On 26 August 2016, the Market Misconduct Tribunal (Tribunal) found that Andrew Left had engaged in market misconduct, having published on a website, a false and misleading report (Report) regarding a company listed on the Hong Kong Stock Exchange, following which there was a substantial fall in its share price. The Tribunal found that he was reckless when he published the Report, having consciously disregarded the real risk that the Report was false and misleading as to material facts. This is a landmark case, being the first time the Securities and Futures Commission has taken action in respect of short seller reports and stock commentaries and the first decision of the Tribunal on the relevant provision.
Andrew Left heads a Los Angeles-based company, Citron Research, which publishes stock commentaries on its website. On 21 June 2012, Mr Left published an in-depth analytical report on Evergrande Real Estate Group Ltd, now called China Evergrande Group (Evergrande), stating, amongst other things, that Evergrande was “essentially an insolvent company”, had “consistently presented fraudulent information to the investing public”, had employed “fraudulent account schemes”, practised “fraudulent accounting”, had “acquired its vast land inventory… by paying bribes to local officials”, had overstated assets and understated liabilities and in fact had a negative equity of RMB 36 billion, which presented “a good short opportunity”.
On the day that the Report was published, Evergrande’s share price fell by almost 20%, and closed 11% down on the day.
Mr Left had himself begun short selling Evergrande shares two weeks before publishing the Report and began repurchasing them on the day of publication, netting a profit of approximately HK$1.6 million.
Mr Left had never previously published commentary about a company on the Hong Kong Stock Exchange. He had been prompted to do so on this occasion by the receipt of an anonymous package containing a lengthy analysis of Evergrande (Draft), making serious allegations of insolvency and fraudulent accounting. According to Mr Left, he did not take the contents of the Draft at face value and instead eliminated any information from it that could not be verified by publically available information.
Section 277(1) of the Securities and Futures Ordinance (SFO)
Section 277(1) of the SFO prohibits dissemination of false or misleading information about securities or futures that is likely to induce another person to trade in the securities or affect the price of the securities. The requisite elements that must be proved are:-
- A person, whether in Hong Kong or elsewhere, must publish (i.e. disseminate) information or be concerned in its dissemination;
- The information must be likely to induce another person to buy or sell securities in Hong Kong or must be likely to maintain, increase, reduce or stabilize the price of securities in Hong Kong;
- The information must be false or misleading as to a material fact; and
- The person who disseminated the information must know, or be reckless, or negligent, as to whether the information is false or misleading as to a material fact.
The Tribunal found that Mr Left had engaged in market misconduct, contrary to s.277(1) of the SFO.
Dissemination of information
There was no dispute that Mr Left headed the research team who prepared the Report and had authorized its dissemination on the Internet, by giving the relevant instructions. He had therefore published the Report and thereby disseminated the information.
Likely effect on the market
The Tribunal made it clear that the test was a predictive, objective test, namely the Tribunal was required to ask itself not whether the posting of the Report on the Internet did have an impact on the Hong Kong market by inducing the sale or purchase of Evergrande shares, but instead was required to determine whether, having regard to all relevant factors, it was probable at the time when the Report was posted that it would have such an effect.
The Tribunal concluded that, even without any form of promotion, it was likely - indeed almost inevitable - that the Report would have become known to the Hong Kong market within a very short time of its publication. Citron Research had established a certain reputation for itself, with a degree of notoriety, and was therefore likely to be given attention, especially given the sensationalist language used in the Report.
Citron Research had an easily ascertainable, somewhat unnerving, reputation, the Tribunal said, and the Report was a substantial document, filled with data, graphs, lists and the like. The allegations contained in it were direct and combative and of utmost seriousness and, whether on more careful analysis, it proved to have no substance, it must on any initial reading have been a disturbing document and one quite capable – even if over a limited period of time- of having an impact on the market.
Accordingly, the Tribunal had no difficulty in determining that the Report, when posted on the Internet, was very likely, within a matter of a few hours, to have a material impact on the trading in Evergrande shares on the Hong Kong market.
False or misleading information as to a material fact
The Tribunal explained that “false” means untrue, “misleading” means to cause an incorrect impression and misleading information means information that is inconsistent with the true state of affairs (ASIC v McLeod (2000) 34 ACSR 135) and “material fact” is a fact that is sufficiently significant to influence a reasonable person to take a course of action e.g. in the present case, to deal in Evergrande shares.
Counsel for Mr Left argued that in order to determine whether the information in the Report was misleading, required an enquiry into Evergrande’s true financial position and in turn demanded a review of its records and documents, so Mr Left sought production of the relevant company records and documents. On the other hand, Counsel for the SFC argued that the matter did not require examination of Evergrande’s primary documents and could be determined on the basis of what information was in the public domain at the time of the Report and it was based on that information that Mr Left’s culpability should be determined. The Tribunal agreed with the SFC and ruled that the only information available to Mr Left was information in the public domain which was the information he used as the basis for the Report.
