Insider dealing restrictions under the Hong Kong SFO can raise practical problems for hedge fund and private equity managers
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November 17, 2020
By Timothy Loh
The Securities and Futures Commission (“SFC”) has prioritized listed company malfeasance for enforcement action. As a result, listed companies and their directors will come under increasing scrutiny as to how they manage material non-public price sensitive information (“MNPI”). In this guide, we draw upon extensive experience representing clients in Market Misconduct Tribunal (“MMT”) proceedings to provide guidance to listed companies and their directors on how to respond if the SFC targets them for enforcement action, including for failure to properly disclose inside information or for dealing on the basis of inside information.
In the first of our companion articles, New Requirements For Disclosure Of Price Sensitive Information: A Guide For Hong Kong Listed Companies, we provide guidance to listed companies and their directors on how to comply with requirements for the disclosure of MNPI. In the second of our companion articles, Market Misconduct Tribunal: A Guide to Penalties and Other Consequences for Misuse of Insider Information, we outline the penalties and other consequences which can be expected for breaching requirements for the proper handling of MNPI.
Tom Atkinson, the new Executive Director of the SFC responsible for the Enforcement Division, recently confirmed that malfeasance by companies listed on the Hong Kong Stock Exchange (“HKSE”) (i.e. HKSE listed companies), including insider dealing and market manipulation, is at the top of the SFC Enforcement Division’s priority list. The confirmation is consistent with the empirical evidence – the SFC is increasingly taking action against HKSE listed companies and their directors on the basis that they have failed to disclose MNPI in a timely or accurate manner, traded whilst in possession of MNPI or failed to handle MNPI in a confidential manner.
In some cases, SFC enforcement action may result in proceedings, including before the Market Misconduct Tribunal (“MMT”) and the Hong Kong courts, for insider dealing, false or misleading disclosure of information or failure to disclose inside information. Such proceedings can result in significant reputational damage and financial liability, both for theHKSE listed companies concerned and their directors. A finding of liability for the mishandling of MNPI can result in penal orders from the MMT as well as action by the SFC to compensate investors. Such a finding of liability can form the basis of statutory actions by investors to recover losses, with the finding of the MMT, if applicable, being admissible as proof of wrongdoing.
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SFC Enforcement action in respect of the mishandling of MNPI invariably begins with an SFC investigation. The investigation typically includes a demand for production of documents and interviews with persons who may be able to assist in the investigation as well as persons who are under investigation.
The SFC’s powers of investigation are draconian. The SFC may require a person to answer a question even if the answer may tend to self-incriminate. Whilst an answer cannot, if an appropriate claim is made, generally be used in criminal proceedings against the person, MMT proceedings are not criminal. As a result, a person may be required to give evidence which would tend to establish his own liability in any subsequent MMT proceedings. This is of particular concern in cases concerning the mishandling of MNPI as, typically, the SFC will opt to pursue this type of potential misconduct through the MMT.
The SFC investigation stage is arguably the most critical stage of any SFC enforcement action, including enforcement action for market misconduct as a result of improper handling of MNPI. It is at the investigation stage that the SFC will decide whether or not to prosecute. Whilst some practitioners prefer to advise clients to remain as tight-lipped as possible and to wait for their day in court, consideration should be given to clients to presenting their story as forcefully as possible at this stage. A decision as to how to proceed should be made in consultation with legal counsel with a strong background in SFC investigations and Market Misconduct Tribunal proceedings relating to the handling of MNPI.
The story should emphasize the legal and human side elements which would most persuasively argue against prosecution and should, naturally, reflect conduct consistent with the regulatory framework for inside information. At the same time, the SFC investigation stage lays down the evidential foundation for any subsequent MMT or other proceedings. Any future statement in such proceedings will be measured against any statement or other evidence tendered earlier during the SFC investigation stage. An inconsistent story may damage credibility.
If legal advice has been obtained in relation to the handling of MNPI which is the subject of an SFC investigation, such advice will be protected by legal professional privilege. Companies will need to consider at the investigation stage whether or not they can and should insist upon legal professional privilege to shield such advice from production.
