In a recent long-anticipated decision by the Hong Kong Market Misconduct Tribunal (Tribunal), the Tribunal held the former chairman and former CEO of China Forestry Holdings Company Limited (Company) liable for market misconduct under the Securities and Futures Ordinance (Cap. 571) (SFO).
Background
The Company was listed on the Hong Kong Stock Exchange on 3 December 2009 and raised over HK$1,677.6 million through its initial public offering (IPO).
In 2018, the Securities and Futures Commission (SFC) initiated proceedings in the Tribunal, against Mr. Li Kwok Cheong (Li KC), an Executive Director and the then Chairman of the Company, Mr. Li Han Chun (Li HC), an Executive Director and the then CEO of the Company, and Top Wisdom Overseas Holdings Limited (Top Wisdom), a company wholly owned and controlled by Li HC, for their involvement in market misconduct, namely the disclosure of false or misleading information, inducing transactions contrary to section 277 of the SFO, and insider dealing contrary to section 270 of the SFO.
Disclosure of false or misleading information
The Allegations
The SFC alleged that various information in relation to the Company’s business operations and finances, as disclosed in the Company’s IPO Prospectus and interim and annual financial results (Disclosed Information), was materially false or misleading, which induced transactions in the shares of the Company (Shares). Further, Li KC and Li HC knew, or alternatively, were reckless or negligent, as to whether the Disclosed Information, or any part of it, was false or misleading as to a material fact or through omission of a material fact.
The Findings
The Tribunal found that the Disclosed Information contained qualitatively material misstatements in terms of the Company’s cash and turnover positions and bank and profit balances. There was overwhelming evidence of substantial falsification of bank documents in the conduct of the Company’s day-to-day forestry business, which was used to misrepresent the truth of its financial affairs. The Tribunal was of the view that Li HC and Li KC, who were involved in the business operations of the Company, had actual knowledge that the Disclosed Information was false or misleading in authorising issuance in their capacity as the then Executive Directors of the Company.
As a result of the material misstatements, information disclosed in the Prospectus was likely to increase the price of the Shares around the time of issuance and thereby induce investors to make IPO subscriptions (in respect of the Prospectus), and induce the sale or purchase of the Shares by potential investors (in respect of the financial results). As for the interim results, the Tribunal found that there was insufficient evidence to show that the effect of the false information was likely to induce investors to sell or purchase Shares.
Insider Dealing
The Allegations
The SFC alleged that in December 2010, the Company’s then auditors discovered issues with the 2010 interim results and would in due course reveal other false and misleading disclosures made by the Company. Li HC, with knowledge of such fact and with knowledge of the false and misleading nature of the Disclosed Information, procured its own company, Top Wisdom, to enter into a placing agreement for disposal of 119 million Shares it held. As a result, Top Wisdom received a settlement sum of over HK$398.2 million.
The Findings
The Tribunal found that the conduct of Li HC and Top Wisdom satisfied the elements required to prove an offence under s.270 of the SFO. The fact that the Disclosed Information contained false statements was not a piece of information generally known to persons who would likely deal in the listed Shares (i.e. potential investors). This rendered the information “insider information” which would more likely than not materially affect the price of the Shares. In engaging in the insider dealing, Li HC caused Top Wisdom to avoid a loss of over HK$353.4 million, being the difference between the price the Shares would have traded at with regard to the true level of cash and cash equivalent balance in the Company versus the price actually paid to Top Wisdom.
Discussion on legal test for “likely to materially affect the price of the listed securities”
One interesting part of the Tribunal’s Judgment is the extensive discussion on the definition of the phrase “likely to materially affect the price of the listed securities”. This is a component required for the “relevant information” element of insider dealing under s.270 of the SFO. In essence, the information would only be “relevant” if it would likely affect the price of the listed securities (i.e. be price sensitive).
The Tribunal reviewed cases from Hong Kong, Singapore and UK and considered which of the following six levels of probability discerned from various cases is the appropriate legal threshold of the test for “likely” in this context: 1. “mere possibility”, 2. “may well”, 3. “real possibility”, 4. “real prospect”, 5. “more likely than less likely”, or 6. “substantial likelihood”. Broadly speaking, the Tribunal in the previous case of Mayer Holdings Limited categorised the first four as representing a less than 50% probability, and the latter two as representing a more than 50% probability.
The SFC submitted there is a need to balance the efficacy of the disclosure requirement by not imposing an overly high standard, while having a threshold high enough so as not to include breaches that are due to mistaken misjudgements of likelihood. As such, the definitions at either extreme end of the spectrum would not be appropriate. The SFC also submitted that a test of over 50% probability should be rejected, as it would exclude cases where there is a real possibility, but the possibility falls short of being more likely than not. On analysis, “real prospect” is the term that strikes the best balance and reflects the purpose of the legislation. The Tribunal affirmed this approach and ultimately concluded that the appropriate threshold for “likely” under s.270 of the SFO is a “real prospect” of materially affecting the price of the listed securities.
Takeaways
This is a welcomed decision, whereby the Tribunal deals comprehensively with the provisions under s.270 and 277 of the SFO and discusses the interesting legal point discussed above. “Likely to materially affect the price” in s.270 means “real prospect” and does not need to be over 50% of probability.
This is not the end of the matter though, as the Tribunal has yet to decide on the final sanctions to be imposed. Further, the SFC had also issued proceedings in the Court of First Instance back in 2011 for an injunction under s.213 of the SFO against Top Wisdom to prevent its dealing with the proceeds of the disposal, which proceedings were stayed pending the Tribunal’s decision. It is expected that the SFC will apply to uplift the stay and continue with the s.213 proceedings.
For further information, please contact:
peter.so@deacons.com
