Clemente Group Holdings Pty Ltd and Australian Securities and Investments Commission
[2016] AATA 758
•29 September 2016
Clemente Group Holdings Pty Ltd and Australian Securities and Investments Commission [2016] AATA 758 (29 September 2016)
Division
TAXATION & COMMERCIAL DIVISION
File Number
2015/0284
Re
Clemente Group Holdings Pty Ltd
APPLICANT
And
Australian Securities and Investments Commission
RESPONDENT
DECISION
Tribunal Senior Member J F Toohey
Date 29 September 2016 Place Sydney The Tribunal affirms the decision under review.
..........................[sgd]..............................................
Senior Member J F Toohey
CATCHWORDS
CORPORATIONS – licensing – application for financial services licence – whether licence should be granted – whether Tribunal has ‘no reason to believe’ applicant will not comply with obligations – decision under review affirmed
LEGISLATION
Corporations Act 2001 ss 911A, 912A, 913B, 920A
CASES
Felden and Australian Securities and Investments Commission [2003] AATA 301
McDonald v Director-General of Social Security (1984) 1 FCR 354
One Re Services Limited and Australian Securities and Investments Commission [2012] AATA 294
REASONS FOR DECISION
Senior Member J F Toohey
29 September 2016
Background
On 28 March 2014, the applicant, then known as FXGlobe Pty Ltd, applied to the Australian Securities and Investments Commission (ASIC) for an Australian financial services licence. The applicant described itself as “… a new company established to provide advisory and dealing services in relation to a range of derivatives products to wholesale clients”, and sought a licence with authorisations to provide financial product advice, deal in a financial product, and make a market for a financial product.
The licensing of financial service providers is governed by the Corporations Act 2001 (the Act). ASIC may only refuse to grant a licence after giving the applicant an opportunity to appear, or be represented, at a private hearing before ASIC, and to make submissions to ASIC in relation to the matter: s 913B(5).
The applicant’s sole director and sole shareholder is Mr David Batten. After seeking further information from the applicant, and after Mr Batten had attended a hearing before an ASIC delegate, ASIC determined on 24 December 2014 to refuse the licence. The applicant seeks review of that decision.
Legislative requirements
Section 911A(1) of the Act provides that a person who carries on a financial services business in this jurisdiction must hold an Australian financial services licence covering the provision of the financial services.
Section 912A(1) provides that the general obligations of a financial services provider are to:
(a) do all things necessary to ensure that the financial services covered by the licence are provided efficiently, honestly and fairly; and
(aa) have in place adequate arrangements for the management of conflicts of interest that may arise wholly, or partially, in relation to activities undertaken by the licensee or a representative of the licensee in the provision of financial services as part of the financial services business of the licensee or the representative; and
(b) comply with the conditions on the licence; and
(c) comply with the financial services laws; and
(ca) take reasonable steps to ensure that its representatives comply with the financial services laws; and
(d) subject to subsection (4)----have available adequate resources (including financial, technological and human resources) to provide the financial services covered by the licence and to carry out supervisory arrangements; and
(e) maintain the competence to provide those financial services; and
(f) ensure that its representatives are adequately trained, and are competent, to provide those financial services; and
(g) if those financial services are provided to persons as retail clients--have a dispute resolution system complying with subsection (2); and
(h) subject to subsection (5)--have adequate risk management systems; and
(j) comply with any other obligations that are prescribed by regulations made for the purposes of this paragraph.
Section 913B(1)(b) relevantly provides that ASIC “must grant an applicant an Australian financial services licence if (and must not grant such a licence unless)” it has “no reason to believe that the applicant is likely to contravene the obligations that will apply under s 912A if the licence is granted”.
At issue in these proceedings are the obligations in subparagraphs (a), (c), (d), (e) and (h) of s 912A(1).
The relevant test
Section 913B(1)(b) requires the Tribunal to determine whether there is “no reason to believe” that the applicant is likely to contravene the obligations that attach to a financial services licence. The test is cast differently from that in respect of decisions concerning banning or cancellation, where it is sought to interfere with an existing right, and where the Tribunal is required to have “reason to believe” that the applicant will not comply with its obligations: s 920A.
The distinction is an important one. In a licensing application, the Tribunal must be positively satisfied that it has “no reason to believe” that the applicant will not comply with its obligations. In One Re Services Limited and Australian Securities and Investments Commission [2012] AATA 294, Senior Member Redfern observed at [56]:
The test is more difficult [than for banning or cancellation] to establish for an applicant seeking the right to be licensed as it is clear from the words of the section that the applicant must establish the negative to the reasonable satisfaction of the decision-maker.
