Australian Securities and Investment Commission v Whitebox Trading Pty Ltd (No 7)

[2019] FCA 849

FEDERAL COURT OF AUSTRALIA

Australian Securities and Investment Commission v Whitebox Trading Pty Ltd (No 7) [2019] FCA 849

File number:

NSD 383 of 2016

Judge:

YATES J

Date of judgment:

7 June 2019

Catchwords:

CORPORATIONS – securities index arbitrage trading – alleged market manipulation – whether the placement of certain orders for XJO Securities, including certain order cancellations and reductions, in the Pre-Open Phase were made for the purpose of affecting Opening Prices in the Opening Single Price Auction of the market conducted by the Australian Securities Exchange – whether defendants were trading with the intention of creating or causing the creation of a false or misleading appearance with respect to the market for and/or price for trading in XJO Securities under s 1041B(1)(b) of the Corporations Act 2001 (Cth) – whether defendants were trading with the intention of creating an artificial price for trading in XJO Securities under s 1041A(1)(c) of the Corporations Act 2001 (Cth)

Legislation:

Australian Securities and Investments Commission Act 2001 (Cth), s 33
Competition and Consumer Act 2010 (Cth)
Corporations Act 2001 (Cth), ss 180(1), 760A, 1041A, 1041B, 1041 E
Corporations Act 1989 (Cth), s 998(1)
Criminal Code Act 1995 (Cth), Sch 2
Criminal Procedure Act 2009 (Vic), s 302
Evidence Act 1995 (Cth), ss 79(1), 140(2)
Securities Exchange Act 1934 (US), s 9
Securities Industry Act 1970 (NSW), s 70
Trade Practices Act 1974 (Cth)

Cases cited:

Adams v Director of the Fair Work Industry Inspectorate [2017] FCAFC 228

Australian Competition and Consumer Commission v Metcash (2011) 198 FCR 297

Australian Competition and Consumer Commission v Olex Australia Pty Ltd [2017] FCA 222

Australian Securities and Investments Commission v Nomura International plc (1998) 89 FCR 301

Australian Securities and Investments Commission v Westpac Banking Corporation (No 2) [2018] FCA 751; (2018) 357 ALR 240

Australian Securities and Investments Commission v Whitebox Trading Pty Ltd & Anor [2017] FCAFC; (2017) 251 FCR 448

Australian Securities and Investments Commission, in the matter of Whitebox Trading Pty Ltd v Whitebox Trading Pty Ltd (No 5) [2018] FCA 1059

Australian Securities and Investments Commission, in the matter of Whitebox Trading Pty Ltd v Whitebox Trading Pty Ltd (No 6) [2018] FCA 1077

Briginshaw v Briginshaw (1938) 60 CLR 336

Casaclang v WealthSure Pty Ltd (2015) 238 FCR 55

Communications Electrical, Energy, Information, Postal, Plumbing and Allied Services Union of Australia v Australian Competition and Consumer Commission (2007) 162 FCR 466

Director of Public Prosecutions (Cth) v JM [2012] VSCA 21; (2012) 37 VR 1

Director of Public Prosecutions for the Commonwealth of Australia v JM [2013] HCA 30; (2013) 250 CLR 135

Fame Decorator Industries Pty Ltd v Jeffries Industries Ltd (1988) 28 ACSR 58

In the matter of Kidder Peabody & Co 18 SEC 559

North v Marra Developments Limited (1981) 148 CLR 42

R v Lloyd (1996) 19 ACSR 528

R v Manasseh and Austin [2002] NSWCCA 27

R v Reynhoudt (1962) 107 CLR 381

Rosenberg v ASIC [2010] AATA 654; (2010) 117 ALD 582

Salvation Army (Vic) Property Trust v Ferntree Gully Corporation (1952) 85 CLR 159

SEC v LEK Securities Corporation 276 F Supp 3d 49 (2017)

Tillmanns Butcheries Pty Ltd v Australasian Meat Industry Employees’ Union (1979) 42 FLR 331

Date of hearing:

2 to 17 July 2018, 19 July 2018, 23 July 2018,
25 to 27 July 2018

Registry:

New South Wales

Division:

General Division

National Practice Area:

Commercial and Corporations

Sub-area:

Corporations and Corporate Insolvency

Category:

Catchwords

Number of paragraphs:

568

Counsel for the Plaintiff:

Mr J A Halley SC with Mr I J M Ahmed and
Mr P J Holmes

Solicitor for the Plaintiff:

Johnson Winter & Slattery

Counsel for the Defendants:

Mr R G McHugh SC with Mr M J Steele SC and
Mr L T Livingston

Solicitor for the Defendants:

Thompson Eslick Solicitors

ORDERS

NSD 383 of 2016

BETWEEN:

AUSTRALIAN SECURITIES AND INVESTMENT COMMISSION

Plaintiff

AND:

WHITEBOX TRADING PTY LTD

First Defendant

JOHANNES HENDRIK BOSHOFF

Second Defendant

JUDGE:	YATES J
DATE OF ORDER:	7 JUNE 2019

THE COURT ORDERS THAT:

1.The Originating Process be dismissed.

2.Unless the question of costs can be agreed:

(a)the defendants file and serve written submissions on that question (limited to three pages) by 4.00 pm on 28 June 2019; 

(b)the plaintiff file and serve written submissions in response (limited to three pages) by 4.00 pm on 10 July 2019; and 

(c)the defendants file and serve any submissions in reply (limited to two pages) by 4.00 pm on 17 July 2019.

3.The question of costs be determined on the papers unless a party wishes to be heard on that question orally.

Note:   Entry of orders is dealt with in Rule 39.32 of the Federal Court Rules 2011.

REASONS FOR JUDGMENT

INTRODUCTION	[1]
LEGAL BACKGROUND	[7]
Relevant provisions	[7]
THE EVIDENCE	[20]
ASIC’s evidence	[20]
The defendants’ evidence	[30]
The joint reports	[45]
Other matters	[47]
SECURITIES INDEX ARBITRAGE TRADING:  AN OVERVIEW	[55]
ASX GUIDANCE NOTE NO 32	[81]
THE RELATIONSHIP BETWEEN WHITEBOX AND NAB	[90]
WHITEBOX’S STATED POSITION ON ITS TRADING STRATEGY	[105]
THE IMPUGNED TRADING	[131]
ASIC’s identification of the impugned trading and the defendants’ strategy	[131]
19 April 2012	[143]
17 May 2012	[146]
19 July 2012	[149]
16 August 2012	[152]
18 October 2012	[155]
Some matters of definition in relation to the impugned trading	[159]
The auction time lines	[163]
Introduction	[163]
19 April 2012	[166]
17 May 2012	[182]
19 July 2012	[196]
16 August 2012	[216]
18 October 2012	[238]
Some observations on the auction time lines	[257]
ASIC’S CASE ON THE IMPUGNED TRADING	[269]
MR MORGAN’S EVIDENCE	[287]
The first pillar	[288]
The second pillar	[292]
The third pillar	[310]
THE CHALLENGE TO MR MORGAN’S EVIDENCE	[313]
Introduction	[313]
Professor Frino’s evidence	[314]
CONCLUSIONS ON MR MORGAN’S EVIDENCE	[336]
The first pillar	[336]
The second pillar	[344]
The third pillar	[366]
An aspect of Mr Morgan’s evidence	[370]
MR GRAVES’ EVIDENCE	[374]
THE CHALLENGE TO MR GRAVES’ EVIDENCE	[386]
The 10% Order Rule	[386]
The 10% Simultaneous Combined Order Rule and the 10% Sequential Combined Order Rule	[400]
The 2 Minute Rule	[419]
Other analyses carried out by Professor Aitken	[428]
CONCLUSIONS ON MR GRAVES’ EVIDENCE	[443]
ADDITIONAL EVIDENCE RELIED ON TO SUPPORT PRICE EFFECTS	[453]
The auction time lines and Mr Clifford’s tables	[453]
Conclusions on additional evidence	[463]
THE REMAINING PILLARS OF ASIC’S CASE	[472]
The fifth pillar	[472]
The sixth pillar	[486]
The seventh pillar	[492]
The eighth pillar	[493]
THE DEFENDANTS’ CRITICISM OF ASIC’S CASE THEORY	[503]
THE “MARKET FOR” CASE	[511]
Introduction	[511]
An issue of construction	[516]
The approach to applying s 1041B(1)(b)	[521]
Conclusion	[541]
THE “PRICE FOR TRADING” CASE	[549]
Introduction	[549]
Conclusion	[554]
THE “ARTIFICIAL PRICE FOR TRADING” CASE	[558]
Introduction	[558]
Conclusion	[562]
BREACH OF DUTY CASE	[567]
DISPOSITION	[568]
SCHEDULE

YATES J:

INTRODUCTION

1. This proceeding concerns alleged market manipulation in the context of securities index arbitrage trading.  The plaintiff, the Australian Securities and Investments Commission (ASIC), alleges that, over five successive Serial Expiry Days in 2012 (being 19 April 2012, 17 May 2012, 19 July 2012, 16 August 2012 and 18 October 2012), the first defendant, Whitebox Trading Pty Ltd (Whitebox), and the second defendant, Mr Boshoff, engaged in a deliberate strategy to manipulate the prices of all 200 individual securities comprising the XJO Index in the OSPA (Opening Single Price Auction), for the sole or dominant purpose of achieving a more favourable Basis (the mispricing between the traded price of SPI Futures and their Fair Price), and thereby to make the index arbitrage positions that Whitebox traded on each of those days in SPI Futures and XJO Securities profitable, or more profitable.

2. ASIC contends that the heart of this strategy was the placement of very large orders or order amendments for XJO Securities late in the Pre-Open Phase, which the defendants could not have had any reasonable expectation that they could trade in the OSPA.  These orders were either cancelled or reduced in volume shortly prior to the Rotation in the OSPA in which the securities were due to trade.  ASIC contends that this was done intentionally to manipulate the Opening Prices of the securities in the OSPA and, thereby, Basis.  ASIC further contends that none of these orders or order amendments represented genuine supply or demand for XJO Securities.

3. By reason of this conduct, ASIC alleges that the defendants contravened certain market manipulation provisions of the Corporations Act 2001 (Cth) (the Act)—s 1041A and s 1041B. In addition, ASIC alleges that, by causing or otherwise permitting Whitebox to contravene the market manipulation provisions, Mr Boshoff also contravened s 180(1) of the Act.

4. In Australian Securities and Investments Commission v Whitebox Trading Pty Ltd & Anor [2017] FCAFC; (2017) 251 FCR 448, the Full Court held, in the context of hearing a separate question in this proceeding, that Ch 2 of the Criminal Code (being the Schedule to the Criminal Code Act 1995 (Cth)) was not engaged in proceedings brought for the imposition of a civil penalty for a contravention of s 1041A and s 1041B of the Act, such as the present. The Full Court reasoned that, if otherwise, ASIC would have to prove the criminal fault elements derived from Ch 2 of the Criminal Code for each of the proscribed physical elements, rather than any state of mind that may be drawn from the terms of the two provisions themselves.  The Full Court noted (at [9]) that it was common ground that it should not, ahead of the present hearing, venture into any consideration of the state of mind that might be required to be established in order to prove a contravention of the two provisions in civil penalty proceedings.  This was because, at the hearing of the separate question, that issue had not been the subject of full and proper consideration in the context of the pleadings, evidence and appropriate submissions. As events have transpired, that issue has not even fallen for consideration and determination now.  ASIC framed its case against the defendants as one of specific intentional conduct, and the parties have joined issue on that question.  The present hearing has been conducted accordingly.  Therefore, ASIC’s case against the defendants turns on whether it has established, on the balance of probabilities, that the defendants acted with the intention it alleges.

5. Although ASIC’s case is brought against Whitebox and Mr Boshoff, for ease of exposition I will simply refer to Whitebox when summarising and discussing the activities of placing, amending, cancelling and/or reducing orders for XJO Securities and purchasing or selling SPI Futures that were undertaken on the five Serial Expiry Days in question, and on the other trading days discussed in the evidence.

6. Capitalised terms and expressions used in these reasons have the meanings given to them in the Primer and Glossary reproduced in the Schedule to these reasons:  see pages 144 to 169 below.

