Hong Kong Regulatory Newsletter
October 2013
IN THIS ISSUE:
FEATURE ARTICLES
LIABILITY FOR INSIDER DEALING NOT CONTINGENT ON PROOF THAT “INSIDE INFORMATION” RECEIVED FROM AN IDENTIFIED CONNECTED PERSON 1
SFAT REVERSES DISCIPLINARY DECISION BY SFC 1
COLUMNS
REGULATORY STANDARDS/ UPDATES 2
SIGNIFICANT ENFORCEMENT ACTIONS 5
Sidley Austin Hong Kong is pleased to distribute its inaugural issue of the “Hong Kong Regulatory” newsletter. This publication will provide updates on the latest developments in regulation of the Hong Kong financial markets, analyses of current enforcement trends and new laws/regulations, as well as practical tips for market participants.
FEATURE ARTICLES
LIABILITY FOR INSIDER DEALING NOT CONTINGENT ON PROOF THAT “INSIDE INFORMATION” RECEIVED FROM AN IDENTIFIED CONNECTED PERSON
On May 10, 2013, the Market Misconduct Tribunal (MMT) in Hong Kong, the statutory tribunal established to adjudicate civil contraventions of the Securities and Futures Ordinance (Cap. 571) (SFO), held that the lack of any
evidential basis that “relevant information” (now renamed “inside information” after Part XIVA became operative on 1 January 2013) was received from a “connected person” (more commonly known as an insider) is not fatal to market misconduct proceedings. Rather, the MMT is justified in drawing adverse inferences that price sensitive information not generally known to the market originated from an insider even though the identity of the insider was unknown: see MMT report re China Huiyuan Juice Group Limited (“Huiyuan”).
CONTINUED ON PAGE 2
SFAT REVERSES DISCIPLINARY DECISION BY SFC
In Hong Kong, on May 20, 2013, the Securities and Futures Appeals Tribunal (SFAT), being the statutory watchdog that reviews regulatory, as well as disciplinary decisions made by the Securities and Futures Commission (SFC), reversed the SFC’s decision to publicly reprimand Christian Denk, a former derivative trader, for hedging activities1.
This landmark decision is the first occasion since the SFAT’s establishment more than a decade ago that the SFAT has reversed a disciplinary decision by the SFC on both culpability and penalty. The SFAT has heard 54 reviews since its inception in April 2003, found in favor of the SFC in 43 cases and allowed appeals against penalty only in 18 cases2.
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1 Christian Denk v SFC (SFAT No. 2/2012) (per Hartmann JA). The SFC initially proposed 9 month suspen- sion, which was later reduced to a sanction of a public reprimand plus fine of HK$1.1 million (after making representations), and eventually commuted to a public reprimand only.
2 “Assessing the effectiveness of HK’s Securities & Futures Appeals Tribunal - Ten years after its creation, has Hong Kong’s Securities & Futures Appeals Tribunal proved an effective review panel?” IFLR, February 2013 (by Sidley Austin partner Alan Linning and associate Dominic James in Hong Kong)
CONTINUED ON PAGE 4
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LIABILITY FOR INSIDER DEALING NOT CONTINGENT ON PROOF THAT “INSIDE INFORMATION” RECEIVED FROM AN IDENTIFIED CONNECTED PERSON
CONT. FROM PAGE 1
COLUMNS: REGULATORY STANDARDS UPDATES 2013
New statutory disclosure regime
Huiyuan was a major P.R.C. based producer of fruit drinks listed in Hong Kong.
In September 2008, after a sustained lack-luster performance, it publicly announced to the market that it would be acquired by Coca-Cola. Ms Sun Min (Min), a shipping magnate, bought in excess of 8 million shares on six separate occasions through three different brokerages and four different companies ahead of the announcement. She later sold the entire share holding within 48 hours of the take-over offer being made public to net a profit in excess of HK$55 million. Min denied having any knowledge about the take-over offer whether through rumor or otherwise and insisted the decision to purchase was part of
a “bottom feeding” trading strategy. Although she had close connections within the management of Huiyuan, there was no direct evidence that she received price sensitive information about the take-over from any insider. Rather the case hinged on circumstantial evidence and the drawing of inferences from ‘cryptic’ handwritten notes contained in a diary kept by Min’s secretary, recording what was alleged to be specific information about the take-over negotiations.
To constitute market misconduct, “inside information” must be received from a person “connected with the corporation”
For the purposes of MMT proceedings, a “connected” person is broadly defined in section 247 of the SFO to include all those persons who may receive confidential, price-sensitive information by reason of their relationship with
a company. The MMT stated that if the information in the diary (which did not identify the bidding company in the negotiations) had come from any of the following class (or classes) of persons it would have come from a “connected” person:
• a director, employee or officer of Huiyuan;
• an officer of any subsidiary or related company;
• a substantial shareholder of Huiyuan or a related company; or
• a person occupying a position which may reasonably be expected to give him access to confidential price-sensitive information by virtue of a professional or business relationship with Huiyuan or any of its related companies. In respect of the takeover negotiations, this last category would include a member of the professional parties advising Huiyuan, namely its investment bankers, bankers, business advisers, solicitors and accountants.
