Berndale Securities Ltd v How Trading Pty Ltd (No 2)
[2010] VSC 218
•26 May 2010
IN THE SUPREME COURT OF VICTORIA
AT MELBOURNE
COMMERCIAL AND EQUITY DIVISION
COMMERCIAL COURT
No. 2023 of 2008
| BERNDALE SECURITIES LIMITED (ABN 63 006 687 467) | Plaintiff |
| And | |
| HOW TRADING PTY LIMITED (ABN 36 101 185 979) and DAVID RICHARD CHARLES WATERHOUSE | Defendants |
---
JUDGE: | JUDD J | |
WHERE HELD: | Melbourne | |
DATES OF HEARING: | 25 February, 1, 30, 31 March and 7 April 2010. | |
DATE OF JUDGMENT: | 26 May 2010 | |
CASE MAY BE CITED AS: | Berndale Securities Ltd v How Trading Pty Ltd (No 2) | |
MEDIUM NEUTRAL CITATION: | [2010] VSC 218 | |
---
PRACTICE AND PROCEDURE – Application to reopen trial – Fresh evidence unknown to defendants at the time of trial – Application allowed.
---
APPEARANCES: | Counsel | Solicitors |
| For the Plaintiff | Mr P Anastassiou SC with Mr H Redd | Blake Dawson |
| For the Defendants | Mr D Grieve QC with Ms D Coulton | Nedovic & Co |
HIS HONOUR:
On 25 February 2010, the defendants made application to reopen the trial in this proceeding, which had concluded on 5 August 2009. The application had been foreshadowed by the defendants’ solicitors on 5 February 2010, and was supported by an affidavit of David Richard Charles Waterhouse sworn 10 February 2010. Mr Waterhouse deposed that from a report in the Business Section of the Sydney Morning Herald on 4 February 2010 he became aware of a proceeding in the Federal Court of Australia in which a number of companies, apparently controlled by Mr Tony Famularo, had appealed against a decision of the administrators of Lift Capital Partners Pty Ltd and Lift Capital Nominees No. 1 Pty Ltd in relation to schemes of arrangement. Mr Waterhouse said that it appeared from the newspaper report that on and between 11 and 18 April 2008 Merrill Lynch had closed out a substantial options portfolio.
Mr Waterhouse mentioned a judgment published by the Federal Court of Australia on 8 February 2010. That decision was in the matter of Lift Capital Partners Pty Ltd (in liq) (No 2).[1] In that proceeding the parties, described as the “Famularo Parties”, claimed to be creditors in respect of surplus proceeds from the sale of shares and option positions. They complained that Lift Capital Partners Pty Ltd (“Lift Capital”), as mortgagee of a large number of shares, had wrongfully transferred those shares to Merrill Lynch. They alleged that, had Lift Captial merely exercised its rights as mortgagee, the Famularo Parties would have been left with a surplus on the sale of the shares, plus the proceeds of the realisation of options which might also have generated a surplus. They claimed that Lift Capital was not entitled to debit the loss on the closing out of the options, which deprived them of the opportunity to trade those options in such a way as to generate profit, rather than the loss that was occasioned by closing out of the options in the peremptory fashion adopted by Merrill Lynch.
[1][2010] FCA 84, 8 February 2010 per Emmett J. The Famularo parties appealed. The Full Court of the Federal Court delivered its judgment on 4 May 2010. The decision is reported as Bacnet Pty Ltd v Lift Capital Partners Pty Ltd (in liq) [2010] FCAFC 36.
Having reviewed parts of the administrator’s report, Mr Waterhouse deduced that Merrill Lynch had closed out a very large number of option positions on 11 and 18 April 2008, including an auction on 18 April 2008. He drew a comparison between the price obtained and the ACH valuations and relied upon the apparent ease with which Merrill Lynch undertook a process which the defendants maintained should have been undertaken on 14 and 15 January 2008 in relation to the How Trading portfolio.