There is no onus of proof in administrative proceedings: McDonald v Director-General of Social Security (1984) 1 FCR 354. However, an applicant will need to provide the Tribunal with sufficient information about its capacity to meet the general obligations of a licensee to enable the Tribunal to be “reasonably comfortable”, on the evidence, of its determination: see Felden and Australian Securities and Investments Commission [2003] AATA 301.
Evidence before the Tribunal
In addition to documents provided by both parties, the Tribunal heard oral evidence from Mr Batten, and from Mr Tamas Szabo who was engaged by ASIC for the purpose of expert evidence in these proceedings.
Mr Szabo has worked in the retail over the counter (OTC) derivatives market for 19 years in the United Kingdom and Australia. He is currently head of Asia Pacific for IG Group PLC whose business is primarily offering OTC derivatives contracts to retail clients and institutions worldwide, but includes institutions on a wholesale basis. ASIC asked Mr Szabo to review the documents supplied by the applicant in support of its application and provide his opinion as to: the risks involved in services of the kind intended to be provided; the meaning of various industry terms; and the ways in which a person providing the services of the kind proposed can mitigate any risks involved, and the extent to which that can be achieved.
After the hearing had concluded, and while the Tribunal’s decision was reserved, ASIC sought to file further evidence which it said appeared inconsistent with evidence given by Mr Batten about his directorship of a particular company. The applicant opposed ASIC’s request. Given the matters in dispute, in particular the respondent’s submissions concerning Mr Batten’s competence, the Tribunal agreed to resume the hearing and hear the evidence and submissions. They are considered below.
Contentions
The applicant submits that the Tribunal should have no reason to believe it will contravene its obligations if the licence is granted. It submits it has in place measures to minimise any risks associated with the business, that Mr Batten has extensive experience in providing financial services to wholesale clients, that he has been a responsible manager, alone or with others, on a number of licenses, and that he was the managing director and sole service provider to retail clients for Boston Merchant Financial over several years, which was a riskier and more onerous venture than that currently proposed.
The applicant submits that Mr Batten’s competence, capacity and integrity have never previously been questioned, that he is a well-known and respected participant in the industry, and has experience surpassing most others currently providing financial services.
The respondent submits that the application should be refused because:
(i)there is a lack of clarity about what the applicant’s business will actually involve;
(ii)the applicant has failed adequately to address the risks involved in the proposed business; and
(iii)Mr Batten is not competent to perform the obligations of a director of the applicant company.
The proposed business
The following description of the business intended to be carried on by the applicant is taken from material it provided to ASIC following a hearing before the delegate on 14 October 2014:
Short Term: … CGH intends to sell liquidity and dealing room services to retail FX and derivatives firms. It is CGH’s intention to ween (sic) said retail FX firms off the B-Book business model of taking the other side of clients’ positions. By providing bank liquidity CGH is keen to educate retail FX firms on the benefits for clients of notion of novation and fair market practice.
Medium Term: The introduction of wholesale clients through Introducing Brokers. This would see CGH delivering white labelled platforms to wholesale individual clients. … this situation is due to demand from Introducing Brokers and would involve CGH offering educative practices. …It would be more aligned to professional trading education that David Batten has gleaned from his time in the corporate arena, such as Intrinsic value trading, risk reward methodology and options theory ideology.
Long term: With the acquisition of sufficient Net Cap Required funding ($1.1Million) (sic), CGH would consider applying for an AFSL variation to enable entry into the retail arena to provide online trading platforms to retail customers. Additionally CGH may look to provide retail client style education services to clients.
The applicant described the clients of its intended business in the short term as “any retail FX and Derivatives firms” such as Easy Capital Group Pty Ltd and Uppoint Group Limited who would hold their own financial services licences.
In the medium term, the applicant stated it “may provide services to wholesale clients who are introduced to us by entities such as Investor Unity Pty Ltd and First Street Financial Pty Ltd”, and it “premium” service would be aligned to “professional trading education” based on Mr Batten’s extensive experience. In evidence to the delegate, Mr Batten said these clients were not the business’s target market, but approaches had been made to him for referrals for these kinds of clients, and he would be hesitant to turn them away.
