On 31 March 2016, the Securities and Futures Appeals Tribunal (SFAT) upheld the SFC’s disciplinary action against Moody’s Investors Service Hong Kong Ltd (Moody’s). This is a landmark decision, as it is the first such action against a credit ratings agency, since the activities of such became regulated by the SFC on 1 June 2011. In addition, this case is noteworthy because the legal principles in relation to the oft-overlooked aspect of false or misleading statements – i.e. statements may be false or misleading when looked at as a whole even if each individual statement is not – are considered and applied by a Hong Kong tribunal. This case will likely have wider application, in particular, in circumstances where there is a statutory obligation not to provide false or misleading statements, e.g., issuing announcements, submitting documents to regulatory authorities and the market misconduct provision of prohibition of dissemination of false or misleading information to induce transactions.
On 11 July 2011, Moody’s (part of the global, world leading credit rating agency) published a report entitled “Red Flags for Emerging-Markets Companies: A Focus on China” (Report), which was distributed to subscribers and available for purchase by the general public on Moody’s website.
In the Report, Moody’s assessed 61 Mainland corporates and assigned red flags to them, each red flag representing an element of potential credit risk. The Report referred to six companies that had been allocated the greatest number of red flags as “negative outliers”.
The Report contained a qualification which stated that an issuer’s tripping of many red flags does not represent an immediate rating concern because Moody’s ratings already reflect many of the issues highlighted by the relevant red flags and the ratings also incorporate more than just the potential concerns that the flags capture. Moreover, there is only limited correlation between lower ratings and a higher number of red flags tripped. The red flags were said to be supplemental to Moody’s existing ratings.
When published, the Report received extensive local and international media attention and had a material impact on the market. A day after publication, the share price of more than half of the corporates red-flagged in the Report experienced substantial falls. Four of the six corporates named as “negative outliers” suffered the biggest drops.
In light of the impact that the Report had on the market, the SFC launched an inquiry and determined that Moody’s had failed to meet the expected standards and comply with practices expected of a licensed corporation in its preparation and publication of the Report. The SFC found that Moody’s had failed to have the required procedural safeguards in place to ensure the integrity of the Report and that the Report itself was in a number of material aspects misleading, confusing and inaccurate, to the extent that it would likely be prejudicial to the interests of the investing public, including Moody’s own clients, and also prejudicial to the integrity of the market.
The SFC determined that Moody’s should be subject to a public reprimand and pecuniary penalty of HK$23 million.
Moody’s applied to the SFAT for a review of the SFC’s decision.
Moody’s argued that the preparation and publication of the Report was not a regulated activity in respect of which it was licensed, as it was not part of its ratings services; and that the Code of Conduct therefore did not apply.
Credit rating is defined in the SFO as meaning “opinions, expressed using a defined rankings system, primarily regarding the credit worthiness…”
The SFAT had no difficulty in concluding that, whether intended or not, the red flag framework constituted a well-defined system or mechanism for judging levels of credit risk and, as such, constituted a credit rating, meaning that the preparation and publication of the Report was a regulated activity.
Moody’s did not really dispute the facts as found by the SFC but disagreed with the conclusions arrived at by the SFC. In Moody’s words, the red flags were no more than “an interesting screen to identify potential areas of concern for follow-up and closer scrutiny”.
The SFAT, in considering whether the Report was unfair, unclear or misleading, set out the following general approach:
- The Tribunal is entitled to look at the document as a whole in order to see what it means taken together. In support, the SFAT cited Aaron’s Reef v Twiss  AC 273 at 281 in which it was said that “If by a number of statements you intentionally give a false impression and induce a person to act upon it, it is not the less false, although if one takes each statement by itself there may be a difficulty in showing that any specific statement is untrue.”
- The Tribunal is entitled to consider not only what is stated within the document but what may be implied or omitted. The damage may lie in the impression conveyed. In support, the SFAT cited:
- R v Kylsant  1 KB 442 at 448 in which it was said that “…this prospectus was false in a material particular in that it conveyed a false impression. The falsehood in this case consisted in putting before intending investors, as material on which they could exercise their judgment as to the position of the company, figures which apparently disclosed the existing position, but in fact hid it.”
- Fraser and Another v NRMA Holdings Ltd and Others (1995) 15 ACSR 590 in which it was said that: “…the combination of what is said and what is left unsaid may, depending on the full circumstances, be likely to mislead or deceive.”
While the SFAT acknowledged that there was no dishonesty on the part of Moody’s, the SFAT upheld (most but not all of) the SFC’s decision that Moody’s had breached General Principles 1 (acting honestly, fairly and in the best interests of clients and integrity of market) and 2 (acting with due skill, care and diligence in the best interests of clients and the integrity of market) of the Code of Conduct, finding that:-
- The Report clearly intended to give the message that the greater the number of red flags, the greater the need on the part of market participants for scrutiny.
- There was a fundamental contradiction in the Report. On the one hand, the Report gave the impression that the greater the number of red flags, the greater the credit risk; on the other hand, the Report stated that there was no significant correlation between the number of red flags and the level of credit risk.
- There was a failure in clear and unambiguous terms to set out in the Report the true nature and purpose of the red flag framework.
- Whatever qualifications were made in the Report, the evidence indicated that the market understood the red flag framework as providing some form of ranking system of credit risk and acted accordingly. The impact on the companies classified as negative outliers was unambiguous – their share prices dropped.
- In its failure to provide commentary on all of the red flags, Moody’s not only made it impossible for readers to accurately assess the significance of the flags in context but, created an unfair, unclear and misleading picture of the creditworthiness of a material number of the companies allocated red flags.
- Errors contained in the report (which related to either wrongly assigning a red flag or failing to do so) were of consequence. Moody’s, holding a special place in the market, must have appreciated that its publication would be followed carefully. There was, therefore, an increased need for accuracy.
The SFAT decided that a public reprimand was appropriate and reduced the amount of fine to HK$11 million.
Commentary – What Constitutes “Misleading Statements”?
This case is noteworthy because the legal principles in relation to the oft-overlooked aspect of misleading statements – i.e. statements may be false or misleading when looked at as a whole even if each individual statement is not - are considered and applied by a Hong Kong tribunal.
Moody’s argued that the qualifications placed in the Report would do away with any potential grounds for inadvertently misleading the market. The SFC was of the view that the qualifications were not of sufficient weight to address the seriously negative connotations in labelling the companies as negative outliers. In essence, the SFAT agreed with the SFC’s view; in particular, the SFAT held that “The result, however, especially as the description was used as a form of headline, was more damning than perhaps was intended and, in the view of the Tribunal, would have acted to push nuanced qualifications to one side.” (para. 186).
This case will likely have wider application, in particular, in circumstances where there is a statutory obligation not to provide false or misleading statements, e.g., issuing announcements, submitting documents to regulatory authorities and the market misconduct provision of prohibition of dissemination of false or misleading information to induce transactions.
Listed companies should pay attention to the drafting of announcements, i.e. they must not only ensure that each and every statement in the announcement is true, but must also consider whether any material information has been omitted from the announcement, whether any disclaimers or qualifications are prominent enough and their contents not diluted or, to use the SFAT’s words, “pushed to one side”, such as to make the whole announcement misleading. Ultimately, the guiding principle is that when the announcement is read as a whole, whether it would create, expressly or impliedly, any misleading representation or impression.
At the time of writing, it is reported that Moody’s will appeal against the SFAT’s decision to the Court of Appeal. It remains to be seen if further guidance and clarification will be given by the Court of Appeal.