While the issues raised in the Lift Capital proceeding were quite different to those before this court, the defendants relied on the conduct of Merrill Lynch when closing out option positions in the market over a short period of time. The defendants argued that Merrill Lynch adopted the very strategy their experts said should have been adopted in the liquidation of the How Trading portfolio in January 2008. They argued that in doing so, Merrill Lynch confirmed the appropriateness of the strategy to unwind or liquidate a large, similar sized option portfolio. The defendants did not simply rely upon the conduct as an “admission” or confirmation, but went on to argue that it undermined the credibility of Messrs Ryan and Craft, the plaintiff’s witnesses, who sought to explain and justify the strategy they had adopted in respect of the How Trading portfolio. The defendants submitted that the new evidence strongly supported their case that the plaintiff acted unreasonably when exercising its default powers. Importantly, the defendants relied upon the evidence to support the validity of the ACH valuation of option contracts as a meaningful indicator of what would have been achievable in the market.
The principles governing the grant of leave to reopen are not in dispute. The decision to reopen is discretionary and requires the consideration of competing objectives – the promotion of finality in litigation and the interests of justice.[2] All parties referred to and relied upon a passage from the judgment of Clarke JA in Urban Transport Authority v Nweiser[3]
The principle which should guide the court in determining whether to grant an application for leave to re-open is whether the interests of justice are better served by allowing or rejecting the application as the case may be. No doubt it is relevant to take account of a number of matters such as likely prejudice to the party resisting the application and the reasons why the evidence was not led in the first place, but there is not, in my opinion, any hard and fast rule which requires the court to reject an application where the decision not call the witness in the party's case was a deliberate one. Of course that does not mean that that is not a very relevant consideration. It is. Where, for instance, a decision was based on tactical grounds it may be difficult to resist the conclusion that the interests of justice were better served by the rejection of the application. But even in that circumstance there may be cases in which it is felt that the client whose application it is should not have to suffer for his or her counsel's deliberate decision. Where the decision is not made for tactical reasons and is based on a mistaken apprehension of the law or the facts the case is more appropriately to be considered as one in which the application has resulted from an error by counsel.
[2]Equuscorp Pty Ltd v Wilmoth Field Warne (2007) 18 VR 250, 259.
[3](1992) 28 NSWLR 471, 478 (with whom Mahoney and Meagher JJA agreed).
The parties also referred to the decision of Austin J in ASIC v Rich.[4] His Honour adopted, as a useful statement of relevant discretionary factors, a list advanced on behalf of the defendants. The list was as follows:[5]
[4](2006) 235 ALR 587; 58 ACSR 414; as cited with approval by Einstein J in Movie Network Channels Pty Ltd v Optus Vision Pty Ltd [2009] NSWSC 132.
[5](2006) 235 ALR 587 [18].
(a) the nature of the proceeding;
(b)whether the occasion for calling the further evidence ought reasonably to have been foreseen;
(c)the consideration of fairness that the defendant is entitled to know all of the evidence he has to meet in taking forensic decisions as to cross-examination and the nature and extent of the evidence he will himself adduce on the matters in question;
(d)the extent to which the plaintiff has embarked upon calling evidence on the issue in question in its case-in-chief;
(e)the importance of the issue on which the further evidence is sought to be adduced to the pleaded issues in the case;
(f)the degree of relevance and probative value of the further evidence sought to be adduced and its potential to involve an undue waste of time;
(g)the prejudice to the defendant in terms of delay in the completion of the proceeding and the consequential costs;
(h)the public interest in the timely conclusion of litigation; and
(i)what explanation is offered by the plaintiff for not having called the evidence-in-chief.
Berndale initially opposed the application on the basis that the liquidation or unwind strategy adopted by Merrill Lynch in relation to the Lift Capital portfolio was not relevant to the issues for determination concerning the actions of Merrill Lynch in relation to the How Trading portfolio. Berndale sought to distinguish the character and composition of the two portfolios. It submitted that the circumstances in which Merrill Lynch unwound the How Trading portfolio had been the subject of extensive evidence and debate at trial and that reopening the case would be an undue waste of time.
The difficulty with Berndale’s submission was that it presupposed the force and correctness of its own case in relation to the circumstances in which the How Trading portfolio had been liquidated. Nevertheless, there was a superficial attraction to the argument that evidence to the effect that Merrill Lynch adopted a particular approach to unwinding a substantial portfolio in April 2008 did not assist the question of whether it acted reasonably when dealing with a different portfolio, at a different time and in a different environment.
