A VIEW FROM HONG KONG

byAlan Linning

Executive DirectorEnforcement

Securities & Futures Commission24 May 2005

The Market Misconduct Regimein Hong Kong

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The Securities & Futures Commission Ordinance, Cap.571 (SFO)

Coming into force on 1 April 2003, SFO introduced a comprehensive civil and criminal regime to address misconduct in Hong Kong’s financial markets.

SFO replaced ten separate Ordinances that covered various forms of misconduct.

SFO is administered principally by the Securities & Futures Commission (SFC).

SFO provides for six forms of market misconduct modelled on existing Hong Kong or Australian law.

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SFO (cont’d)

The six forms of market misconduct provided for in Part XIII, SFO are:– Insider dealing (section 270);– False trading (section 274);– Price rigging (section 275);– Disclosure of information about prohibited transactions

(section 267);– Disclosure of false or misleading information inducing

transactions (section 277); and– Stock market manipulation (section 278).

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Dual Civil and Criminal Regimes

Instances of market misconduct contained in Part XIII are repeated as criminal offences in Part XIV.

Two Parts are mutually exclusive in their application.

Under Part XIII, instances of alleged market misconduct are heard by the Market Misconduct Tribunal while proceedings under Part XIV are before the criminal courts.

No duplication of punishment for same market misconduct: sections 283 and 307.

SFC makes decisions whether to refer for civil action or criminal prosecution subject to final decision by Financial Secretary (civil) or Secretary for Justice (criminal).

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The Market Misconduct Tribunal (MMT)

The MMT is based on the Insider Dealing Tribunal, which it has now superseded.

The Tribunal comprises a Chairman, who is a High Court Judge and two other members, who cannot be public officers.

A Presenting Officer appointed by the Secretary for Justice conducts the proceedings before the Tribunal.

Inquiry instituted before the Tribunal by the Financial Secretary by providing the Chairman with a written statement of the nature and elements of the alleged breach and identifying those alleged to have committed market misconduct.

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MMT (cont’d) The Tribunal determines:

– Whether market misconduct has taken place;– The identity of those who have engaged in misconduct;– The amount of any profit gained or loss avoided as a result of the

market misconduct; and– The penalties to be imposed.

Standard of proof: a balance of probabilities.

Proceedings before the Tribunal are an inquiry not a trial and Tribunal may order the SFC to make further investigations and obtain further evidence.

Tribunal has power to consider any oral or documentary evidence, even if the material would not be admissible in evidence in a court of law.

Tribunal may consider self-incriminating testimony gathered by SFC in exercise of its investigatory powers.

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MMT Sanctions

At the conclusion of an inquiry, the Tribunal may make any of the following orders against a person identified as having engaged in misconduct:– An order disqualifying a person from being a director of or being

involved in the management of a listed corporation for up to five years;– An order preventing a person from dealing, directly or indirectly, in

Hong Kong with securities or other regulated products for up to five years;

– An order that the person pay to the Hong Kong Government an amount equivalent to the profit gained or the loss avoided as a result of their market misconduct with compound interest;

– A cease and desist order;– An order for the costs reasonably incurred by the Hong Kong

Government and/or the SFC in the inquiry and related investigations; and

– An order that a body which may take disciplinary action against the person be recommended to do so.

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Criminal Regime

Prosecution has burden of proof and must prove its case to the criminal standard of proof beyond reasonable doubt.

SFC has power to prosecute cases summarily.

SFO applies Department of Justice Prosecution Guidelines.

More serious cases referred by SFC to Department of Justice for prosecution on indictment.

Significant sanctions for conviction:– Summary: 3 years gaol and/or HK$1 million fine– Indictment: 10 years gaol and/or HK$10 million fineMMT sanctions also available on conviction.

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Civil Liability for Market Misconduct

Sections 281/305 SFO.

Potential liability to pay compensation in damages for pecuniary loss sustained by another person as a result of market misconduct.

Whether or not the loss arises from the other person having entered into a transaction at a price affected by the misconduct.

No liability to pay compensation “unless it is fair, just and reasonable in the circumstances of the case …”.

