On 12 October 2018, the Court of Final Appeal (CFA) found former executives of a listed company, Asia TeleMedia Limited (ATML) culpable for insider dealing. The majority four to one decision examines the "innocent purpose" defence which is frequently relied on by insider dealers. In doing so, it discusses the meaning of the 'use' of insider information in the context of Section 271(3) of the Securities and Futures Ordinance (SFO) and reiterates Hong Kong's firm stance against market misconduct behaviours.
Setting the scene
The SFC had constituted a market misconduct tribunal (MMT) to investigate dealings in ATML's shares between February and June 2007. Yiu Hoi Ying Charles (Charles), ATML's Director of Finance and an executive director, and Wong Nam Marian (Marian), ATML's corporate secretary, were both investigated.
In the early 2000s, ATML was kept on what its auditors considered "life support" and owed an individual creditor, Madam Liu Lien Lien (Madam Liu) more than HK$83 million. In February 2007, Madam Liu assigned ATML's debt to a BVI company, Goodpine Limited (Goodpine) (the Assignment). Soon afterwards, Goodpine demanded full payment from ATML of the debt and threatened legal proceedings. In April 2007, Goodpine served a statutory demand on ATML seeking payment within 21 days (the Statutory Demand), failing which they would present a winding up petition. The Assignment, the demand for full payment, and the Statutory Demand were not publicly announced. In June 2007, Goodpine issued a winding-up petition against ATML. Trading in ATML's shares were suspended.
In the same period, the value of ATML's shares surged to an unprecedented high, and Marian and Charles exercised their share options between April and June 2007 (i.e. during the course of the demand for full payment, the Statutory Demand and up to the day just before the winding up petition was issued) to net profits of some HK$5 million each.
The MMT's findings
The MMT had no difficulty concluding that the Assignment and the Statutory Demand were insider information, being information which, if known to the public, would affect ATML's share prices. The MMT also concluded that the Assignment and the Statutory Demand were known to Charles and Marian, and all the elements for culpability of insider trading were established.
However, Charles and Marian were acquitted on the basis of Section 271(3) of the SFO, which provides that "a person shall not be regarded as having engaged in market misconduct…through his dealing in listed securities…if he establishes that the purpose for which he dealt in [them] was not for the purpose of securing or increasing a profit, by using relevant information." This is also known as the "innocent purpose" defence, where a person is able to point to evidence which demonstrates that they acted for a purpose which entirely excluded securing profits by using relevant information.
The MMT found that Charles and Marian were motivated to take advantage of the sudden surge in share price, and "quite literally the chance of a lifetime" to sell at an unprecedented price. In the MMT's words, "…it must be accepted on balance [that the] sole motivating factor [was] to take [their] share of manna found on the desert floor, that is, to profit from an unexpected speculative boom in the share price at the time…unconnected with any desire to avoid a loss by reason of the price sensitive information in possession." This was bolstered by Charles and Marian's argument that they believed that settlement of the debt would happen 'behind closed doors' and without the public ever knowing about it. The MMT was presented with evidence which led it to conclude that "…as it had been in the past with Madam Liu, the matter [of the debt] would somehow, however slow and muddled the process, be dealt with behind closed doors…and would not therefore become a matter to influence the market." The MMT acquitted Charles and Marian.
The Court of Appeal's findings
The SFC appealed the MMT's decision to the Court of Appeal (CA). The SFC argued:
- that Charles and Marian had 'used' inside information by withholding its disclosure in breach of their respective disclosure obligations and, at the same time, knowingly and directly profiting from falsely inflated share prices which they contributed to maintaining through non-disclosure. The CA rejected this, stating that this involved a strained interpretation of the word 'use' for the purposes of Section 271(3) and conflates the meaning of 'withhold' and 'use'; and
- that the MMT's findings that Charles and Marian believed settling the debt would be done behind closed doors was wrong. The CA rejected this too, stating the CA had no basis to interfere since it was impossible to say those findings were unsupported by evidence or plainly wrong.
The CA upheld the MMT's findings acquitting Charles and Marian.
The CFA's findings
The SFC appealed to the CFA with the key question of whether Charles and Marian were able to rely on Section 271(3). The burden is on the implicated person to prove, on a balance of probabilities, that his or her dealing with the relevant securities did not include the purpose of securing or increasing a profit (or avoiding or reducing a loss) by using inside information. The CFA found that:
- at the material time, Charles and Marian knew only too well that the prices at which they managed to sell their ATML shares were artificially high as a result of information that was not publicly known and this knowledge meant they were able to earn massive profits;
- it is possible to conclude that at least one of the purposes of their dealing in the shares included making gains by the use of the information they had; and
- by its very nature, all insider information is "behind closed doors" and the MMT's reliance on Charles and Marian's argument that the debt would have been settled without public knowledge is plainly wrong.
The CFA considered that, in the context of Section 271(3), "use" must refer to making one's decision to buy or sell listed securities because of the quoted market price, knowing that the price is either artificially high or low because the relevant information is not generally known to the market. By doing so, one is "employing the price sensitive information to one's own advantage in order to steal a march on the rest of the market" – and the word 'use' must be understood to mean the turning of the possession of inside knowledge into action.
Charles and Marian were culpable of insider dealing and not able to rely on the Section 273(1) defence.
Hong Kong and its courts have increasingly taken a staunch and unforgiving approach to market misconduct cases. In the words of Chief Justice Ma: "Insider dealing is an insidious activity that is detrimental to the reputation of any major financial centre." Hong Kong is no exception. Executives of listed companies would be wise to consult with legal professionals when price-sensitive information comes to light, especially when contemplating a simultaneous share sale.