30 May, 2018
In a recent decision Securities and Futures Commission v Qunxing Paper Holdings Co Ltd (No 2) [2018] 1 HKLRD 1060, the Hong Kong court adopted a pragmatic approach in granting statutory relief in an action brought by the SFC for the benefit of investors in relation to market misconduct committed by a former listed company. This robust decision in favour of the SFC (and in turn the investing public) will be of concern to those persons who are not counterparties to the impugned transaction but were otherwise involved and who may now find themselves also liable for regulatory breaches.
The statutory regime under section 213 of the Securities and Futures Ordinance ("SFO")
Section 213 of the SFO confers a power on the court, upon application by the SFC, to make orders in cases of contravention of provisions of the SFO and Parts II and XII of the Companies (Winding Up and Miscellaneous Provisions) Ordinance. Examples of contraventions include market misconduct, misstatements in prospectuses, failure to comply with requirements relating to disclosure of price sensitive information, and offering investment products without SFC authorisation.
Proceedings under section 213 are remedial in nature and aim to compensate the victims of these contraventions. The court is empowered to make a wide range of orders including injunctions, appointing an administrator, a declaration that a contract is void or voidable, and an order requiring payment of damages. The court's power under section 213 extends to making orders against those persons who have contravened the relevant statutory provisions, as well as other persons who have aided or abetted, induced, been knowingly involved in, or attempted or conspired to commit such contravention.
Background of the Qunxing case
In the Qunxing action, the 1st defendant, Qunxing Paper Holdings Co. Ltd ("Qunxing"), was listed on the Main Board of the Stock Exchange of Hong Kong. The 2nd defendant, Best Known Group Ltd, was a subsidiary of Qunxing. The 3rd and 4th defendants were at all material times the executive directors and decision-makers of Qunxing, being its Chairman and Vice Chairman respectively.
The gist of the section 213 action brought by the SFC was that Qunxing, with the involvement of the 2nd to 4th defendants, had published materially false or misleading information concerning its financial position which was likely to have induced investors to subscribe for or purchase its shares when they would otherwise not have done so, and had suffered loss as a result.
The court's ruling
The court applied a purposive construction to s.213, holding that it essentially provided a statutory regime whereby the SFC as regulator could take action to obtain civil remedies for the benefit of investors, who might otherwise be deterred by cost and other considerations from instituting legal proceedings individually to obtain redress for their relatively small losses.
With a view to giving effect to this legislative intention, the court affirmed the flexibility and width of the s.213 powers in the following two key aspects:
1 – The court was willing to make an order against persons who had directly or indirectly been knowingly involved in the matters, who were not necessarily themselves counterparties to the impugned transaction. This would include those persons who had aided or abetted a contravention or simply had been involved in it. The court made orders against the 2nd to 4th defendants, who were not counterparties to the transaction with investors but were knowingly involved in the contravention. Not surprisingly, the court found a high degree of culpability on their part for the contraventions and no unfair prejudice would be caused by making an order against them.
2 – The court dispensed with the requirement to prove all the requirements of a private law cause of action of deceit in the case of each investor in the s.213 action. Generally, a claim on the basis of misrepresentation requires proving elements such as inducement and reliance. The court recognised that, in reality, it would involve a complex, lengthy and costly process to ascertain (if at all ascertainable) the circumstances of every individual investor, which would otherwise destroy the efficacy of the statutory scheme and legislative purpose. The court therefore relied on expert evidence which showed that the relevant false financial information was, on a general level, likely to influence investors to purchase Qunxing shares or at least not to sell them, and to affect the share price accordingly. Importantly, the court acknowledged the possibility that such information would have found its way into market commentaries and would have been reflected in market sentiment about Qunxing shares and ultimately in the prevailing share price, irrespective of whether an investor read the relevant IPO Prospectus, annual reports and results announcement.
Practical implications and recommendations
While the legislature has not provided for a class action mechanism for investors to seek redress in their own right, a potential implication of this decision is that the SFC may more readily make use of the statutory regime under s.213 to seek remedies for the benefit of investors, with a view to protecting the investing public and maintaining confidence in the industry.
In the Qunxing case, the court ordered that the defendants make payments totalling some HK$1.42 billion to shareholders and public investors. According to the SFC, only HK$112 million of assets held by the defendants have been found to be located in Hong Kong. It is perhaps not surprising that there is a gap between the amount ordered to be paid by the defendants and the amount realistically recoverable. Given that court has demonstrated its willingness to adopt a more flexible approach to statutory construction, the SFC may take a more aggressive approach going forward to pursue more persons "knowingly involved" in a transaction in order to obtain compensation for affected investors.
The court may make orders against persons knowingly involved "so far as it can reasonably do so", i.e. where (i) it is desirable that the order be made and that (ii) the order will not unfairly prejudice any person. In the Qunxing action, as the defendants did not contest the proceedings, the court adopted a fairly broad brush approach in making its decision on this issue, with the benefit of submissions made on behalf of the SFC only. In a future case where a defendant makes submissions as to why an order might be undesirable and unfairly prejudicial, further judicial guidance on this point can be expected.
It is advisable that parties closely connected to activities conducted by listed companies (for examples IPO sponsors, auditors and other advisors of listed companies) maintain vigilance in complying with their regulatory obligations and ensure that proper documentation is kept. They should maintain adequate systems and control in relation to compliance matters such as verifying the accuracy of assertions made by listed companies. The consequences of breaches could be potentially far reaching in light of the Qunxing decision.