   LEGAL BACKGROUND

   Relevant provisions

7. Section 1041B(1)(b) of the Act provides:

   A person must not do, or omit to do, an act (whether in this jurisdiction or elsewhere) if that act or omission has or is likely to have the effect of creating, or causing the creation of, a false or misleading appearance:

   …

   (b) with respect to the market for, or the price for trading in, financial products on a financial market operated in this jurisdiction.

8. ASIC alleges that the defendants contravened this provision in two ways. 

9. First, the defendants engaged in acts that had, or were likely to have, the effect of creating, or causing the creation of, a false or misleading appearance as to the market for XJO Securities in the Pre-Open Phase of the market conducted by the ASX.  ASIC referred to this as the “market for” case.

10. Secondly, the defendants engaged in acts that were likely to have the effect of creating, or causing the creation of, a false or misleading appearance as to the price for trading in XJO Securities on the ASX.  ASIC referred to this as the “price for trading” case.

11. In respect of Whitebox, the alleged contraventions, in each case, relate to each of the Serial Expiry Days in question in this proceeding.  In respect of Mr Boshoff, the alleged contraventions relate to each Serial Expiry Day other than 16 August 2012.

12. Section 1041A of the Act relevantly provides:

    A person must not take part in, or carry out (whether directly or indirectly and whether in this jurisdiction or elsewhere):

    (a)       a transaction that has or is likely to have; or

    (b)       2 or more transactions that have or are likely to have;

    the effect of:

    (c)creating an artificial price for trading in financial products on a financial market operated in this jurisdiction; … 

13. ASIC alleges that the defendants took part in a series of transactions that were likely to have the effect of creating an artificial price for trading in XJO Securities.  I will refer to this as the “artificial price for trading” case.  In respect of Whitebox, the alleged contraventions relate to each of the Serial Expiry Days in question in this proceeding.  In respect of Mr Boshoff, the alleged contraventions relate to each Serial Expiry Day other than 16 August 2012.

14. These market manipulation provisions are found in Ch 7 of the Act, whose main object is set out in s 760A:

    The main object of this Chapter is to promote:

    (a)confident and informed decision making by consumers of financial products and services while facilitating efficiency, flexibility and innovation in the provision of those products and services; and

    (b)fairness, honesty and professionalism by those who provide financial services; and

    (c)       fair, orderly and transparent markets for financial products; and

    (d)the reduction of systemic risk and the provision of fair and effective services by clearing and settlement facilities.

15. ASIC submitted that consistently with s 760A, numerous authorities have emphasised that ss 1041A and 1041B (or their precursors) are designed to protect the integrity of the market and to ensure that it operates in a transparent and efficient manner.

16. In R v Lloyd (1996) 19 ACSR 528 (Lloyd), Murray J said (at 548):

    … an essential feature of a system of trading in securities in listed corporations by bidding for stock at centralised Stock Exchanges [is] that the system does reflect the interplay of the market forces of supply and demand… Investor confidence is the quality which the market must be able to maintain.  If investors become suspicious that the values of securities which the market reflects do not provide a measure of the worth of the stock then it seems obvious that they will be reluctant to invest.

17. In Fame Decorator Industries Pty Ltd v Jeffries Industries Ltd (1988) 28 ACSR 58 (Fame Decorator), Gleeson CJ said (at 62-63):

    Section 998 [the precursor to s 1041B] aims to preserve the integrity of the share market. Markets, in reflecting the interaction of forces of supply and demand, may suffer from a variety of imperfections, including mismatches of information, without such imperfections destroying their integrity.

18. ASIC submitted that these statements provided the lens through which this case must be approached.

19. To these statements can be added the following statement by Mason J concerning the object of s 70 of the Securities Industry Act 1970 (NSW) (a precursor of s 1041B(1)(b) of the Act) in North v Marra Developments Limited (1981) 148 CLR 42 (Marra Developments) (at 59):

    It seems to me that the object of the section is to protect the market for securities against activities which will result in artificial or managed manipulation. The section seeks to ensure that the market reflects the forces of genuine supply and demand. By “genuine supply and demand” I exclude buyers and sellers whose transactions are undertaken for the sole or primary purpose of setting or maintaining the market price. It is in the interests of the community that the market for securities should be real and genuine, free from manipulation. The section is a legislative measure designed to ensure such a market and it should be interpreted accordingly.

    THE EVIDENCE

    ASIC’s evidence

20. ASIC read the following affidavits:

    ·Oliver Peter Bainbridge, affirmed on 5 August 2016;

    ·Douglas Beem, affirmed on 27 April 2016;

    ·David Jan Bosenberg, affirmed on 2 November 2016;

    ·Robert Thomas Clifford, affirmed on 21 April 2016, 9 August 2016, and 7 December 2016;

    ·Matthew Crocker, affirmed on 29 September 2016;

    ·Phillip Drury, affirmed on 2 July 2018;

    ·Patrick John Feeney, sworn on 4 November 2016;

    ·Rosemarie Gates, affirmed on 3 November 2016;

    ·Martin Ihring, affirmed on 4 November 2016;

    ·Benjamin Layton Jackson (three affidavits affirmed on 4 November 2016);

    ·Geoffrey Keith Louw, affirmed on 20 October 2016;

    ·Sue Lumb, affirmed on 2 November 2016;

    ·Katie McDermott, affirmed on 4 November 2016;

    ·Shaun Nicholls, affirmed on 26 June 2018;

    ·Joanna Papantoniou, affirmed on 10 November 2016;

    ·Andrew Giles Smith, affirmed on 4 November 2016;

    ·Kamilla Soos, affirmed on 3 November 2016;

    ·Andrew David Stevenson, affirmed on 1 November 2016;

    ·Peter Stewart; affirmed on 4 November 2016;

    ·Jessica-Marie Todhunter, sworn on 21 April 2016 and 4 November 2016;

    ·Philip Tolhurst, affirmed on 3 November 2016;

    ·Stephen John Weeks, affirmed on 3 November 2016;

    ·Robert Malcolm Wilkie, affirmed on 2 July 2018;

    ·Henry John Willoughby, affirmed on 27 October 2016; and

    ·Mark Zvolanek, affirmed on 2 November 2016.

21. The only deponent from this group who was cross-examined was Mr Feeney.

22. ASIC also called expert evidence from William Morgan and Hugo Graves.

23. Mr Morgan has a Bachelor of Commerce degree awarded by the University of Queensland.  His early career was spent in a variety of roles in the IT industry, including computer programming, business analysis, project management and system architecture.  From 2005 to 2012, he worked in Hong Kong and Sydney for Credit Suisse in the Equity Derivatives group.  From late 2007 until the end of 2012, Mr Morgan was employed by Credit Suisse as an Equity Derivatives Trader in the Sydney office.  In this role, he implemented index arbitrage trading between SPI Futures and XJO Securities.  He was also involved in trading SPI Futures in 2010 when based in the Hong Kong office.

24. Mr Morgan prepared three reports which responded to a series of questions dealing with index arbitrage trading, and specifically the trading carried out by Whitebox on the Serial Expiry Days in question in this proceeding.

25. There were substantial objections to parts of Mr Morgan’s first report (the other two reports were amending reports).  One set of objections was directed to paragraphs 101 to 103 of the report and certain sections of Mr Morgan’s Joint Report with Mr de Kantzow and Professor Frino.  I ruled on those objections during the course of the hearing:  Australian Securities and Investments Commission, in the matter of Whitebox Trading Pty Ltd v Whitebox Trading Pty Ltd (No 5) [2018] FCA 1059 (Whitebox No 5). Another set of objections was directed to paragraph 129 of Mr Morgan’s first report and related paragraphs, which the parties, by agreement, accepted were dependent for their admissibility on the admissibility of paragraph 129. In the circumstances discussed in a later section of these reasons (see [297] – [302]), the parties agreed that the ruling on the admissibility of these paragraphs should await the cross-examination of Mr Morgan, and should be made in these reasons. For the reasons given at [303] – [306] below, I will admit the challenged paragraphs.

1. The defendants maintained a challenge to the weight I should give to Mr Morgan’s evidence in light of the extent and nature of his trading activities.  The basis for this challenge is adequately summarised at [10] in Whitebox No 5 and is not repeated here.  The defendants made clear, however, that, beyond the matters noted above, they did not challenge Mr Morgan’s ability to discuss principles of index arbitrage trading or index arbitrage pricing.

2. Mr Graves is a stockbroker currently working as a retail investment adviser.  He has worked in the field of stockbroking and funds management for over thirty years.  He has managed orders for equities and derivatives on behalf of retail and institutional clients on a full-time basis.  As part of his duties as an adviser, Mr Graves has managed the placement of orders, and their amendment and cancellation, on the ASX , including in the Pre-Open Phase of the market.  Mr Graves prepared a report which responded to a series of questions dealing with the effects of amending or cancelling orders for XJO Securities in the Pre-Open Phase, specifically in relation to the orders, amendments and cancellations placed by Whitebox on the Serial Expiry Days in question in this proceeding. 

3. The defendants criticised substantial parts of Mr Graves’ report which, they submitted, were based on “illogical and absurd reasoning”.  I deal with those criticisms below.  ASIC suggested in closing submissions that, at times, Mr Graves found it difficult to follow the thrust of certain questions put to him in cross-examination.  This suggestion seems to have been made to support Mr Graves’ evidence, as if to contend that, where his evidence was unfavourable to ASIC’s case, Mr Graves might not have fully understood the questions he was asked.  If that is the suggestion, I reject it.  I accept that Mr Graves was a cautious witness.  But I have no doubt that he understood the questions put to him and that he answered those questions honestly and to the best of his ability.

4. ASIC also relied on a report prepared by Associate Professor Artem Prokhorov, who is an econometrician.  Associate Professor Prokhorov performed testing to validate work undertaken by Mr Clifford (who is referred to above) in analysing data and producing a series of tables on trading undertaken by Whitebox on the Serial Expiry Days in question in this proceeding.  He was not required for cross-examination.

   The defendants’ evidence

5. The defendants called expert evidence from Michael de Kantzow, Professor Alex Frino, and Professor Michael James Aitken AM.

6. Mr de Kantzow has worked in financial markets since 1987.  From 1992 until 1996, he was employed by A.B.S. White and Co, where he had responsibility for advising retail and institutional clients on equity option strategies and risk management, executing orders on the ASX derivatives trading floor, and supporting the registered trader operation in option market making.  From 1996 to 2001, he was employed by HSBC Securities (Australia) Limited, initially in institutional derivative broking and execution, and subsequently as Head of Equity Option Trading.  From 2002 to late 2008, he was employed by ABN-Amro Australia as Head of Derivatives Trading, where he was responsible for listed and over-the-counter equity option market making and SPI Futures options trading including, amongst other things, index arbitrage.  In 2009, he established Cross Capital Pty Limited, which has conducted derivative trading activity in the equity, interest rate and SPI Futures markets.

7. Mr de Kantzow prepared a report in which he commented on specific aspects of Mr Morgan’s and Mr Graves’ respective reports, commented generally on how securities index arbitrage trading was undertaken in the Australian market in 2012, and reviewed and commented on auction time lines, graphs and tables on which the defendants relied in their case.

8. In cross-examination, ASIC mounted a substantial attack on Mr de Kantzow’s credit.  On the fourteenth day of the hearing, in the context of an application by ASIC to re-open its case, the defendants agreed to the following acknowledgement:

   …the parties have agreed that the defendants accept that Mr de Kantzow’s evidence should be given no credit and that his opinions should be given no weight except insofar as his evidence may support the plaintiff’s case, and, accordingly, the plaintiff is at liberty to rely on his evidence to the extent that it supports the plaintiff’s case…

9. Professor Frino is Professor of Economics and Deputy Vice Chancellor at Wollongong University.  He is also an Executive of Capital Markets Cooperative Research Centre Limited (CMCRC).  He has previously worked as a Senior and Visiting Economist at the Sydney Futures Exchange.  He was instrumental in developing the S&P/ASX 2000 Futures Contract and selecting the index (the XJO) on which those contracts are written.  Professor Frino prepared two reports in which he commented on, and responded to questions directed to, Mr Morgan’s reports. 