ASIC submits that intrinsic value trading, risk reward methodology and options theory ideology (see above at paragraph 17) are core concepts relevant to all trading, and not indicative of providing education on more complex trading methodology, and are not concepts “more aligned to professional trading”.
In the longer term, the applicant said it “may develop a network of Introducing Brokers … which will emanate out of some advertising and Mr Batten’s extensive industry contact network”.
The applicant said that, as neither was a short-term objective, no formal discussions had taken place or agreements sought, in respect of the medium and long term aims.
ASIC submits that the nature of the business proposed to be carried on under the licence remains unclear and, in particular, whether or not the applicant would itself take positions in the market and, if so, to what extent.
In the ‘Overview of Make a Market Related Activities’ in the C3 Proof: Market Maker Statement submitted to ASIC, the applicant stated that “client orders create a direct financial exposure for [the applicant], which it may retain or hedge out”. Giving evidence, Mr Batten said he was hoping to do both, and also that the applicant would not be retaining direct financial exposure but “hedging the whole lot”. Asked what had led to this change, Mr Batten said: “Nothing, just really, the business model”. Pressed about this, Mr Batten said the model had not really changed but he wished to keep the option that was “quite happy to hedge everything”, and he was “open to either”.
Based on the information provided at various stages of the application, in particular Mr Batten’s somewhat equivocal evidence about the applicant’s intentions in respect of hedging its financial risk, and that the nature of the business appears to change when questioned or the challenged, I find there is a lack of clarity in the applicant’s proposal.
Are risks adequately addressed?
ASIC submits that the applicant appears to lack a full appreciation of the risks associated with the proposed business, regardless of hedging. In particular, it is submitted that Mr Batten has downplayed the risk associated with sudden or large movement in the market, even where positions are fully hedged, and that the applicant has, or will have, inadequate financial resources to mitigate that risk.
Mr Szabo gave evidence that the risks associated with the proposed business are: client money; the average and credit risk; position risk; counterparty risk in liquidity risk; scale; and outsourcing. In his view, the risks could be mitigated by having appropriate financial resources and employing experienced staff but he does not consider the applicant has sufficiently addressed the risks to which the business is exposed.
Mr Szabo gave evidence that, because the products proposed to be offered are leveraged, any significant move in the underlying markets dealt with by the applicant could result in the need for large cash margin calls from clients; depending on the leveraged rates offered and the volatility of the type of markets, the risk would vary but, if realised, the applicant would need sufficient capital reserves to underwrite its clients’ deficits; in the absence of sufficient capital reserves of its own to cover the shortfall, it would need to draw on client money. In Mr Szabo’s opinion, seeking client approval, which Mr Batten said the applicant would do, before hedging a client position in this way is impractical where decisions need to be made very quickly.
In cross-examination, Mr Szabo acknowledged that the position risk to the applicant would be reduced by all trades being hedged to a liquidity provider but said that is only one element of the risk. In his opinion, fully hedging trades provides no protection in the event of a sudden large movement in the market, and only large capital resources to withstand such a move effectively mitigate the risk.
Mr Szabo gave evidence that the applicant would apparently need to rely on client money to operate its business; it would need significant capital reserves to mitigate potential losses of the firm and its clients, and there is no evidence of its financial capacity or how it envisages mitigating this risk. Mr Szabo cited a number of cases internationally in which client money was lost on account of the use of client money.
Mr Batten has withdrawn capital from the applicant in the course of its application for a licence, leaving it with approximately $10,000 at present. Mr Batten says, quite reasonably, that he could not afford to have approximately $100,000 sitting in the company effectively doing nothing for months, and that he would replace that sum if the licence is granted. Although he maintained that the risk is much reduced for wholesale clients and that adverse movements pose a risk for any business, he conceded that the risks are the same for wholesale and retail clients.
In relation to counterparty risk and liquidity risk, Mr Szabo gave evidence that an essential requirement of a business of the kind proposed is the ability to continuously pass through exposure to a third party in order to offset risks to itself and its clients. Mr Batten gave evidence that he has a number of companies willing to provide liquidity, but companies will not sign contracts without the financial services licence in place for commercial reasons. While that is not unreasonable, it remains unclear from Mr Batten’s evidence that he will be able adequately to mitigate the risk.
The applicant contends that Mr Szabo’s evidence is of limited value in this case because his experience is in retail OTC derivatives markets and he has applied the different and higher standards applicable to retail OTC derivatives. Mr Szabo gave evidence that he has considerable experience with wholesale clients and that both are entitled to protection.
