FEDERAL COURT OF AUSTRALIA

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

ORDERS

THE COURT:

1.    Makes the ruling in paragraph 36 of the reasons published as Australian Securities and Investments Commission v Whitebox Trading Pty Ltd [2018] FCA 1059.

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

REASONS FOR JUDGMENT

(Revised from transcript)

YATES J:

1    The plaintiff alleges that the defendants have contravened s 1041B of the Corporations Act 2001 (Cth) (the Act) by performing acts that had, or were likely to have, the effect of creating a false or misleading appearance with respect to the market for XJO securities trading on the Australian Securities Exchange (ASX), and that were likely to have the effect of creating a false or misleading appearance with respect to the price for trading XJO securities. XJO securities are securities that comprise the S&P ASX 200 Index (the XJO Index).

2    The plaintiff also alleges that the defendants have contravened s 1041A of the Act by taking part in or carrying out one or more transactions that were likely to have the effect of creating artificial prices for trading XJO securities on the ASX.

3    The defendants’ impugned conduct is alleged to have taken place in the course of index arbitrage trading which, relevantly, is a trading strategy that involves buying or selling XJO securities and selling or buying SPI futures traded on the futures market called the ASX24. SPI futures are futures contracts based on the XJO Index.

4    William Morgan has been called by the plaintiff as an expert witness in index arbitrage trading. From 2005 to 2012, Mr Morgan worked in Hong Kong and Sydney for Credit Suisse in its equity derivatives group. From the beginning of 2011 until December 2012, he worked in the Sydney office as an equity derivatives trader covering the Australian market. He was asked by the plaintiff to address a series of questions in relation to the defendants’ trading activities on consecutive serial expiry dates for SPI futures from 19 April 2012 to 18 October 2012.

5    On 6 July 2018, objection was taken by the defendants to certain paragraphs of a report prepared by Mr Morgan on 26 May 2016, including para 101. Paragraph 101 and other paragraphs of the report address, in part, the following question posed for Mr Morgan’s consideration:

What were the typical trading strategies and methodologies employed by competent and experienced index arbitrage traders on the ASX and ASX24 in 2012 both generally and for the purposes of trading an index arbitrage position prior to and during the course of the OSPA?

6    OSPA refers to the Opening Single Price Auction. This is a series of opening single price auctions for securities traded on the ASX, which take place at the commencement of trading at market opening in each of five different rotation groups where matching/overlapping bids and asks in the central order book at the time are matched, and trades result at prices known as “opening”, “auction” or “match” prices calculated by an algorithm called the ASX Algorithm.

7    The point of present significance is that the quoted question is directed, in part, to index arbitrage trading prior to and during the course of the OSPA, which comprises part of the pre-open period or phase (the pre-open phase) before actual (market) trading in securities begins. The use of the word “trading” in relation to this is perhaps inapposite. Nonetheless, the defendants’ impugned conduct concerns its “trading” activities in this period. The subsequent period of market trading is referred to as intraday trading.

8    I admitted paragraph 101 over the defendants’ objection. I was satisfied that a sufficient basis had been established for the reception of that evidence. In coming to that view, I had regard in particular to paragraphs 32 to 42 of Mr Morgan’s report. In short, I was satisfied that the evidence given in that paragraph was based substantially on his training and experience as a trader on Credit Suisse’s equity derivatives desks in Hong Kong and Sydney, which involved (according to Mr Morgan) applying the principles of index arbitrage trading.

9    On 9 July 2018, Mr Morgan was cross-examined on his experience as an index arbitrage trader. This occurred during the course of a concurrent evidence session with Michael de Kantzow and Alessandro Frino. Mr de Kantzow and Professor Frino are expert witnesses called by the defendants.

10    In the course of Mr Morgan’s cross-examination, the following matters emerged.

    Mr Morgan has no experience of index arbitrage trading outside Credit Suisse.

    Mr Morgan’s experience at Credit Suisse was in intraday trading.

    In this regard, he had experience as part of a team in establishing trading positions, although this was not a frequent activity for him without supervision. He also had experience in closing out positions.

    Mr Morgan has not himself traded to establish new arbitrage positions in the pre-open phase.