Having regard to the centrality to the defendants’ case of its allegation that Merrill Lynch acted unreasonably by failing to close out the How Trading portfolio on 14 and 15 January 2008, coupled with the explanation given by Messrs Ryan and Craft during the trial to explain why it was not possible to close out the How Trading portfolio at prices around the ACH valuations, the liquidation of the Lift Capital portfolio took on particular significance. Messrs Ryan and Craft had maintained that it would have been impossible to close out the How Trading portfolio over a short period of time, at least at a “reasonable price”. They were scornful of the ACH valuation as a relevant measure of the price at which a portfolio might be closed out over a short period of time. In contrast, they had closed out the Lift Capital portfolio over a few days at prices which were said to be close to ACH valuations.
It was not suggested by Berndale during the course of the trial that the defendants knew or ought reasonably to have known of the liquidation of the Lift Capital portfolio. The defendants submitted that the evidence should have been disclosed by Berndale. The facts relating to the liquidation of the Lift Capital portfolio were obviously known to Messrs Ryan and Craft, who were instrumental in both liquidations. The defendants submitted that Mr Ryan’s evidence was less than frank and that an honest witness would have volunteered his involvement in that liquidation.
Berndale sought to justify Mr Ryan’s failure to disclose the Lift Capital portfolio experience by reference to the limiting scope of questions put to him during cross-examination, which sought responses only of his experience at liquidating an options portfolio before 14 January 2008. In my opinion, Berndale, and Mr Ryan in particular, must have been aware during the trial, and during Mr Ryan’s evidence in particular, of the significance that the Lift Capital portfolio experience might have had to the defendants’ case. Given the proximity of the events, it could not have been overlooked. There is also a real question as to whether Berndale’s discovery obligations extended to this material, having regard to the way in which the defendants put their case. It is information which I regard was highly relevant to the defendants’ case, even though Berndale may disagree with that case.
I declined to rule on the defendants’ application to reopen the trial without first hearing all of the evidence that each party wished to adduce in relation to the new material. By adopting that course, I was better informed about its relevance and probative value. The defendants relied upon the affidavit of Mr Waterhouse to provide background information and introduce the report to creditors by the administrators of Lift Capital. I gave leave to the defendants to issue a subpoena calling for a narrowly defined category of documents relating to the Lift Capital transactions. Those documents were introduced into evidence. The defendants also called Mr Best and Mr Semple. Berndale called Mr Ryan, Mr Craft and Mr Gibson. Each witness had given evidence at trial.
The course of the evidence did not proceed strictly as if the defendants were applicants. Mr Best, for example, prepared a witness statement after having read the witness statements prepared by Mr Ryan and Mr Gibson. Mr Semple’s witness statement was also prepared after he had an opportunity to read the statement prepared by Mr Ryan. As a consequence, and because the information in relation to the liquidation of the Lift Capital portfolio was in the hands of Berndale, I will deal first with Berndale’s evidence, followed by the evidence adduced on behalf of the defendants.
Berndale’s evidence was directed to establishing that it was not possible to compare the Lift Capital experience to the How Trading experience. It submitted that the portfolios were different in material respects, as was the market at the relevant times. It was not submitted, however, that the duty, if any, owed by Merrill Lynch to its client when liquidating the Lift Capital portfolio was any different to that which was owed by Berndale to How Trading when liquidating its portfolio.
Mr Ryan said that he became aware of the Lift Capital portfolio shortly before the appointment of administrators to Lift Capital on 10 April 2008. He was told of the composition of the options portfolio and associated stock hedges. On the same day, he sought assistance from Mr Craft.
Mr Ryan said that Lift Capital had a stock portfolio that was hedged with options. It had minimal upside and downside risk. BHP represented 85 per cent of Lift Capital’s positions. He said that all of Lift Capital’s put options were long, and all of its call options were short. He said that Lift Capital’s long and short BHP strikes were either overlapping, or nearly overlapping. He described the portfolio as benign. He explained his description by referring to the portfolio as “synthetic stock” or “almost a flat portfolio”. He said that the Lift Capital portfolio was “flat Delta”, which meant that it neither profited nor lost if the market moved. It was “long Gamma”, which meant it profited if its stocks were more volatile than expected; and “short Vega”, which meant it lost money if implied volatilities rose.
