Bank of New Zealand v Deloitte Touche Tohmatsu [2008] NZCA 25; [2009] 1 NZLR 53; [2008] NZCCLR 23 (22 February 2008)

Last Updated: 2 February 2018

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IN THE COURT OF APPEAL OF NEW ZEALAND

CA238/06
[2008] NZCA 25

BETWEEN BANK OF NEW ZEALAND
First Appellant

AND ACCESS BROKERAGE LIMITED (IN LIQUIDATION)
Second Appellant

AND NEW ZEALAND EXCHANGE LIMITED
First Respondent

AND DELOITTE TOUCHE TOHMATSU
Second Respondent

Hearing: 2 October 2007

Court: Robertson, Arnold and Ellen France JJ

Counsel: A R Galbraith QC, B R Latimour and S E Russell for First and Second Appellants
M G Ring QC, P J Hunt and R Scott for First Respondent
C M Fairnie (observing) for Second Respondent

Judgment: 22 February 2008 at 3 pm

JUDGMENT OF THE COURT

1. The appeal is allowed. The claims by the Bank of New Zealand and by Access Brokerage Limited (In liquidation) against the New Zealand Exchange Limited are reinstated.
2. The claims against Deloitte Touche Tohmatsu are reinstated.

100. The order for costs in the High Court is quashed.

4. The first respondent must pay to each of the appellants costs of $3,000 plus usual disbursements. We certify for second counsel.

REASONS OF THE COURT

(Given by Ellen France J)

Table of Contents

Para No

Introduction [1]
Factual background [4]
The claim by BNZ [12]

Basis of the claim [13]

The approach in the High Court [15]
The issue and the parties’ submissions [27]
The statutory and regulatory background [33]
THE SECURITIES MARKETS ACT 1988 [35]
THE SECURITIES ACT 1978 [46]
THE NZX RULES [48]
Discussion [74]
IS NZX A REGULATOR IMMUNE FROM PRIVATE LAW DUTIES? [74]
THE PURPOSE OF THE RULES AND OF THE INSPECTION FUNCTION [91]
Conclusion [101]
The claim by Access [102]
The approach in the High Court [103]
Discussion [109]
Other matters [119]
Result and costs [120]

Introduction

[1] Access Brokerage Limited (“Access) was a stockbroker and a member of the New Zealand Exchange Limited (“NZX”). Access was placed in liquidation in September 2004 after its directors advised NZX that it was unable to meet obligations to clients of over $4.5 million. The Bank of New Zealand (“BNZ”) was Access’ banker. BNZ settled Access’ indebtedness and took assignments of Access’ clients’ rights of action.
[2] BNZ and Access then issued proceedings against NZX and against Deloitte Touche Tohmatsu (“Deloitte”). (Deloitte undertook inspection functions in relation to Access on behalf of NZX for a period before NZX decided to carry out the inspection function itself.) The claim is that NZX breached duties of care in tort to protect Access’ clients (who BNZ is subrogated for) and Access against their losses resulting from the liquidation of Access. Access also pleads a breach of duties in contract. The focus of the claims is on NZX’s performance of its statutory functions of inspection of the financial information provided by Access in the year leading up to its failure.
[3] In a decision now reported as Bank of New Zealand v Deloitte Touche Tohmatsu [2006] NZHC 1082; [2007] 1 NZLR 663 (HC), Harrison J granted NZX’s application to strike out the claims against it by BNZ and Access. BNZ and Access appeal against the decision to strike out. The parties approached the appeal on the basis that the principal issue is whether NZX is a public regulator immune from private law duties of the type relied on by BNZ and Access.

Factual background

[4] Access was in business as a broker for some years. Peter Marshall was its chief executive and one of its directors. The other directors were William Garlick and Murray Bolton. The principal shareholder was Mr Garlick or his interests.
[5] At the relevant times, Access was a stockbroker and “member firm” under the rules and regulations of the New Zealand Stock Exchange (“NZSE”). It was then an “NZX firm” and, later, a “market participant” under the rules and regulations of NZX. We will refer to the various rules and regulations collectively as the rules.
[6] As Harrison J said at [13], the NZSE was originally a mutual organisation owned by its member broking firms. It was set up by the Sharebrokers Amendment Act 1981 to replace the Stock Exchange Association of New Zealand and exchanges located around New Zealand which had been operating under the Sharebrokers Act 1908 (see: New Zealand Stock Exchange v Listed Companies Association Inc [1984] 1 NZLR 699 at 701 (CA)).
[7] In October 2002, the members of NZSE voted to demutualise under authority given by the New Zealand Stock Exchange Restructuring Act 2002 (“Restructuring Act”) (a private bill promoted by NZSE). The members resolved to restructure NZSE as a limited liability company to be known as NZSE Limited. NZSE Limited changed its name to NZX in June 2003 when it became listed itself on the NZSE market.
[8] Under the NZX rules, Access was required to hold on trust its clients’ assets (money and securities) and to maintain minimum levels of liquidity. Compliance with these requirements and the rules more generally was monitored by NZSE and then NZX through the inspection function. Between 1996 and 2000, NZSE engaged Deloitte to undertake the inspection function. Deloitte was paid professional fees for its work. From 1 January 2003, NZX undertook the inspection duties itself. NZX charged fees for doing this work (some $20,000 per annum for inspecting Access).
[9] In the course of its annual inspection of Access in 2003, NZX identified various breaches of the rules. Access was advised of these and then, in its final inspection report (October 2003), NZX set out a timetable for the rectification of various matters. Matters did not come to a head until 3 September 2004 when Mr Garlick notified NZX that Access could not meet its obligations to its clients and so there was a shortfall in its funds.
[10] On 6 September 2004, the first working day after receipt of Mr Garlick’s advice, NZX declared Access a defaulter under the rules and suspended Access as an NZX firm, effective immediately. Liquidators were appointed shortly after that.
[11] Access had its client trust account and other accounts at the BNZ. BNZ met the shortfall in the funds available for Access to meet its obligations to its clients.