Circumstantial evidence and adverse inferences that source of information originated from an insider
There was no direct evidence that Min knew of the information in the diary or received it from any connected person identified by the SFC. Min made no
admission of knowledge while her secretary had no recollection of receiving the information from some third party or passing it onto her employer. The only evidence that Min had such knowledge was circumstantial and to be inferred from the specific nature of the information in the diary.
May 2012/13: The Securities and Futures Ordinance (SFO) was amended to give statutory backing to the requirement for listed corporations to promptly disclose price sensitive information. It also empowers the SFC to bring civil proceedings for alleged contraventions before the Market Misconduct Tribunal directly, including in relation to the existing six types of market misconduct under the SFO.
More recently, Ashley Alder (CEO, SFC) stated publicly that it is no excuse for directors or officers of listed companies to fail to promptly disclose price sensitive information in a timely fashion because they had not yet obtained/were in the process of seeking legal advice.
OTC derivatives
September 2013: The SFC/HKMA published a consultation conclusions paper on the regulation of the over- the-counter (OTC) derivatives market and also supplemental consultation paper to regulate persons who serve as intermediaries (i.e. as dealers, advisers or clearing agents) in the OTC derivatives market or act as systemically important players (SIPs), i.e. players in Hong Kong who are not licensed or registered with either the HKMA or SFC, but whose positions and activities in the OTC derivatives market may raise concerns of potential systemic risk in July 2012.
On June 28, 2013, a draft Bill with the formal wording for the proposed changes was tabled to LegCo. SFC released conclusions on further proposals for regulating OTC derivatives market on September 6, 2013. The revised proposals have been incorporated into the relevant Bill, and the SFC/HKMA plan to conduct a public consultation later this year.
In such circumstances, the MMT ruled that:
“If the identity of the person (or persons) who passed the information cannot be ascertained, the issue, to be determined is whether, on a consideration of all the evidence, a compelling inference could be drawn that the source of the information must have been an unidentified “connected” person and that Min must have known of that fact. (per Hartmann JA)
Thus, provided the information was specific enough, the MMT held it could infer that it originated from an insider even though the identity of the insider was unknown. Although the information contained in the diary was not exhaustive, it was sufficiently specific and accurate that:
“[it] could not have been obtained…on the tail of a rumor or from some unconnected financial adviser. It must have come from somebody close to the negotiations, somebody therefore, either as a company officer, a substantial shareholder or a professional adviser who was a connected person. In our judgment, that is the single, compelling inference that must be drawn.” (per Hartmann JA)
Put simply, at any earlier or later time of the year, there would have been no basis in fact (or rumor) upon which the information in the diary could have contained the details it did about the takeover negotiations.
Working assumption that price sensitive information will be passed on without delay
The MMT also stated that, in its judgment, an examination of the structure and wording of the entries made in the diary gave rise to a compelling inference that the information must have come from Min or, if not, that Min must have known of the information but added:
“If however, as to who first came to know of the information, it should be held that it is reasonably possible that [the secretary] herself first came to know of it, we reject any suggestion that she may have failed for some unstated reason to pass it on to [Min] and to do so without delay.”
This was because the MMT took the view that price sensitive information will in the usual course of events be passed on without delay, absent any impediment or explanation preventing a secretary from passing on such vital information. The MMT therefore rejected the testimony of the secretary that the information contained in the diary originated from a forgotten contact, for forgotten reason and that she had neglected to pass it on by way of pure oversight.
Diaries are (generally) not used as notebooks
The MMT also had no hesitation in rejecting the absolute assertion made by the secretary that the diary was used solely as a notebook and that the entries made therein did not correspond to any specific timeframe. The MMT reached the view that this assertion was “plainly tactical, her intention being twofold; first, to sever any connection between the dates when the entries were made
with the almost contemporaneous events that were taking place in respect of the takeover of Huiyuan and, second, to cast the entries adrift from the dates when the purchase of shares in Huiyuan commenced.”
COLUMNS: REGULATORY STANDARDS UPDATES 2013
IPO sponsor liability
October 2013: The SFC published its consultation conclusions on the regulation of IPO sponsors. The new regime will become effective on October 1, 2013. The amendments to the Corporate Finance Adviser Code of Conduct (CFA Code) and the Additional Fit and Proper Guidelines for Corporations and Authorized Financial Institutions applying or continuing to act as Sponsors and Compliance Advisers (Sponsor Guidelines) will also become effective on the same day. A sponsor which submits a listing application on or after October 1, 2013 is required to comply with the Provisions.
