Responding to SFC Enforcement Action: New Tactics?
November 23, 2007
By Timothy Loh and Howard Burchfield III
A recent decision of the Hong Kong Court of Appeal has raised the issue of whether disciplinary proceedings against licensed and registered persons are civil or criminal in nature. While a subsequent decision of the SFAT has ruled that such proceedings are civil, the current state of the law remains unsettled with at least the possibility of a higher standard of proof available in certain instances. In this article, we examine these developments, and more importantly, what the repercussions could be for licensed and registered persons who find themselves in the crosshairs of the SFC.
TIMOTHY LOH | Financial Services & Law Review
Vol. 1 (2007) at p. 9
The Securities and Futures Ordinance "SFO") establishes the
framework by which licensed or registered persons are regulated. Where they misconduct themselves, it
provides for them to be disciplined and, in some cases, subjected to criminal
proceedings or proceedings before the Market Misconduct Tribunal ("MMT").
Under this framework, disciplinary sanctions may be
imposed on licensed and registered persons for conduct which may also serve as
the subject of criminal offences. Perhaps more significantly, disciplinary sanctions in such cases may
exceed criminal sanctions, even though the legal rights afforded to defendants
in disciplinary proceedings are far fewer than those afforded in criminal proceedings.
In principle, this is wrong. Indeed, the recent decision of the
Court of Appeal in Koon Wing Yee v. Insider Dealing Tribunal suggests that legal rights afforded
to defendants in disciplinary proceedings may be more extensive than those
currently afforded to them.
THE KOON DECISION
In Koon, the Court of Appeal held that proceedings before the Insider Dealing Tribunal
("IDT") were criminal in nature even though the legislature had classified them as civil proceedings
under the now-repealed Securities (Insider Dealing) Ordinance. As a result, the targets of those IDT
proceedings were entitled to the protection of Articles 10 and 11 of the Hong Kong Bill of Rights ("HKBOR"), including the right against self-incrimination and the heightened criminal
standard of proof.
Consequences of Koon
The Koon decision opened up the possibility of litigation in relation to whether
enforcement proceedings designated by the legislature as civil can retain that classification or should now be regarded as criminal.
Challenges based on Koon
have been raised before both the MMT and the Securities and Futures Appeal
Tribunal ("SFAT "). Although those challenges were
rebuffed, with at least the MMT ruling now the subject of judicial review, they
offer guidance for how licensed and registered persons faced with disciplinary
proceedings under the SFO may proceed in the future.
The Three Criteria
Based on Koon,
3 factors determine whether proceedings are criminal or civil in nature:
- the characterization of the offense under domestic
law;
- the nature of the offense; and
- the nature and degree of severity of the penalty.
The Characterization of the Offense
The SFO classifies disciplinary proceedings as
civil in nature, establishing that it is sufficient for the SFC to be satisfied
on the standard of proof applicable to civil proceedings in a court of law that
a licensed or registered person has contravened the SFO or any requirement made
thereunder.
However, as the court noted in Koon, the
classification of disciplinary proceedings as civil in nature is the least
important of the 3 factors. Thus, in Koon, the court decided that insider dealing proceedings were
criminal even though the legislature had classified them as civil. If it were otherwise, the legislature
could create offenses punishable by incarceration and then insulate them from
judicial scrutiny and the protections available in criminal proceedings merely
by classifying as civil.
The Nature of the Offense
Disciplinary sanctions serve 2 purposes, the first
being to protect the public and the second being to punish a licensed or
registered person for misconduct.
Under Koon, the nature of an offense will tend to be civil where sanctions are imposed
primarily to protect the public but criminal if the sanctions are primarily
intended to punish the offender.
There is also a moral component involved in
establishing the nature of the offense, although it is often given less weight
than the purpose of the sanctions; the Koon
decision looked both to the element of dishonesty involved in the offense of
insider dealing and to the fact that insider dealing is treated as a crime by
many jurisdictions.
The Nature and Degree of Severity of the Penalty
The nature and degree of severity of a penalty
includes consideration of whether an offense may result in incarceration or
other loss of liberty. Generally, the loss of one's ability to practice a chosen trade (for example, as a broker)
is not likely to be regarded as a loss of liberty.
However, the prospect of a significant financial
penalty may cause proceedings to be criminal in nature. This is so even if the penalty is
calculated by reference to the profit made or loss avoided. Thus, in Koon,
the fact that insider dealing could be punished by a fine of up to 3 times the
amount of profit made or loss avoided resulted in a finding that proceedings
before the IDT were criminal in nature.