Elements of Insider Dealing

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Insider Dealing

Insider Dealing concerns the wrongful use of confidential, price sensitive information about a listed corporation. This type of information is known in the SFO as “relevant information”.

For information to be “relevant information”, it must possess three elements:– The information must not be generally known to the market;

that is to those individuals and institutions accustomed or likely to deal in the securities of the corporation;

– It must be specific information; and– It must be information of the kind which, if it were known to

the market, would be likely materially to affect the price of that company’s listed securities and the insider must know that this is so (see section 285(1)).

The approach of the Insider Dealing Tribunal.

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Insider Dealing: Civil Liability

Insider dealing occurs:

When a person “connected with” a listed corporation, whilst in possession of information which he knows is relevant information deals in the listed securities of that corporation or their derivatives or in the listed securities or derivatives of a related corporation (dealing liability; section 270(1)(a)).

When a person “connected with” a listed corporation, counsels or procures another person to deal in listed securities, knowing the information to hand is “relevant information” and “knowing or having reasonable cause to believe that the other person will deal in them” (dealing liability; section 270(1)(b)).

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Insider Dealing: Civil Liability (cont’d)

When a person “connected with” a listed corporation discloses information known to be relevant 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 etc. (disclosure liability; section 270(1)(c)).

When a person has information which he knows is relevant information in relation to a listed corporation and which he received, directly or indirectly, from a person whom he knows is connected with the corporation and whom he knows or has reasonable cause to believe held the information as a result of being connected with the corporation shall not:– deal in the listed securities of the corporation or their derivatives

etc; or– counsel or procure another person to deal in such listed securities

or derivatives (recipient liability: section 270(1)(5)).

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Insider Dealing: Civil Liability (cont’d)

Similar liability in relation to takeovers. Section 270(1)(b) prohibits the person contemplating the takeover (or its abandonment) from dealing, counselling or procuring another person to deal. Section 270(1)(d) addresses the position of a recipient of information about the takeover, the person who receives advance notice of the planned takeover offer or its abandonment.

There are also overseas markets offences. Section 270(2) imposes liability for insider dealing for acts committed in Hong Kong with a view to dealing in listed securities or their derivatives undertaken outside Hong Kong on a “stock market other than a recognized stock market”.

Section 270(2)(a) imposes liability on a person who knowingly has relevant information in any of the circumstances described in Section 270(1) from counselling or procuring another person to deal in the listed securities of a listed corporation or their derivatives (or those of a related corporation) outside Hong Kong.

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Insider Dealing: Civil Liability (cont’d) Section 270(2)(b) imposes liability on such a person who discloses

relevant information to another person, “knowing or having reasonable cause to believe” that the recipient or some other person will make use of it for the purpose of dealing in the listed securities or their derivatives outside Hong Kong.

Section 279 provides that every officer of a corporation must take all reasonable measures from time to time to ensure that proper safeguards exist to prevent the corporation from acting in a way which would result in the corporation perpetrating market misconduct.

Where a corporation is identified by the MMT as having engaged in market misconduct which is attributable to a breach by an officer of his duty under section 279, the MMT may make orders against the officer after giving him a reasonable opportunity of being heard.

Section 291 creates criminal offences for insider dealing.

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Insider Dealing: Defences

A party facing insider dealing liability under section 270 may be able to rely on one of the statutory defences set out in sections 271, 272 and 273 to avoid liability. The onus of proving these defences falls on the implicated party. The standard of proof in establishing the defence will be on a balance of probabilities.

The defences include:– No profit motive;– Innocent agent;– Performance of underwriting agreement;– Chinese walls;– Market information and facilitation;– Pre-existing right to subscribe; and– Dealings by trustee or personal representative.

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Insider Dealing: Defences (cont’d)

Separate “safe harbour” defence under section 282 where SFC makes rules to prescribe circumstances in which conduct that would otherwise constitute market misconduct under Part XIII shall not be regarded as constituting market misconduct, eg, price-stabilizing action in connection with public offering of shares.