Electronic trading
March 2013: A consultation paper with new rules to regulate electronic / algorithmic / high-frequency trading was published. The new regime (together with revisions to the Code) will come into effect on January 1, 2014.
New Professional Investor Regime September 2013: The SFC published
a 3-month consultation paper to amend the professional investor regime to:
(i) declassify or raise the minimum asset requirements of high net worth individual investors from being regarded as professional investors under the Professional Investor Rules; (ii) preserve the current classification of professional investors who are corporations subject to licensed persons accessing suitability; and (iii) re-write client agreements so as to give contractual effect to the Suitability Requirements in the Code of Conduct. The reforms do not affect institutional investors, but represent a significant shift onto advisers and away from individual choice, responsibility, caveat emptor. If implemented, banks/ intermediaries selling investment products to any individual must comply with the Suitability Requirements in the
Hong Kong Regulatory Newsletter
No inference from steps taken to disguise the form of trading
The MMT did however conclude that (on the evidence) it was not possible to draw any adverse inference from the fact that Min used several different
companies to trade in the same shares and employed the services of different brokers. Even though the MMT accepted that this could be described as a disguised form of trading, there was no evidence that such practice was an unusual one or used for illegitimate purposes. It was entirely consistent with Min’s historic trading patterns having regard to the volume of trading.
Conclusion
The whole of the SFC’s case against Min relied upon adverse inferences to be drawn from apparently suspicious trading activity absent any direct evidence that price sensitive information was personally known to Min, or that such information was disclosed from an insider. The law relating to the approach to be taken to inferences of fact is clear, and is set out in Lee Ming Tee and Nina Wang, namely that when dealing with allegations of impropriety, findings of wrongdoing cannot be reached by conjecture nor on a mere balance of probabilities, but from proved facts. Although the MMT in Huiyuan accepted this approach is to be taken in cases involving alleged serious misconduct,
including insider dealing cases before the MMT, it is clear that failure by the SFC
COLUMNS: REGULATORY STANDARDS UPDATES 2013
Code and cannot rely on any term(s) in client agreements that exclude such requirements (or limit liability), potentially banning execution-only agreements.
Short selling – sale of placing shares prior to completion of a placement is illegal
August 2013: The SFC has warned that market participants could face criminal prosecution for illegal short selling if they sell placing shares before completion of a placement. Placees should not rely on assurances (verbal or written) given by a placing agent about an expected allocation prior to a placement becoming unconditional.
to establish a factual basis that “inside information” was in fact received from a connected person is not fatal in the context of MMT proceedings. In contrast, last year, the High Court struck-out an insider dealing claim brought by the SFC in the context of a take-over as speculative, applying the civil standard of proof: see SFC v SSCP Holdings (Hong Kong) Ltd & Ors [2012] HKCFI 1372. For the time being, it seems clear that the SFC are entitled to invite the MMT to draw adverse inferences to establish market misconduct based on alleged connections to unknown third parties not involved in the proceedings and in respect of which no claim is pursued.
SFAT REVERSES DISCIPLINARY DECISION BY SFC
The SFC alleged that Denk negligently inputted large sell orders for certain stock during the final few seconds of the Closing Auction Session (CAS3) at prices significantly away from the normal price at the opening session. The SFC’s investigation did not find any manipulation. However, the SFC considered the size of Denk’s sell orders in the last seconds of the CAS system was likely to create undue volatility in the closing price of the shares.
No duty to avoid moving the market downwards
Although the SFC accepted the trading was done for genuine legitimate hedging purposes, it argued Denk had been negligent because, as an experienced trader, he ought to have known that the size of his orders would likely move the share price in view of the market liquidity in the circumstances. The SFC therefore considered that Denk should have managed his hedging requirements well before the market closed and argued such conduct breached a traders’ obligations under the Code of Conduct (General Principle 2) to act with due skill, care and diligence, in the best interests of market integrity.
In its written reasons, the SFAT commented on the inherent instability of the CAS system which meant, amongst other things, that Denk was unable to view the order depth when placing his sell orders and added in relation to the standard of care expected of a trader that :
“The requirement imposed on a trader to act with due skill, care and diligence in the best interests of his employer and the integrity of the market does not require him to be proved correct on all occasions by looking to the results of his actions. Traders, such as the applicant, must exercise judgement in difficult and pressing circumstances; they must act as they see matters, doing so in the light of their experience and skill. The fact that the market may act against them is not of itself evidence that they have
failed to act with due skill, care and diligence. Nor is the fact that, with the benefit of hindsight, it may be said that they could have adopted a safer tactic.” (per Hartmann JA)