The claim by BNZ

[12] We deal first with the decision to strike out the claim by BNZ. There is no dispute that the relevant principles on a strike-out are as summarised in AttorneyGeneral v Prince and Gardner [1998] 1 NZLR 262 at 267 (CA).

Basis of the claim

[13] BNZ alleges breaches of a duty of care in negligence by NZX in carrying out the annual inspection in August 2003 and in its subsequent conduct. There are two primary aspects to the claim. The first is that NZX failed to conduct the annual inspection with reasonable professional skill, care and competence. The second aspect is that, having identified serious issues and breaches of the rules, NZX failed to take satisfactory steps to require Access to correct the situation or, if that was not possible, to suspend Access’ designation as an NZX firm.
[14] A complaint that NZX had an unfulfilled obligation to appoint an independent inspector is not pursued.

The approach in the High Court

[15] Harrison J saw the purpose of the NZX rules and regulations as being to impose “strict financial obligations and collective responsibilities on all brokers” (at [121]). That was a necessary purpose given the importance of the interdependence of brokers to the market’s integrity and efficiency.
[16] With this reference point in mind, the Judge said that the inspector’s “predominant function” was to give NZX the information it needed to fulfil its “statutory duty of oversight of the market as a whole” (at [122]). The Judge described the inspector as reporting monthly on two different issues to NZX, first as to trends in NZX firms’ and industry performance and, secondly, as to “anticipated unsatisfactory situations or breaches” of the regulations (at [122]).
[17] Harrison J considered that the inspector’s “ultimate” purpose was to help NZX in its assessment of the effectiveness of the regulations and the inspector’s own role. Taking “positive steps for the purpose of protecting the [NZX fidelity] fund” was an incidental purpose (at [123]).
[18] Hence, at [127] the Judge rejected the submission from BNZ that:

[A] critical purpose of the inspection provisions of the rules and regulations was to protect clients from loss through misappropriation of their funds or a broker’s insolvency, or that the predominant purpose of the inspection regime was to ensure that trust funds and liquidity levels were maintained for the benefit of a broker’s clients.

[19] Rather, Harrison J saw the purpose of the inspection function as related to protection of the market as a whole (at [135(2)]).
[20] It followed from this view of the purpose of the inspection function that the Judge saw the analogous cases as those where it was held that there was no duty of care, in particular, Yuen Kun Yeu v Attorney-General of Hong Kong [1987] UKPC 16; [1988] 1 AC 175 (PC (HK)) and Davis v Radcliffe [1990] 2 All ER 536 (PC (IoM)).
[21] The Judge similarly rejected the submission that there was an analogy between this case and those cases, such as Price Waterhouse v Kwan [1999] NZCA 311; [2000] 3 NZLR 39 (CA), involving auditors of solicitors nominee company accounts. In that context, Harrison J saw a distinction between the audit and inspection functions in NZX’s rules as an important one (at [135(1)]).
[22] Harrison J also considered whether there was a special relationship between NZX and Access. Two factors led Harrison J to conclude there was no special relationship (at [131]). The first was that neither the inspector nor NZX had the power to control the day to day activities of Access. All NZX could do was to stop Access carrying on business by declaring it a defaulter. The second aspect was the absence of any relationship between the clients of Access and NZX prior to the point when the clients invested in Access.
[23] For these reasons, the Judge did not consider the necessary degree of proximity and relationship were present. Nor did Harrison J see any basis on which reliance on the existence of an inspection regime as a “guarantee of a broker’s soundness” could be shown (at [140]).
[24] If there was proximity, the Judge was nonetheless satisfied that there were policy factors which were determinative of BNZ’s claim. Those factors were, one, the risk of indeterminate liability, two, an unjustifiable burden on NZX, and three, the fact that liability would cut across the “settled mechanism” for the allocation of market risk (at [148] – [153]).
[25] Finally, Harrison J was not satisfied it would be just and reasonable to impose a duty. First, because the liability would be for the loss caused by another party’s breaches and secondly, because there were other remedies which had not been pursued (at [156] – [158]).
[26] The Judge would also have struck out the claim on the basis that it was mismanagement by Access which caused the loss not any negligence by NZX (at [161] – [163]).

The issue and the parties’ submissions

[27] The parties agree that BNZ’s appeal turns on the characterisation of the role of NZX and of the purpose of the inspection regime. The positions taken by the parties on NZX’s role and on the purpose of the inspection regime are, however, in stark contrast.
[28] BNZ’s case is that NZX is a commercial body, listed on the stock exchange and operating a securities market for the purpose of making a profit for its shareholders. NZX is not, in BNZ’s submission, a statutory regulatory body representing the general public interest. The latter role is fulfilled by the Securities Commission.
[29] BNZ also says that the immediate purpose of the imposition, via the conduct rules, of terms requiring trust funds and minimum liquidity levels is to protect brokers’ clients. Further, BNZ argues that the purpose of inspection is to make sure that the trust funds and liquidity levels are maintained for the benefit of brokers’ clients.
[30] On this basis, BNZ submits that there is no good reason why NZX should not owe duties in private law. Finally, BNZ also says these matters should not be decided in the absence of evidence.
[31] NZX says that it is the regulator of the stock market, and that the principal purpose of NZX and the inspection regime is to ensure the orderly conduct of the market. The fact that NZX happens to be a listed company does not, in NZX’s submission, alter its regulatory nature. The regulatory role means that it is required to make decisions in the public interest balancing competing demands in terms of the public good.
[32] The authorities such as Yuen Kun Yeu, Davis v Radcliffe and AttorneyGeneral v Body Corporate 200200 [2007] 1 NZLR 95 at [41] (CA) make it plain, NZX submits, that regulatory bodies of this nature are not subject to private law duties and, indeed, NZX says that such a duty would be inconsistent with the statutory scheme. NZX argues that this is a matter of law and that the court is not going to be helped by evidence on the issue.

