) Bill para 5.113).
directors’ reasons for being satisfied that the provision of non-audit services did not compromise the auditor independence requirements of the Corporations Act: Corporations Act s 300(11B). Unlike the position in the United States arising from the Sarbanes-Oxley legislation, the Corporations Act does not treat any particular non-audit services as necessarily incompatible with auditor independence.
Professional standards
The Institute of Chartered Accountants in Australia and CPA Australia have jointly issued Professional Standard F1: Professional Independence dealing with auditor independence, which was revised with effect from 1 January 2005. That standard also requires rotation of lead engagement and audit review partners every five years; requires a written independence declaration by the auditor for each half year and full year financial report; and imposes restrictions on financial interests, loans and borrowings between an audit firm, audit partner or member of the audit team or their immediate family, on the one hand, and an audit client, on the other; imposes limits on consultancy arrangements and also imposes limits on auditors being employed by audit clients.
The Corporate Law Economic Reform Program (Audit Reform and Corporate Disclosure) Act 2003 and the indirect impact of the Sarbanes-Oxley legislation (and its direct impact on Australian companies with securities traded on US markets) are leading to significant changes in Australian audit practice.
As in the United States, the Australian audit firms have typically separated from or disposed of their consultancy businesses. It appears that the four major Australian audit firms, which are associated with global audit firms, are now less likely to accept non-audit engagements from their audit clients due to the potential for perceived conflicts, and the possible contravention of the Sarbanes-Oxley legislation in respect of Australian listed companies whose securities are traded in the United States. Particularly in the area of insolvency services, a number of partners of the larger audit firms have left to establish independent insolvency practices, in order to seek to minimise the impact of conflicts of interest on their workflow.
It is also likely that audit fees will increase, since there is now less incentive for audit firms to discount those fees in order to obtain access to companies’ other non-audit work, and those firms perceive the amendments made by the Corporate Law Economic Reform Program (Audit Reform and Corporate Disclosure) Act 2003 as giving rise to increased compliance costs and greater legal risk. ASIC is also conducting a regulatory inquiry reviewing the extent to which larger audit firms are complying with the new auditor independence requirements.
The Corporate Law Economic Reform Program (Audit Reform and Corporate Disclosure) Act 2003 is available from the Attorney-General’s website at www.comlaw.gov.au and background materials to that Act are available at www.treasury.gov.au. Following the amendments made by the Corporate Law Economic Reform Program (Audit Reform and Corporate Disclosure) Act, ASIC issued Policy Statement 180 dealing with auditor registration and revised Practice Note 34 dealing with auditors’ obligations to report certain matters to ASIC, which are available on ASIC’s website at www.asic.gov.au. Professional Standard F1 – Professional Independence issued by the Institute of Chartered Accountants in Australia and CPA Australia is available at www.cpaaustralia.com.au.
Unlike the position as to conflicts of interest affecting financial institutions and auditors, conflicts of interest affecting lawyers has not been a matter of recent controversy in Australia. The position as to conflict of interest is governed by legislation, case law and professional rules in Australia. Since lawyers are officers of the court, they also fall within the jurisdiction of the Supreme Courts of the Australian States and Territories and the Australian Federal Courts. The Australian states have also enacted legislation dealing with conduct of lawyers and the professional bodies also exercise discipline over their members.
The Australian legal environment is relatively concentrated, with several large firms being retained in most major transactions and complex litigation. The larger Australian firms typically act for clients in banking, merchant banking and insurance which are competitors in aspects of their business. The Australian firms, and particularly the larger firms, have well-developed procedures to seek to avoid conflict of interest, including taking conflict searches prior to accepting new instructions. Chinese walls may be established, with client consent, to allow a firm to act for more than one party in a complex commercial transaction, although such arrangements are rarely, if ever, implemented in litigation.