10. ASIC criticised Professor Frino’s evidence on the basis that, on the matters in question, his evidence was “entirely academic and theoretical”.  This criticism was made in the context of comparing Professor Frino’s evidence with Mr Morgan’s evidence which, ASIC submitted, was based on practical experience in securities index arbitrage trading.  Despite its criticism, ASIC did not object to the admissibility of Professor Frino’s opinions.  I do not accept that the evidence Professor Frino gave was in any way undermined by the fact that, for example, he had never personally traded SPI Futures or had never been asked before to consider securities index arbitrage activities undertaken in the Pre-Open Phase.

11. ASIC submitted that “the greatest difficulty” with Professor Frino’s evidence was that he had not analysed the data relating to Whitebox’s order and trading activity on the Serial Expiry Days in question and was not aware of Whitebox’s stated position on its trading strategy.  ASIC submitted that these omissions “radically diminish(ed)” the utility of Professor Frino’s opinions in drawing inferences about the defendants’ “intentions and purposes”.

12. I do not accept that the utility of the opinions expressed by Professor Frino were diminished by these matters.  As the defendants correctly pointed out, Professor Frino was not asked to address the defendants’ states of mind.  The questions he was asked were directed to specific parts of Mr Morgan’s report.  On these matters, Professor Frino had the requisite expertise to express opinions.

13. Professor Aitken is Professor in ICT Strategy at Macquarie University and the Chief Executive Officer and Chief Scientist of CMCRC.  Professor Aitken prepared two reports in which he commented on, and responded to questions directed to, Mr Graves’ report. 

14. ASIC submitted that Professor Aitken was “an unsatisfactory witness in several respects”.  First, ASIC submitted that he was argumentative, defensive and resistant to acknowledging errors in his own report.  Secondly, ASIC submitted that he showed a lack of familiarity with the contents of his reports and an inattention to the detail in them.  Thirdly, ASIC submitted that Professor Aitken displayed a tendency to behave as an advocate, particularly on the need for “surveillance protocol evidence”, rather than focussing on the evidence he had been asked to consider and address.

15. I accept that, at times, Professor Aitken was argumentative beyond merely seeking to explain the basis for the opinions he had expressed.  This was particularly so in his advocacy (because that is what it was) of the need for “surveillance protocol evidence”.  I think, however, that, at other times, Professor Aitken’s evidence and demeanour were the product of the frustration he genuinely felt at the unsoundness of opining about price effects in the market for XJO Securities on the basis of rules of thumb (as Mr Graves had done), rather than on the basis of empirical evidence.  In light of my findings in relation to Mr Graves’ evidence, some of Professor Aitken’s frustration is understandable. 

16. It is also true that, on occasion, Professor Aitken was corrected on matters of detail in his reports.  I do not think, however, that he is to be criticised for that, given the nature and the amount of the data covered in his reports.

17. Overall, and contrary to ASIC’s submission, I do not accept that Professor Aitken was an unsatisfactory witness.  On relevant matters, I do not think that his evidence was seriously undermined.

18. The most trenchant criticism of Professor Aitken’s evidence by ASIC was that it was “tainted” because of his view that it was not possible to express an opinion on whether the placement of Whitebox’s impugned orders would be likely to have any effect on the Opening Prices of XJO Securities in the OSPA.  This was because, in Professor Aitken’s view, there was no scientific or reliable method to recreate the market place to identify what the Opening Prices would have been absent Whitebox’s orders.  This is a legitimate opinion.  I do not accept that Professor Aitken’s evidence was “tainted” simply because he steadfastly maintained this view—a view that was directly critical of the reliability of the evidence that ASIC adduced on this question.

19. The defendants also read an affidavit by Michael Rudolf Samerski affirmed 15 November 2017.  Mr Samerski is a trading system software engineer who reviewed and verified a series of computer programs used to generate output reports and graphs deployed by the defendants, in particular a number of auction time lines to which I will make further reference.  Mr Samerski was not required for cross-examination.

    The joint reports

20. Pursuant to orders made by the Court, joint experts’ reports were prepared by Associate Professor Prokhorov and Professor Aitken; Mr Morgan and Mr de Kantzow; Mr Morgan, Mr de Kantzow, and Professor Frino; and Mr Graves, Mr de Kantzow and Professor Aitken.  These reports were tendered in ASIC’s case.  An updated summary of responses, prepared by Associate Professor Prokhorov, was also tendered in ASIC’s case.

21. Evidence was given concurrently by Mr Morgan, Mr de Kantzow and Professor Frino.  Evidence was also given concurrently by Mr Graves, Mr de Kantzow and Professor Aitken.  The witnesses were cross-examined in the course of giving evidence in these sessions.

    Other matters

22. It is convenient at this juncture to briefly note other matters concerning the basis on which ASIC’s case falls to be considered.

23. First, the parties accepted that ASIC bears the onus of proof of its allegations and that the civil standard of proof applies, informed by s 140(2) of the Evidence Act 1995 (Cth) which provides:

    Without limiting the matters that the court may take into account in deciding whether it is so satisfied, it is to take into account:

    (a)       the nature of the cause of action or defence; and

    (b)       the nature of the subject‑matter of the proceeding; and

    (c)       the gravity of the matters alleged.

24. It is to be noted in this connection that, in the present case, ASIC seeks, amongst other relief, the imposition of pecuniary penalties and banning orders against each defendant.  I bear in mind the admonition expressed by Dixon J in Briginshaw v Briginshaw (1938) 60 CLR 336 that in reaching reasonable satisfaction, the Court should not proceed on “inexact proofs, indefinite testimony, or indirect inferences”.

25. Secondly, as the case brought by ASIC is one of intentional conduct, and as there is little direct evidence that elucidates the defendants’ intentions, it will be necessary for the Court to draw inferences from established facts.  Thus, consistently with the propositions stated above, ASIC bears the onus of establishing the inferences for which it contends on the balance of probabilities. 

26. In Australian Competition and Consumer Commission v Olex Australia Pty Ltd [2017] FCA 222 (Olex) at [479], Beach J observed:

    A finding may be made in the absence of direct evidence. All that is necessary is that the more probable inference from the circumstances that sufficiently appear by evidence, left unexplained, justifies the conclusion. “More probable” means no more than that upon the balance of probabilities, such an inference has a greater degree of likelihood. A party who relies on circumstantial evidence must show that the circumstances raise the more probable inference in favour of what is alleged. It is not sufficient that the circumstances give rise to conflicting inferences of an equal degree of probability or plausibility or that the choice between them can only be made by conjecture. I accept though that the process of inference may involve an intuitive element that is not susceptible to detailed support or explanation.

27. Thirdly and relatedly, the Court may infer the effect that particular conduct has or is likely to have from its purpose as established on the evidence.  Thus, in Director of Public Prosecutions for the Commonwealth of Australia v JM [2013] HCA 30; (2013) 250 CLR 135, (JM), the High Court said at [73]:

    Because s 1041A prohibits transactions which are likely to have that effect, it is not necessary to demonstrate, whether by some counterfactual analysis or otherwise, that the impugned transactions did create or maintain an artificial price. It is sufficient to show that the buyer or seller set the price with the sole or dominant purpose described.

28. Similarly, the Court may infer the purpose of particular conduct from its effect:  Olex at [494]; Australian Securities and Investments Commission v Westpac Banking Corporation (No 2) [2018] FCA 751; (2018) 357 ALR 240 (Westpac) at [1938].

29. Fourthly, where there is an unexplained failure to call evidence, the Court can infer that such evidence would not have assisted the defendants, even in a civil penalty case:  Adams v Director of the Fair Work Industry Inspectorate [2017] FCAFC 228 at [147]; Communications Electrical, Energy, Information, Postal, Plumbing and Allied Services Union of Australia v Australian Competition and Consumer Commission (2007) 162 FCR 466 at [28] and [76].

    SECURITIES INDEX ARBITRAGE TRADING:  AN OVERVIEW

30. On 9 April 2018, I made orders to facilitate the preparation by the parties of an agreed primer, including a glossary of terms, which would provide a basic description of securities index arbitrage trading.  The Primer and Glossary, prepared by the parties, are reproduced in the Schedule to these reasons.  The statements made in them can be treated as agreed facts for the purpose of this proceeding. 

31. In these reasons, I have also treated the statements as assumed knowledge on the part of the reader.  Proceeding on this basis, I have endeavoured to avoid unnecessary repetition of this background material in the body of these reasons.  Nonetheless, it will assist in understanding the context in which the present proceeding arises to provide, at this stage, a brief overview of securities index arbitrage trading which draws on various strands of the Primer and certain aspects of the evidence.

32. Securities index arbitrage trading involves trading stock index futures against the constituent securities that make up the stock index.   

33. In the case of the ASX, the primary stock futures are SPI Futures.  These are futures contracts written over the S&P/ASX 200 Index.  The index is conveniently referred to as the XJO.  The securities that make up the XJO are conveniently referred to as XJO Securities. 

34. The terms of the futures contracts are standardised and provide for the purchase or sale of the financial instrument on a given future date (the Expiry Date) at a price fixed at the time the contract is made (the Contract Value). 

35. There are two types of SPI Futures—Quarterly SPI Futures (SPI Futures that expire on the third Thursday of March, June, September or December) and Serial SPI Futures (SPI Futures that expire on the third Thursday of each of the other, intervening months).  This proceeding is concerned with trading that involves Quarterly SPI Futures.  However, the impugned trading took place on Serial Expiry Days.

36. SPI Futures are cash-settled contracts.  They do not require the physical securities making up the index to be transferred on the Expiry Date.  Rather, the buyer or seller is required to pay to the counterparty the difference between the Contract Value and the value of the instrument at the Expiry Date.  The direction of the movement in value will determine whether it is the buyer or the seller who pays. 

37. SPI Futures derive their value from the index. The XJO has a price level which changes constantly.  It is calculated from the prices at which XJO Securities trade during the hours that the ASX is open.  A person who holds an amount of constituent securities in the exact proportion in which the securities make up the XJO is able to replicate the overall value of the index. 

38. The strategy involved in securities index arbitrage trading is to make a profit from any real-time price discrepancy between the Fair Price of given SPI Futures and their market value.  The measure of this mispricing is called Basis.  Arbitrageurs who identify mispricing seek to capture the available potential profit (represented by Basis) by buying an amount of one of the financial products (SPI Futures or XJO Securities) while selling an amount of equivalent value of the other financial product (XJO Securities or SPI Futures), thereby executing trades on the two markets.

39. These mispricing opportunities do not only arise when the two markets are open.  They can also exist at times when the market for XJO Securities is in the Pre-Open Phase (i.e., not open for Normal Trading) and when the ASX24 has commenced to trade SPI Futures.  This is because the arbitrageur is able to make calculations based on the indicative prices for each security that are generated and published in the Pre-Open Phase (when buy or sell orders for securities and baskets of securities can be placed) leading up to the OSPA. 

40. The Pre-Open Phase commences at 07:00 to 10:00 (+/- 15 seconds) running through to 10:09 (+/- 15 seconds).  The OSPA is a series of opening single price auctions for securities on the ASX which take place after the Pre-Open Phase but before market opening, according to groupings of securities based on the alphabetical precedence of their Ticker Codes.  There are five groupings, referred to as Rotation Groups.  The auctions are staggered, but each auction (or Rotation) occurs at a precise time that falls within a 30-second window randomly generated by ASX Trade (the platform on which the XJO Securities are traded).  The window for A-B securities (Group 1) is 09:59:45 to 10:00:15; for C-F securities (Group 2), 10:02:00 to 10:02:30; for G-M securities (Group 3), 10:04:15 to 10:04:45; for N-R securities (Group 4), 10:06:30 to 10:07:00; and for S-Z securities (Group 5), 10:08:45 to 10:09:15.

41. As more orders come into the Order Book in the Pre-Open Phase, calculated and published indicative prices might change.  Correspondingly, arbitrageurs’ assessments of mispricing might also change.  Arbitrageurs can monitor, calculate and re-calculate Basis throughout this phase.   Fast Basis is a calculation of Basis undertaken at the rate of five times per second.  It includes the effect of the trader’s own orders as well as of the others traders’ orders.