The statutory and regulatory background

[33] To decide which of these two views is correct, it is necessary to examine the relevant statutory framework and the rules particularly those relating to the inspection function. Some assistance can also be gained in this case from what NZX and the Securities Commission have said in public documents about their respective roles and from what NZX has said about the inspection regime.
[34] In terms of the statutory background, we first examine the framework for NZX provided in the Securities Markets Act 1988. Secondly, we briefly discuss the role of the Securities Commission under the Securities Act 1978.

THE SECURITIES MARKETS ACT 1988

[35] Part 2B of the Act deals with the registration, conduct, and control of exchanges. Securities exchanges must be registered (s 36A) but any body corporate may apply to become a registered exchange. (The chief executive of the Securities Commission deals with registration applications.)
[36] A registered exchange must operate each of its securities markets in accordance with conduct rules for that market. Those conduct rules include “listing rules” relating to listing on the market and “business rules” that govern the conduct of business on that market and persons authorised to undertake trading activities in that market (s 36H). The initial conduct rules prepared by NZX following the restructuring were approved by the Governor-General by Order in Council (New Zealand Stock Exchange (Conduct Rules, Control Limit, and Restructuring Day) Order 2002) on 18 November 2002 as required by s 11(2) of the Restructuring Act. They are to be treated as having been approved under s 36O of the Securities Markets Act (s 11(5)).
[37] The requirement of some ministerial oversight of the conduct rules dates back to the Sharebrokers Act 1902. The rationale for the requirement in the Restructuring Act was explained by Hon Marian Hobbs MP, who introduced the bill, in this way during the third reading debate ((20 February 2002) 598 NZPD 14513):

The bill achieves the appropriate balance between the responsibilities and concerns of the exchange, and those of the Government. This balance is achieved on the one hand by the exchange retaining responsibility for the making and administering of the conduct rules under the bill, which reflects the unique position the exchange has to assess and respond to market practices, to ensure the efficient and effective functioning of the markets.

On the other hand, the Minister is given the power only to recommend non-approval of the conduct rules or disallowance of a change to those rules, but only if those rules would not be in the public interest. This safeguards the public interest of ensuring that the conduct rules do not derogate from investor confidence in, and the proper functioning of, the exchange’s capital markets. This balance is achieved by Government intervention in the conduct rules being deliberately set at a high threshold. This high threshold ensures that an objective test is employed and that it is not an issue of arbitrary, political will. The Australian legislation strikes a similar balance in relation to the Australian Stock Exchange, which recently has also converted from a mutual into a company. (Emphasis added.)

[38] Any new rules or a proposed change to an existing rule must be provided by the exchange to the Minister before making that rule or change (s 36J). The new rules or amendments are subject to disallowance in accordance with the disallowance process in s 36L. The Minister must not disallow a proposed conduct rule or change unless the Minister is satisfied, amongst other things, that it is in the public interest to do so (s 36LJ(2)). In determining whether or not to disallow all or part of the proposed conduct rule or change, the Minister must seek the advice of the Securities Commission (s 36L(3)).
[39] If the proposed conduct rule(s) relate to a new securities market and the Minister is satisfied it is in the public interest to apply the approval process set out in the Act, the process in s 36O will apply (s 36N). Again, in deciding whether or not to apply the approval process, the Minister must seek the advice of the Securities Commission (s 36N(3)). Section 36N(2) states that before applying the approval process, the Minister must have regard to:

(a) the integrity and effectiveness of securities markets in New Zealand; and

(b) the confidence of investors in securities markets in New Zealand; and
(c) the extent of the difference between existing securities markets operated by the registered exchange and the new securities market; and
(d) the extent of the difference between the existing conduct rules and the proposed new conduct rules or changes.
[40] The approval process mechanism in s 36O is an Order in Council made on the recommendation of the Minister. In terms of s 36O(2) the Minister “must” recommend that a proposed conduct rule or change be approved unless the Minister is satisfied that:

(a) it is not the public interest to do so; or

(b) the listing rules for the [relevant] securities market to which the proposed conduct rule or change relates do not achieve the purpose of subpart 1 of Part 2 (after having regard to that purpose, the criteria stated in section 19A, and any other matters that he or she considers relevant).
[41] Part 2 sets out the regime for continuous disclosure by public issuers of material information. Public issuers must notify information in accordance with the continuous disclosure provisions of the listing rules of a registered exchange in the specified circumstances (s 19B). We note here that, in terms of ss 19K to 19PA of the Securities Markets Act, there are civil remedies to enforce the continuous disclosure regime. Those remedies include the power of the court to order disclosure (s 19K) or to impose pecuniary penalties for contraventions of the regime (s 19L).
[42] Conduct rules must be available for public inspection (s 36Q), but these rules are not regulations for the purposes of the Regulations (Disallowance) Act 1989 or the Acts and Regulations Publication Act 1989 or for any other purpose (s 36R).
[43] In terms of the interrelationship between a registered exchange and the Securities Commission, an exchange must advise the Commission of various matters. Relevantly, the Commission must be told if the exchange knows or suspects that a person has committed, is committing, or is likely to commit a “significant contravention” of the conduct rules or of the Act or related Acts (s 36ZD).
[44] Section 46 provides that a registered exchange is not liable for any act done or omitted in compliance with a direction by the Securities Commission under s 36ZO. Under s 36ZO, the Commission has various powers of direction, for example, to direct a registered exchange to suspend trading for a period.
[45] Finally, s 47(1) provides that a registered exchange is not liable for anything it does or fails to do under Part 2 or Part 2B, “unless it is shown that it acted in bad faith or without reasonable care”.