Mr Ryan explained that, in relation to the Lift Capital portfolio, he followed the same strategy as he had employed when seeking to prepare the How Trading portfolio for liquidation. With the How Trading portfolio he said he wanted to remove as much risk as possible and the strategy he developed was to first hedge the Delta exposure, reduce the Gamma and Vega and then auction the portfolio. For the Lift Capital portfolio, he first examined the key “Greeks” in order of Delta, Gamma and Vega. He said the Delta of the Lift Capital portfolio was essentially flat and the Gamma was positive. Therefore, neither the Delta nor the Gamma needed attention. The Vega in the Lift Capital portfolio was negative. Accordingly, on Friday 11 April 2008 he asked Mr Craft to close out March 2010 BHP $39 and $40 strikes. His purpose was to reshape the portfolio so that it could, with greater certainty, be auctioned successfully in order to achieve the best price for Lift Capital. Mr Craft successfully closed out those positions the same day.
Mr Ryan said that it was much easier and quicker to implement the unwind strategy for the Lift Capital portfolio than it had been for the How Trading portfolio. He said that when he assumed control of the Lift Capital portfolio, the only Greek that was in issue was Vega and the positions were liquid so that it was easier to reduce the Vega. He said that the liquidity of the Lift Capital positions was largely the result of its strike prices.
By way of comparison, he said that How Trading had a portfolio that contained massive risk and no hedge. Its positions were relatively ill-liquid, which meant that it was a slow process to reshape the portfolio into a state to be auctioned. He said that the key difference had to do with the strikes. The Lift Capital portfolio was relatively close to the money while the How Trading portfolio was a long way out of the money. He said that when options were close to the money they were much more liquid, and that liquidity was important.
Mr Ryan said that most of the liquidity for options traded in the market falls within the range of 90 to 110 per cent of strike. They were close to the money. He said that 79 per cent of the Lift Capital portfolio fell within that range, but that How Trading had less than 2 per cent of its portfolio within that range. He said that 90 per cent of the How Trading portfolio had a strike of 80 per cent of spot or less. By way of contrast, the Lift Capital portfolio had no positions at 80 per cent of spot or less.
Mr Ryan went on to say that, in January 2008, the market became unexpectedly volatile. Financial stocks in particular suffered a shock in January 2008. Volatility in those stocks did not return to pre-January 2008 levels by April 2008. In contrast, BHP shares came much closer to pre-January 2008 levels by that time. He said that the volatility of financial stocks was a reflection of the impact of the global financial crisis.
Mr Ryan was challenged on the time taken to prepare the How Trading portfolio for auction and the delay that occurred once the portfolio had been hedged. It took about a month to obtain ASX permission. During that month no action was undertaken by Merrill Lynch to further unwind or liquidate the portfolio. When asked why he considered that it was prudent and wise to close out about $20 million worth of call option positions in the Lift Capital portfolio on 11 April, but imprudent and unwise to close out positions in the How Trading portfolio after 2 February 2008, Mr Ryan said,
The reason, your Honour, is because they are two completely separate portfolios. The Lift Capital portfolio, the transactions that are listed in June and August for 1000 options and 304 options, they are just like stock. It is as easy to execute as synthetic stock. The 629 and the 711 March 2010 BHP options were repurchasing Vega. Now that strike was at the money and the market is much, much more liquid than at the money, than what it is out of the money. That is the whole crux of the argument. The How portfolio had to be auctioned because we had essentially exhausted what liquidity we could find and we struggled with the listed market, so we had to go down the route of the OTC auction for the How portfolio, there was no other choice. No other choice.[6]
[6]T56.
When asked when he first decided to take the How Trading portfolio to auction, Mr Ryan answered,
Very early in the equation because this portfolio, to be honest, its quite toxic, its not something that is traded readily in the market, the turnover of the portfolio would be absolutely horrific at the best of times, yet we had a situation which worsened. So that the answer is, very early on in the stage. To give you a date, it would have been probably late December, early January.[7]
[7]T56.
Mr Ryan’s thesis was that a hedged portfolio was more attractive to prospective buyers who would see “a smaller risk, a smaller size portfolio”. He said that Merrill Lynch was able to gain approval to auction the Lift Capital portfolio within a very short period of time because of the precedent that had been set with the ASX over the How Trading portfolio. He also said that not only would it have been impossible to liquidate the How Trading portfolio on the open market between 6 February (when the hedging activity had been completed) and 5 March 2008, but the fact that Merrill Lynch had already gone to the listed market so often meant that the only option was an auction.