According to the applicant’s revised A5 Business Description Core Proof, key financial service functions will be undertaken by “the Responsible Manager and senior qualified staff”, with “[l]egal and compliance advice/services” to be outsourced to the applicant’s solicitors, and the external audit function outsourced to an unidentified provider (subsequently identified as Block Legal).
In Mr Szabo’s opinion, the applicant appears to place high reliance on third parties to operate the business, for instance outsourcing of IT, compliance and finance accounting functions. He conceded that outsourcing is common, and it would be unrealistic for the applicant to develop its own IT, but it would not be unrealistic for the applicant to have an in-house compliance officer, and a financial accountant responsible for client money and with oversight of market exposures and risk.
Mr Batten disputes Mr Szabo’s evidence and says he has run a number of companies from start-up and never had trouble getting staff who are “normally lined up outside and down the road”. He estimates a minimum of two staff would be needed and said a number of people known to him from his work in the industry are wanting to work for him and he would only have to “make a phone call”. He identified a person willing to work as the financial accountant, and said he would be the compliance officer himself but would use his solicitors as “an outsource compliance source”. Mr Batten disputed the suggestion that he was “overly optimistic” about his ability to obtain skilled labour.
Mr Szabo gave evidence that the number of staff appears to be inadequate for the proposed business. In his view, the suggestion that Mr Batten can engage sufficient experienced staff within a matter of weeks is unrealistic and “does not appear consistent with a thorough licence application”. In particular, it is not clear how they would monitor markets over 24-hour periods.
I accept Mr Batten’s argument that it is not commercially practical to expend significant resources engaging staff before the outcome of a licensing application but, as the proposal stands, the business would rely almost entirely on Mr Batten. His evidence raises questions about his estimate of the staff required and his ability to engage suitably qualified people in a short time. I prefer Mr Szabo’s evidence that Mr Batten’s estimate of staffing appears inadequate.
Mr Batten’s competence
Mr Batten gave evidence that he has worked in the financial services industry for 27 years as a derivatives trader/broker for a number of investment banks and licensed financial service providers. He has been the Responsible Manager on four financial services licences, prior to this application, in respect of providing derivatives advice, dealing and market making services to retail and wholesale clients. He says his good fame and character have never been brought into question and, to the best of his knowledge, he has never been the subject of a complaint to, or investigation by, ASIC.
Material provided by Mr Batten in support of the application contained a number of inaccuracies and inconsistencies. They include:
·a balance sheet certified as correct by Mr Batten on 28 March 2014 in his capacity as director incorrectly stating total liabilities as $9,000;
·whereas the applicant initially advised ASIC that shares paid and issued as at 20 May 2014 were $100 for 100 units, the Balance Sheet as at 28 April 2014 showed capital paid up was $100,000. Mr Batten said he apologised for the confusion which resulted from an apparent miscommunication between him and his accountant;
·the original A5 Proof: Business Description provided to ASIC introduced the applicant as “Boston Merchant Financial Pty Ltd”, and incorrectly cited ASIC Regulatory Guide 166 concerning financial requirements for licensing;
·a “market maker flow diagram” did not match the description set out in the C3 Proof: Market Maker Statement.
In each case, Mr Batten acknowledged the error and corrected it, and it is fair to say that none is of itself particularly significant. However, their number and nature indicates to me that Mr Batten’s general approach to the documentation required for the licensing application was not as thorough or careful as could reasonably be expected.
Of more concern, ASIC submits, is that the applicant provided inconsistent information concerning its relationship with FXGlobe Ltd, a Cyprus-based entity, with which it said initially that it had a relationship and would likely utilise its introducing banker and liquidity provider arrangements. In subsequent information provided to ASIC, the applicant advised it had no relationship with any third party and FXGlobe Ltd would not be an introducing broker, and no arrangement was in place, or contemplated, with introducing bankers.
According to information provided to ASIC on 29 May 2014, the applicant did not have an arrangement with third parties for hedging but would “possibly” use one or more of seven specified entities. On 15 July 2014, the applicant advised that the trading systems and software of the proposed business would be “owned by FXGlobe Ltd’s chosen a third party provider and will be provided to FXGlobe, together with full ongoing support and maintenance” and “[a]ll decisions and actions regarding the IT level (business case and requirements), the procurement policy and the implementation policy and procedures are made in conjunction with the chosen third-party provider, as required.”