THE SECURITIES ACT 1978

[46] The role of the Securities Commission on its establishment in 1978 was primarily that of a public watchdog with a law reform function (s 10 of the Securities Act as enacted and see: City Realties Ltd v Securities Commission [1982] 1 NZLR 74 at 78 (CA); and Borrowdale and others Morison’s Company and Securities Law: Volume 4 (looseleaf ed) at 5,011,063)).
[47] The Commission’s brief was expanded with the reforms implemented by the Securities Markets and Institutions Bill in 2002. The Commission now relevantly has powers to enforce the continuous disclosure regime (s 19G of the Securities Markets Act), to require an exchange to provide it with information (s 36ZK of the Securities Markets Act), as well as various powers and functions relating to advertising of securities (s 38B of the Securities Act), and prospectuses (s 44 of the Securities Act).

THE NZX RULES

[48] The NZX Business Rules and NZX Regulations were in force from 1 January 2003 until 3 May 2004. From 3 May 2004, the NZX Participant Rules replaced the earlier Business Rules and Regulations but the relevant provisions are substantially the same. We refer to the rules and regulations in force in August 2003 when NZX inspected Access. (We use the abbreviation “reg” to refer to the regulations and “r” for the rules.)
[49] Applications for designation as an NZX firm are made to the board of directors of NZX (“the board”) and designation follows so long as the required information is provided. Once a firm is an NZX firm, the rules form a binding contract between the NZX firm and NZX (r 2.4).
[50] There are ongoing requirements for NZX firms set out in r 3 and these include the obligation to “observe proper ethical standards and act with honesty, integrity, fairness, due skill and care, diligence and efficiency” (r 3.1(a)). The firm is also required to comply fully with the rules, the regulations and the code of practice and at all times to observe good stockbroking practice (r 3.1(c)). There is an obligation to comply with any direction given by NZX under the rules, the regulations or the code of practice (r 3.1(e)).
[51] Rule 14.1 sets out a number of situations in which a firm is deemed to be a defaulter including r 14.1(d) which provides:

(d) [W]here the Board has made such enquiries (if any) as it thinks fit and resolves that, in its opinion, other circumstances exist which justify such NZX Firm being considered a Defaulter in order to protect the financial interests of all other NZX Firms or of the investing public or for such other reasons as may be considered to be relevant in the interests of the well-being and proper conduct of NZX.

[52] Rule 16 deals with NZX firms’ accounts, audit and supply of information. There is a requirement to keep books of account and, when notified by the board, an NZX firm shall within the specified time supply to the chair a certificate of audit and report from a practising chartered accountant. The board has full and absolute power to call upon any NZX firm to produce promptly for inspection by the board or its duly appointed representatives or the inspector, all books, records, and other documents relating to its business as a broker and to require NZX firms to make their employees, contractors and consultants available to appear before the board representatives for the inspector at any time and to give such information as may be as required.
[53] Rule 17 requires the board to appoint an inspector. The inspector has power to, amongst other things, inspect the financial records and to require from any NZX firm an explanation of any item or state of affairs whatsoever in relation to the firm’s stockbroking business which in the opinion of the inspector appears to need an explanation or to be at variance with the rules, the regulations, the code of practice, or with good stockbroking practice (r 17.2(b)). Rule 17.1(c) provides that each inspector shall be “directly responsible” for the work carried out by that inspector under the rules.
[54] In terms of r 17.3, each NZX firm has an obligation to satisfy the inspector that its accounts and related records are being maintained in a satisfactory manner and it has “reasonable” internal systems and checks in place. Further, each NZX firm must supply to the inspector on an ongoing basis such information as may be requested by the inspector (r 17.4).
[55] Failure to comply with rr 16 and 17 makes the firm liable for immediate suspension of its designation as an NZX firm by the board (r 17.5).
[56] Capital adequacy requirements are set out in r 18. Rule 18.1 states that:

To ensure that NZX Firms are at all times capable of meeting their financial obligations, every NZX Firm shall at all times maintain its Liquid Capital at or above the Prescribed Level [as per a formula set out in the regulations],except as provided in Rule 18.2 of Part A.

[57] The board is required to make arrangements for a fidelity guarantee fund (r 19).
[58] Turning then to the regulations, reg 3 deals with clients’ assets and client funds accounts. In terms of reg 3.2, the total client assets held by the NZX firm must at all times match or exceed the firm’s total outstanding broker obligations and each NZX firm is obliged to hold its client assets on trust for its clients.
[59] Further, all securities recorded as being held in an NZX firm’s transfer account must be held by the firm on trust for its clients with uncompleted contracts (reg 3.3).
[60] An NZX firm must open and maintain a client funds account (reg 3.4). That is a trust account held by the firm for the benefit of the firm’s clients for its outstanding broker obligations (reg 3.1(c)). Firms must ensure, amongst other matters, that clients’ funds accounts are not overdrawn and funds in the client funds account may not be used as security for any obligation of the firm, or of any other person (reg 3.5).
[61] When an NZX firm receives any money for securities which have been sold, the money must be paid into a client funds account (reg 3.6 (b)). In terms of reg 3.8, all amounts that have to be paid into a client funds account under reg 3.6 are held upon trust. The funds are to be applied in the following way:

(a) in reimbursing NZX Firm for any amount paid by it in settling the purchase of Securities for clients ... ;