Ultimately, Mr Ryan acknowledged that the existence or otherwise of hedges in a portfolio came down to a question of price. In other words, the absence of hedging, or a perception that a portfolio was unhedged, or the perceived size of the portfolio, together with its hedges, would be reflected in the price for the portfolio at auction. Those factors would not necessarily translate into a price differential when closing out individual contracts within contrasting portfolios.
The concession concerning the impact of hedging on price is consistent with earlier evidence given by Mr Gibson and Mr Craft. When Mr Ryan said that there was no other choice but an OTC auction for the How Trading portfolio, he cannot be taken to mean that there was no available market within which to close out the contracts. He said that financial stocks started to tank and kept going down in January 2008 before Merrill Lynch took over the portfolio. Offshore events exacerbated the problem and the listed market and the OTC market dried up. Liquidity had been exhausted.
Mr Gibson contrasted the How Trading and the Lift Capital portfolios. He described both portfolios as sizeable. The How Trading portfolio related to 23 stocks; whereas the Lift Capital portfolio only seven. The How Trading portfolio contained 116 option series; whereas the Lift Capital portfolio only 55. The How Trading portfolio contained 18,269 options contracts; the Lift Capital portfolio, 25,996. The notional value of the How Trading portfolio was approximately $545 million; the Lift Capital portfolio approximately $660 million. 77.77 per cent of the How Trading portfolio was focussed on financial stocks; whereas 83.64 per cent of the Lift Capital portfolio comprised positions written in relation to BHP stocks.
In relation to hedging, Mr Gibson contrasted the unhedged position of the How Trading portfolio with the Lift Capital portfolio. He said that the Lift Capital portfolio had extensive hedging against adverse share price movements. This strategy, he said, largely insulated the portfolio from any adverse share price movements in the short term. He said that the How Trading portfolio had no protection from adverse volatility movements in the portfolio, apart from three NAB put options. He drew attention to the fact that the How Trading portfolio was on average 31.9 per cent out of the money. This was to be compared with the Lift Capital portfolio which was on average 14.7 per cent out of the money.
Mr Gibson said that the Delta hedging undertaken by Berndale on 14 January 2008, through the short sales of stock, did not operate as a complete hedge against adverse market movement. He said this was because a Delta hedge will only be effective against relatively small movements in the underlying stock, not large movements. He described the Lift Capital portfolio as “synthetic stock”. Mr Gibson said that if a prospective buyer had been offered the How Trading portfolio within several days of 14 January 2008, the absence of Gamma and Vega hedges would have had a substantial effect on price. He said that any party considering the portfolio would have to consider the risk of the portfolio and whether they had adequate market capitalisation to accept it. He agreed that the value or price would be one determined by the market regardless of the existence of any hedges, although was reluctant to agree to the impact of the absence of Gamma or Vega hedges on price. He said he would only be guessing.
As with other aspects of the case for the plaintiff and defendants, their approach to the marketability of the How Trading portfolio and the experience of Merrill Lynch in disposing of the Lift Capital portfolio, were like ships passing. The Merrill Lynch paradigm commenced with the assumption that the portfolio should be prepared for auction and auctioned. The best price could be achieved by making the portfolio more attractive to an institutional trader. The defendants approached the portfolio on a contract by contract basis, seeking to demonstrate that, at a price, there was always a market. They argued that Berndale/Merrill Lynch had acted unreasonably by never having approached the liquidation of the portfolio on a contract by contract, or series by series basis. To the defendants’ case, hedging was completely unnecessary as a precursor to the closing out of positions, the real question was price.
The defendants criticised the evidence of Mr Gibson for its lack of attention to detail. When explaining the characteristics of each portfolio, Mr Gibson said,
The characteristics are that the How Trading portfolio contained long dated sold puts and sold calls, the Lift Capital portfolio had shorter dated bought puts and longer dated sold calls.[8]
The defendants argued that the How Trading portfolio contained no sold long dated call options. They submitted that the error was no mere oversight but demonstrated inattention. There were other aspects of Mr Gibson’s evidence that were said to be unsatisfactory. When expressing his opinion as to what a party considering the purchase of a portfolio would consider, Mr Gibson mentioned the risk of the portfolio, market capitalisation of the purchaser, ACH approval, and whether the prospective purchaser had the wherewithal and expertise to be able to manage the positions. He went on to say, “There would be other factors too that I haven’t thought of”. As an expert, Mr Gibson’s evidence is diminished by such advocacy.