ASIC submits that, given the changing information about the applicant’s relationship with FXGlobe Ltd, it was not possible to identify the entities on which the applicant intended to rely for its IT services or hedging services. Further, that the applicant would not be “proactive” in providing a full explanation when circumstances required a change in business plans.
Although Mr Batten has explained that the original intention was that FXGlobe Ltd – Cyprus be involved in the applicant’s business, the model had evolved and it was no longer intended it be involved. ASIC submits that the Tribunal cannot be confident that the applicant will discharge its obligations in light of continuing changes to the proposed business model. I agree that the changing information undermines confidence that the applicant has a clear model for it proposed business.
Directorship of Invest Nexus Pty Ltd
The Tribunal heard evidence about Mr Batten’s directorship of Invest Nexus Ltd from March 2014 at a time when it was attempting to raise capital. Mr Batten gave evidence that he was made a director of Invest Nexus by a Mr Wang without his knowledge and that he “got off quick smart” when it came to his attention. He denied consenting to being made director of Invest Nexus. He said this was not the first time Mr Wang had made him a director of a company without his knowledge, and he had lodged complaints with ASIC about him.
Mr Batten could not recall precisely the dates of his directorship of Invest Nexus but conceded that it lasted around 13 months and ended around April 2015. In any event, he maintained he had no idea throughout that time that he was a director save for approximately two weeks after he attended a meeting with the auditor and learned of his involvement.
At the resumed hearing, documents signed by Mr Batten as director of Invest Nexus were put to him comprising: Invest Nexus’ financial statements and reports to 30 June 2014; the annual financial report for Invest Nexus for the 2014 year; an undated Director’s Declaration and Undertaking; the original prospectus for Invest Nexus signed 9 April 2014; and a Notification of Resolution Form 205 signed on 27 March 2014.
Mr Batten acknowledged his signatures on the documents and said he was confused when first asked about his knowledge of his directorship of Invest Nexus because, when he was “looking after” a number of companies for Mr Wang, they changed names “every couple of weeks” and he thought the documents he was asked about related to another company of which he had been made director without his consent.
Under cross-examination, Mr Batten conceded that, while he was himself a director of Invest Nexus at the time, Mr Wang was not a director or shareholder, and he conceded that he continued to “look after” a number of companies for him, and did not resign his directorships, for some months after learning that Mr Wang had appointed him as a director without his knowledge. Mr Batten disputed that this was irresponsible, or that it was not in the best interests of the companies of their shareholders, and said he realised that he could “clean him [Mr Wang] up”.
Given the number of companies in which Mr Batten was involved, and accepting his evidence that Mr Wang had made him a director of companies without his knowledge, I accept there was room for some confusion on his part about a particular company but that does not adequately explain the contradictions in his evidence. The fact remains that he did not resign his directorship of Invest Nexus as soon as he learned what Mr Wang had done, or that he was willing to act as director of companies on behalf of someone who was neither director nor shareholder.
Taking into account all of these matters, the Tribunal cannot have real confidence that Mr Batten will discharge his obligations in respect of the proposed business should a licence be granted.
Conclusion
It is submitted for the applicant that ASIC’s position relies on an unrealistic standard of impossible perfection. I do not accept that is so. The question is whether the Tribunal has no reason to believe that the applicant is likely to contravene the obligations that will apply under s 912A if the licence is granted. I am not reasonably satisfied that there is no such reason.
Mr Szabo is an independent person with expertise to provide an opinion on the obligations that attach to a financial services licence, and the risks associated with the proposed business. I prefer his assessment of the risks associated with the proposed business to Mr Batten’s evidence.
In my assessment of the evidence, the applicant has not demonstrated that it has sufficient technical, human and financial resources to conduct the proposed business and mitigate the risks associated with it, and Mr Batten does not appear seriously to have addressed those risks. There is sufficient reason to believe that the applicant is likely to contravene the obligations that will apply under s 912A if the licence is granted, in particular the obligations in s 912A (d), (e) and (h).
For these reasons, I affirm the decision under review.
I certify that the preceding 56 (fifty -six) paragraphs are a true copy of the reasons for the decision herein of Senior Member J F Toohey .........................[sgd]...............................................
Associate
Dated 29 September 2016
Date(s) of hearing 23 November 2015 & 2 June 2016 Counsel for the Applicant Mr S Lees Solicitors for the Applicant Block Legal & Compliance Counsel for the Respondent Mr J Hmelnitsky Solicitors for the Respondent Australian Securities and Investments Commission
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