20 May, 2015
On 26 February 2015, China Metal Recycling (Holdings) Limited ("China Metal Recycling" or the "Company"), a Hong Kong listed company, became the first company to be wound up on public interest grounds on the application of the Securities and Futures Commission (the "SFC") under section 212 of the Securities and Futures Ordinance (Cap 571) ("SFO").
The case involved a massive accounting fraud perpetrated by Company management over an extended period using a complicated web of sham entities and false dealings. That the fraud spanned a period during which the Company listed on the Hong Kong Stock Exchange ("Stock Exchange") makes the fraud especially egregious.
The case provides a useful application of the principles by which decisions to wind up a company in the public interest should be made. It also provides unwelcome justification for concerns held in some quarters about the potential for corporate misconduct in Hong Kong listed Mainland companies.
China Metal Recycling was incorporated in the Cayman Islands on 18 July 2007 and, after issuing a prospectus, was listed on the Stock Exchange on 22 June 2009.
In December 2009, the SFC began an investigation into whether there had been false or misleading disclosures by the Company which had induced transactions in its shares. By the time of the winding up application, the SFC's case was that China Metal Recycling had engaged in an elaborate accounting fraud which had led to significant overstatements of the Company's revenue and profits over several years.
The SFC alleged that this had been achieved by dishonest round robin fund flow schemes, through which substantial amounts were paid by a Company affiliate to purported suppliers and circulated back by purported customers. False bills of lading had been used to give the impression of genuine shipments underlying the false transactions. It was alleged that, from 2007 to 2009, the Company's revenues were overstated in this manner by around 46 per cent and its gross profit was overstated by around 72 per cent.
Trading in the Company's shares was voluntarily suspended on 28 January 2013 pending the release by the Company of a clarification announcement in relation to inside information of the Company. The winding up petition was presented on 26 July 2013 and the Company was placed into provisional liquidation on the same day.
The Court made the winding up order on the grounds that the order was desirable in the public interest. It was found to be clear that the round robin funds transfers had taken place, that the relevant bills of lading did not represent genuine shipments and that a major orchestrated deception was perpetrated on investors, the Stock Exchange and others involved in the listing of the Company, which went to the integrity of its listing.
The Court noted that there would appear to have been, at the very least, a very serious contravention of section 298 of the SFO (disclosure of false and misleading information inducing transactions) and section 342F of the Companies (Winding Up and Miscellaneous Provisions) Ordinance (Cap 32) (criminal liability for misstatements in a prospectus).
Other aspects of the Court's reasoning that are of relevance were that:
- As the term "public interest" is not defined under Hong Kong statute, the term should be interpreted by reference to the regulatory functions and objectives of the SFC in sections 4 and 5 of the SFO.
- When a winding up order is sought on public interest grounds, the solvency or viability of the business of the company is not itself significant; the interests of the investing public and the integrity of the market are of principal concern.
- Isolated acts may not be sufficient to justify a winding up, any act must be of sufficient
- significance for the severe sanction of a compulsory winding up to be appropriate.
- It must be clear to those involved in the promotion of companies and the raising of finance in the equity markets that deceptive and misleading practices in the promotion of a company are likely to result in a winding up.
- The fact that offending activities have ceased does not mean a more lenient approach should be taken by the court.
- The appropriate order in a case where a listing has been obtained by wholly dishonest fabrication of accounts would almost invariably be a win.
For further information, please contact:
Ben Hammond, Partner, Ashurst
ben.hammond@ashurst.com
Gareth Hughes, Partner, Ashurst
gareth.hughes@ashurst.com
Christopher Whiteley, Partner, Ashurst
christopher.whiteley@ashurst.com
