A broker’s clumsy plans to manipulate the market in one of the two companies he chaired breached his director’s duties to both. 

    Often, civil penalty proceedings brought by the Australian Securities and Investment Commission (ASIC) against directors are settled by the parties producing a statement of agreed facts. These facts are then taken to a court to fix an appropriate penalty having regard to the specific laws that have been contravened. A director’s behaviour can involve several distinct contraventions arising from a single source, as Justice Angus Stewart’s recent penalty decision in ASIC v Blumenthal [2024] FCA 384 shows.

    The facts in the Blumenthal case read like a made-for-TV movie. Throughout 2021, Adam Blumenthal was chair of two companies — EverBlu Capital Pty Ltd (a licensed stockbroker and corporate adviser) and Creso Pharma Ltd (an ASX-listed medicinal cannabis business). He was also the sole director and shareholder of Anglo Menda Pty Ltd, which lent money to EverBlu clients to trade shares. Creso was a corporate advisory client of EverBlu. Blumenthal was a substantial shareholder in Creso and in February 2021, his total investment in the company was valued at about $30m.

    In March 2021, Blumenthal arranged for Creso to retain Tyson Scholz and Aldo Sacco to provide Creso with consultancy, marketing and promotional services. Scholz was a social media finance influencer known on Instagram as the “ASX Wolf”. He regularly posted on Instagram and in chatrooms, pumping shares in companies in which he had invested, and sold share tips and conducted share-trading seminars. Scholz was also a stockbroking client of EverBlu and, over the course of 2021, borrowed $7,125,460 from Blumenthal’s private company, Anglo Menda, to buy Creso shares.

    Breaching the law

    Also in March 2021, Blumenthal began manipulating the market in Creso shares. He did this by going into EverBlu’s suspense account and client accounts and altering client orders for Creso shares. On 14 occasions, he disaggregated single client orders “with the intention... of representing to the market that there were more individual bidders for Creso shares than in fact existed”. As part of his settlement with ASIC, Blumenthal agreed that “the conduct was likely to have had the effect of creating, or causing the creation of, a misleading appearance with respect to the number of market participants actively trading Creso shares” in breach of the law.

    The conduct continued until November 2021, when the Australian Federal Police executed search warrants on Scholz and EverBlu at ASIC’s instigation. Following an investigation, the Federal Court found that Scholz had contravened the law requiring him to hold a financial services licence, and in 2022 he was permanently banned from carrying on a financial services business. In 2023,

    ASIC accepted a court-enforceable undertaking from Blumenthal and EverBlu, by which Blumenthal undertook not to be involved in financial services for five years and Everblu undertook to cease offering financial services to new clients and apply for cancellation of its AFS licence. ASIC eventually cancelled EverBlu’s AFS licence in February 2024.

    Directors’ duties

    Blumenthal’s conduct caused three distinct harms — to market integrity, to the interests of EverBlu, and to those of Creso. But as Justice Stewart observed, “The contraventions are interrelated. They each had their source in Mr Blumenthal’s large shareholding in Creso, his position as the chairman of a financial services licensee with a capacity to employ trading strategies, and his intention of presenting a false or misleading picture to the market for Creso shares. The contraventions concerned fundamental obligations by a senior officeholder in each corporation and, in the case of EverBlu, a senior officer who oversaw and participated in the stockbroking services it provided”.

    The headline issue is Blumenthal’s attempt to manipulate the market. But because of the harms his conduct caused EverBlu and Creso, the case also contains useful lessons about directors’ duties and ASIC’s approach to enforcing them.

    In addressing the harm to EverBlu, ASIC applied the “stepping-stones” approach to liability. Blumenthal breached his statutory duty of care as a director of EverBlu when he engaged in the conduct that resulted in disaggregation of client orders for Creso shares, because of the risk that conduct posed to the interests of EverBlu as a financial services licensee.

    As the judge observed, EverBlu, “maintained a suite of internal policies that included procedures directed towards compliance with its [financial services licence] and the general law”. These should have prevented Blumenthal, as a director and chair of Creso, providing advice about or accepting client instructions in relation to its shares. His conduct was negligent because it, “was in breach of a number of EverBlu’s policies, including the Dealing Manual, Document Retention Policy, Conflicts of Interest Policy, Personal Dealing Policy and Compliance Framework”, and caused EverBlu “to be in breach of its [statutory obligations as a financial services licensee] which jeopardised EverBlu’s interests including by creating a real risk of regulatory action”.

    The stepping-stone cases demonstrate that, where a director’s conduct exposes their company to a foreseeable risk of harm to its interests, they contravene their statutory duty of care if a reasonable director in their situation would not have engaged in that conduct. The negligence lies in exposing the company to the risk, whether or not the harm eventuates and regardless of whether it causes direct financial loss to the company.

    The harm to Creso resulted from the decision to retain and then pay Scholz and Sacco. Here, Blumenthal contravened both his duty of care and his duty to act in the best interests of Creso.

    The agreed facts indicate that he was negligent in putting the retainers in place, and then, “in the absence of sufficient due diligence and documentation, and the imposition of measurable deliverables, authorising and coordinating Creso’s payment” of their invoices, which totalled $2,013,000 for Scholz and $1,237,500 to Sacco.

    Blumenthal’s breach of the best interests duty arose out of the payment to Scholz. Scholz was indebted to Anglo and the payments he received from Creso enhanced his ability to repay the loan. The duty requires that directors make decisions having regard to the company’s best interests, not their own. The agreed facts indicate that Blumenthal breached that duty by failing to avoid the conflict between Creso’s interests and the advantage he stood to gain from Creso putting Scholz in funds. He failed to disclose his financial relationship with Scholz to the Creso board and failed to exclude himself from approving Scholz’s invoices.

    In April, Justice Stewart ordered Blumenthal to pay $850,000 in civil pecuniary penalties plus costs, and disqualified him from managing companies (apart from his own investment companies) for five years. He also undertook not to be involved in the financial services industry for the same period, which may be little comfort to those caught up in the clumsy plan.

    This article first appeared under the headline 'Meddling with the Market’ in the June 2024 issue of Company Director magazine.

    Dr Pamela Hanrahan is an Emerita Professor of the University of NSW and a consultant at Johnson Winter Slattery.

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