In an unprecedented judgment written last week, the High Court awarded damages to a company whose former managing director had abused his position of trust and breached his fiduciary duties to the company by exploiting its lax practices for his own personal gain.

The Facts

Mr Carlsson was a managing director of the plaintiff, which operated as a stockbroker and was a member of the South African Futures Exchange (SAFEX). Carlsson also controlled Foveros, a company which had been deregistered at the time the trial began, but which previously traded in Single Stock Futures (SSFs) on SAFEX as a client of the plaintiff.

Mechanics of Single Stock Futures trading

Trading in SSFs involves three parties: the investor, the stockbroker and the clearing member. The clearing member (usually a bank) and the stockbroker are both members of SAFEX, which allows them to trade in SSFs. The relationship between the stockbroker and clearing member is governed by the SAFEX rules, whereas the stockbroker-investor relationship is governed by a contract between the parties.

The investor, like Foveros, invests money in a dedicated account with a stockbroker such as the plaintiff. By doing so, the investor can instruct the stockbroker to purchase specific SSFs related to a nominated listed company's shares. To effect the purchase, the stockbroker uses the funds in the account to pay the financer of the SSF (ie the clearing member).

The SSF effectively works like a bet on whether the share price of the nominated company will increase. When the share price of the company goes up, the value of the SSF increases and the clearing member pays the difference. However, if the price decreases, the investor's account must be "topped up" with the difference in the value of the SSFs.

Where applicable, the "topping up" must occur on a daily basis or within a deadline set by the clearing member. SAFEX rules dictate that the clearing member interacts only with the stockbroker and not the investor. Accordingly, the stockbroker, as the agent of the investor, tops up the account within the given deadline dictated by the clearing member on the investor's behalf. The investor is then obliged to reimburse the stockbroker.

The contract between stockbroker and investor usually gives the stockbroker the power to unilaterally sell off the investment, or "close out the position" in investment jargon, if the investor fails to comply with its obligations to repay the stockbroker within the same deadline. Once the position has been closed out, the amount owing is deemed a loan and the investor must repay the stockbroker.

The case

In this case, all interaction between Foveros and the plaintiff was conducted exclusively through Carlsson and this was treated as a "staff account" (ie a staff member trading for his own benefit).

Carlsson knew that the plaintiff was in the habit of not enforcing its right to collect payment from its investor clients timeously. This was not a problem for the company in a rising SSF market. However when the economy went into a recession in mid-2008, the market became volatile and the practice of indulging clients became dangerous for the plaintiff, which found itself carrying an ever-increasing debt on behalf of its clients.

The financial director and SAFEX compliance officer, Mr Malan Saaiman, notified the other directors of the financial predicament of the plaintiff and addressed the company's inability to continue carrying its clients. He specifically addressed the issue of staff accounts and requested payment of amounts owing to the company. Following this, the plaintiff closed out the position on a number of other clients but Foveros continued trading as usual, despite the risk to the plaintiff company.

Despite promising to top up Foveros' account, Carlsson did not do so and in fact withdrew money from the account. By the end of August 2008, the board of directors intervened and sold Foveros' investment to halt the increasing risk to the plaintiff's financial situation. The amount claimed from Carlsson is the amount owing by Foveros to the plaintiff.

The plaintiff sued Carlsson in his capacity as a director of the plaintiff, and not in the capacity as the investor client. The argument was that Carlsson abused his position of trust as a director and exploited the plaintiff's practice of indulging clients in respect of late repayments to top up the accounts, for his own personal gain.

Carlsson was in a position to prevent the loss to the plaintiff (and, in fact had a duty to do so) by unilaterally closing out Foveros' position while the risk to the plaintiff was still relatively modest. He had a number of opportunities to close out on Foveros' position but chose not to, in order to further his own personal gains. Furthermore, the managing director's role is to conduct the business of the company to its advantage and to take reasonable care of its affairs, which Carlsson clearly did not do. Accordingly, the court found in favour of the plaintiff and ordered Carlsson to pay the sum of approximately ZAR 1,2 million.

Applicable Legislation

At the time of the incident, the Companies Act 61 of 1973 was in operation (the Old Act). The Old Act did not specifically provide for the nature of a director's fiduciary duties in respect of the company. However, the common law on the matter was well developed and provided that the director must act in the best interests of the company. Where there is a conflict of interest between the director's personal interests and that of the company, the director is obliged to put the company's interests first. Under the common law, the managing director's role is to conduct the business of the company to its advantage and to take reasonable care of its affairs. This is but one of many aspects of a director's fiduciary duty to a company.

The Companies Act 71 of 2008 (New Act), which is now in operation, codifies the common law position on fiduciary duties of a director and provides a remedy whereby not only the company but also shareholders and any person who suffers damages as a result of the director's breach of his or her duties in terms of the New Act may, claim damages from the director personally.

The New Act sets out strict standards of conduct expected of directors and other persons who exercise general executive control over and management of the whole or a significant portion of the business and activities of the company, or who regularly participate to a material degree in such control and management. The latter two categories of persons are known as "prescribed officers" under the New Act.

Conclusion

This case serves as a reminder to directors and prescribed officers that their fiduciary duties to the company are paramount and should be at the fore of all decision making, at the risk of attracting personal liability.

Written by Natasha Pather under the supervision of Lisa Swaine, Webber Wentzel.