In the recent decision of Director of Public Prosecutions (Cth) v JM, the High Court has applied a wide definition to market manipulation as prohibited by the Corporations Act 2001 (Cth).

Background

This case involved a prosecution by the Commonwealth Director of Public Prosecutions of an unnamed defendant, who was the CEO and a director of X Ltd, a company listed on the Australian Securities Exchange (ASX). In 2005 Z ApS, a company associated with the accused, exercised a number of call options for X Ltd shares. Z ApS entered into an agreement with Opes Prime Securities (Opes) whereby Opes would finance the $10m investment in exchange for a security over Z ApS’ shares and options in X Ltd. Under the agreement the accused was required to maintain collateral of value at least equal to four times the loan amount. Accordingly, Opes would undertake a daily valuation of the collateral using the closing price of X Ltd’s shares, and if the share price dropped below the required amount Opes would issue a margin call requiring the accused to provide additional collateral. By July 2006, the price of X Ltd shares had declined, and Opes had made a number of margin calls requiring over $2m in additional collateral.

In May 2006, Mr N, the accused’s son-inlaw, sent a fax to the accused proposing an arrangement whereby Ms N, the accused’s daughter and Mr N’s wife, would maintain a floor price for shares in X Ltd by buying shares in the company at arms’ length using funds gifted to her by the accused. Between May and September 2006, the accused paid a total of $1.6m to Mr and Ms N. However, it was not unusual for the accused to gift such funds to his children and grandchildren.

On 28 June 2006, a representative of Opes sent an email to Mr N warning of a margin call in excess of $700,000 would be made should the closing price of X Ltd shares drop to 33c. On 4 July 2006, Ms N put in an order for X Ltd shares at 35c resulting in the shares closing at that price. If it were not for this order, the shares would have closed at 34c. Later that day Ms N wrote an email to the accused stating “I had to buy 65k shares on close, just to keep it at 35 as someone dumped 70k [sic] at 34c when the market was in settlement.” The accused annotated the email with a note that said “150k — [Ms N] from [accused’s initials] (-> Bal = 150k)”. On 5 July 2006, the accused caused a cheque for $150,000 to be drawn on his bank account payable to Mr and Ms N.

The accused was charged with 39 charges of market manipulation, contrary to section 1041A of the Corporations Act 2001 (Cth) (Act), and two charges of conspiring with Mr and Ms N to take part in transactions contravening that provision. The accused did not deny that the activities outlined above had occurred. However, the accused denied that these activities were engaged in for the sole or dominate purpose of manipulating the closing price of X Ltd shares. The accused contended that the alleged correspondence from Mr and Ms N to himself was unsolicited and he did not act on it.

Prohibition on market manipulation

Section 1041A provides that a person must not, directly or indirectly, take part in, or carry out, a transaction that has or is likely to have the effect of creating or maintaining an artificial price for trading in financial products. Section 1311(1) of the Act provides that contravention of section 1041A is an offence.

Cornering and squeezing of the market

The Victorian Court of Appeal held that the term artificial price was a legal term which reflected American legal notions of market manipulation by ‘cornering’ or ‘squeezing’.” The Court of Appeal referred to the United States case of Cargill Inc v Hardin 452 F 2d 11154 (1971) which explained the terms ‘cornering’ and ‘squeezing’ in relation to a futures market. The Court in Cargill held that ‘cornering’ amounts to a monopoly of a cash commodity, coupled with the ownership of long futures contracts in excess of the amount of that commodity such that people holding short futures contracts, who cannot obtain the cash commodity, are forced to offset against long futures contracts at high prices dictated by the holders of those long futures contracts. The term ‘squeezing’ refers to a less extreme situation where there may not be an actual monopoly of the cash commodity but the deliverable supplies of that commodity are low.

The High Court held that the terms have no direct application to the market for listed shares. The Court explained that the terms are dependent on the separation of the futures market and the market for the commodity which is the subject of the futures contract, and there is no separate market for the future sale of shares.

The Court further held that nothing in section 1041A suggested that the section should be confined to circumstances where the buyer or seller accused of market manipulation had a monopoly over the market for those shares.

Genuine supply and demand

In confining their analysis to on-market transactions in shares listed on the ASX, the High Court interpreted market manipulation broadly and held that the term ‘artificial price’ should be construed to include a transaction where the on-market buyer or seller of listed shares undertook the transaction for the sole or dominant purpose of setting or maintaining the price of those shares. The Court explained that such a price would be artificial as it would not be “a price which reflects the forces of genuine supply and demand in an open, informed and efficient market”.

The High Court said that by purchasing shares for the sole, or at least dominant, purpose of ensuring that the price of the shares did not fall below the price paid for that purchase, the transaction has or is likely to have the effect of creating, or maintaining, an artificial price for trading in those shares. Thus it is not necessary to prove that the transactions did create or maintain an artificial price, rather it is sufficient to show that this was the buyer or seller’s sole or dominant purpose in setting the price.