Pitfalls of Non-Compliance
A New Landscape for Listed Companies

We have recently seen a dramatic shift in the enforcement priorities of the SFC. Where the SFC once focused primarily on regulating brokers, asset managers, financial advisers and other licensed intermediaries, it is clear today that there is a real and substantial focus on listed companies. Both the anecdotal and quantitative data confirm the shift. The number of investigations conducted by the SFC’s Enforcement Division has fallen in absolute terms, which is consistent with the SFC’s current philosophy of being more selective in its enforcement activities. However, the number of investigations focused on listed companies has increased as a proportion, with the number of investigations into corporate disclosure increasing 22% over the last financial year and the number of investigations into corporate mis-governance remaining relatively steady during the same period.

The shift is consistent with the stated position of the SFC, namely to prioritise listed company malfeasance and fraud as well as the standards of listing sponsors. This article briefly summarises the SFC enforcement process that listed companies may experience.

Initiation of action

SFC enforcement actions against listed companies often begin with a request for documents pursuant to the Securities and Futures Ordinance ("SFO") Section 179. Under this provision, the SFC may require the production of any records or documents of a listed company in certain circumstances, such as where it appears to the SFC that the persons concerned in the listing of a company or in the management of a listed company may have engaged in fraud, misfeasance or other misconduct towards any of the company’s shareholders. The SFC may also use this power to obtain records or documents from a company’s present and former directors or employees, and to require the company or its officers, as applicable, to provide an explanation of those records or documents. Enquiries under Section 179 may be used, for example, where there is a concern that a listed company has failed to comply with the listing rules of the Stock Exchange of Hong Kong.

Enquiries under Section 179 are preliminary to a full investigation. They are typically initiated by the Corporate Finance Division of the SFC rather than the Enforcement Division. In this regard, they present a lower risk to listed companies because the role of the Corporate Finance Division is to ensure proper regulation of listed companies, whereas the role of the Enforcement Division is to find wrongdoing and to prosecute it.

Nevertheless, listed companies should recognise that Section 179 enquiries pose real risks, as the failure to adequately address such enquiries can result in a referral from the Corporate Finance Division to the Enforcement Division. The seriousness of a Section 179 enquiry is evident from the fact that the SFO abrogates the privilege of self-incrimination so that any person requested by the SFC to provide an explanation of records or documents cannot decline the request on the grounds that such explanation may tend to incriminate him. Instead, the person must provide the explanation but the explanation may not be used against him in criminal proceedings except for perjury and its like offences.

Investigations

Investigative action taken by the Enforcement Division of the SFC poses a higher level of risk to listed companies as it may lead to civil or criminal sanctions. Investigations take place under Section 182 of the SFO, which permits the SFC to invoke draconian powers where, amongst other things, it has reasonable cause to believe that there may have been a breach of the SFO or the prospectus provisions of the Companies (Winding-up and Miscellaneous Provisions) Ordinance. The SFC may also use its investigation powers where it has reasonable cause to believe that a person may have engaged in defalcation, fraud, misfeasance or other misconduct in connection with any dealings in securities. The SFC may, for example, initiate an investigation where there is initial evidence to suggest insider dealing, the failure of a listed company to disclose inside information, or a serious lapse in the duty of care owed by the directors of a listed company.

As part of an investigation, the SFC may apply to a magistrate for a warrant to enter premises, by force if necessary, and to search and seize records or documents. Once an investigation has commenced, the SFC may also require a person to attend an interview to answer questions and otherwise to provide all assistance which the person may reasonably give. As with Section 179 enquiries, the privilege of self-incrimination is abrogated for full investigations.

Prosecution

If the SFC investigators believe that wrongdoing has taken place, the SFC may proceed to prosecution. In this regard, there has been an evolution in both the SFC’s approach as well as to the range of options available to it.

The introduction of the new statutory requirement for listed companies to disclose inside information, that came into force on 1 January 2013, has given the SFC substantially more flexibility to pursue failures to truthfully and completely disclose price sensitive information in a timely fashion. The SFC has been quick to leverage this option and so far, has instituted three cases in the Market Misconduct Tribunal against listed companies and their directors for a breach.

The SFC’s recent announcement of its new policy of 'front-loaded' regulation confirms the SFC will revive and exercise its powers to suspend or cancel listings of companies. These erstwhile dormant powers have long been available under the Securities and Futures (Stock Market Listing) Rules (SMLR), but only resurfaced following the failure to implement changes proposed under SFC and HKEX joint consultation on listing regulation.

Another major change in the SFC’s approach over the past few years has been to seek remedies for investors who have suffered a loss as a result of misconduct by listed companies and their directors. These remedies are, in many cases, supplemental to sanctions which may apply to wrongdoers and may include court orders to compensate investors for losses incurred, orders for a listed company to sue its directors (past or present) and orders to disqualify individuals from serving as directors. Thus, whilst directors of listed companies are not regulated by the SFC, they now face many of the same types of regulatory burdens often associated with membership of a regulated profession.

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This article was originally published in the February, 2018 edition of CSj, the publication of the Hong Kong Institute of Chartered Secretaries (http://csj.hkics.org.hk).