[8]T94.
Mr Gibson repeated evidence he had earlier given to the effect that strikes that are within 10 per cent of the share price are described as “close to the money” and more liquid. He said that once they go over 20 per cent they start becoming quite difficult. By this he meant “difficult to deal with so it’s a subject to price matter, the price”. By price, he meant that “it’s difficult to buy anything close to what I would deem to be its fair value”.[9] He went on to say,
When a calculation is made for the volatility that an option trades at, what happens is as it gets further and further out of the money the volatility of the option tends to go up. What we would describe as fair value its starts getting more expensive to get the option. [10]
This evidence is consistent with the notion that a “fair price” is not necessarily the market price. Fair price seems to be no more than a subjective concept, perhaps determined by internal financial modelling, being a price at which a trader would hope to effect a transaction but which may have no relationship to the market price. This concept was prominent in the minds of Messrs Ryan and Craft when giving evidence during the trial.
[9]T97.
[10]T97.
The evidence-in-chief given by Mr Craft was directed primarily to a suggestion, implicit in a draft statement of Mr Semple, that of the option positions closed out by Berndale between 14 January and 13 February 2008 the vast majority were purchased by crossing them on the Merrill Lynch house account. The allegation, if correct, would have been significant in the sense that it might tend to suggest that the efforts by Merrill Lynch in January 2008 to close out How Trading positions was dependent upon its own willingness to absorb those positions. This was particularly poignant in the context of the Lift Capital portfolio because Merrill Lynch participated in the acquisition of the portfolio.
Mr Craft denied that Merrill Lynch was on the other side of any of the How Trading transactions and explained the reference to Merrill Lynch in the trading statement as indicating that he engaged Merrill Lynch as the broker for the purpose of effecting the transactions.
The misunderstanding, for that is what it seems to have been, concerning the role of Merrill Lynch as an opposite party in the transactions, was not surprising because of the role of Merrill Lynch in the liquidation of the Lift Capital portfolio and the How Trading portfolio. Merrill Lynch made a bid for the How Trading portfolio. Another example of an actual or potential conflict was the internal hedging undertaken by Merrill Lynch in November and December 2007. These transactions were described as the Merrill Lynch house trades. Once a broker extends its range of activities beyond providing client services and embarks upon trading activity in the same market in its own right, it will inevitably attract suspicion, criticism and expose itself to the very kind of allegations as have been made in this case.
Mr Craft was the person who responded to instructions from Mr Ryan in connection with the liquidation of the Lift Capital portfolio, just as he had done in the case of How Trading. His experience and rejection of the ACH valuations were the subject of evidence at trial and yet, like Mr Ryan, he made no mention at all of the liquidation of the Lift Capital portfolio.
Mr Craft was questioned about closing out call options on 11 April 2008. He agreed that he had closed out 2,645 BHP call option positions at a cost of almost $21 million. Of those, 1,340 were March 2010 calls. He agreed that they were long dated positions. When it was put to him that he had experienced no difficulty in finding buyers in the market, he was reluctant to concede the point. He said he did not know how much difficulty he had. He was also reluctant to compare the price with the ACH valuation. He said he did not know what the ACH valuation was.
When asked directly whether he made any assessment of the value at which he was transacting the purchases, he said,
I definitely would have assessed the value. I would have looked at the market, I would have calculated the implied (volatility) but I definitely wouldn’t have looked at the ACH valuation. That’s not something that I consider at all in my trading.[11]
He did not regard it as important. To give some measure of size to the trading undertaken on 11 April by Mr Craft, he said that it was a big trade but not an exceptional event.
[11]T144.
Mr Craft was asked whether there was any difference in the way he went about his business in relation to the Lift Capital account in April 2008, and the way in which he went about his business in relation to the How Trading account in January and February 2008. He answered,
The way I executed on day 1, I guess, were very similar but then obviously How Trading – I was only involved in one – Lift, the second portfolio which involved Lift, I was only involved in one day of execution which was basically ringing brokers rather than the whole unwind process of then executing into the market and I wasn’t involved in the Delta hedging of Lift. So I think they were similar but I was involved in different way in both so I can’t really compare.[12]
[12]T149.