The SFC chose to focus on two specified areas of the Report to demonstrate that it was false and/or misleading as to a material fact, namely the assertions that Evergrande had engaged in fraudulent accounting (presenting fraudulent information to the investing public) and that in reality Evergrande was insolvent. The Tribunal was satisfied that these core allegations were false and/or misleading as to material facts and displayed an ignorance of or disregard for, accountancy standards that Evergrande was obliged to follow.
Knowledge, recklessness or negligence
The Tribunal explained the tests involved in proving knowledge, recklessness or negligence and ruled in relation to each as follows.
The test as to knowledge was whether Mr Left knew when he published the Report that the information in question was false or misleading. The SFC conceded, and the Tribunal agreed, that actual knowledge on Mr Left’s part had not been established.
The test in respect of recklessness (which is subjective) was:
- When Mr Left published the Report, was he aware of the risk that the information in question was false or misleading?
- Was he further aware that in the circumstances the risk was of such substance that it was unreasonable to ignore it?
- Did he nevertheless, although aware of (a) and (b) above, go ahead and publish it?
The Tribunal found that Mr Left had been reckless in his publication of the Report. The fact that Mr Left had many years of experience in publishing corporate commentaries, seemingly specializing in hunting down corporate fraud, meant that he must have appreciated that anonymous reports of this kind making allegations of fraud, payment of bribes and other illegal dealings required careful scrutiny.
The Tribunal had no difficulty in concluding that when Mr Left published the Report he consciously disregarded the real risk that the Report, even after his amendments, was false and misleading as to material facts. In this regard, what could not be ignored, the Tribunal said, was that the allegations contained in the Draft were based on a supposed understanding of the relevant accounting regulations and standards, these being of some complexity, and in important respects, particular to Hong Kong. Yet, Mr Left when conducting his verification exercise, chose not to take the most obvious precaution of seeking expert advice. Nor did he approach Evergrande for clarification of those matters. He went ahead without such advice while still retaining the sensationalist language of the Draft, language that of itself, he must have appreciated would cause a degree of consternation among members of the investing public.
Counsel for Mr Left argued that negligence was not properly to be read as applying to all persons but only to those persons who, by their actions, had an existing duty and a standard of care to meet and it had to be demonstrated that the person stood in or had assumed a special relationship to the market, e.g., a director of a listed company or a licensed analyst. The Tribunal rejected such an interpretation and held that the section imposes a duty of care on all persons who choose to disseminate information that is likely to have an impact on the market and the duty of care is owed to the market.
The test in respect of negligence (which is objective) was in compiling and publishing the Report, did Mr Left exercise that level of care to avoid the inclusion of false or misleading information as to material facts that is realistically required of a reasonably prudent person carrying out the function of a market commentator or analyst? For the same reasons as above, the Tribunal found that Mr Left had been negligent.
On 19 October 2016, the MMT made a cold shoulder order against Mr Left that he be banned from trading securities in Hong Kong for the maximum period of five years, a cease and desist order and a disgorgement order that Mr Left is to return the profit of HK$1,596,240 from shorting shares of Evergrande and to pay the SFC’s investigation and legal costs.
As the Tribunal emphasised in its ruling, the purpose of s.277(1) is to protect the investing public by ensuring that information placed before it is not false or misleading to a material fact. It can be readily appreciated that if a person who disseminated information has knowledge (or is reckless, which is tantamount to knowledge in most cases) as to whether the information is false or misleading as to a material fact, then he should be found liable under s.277(1).
In relation to “negligent” dissemination, The Tribunal held that s.277(1) imposes a duty of care on all persons who choose to disseminate, or be concerned in the dissemination of, information that is likely to have an impact on the market and that duty of care is owed to the market.
However, the “negligence” aspect of the section (which does not depend on knowledge and is an objective test and standard) may potentially cast a net which is wide enough to catch genuine stock commentaries in relation to listed companies (especially those listed companies which are known to be notoriously problematic) which are subsequently found to have contained false or misleading statements.
This is the second case, after Moody’s case, which has impacted on the way commentaries can be made against listed companies. These two cases will likely make market commentators and analysts think and write carefully and act prudently when publishing commentaries against listed companies.
The Tribunal said that the right of freedom of expression is not an absolute right and referred to journalists as an example. It appears that the Tribunal was referring to the law of defamation as affecting the right of freedom of expression. However, the law of defamation has a defence of “fair comment” to protect the defendant against defamatory statements but by analogy the same is not present in s.277(1) of the SFO. Potentially and in one sense, s.277(1) will affect the right of freedom of expression more than the law of defamation does. It remains to be seen as to how the content and the scope of the duty of care (which is owed to the market) and its standard are to be developed in future cases.