42. In this phase, some arbitrageurs can also calculate Underlying Basis, which is a hypothetical calculation of Basis that ignores the arbitrageur’s own orders in relation to XJO Securities.  Therefore, comparing Underlying Basis with Basis will indicate the impact of the arbitrageur’s trading on Basis.  If the arbitrageur is not amending or changing orders, but Underlying Basis is moving, then Underlying Basis will provide some insight to the arbitrageur as to the direction of the market and the flow of orders placed by others.  For this reason, Underlying Basis is a useful information cue which enables the arbitrageur to understand what is happening in the order book for XJO Securities.  Over time, Underlying Basis will show the direction and persistence of mispricing, particularly where Basis swings between substantially positive and substantially negative values.  There was significant volatility in Basis on the five Serial Expiry Days in question in this proceeding.

1. It is appropriate at this stage to introduce the notion of Basis Decay.  This is the phenomenon where, in the Pre-Open Phase, mispricing declines towards zero as the OSPA approaches.  Because of this phenomenon, an experienced and competent arbitrageur would not expect any large available Basis to persist until the Opening Phase.

2. Ideally, an arbitrageur might aim to establish an arbitrage with matched positions, in value, of SPI Futures and XJO Securities, with the XJO Securities held in their proportionate weight in the XJO.  In such a position, the arbitrageur would not be exposed, in the main, to market movements, and the arbitrageur would be able to establish and carry large arbitrage transactions without taking significant market risk.  In practice, however, there will be discrepancies between the value of XJO Securities held in an arbitrage position and the value of the SPI Futures held against that position.   

3. Where the SPI Futures are not matched with XJO Securities in equivalent value or in their proportionate weight in the XJO, the arbitrageur will have market exposure to the extent of the mismatch.  Put simply, if the two legs of the arbitrage transaction do not create a perfect hedge, the arbitrageur will be exposed to a corresponding market risk.  But the appetite for market risk (which will include the perceived size of an arbitrage profit) will vary among arbitrageurs.  This may be reflected in the various strategies that different arbitrageurs might choose to pursue with a view to profiting from this form of trading, including holding an unhedged (unmatched) position in the course of actual market trading in either XJO Securities or, indeed, in SPI Futures.  Index arbitrageurs can and do behave differently.

4. A securities index arbitrage trading position in which futures are sold and securities are bought is called a Positive Index Arbitrage (or, simply, a positive arbitrage).  In a positive arbitrage, the transaction will be profitable only if the calculated figure for Basis is positive.  All things being equal, the more positive this figure, the more profitable the transaction should be.

5. Conversely, a trading position in which futures are bought and securities are sold is called a Negative Index Arbitrage (or, simply, a negative arbitrage).  In a negative arbitrage, the transaction will be profitable only if the calculated figure for Basis is negative.  All things being equal, the more negative this figure, the more profitable the transaction should be. 

6. Other variables that can affect the profitability of a particular trade include the size of the position taken and the price at which SPI Futures can be bought or sold.  The price at which SPI futures can be bought or sold is a function of the liquidity of SPI Futures in the market.  This liquidity can increase or decrease substantially in a short period of time (in a matter of seconds).

7. Generally speaking, a larger “cash” order (i.e., an order to buy or sell XJO Securities) which is hedged will be more profitable than a smaller order which is hedged, for a given level of mispricing.

8. In the evidence, two measures have been adopted to indicate the size of orders (whether buy or sell) that were being placed by Whitebox for XJO Securities on the Serial Expiry Days in question. 

9. The first is called a SPI Equivalent.  This is essentially a measure of value.  It represents the volume of SPI Futures that is equivalent in value to the dollar value of the orders for XJO Securities (whether buy or sell) that Whitebox was seeking to trade.  This measure was adopted by ASIC in its evidence.

10. The second is called Shares per Hedge Equivalent or, simply, SPHE.  This is essentially a measure of volume.  It represents the number of futures equivalent shares that an arbitrageur is seeking to trade (whether buy or sell) by the order that is placed.  For example, an order for XJO Securities equivalent to 500 SPHE means that the order is for 500 times each security’s specific shares per hedge.  This measure was adopted by the defendants in their evidence.

11. In these reasons, I refer to both measures.  It has been necessary to do so because of the way in which the evidence has been presented and because of the way in which the parties, correspondingly, advanced their respective cases.  In undertaking comparisons it should be borne in mind that the numerical values of each measure do not necessarily correlate.

12. Additionally, in respect of SPHE figures utilised in the defendants’ evidence, I have approximated the precise numbers for ease of expression.  These have generally been rounded to the closest 100 SPHE.  In respect of the July, August and October Reductions (which are defined below), these have been rounded to the closest 10 SPHE in order to delineate each incremental reduction in SPHE occurring at each order amendment.

13. Similarly, times in the auction timelines, which are expressed to microseconds, have been rounded to the closest second.

    ASX GUIDANCE NOTE NO 32

14. On 18 January 2008 ASX issued GN 32 – Bulk authorisation of Index Arbitrage Orders in ITS (GN 32).  GN 32 is expressed to apply to orders entered to exit or unwind an index arbitrage hedge position during the Pre-Open Phase on an expiry day and any other time when opening or altering an index arbitrage hedge position with orders to be executed at market open.  It applies, therefore, to securities index arbitrage orders placed in the Pre-Open Phase on any trading day, not just on expiry. 

15. GN 32 draws particular attention to a participant’s underlying responsibilities to avoid conduct that may result in either an unfair or disorderly market (Rule 14.2) or market manipulation (Rule 13.4).  It makes the following general statements:

    ASX recognises the importance and legitimacy of index arbitrage orders in the Australian financial markets.

    ASX also recognises that the close out of an index option or index futures position on a derivatives expiry day necessitates the entire underlying basket relating to that index position to be liquidated, irrespective of price, at a time when the price of the basket equates as closely as possible to the settlement price of the related index derivative.  That is, timing and execution of volume is more important to the holder of the position than price.  This is achieved by unwinding the underlying basket during the opening option on expiry day.

    The same strategy applies to any re-weighting of an index arbitrage position prior to expiry when the underlying is bought or sold, again irrespective of price.

    However, a Participant’s rights and obligations under the Rules apply equally in respect of trading index arbitrage orders as they do when trading other types of orders.  The need to convert products into cash (or vice versa) over a short period does not confer on the index arbitrageur the right to ignore the consequences or effect that its trading might have on the market.  Consequently an arbitrageur may need to give special consideration to the effect of its trading in large size where the trading is also condensed into a short period.

    A Participant that takes account of, and has care as to the likely effect of, its index arbitrage orders is less likely to contravene the Rules as a result of trading such orders.  Where a Participant can demonstrate that the index arbitrage orders:

    (a)     reflect genuine index arbitrage activity; and

    (b)do not appear to have been placed with an intention to manipulate or cause a disorderly market having regard to, amongst other things:

    (i)         the time the order was placed;

    (ii)        the size of the order; and

    (iii)      the effect of the composition of the order,

    then ASX will take such matters into consideration when determining whether the Rules appeared to have been contravened.

16. With respect to the size of index arbitrage orders, GN 32 states:

    The size of an index arbitrage order can cause imbalance to the existing market price levels.  Prior to effecting an index arbitrage order the Participant should assess how much volume has been traded on previous expiries, and together with more recent volumes, assess whether the size of the order can be reasonably absorbed by the market given current trading conditions.

    Where the volume to be executed in the index arbitrage order is in excess of previous levels, such that the price might be expected to be materially affected, the Participant should take special precautions such as early entry of the index arbitrage orders to minimise market impact.  Precautionary activity of this kind may demonstrate the Participant has exercised sufficient care to minimise the market impact of a high-volume index arbitrage order.

    Conversely, materially increasing the size of the order once the order has been initially entered may indicate the Participant has not exercised sufficient care in assessing the likely impact of the order amendment.  In this regard it is noted that where a Participant materially amends the volume of an existing index arbitrage order, ASX will regard the amendment as the entry of a new index arbitrage order.

17. GN 32 sets out four explicit guidelines. 

18. Guideline 1 is:  

    ASX expects a Participant to be able to demonstrate that it has taken reasonable steps to verify that there is an approximately equal and opposite derivatives transaction corresponding with the index arbitrage order.

    Appropriate verification may include documentary evidence such as contemporaneous records of discussions with clients prior to the placement of the orders, transaction confirmations, correspondence or directions.  Such evidence must be available to allow ASX Compliance and Surveillance to readily conduct a review of bulk authorisation transactions.

19. Guideline 2 includes the following:

    The basic guideline that Participants should apply to the entry of index arbitrage orders is to enter them as early as possible.  This allows other Participants and their clients to react to the orders and take advantage of the increased volumes to be traded at the open.  Early entry of arbitrage orders gives others the opportunity to trade against them which may minimise price volatility at the open.

20. Guideline 2 also sets out the time by which an order should be placed, based on the total basket size.  For baskets valued at up to $100 million, the guideline stipulates that orders should be placed no later than one minute before each Group opening.  For larger baskets, longer time periods are stipulated.

21. Guideline 3 is:  

    A Participant which has entered an index arbitrage order in accordance with this Guidance Note should be able to amend the prices of the stocks included in the order so as to ensure that the required volume is transacted.  If for example, a Participant enters an order in accordance with this Guidance Note, and, by virtue of that time at which the order was entered the order is immediately overbid or offered, the Participant is able to amend the price of its orders with a view to trading the order.  Any price amendment should be made within the principles of the operation of a fair, orderly and transparent market, as waiting until immediately before the group opening may cause unreasonable market disruption.

22. Guideline 4 is:  

    As noted above ASX will consider a Participant materially amending the volume of an existing index arbitrage order to have entered a new index arbitrage order.  As a “new” index arbitrage order, that order would be subject to the verification, time and price guidelines above.

    THE RELATIONSHIP BETWEEN WHITEBOX AND NAB

23. In late 2009, Whitebox entered into negotiations with National Australia Bank Limited (NAB) in respect of the provision by Whitebox of securities index arbitrage trading services to NAB.  In 2010, the negotiations culminated in a series of agreements by which NAB effectively outsourced its index arbitrage trading activities to Whitebox.  At all times relevant to this proceeding, Mr Boshoff was Whitebox’s sole director.

24. The contractual arrangements included an agreement styled Software Supply and Commercial and Personnel Services Agreement.  This agreement was entered into on 9 March 2010 between NAB, Whitebox, Mr Boshoff, Warren Green, Simon Archer and Alexander Gamper.  It was amended on 9 July 2010 and 24 September 2010.  Under these various agreements, Whitebox agreed to provide, in broad terms, the services of Mr Boshoff and Mr Green in relation to trading financial products; Mr Gamper in relation to maintaining, developing and servicing the software to be employed in respect of the trading; and Mr Archer in relation business management and co-ordination.  The agreements also granted licences to NAB to install and use certain identified software.  These arrangements were implemented in about mid-2010.  In the ordinary course, Mr Boshoff and Mr Green placed orders for trading.  If Mr Boshoff or Mr Green were absent, Mr Archer would place and trade orders. 

25. By Deed dated 19 January 2011, NAB appointed Whitebox, Mr Boshoff and Mr Green as its authorised representatives under its Australian Financial Services Licence.  Later (it seems sometime in 2011), NAB also appointed Mr Archer as one of its authorised representatives. 

26. During the time that securities index arbitrage trading was conducted by Whitebox and its personnel pursuant to these arrangements, UBS Securities Australia Pty Ltd (UBS), as a “trading participant” of ASX, provided direct market access services to NAB to enable Whitebox and its personnel to send orders and trading messages to ASX Trade regarding XJO Securities.  JP Morgan Securities Limited (JP Morgan) provided services to NAB that enabled Whitebox and its personnel to trade and clear SPI Futures on ASX24 (the futures trading platform) for the purpose of conducting securities index arbitrage trading.

27. NAB placed market risk limits on Whitebox in respect of its trading.  One of these limits was a Gross Delta Limit.  This was the absolute value limit of Whitebox’s positions in XJO Securities and SPI Futures.