Acting for clients with conflicting interests at the same time
Australian law generally treats the relationship between a lawyer and his or her client as fiduciary in character, since the solicitor-client relationship has at its core an element of confidence and influence which equity will preserve and protect: Beach Petroleum NL v Abbott Tout Russell Kennedy (1999) 48 NSWLR 1 at [188]–[189]. A lawyer has a duty to avoid any real and sensible possibility of conflict between his or her duty to serve his or her client’s interests and his or her personal interests; any actual conflict between the lawyer’s duty to serve a client’s interests and his or her duty to serve another client’s interests; and any real risk of a conflict between the lawyer’s duty to hold information of a former client confidential and his or her duty to serve another client’s interests by divulging that information, unless the lawyer obtains the consent of the relevant clients to his or her acting for both clients after disclosing all material facts, or the duty is limited by contract with the clients’ fully informed consent: Oceanic Life Ltd v HIH Casualty and General Insurance Ltd & Ors [1999] NSWSC 292 at [40]. The decision of the Privy Council in Clarke Boyce v Mouat (1994) 1 AC 428, [1993] 3 WLR 1021 establishes that a lawyer should not act for more than one party without the informed consent of each of the parties, being consent given by the client in the knowledge that there is an actual or potential conflict between the parties’ interests, and also that the lawyer, while acting for all parties, may be prevented from disclosing all relevant information to each party or giving advice to one party contrary to the other’s interests. The degree of sophistication of the client may be relevant to determining the adequacy of the disclosure made to that client: Taylor v Schofield Peterson [1999] 3 NZLR 434.
A lawyer who acts for two parties to a transaction in circumstances of conflict of interest without the fully informed consent of those parties will be liable for breach of fiduciary duty: Nocton v Lord Ashburton [1914] AC 932; Day v Mead [1987] 2 NZLR 443; Waimond Pty Ltd v Byrne (1989) 18 NSWLR 642; Blackwell v Barroile Pty Ltd (1994) 51 FCR 347 at 359–360, 123 ALR 81 at 92–93. If a lawyer acts for a client in a matter in which he or she has a personal interest, that transaction may be set aside in the absence of proper disclosure of that interest: Maguire v Makaronis (1997) 188 CLR 449, 144 ALR 729.
The general law position is reinforced by the professional rules made by Australian law societies. For example, Rule 9 of the Revised Professional Conduct and Practice Rules 1995 (NSW) provides that a lawyer who intends to accept instructions from more than one party to any proceedings or transaction must be satisfied, before accepting a retainer to act, that each of the parties is aware that the lawyer is intending to act for the others and consents to the lawyer so acting in the knowledge that the lawyer may thereby be prevented from disclosing to each party all information, relevant to the proceedings or transaction within the lawyer’s knowledge, or giving advice to one party which is contrary to the interests of the other, and will cease to act for all parties if the practitioner would otherwise be obliged to act in a manner contrary to the interests of one or more of those parties. That rule goes further than the decision in Clarke Boyce, above by requiring a lawyer who is acting for more than one party to any proceedings or transaction, and who determines that he or she cannot continue to act for all of those parties without acting in a manner contrary to the interests of one or more of them, to cease to act for all of those parties.
Generally, the rules of Australian courts provide that a lawyer cannot represent two parties in the same litigation if, even through not directly opposed to one another, the interests of the clients are not the same: for example, NSW Supreme Court Rules Pt 66 rule 2, Federal Court Rules Order 45 rule 2. In relation to transactional work, Australian courts have expressed the view that the practice of a lawyer acting for both vendor and purchaser in a transaction is undesirable: Commonwealth Bank of Australia v Smith (1991) 42 FCR 390, 102 ALR 453 at 478. Similarly, conflicts of duty have been found to have arisen as a result of a solicitor acting for mortgagor and mortgagee, lessor and lessee and guarantor and lender.
Acting against a former client
Before the decision of the House of Lords in Prince Jefri Bolkiah v KPMG [1999] 2 AC 222, [1999] 2 WLR 215, Australian courts had identified three bases on which a solicitor might be prevented from acting for a client in a matter that might adversely affect the interests of a former client. These were breach of a duty to hold information confidential; breach of a duty of loyalty; and the court’s inherent jurisdiction over solicitors. Since the decision in Prince Jefri, some Australian courts have followed the reasoning in that decision in holding that a court’s jurisdiction to prevent a lawyer from acting against the interest of a former client is solely founded on the protection of confidential information and is not connected with conflict of interest principles: Belan v Carey [2002] NSW SC 58 at [15]; British American Tobacco Australia Services Ltd v Blanch [2004] NSWSC 70; PhotoCure ASA v Queen’s University at Kingston (2002) 56 IPR 86 at [53] ff; Asia Pacific Telecommunications Ltd v Optus Networks Pty Ltd [2005] NSWSC 550. Other Australian courts (and particularly the Victorian Supreme Court) have continued to hold that, in addition to a duty of confidentiality, a lawyer also owes an equitable duty to his or her former client, even after his or her retainer has concluded, not to act for another person in the same matter or a closely related matter against the interests of his or her former client: Spincode Pty Ltd v Look Software Pty Ltd (2001) 4 VR 501 at [53]; Village Roadshow Pty Ltd v Blake Dawson Waldron [2003] VSC 505 at [41], [51].
