Price Sensitive Information and the Market Misconduct Tribunal: A Primer for Listed Companies and Their Directors
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 price sensitive information. In this primer, 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.
Tom Atkinson, the new Executive Director of the SFC responsible for the Enforcement Division, recently confirmed that listed company malfeasance, including insider dealing and market abuse, is at the top of the Enforcement Division’s priority list. The confirmation is consistent with the empirical evidence – the SFC is increasingly taking action against listed companies and their directors on the basis that they have failed to disclose non-public price sensitive information in a timely or accurate manner, traded whilst in possession of such information or failed to handle the information in a confidential manner.
In some cases, this enforcement action may result in proceedings before the MMT. MMT proceedings can result in significant reputational damage and financial liability, both for the directors and the listed companies concerned. A finding of liability by the MMT can trigger further action by the SFC to compensate investors and can form the basis of statutory actions by investors to recover losses, with the finding of the MMT being admissible as proof of wrongdoing. In the case of Tiger Asia, the SFC sought compensation orders of over HK$45 million from the hedge fund and its officers. Similarly, in the Du Jun and Tsoi Bun cases, the SFC sought compensation orders of over HK$23 million and HK$13 million respectively.
A director found liable by the MMT may be disqualified from serving as a director, and may be banned from trading in the market, for up to 5 years. A director may also face monetary penalties including orders to account for any profit gained or loss avoided, to pay a regulatory fine, or to pay the Government and the SFC any costs reasonably incurred by them as a result of the misconduct. The costs can be relatively high, with figures in the HK$3 million to HK$7 million range not being unusual. Directors and officers liability insurance may not provide adequate coverage. Though not yet settled, even where policy language covers regulatory fines, caselaw suggests that even a finding of a negligent breach of regulatory requirements may be sufficient to bar indemnity.
Proceedings before the MMT are invariably foreshadowed by 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.
Significance of Investigation Stage
The investigation stage is arguably the most critical stage of the enforcement process. It is at this stage that the SFC will decide whether or not to prosecute. Thus, whilst some practitioners prefer to advise clients to remain as tight-lipped as possible and to wait for their day in court, we often advise clients to present their story as forcefully as possible at this stage. 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. At the same time, the 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 investigation stage. An inconsistent story may damage credibility.
Legal Professional Privilege
If legal advice has been obtained in relation to the handling of price sensitive information which is the subject of an investigation, 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 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 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.
Prosecution and Other Options
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.
Market Manipulation and Insider Dealing
If the way that price sensitive information 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:
- A disqualification order, meaning for a director that he will be disqualified from being a director for a period of up to 5 years
- A cold shoulder order, meaning that the company or a director will be prohibited from dealing in any securities for a period of up to 5 years
A cease and desist order, meaning that the company or a director will be prohibited from perpetrating the conduct that constitutes market misconduct and may commit a criminal offence if the company or the director, as the case may be, is found by the MMT in the future to have failed to comply with this prohibition
A cost order, meaning that the company must pay the costs incurred by the Government or the SFC in pursuing the market misconduct
A disgorgement order, meaning that the company or a director must pay an amount not exceeding the amount of profit gained or loss avoided as a result of the market misconduct.
MMT proceedings differ from criminal proceedings in 2 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 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 market misconduct (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. In other words, the initiation of criminal proceedings for particular conduct will preclude MMT proceedings for the same conduct. Conversely, the institution of MMT proceedings for particular conduct 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 insider dealing 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.
Non-Disclosure of Inside Information
The failure to disclose non-public price sensitive information 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 price sensitive information 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.
Market Misconduct Tribunal
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 price sensitive information is governed by an array of overlapping 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 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 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 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. If no such differentiation exists under the law, the man on the street making market commentary may be held to the same standard as a listed company and its directors, an approach that may stifle discussion. However, it is unclear how such differentiation would, if at all, affect the standard of care for a listed company and its directors.
Where the information 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.
Non-Disclosure of Inside Information
The provisions requiring the disclosure of non-public price sensitive information govern not only the timing of such disclosure but also the content of such disclosure. In this latter respect, as with the provisions governing market manipulation described above, 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.
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.”
"As Soon As Reasonably Practicable"
So far as timing is concerned, the section 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. As a result, premature disclosure without having taken professional advice or without having verified the facts 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.
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.
Effect of SFC Guidelines
In this regard, the SFC’s Guidelines provide examples and discuss particular situations to illustrate the SFC’s view on whether information 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 .
Effect of Listing Rules
Equally, whilst the Rules Governing the Listing of Securities on The Stock Exchange of Hong Kong Limited and the Rules Governing the Listing of Securities on The Growth Enterprise Market of The Stock Exchange of Hong Kong Limited (together “Listing Rules”) set out circumstances in which disclosures may be required, strictly speaking, these rules provide mere context and 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 Stock Exchange of Hong Kong (“Stock Exchange”) 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 provisions mandating disclosure of non-public price sensitive 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.
The restrictions against insider dealing under the SFO use the same definition of “inside information” to describe non-public price sensitive information 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 for the foregoing.
Under these restrictions, so far as directors are concerned, a director of a 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;”
Effect of Listing Rules
Co-extensive with the insider dealing restrictions under the SFO, the Listing Rules restrict dealings by directors when they may be in possession of price sensitive information. 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 Listing Rules and a breach of the SFO. A breach of the 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 Listing Rules may also constitute a breach of the SFO, with the result that both the Stock Exchange and the SFC may take enforcement action.
Quite apart from the insider dealing provisions above, the SFC may rely upon the anti-fraud provisions of the SFO to address insider dealing. 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 information 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 held that the employee’s misuse of the information 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 insider dealing 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.
About the Firm
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