28. Other limits included a Stop Loss Daily Limit (essentially, the amount that could be lost in a single day) and a Stop Loss Rolling Month to Date (Rolling MTD) Limit (essentially, the sum of one-day losses over the preceding 20 business days).  ASIC submitted that these limits were of particular relevance on the Serial Expiry Days in question because the greater the extent to which Whitebox’s trades for NAB were unhedged at any given time, the greater the risk that it could lose money for NAB and breach those limits.  ASIC submitted that, in practical terms, this put a considerable constraint on Whitebox’s ability to carry an unhedged position in either XJO Securities or SPI Futures from the Pre-Open Phase into Normal Trading, even if such a strategy were considered to be rational.

29. Under its arrangements with NAB, Whitebox derived Personnel Fees, Software Fees and Performance Payments. 

30. The Personnel Fees comprised stipulated monthly payments in respect of the provision of services rendered by Mr Boshoff, Mr Gamper, Mr Green and Mr Archer. 

31. The Software Fees were a stipulated percentage of “Annual Net Revenue” as defined in the Software Supply and Commercial and Personnel Services Agreement and its amending agreements.  These fees were invoiced annually in arrears.  In essence, “Annual Net Revenue” was revenue earned by NAB from Whitebox’s securities index arbitrage trading using the software licensed by Whitebox to NAB for this purpose, less Whitebox’s costs in providing the services (other than salaries, contractor fees and other remuneration or benefits paid by NAB in respect of Whitebox’s personnel).

32. The Performance Payments were required to be made under a “Performance Plan” based on the performance of Whitebox’s Traders, essentially Mr Boshoff and Mr Green.  The payments were calculated by reference to an “Incentive Multiple” which was, initially, 12.5% for Mr Boshoff and 2.5% for Mr Green, although the multiple could be varied as between Mr Boshoff and Mr Green, provided the total Incentive Multiple was 15%.  The payment of part of each year’s Performance Payment (25%) was deferred and paid (subject to certain conditions) in the following financial year.

33. ASIC submitted that, by reasons of these various financial arrangements, Whitebox had a direct financial interest in maximising the revenue it generated for NAB, as well as an indirect interest in maintaining NAB’s commercial relationship with Whitebox and its personnel.  ASIC submitted that Mr Boshoff had an indirect financial interest in Whitebox maximising the revenue it generated for NAB because of his 100% shareholding in a company called H B Capital Aust. Pty. Limited, which in turn held dividend shares and 100% of the ordinary shares in Whitebox.  In the period 9 March 2010 to 31 December 2012, Whitebox earned, and was paid, a total of $4,639,952.63 from NAB in respect of Personnel Fees, Software Fees and Performance Payments. 

34. On 21 December 2012, NAB terminated its contractual arrangements with Whitebox.  The reason for that termination can be stated shortly.  On 18 October 2012 (one of the trading days in question in this proceeding), Whitebox placed orders which resulted in a spike in the price for Group 1 securities.  This trading is described in more detail below:  see [238] – [256].  NAB considered Whitebox’s trading to be a breach of its express warranty in the Software Supply and Commercial and Personnel Services Agreement (as amended) that it would perform its contractual obligations with due care and skill and in a proper and professional manner.  NAB also considered this to be a breach by Whitebox of an implied term of the agreement that it would perform its obligations with reasonable care. 

35. Following that price spike, NAB (on 19 October 2012) directed Whitebox to cease all trading on its account.  On the same day, UBS sent a letter to NAB confirming that, by mutual agreement, NAB would no longer trade through UBS’s direct market access services, although this was revised temporarily on 23 October 2012 to allow NAB to reduce and close out the positions it then held. 

36. In early December 2012, NAB closed its Index Arbitrage Desk.  By 20 December 2012, the positions held by that desk had been reduced to zero.  On 21 December 2012, at NAB’s request, JP Morgan disabled the accounts through which Whitebox personnel had traded SPI Futures on ASX24.  

37. For the period 1 October 2011 to 30 September 2012, Whitebox earned Performance Payments of $521,330.00 (excluding GST) (i.e., in addition to those amounts referenced above).  NAB did not pay this sum to Whitebox as it considered the sum to have been forfeited under the Performance Plan by reason of Whitebox’s alleged breaches of contract/duty.

    WHITEBOX’S STATED POSITION ON ITS TRADING STRATEGY

38. In a document prepared in 2009 by Whitebox’s index arbitrage team at the time that negotiations were underway between Whitebox and NAB to provide securities index arbitrage trading (and, I infer, used for the purpose of those negotiations), Whitebox referred to “our (t)rading strategy” as “at all times perfectly hedged (Futures and ETF’s to Cash)” with “no delta to generate PNL”.  The document emphasised that Whitebox had traded in Australia “with a very low risk profile”.  When dealing with market risk, the document stated:

    … In short WB strategy is one of NO delta, thus making us immune of [sic] Market movements both intraday and those from offshore and overnight.

39. Following the price spike caused by Whitebox’s trading on 18 October 2012, ASIC was provided with a document that sought to explain Whitebox’s trading strategy on that day.  This document was prepared with Mr Boshoff’s and Mr Archer’s assistance, and confirmed by them as being correct.  This document was referred to in the evidence as the Schedule A document.   

40. In a section headed “Overview of ASX SPI 200 Futures /ASX SPI 200 financial product arbitrage trading”, the Schedule A document states (omitting footnotes):

    1.1National Australia Bank Limited (“NAB”) engages in proprietary trading in ASX SPI 200 Futures (“Futures”) and the financial products that comprise the ASX SPI 200 Index (“Cash”) so as to profit from mispricings between the relative market prices of Futures and Cash, taking into account the financing costs of carrying Cash until the expiry of the relevant Future and the likely effect of any future dividend payments.

    1.2Known as “program trading”, this is a form of index arbitrage trading and involves NAB’s index arbitrage team using proprietary technology to identify mispricings between Futures and Cash.  Specifically, the team runs algorithms to determine the “fair value” of a weighted (yet imperfect) basket of the underlying financial products that comprise Cash against the strike price of the relevant future contracts at that time.  These algorithms take into account the funding costs of holding Cash to expiry, and model the impact of dividends that will be received or required to be passed though by NAB during the period.  Where the strike price of the futures contract is assessed as being equal to the “fair value” of the underlying weighted Cash basket, no mispricing exists and NAB will not trade.  The index arbitrage team continually calculates this “fair value” based on live price data which is marked to market.

    1.3Where this process identifies that Futures are more expensive than the fair value of the underlying weighted Cash basket, the index arbitrage team will sell Futures and purchase Cash.  Where Futures are cheaper than the fair value of the underlying weighted Cash basket, Futures are purchased and Cash is sold (by short selling if required). The number of Futures and Cash bought and sold is guided by reference to an algorithm which estimates, given the level of mispricing, how much Cash can be bought or sold before the mispricing is spent and there is no more opportunity to profit on the arbitrage.

1. The reference in these passages to NAB’s index arbitrage team is to the Whitebox traders.

2. The document goes on to describe Whitebox’s trading strategy, including by reference to the document prepared in 2009:

   1.4The index arbitrage team’s strategy is to capitalise on mispricing without exposing themselves to either market (delta) or specific risk (risk associated with specific stocks).  The reference to delta in this context is the misbalance between the nominal value of the Cash and Futures position stated in Futures contracts. To address the delta risk, the index arbitrage team hedges its Cash position through the buying or selling of Futures.  Tab 1 contains a more detailed description of the risk mitigations built into the index arbitrage team’s approach. This description was prepared in 2009 by the index arbitrage team at the time they were negotiating with NAB to provide arbitrage trading services.

3. The document then describes how this strategy is, in general terms, implemented:

   1.5The index arbitrage team begin reviewing the developing indicative auction price for Cash from approximately 8am every trading day as against the last closing price of Futures on Sycom, (available at 7am on trading days other than Monday) and analysis of overseas markets and other external factors that may impact the opening price of Futures.  Based on that analysis, the arbitrage trading team places and amends orders in the Pre-Opening Phase of the Cash market in anticipation of potential mispricing at Market Open and orders start to be placed from 8am.  The index arbitrage team’s strategy with the early orders is to submit Cash orders or bids based on the perception of mispricing being seen at that time as if such mispricing was to persist to unwrap.  As the perception of mispricing changes throughout the morning (with other activity in the auction) the orders are amended (and in some cases from Sell to Buy orders and vice versa) as more information becomes available.  From 9.40am, indicative auction prices for Futures become available through pre-open on ASX24, and at that time, the central order book for the Cash market starts reflecting the majority of orders that is likely to be present in the opening auction of the Cash market.  Therefore, following that time the accuracy of information relating to mispricing improves, and the ability of the index arbitrage team to predict mispricing at Market Open increases, and following the opening of the Futures Market on ASX24 at 9.50am, it becomes possible for the index arbitrage team to establish a strategy for execution.  However, due to the transient nature of mispricing, there is a risk that the index arbitrage team may buy or sell Futures too early and find that the mispricings disappear before the Opening rotation, leaving them with a delta and a possible loss on those Futures trades.  Accordingly, the purchase or sale of Futures to secure the “hedge” is executed as close possible to when the Cash can actually be bought or sold.

4. In later paragraphs of the document, dealing specifically with the trading on 18 October 2012, Whitebox referred (in para 4.9) to “the index arbitrage team’s usual practice” of transacting, as far as possible, futures:

   … as closely as possible to the time at which it transacts in Cash to minimise risks of market movement before positions can be offset.

5. In the same vein, another passage in the document (para 4.10, dealing with the disparity between Whitebox’s cash and futures positions close to the commencement of the OSPA on 18 October 2012) referred to the need for Whitebox to have acquired 471 SPI Futures:

   … to have its hedge on the then Cash offer, in place before the opening of Group 1 on the ASX at 10.00.00AM +/- 15 seconds.

6. The Schedule A document then explains:

   4.12Given these developments, if the index arbitrage team had maintained the Cash offer at its then size, it would have resulted in NAB obtaining a Cash position following the Market Open that was unhedged and carrying severe delta risk.  This would have been contrary to the index arbitrage team’s trading strategy.

7. I accept that the “This” in the last sentence of the quote refers not simply to carrying an unhedged position into Normal Trading but an unhedged position carrying “severe” delta risk.

8. In closing submissions, the defendants sought to explain or qualify various passages in the Schedule A document, including by reference to the 2009 document. In light of various email chains in evidence, the defendants submitted that the Schedule A document had been prepared rapidly and in circumstances of urgency to answer a notice served under s 33 of the Australian Securities and Investments Commission Act 2001 (Cth). They argued that Mr Boshoff had either two or five minutes to review the document before providing his confirmation of its accuracy. They pointed to various omissions and misdescriptions of a relatively minor nature to suggest that Mr Boshoff did not read a draft of the Schedule A document carefully before providing his confirmation.

9. The defendants also submitted that a number of passages in the Schedule A document—in particular, para 1.4 quoted above—should be understood as referring to intraday trading, when both the ASX and ASX24 were open; not to arbitrage activity in the Pre-Open Phase.  This was because para 1.4 refers to a strategy of capitalising on mispricing without exposure to market (delta) risk or specific risk (risk associated with specific stocks).  The defendants submitted that it is impossible to avoid risk in the Pre-Open Phase because it is impossible to trade both the cash and futures legs of an index arbitrage simultaneously.  This trading can only be done when the cash and futures markets are open.  In the meantime, an imbalance between the cash and futures positions cannot be avoided.

10. The defendants submitted that the statements made in paras 4.9, 4.10 and 4.12 of the Schedule A document were dealing specifically with Whitebox’s order activity on 18 October 2012, and not more generally in the course of its index arbitrage trading.  I accept that this is the context in which those statements were made. The defendants submitted that the statement in para 4.9 about transacting the futures leg of the arbitrage as closely as possible to transacting the cash leg should not be understood as being directed to the time of Whitebox completing its trading on the futures leg.  They submitted that completing trading on the futures leg is a function of the size of the mispricing that might have been captured, and the conditions in the futures market, on the day.  They argued that if significant mispricing had been captured, the risk involved in deferring part of the futures leg until after market opening would be acceptable.