3 CAS was in operation since May 2008 until it was shut down at the end of March 2009 due to its inherent instability.
It was also accepted that Denk (and traders alike) have no duty to avoid moving the market downwards. In particular, this meant that:
“…If, in order to protect the best interests of his employer, it was necessary to put in sell orders that would result in a decline in the share price then so be it. His duty under the Code of Conduct was simply to ensure that the integrity of the market was not undermined, in short that there was no artificial distortion of the market.” (per Hartmann JA)
In this case the SFAT was persuaded, on the evidence (although closely balanced), that Denk had exercised his judgment on the data available to him at the time. He could not be responsible for the inherent instability of the CAS system or for the impact of information he could not see at the time. The SFAT accepted that Denk did in fact pay sufficient heed to the risk of undermining the integrity of the market in acting as he did based on his skill and experience which had on 29 previous occasions ensured that his sell orders were met without volatility that attracted criticism from the regulators.
Standard and burden of proof in disciplinary cases
In addition, the SFAT also confirmed that a more flexible standard of proof ought to be adopted by the SFC in disciplinary cases commensurate with the gravity of the charge. Although not criminal in nature, the SFAT took the view that disciplinary proceedings may give rise to charges which would also found serious criminal charges. In such instances, it would be appropriate for the SFC to apply a criminal or equivalent standard verging on proof beyond a reasonable doubt.
Here the SFAT considered that something more than the usual civil scale ought to apply. This was because the reputation (and career prospects) of a professional person or trader should not be lightly destroyed by a charge of negligence that applies a standard of proof no higher than the balance of probabilities.
Conclusion
It remains to be seen in the years ahead whether the SFAT’s decision in Denk’s case will influence the SFC’s behavior in reaching disciplinary decisions. Hitherto, the SFC’s desire to set regulatory standards for the industry as a whole has historically assumed greater importance than mitigating factors, which had less resonance.
In June 2011, in Tsien, an aggrieved party appealed to the CA on the proper role and function of the SFAT when reviewing SFC decisions. The CA confirmed, for the first time, that SFAT hearings are to be conducted afresh on the basis of a complete review of the merits. The CA noted that SFC decisions should not be afforded undue “respect,” particularly in light of its often self-fulfilling role as investigator, prosecutor, jury and judge.
SIGNIFICANT ENFORCEMENT ACTIONS IN 2013 TO DATE
Sponsor liability
The SFC revoked Mega Capital (Asia) Company Ltd’s licence to advise on corporate finance and fined it HK$42 million for failing to discharge its sponsor duties when it acted as the sole sponsor in the listing application of Hontex in 2009. This represents the biggest fine imposed for sponsor failures to date.
Internal control failures
• The securities trading arms of a number of European HQ’d investment banks were reprimanded and fined HK$1.6 million, HK$1.6 million and HK$2.5 million for regulatory breaches and internal control failings relating to position limit failures.
• A privately held specialist asset management company was reprimanded and fined HK$1.5 million for regulatory breaches and internal control failures concerning a large number of short-selling input errors.
Life bans
Life bans were imposed on five licensed representatives in 2012/13:
• They were banned for life for fraud and misappropriation of client assets.
• One was banned after being convicted of conspiracy to defraud in relation to trading of warrants.
• Du Jun (a former trader of a U.S.-based investment bank) was banned for life for insider dealing.
SIGNIFICANT ENFORCEMENT ACTIONS IN 2013 TO DATE
s.183 Notices – power to compel production of audit papers for investigation subject to state secrets
In August 2012, the SFC brought proceedings against a global accountancy firm to compel it to disclose its audit working papers in response to s.183 notices relating to its work as the reporting accountant and auditor in the intended listing application (Standard Water Ltd). The accountancy firm resigned as auditor after it discovered undisclosed accounting irregularities. It has argued it has a reasonable excuse to refuse to comply with the notices because (among others) the audit working papers cannot be lawfully produced to the SFC without contravening various restrictions under P.R.C. law, including laws restricting the transfer of state secrets and archives outside China without the approval of P.R.C. authorities. The trial concluded in August 2013, and written judgment was reserved to be handed down at a later date.
Section 213 - Civil actions for remedial orders
On May 10, 2013, the Court of Final Appeal (CFA) handed down its written decision in Tiger Asia ruling that the civil courts have jurisdiction to grant final remedial orders for suspected market misconduct without there being any prior determination of misconduct by the criminal courts or Market Misconduct Tribunal (MMT). On July 11, 2013, the SFC commenced parallel proceedings before the MMT.
Sidley garnered two awards in Dispute Resolution and Regulatory/Compliance in 2013:
International Firm of the Year for Dispute Resolution, China Law & Practice
Firm of the Year for China Regulatory/Compliance, Asian-MENA Counsel
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