    Credit Suisse did not itself trade to establish new arbitrage positions in the pre-open phase.

11    It is apparent that the question I have quoted (see [5] above) is directed, in part, to the pre-open phase.

12    In light of the evidence emerging from this cross-examination, the defendants seek to renew their objection to para 101 of Mr Morgan’s report and extend it to paras 102 and 103 (except for the first sentence of para 103), and also to certain comments and observations made by Mr Morgan in a joint report he has made with Mr de Kantzow and Professor Frino (the Joint Report).

13    The relevant parts of paragraphs 101 to 103 to which objection is taken are as follows:

101.    If an index arbitrage trader was placing orders in the OSPA to buy or sell XJO Securities as part of an index arbitrage strategy based upon where indicative match prices of XJO Securities are then it would be likely that they would aim to sell or buy an offsetting amount of SPI in a consistent manner through the course of the OSPA. However, if the trader perceived an opportunity to trade the SPI profitably they may choose to increase or decrease the speed of their execution.

102.    Having bought or sold XJO Securities in the first rotation of the OSPA for the purposes of executing an index arbitrage strategy a trader would then need to continue to buy or sell XJO Securities in the subsequent rotations in the same size relative to their weight in the XJO index, as those securities already traded. If subsequent rotations were traded in different relative sizes, then the position would be unmatched without further trading in the XJO Securities that had already begun trading and could expose the trader to market risk due to the unbalanced legs.

103.    … In general, the aim is to trade an equivalent and opposite value of SPI futures contracts and XJO Securities with the XJO Securities traded in the proportionate size as they comprise the XJO. As the price of these financial products is constantly changing an arbitrage trader will seek to trade the component parts as simultaneously as possible to minimise market risk.

14    The gist of these paragraphs is:

    If an index arbitrage trader were placing orders in the OSPA to buy or sell XJO securities, then it would be likely that the trader would aim to sell or buy an offsetting amount of SPI in a consistent manner throughout the course of the OSPA, but with the speed of executions possibly varying.

    Having “traded” in the first rotation of the OSPA, the trader would then need to continue to buy or sell XJO securities in the subsequent rotations in the same size as the securities already traded, but relative to their weights in the XJO Index.

    The general aim of the index arbitrage trader is to trade an equivalent and opposite value of the SPI futures and XJO securities as simultaneously as possible, to minimise market risk.

15    So far as the Joint Report is concerned, the second, third and fourth boxes on page 2 thereof contain Mr Morgan’s comments directed to the question I have quoted. These comments concern trading strategy in the pre-open phase.

16    The second box on page 4 of the Joint Report contains Mr Morgan’s comments on other questions which are directed to an assessment of the likelihood that an amount of SPI futures could be traded at a particular price over a future period of time. Mr Morgan’s comments, in part, express opinions on trading strategy in the pre-open phase. I refer specifically to that part commencing:

Alternatively, the Whitebox traders would have been conscious of the market impact of removing all or part of their orders …

continuing to the end of the comments made in that box.

17    The second, third and fourth boxes on page 5 of the Joint Report contain Mr Morgan’s comments on a further question directed to the expression of an opinion on whether the defendants’ trading on serial expiry days was consistent with an objective of trading a given quantity of SPI futures matching the total quantity of a series of order sets for XJO Securities. Mr Morgan’s comments in these boxes are directed to expressing opinions on trading strategy and patterns of trading activity involving orders for XJO securities in the course of index arbitrage trading in the pre-open phase.

18    Put simply, the defendants submit that the opinion evidence which Mr Morgan purports to give in paragraphs 101 to 103 of his report, and through the comments that I have identified in the Joint Report, is not evidence based substantially on specialised knowledge for the purposes of s 79 of the Evidence Act 1995 (Cth). The defendants submit that Mr Morgan’s evidence in this regard stands as mere opinion, based it would seem on his own reasoning or logic. In the course of argument, the defendants made clear that they dispute not only the fact that Mr Morgan has expertise in index arbitrage trading in the pre-open phase, but also that he has sufficient expertise in index arbitrage trading generally to express the opinions I have identified.