(b) in payment to selling clients of the sale price for Securities transferred into NZX Firm’s Transfer Account by the client;
(c) in payment to any other person for whom funds have held in the Client Funds Account; and
(d) in payment of brokerage and other charges properly payable to NZX Firm by its clients for transactions under Regulations 3.8(a) and (b).
[62] The regulations also prescribe levels of liquid capital that must be held by a firm (reg 10.10). A full calculation of the prescribed and actual liquid capital levels for an NZX firm must be done at the end of each month and provided as part of the required monthly returns (reg 10.11). There is also a requirement to maintain a log of the relevant calculations and to supply that log with the return at the end of each month (reg 10.11).
[63] There are further provisions dealing with accounting records and controls in reg 11.1. The records, amongst other matters, are to be maintained in a manner such that they disclose, or are capable of disclosing (in a prompt and appropriate fashion) the financial and business information which will enable the firm’s management to identify, quantify, control and manage the firm’s risk exposures and safeguard the firm’s assets, including assets belonging to others for which the firm is responsible.
[64] There is provision for an audit of the firm’s books (reg 12).
[65] Regulation 13 deals with inspection. There are various requirements for the provision of information to the inspectorate, for example, a copy of a trial balance on a monthly basis is to be sent to the inspector (reg 13.1(b)). Profit and loss account and balance sheets are to be sent to the inspector within two months of the end of the firm’s financial year (reg 13.1(f)).
[66] The inspector is required, amongst other matters, to inspect the separate accounting and internal control records of every NZX firm at least once in each calendar year to determine if the firm is carrying out its duties under the regulations. In particular, reg 13.2(b) provides that:

[T]he Inspector shall test the records to the extent he or she considers necessary to enable him or her to form a prima facie opinion as to the effectiveness of the system in operation and the accuracy of the accounting and internal control records;

[67] The inspector must review the procedures relating to reconciliations, internal systems and management of portfolios to “become satisfied” that the regulations are being complied with (reg 13.2(d)). There is a requirement to carry out sample verification (the extent of which is at the inspector’s discretion), based on audit procedures, of clients’ accounts (reg 13.2(f)).
[68] The inspector must report to NZX each month identifying (reg 13.2(i)):

[S]uch trends in NZX Firms and industry performance and anticipated potential unsatisfactory situations or breaches of these Regulations as will assist NZX to continually assess, review and/or enhance the effectiveness of these Regulations and the role of the Inspectors.

[69] Where for any reason the inspector becomes aware of “any unsatisfactory feature”, or any situation which in the inspector’s opinion could give rise to a claim on the fidelity fund, the inspector is required to take various steps (reg 13.3). These include requiring the firm concerned “immediately” to correct the situation or otherwise satisfy the inspector that the fund is not at risk (reg 13.3(a)).
[70] The full costs of the inspector and of NZX in ensuring compliance with the regulations are payable by brokers (reg 13.6).
[71] If an NZX firm does not maintain liquid capital at the prescribed level, the firm can be treated as a defaulter (reg 13.8).
[72] Finally, we refer to the code of practice. (For ease of reference, when referring to code rules we use the abbreviation “c”.) The code is a statement of required practice for NZX firms (c 1.4). The obligations in the code of practice complement and in some cases are additional to, those in the rules and regulations (c 1.5).
[73] Code rule 4.8 states that NZX firms shall ensure that their partners, officers and directors are sufficiently active in the firm’s affairs so “as to ensure the firm’s compliance with statutory and self-regulatory obligations” (c 4.8(a)). The firms must have in place systems for supervising accounts and representatives and for compliance with applicable regulations (c 4.8(b)).

Discussion

IS NZX A REGULATOR IMMUNE FROM PRIVATE LAW DUTIES?

[74] The legislative environment suggests that NZX may have some regulatory functions but is it, as NZX contends, the regulator of the stock market and thus immune from private law duties?
[75] This question turns on where on the spectrum of regulation a particular entity falls. For example, at one end, there are sporting bodies “regulating” the conduct of a sporting code. At the other end, there are statutory regulators like the Securities Commission with associated public powers. As to where NZX fits, NZX has, necessarily, the focus of a listed company on commercial success. That is in contrast to the focus of the regulator who acts solely on the basis of the regulator’s view of the public interest and the common good. We do not consider that the corporate structure can be, as Mr Ring submits is the case, completely ignored. To illustrate the point, the Act contemplates more than one registered exchange. What if there were five? Could it be said they are all the regulators in the common good? We doubt that would be so.
[76] The commercial focus of NZX is evidenced in its decision to move the inspectorate function in-house. The NZX annual report for 2004, which was referred to in the High Court, makes the point that the decrease in NZX’s expenditure for 2003 was in part due to bringing expertise in-house. The report continues by noting that this was “a deliberate strategy employed to cut the reliance on external advisors and to build our own intellectual property” (at 5). The report continues that it was a decision that had led to positive results both financially and in terms of quality of product.
[77] The 2005 annual report put it this way at 8:

Running an exchange is in reality about running well regulated businesses. As the frontline regulator of the markets, NZX works closely with the Securities Commission to enhance and optimise the regulatory environment in New Zealand. The goal: a transparent and efficient marketplace designed to protect investors, provide a cost-effective means of raising capital and facilitate growth for participants. We regulate companies as well as market participants – issuing our brand to those that meet the standards we set. And we monitor their performance to ensure confidence and integrity are maintained.