Producing such advice may help to characterize the company as being cooperative and may lay the groundwork for an argument of the reasonableness of the conduct of the listed company and its directors. If this approach is taken, the company will need to further consider the extent to which it will waive privilege.
Refusing to produce such advice may frustrate the ability to tell the story and hence, justify conduct. In particular, if a listed company or its directors followed legal advice as to the handling of MNPI, they may wish to disclose the advice to show that they not only took advice but followed it. By maintaining privilege over the advice, the listed company and its directors would not be able to make this argument.
In the case of a director, the consequence of such frustration may be to lay the groundwork for a defence by the director that he does not have a reasonable opportunity to be heard. In this regard, as a matter of natural justice, the MMT has no jurisdiction to make a finding against a director who has not had such an opportunity to be heard.
Following at least an initial investigation, the SFC may decide to prosecute or take remedial action or both. Prosecution options vary depending on the type of alleged misconduct.
If the way that MNPI was handled is classified as market manipulation or insider dealing and the SFC chooses to prosecute, it can generally do so by initiating either criminal proceedings or proceedings before the MMT.
Proceedings before the MMT are civil rather than criminal in nature. Nevertheless, in addition to reputational consequences, such proceedings can result in a range of penalties including, in the case where a listed company or its directors mishandles MNPI:
MMT proceedings differ from criminal proceedings in two significant ways. First, criminal proceedings may result in jail time whereas MMT proceedings cannot. Jail time in criminal proceedings for an offence committed by a director or a listed company of which he is a director can be as high as 10 years.
Secondly, the rules of evidence and the standard of proof are higher in criminal proceedings compared to MMT proceedings. For example, in a criminal proceeding, the prosecution must prove its case for insider dealing or mishandling of inside information beyond reasonable doubt. In contrast, in an MMT proceeding, liability will be established if it is simply more probable than not that the specified person engaged in insider dealing or mishandled inside information (i.e. on a civil standard of proof).
As a general principle, a person cannot be subjected to both criminal proceedings and MMT proceedings for the same conduct in reliance of the market misconduct provisions of the SFO governing insider dealing and market manipulation. Thus, for example,, the initiation of criminal proceedings for insider dealing or the mishandling of inside information will preclude MMT proceedings for the same conduct. Conversely, the institution of MMT proceedings for insider dealing or the mishandling of inside information will preclude criminal proceedings for the same conduct.
This is not to say that there is no risk of prosecution both through criminal and MMT proceedings. For example, although there is no precedent, there is a theoretical possibility that misuse of MNPI may be prosecuted both through the MMT under the market misconduct provisions governing insider dealing and through the criminal courts relying on the anti-fraud provisions of the SFO as these anti-fraud provisions are not per se market misconduct provisions.
The failure to disclose MNPI in a timely or accurate manner may result in a breach of the requirement for a listed company and its directors to disclose inside information. If the failure is so classified (as opposed to being classified as market manipulation), it may be prosecuted only through MMT proceedings. There are no statutory provisions establishing criminal offences for this type of breach.
MMT proceedings for this type of breach may result in a fine of up to HK$8 million (but not an order for disgorgement). At the same time, on a finding of a breach, the MMT may order that the listed company appoint an independent professional advisor to advise on compliance or that the directors undergo compliance training. As with market manipulation and insider dealing, directors may face a disqualification order, a cease and desist order and a cold shoulder order as well as orders to pay the SFC’s costs in the investigation and proceedings.
Separate from prosecution, the SFC may seek remedial action even before any liability has been established by the MMT or a criminal court. For example, the SFC can apply to court to freeze the assets in Hong Kong of suspected wrongdoers. The frozen assets may later be applied to compensate investors for losses arising from the misconduct.
Such remedial action is sought before a judge in the High Court of Hong Kong rather than through the MMT. Remedial court orders result in financial consequences that may well exceed the maximum fine that could be ordered by the MMT itself. This is because the loss to investors arising from the mis-handling of MNPI can run very high and there is no statutory limit on the amount of compensation the court may order to be paid for such loss.
The MMT is an administrative body akin to a court. It is chaired by a judge and assisted by two lay members. The lay members are typically academics in finance or business studies or members of the finance industry. Their presence is intended to provide greater market expertise to the tribunal.