19    The defendants submit that the utility in revisiting the admissibility in para 101 of Mr Morgan’s report and dealing with the other objections I have identified is that if the evidence is now rejected, they will be relieved of the task of cross-examining Mr Morgan on these matters.

20    The plaintiff advances a number of submissions in support of the reception of the evidence to which objection is taken. These submissions can be condensed to the following propositions.

21    First, the evidence establishes that Mr Morgan has sufficient expertise to give the challenged opinions.

22    Secondly, the challenged opinions involve an application of specialised knowledge to the particular circumstances of index arbitrage trading in the pre-open phase. The plaintiff submits that this is an entirely orthodox example of an expert extrapolating from the general to the particular using his or her specialised knowledge.

23    Thirdly, the defendants’ objections are really an attempt to define out of existence an area of expertise or specialised knowledge on which an opinion can be given. The substance of this submission is that index arbitrage trading in the pre-open phase does not constitute a separate and distinct field of specialised knowledge in respect of which those with generalised experience in index arbitrage trading cannot express opinions.

24    Fourthly, the raising of the defendants’ objections now is somewhat artificial when the experts have met, discussed their respective views and recorded their areas of disagreement in a Joint Report.

25    Fifthly, even if the Court should ultimately come to the conclusion that whatever specialised knowledge Mr Morgan might have cannot be applied to the circumstances of the pre-open phase, that is an assessment which should be made at the conclusion of the hearing when all the evidence has been received and when submissions in relation to that evidence can be fully developed. In this connection, the plaintiff relies on the observations made by Branson J in Sydneywide Distributors Pty Limited v Red Bull Australia Pty Limited [2002] FCAFC 157; (2002) 234 FCR 549, (Red Bull) at [16]-[17]:

16    Further, the requirement that an expert opinion be wholly or substantially based on the witness's specialised knowledge is not, in my view, intended to require a trial judge to give meticulous consideration, before ruling on the admissibility of the evidence of the opinion, to whether the facts on which the opinion is based form a proper (in the sense of logically or scientifically or intellectually proper) base for the opinion. Were the position otherwise the smooth running of trials involving expert evidence could be expected to be interrupted by the need to explore in detail, in the context of admissibility, matters more properly considered at the end of the trial in the context of the weight to be attributed to the evidence. It is sufficient for admissibility, in my view, that the trial judge is satisfied on the balance of probabilities on the evidence and other material then before the judge that the expert has drawn his or her opinion from known or assumed facts by reference wholly or substantially to his or her specialised knowledge. In many cases the relevant evidence and other material that will be before the judge at the time that the judge is required to rule on admissibility will extend little, if at all, beyond the purported expert's affidavit or report or, where only oral evidence is intended to be adduced, the earlier oral evidence of the witness and the form of the question to which objection has been taken. In the Federal Court, the usual practice of requiring expert evidence to be reduced to writing, together with the Guidelines for Expert Witnesses referred to in [13] above, will generally ensure that there is sufficient material before the judge to enable the judge to form a view, on the balance of probabilities, (albeit, in the context of the trial as a whole, a provisional view) as to whether an opinion is wholly or substantially based on the witness's specialised knowledge. In most other jurisdictions there are now comparable equivalent rules or guidelines.

17    Evidence later adduced, most likely in cross-examination, might reveal that an opinion proffered in an affidavit or report is not wholly or substantially based on the witness's specialised knowledge, or that the expert made an error (whether of logic, science or otherwise) in the process of reaching his or her opinion. While that evidence might be relevant to admissibility in a hypothetical sense, it would not, of itself, demonstrate error in the earlier ruling that the affidavit or report be received in evidence. The correctness of that ruling is to be judged by reference to the relevant evidence and other material before the judge at the time of the ruling. The evidence might, however, be of crucial importance with respect to the weight to be accorded the opinion at the end of the day.

26    I record the following matters.

27    As I have noted, Mr Morgan’s report was prepared on 26 May 2016. The opinions he has expressed have been subjected to detailed analysis by Mr de Kantzow and Professor Frino, who have prepared their own responding reports.