11. The defendants submitted that the statement in para 4.10 about the “need” for Whitebox to acquire 471 SPI Futures before the opening of the Group 1 Rotation on 18 October 2012 (quoted at [112] above), should not be read as an absolute statement. The defendants submitted that it was not necessary to attempt to trade, Group by Group, a number of SPI Futures corresponding in value to the percentage of the ASX 200 represented by each Group. The defendants supported this submission by reference to data on Whitebox’s futures trading on Expiry Days in 2012. The defendants submitted, and I accept, that the data shows that Whitebox did not adopt a rigid, formulaic approach of matching futures with the proportion of the cash leg as it traded. The defendants also submitted that the data shows that Whitebox did not have a rigid approach of precisely matching the futures and cash legs even as at the time of the Group 5 Rotation. As a matter of fact, this is true, although on a number of days the difference between the futures leg and the cash leg is either non-existent or small. On other days, the difference is more marked. However, overall, the data shows that, in practice, the matching of the two legs at particular times was less rigid than the statement in para 4.10 suggests: see Appendix D to the defendants’ closing submissions.

12. The Schedule A document was prepared for submission to ASIC on a matter of considerable importance, namely to address and explain Whitebox’s arbitrage activity on 18 October 2012.  It is written in plain terms with, in my view, a plain meaning.  I do not think it calls for the nuanced reading advocated by the defendants in submissions.  If the document does not mean what it says, or did not accurately represent Whitebox’s position at the time it was prepared and given to ASIC, then the defendants could have called, and should have called, evidence on that matter.  There is nothing before me to suggest that at any time since 2012, the defendants sought to qualify the deliberate statements made in the document, other than by submissions in this proceeding.  

13. I am particularly unmoved by the suggestion that Mr Boshoff did not carefully read or did not carefully consider the draft of the Schedule A document that was submitted for his confirmation.  The document was prepared with his assistance.  Given the circumstances in which, and the occasion for which, it was prepared, I am not prepared to act on the mere suggestion that, at the time, Mr Boshoff might not have given the document the attention it so clearly deserved.  If Mr Boshoff acted carelessly in that regard, then that circumstance calls for evidence, not simply a suggestion made argumentatively in submissions.

14. The passages I have quoted above stand as Whitebox’s general and usual trading strategy.  They are consistent with a strategy that was directed to avoiding market risk due to holding an unhedged position.  The passages indicate that the manner in which risk was to be minimised was to ensure that there was no significant time-gap between buying/selling XJO Securities and selling/buying SPI Futures.  It was also to be managed by not carrying an unhedged position into Normal Trading.  Read in context, the Schedule A document was seeking to explain that, as matters transpired, Whitebox’s trading on 18 October 2012 was, overall, in accordance with its general and usual trading strategy.  However, the evidence shows that this general and usual trading strategy was not followed invariably on other days.  As I will come to explain, Whitebox’s appetite for risk was not as adverse as the Schedule A document and, indeed, the 2009 document suggest.

15. ASIC submitted that the fact that Whitebox sought to trade XJO Securities and SPI Futures contemporaneously and in a manner that minimised risk was important for two reasons.  First, it informed the question whether there was an intention on the Serial Expiry Days in question to trade the large orders for XJO Securities which Whitebox had placed (discussed in more detail below) in circumstances where (as ASIC contended) Whitebox could not have expected to trade SPI Futures profitably in a manner consistent with its stated strategy of minimising market risk.  Secondly, the rate at which, and manner in which, Whitebox traded SPI Futures in the Pre-Open Phase and the OSPA enables the Court to infer the amount of XJO Securities Whitebox actually intended to trade during the OSPA.  These submissions are related to (what ASIC described as) the second and third “pillars” of its case:  see below.

16. It is convenient at this point to also refer to certain email correspondence between Mr Boshoff and Mr Stevenson from NAB in October 2012; in particular an email on 26 October 2012 when Mr Boshoff was responding to a query raised by Mr Stevenson (who was then the Head of Market Risk Oversight – Rates, Credit & Equities) about Whitebox’s trading on 18 October 2012.  In that email, Mr Boshoff said: 

    Our strategy during the early lead up of the Auction is to submit orders that can possibly lead to a mispricing trade if mispricing persists to the unwrap (an obviously presuming we can hedge the futures).  When there is as much volatility in the basis as we saw from 9:40am and so much of it we are not overly concerned to balance the market precisely with our orders (the volatility makes that impossible) but rather to make sure we respond to the big basis moves.  Referring to table provided by Mallesons the amend that we did at 9:48:14 from nominal 2000 futures was a response to basis spiking up to 17bps.  Our amendment to 1900 nominal futures brought basis back to 7.2 bps and our system indicated that an amendment of a further 100 lots would take it to -14bps.  Our experience is that as the market opening approaches basis generally becomes less volatile and we are then able to accurately calibrate it to provide us with enough mispricing to commercially justify our basket.  Please note in table 1 the ‘No Action’ entries during 9:59am. 

    (Errors in original; emphasis added.)

17. As the defendants pointed out in submissions, the figures quoted in the email for Basis do not appear to be accurate.  They certainly do not correlate with the figures given in the auction time line for 18 October 2012, which the parties accepted is accurate.

18. However, the matter of present significance is Mr Boshoff’s statement that, as the market opening approaches, Basis generally becomes less volatile and “we are then able to accurately calibrate it to provide us with enough mispricing to commercially justify our basket”.

19. The defendants submitted that the word “calibrate” in this passage should be understood as referring to the size of Whitebox’s cash orders in SPHE, not to Basis as such.  The defendants submitted that while Whitebox was able to set (calibrate) its cash order size, it was not, and is not, possible for any arbitrageur to set (calibrate) Basis, given that Basis is a function of the orders in the Order Book at any one time.  Thus, it would have been impossible for Whitebox to predict how other orders in the book would change, either in response to Whitebox’s orders or otherwise, so as to affect Basis.  I note in this connection that the amendment to which Mr Boshoff referred was made at 9:48:14, significantly more than eleven minutes before the earliest time that the Group 1 Rotation could occur—a very lengthy period in the scheme of things, in which the order activity of other arbitrageurs and traders could radically change the size and even direction of Basis.  I accept that, in these circumstances, this would be a strange use of the word “calibrate”.

20. To support their submission, the defendants also drew attention to the words:  “to provide us with enough mispricing to commercially justify our basket”.  The defendants submitted that Whitebox could not “commercially justify” a loss-making basket or one that would require it to carry a disproportionate risk on the futures leg.  This was something Whitebox could “calibrate” by amending orders closer to the time of the Rotation for each Group, given that Basis tends to decay as market opening approaches.

21. As a matter of syntax, it is difficult to read the word “calibrate” in the quoted passage in Mr Boshoff’s email as referring to anything other than Basis.  However, if Mr Boshoff did intend to convey that meaning, I accept the defendants’ submission that Whitebox could not “calibrate” Basis.  No doubt Whitebox’s orders could affect Basis, but the extent to which this would be so depended on the order activity of other arbitrageurs and traders, a matter over which Whitebox had no foreknowledge or control.

22. The defendants submitted that there is nothing improper in amending orders as the OSPA approaches, even very close to the OSPA, so as to avoid a loss-making position or to reduce risk or to increase the prospect of profiting from an order.  They accepted as uncontroversial the fact that an amendment to an order can have an immediate effect on the IMP.  But, they submitted, to do so is entirely consistent with the rationality of the strategies accepted by Mr Morgan in the witness box.  The defendants emphasised that ASIC’s case is that Whitebox placed earlier orders or amendments without even a contingent intention to execute them, for the purpose of manipulating the Opening Prices of the securities concerned.

23. I accept the defendants’ submission that there is nothing improper in amending orders as the OSPA approaches, even very close to the OSPA, so as to avoid a loss-making position or to reduce risk or to increase the prospect of profiting from an order.  The conduct which ASIC alleges is of an entirely different character.

    THE IMPUGNED TRADING

    ASIC’s identification of the impugned trading and the defendants’ strategy

24. In this section of my reasons, I summarise ASIC’s identification, in its written closing submissions, of the impugned trading on each of the five Serial Expiry Days in question.  ASIC’s written submissions were supplemented by charts (used in opening), and tables which nominated the particular orders that were said to give rise to the allegedly contravening conduct.   

25. ASIC submitted that Whitebox’s trading on these days was characterised by a “deliberate, clear and substantially consistent strategy” which enables the Court to interpret the Whitebox trading and to assess the defendants’ intentions when placing (or causing Whitebox to place) the orders the subject of this proceeding. 

26. In general terms, this strategy was to place very large orders for XJO Securities in the Pre-Open Phase which were subsequently cancelled or significantly reduced in volume in the period shortly prior to the relevant rotation of the OSPA in which the orders were due to trade, without permitting the market time to react.  ASIC’s case is that, by placing these particular orders, and cancelling or reducing them when it did, Whitebox and Mr Boshoff were intending to manipulate the Opening Price for the XJO Securities to create mispricing that could then be exploited for profit.  In short, there was no genuine intention to trade the large orders.

27. ASIC submitted that, consistently with this strategy, the defendants never sought to trade SPI Futures at either the rate or with the “aggression” that would have been needed to match these very large orders of XJO securities if carrying out a perfectly hedged index arbitrage.  According to ASIC, the rate at which Whitebox did trade SPI Futures was consistent with trading the much smaller SPI Futures position it in fact traded on each of the Serial Expiry Days in question.  In this connection, ASIC singled out for particular mention Whitebox’s trading on 19 April 2012 when Whitebox did not commence placing orders for and trading SPI Futures until 9:59:22.  This allowed only 23 seconds within which to trade the approximately 306 SPI Futures necessary to match, by the earliest commencement of the Group 1 Rotation, the Buy Orders for Group 1 securities.

28. ASIC submitted that, consistently with its stated trading strategy, on the Serial Expiry Days in question, Whitebox placed and traded index arbitrage orders in a way that sought to minimise its exposure to the risks that might arise from a mismatch between its positions in XJO Securities and SPI Futures.  ASIC submitted that, with the exception of subsequent trading undertaken on 19 April 2012, Whitebox did not trade SPI Futures after 10:08:45, the earliest possible time for the commencement of the last Rotation of the OSPA.  The SPI Futures that Whitebox traded in the period prior to 10:08:45 substantially matched the value of Whitebox’s position in XJO Securities in the OSPA.  Exceptionally, on 19 April 2012, Whitebox in fact acquired an additional position in XJO Securities after the commencement of the OSPA.  In order to hedge this position, it sold additional SPI Futures.

29. ASIC submitted further that the defendants’ strategy was to “capture” Basis and “mask” Underlying Basis (i.e., the potential profit that would exist in the absence of Whitebox’s orders) from the rest of the market.  ASIC explained this aspect of its case by reference to the phenomenon of Basis Decay.  ASIC said that, because of the size of the orders that Whitebox had in the market, there was a large difference between the mispricing that would have existed absent Whitebox’s order (Underlying Basis) and the mispricing that existed with Whitebox’s orders (Basis).  This difference was only visible to Whitebox and, according to ASIC, was thereby “masked” from the rest of the market.  ASIC argued that it was this difference that provided the opportunity for Whitebox to profit by removing order volume.  Relatedly, it explained the rationale for Whitebox placing large orders for XJO Securities and then cancelling them or reducing their volume substantially shortly before the orders were due to trade in the OSPA.  

•      5.10pm to 7.00am and 9.50am to 4.30pm (during US daylight saving time)

•      5.10pm to 8.00am and 9.50am to 4.30pm (during US non-daylight saving time)

the times are Sydney times. US daylight saving begins first Sunday in April and ends last Sunday in October.

Before the opening of each session there is pre-open phase, lasting approximately 10 minutes, which is immediately followed by an opening auction at 5:09:30pm (prior to the commencement of the night session) and 9:49:30 am (prior to the commencement of the day session).

60. Prior to the ASX24 the trading platform for the trading of futures including the SPI was called “SYCOM”. Accordingly, the industry sometimes refers to the closing price at the end of the morning session (7:00am/8:00am) for a SPI Futures contract as its “last SYCOM price”.