In theory, the MMT is an inquisitorial tribunal, meaning that its function is to investigate and report on what happened. In practice, the MMT assumes a role similar to a court in an adversarial proceeding, with the defendants, called specified persons, squaring off against a prosecutor, called the presenting officer, appointed by the SFC.
The specified persons will normally be represented by both their solicitors and counsel. The presenting officer will typically be a senior member of the bar instructed by the SFC’s legal department.
Proceedings before the MMT are generally open to the public. This means, for example, that journalists can attend MMT hearings and report on the proceedings as they unfold. In the past, the news media has given substantial profile to certain cases. Accordingly, a listed company and its directors who are subjected to MMT proceedings may be exposed to risk of reputational damage even before the MMT makes any adverse finding or determination.
The handling of MNPI is governed by an array of overlapping market misconduct provisions relating to market manipulation, insider dealing and requirements to disclose inside information. The provisions are overlapping, with some conduct falling into more than one set of provisions. For example, a listed company’s disclosure of information that is materially incorrect may be classified either as market manipulation or a breach of the requirement to disclose the inside information. The SFC’s decision on how to pursue any given case is significant because, as set out above, the penalties may differ markedly.
The market misconduct provisions concerning market manipulation ensure that information disseminated to the public by, amongst other people, a listed company and its directors is neither false nor misleading. Section 277(1) of the Securities and Futures Ordinance (“SFO”), which is subject to prescribed exemptions for the benefit of the news media, states:
Disclosure of false or misleading information inducing transactions takes place when, in Hong Kong or elsewhere, a person discloses, circulates or disseminates, or authorizes or is concerned in the disclosure, circulation or dissemination of, information that is likely-
(a) to induce another person to subscribe for securities, or deal in futures contracts, in Hong Kong;
(b) to induce the sale or purchase in Hong Kong of securities by another person; or
(c) to maintain, increase, reduce or stabilize the price of securities, or the price for dealings in futures contracts, in Hong Kong,
(i) the information is false or misleading as to a material fact, or is false or misleading through the omission of a material fact; and
(ii) the person knows that, or is reckless or negligent as to whether, the information is false or misleading as to a material fact, or is false or misleading through the omission of a material fact.
Listed companies and their directors should be aware that under the SFO, s. 277, they may be found liable on the basis that they have been negligent as to whether any information disclosed by the company is false or misleading as to a material fact or by omission of a material fact. There is no need for a dishonest intent to deceive the investing public to establish liability.
Negligence can be a difficult standard in practice. It is not easy in foresight to anticipate what a court, in hindsight, might determine to be the standard of care required. The standard which one man deems to be reasonable may differ from the standard which another man deems to be reasonable.
What is clear is that investors are generally in no position to verify the accuracy of information disclosed by a listed company. In other words, the listed company and its directors usually have a monopoly on information concerning the company. Since the regulatory framework assumes that the price of the securities of a listed company is largely determined by information concerning the company, the regulator is legitimately concerned to ensure that any information disclosed by the company is correct and complete.
However, the market manipulation provisions in the SFO, s. 277 also govern disclosures other than by listed companies and their directors, such as commentary by research analysts and the man on the street. To the extent that the integrity of the market is enhanced by a robust debate as to the value of a company, a difficult question thus arises as whether the courts should construe the provisions to differentiate between listed companies and their directors on the one hand and other persons on the other hand and, if so, how the language of these provisions can be interpreted to achieve such differentiation.
Where MNPI is forward looking or otherwise in the nature of an opinion, difficult questions may arise as to whether the information is false or misleading. In this regard, the MMT report in respect of Evergrande suggests that an opinion may constitute false or misleading information. In that case, using bold and racy language, a report prepared by a short seller asserted that Evergrande was insolvent and had engaged in fraud. The report set out the full analysis behind these assertions and it was clear that the assertions were derived from this analysis. Nevertheless, the MMT found that the assertions constituted information that was false or misleading.
The provisions requiring the disclosure of inside information under the SFO, s. 307B govern not only the timing of disclosure of inside information but also the content of such disclosure. Under these provisions, a listed company and its directors may be faulted if the information disclosed is false or misleading as to a material fact or through the omission of a material fact or if the information is disclosed late.