Mr Craft confirmed that he was instructed by Mr Ryan to unwind a certain amount of risk on 11 April. By that he meant closing out a position by buying back an equal number of call options. He accepted that, by buying back $2,644 BHP call option positions on 11 April 2008, he achieved the elimination of some risk. The balance of the portfolio was closed down at public auction in the following week.
Mr Craft was asked whether there was any reason why he could not have continued to close out positions on the market. He said that it would have been possible had he been instructed to do so. He said, “(i)t could have been done”.
Mr Craft was taken back to evidence he had given at the trial in which he said he “traded the How Trading account as if it was a house account held by Merrill Lynch”. He distinguished his approach to the Lift Capital portfolio. He said that, in relation to the How Trading account,
I was given the account and told, “this is the firm’s risk. Let’s unwind it as best and profitable or lowest (cost) as we can”. The Lift, I was literally given a list, you know, told “we need to buy back and unwind a certain amount of options today rather than give the portfolio as a whole” and given the authority to unwind it as best as possible, I was just given a few trades to do on that particular day.[13]
[13]T155.
In relation to the How Trading portfolio, Mr Craft said it would not have been possible to buy back the positions at the ACH valuation. He said that “the market would have moved in unwinding this portfolio”. He accepted that he did not know to what extent. The time under consideration was 13 February 2008.
Mr Craft accepted that by 13 February 2008 he personally considered that the How Trading portfolio had been managed to a condition where it was appropriately hedged and ready to be offered for auction. From 13 February 2008, he was no longer involved in the unwind process.
When giving his evidence Mr Best had the advantage of having read the evidence of Mr Ryan and Mr Gibson. He had reviewed the Lift Capital portfolio and was asked to comment on whether the method of dealing with that portfolio had any relevant comparisons with the closing of the How Trading portfolio in the early part of 2008. Mr Best’s evidence-in-chief, in the form of a witness statement, contained unhelpful comment on the validity of opinions expressed by Messrs Ryan and Gibson.
Nevertheless, when comparing the portfolios Mr Best made the following observations. The Lift Capital portfolio was larger in value than the How Trading portfolio. He acknowledged that the Lift Capital portfolio was hedged, although he noted that Merrill Lynch had hedged the Delta of the How Trading portfolio within a matter of hours on Monday 14 January 2008. He accepted that the How Trading portfolio was more diversified than the Lift Capital portfolio, but said that such diversification would make the portfolio easier to close or trade because it was not centred on one stock. He pointed out that the Lift Capital portfolio had many long dated positions, much like the How Trading portfolio. He compared volatility on 14 and 15 January 2008 with 10 – 15 April 2008, over a five day average, 30 day average and 50 day average. For the five day average, volatility on 10 and 11 April 2008 was slightly below 14 and 15 January. Volatility on 14 April was at about the same level.
Mr Best pointed to the closing out on market, on 11 April 2008, of the BHP options as evidence that the market was able to manage a significant volume of options when underlying stock was liquid. He reaffirmed his opinion “without doubt that the How Trading portfolio could have been closed within two days of Berndale taking control of the account”. With liquid underlying stock, Mr Best said he found it difficult to understand why Berndale seems to have ignored the available existing market to close out the positions.
Mr Best undertook a review of daily statements issued to How Trading by Berndale and compared that information with the ACH valuation in an attempt to further bolster his opinion that the positions could have been closed out at or around the ACH valuation. There were instances, pointed out to him in cross-examination, where there was a significant disparity. But, in the overall analysis undertaken by him, there were relatively few examples in which there was a real discrepancy. The purpose of the analysis was to demonstrate that transactions could have been effected at or around the ACH valuation, because options were, in fact, trading during this time at such prices.
Berndale submitted that the evidence given by Mr Best was no more than a restatement of his core thesis that the How Trading portfolio could and should have been closed-out within several days of 14 January 2008, for a price equal to or near the ACH valuation. It submitted that Mr Best displayed only a rudimentary understanding of the ACH valuation. Deliberately or otherwise, Berndale sought to convert the evidence given by Mr Best into a rigid adherence by him to the ACH valuation as the basis for trading. Mr Best said no such thing. He used the ACH valuation as historical data to demonstrate, insofar as it went, that particular options had been traded at a particular price.