Australian courts have previously held that there is an inherent jurisdiction to restrain a lawyer from acting against a former client, by reason of the court’s control over the conduct of its officers, including the need to maintain and enhance public confidence in the legal profession and the administration of justice: D&J Constructions Pty Ltd v Head (1987) 2 NSWLR 118 at 123; Wan v McDonald (1992) 33 FCR 491 at 513. Australian courts have also previously emphasised the adverse view which a fair-minded and reasonably informed member of the public might form of the administration of justice if a lawyer were permitted to act against the interests of a former client: Murray v Macquarie Bank Ltd (1991) 33 FCR 46 at 49; Newman as Trustee for the Estates of Littlejohn v Phillips Fox (a firm) [1999] WASC 171 at [42], (1999) 21 WAR 309; Oceanic Life Ltd v HIH Casualty & General Insurance Ltd & Ors, above at [48]; Sent and John Fairfax Publishing Pty Ltd [2002] VSC 429 at [111]–[116]; Village Roadshow Ltd v Blake Dawson Waldron, above at [47]. It has also been suggested that this principle may extend to prevent a lawyer acting not only against a company which is its former client but also against the directors of that former client: Macquarie Bank Ltd v Myer & Ors [1994] 1 VR 350. However, more recent decisions cast into doubt whether a court will seek to step beyond merely ensuring that the confidential information of former clients is protected: PhotoCure ASA v Queen’s University at Kingston, above at [54]–[56].
Australian courts have shown little sympathy for the proposition that a rigorous application of conflict principles may cause considerable inconvenience for clients (as well as their advisers) where a significant proportion of complex commercial litigation in Australia is conducted by a small number of large firms: Village Roadshow Ltd v Blake Dawson Waldron, above at [50], but contrast the recognition of the “modern legal environment” in Asia Pacific Telecommunications Ltd v Optus Networks Pty Ltd, above at [51–[55].
Protection of confidential information
As indicated above, conflicts of interest involving lawyers may also involve issues as to protection of confidential information. An Australian court will restrain a lawyer from acting in a particular matter if a reasonable person who was informed of the relevant facts might reasonably anticipate a danger of misuse of confidential information of a former client and there is a real and sensible possibility that the practitioner’s interest in advancing the case in that litigation might conflict with his or her duty to keep that information confidential, and to refrain from using that information to the detriment of a former client: Sent and John Fairfax Publishing Pty Ltd, above at [33]; Village Roadshow Ltd v Blake Dawson Waldron, above at [34]. Australian courts have been influenced by the views expressed by the House of Lords in Prince Jefri Bolkiah v KPMG (a firm), above, that, once it appears that a lawyer is in receipt of confidential information, the burden shifts to the lawyer to satisfy the court on the basis of clear and convincing evidence that all effective measures have been taken to ensure that no disclosure of that information will occur: Spincode Pty Ltd v Look Software Pty Ltd, above. Australian courts will also readily infer confidential information was communicated within a lawyer-client relationship, so as to invoke their jurisdiction to protect such information: Village Roadshow v Blake Dawson Waldron, above at [37].
Australian courts have moved away from the proposition that the knowledge and duties of one member of a partnership will necessarily be imputed to the other members of that partnership, and towards an acceptance that, although a presumption exists that knowledge of one partner in a law firm is imputed to all other partners, that presumption may be rebutted: Unioil International Pty Ltd v Deloitte Touche Tohmatsu (No 2) (1997) 17 WAR 98 at 110–11 (citing Sopinka J in MacDonald Estate v Martin (1990) 77 DLR (4th) 249); Newman as Trustee for the Estates of Littlejohn v Phillips Fox, above at [34]. None the less, Australian courts have restrained a firm from acting for a defendant to litigation, where an individual who previously acted for the claimant in that litigation has joined that firm: Newman as Trustee for the Estates of Littlejohn v Phillips Fox, above.