28    On 13 December 2017, I made the following order (Order 6) requiring Mr Morgan, Mr de Kantzow and Professor Frino to confer:

By 29 March 2018 Mr Morgan, Mr de Kantzow and Professor Frino are to attend a conference or conferences in person, at times and places to be agreed between them, at which they will:

(a)    identify issues with respect to Mr Morgan’s responses to Questions 1, 2, 3, 5, 6, 7, 10, 11, 12, 15, 16, 17, 20, 21, 22, 25, 26 and 27 in his report and the opinions of Mr de Kantzow and Professor Frino as to those responses, on which they agree, partly agree or disagree and why they partly agree or disagree;

(b)    prepare, sign and deliver to the legal representatives of the parties a joint report in which they list each of those issues with which they agree, partly agree or disagree and, where they partly disagree or disagree, briefly state the reasons for any such disagreement or partial disagreement (which explanation may include cross-referencing to their reports).

29    At that time, no objection was or had been raised, at least with the Court, that Mr Morgan did not have specialised knowledge that would enable him to express the opinions in his report or to engage meaningfully with Mr de Kantzow and Professor Frino on all issues on which there was disagreement. In compliance with that order, Mr Morgan, Mr de Kantzow and Professor Frino duly met on 6 March 2018 and prepared the Joint Report which sets out, amongst other things, the areas of their disagreement.

30    The present hearing commenced on 2 July 2018. The first week was taken up with opening addresses, with Senior Counsel for the plaintiff opening on 2, 3 and 4 July and Senior Counsel for the defendants opening on, substantially, 5 and 6 July. In the course of both openings, I was taken to aspects of the expert evidence, including Mr Morgan’s, Mr de Kantzow’s and Professor Frino’s separate reports. The areas of dispute between them were exposed and agitated.

31    The concurrent evidence session involving all three witnesses commenced on the next hearing day, 9 July 2018. That session continues at the time of delivering these reasons, although Professor Frino’s continued attendance has been now excused.

32    There is no doubt that the defendants have made a substantial challenge to the basis on which Mr Morgan’s opinions have been expressed, both as to his competence to give expert evidence on the typical trading strategies and methodologies employed by competent and experienced index arbitrage traders on the ASX and ASX24 in 2012, and on the question of establishing index arbitrage positions prior to and during the OSPA.

33    However, on 6 July 2018, at the conclusion of the openings and before the concurrent evidence session commenced, I formed at least the prima facie view that Mr Morgan had sufficient specialised knowledge to give the evidence then under challenge, and that this evidence was based substantially on that knowledge. What has since emerged is the evidence given by Mr Morgan whilst under cross-examination in the current concurrent evidence session.

34    I am not persuaded that at this juncture it would be appropriate to revisit the ruling I made on 6 July 2018 before the concurrent evidence session commenced, simply because Mr Morgan has given answers which the defendants see as bolstering their contention that at least some of his opinions are not based substantially on specialised knowledge. I am also not persuaded that I should now entertain an extension of the challenge to other aspects of Mr Morgan’s evidence, including the comments he has made in the Joint Report. I am acutely aware of the different positions the parties have adopted in relation to both the scope and level of specialised knowledge required to express opinions on trading strategies and methodologies in index arbitrage trading on the ASX and ASX24, including in relation to establishing positions in the pre-open phase. However, the stage has been reached (particularly in light of all that has happened over the last eight hearing days) where a mature decision on the ultimate utility of Mr Morgan’s evidence and the extent to which reliance can be placed on it for the purposes of fact-finding should await the reception of all the evidence and the development of final submissions.

35    I am not persuaded that the defendants’ objection as now expressed is so clear that a final view can be reached now that the challenged evidence is not based substantially on specialised knowledge. To attempt to adjudicate in a final way on that matter now simply because of some answers given in cross-examination only serves to dislocate and disrupt the trial process. In making that observation I bear in mind Branson J’s cautionary observations in Red Bull which I have quoted.

36    Therefore, given the stage at which the hearing has reached, I do not accede to the defendants’ application that I should now reject those parts of Mr Morgan’s evidence to which objection has now been taken.

37    I appreciate that the defendants may wish to cross-examine Mr Morgan on those parts of his report and the Joint Report which they contend are not substantially based on specialised knowledge. That, of course, will require them to make forensic decisions, but making such choices is a normal part of the trial process.

Associate:

Dated:    12 July 2018