[78] In this context, NZX makes something of the level of ministerial involvement with the rules and the public interest factors that are relevant to the Minister’s approval process. However, the extent of ministerial involvement is fairly limited and the public interest factors are set at a reasonably high level.
[79] Further, while NZX has some functions which are regulatory in kind, we do not see it as in the same category as, for example, the Securities Commission. The interaction between NZX and the Commission and the Commission’s functions and associated powers, for example, to hear evidence (s 69B of the Securities Act) and to summons people (s 69D of the Securities Act) support the view that the Commission is the primary regulator.
[80] We consider that the difference between the traditional regulator and NZX is apparent from contrasting NZX’s role with that of the bodies considered in Yuen Kun Yeu and Davis v Radcliffe.
[81] The plaintiffs in Yuen were four residents of Hong Kong who had made substantial deposits with a registered deposit-taking company. The company went into liquidation and the plaintiffs lost all of their money. They sued the Attorney-General of Hong Kong as representing the Commissioner of Deposittaking Companies in negligence in relation to functions under the Deposittaking Companies Ordinance.
[82] The Ordinance was enacted with the purpose of regulating the taking of money on deposit, and to make provision for the protection of persons who deposit money and for the regulation of deposit-taking businesses for monetary policy purposes.
[83] The Commissioner of Banking was appointed to be the Commissioner of Deposit-taking Companies. The Commissioner’s functions included registering companies as deposit-taking companies but with a right to refuse registration if a company was not a “fit and proper body” to be registered. The Commissioner maintained a register that was open to inspection. Lord Keith of Kinkel, delivering the judgment of their Lordships, emphasised at 195 that it might be “a very delicate choice” whether to deregister immediately or let a company go on in the hope that its financial position would improve. A similar situation, Mr Ring says, might arise for NZX.
[84] However, Lord Keith went on to point out at 195 that the power to refuse registration, or to revoke or suspend it, was quasi-judicial in character and hence there were various appeal rights from the Commissioner’s decision. Further, the Commissioner had no power to control the day to day management of a company and all he or she could do was to put a company out of business or allow it to continue. Lord Keith doubted that the supervision exercised by the Commissioner could be close enough to prevent fraud in time to forestall loss to depositors (at 195). While NZX has some regulatory functions, those functions on their face do not come within the category of “quasi-judicial” activity.
[85] There was no equivalent in the facts in Yuen to NZX’s inspection power, and there is some merit in BNZ’s submission that there are matters on which evidence could assist the court. Those matters include the nature and extent of the inspector’s role and their involvement, if any, in the management of Access. As to the former, the Securities Commission in its inquiry into NZX’s role prior to the collapse of Access concluded that:

233. On the evidence the Commission has, the Access inspection put little weight on examining transaction records for evidence of misuse of client funds or the client funds account. It does not appear to have been expected that the inspectors should do otherwise. Apart from one question relating to misuse of client funds in the RFI [Request for Information], repeated in the work programme, there is no indication that the NZX compliance programme at the time sought to examine whether brokers were complying with this important aspect of the Rules. The work programme focussed on the settlement of client trades, not misuse of funds.

[86] Their Lordships saw the later case of Davis v Radcliffe as indistinguishable from Yuen (at 540). Davis involved the Savings and Investment Bank (“SIB”) which was incorporated on the Isle of Man. The Banking Act 1975 established a system of licensing banks under which the SIB was licensed. The SIB was subsequently wound up with a deficit of more than £40 million. The depositors brought proceedings against the Treasurer and members of the Finance Board. The duties of the Finance Board, an unincorporated body, included preparing and submitting to the Governor draft proposals for budgetary policy and other financial matters relating to the Isle of Man. Licence applications by banks were dealt with by the Treasurer but the Board gave directions to the Treasurer in that respect. The Treasurer could suspend or discontinue a banking business and did have power to inspect the books.
[87] Lord Goff of Chieveley in delivering the judgment of their Lordships in Davis, described the function of the Finance Board and that of the Treasurer as “typical functions of modern government, to be exercised in the general public interest” (at 541). Further, Lord Goff said that these functions were “of the broadest kind, for which parallels can doubtless be drawn from other jurisdictions” (at 541).
[88] Lord Goff made the point that the licensing system was intended to operate in the interests of the public as whole. It followed, Lord Goff said at 541, that when those dealing with its operation were faced with making decisions such as refusing to renew a licence or to revoke a licence those decisions:

[C]an well involve the exercise of judgment of a delicate nature affecting the whole future of the relevant bank in the Isle of Man, and the impact of any consequent cessation of the bank’s business in the Isle of Man, not merely on the customers and creditors of the bank, but indeed on the future of financial services in the island.

[89] In those circumstances, Lord Goff said at 541 that:

[C]ompeting considerations have to be carefully weighed and balanced in the public interest ... . The making of decisions such as these is a characteristic task of modern regulatory agencies; and the very nature of the task, with its emphasis on the broader public interest, is one which militates strongly against the imposition of a duty of care being imposed on such an agency in favour of any particular section of the public.

[90] In our view, while aspects of NZX’s role will necessitate consideration of the public interest, the commercial focus of NZX puts it in a different category from the organisations dealt with in these two cases.