RESPONSE TO KOON
The initial response to Koon has been tepid. The MMT has ruled that MMT proceedings
are civil in nature. Similarly, the SFAT has ruled that disciplinary
proceedings are civil in nature but that the applicable standard of proof is
subject to a sliding scale of legal protection.
SFAT Decision
In holding that disciplinary proceedings were civil
in nature, the SFAT relied on 2 points. First, the SFAT noted disciplinary proceedings are not of general
application. Instead, they are limited to a restricted group (i.e.
licensed or registered persons). Accordingly, based on English judicial precedent, they are unlikely to
be classified as criminal unless they may lead to a loss of liberty.
Secondly, the SFAT found that disciplinary
proceedings are concerned with both punishing offenders and protecting the
public. Consequently, disciplinary proceedings are not necessarily criminal in nature.
However, the fact that disciplinary proceedings may
be civil in nature does not mean that protections afforded criminal proceedings
are necessarily absent. The sliding
standard of proof mentioned above, reflecting the maxim that graver allegations
require weightier proof, is one example of heightened protections available in
a so-called civil proceeding.
Ultimately, depending on how the Koon
factors are applied in any given case, other criminal protections,
particularly those implicated under the HKBOR, could come into play.
Practical Implications
Because the Koon
criteria must be applied on a case-by-case basis, the SFAT decision cannot be
read as support for the proposition that all disciplinary proceedings will be
regarded as civil. Moreover, the SFAT is not a judicial body and its decisions are subject to review. Thus, some
uncertainty remains.
In the right case, it may be possible to secure a
criminal classification for certain proceedings, and the procedural protections
that go along with such a classification. Even if not, it may be possible to
press for greater legal rights including the application of a higher standard
of proof, analogous if not identical to the criminal standard.
ARGUING FOR A CRIMINAL STANDARD
While there is judicial authority that a
disciplinary proceeding is unlikely to be classified as criminal unless it
involves or may lead to a loss of liberty, we do not believe that this means
that disciplinary proceedings will never be classified as criminal.
Discipline in lieu of Criminal Prosecution
In particular, in a disciplinary proceeding, where
the misconduct may also be prosecuted as a criminal offence under the SFO and
the penalty proposed would exceed that available through the criminal proceedings,
there is a compelling argument that the disciplinary proceeding should be
treated as criminal. It is anomalous that where misconduct is prohibited as a
criminal offence, disciplinary proceedings with fewer legal protections can be
taken to punish that misconduct with sanctions which exceed those customary for
the criminal offence.
In this regard, there have been a number of
disciplinary and criminal proceedings in relation to unlicensed dealing in
securities. In these cases, the
sanctions imposed on a disciplinary basis have far exceeded those imposed on a
criminal basis. For example, in
one disciplinary case, a representative of a global financial institution was
fined HK$287,372 by the SFC for dealing in securities without a license for a
period of approximately 2 months.
In contrast, in a different case prosecuted as a criminal offence, a
bank was fined a mere HK$40,000 for dealing in securities without a license for
a period of approximately 6 months.
The most striking aspect of the contrast in the
size of the penalties in these cases is that in the disciplinary case, the SFC
specifically found that the public had suffered no harm as a result of the
representative's actions. In other words, the fine was designed to punish the
representative rather than to protect the public.
Under the criteria above, such disciplinary
proceedings ought to have been classified as criminal since:
- unlicensed dealing in securities is a criminal
offence,
- the fine was designed to punish the representative
rather than to protect the public, and
- the fine's amount was far greater than what would
likely have been imposed in a criminal proceeding.
Consequences of Criminal Classification
If a disciplinary proceeding is treated as criminal
rather than civil in nature, the following consequences may arise:
- the SFC may lose the right to compel or use
testimony of a self-incriminatory nature;
- the SFC may lose the right to rely upon hearsay
testimony and to shield witnesses from cross-examination;
- the SFC may have to meet the higher criminal
standard of proof; and
- the SFC may have to comply with the legal
protections afforded to defendants under the HKBOR.
FALLING BACK ON THE CIVIL STANDARD OF PROOF
Even if disciplinary proceedings are treated as
civil in nature, the evolving law in this arena promises to provide an
increasing number of opportunities for legal counsel to assert legal rights
normally afforded only in criminal proceedings.
In particular, the recent MMT and SFAT decisions
have reiterated the sliding nature of the civil standard of proof and have left
the possibility open that in certain disciplinary proceedings, the civil
threshold may approach or even be identical to the criminal standard.
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