Index arbitrage

Overview

61. Securities index arbitrage is a trading strategy by which the securities (or a proxy portfolio of securities) comprising an index, are traded against futures (or similar derivative products) that derive their value from that index.

62. Index arbitrage trading in Australia which involves the XJO, involves buying (selling) securities (or a proxy portfolio of securities) comprising the XJO, and selling (buying) SPI Futures, with a view to profiting from any price disparity from “Fair Price” of the SPI (explained further below). The selling elements and buying elements of establishing an arbitrage position are respectively known as the two “legs” of an arbitrage position.

63. The two legs of an index arbitrage are sometimes called “Cash” when referring to the securities side and “futures” when referring to the futures side, i.e. “buying Cash selling futures”, “selling Cash buying futures”.

Fair Value, Fair Price and Mispricing

64. To assess whether there are arbitrage opportunities, an arbitrageur will calculate “Fair Value” of the SPI. This is generally the value as calculated by the particular arbitrageur (measured in index points) of the funding costs (and possibly stock borrow costs) and estimated dividend flows between the trade settlement date of the Cash and the futures Expiry Date. This “Fair Value” is added to the level of the XJO to calculate the “Fair Price” for the SPI. Each arbitrageur is subject to varying costs of funding and stock borrow costs, and will calculate their own estimates of expected dividends flowing from the underlying stocks to the holder of the stocks. This means every arbitrageur will have their own calculation of Fair Value, and hence their own calculation of the Fair Price of the SPI.

65. Mispricing is the measure of any divergence between the calculated Fair Price of the SPI and the market price of the SPI. It is described in “basis points” (bps), each being 1/100th of one percent. So, for example, if the SPI is trading at a level one percent above Fair Price, this is described as 100 bps of mispricing. This mispricing is known as “Basis”.

66. The glossary of terms further expands on the definitions of “Fair Value”, “Fair Price” and “Basis”.

67. Arbitrageurs that identify mispricing, or Basis, are incentivised to capture the available potential profit by executing trades between the two markets, i.e. buying (selling) the SPI Future and selling (buying) individual stocks that comprise (in whole or sometimes in part as a proxy portfolio) the XJO in their appropriate quantities/weightings. The level of mispricing required will vary between arbitrageurs as it will reflect their different Fair Price calculations and also the transaction costs involved in executing the trades.

Index arbitrage activity

68. If there is mispricing when both the ASX and Futures markets are open for trading arbitrageurs generally will seek to profit from that mispricing by executing trades as close as simultaneously as possible on both exchanges, and to repeat that process throughout intra-day trading. This type of index arbitrage activity is sometimes described as “vanilla” index arbitrage. Many arbitrageurs have automated systems or deploy algorithms to trade on both legs during intraday trading as an index arbitrage strategy.

69. Index arbitrage opportunities, however, can also exist at times when both markets are not open, as can be the case when ASX Trade is in the Pre-Open Phase (i.e. not open for Normal Trading) but ASX 24 has commenced trading SPI Futures in the morning session from approx. 9:50 am. These opportunities arise because the arbitrageur may be able to make calculations or observe calculations of the indicative opening prices for each security during the Pre-open Phase between 7am and the Opening Phase. The arbitrageur then may be able to calculate a theoretical opening XJO index level and compare that calculation to the last trade of the overnight SPI Futures trading session (the “last SYCOM price”). If the disparity is larger than Fair Value, this would suggest that there exists a potentially profitable index arbitrage opportunity. The arbitrageur may then enter orders for “baskets” of XJO securities into the ASX Trade order book, anticipating that the SPI futures leg of the arbitrage can be executed at a time after 9:50 am, should the potential profit (or Basis) remain apparent at that point. Such activity involves a timing mismatch between executing the futures and executing the Cash legs. As such, unhedged risk is necessarily accepted in this style of arbitrage.

70. The likelihood of a potentially profitable arbitrage existing (i.e. mispricing existing) tends to be higher on futures contract expiry days each month. This is because index arbitrageurs (and other market participants) who have held an arbitrage position to expiry will potentially be closing out their securities (Cash) positions at expiry. As the expiring SPI Futures contract is settled by reference to the first traded price of the XJO securities on the expiry day (which generally will be for most securities its Opening Price), those arbitrageurs are generally agnostic as to the Opening Price for each individual security. To explain, any “loss” experienced by the arbitrageur in buying or selling the component stocks at the Opening Price is made good by the concomitant adjustment to the expiring futures’ settlement price. Such arbitrageurs are only likely to be concerned that their Cash position is able to be fully traded at the Opening prices. As the ASX does not allow “Market Orders”, arbitrageurs who are closing out their Cash positions on expiry will therefore, to ensure execution, tend to place their orders in the Pre-open Phase in what is described as “deep in the book”. That is, an arbitrageur selling stock will place a limit order at a price considered to be well below the likely opening price for the stock at Opening; conversely, if he or she is buying stock, he or she will place a limit order at a price assessed to be well above the likely opening price of the stock at Opening.

71. The extent of such activity on a futures expiry day can, amongst other causes, lead to there being (or expected to be) mispricing at or around the time of ASX Opening. That mispricing (or expectation of mispricing) allows other index arbitrageurs to seek to profit from it by seeking to establish Index arbitrage positions against the next quarterly expiring futures contract.

72. An arbitrageur with the IT resources to conduct calculations of “indicative” XJO prior to ASX opening is in a position to assess whether (and to what potential extent) index arbitrage opportunities may exist at or around the time of ASX Opening and is better placed to then make decisions to enter, amend or cancel orders in the order book during the Pre-open Phase, placing him into a position to profit from any mispricing that may persist at or around the ASX Opening.

73. Because of the nature of the Pre-open Phase, assessments of mispricing will change throughout the morning as more order activity comes into the order book of ASX Trade. Arbitrageurs can monitor, calculate and re-calculate Basis, i.e. the mispricing, throughout the Pre-open Phase. Some are also able to calculate hypothetical Basis absent their own orders. Such calculations are sometimes known as calculations of “Underlying Basis”.

Management of an Index Arbitrage position

74. An arbitrageur who has bought securities and sold futures is said to be “long stock / short futures” or to hold a “positive arbitrage” position. An arbitrageur who has sold securities and bought stock is said to be “short stock / long futures” or to hold a “negative arbitrage” position.     In either case, there are essentially three ways for the arbitrage position to evolve, as follows:

(a) The arbitrageur may await a favourable move in Basis so that the stock and futures legs can both be reversed (unwound) in the market, thus capturing part or all of the anticipated profit, or

(b) The arbitrageur may ‘roll’ the arbitrage by buying back (selling back) the futures leg prior to expiry and selling (buying) futures that expire in a subsequent month, all the while retaining their position in the stocks underlying the index, or

(c) The arbitrageur may hold the arbitrage to the futures expiry day, whereupon the stocks are likely to be bought (sold) at Opening Prices, and the price realised will be reflected in the held expiring futures position, which is subsequently cash settled.

75. A wide and varied group of participants engage in Index Arbitrage in various forms and can apply differing trading practices, depending on their trading mandate and risk appetite and perception of risk.

Risks

76. Depending on how and when Index Arbitrage is undertaken, there are a variety of risks associated with it. These can include:

(a) interest rate risk (i.e., in very simple terms, the risk that interest rates that transpire will differ from the assumed interest rates used to calculate the Fair Value of futures);

(b)     unexpected changes in dividend size or timing;
         (c)     risk of index constituent stocks being suspended from trade;

(d) stock borrow risk i.e. that stock previously borrowed to settle short sales is unexpectedly recalled by the lender;

(e) Unhedged exposure risk (i.e. in very simple terms, the futures position and Cash position are not fully hedged so they may be exposed to price movements).

77. Different participants may have different approaches and adopt different strategies to identify, manage and mitigate risks. Among other things, this may be influenced by what risk the arbitrageur has a mandate to accept and their own appetite for risk.

Glossary of Terms

• “All Transactions Reports” refers to reports which record for particular securities, in a chronological order, with a timestamp to one thousandth of a second, all orders that were placed, amended or cancelled and all trades and session states, that occurred in the ASX Trade order book in a specified time period as covered in the report; with report identifier style “AllTransactionReport[security code] _YYYYMMDD”.

• “ASE” means Australian Securities Exchange Limited (ABN 83 000 943 377), a wholly owned subsidiary of ASX Limited.

•       “Ask” (also see “Offer”) is a sell order for (relevantly) securities or futures.

• “ASX” is the market for the trading of various financial products, including equities (securities or units/interests in listed registered schemes), operated by ASX Limited (ABN 98 008 624 691), which is commonly known as the stock exchange. In some contexts, a reference to ASX may be a reference to ASX Limited itself.

• “ASX24” (formerly known as the Sydney Futures Exchange) is the market for trading in futures contracts (such as SPI Futures), options contracts and other derivative contracts operated by ASE (a wholly-owned subsidiary of ASX Limited).

• “ASX Trade” is the electronic order and execution platform for equities operated by ASX Limited.

• “ASX Trade24” is the electronic order and execution platform for futures operated by ASE.

•       “Auction Price” – see “Match Price”.

• “Audit Trading Logs” refers to reports which record messages concerning orders or trades that were received, processed, recorded and published on ASX Trade24 during a specified time period as covered in the report; with report identifier style “TRADINGSERVICE_Audit_Trading_Log”.

• Basis Mark” is a term referring to a trade offset that might be applied by an arbitrageur to adjust, or offset, what would otherwise be the Fair Price in an arbitrage model.

• “Basis” is a measure of mispricing which may give rise to an arbitrage opportunity. Basis can be calculated as follows:⁸

BASIS=

(  Futures Price-Index Level-Fair Value )      X    10,000

Index Level

And if an arbitrageur is using a Basis Mark, then the Fair Value figure may be adjusted by the Basis Mark.

• “Basis Decay” is a phenomenon observed in the Pre-open Phase whereby Mispricing declines as the Opening Phase approaches

• “Basket” is a set of XJO Securities that replicates in full or in part constituent securities in the XJO according to their general weighting in the XJO.

_____________________

⁸ “Index Level” in the formula is what an index arbitrageur calculates as the relevant Index level (XJO level or indicative XJO level) depending on the methodology employed for the calculation and also the purpose or use of the calculation.

• “BD2” a broadcast message from ASX Trade that broadcasts the XJO level during Normal Trading every 30 seconds.

•       “Bid” is a buy order for (relevantly) securities or futures.

• “BO10” is a broadcast message from ASX Trade that broadcasts during the Pre-open Phase indicative opening/auction/match prices for all securities listed on the ASX. The BO10 message broadcast is subject to a 500 millisecond “holdback”, which means that the message may include the accumulated effects of several orders occurring within the preceding 500 millisecond period.

• “Cash” in the context of arbitrage is a reference to the equities, primarily securities, or some of them that comprise the XJO, so that a reference to the “cash market” is a reference to the securities market as opposed to the futures market.

• “Cash-settled Futures Contract” is a futures contract that requires the seller or buyer to pay to its counterparty, on its Expiry Date (subject to any deferred settlement), the difference between the Contract Value and the value on the Expiry Date of the contracted commodity or financial instrument underlying the futures contract.

• “Cheap” – if the SPI Futures contract is trading at a price which is at a discount to Fair Price (i.e. so that Basis is a negative number) then the futures contract is said to be trading “cheap”.

• “Deliverable Futures Contract” is a futures contract that requires the seller of the commodity or financial instrument that underlies the futures contract to deliver the contracted quantity of the commodity or financial instrument on the contract’s Expiry Date (subject to any deferred settlement).

• “Direct Market Access” or “DMA” is a facility offered by brokers to clients that allows a client of a broker to place an order directly into an exchange trading system, which is routed through the particular broker’s system.

• “Exchange for Physical” or “EFP” – there is an EFP market available to arbitrageurs to manage inventory levels. This is a market usually offered by SPI futures brokers that allows for SPI Futures and arbitrage baskets to be exchanged at pre-agreed levels between traders. Each “leg” is then transacted by reporting to the exchange as an EFP.

• “Fair Price” – arbitrageurs calculate Fair Value and add it to the XJO level to calculate their fair price of the SPI Futures. If there is no mispricing, the SPI Futures trading price should equal the fair price.