THE PURPOSE OF THE RULES AND OF THE INSPECTION FUNCTION

[91] As the appeal was argued, our view on the role of NZX is probably sufficient to deal with the appeal in relation to the claim by BNZ. But, in addition, we agree with BNZ that an important purpose of the rules and of the inspection function is to protect the broker’s clients. That approach also supports the view that it is at least arguable that NZX owes some private duties.
[92] We agree with the Judge that an orderly market is one of the objectives of the rules and of the inspection regime but we do not consider it is the overriding objective. Rather, there are a number of aspects of the rules that can only be interpreted as having the purpose of protecting the interests of the clients of brokers.
[93] It follows from this purpose that the better analogy is with those cases involving auditors of solicitors’ trust accounts and nominee companies where it has been accepted there may be a duty of care: Price Waterhouse v Kwan; Sievwright James & Co Securities Ltd v Borrick HC DUN CP20/194 21 December 1998; and Stringer v Peat Marwick Mitchell & Co [2000] 1 NZLR 450 (HC) involving auditors of solicitors’ trust accounts and nominee companies.
[94] The relevant features of the rules include the requirements to hold clients’ money and securities in trust and to maintain high levels of liquidity. Associated with those requirements are the obligations, for example in reg 11.1, to keep accounting records. While these features may also assist in maintaining an orderly market, they must have protection of the clients’ interests at their heart. To illustrate, if that is not so, why is an NZX firm required by reg 13.1(k)(ix) to have systems of internal control with measures that, “so far as is reasonably practicable”, minimise “the risk of losses to the business from irregularities, fraud or error and identify such matters if they occur so that prompt remedial action may be taken by Management”? Protecting the fidelity fund is a part of the rationale for this sort of requirement but it can be only an ancillary purpose.
[95] The inspection function must be seen as corresponding to the purpose of protecting clients’ interests. While the rules are published, apart from inspection, it would be difficult for clients to be satisfied as to compliance.
[96] NZX relies on the statement in reg 13.5 that the functions of the inspector are not to be regarded for any purposes as an audit. This factor also had some resonance for the Judge. An inspection is not, of course, an audit and so does not provide the same “fit for” warranty as an audit. However, it does not follow that the inspector is not obliged to exercise due care and skill and indeed reg 13.5 says the inspector “shall exercise normal professional care and skill”.
[97] Further, the inspector’s associated powers suggest some parallels with an audit. For example, the inspector does have powers to obtain and access information from the firm (see r 17.2). We also agree with BNZ that the court may be assisted by evidence as to the extent of interaction between the inspector and brokers over inspections. It is pleaded, for example, that NZX gave Access both its draft inspection report of 15 September 2003 and its final report of 24 October 2003. What happened in the course of that exchange may be relevant.
[98] The requirement to report unsatisfactory situations to the Commission is also consistent with this conception of the inspector’s role, as is NZX’s own statement in its Code of Practice and May 2003 media release. NZX required Access to amend its disclosure statement to its clients to reflect that NZX was its regulator and that NZX inspectors were conducting inspections (see s 3(2) of the Investment Advisers (Disclosure) Act 1996).
[99] Finally, as to whether or not strike-out is appropriate, it is also relevant that s 47 of the Securities Markets Act protects a registered exchange from liability in certain situations. This section was inserted into the Bill at the select committee stage. The Committee’s report explained that ([2002] AJHR I 22C at 263):

One submitter suggests that the bill should be amended to give some protection from liability in relation to the exercise of a registered exchange’s functions or duties under Part 2 or Part 2B. The majority recommends that the bill be amended to include protection for registered exchanges that is the same as that applying to the [Securities] Commission. This will ensure that the protection is not available if the exchange acts in bad faith or without reasonable care. Officers, employees, and agents of the exchange would not be protected if they act in bad faith.

[100] The Commission has a similar immunity in s 28 of the Securities Act. In Fleming v Securities Commission [1995] 2 NZLR 514 this Court upheld a decision to strike out. The claim was that the Commission owed a duty of care to protect potential investors once the company involved had breached the now repealed s 44A of the Securities Act dealing with misleading advertising. The effect of s 47 should not therefore be over-stated, but it does at least indicate the possibility of liability where reasonable care is lacking.

Conclusion

[101] For these reasons, we conclude that BNZ is right that NZX is primarily a commercial body, albeit it has some regulatory functions and that an important purpose of the inspection regime is to protect the interests of the broker’s clients. As the matter was argued, that is sufficient to allow the appeal in relation to the claim by BNZ. We add that while there may be issues about causation the matter is at least arguable and so should not be struck out on that basis.

The claim by Access

[102] Harrison J focused on the breach of contract claim by Access against NZX and it is not suggested that in this case any different issues arise in relation to the negligence claim. The breach of contract claim is based on the term of the contract (in the rules) that in carrying out his or her duties, an inspector should exercise “normal professional care and skill”. The particular allegations are that NZX did not adequately inspect, test or review the various records.

The approach in the High Court

[103] The Judge saw the issue here as being whether Access was entitled to rely on NZX’s proper performance of its contractual duties to protect it from the loss it now seeks to recover. His Honour said the scope of the inspector’s duties did not extend that far for a number of reasons, summarised at [82].
[104] First, Access effectively sought to sue NZX for the adverse financial consequences of its own failure, which is contrary to the principle that a party in breach of a contract cannot take advantage of its wrongs.
[105] Secondly, NZX had no role in relation to Access’ management or control and was not responsible for Access’ failure to establish and maintain the necessary internal controls.
[106] Thirdly, it was outside the scope of an inspector’s duties to protect a broker from its own failure to perform or remedy breaches.
[107] Fourthly, the inspector was bound to report to NZX rather than to the broker and only dealt with the broker when he or she became aware of an “unsatisfactory feature” or other situation which could give rise to a claim on the fidelity fund. The Judge saw the purpose of that duty as being to protect the fund, not the broker.
[108] Finally, the inspection function was not like the audit function so there was no suggestion, for example, of providing a “true and fair view” of the company’s accounts (at [82(5)]).

Discussion

[109] The primary argument made by NZX in relation to the claim by both appellants is that the alleged duties are inconsistent with the regulatory regime. On our analysis above as to the nature of the inspection regime and as to the role of NZX, this argument falls away in respect of the claim by Access as well.
[110] The thrust of the other arguments made by NZX culminates in the submission that this case can be distinguished from the authorities relied on by Access particularly those in which it was held that the “innocent” partners may have claims against the auditor arising out of the fraudulent actions of another partner such as Dairy Containers Ltd v NZ Bank Ltd [1995] 2 NZLR 30 (HC), Law Society v KPMG Peat Marwick [2000] EWCA Civ 5563; [2000] 4 All ER 540 (CA), and Stringer v Peat Marwick Mitchell.
[111] In Dairy Containers, the fraud of three senior executives over a number of years was not detected by the Auditor-General’s annual audit of the company. The company successfully sued the Auditor-General. Thomas J at 55 agreed with Moffitt J in Pacific Acceptance Corporation Ltd v Forsyth (1970) 92 WN (NSW) 29 (SC) that auditors, in planning and undertaking their work, had to be “mindful” of the possibility of fraud. Thomas J continued:

If and when the auditor discovers an apparent irregularity, they must carry out such further tests or make such further inquiries as may be required to be satisfied that, in fact, no irregularity exists. If an irregularity is found to exist they must be satisfied, or take such further steps as may be necessary to be satisfied, that the irregularity will not affect the truth of the accounts. If the circumstances are such as to give rise to a reasonable suspicion of fraud, they must necessarily proceed further and either determine that no fraud exists or report their suspicion to the general manager, or the board, or even the shareholders of the company, as may be appropriate in the circumstances of the case.