The general law position is reinforced by the professional rules made by Australian law societies. For example, Rules 2 and 3 of the Revised Professional Conduct and Practice Rules 1995 (NSW) deal with a lawyer’s duty to maintain a client’s confidentiality during and after his or her retainer, and prohibit a lawyer from accepting a retainer to act for another person in any action or proceedings against, or in opposition to, the interests of a former client, lawyer or his or her firm, from whom the lawyer or his or her firm has obtained confidential information material to the action or proceedings, if the former client might reasonably conclude that there is a real possibility that information will be used to his or her detriment.
Chinese walls and client consent
One possible means of avoiding the risk of disclosure of information of a former client to legal representatives of a new client within a firm is the creation of a Chinese wall. Such an arrangement may include mechanisms such as separation of the lawyers acting for the former client and the lawyers acting for the new client in separate departments or separate offices and security mechanisms such as limiting access to files and databases.
Australian courts have historically been sceptical of the use of Chinese walls in this context: D&J Constructions Pty Ltd v Head, above at 122; In the Marriage of Magro (1989) 93 FLR 365. A Chinese wall was held to be insufficient to avoid the risk of prejudice to a former client in Mallesons Stephen Jaques v KPMG Peat Marwick (1991) 4 WAR 357 and in Newman as Trustee for the Estates of Littlejohn v Phillips Fox, above. However, in Prince Jefri Bolkiah v KPMG (a firm) above at 227, Lord Millett observed that there is no rule of law that a Chinese wall is insufficient to avoid that risk that confidential information of a former client may come into the possession of the new client, but held that the Chinese wall proposed in that case was not sufficient to protect the former client’s confidential information, since it had been created within a department where the relevant staff were accustomed to working with each other, and on an ad hoc basis rather than being part of the firm’s ongoing organisational structure.
On the other hand, a Chinese wall was held to provide sufficient protection against disclosure of a former client’s confidential information in Fruehauf Finance Corpn Pty Ltd v Feez Ruthning [1991] 1 Qd R 558; Bureau Interprofessionel Des Vins De Bougogne v Red Earth Nominees Pty Ltd [2002] FCA 588; and PhotoCure ASA v Queen’s University at Kingston, above at [60]–[61], where Goldberg J observed that:
“… D&J Constructions was decided 15 years ago and since that time the
nature of legal practice has changed. The courts are now more prepared to
accept the concept of ‘Chinese walls’ and the quarantining of information
within an organisation as Lord Millett recognised in Bolkiah, Staytler J
accepted in Newman v Phillips Fox … and Ryan J accepted in Bureau
Interprofessionel Des Vins De Bougogne v Red Earth Nominees.”
Matters which may assist in establishing the efficacy of a Chinese wall would include (if possible) embedding it in the structure of a firm rather than erecting it on an ad hoc basis; educational programmes or procedures, record keeping or disciplinary sanctions for breach; and extending the relevant procedures not only to legal staff but also administrative staff.
Australian courts will also permit a lawyer to act against the interests of a former client in circumstances that the client, having been made aware of the possible conflict arising out of that situation, decides not to complain, and will not later permit that client to resile from that position: South Black Water Coal Ltd v McCullough Robertson (unreported, 8 May 1997, Muir J).
There appears to be less public controversy concerning conflicts of interest affecting lawyers than in relation to conflicts of interest affecting financial institutions or accountants. As noted above, the Australian courts have taken a relatively strict approach to conflicts of interest, and there is little likelihood of further legislative intervention in the area.
See A D Mitchell, ‘Chinese Walls in Brunei: Prince Jefri Bolkiah v KPMG (a firm)’ [1999] 22 UNSWLJ 243 ; L Aitken, ‘Chinese Walls, Fiduciary Duties and Intra-Firm Conflicts – a Pan-Australian Conspectus’ (2000) 19 Australian Bar
Review 116 at 117; F Riley, New South Wales Solicitors Manual: a commentary on the law and practice relating to the profession of the solicitor in New South Wales (Looseleaf), Law Society of New South Wales, Sydney, 2000; G Bourke, Practice Paper PR2: The Solicitors Relationship with the Client, The College of Law: Practice Papers, Volume 3, Butterworths, 2004.
