No pooling of accounts where clients’ interests in mixed funds are not rateably equal

Last week, Justice Brereton of the Supreme Court of New South Wales handed down the long-awaited judgment in Re BBY Limited (Receivers and Managers appointed) (in liquidation) (No 2) [2018] NSWSC 346, determining that no pooling order should be made in respect of the client segregated accounts (CSAs) maintained by the insolvent stockbroking firm, BBY Limited (In Liquidation) (BBY).

This represents another landmark ruling in relation to pooling of accounts, following Justice Black’s decision in Re MF Global Australia (In Liq) [2012] NSWSC 994. It provides further guidance to insolvency practitioners and creditors on the principles of pooling and, more specifically, their application in the context of a stockbroker’s insolvency.

The BBY liquidation

Prior to the commencement of its voluntary administration on 17 May 2015 (and its subsequent liquidation on 22 June 2015), BBY was one of the largest stockbroking, corporate advisory and asset management firms in Australia. It offered a broad range of financial products, and operated its business (including its handling of client moneys) by reference to different product lines, namely: Equities, Exchange-Traded Options (ETOs), Futures, FX, derivative products offered by Saxo Capital Markets Australia (Saxo) and products offered by Interactive Brokers LLC (IB).

Client moneys deposited with BBY was required by Subdivision A in Division 2 of Part 7.8 of the Corporations Act 2011 (Cth) to be held in client segregated accounts (CSAs). As at the administration date, there were 55 CSAs holding approximately $15 million. Although each of the CSAs was allocated to one of the six product lines, there appeared to have been transactions between CSAs both within and across the different product lines, as well as misappropriation of funds by BBY. The liquidators’ estimate was that there would likely to be a shortfall in client moneys in the order of $20 million.

Liquidators seek guidance on distribution of client moneys

The liquidators of BBY commenced proceedings in the Supreme Court of New South Wales in August 2015, seeking directions as to how the client moneys in the CSAs and other client-related recoveries should be dealt with and ultimately distributed. At the request of the liquidators, the Court appointed four representative defendants representing clients from different product lines. The Securities Exchanges Guarantee Corporation (SEGC) - the trustee of the National Guarantee Fund against which certain investors in the ASX-operated markets may claim compensation - was also joined as a defendant to the proceedings.

The key issue before the Court was whether, for the purposes of making distributions to clients in accordance with the payment waterfall in Regulation 7.8.03(6) of the Corporations Regulations 2011 (Cth), the liquidators should “pool” the CSAs in the Equities/ETO product lines (which had minimal shortfall as at the date of administration) with the CSAs in the Saxo, Futures and FX product lines (which had a deficiency of approximately $18m).

Should the client moneys be pooled?

Although Regulation 7.8.03(6) does not authorise the pooling of CSAs - even those within the same product line - for the purposes of distribution, the Court has jurisdiction under sections 479(3) and 511 of the Corporations Act (now section 90-15 in Schedule 2 of that Act) to make a pooling order, permitting the departure from strict proprietary rights in circumstances where it is not reasonably and economically practical to identify or trace the interests of individual clients in a mixed fund.

Importantly, pooling is only warranted if the funds are so intertwined such that each client can reasonably be regarded as having an interest in the mixed fund that is “rateably equal” to the interest of each other client. Whether this will be so depends on the scale of mixing, relative sizes of the funds, the deficiencies in the funds and, above all, the extent of the interest of the contributing fund in the mixed fund.

In the case of BBY, the proponents for pooling (including the liquidators) pointed to a large volume of transactions between CSAs which, they say, evidence mixing of a sufficient degree so as to warrant pooling. However, the Court ultimately found that there was only one transaction which directly contributed to the Equities/ETO CSAs and constituted relevant mixing of client funds – that transaction was a transfer of $12 million from a Saxo CSA to an Equities/ETO CSA on 2 December 2011.

In determining whether Saxo clients (and clients from other product lines) have an interest in the Equities/ETO CSAs that is rateably identical to that of the Equities/ETO clients, the Court considered it relevant to look at the extent of any remaining benefit to the recipient fund (being the Equities/ETO CSAs) given by the donor fund (being money of Saxo clients).

In that regard, the Court took into account:

• a series of transfers (totalling $28.7m) by BBY to Saxo Bank in April to December 2014, comprising funds that were cobbled together from CSAs in other product lines, which transfers (at least ostensibly) reconstituted the Saxo client moneys previously misappropriated from the Saxo CSAs;
• the termination of the Saxo arrangement in February 2015 which involved the return of funds (in the amount of $50.5m) from Saxo to BBY, the on-payment by BBY of (only) $41.8m to Saxo clients and the closing out of most Saxo client positions before the date of administration, which meant that the current Saxo client constituency is not representative of those whose money comprised the $12m transfer in December 2011; and
• the volume of transactions that passed though the Equities/ETO CSAs after December 2011 (which was more than 3 years before the administration date). Between December 2011 and May 2015, over $240m had been deposited into, and $212m paid out, of the Equities 8994 account alone (being the account into which the $12m was initially transferred) and there were a number of other Equities/ETO CSAs through which thousands of transactions occurred during the intervening period. Those transactions had the effect of diluting the interest of Saxo clients in the Equities/ETO CSAs.

In light of the above, notwithstanding the mixing of funds in December 2011, the number and extent of intervening transactions meant that the funds in the Equities/ETO CSAs as at the administration date of only included money of current Saxo clients to a minor extent, if at all.

Indeed, where the Equities/ETO CSAs largely reconcile, but where the Saxo CSAs are significantly deficient, the Court considered that it would work a disproportionate windfall to the current Saxo clients and a considerable injustice to the Equities/ETOs clients, to direct pooling on the basis that a relatively modest amount of Saxo money had mixed into Equities/ETO CSAs many years ago. Accordingly, the Court ultimately concluded that the Equities/ETO CSAs ought not be pooled with the Saxo CSAs (or with CSAs in the other product lines).

Take-away points

The key take-away point from this case are that:

• the Court will take a pragmatic approach towards the question of pooling, such that it will not require strict proof of legal entitlements or absolute impossibility of tracing;
• on the other hand, it will not alter relatively clear property interests by reference to some notion of common misfortune, or allow one fund to unduly benefit at the expense of another; and
• in each case, the Court will closely examine the relevant transactions involving the accounts and form a view – which may be an impressionistic one – as to the likely extent of the interest of each client (or each client group) in those accounts.

In reaching the conclusion (that pooling was not appropriate in the circumstances of this case), the Court helpfully explained and summarised in its judgment:

• the equitable tracing principles, which informed its determination of the extent of a beneficiary's (or, in this case, a client group's) interest in a mixed fund; and
• the relevant provisions in Part 7.8 Div 2 Sub-Div A of the Corporations Act and Corporations Regulations, which govern the conduct of Australian Financial Services Licensees in their handling of client moneys and which provide for how such moneys are to be dealt with if a licensee ceases to be licensed (including by reason of insolvency).

SEGC is the Fourth Defendant in the proceedings and it opposed pooling; Clayton Utz acted for SEGC.