Sections 307B(1) to (3) of the SFO, which are subject to prescribed exemptions, state:
(1) A listed corporation must, as soon as reasonably practicable after any inside information has come to its knowledge, disclose the information to the public.
(2) For the purposes of subsection (1), inside information has come to the knowledge of a listed corporation if—
(a) information has, or ought reasonably to have, come to the knowledge of an officer of the corporation in the course of performing functions as an officer of the corporation; and
(b) a reasonable person, acting as an officer of the corporation, would consider that the information is inside information in relation to the corporation.
(3) Without limiting subsection (1), a listed corporation fails to disclose the inside information required under that subsection if—
(a) the information disclosed is false or misleading as to a material fact, or is false or misleading through the omission of a material fact; and
(b) an officer of the corporation knows or ought reasonably to have known that, or is reckless or negligent as to whether, the information disclosed is false or misleading as to a material fact, or is false or misleading through the omission of a material fact.
So far as timing is concerned, the SFO, s. 307B requires disclosure only when a “reasonable person” would consider that the information is “inside information” and then, only “as soon as reasonably practicable”. Under the Guidelines for Disclosure of Inside Information (“Guidelines”), the SFC acknowledges that in handling potential inside information, a listed company may need to take steps to ascertain sufficient details, make an internal assessment of the subject matter and its likely impact, obtain professional advice and verify the facts before issuing a full announcement.
In this vein, listed companies should bear in mind that a disclosure that is false or misleading as to a material fact or by omission of a material fact may constitute market manipulation under the SFO, s. 277 or may constitute non-compliance with the SFO, s. 307B. As a result, premature disclosure of information thought to be inside information without having taken professional advice or without having verified that it is in fact so may result in liability.
Whilst the SFC acknowledges that it may take some time to seek clarification and suggests that a listed company in such a situation should consider issuing a holding announcement and applying for a trading suspension in the meantime, strictly speaking, such action does not constitute a defence to an allegation of a breach of the requirement to disclose inside information in a timely manner. Unless exempted, the law requires that the listed company actually disclose the inside information.
The provisions of the SFO, s. 307B mandating disclosure of inside information provide that disclosure may be delayed in certain circumstances where the confidentiality of the information is preserved. During this interim period of time ahead of disclosure, the listed company and its directors are prohibited from benefiting from this information under insider dealing laws.
It is not always easy to ascertain when information would constitute “inside information”. Under the SFO, inside information must be specific to a company, its shareholders or officers or its securities or their derivatives. It must be information which is not generally known to persons who are accustomed or would be likely to deal in the securities of the listed company but would, if generally known to them, be likely to materially affect the price of those securities.
In practice, it can be difficult to ascertain whether information would be likely to materially affect the price of securities if that information were known to persons generally accustomed to dealing in them. Necessarily, the assessment requires the exercise of judgment and there will be many cases where reasonable businessmen will differ as to the impact of a piece of information.
In this regard, the SFC’s Guidelines provide examples and discuss particular situations to illustrate the SFC’s view on whether information thought to be MNPI would constitute inside information. However, as the Guidelines themselves acknowledge, these examples and discussions do not have force of law and do not bind the MMT or any court. Information which may constitute inside information in one circumstance may not constitute inside information in a different circumstance or vice-versa. For example, the signing of a HK$100 million contract may be price sensitive for a small company but not be so for a large company.
Equally, whilst the Rules Governing the Listing of Securities on HKSE and the Rules Governing the Listing of Securities on The Growth Enterprise Market of HKSE (together “Listing Rules”) set out circumstances in which disclosures may be required, strictly speaking, these rules provide mere context. They do not offer binding guidance as to whether information constitutes inside information under the SFO.
A breach of the disclosure requirements under the Listing Rules does not necessarily constitute a breach of the SFO but it may do so. This is not to say that no consequences flow from a breach of the Listing Rules where there is no breach of the SFO. The HKSE can sanction a listed company and its directors by private reprimand, public censure, suspension of the company’s listing or de-listing of the company.