• “Fair Value” is a calculation undertaken to assess the appropriate price of the SPI Futures in relation to the level of the XJO. It generally accounts for the value of stock dividends paid or received, and the funding cost of holding equities. The Fair Value sets out in index points (both the XJO and SPI Futures are quoted and priced in Index Points) how the SPI Futures should be priced relative to the level of the XJO. Associated with holding a long or short stock position against a futures position is funding cost and dividends. Fair Value can be calculated as follows:

Position Long Stock Short Stock Funding Cost Have to Pay Cost of Funding Position Receive Interest on Proceeds of Sale, less stock borrow cost Dividends Receive Dividend from holding stock Have to pay Dividends to party that lent me the stock scrip to short

Long Fair Value = funding costs – dividends received

Short Fair Value = interest received – stock borrowing cost – dividends paid

• “Good Till Cancel” (“GTC”) orders remain in the order book until traded or otherwise cancelled.

• “Index” – in the context of how that term will be generally referred to in these proceedings, it is an abbreviation for the S&P/ASX 200 Index (aka the XJO).

• “Index Point” is a measure for the level of the S&P/ASX 200 Index (aka the XJO) and for the price of SPI Futures (the price of a SPI Future being quoted in index points). For each SPI Future, the value of each index point is equal to $25.

• “Indicative Match Price” (“IMP”) or “Indicative Auction Price” (“IAP”) or “Indicative Open Price” (“IOP”) is a calculation, undertaken at a point in time in the Pre-open Phase, of what the Opening Price of a stock would be if the OSPA for that stock were hypothetically held at that point in time. That indicative price is derived from the bids and asks current in the ASX Trade order book at the time of the calculation, applying the ASX Algorithm at that point in time; and is recalculated each time an order is entered, amended or cancelled in ASX Trade.

• “Indicative Match Volume” (“IMV”) is the calculation of the quantity of a security that would be traded at the Indicative Match Price, if the market were hypothetically open at the time of the calculation. The IMV is calculated by applying the ASX Algorithm at the time of the calculation; and is recalculated each time an order is entered, amended or cancelled in ASX Trade.

• “Long” – a long position is a bought position. This can apply to either securities or futures.

• “Long Fair Value” is the fair value as calculated from the perspective of a person who is long (buying) securities and short futures. Long Fair Value can be calculated as follows:

Long Fair Value = funding costs — dividends received

• “Market Participant” means, in relation to a financial market, a person who is allowed to directly participate in the market under the market's operating rules. For example, an ASX Trading Participant is a Market Participant.

• “Match Price” “Opening Price” or “Auction Price” is the opening price of securities listed on the ASX as set as a result of the series of five auctions (OSPA) conducted at the start of each of the Group Rotations in the Open Phase, where overlapping bids and asks for securities from the Pre-open Phase that remain in the book at the time of the OSPA, are matched, and trades result, at prices known as the Match Price (also sometimes known as the “opening price” “auction price” or “equilibrium price”) as derived by operation of the “ASX Algorithm”.

• “Maximum Executable Volume” is the maximum volume (i.e., quantity) of a security that would be traded at a particular price level.

• “Mispricing” – arbitrageurs calculate Fair Value and add it to the XJO level to determine the fair price of the SPI Futures. If there is no mispricing, the trading price of SPI Futures should equal their Fair Price. Any variation between the fair price of the SPI Futures and the price at which the SPI Futures is trading is the mispricing. Mispricing is also described as “Basis” and measured in basis points, each being 1/100 of 1%. For instance, if the futures price is trading at 1% above fair price then one would say that basis is +100 basis points.

•       “Negative Index Arbitrage” is a reference to buying futures and selling Cash.

• “Normal Trading” – the Open phase starts immediately after the Pre-open Phase and lasts until the start of the Pre-CSPA at 4pm. The Open phase commences with the OSPA in the first rotation. During the Open phase (also known as Normal Trading) orders may be entered, amended, cancelled and traded. During Normal Trading, ASX Trade matches bids and asks automatically and immediately whenever the price for a bid and an ask for a security “overlap”, that is, when the price of the bid is equal to or greater than the price of the ask.

•       “Offer” – see “Ask”.

•       “Open Interest” refers to open positions in a SPI Future.

•       “Opening Price” – see “Match Price.

• “Operator Reference Number” or “Opref Number” refers to the identifier code (as an operator reference) assigned by a Market Participant (aka. broker) for an entity/ client submitting orders to the ASX Trade platform, as noted on the All Transactions Reports.

• “Option” a contract that offers the buyer the right, but not the obligation, to buy or sell a security or other financial asset at an agreed-upon price during a certain period of time or on a specific date.

• “OSPA” refers to the series of opening single price auctions for securities on the ASX, which take place at the commencement of trading at market opening in each of the 5 different Rotation Groups, where matching /overlapping bids and asks in the order book at the time are matched and trades result at prices known as “opening”, “auction” or “match” prices as calculated by the ASX Algorithm.

• “Positive Index Arbitrage” is a reference to selling futures and buying Cash (i.e., securities).

• “Pre-open Phase” – the Pre-open Phase refers to the period that takes place from 7am to 10am (+/- 15 seconds) running through to 10:09am (+/- 15 seconds) for the last Rotation Group on each ASX trading day where Market Participants can enter orders into ASX Trade prior to the ASX opening, but where ASX Trade does not trade orders.

• “Price Step” is a reference to “Tick Size” which, in the ASX, are the minimum price multiples for a security. Price Step is the increment determined by the ASX between price levels for each stock or security. For futures the price step is one index point and for securities it depends upon the market price of the security – up to 10c, the Price Step is 0.1c; 10c up to $2, the Price Step is 0.5c; above $2, the Price Step is 1c.

• “Quarterly Expiry Day” is a day on which “quarterly” SPI Futures expire. The SPI Futures market has quarterly expiry days generally on the third Thursday of March, June, September and December.

• “Replicating Basket” – is a reference to a basket of each of the securities comprising the XJO that are each held in proportions to the weightings given to the securities in calculating the level of the XJO.

• “Rich” – if the SPI Futures contract is trading at a price which is a premium to Fair Price (i.e. so that Basis is a positive number) the futures contract is said to be trading “rich”.

• “Rotation” and “Rotation Group” – securities are divided into the following five groups of securities, known as “Rotation Groups” or simply “Groups”. Rotation Groups are organised alphabetically according to the first letter of their ticker code: A-B, C-F, G-M, N-R and S-Z. Each Rotation Group has its opening auction (OSPA), known as a “rotation”, at a precise time that is randomly generated by ASX Trade but which falls within the following 30-second windows:

Rotation

Range of possible rotation

times

•     A-B securities (first

     rotation):

•     Between 09:59:45am and

     10:00:15am

•     C-F securities (second

     rotation):

•     Between 10:02:00am and

     10:02:30am

•     G-M securities (third

     rotation):

•     Between 10:04:15am and

     10:04:45am

•     N-R securities (fourth

     rotation):

•     Between 10:06:30am and

     10:07:00am

•     S-Z securities (fifth

     rotation):

•     Between 10:08:45am and

     10:09:15am

• “S&P ASX 200 Index” or “ASX 200” or “Index” or “XJO” is a reference to the S&P/ASX 200 Index (which has the ASX code “XJO”).

• “Serial Expiry Day” is a day on which “serial” SPI Futures (that is, SPI Futures that are not “quarterly” SPI Futures) expire. The SPI Futures market has serial expiry days generally on the third Thursday of each non-quarterly expiry month, which comprise January, February, April, May, July, August, October and November.

• “Settlement Value” is the price payable for settlement of a SPI Future upon its expiry. The Settlement Value is calculated on the first traded price of the security on that day (which for most securities will be its Opening Price that Expiry day) or if the security did not trade on the Expiry Date, its last traded price).

• “Shares per Hedge” or “SPH” – the Shares per Hedge (“SPH”) of any stock index future (such as a SPI Future) is that number of shares that need to be held for each constituent security of the Index to hedge each futures contract. As the SPH figure is different for every stock and related to the price and weight of that stock in its index, the SPH is a calculation of the theoretical share size that should be held against any futures position as a hedge.

• “Shares per Hedge Equivalent” or “SPHE” is a descriptor used by the Defendants in these proceedings to indicate how many futures equivalent number of shares an arbitrageur has in the book or has been filled for. By way of example, if there are 500 SPHE orders or executions, this refers to there being 500 times each stock's specific shares per hedge as orders or executions. It is also sometimes referred to as having a 500 SPI Equivalent number of shares or a 500 SPI cash position.

• “Short Fair Value” is Fair Value calculated from the perspective of someone who is short (i.e., selling) securities and long (i.e., buying) futures. Short Fair Value is calculated as follows:

Short Fair Value = interest received – stock borrowing cost – dividend paid

• “SPI Equivalent” is a term used by the Plaintiff in these proceedings as a measure of the value     of orders or trades in respect of XJO Securities and represents the volume of SPI Futures that is equivalent in value to the dollar value of the orders or trades. The Plaintiff calculates it by       dividing the dollar value of the orders or trades (calculated by multiplying the volumes of the    XJO Securities for which the orders were placed or traded by the closing prices of those securities on the ASX on the previous trading day) by 25 times the last trade price for the SPI Futures on ASX24 at the time of the CSPA on the previous trading day. The Defendants use the term “SPI Equivalent” in these proceedings in a different way to the way the Plaintiff has used the term as described in the definition above referring to “Shares per Hedge Equivalent” or “SPHE”.⁹

• “SPI Futures” or “SPI” – ASX SPI 200 Futures contracts tracks the performance of the XJO.

• “Standard & Poor’s” – also referred to as “S&P”. Part of the McGraw Hill Financial Inc group. The XJO is produced, maintained and published by Standard & Poor’s.

•       “Tick Size” – see “Price Step”.

• “Ticker Code” –tradable financial products quoted on ASX are assigned a unique identifier generally known as a Ticker Code. Ordinary shares in a listed company are usually identified by a three-letter code. For example, TLS is the ticker code for ordinary Telstra shares. A ticker code consisting of more or fewer than three characters usually indicates something different from the ordinary shares of a company.

• “Underlying Basis” the level of Basis as it would be absent the orders placed by the relevant arbitrageur.

• “Vanilla Arbitrage” – this type of arbitrage involves executing baskets of constituent securities in the Index and executing Futures at a time when all those securities are open and trading at the same time as Futures are trading in the SPI Futures market, thus minimizing possible mismatch between long and short exposures.

•“XJO” – the ASX code for the S&P/ASX 200 Index. That index is therefore also known as the XJO.

• “XJO Equivalent” is a term used by the Plaintiff in these proceedings as a measure of the value of orders or trades in respect of XJO Securities and represents the number of iterations of the XJO that is equivalent in value to the dollar value of the orders or trades. The Plaintiff calculates it by dividing the dollar value of the orders or trades (calculated by multiplying the volumes of the XJO Securities for which the orders were placed or traded by the closing prices of those securities on the ASX on the previous trading day) by 25 times the closing level of the XJO on the previous trading day.

• “XJO Securities”, “XJO Stocks” or “ASX 200 Stocks” is a reference to those securities that comprise the S&P/ASX 200 Index (aka the XJO) from time to time.

___________________________

⁹ There is a dispute between the parties as to whether the term “SPI Equivalent”, in the manner as used by the Plaintiff, is an industry recognised term.

Schedule

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SPI Futures contract	Contract type	Expiry Date	ASX 24 coding	Bloomberg coding	TRTH coding
April 2012 SPI Futures	Serial	19 April 2012	APF2	XPJ12	YAPJ2
May 2012 SPI Futures	Serial	17 May 2012	APK2	XPK12	YAPK2
June 2012 SPI Futures	Quarterly	21 June 2012	APM2	XPM12	YAPM2
July 2012 SPI Futures	Serial	19 July 2012	APN2	XPN12	YAPN2
August 2012 SPI Futures	Serial	16 August 2012	APQ2	XPQ12	YAPQ2
September 2012 SPI Futures	Quarterly	20 September 2012	APU2	XPU12	YAPU2
October 2012 SPI Futures	Serial	18 October 2012	APV2	XPV12	YAPV2

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