[112] In Law Society v KPMG Peat Marwick [2000] 1 All ER 515 at [43] (Ch), Sir Richard Scott VC said that the client (and hence the Law Society by subrogation) could pursue private law remedies in relation to the action of the dishonest solicitor “which would leave the negligent reporting accountant with the ultimate responsibility for the loss”. That observation was referred to with approval by the Court of Appeal in Law Society v KPMG Peat Marwick at [16] per Lord Woolf CJ.
[113] Similarly, Stringer involved a claim by the “innocent” solicitors in the law firm against the auditors. The Court took the view that policy factors weighing against the recognition of a duty of care were not “sufficiently compelling” to entitle the Court to strike out the claim where recognising a duty of care would not “undermine the credibility of the audit regime ... or be inconsistent with that regime” (at 464).
[114] NZX says that the auditor situation addressed in those cases is different because the purpose of the audit is in part to provide the company’s shareholders with information so that they can assess whether or not management is doing their job properly (see: Caparo Industries plc v Dickman [1990] UKHL 2; [1990] 2 AC 605 at 630 (HL)). NZX also argues that Access is not “innocent” because its personnel, whose conduct must be attributable to it, were in breach of their obligations to Access and their conduct caused Access itself to be in breach. In this context, NZX submits, there was a person to whom NZX could look to, namely, Mr Marshall acting on behalf of the company. For these purposes, Mr Ring said that Mr Marshall was Access, he was the Managing Principal and the designated conduit to NZX and it was his obligation to ensure compliance. NZX makes a similar public policy argument in relation to causation and also submits that it was not reasonably foreseeable that Access would suffer loss through NZX failing to prevent any subsequent wrongdoing on the part of Access’ own Managing Principal.
[115] We have already dealt with the arguments based on the purpose of the inspection regime vis-à-vis that of the auditor. But, in any event, we consider NZX’s further arguments relate to matters that can only be resolved at trial on the basis of evidence as to the inspection function. A number of the matters relied on by the Judge, for example, the extent to which an inspector might have a role in relation to Access’ management or control, are in the same category. Similarly, the extent to which the actions of Mr Marshall are to be attributed to Access is a question that is highly dependent on the factual matrix.
[116] Finally, NZX supports Harrison J’s conclusion that any alleged breaches by NZX did not cause Access to become unprofitable and ultimately insolvent, or to trade in a manner which breached the regulatory regime. Nor, NZX says, did they cause Access to trade in ignorance of this reality. Rather, NZX submits, the Judge was right that NZX’s August 2003 report was an opportunity for Access to remedy its breaches but Access did not do so. NZX’s alleged breaches then simply allowed the status quo to continue with Mr Marshall’s knowledge.
[117] We consider that the extent to which Access was at fault and so broke the causative link will be a relevant issue at trial. As Evans-Lombe J said in Barings plc (in liquidation) v Coopers and Lybrand [2003] EWHC 1319 at [838] (Ch) this issue is “fact-sensitive” to the particular case and is appropriately determined on the basis of the evidence. We note also the suggestion in Todd (gen ed)) The Law of Torts in New Zealand (4ed 2005) at [21.3(4)] that “[i]f there is a legal duty to safeguard another from self-harm, a breach of the duty must be a cause even of that harm.” (See on the latter aspect various decisions of the House of Lords which conclude that where the scope of the defendant’s duty includes a duty to protect the plaintiff against his or her own deliberate actions, the chain of causation cannot be broken by the very act the defendant is obligated to protect the plaintiff from: Environment Agency (Formerly National Rivers Authority) v Empress Car Co (Abertillery) Ltd [1998] UKHL 5; [1999] 2 AC 22 at 31 (HL); Reeves v Commissioner of Police of the Metropolis [1999] UKHL 35; [2000] 1 AC 360 (HL) at 367 – 368 (per Lord Hoffmann), at 374 (per Lord Jauncey of Tullichettle) and at 381 (per Lord Hope of Craighead); and Kuwait Airways Corporation v Iraqi Airways Co (Nos 4 and 5) [2002] UKHL 19; [2002] 2 AC 883 (HL) at [69] - [71] (per Lord Nicholls of Birkenhead) and at [127] – [128] (per Lord Hoffmann).)
[118] The matters raised by NZX illustrate the difficulties the claim by Access may well face at trial but, for the reasons we give, it is premature to strike out the claim brought by Access.

Other matters

[119] The claims against the second respondent, Deloitte, were also struck out in the High Court. It is agreed that this was an error because Deloitte, who appeared on a “watching brief” basis, had not applied to strike out the claims against it made by the appellants. Accordingly, we reinstate the claims against Deloitte.

Result and costs

[120] The appeal is allowed and the claims by BNZ and Access against NZX are reinstated. The claims against Deloitte are reinstated by consent.
[121] Having been successful the appellants are entitled to costs in this court. We certify for second counsel.
[122] The order for costs in the High Court is quashed.

Solicitors:
Bell Gully, Auckland for First and Second Appellants
McElroys, Auckland for First Respondent
Simpson Grierson, Auckland for Second Respondent