On 26 November 2015, the Market Misconduct Tribunal (MMT) ruled that three former executives of Asia Telemedia Ltd (ATML) had not engaged in insider dealing in ATML shares. The case is interesting, as it appears to be the first recent case in which the defence of “no profit motive” under section 271(3) of the Securities and Futures Ordinance (SFO) has been successfully made out.
In around 2002, ATML (then called Mansion House Group) became indebted to one Liu Lien Lien (Madam Liu) by some HK$58 million, which was ATML’s largest debt. ATML had a negative net asset value for a number of years and its only “value” was the value of the listed shell. During the period from July 2002 to May 2006, Madam Liu served 5 statutory demands on ATML, none of which were followed up by legal proceedings and instead resulted in new payment arrangements being made.
On 1 February 2007, Madam Liu assigned the debt to Goodpine Limited by Deed of Assignment (Assignment) for a consideration of HK$25 million. On 5 February 2007, Goodpine’s solicitors sent a notice of the Assignment, together with a demand for payment, to ATML’s solicitors.
Between February and May 2007, the share price of AMTL suddenly surged from around HK$0.2 per share in mid-February to its peak of HK$0.97 per share in May 2007, apparently due to the fact that as a result of an increasing integration of the Mainland and Hong Kong securities markets, market attention was drawn to “small cap” stocks engaged in securities business, of which ATML was one.
Between 26 February 2007 and 5 June 2007, the former Chairman and three executives sold their ATML shares by exercising their share options. On the sale of shares, the three executives made a total net profit of HK$12.2 million.
On 26 April 2007, Goodpine’s solicitors sent a statutory demand to ATML, demanding payment of the debt of over HK$70 million within 21 days. Offers of payment of HK$8 million were made in May 2007 by ATML, but no reply was received from Goodpine’s solicitors.
On 6 June 2007, Goodpine served a winding-up petition on ATML. The following day, ATML’s shares were suspended from trading before the market opened. The closing price on 6 June 2007 was HK$0.83. On 15 June 2007, ATML announced that it had been served with a winding-up petition by Goodpine. Trading remained suspended until 18 October 2007, when on resumption of trading, the share price dropped 62% to HK$0.315.
In short, the SFC’s case was that the Chairman and three executives had engaged in insider dealing because each of them sold the shares after knowing of the notice of Assignment sent to ATML on 5 February 2007 and the service of the statutory demand on ATML on 26 April 2007, but before the announcement of the winding-up petition and the whole matter was made public on 15 June 2007.
Due to acute illness, the former Chairman had not attended the hearing before the MMT. The MMT ruled that since he was not able to give instructions for his defence, he had not therefore been given a reasonable opportunity to be heard. The MMT was not therefore able to decide whether the former Chairman had engaged in insider dealing.
Not surprisingly, the MMT found that the Assignment, the letter of demand and the consequent statutory demand constituted price sensitive information and that two of the executives knew that the information was price sensitive when they dealt with the shares. However, the MMT found that the two executives had made out the defence of “no profit motive” under s.271(3) of the SFO. In relation to the third executive, who occupied a more junior position than the other two and was essentially an outsider, the MMT found that she did not know that the information was price sensitive. Section 271(3) provides a defence where a person, having dealt in the shares of a listed company when knowingly in possession of price sensitive information, can establish, on a balance of probabilities, that when he dealt, “the purpose for which he dealt … was not, or where there was more than one purpose, the purposes did not include, the purpose of securing or increasing a profit or avoiding or reducing a loss.” In other words, the person had no desire to make a profit or avoid a loss by the use of that price sensitive information.
The MMT said that it is not sufficient to establish that the price sensitive information was only a subsidiary motivating factor, it must be established that it was not in any way a causative factor.
The two executives both asserted that their sole motivation for selling their shares was the sudden and unexpected surge in the share price and they believed that the matter would be dealt with behind closed doors and would not become known to the public. The MMT accepted their explanations.
In coming to this conclusion that the sole motivation was to seize a sudden and unexpected surge in the price of the shares, it appears that the MMT was influenced by the following factors:
- The three executives had relatively modest salaries and the sudden surge in the share price was a chance of a lifetime to profit from the windfall. To use the MMT’s words, it was “to take his share of manna found on the desert floor.”
- There were other employees of the company, both in Hong Kong and in the Mainland, who were probably not aware of the price sensitive information and who exercised their share options and sold the shares during the period of the sudden surge in the share price.
- There had previously been numerous statutory demands served on ATML by Madam Liu, all of which had resulted in some sort of negotiation and new repayment terms.
- The executives did not sell their shares all in one go or in one or two days before the expiry of the deadline for complying with the statutory demand; they sold over a period time. In the case of one of the executives, even though he was granted an option to acquire 8 million shares, he chose to exercise his options in respect of 6 million only, leaving 2 million to be dealt with at a later stage.
Note of Caution by the MMT
In coming to this conclusion, the MMT was conscious of the fact that some may find its decision morally unappealing and question how an executive director of a listed company could still deal in the shares without being found liable for insider dealing, simply because he thought that the damaging information would remain confidential and the company’s problem would be resolved.
The MMT said that this may explain why some academic commentators have expressed the view that the s.271(3) defence should be limited to occasions when a person was compelled to deal or had no choice to deal, a limitation that has been disapproved in Hong Kong. In Henry Tai Hon Leung v Insider Dealing Tribunal, CACV 333/2004 at paragraph 28, the Court of Appeal, in interpreting the predecessor provision of s.271(3) said that compulsion to deal was not a test for this defence.1
The MMT justified its decision on two bases:
- The mischief to be avoided is the use of confidential information to “steal a march” on ordinary investors. If, however, the confidential information has not been used in that manner, then there has been no mischief.
- There is no risk of the floodgates being opened because only in rare circumstances will a person who deals in shares in a listed company while in possession of price sensitive information, be able to demonstrate that his dealing was totally unconnected with any desire to avoid a loss or make a profit.
While case law has established that in order to successfully make out a defence of “no profit motive” to insider dealing, there is no need to prove that the person was compelled to deal or had no choice to deal, as the MMT has pointed out, only in rare circumstances will a person who deals in shares in a listed company while in possession of price sensitive information be able to demonstrate that the dealing was totally unconnected with any desire to make a profit or avoid a loss. It is not sufficient to establish that the price sensitive information was only a subsidiary motivating factor- it must be established that it was not in any way a causative factor. This defence is bound to be fact sensitive. On the special facts of this case, the former executives of ATML were able to successfully make out this defence.