Berndale submitted that Mr Best made a series of “striking” admissions, including that professional traders undertake their own analysis of the value of an option series; professional traders do not rely entirely or exclusively on valuations published by the ACH; different valuation models might involve a degree of judgment or subjectivity; the ACH valuation reflects only trading that has taken place; and market-makers and professional traders use their own models and live pricing systems to decide whether or not to make a trade. It is not remarkable that Mr Best accepted all of these matters. What is remarkable is that Berndale appears to have misunderstood the thrust of Mr Best’s evidence.
Berndale criticised Mr Best’s evidence for its simplicity. On the other hand, it is the simplicity of the propositions advanced by him that made them plausible. The analysis undertaken by Mr Best assists the defendants’ case. It is true that the evidence of Mr Best involves a restatement of earlier positions. So does the evidence of Mr Semple, Mr Ryan and Mr Craft. This was necessarily so because of the significance the defendants attached to the method and timing of the liquidation of the Lift Capital portfolio as a means to undermine the rather brittle position adopted by Berndale (in particular Messrs Ryan and Craft) at trial to explain their strategy.
The evidence-in-chief of Mr Semple is contained in two witness statements. Berndale submitted that his evidence, like that of Mr Best, was a restatement of the core thesis given at the trial. There was very little new material advanced by Mr Semple which assisted an understanding of the significance of the Lift Capital portfolio to the issues before the court, except to comment on the evidence given by Mr Ryan. One helpful calculation, undertaken by Mr Semple, was the overall debt position of How Trading on each business day on and between 14 January 2008 and 7 March 2008. From the point at which Merrill Lynch had prepared the portfolio for auction until the date of the auction, the debt increased by over $3 million.
It was never part of the defendants’ case that Merrill Lynch was bound to auction the portfolio more rapidly than it had. However, the defendants pointed to the delay, when compared with the rapid auction of the Lift Capital portfolio, to emphasise what they described as the complete incompetence of Merrill Lynch. The plaintiff countered that argument by explaining the delay to auction the How Trading portfolio as a consequence of difficulties in obtaining permission from the ASX. That experience enabled the plaintiff, so it was said, to obtain permission more quickly in the case of Lift Capital portfolio.
CONCLUSION
I am persuaded that the defendants’ application to reopen the trial should be allowed and the relevant and admissible evidence adduced by the parties on this application admitted as evidence in the trial.
Berndale did not submit that the defendants ought to have adduced the evidence of the liquidation of the Lift Capital portfolio at trial. That evidence was, of course, known to the plaintiff. Having regard to the nature of the case advanced by the defendants and the plaintiff’s response, it was disingenuous of Mr Ryan not to reveal his involvement in the Lift Capital portfolio liquidation during the trial. Notwithstanding the narrow focus of the questions asked of him, concerning his experience, I can only infer that Berndale, and its witnesses, studiously avoided any mention of the Lift Capital portfolio. Documents in relation to the transaction ought to have been discovered by Berndale when it became apparent that it would be contending that it was impossible to close out positions in a volatile market at a price at or near the ACH valuation. Berndale ought to have known that the evidence would be regarded by the defendants as very important to their case. Berndale ought to have known that the evidence was probative of a fact in issue and might, if disclosed, tend to undermine its own case.
Some of the evidence is no more than a repetition of that which was given at trial. Mere repetition will not improve that evidence. There were instances, however, where evidence that was given about the How Trading portfolio, in the context of the comparison with the Lift Capital portfolio, added clarity to, or gave a new perspective on, evidence given at trial. Some evidence given by Mr Ryan, Mr Craft and Mr Best fell into that category. The most important evidence, however, was what Mr Ryan and Mr Craft were able to achieve with the Lift Capital portfolio.
In my opinion, the evidence tends to support the defendants’ case that Merrill Lynch acted unreasonably in the exercise of default powers when liquidating the How Trading portfolio. The evidence, if available, would have provided them with an example of what they contend was reasonable, or what a reasonably prudent broker would have done upon assuming control of an account for the purpose of unwinding or liquidating the account. The evidence would also have provided material with which to undermine the credibility of the evidence given by Messrs Ryan and Craft concerning their rejection of the defendants’ strategy to close out all positions on and within a few days of 14 January 2008.
---
0
4
0