It is significant to note that inside information is defined by reference to whether the information would be likely to materially affect the price if known to persons who are accustomed or would be likely to deal in the securities of the specific listed company. In contrast, it is sometimes assumed that inside information is defined by reference to whether a reasonable person would consider that such information would be material to his valuation of the prospects of the company. The distinction is significant given that certain companies, particularly those which are thinly traded, may, historically be more unresponsive to news.
The restrictions against insider dealing under the SFO, s. 270 use the same definition of “inside information” to describe MNPI and suffer from the same uncertainties associated with this definition. There are separate restrictions for take-over bidders, connected persons and persons who receive information from the foregoing.
Under these restrictions, so far as directors are concerned, a director of an HKSE listed company must not deal in the listed securities of that company or their derivatives, if he possesses inside information. Equally, the director must not counsel or procure another person to deal, or disclose inside information to another person, knowing or having reasonable cause to believe that the other person will either (i) deal in the listed securities or their derivatives, or (ii) counsel or procure some other person to do so.
Sections 270(1)(a) and (c), which are subject to a number of exemptions, state:
(1) Insider dealing in relation to a listed corporation takes place-
(a) when a person connected with the corporation and having information which he knows is inside information in relation to the corporation-
(i) deals in the listed securities of the corporation or their derivatives, or in the listed securities of a related corporation of the corporation or their derivatives; or
(ii) counsels or procures another person to deal in such listed securities or derivatives, knowing or having reasonable cause to believe that the other person will deal in them;
(c) when a person connected with the corporation and knowing that any information is inside information in relation to the corporation, discloses the information, directly or indirectly, to another person, knowing or having reasonable cause to believe that the other person will make use of the information for the purpose of dealing, or of counselling or procuring another person to deal, in the listed securities of the corporation or their derivatives, or in the listed securities of a related corporation of the corporation or their derivatives;
Co-extensive with the insider dealing restrictions under the SFO, the HKSE Listing Rules restrict dealings by directors when they may be in possession of MNPI. For example, under the Listing Rules, a director of a listed company must not deal in any securities of the company on days during the “blackout” period immediately preceding the publication of the company’s financial results. The blackout period runs from 30 days prior to the release of the interim financial results to the date of the release of these results and from 60 days prior to the release of annual financial results to the date of the release of such results.
However, as with the disclosure of inside information, it is important to distinguish between a breach of the HKSE Listing Rules and a breach of the SFO. A breach of the HKSE Listing Rules is not necessarily a breach of the SFO. In the absence of a breach of the SFO, there is no jurisdiction for the SFC to prosecute or to seek remedial action. Conversely, a breach of the HKSE Listing Rules may also constitute a breach of the SFO, with the result that both the HKSE and the SFC may take enforcement action.
Quite apart from the specific provisions of the SFO relating to insider dealing set out above, the SFC may rely upon the anti-fraud provisions of the SFO, s. 300 to address the misuse of MNPI. In this case, the SFC may prosecute for a criminal breach of these provisions or seek remedial measures for a breach of these provisions. The latter requires the SFC only to meet a civil standard of proof.
Section 300 of the SFO states:
(1) A person shall not, directly or indirectly, in a transaction involving securities, futures contracts or leveraged foreign exchange trading-
(a) employ any device, scheme or artifice with intent to defraud or deceive; or
(b) engage in any act, practice or course of business which is fraudulent or deceptive, or would operate as a fraud or deception.
(2) A person who contravenes subsection (1) commits an offence
(3) In this section, a reference to a transaction includes an offer and an invitation (however expressed).
In Securities and Futures Commission v. Young Bik Fung  HKCFI 57, a bank employee traded on MNPI about a listed company transaction that she had learned in the course of her employment. The insider dealing provisions of the SFO did not apply as the listed company was not listed in Hong Kong. The Court of First Instance held that the employee’s misuse of the MNPI for personal profit in breach of her duty of confidentiality constituted a fraudulent or deceptive act or scheme within the meaning of section 300.
The reach of section 300 as a regulatory tool against the misuse of MNPI remains unclear following this case. The Court did not say that the fraud occurred as a result of defrauding the market. Instead, it said that the fraud occurred as a result of a breach of the duty of confidentiality. Nevertheless, for a director, the case is relevant as directors will owe duties of confidentiality to their companies.
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