Similar defences in relation to criminal offences of insider dealing (sections 292, 293 and 294).

Elements of Other Market Misconduct Offences

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Market Manipulation

Modelled on existing Hong Kong law or Australian law with mental element/defences made clearer.

Securities and futures provisions generally identical.

3 types: False trading; Price rigging; and Stock market manipulation (securities only).

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False Trading

Securities and futures.

Intentionally or recklessly create false or misleading appearance of active trading, with respect to market or price (sections 274/295(1) and (2)).

On market wash sales or matched orders with reverse onus “no prohibited purpose” defence (securities only) (sections 274(5)- (7)/295(5), (7) and (8)).

Transact (including cross market) intentionally or recklessly creating or maintaining artificial price (sections 274/295(3) and (4)).

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False Trading: Examples

Intentionally creating a false or misleading appearance of active trading:– Wong Pui Ming and others trading in the shares of Fujikon Industrial

Holdings Ltd.

Intentionally creating a false market:– Richard Han and Super Glory trading in the shares of Fortuna

International Holdings Ltd.

Effecting purchases and sales of securities involving no change in beneficial ownership:– Chow Lung On trading in the shares of Tern Properties Company

Limited

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Price Rigging

Securities and futures.

Maintain, increase, reduce, stabilise or cause fluctuations in price of securities or futures through wash sale (securities only) or artificial or fictitious transaction or device (sections 275/296(1) and (2)).

Reverse onus “no prohibited purpose” defence for wash sales limb (sections 275(4)/296(5)).

Price effect must be intentional or reckless on artificial/fictitious transaction/device limb.

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Stock Market Manipulation

Securities only.

Transact in corporation’s securities, increasing price of securities with intention of inducing person to subscribe or purchase or refrain from selling corporation’s or related corporation’s securities (sections 278/299(1)(a) and (2)(a)).

Transact in corporation’s securities, reducing price of securities with intention of inducing person to sell or refrain from purchasing corporation’s or related corporation’s securities (sections 278/299(1)(b) and (2)(b)).

Transact in corporation’s securities, maintaining or stabilising price securities with intention of inducing person to subscribe or purchase or sell corporation’s or related corporation’s securities or refrain from doing so (sections 278/299(1)(c) and (2)(c)).

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Disclosing Information About Prohibited Transactions

Securities and futures.

Disclose etc information that price of securities or futures increased, reduced, maintained or stabilised etc because of prohibited transaction if person or associate: party to transaction or receive or expect to receive benefit (sections 276/297)

Under “benefit limb”, a defence if acting in good faith or benefit not from party to transaction or associate.

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Disclosing False orMisleading Information

Liability arises where a person discloses, circulates or disseminates, or authorizes or is concerned in the disclosure, circulation or dissemination of false or misleading information knowing, reckless or negligent (civil only) as to whether it is false or misleading being information that is likely to induce subscription, sale or purchase of securities or dealing in futures or increase, reduce, maintain or stabilise price (sections 277/298).

Defences:– Mere “conduit” - printers, publishers etc.;– Live broadcast; and– Internet hyperlink.

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Provision of False or Misleading Information

If a person, in purported compliance with a requirement imposed under the relevant provisions, provides to a specified recipient any information which is false or misleading in a material particular and he knows that, or is reckless as to whether, the information is false or misleading in a material particular, he commits an offence (section 384).

“Dual filing” regime Securities & Futures (Stock Market Listing) Rules – disclosures that listing candidates and listed companies make to the public must be filed both with SEHK and SFC. Effect is that statutory liability under SFO attaches to that disclosure.

Penalties– On indictment : 2 years and HK$1 million– On summary : 6 months and HK$100,000

Huafeng Textile International Group Ltd. and Mr. Cai Yang Bo

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Global Markets:International Enforcement

Market manipulation provisions expressly apply to:– conduct in Hong Kong that affects overseas markets; and– conduct overseas that affects Hong Kong markets.

Necessary to adapt to reality of globalized markets.

Conduct that affects overseas markets from Hong Kong only punishable in Hong Kong if punishable overseas (sections 282/306).