The Securities and Futures Commission (“SFC”) has been steadily getting more creative in the use of its powers and we can expect them to continue to do so, given their recent success in obtaining compensation for investors for financial misstatements in a company’s prospectus. The SFC successfully obtained a court order under section 213 of the Securities and Futures Ordinance (“SFO”), that Hontex International Holdings Co. Ltd. (“Hontex”) pay back more than HK$1 billion raised in its 2009 initial public offering. This will give further impetus to the SFC’s push to improve the quality of disclosure in prospectuses and their controversial proposal – the consultation period for which has been extended to end of July – to make sponsors (who advise companies to a listing on the Hong Kong Stock Exchange) criminally liable for faulty prospectuses. And finally, a sting in the tail – what will this mean for financial institutions with self-reporting obligations and their new obligations, effective December 2012, to self-report suspected market misconduct by their clients?
The SFC’s announcement in relation to the Hontex order can be found here http://www.sfc.hk/sfcPressRelease/EN/sfcOpenDocServlet?docno=12PR63
Section 213 gives the SFC the power to seek a broad range of orders, including; restraining orders, orders requiring restorative steps to be taken, the appointment of an administrator to property and declarations that contracts are void. In addition to the specific types of orders that are provided for under section 213, the Court to make any ancillary order it considers necessary. The SFC can use this section where there has been a contravention of the SFO or where it appears that a contravention has occurred. Until recently, section 213 had not been widely used by the SFC.
This is no longer the case; Hontex is the second example we have seen this year where the SFC has successfully relied on section 213 to obtain court orders, where there has been no ruling by either the Court or the Market Misconduct Tribunal (“MMT”) –the two bodies able to make a ruling – of a breach of the market misconduct provisions of the SFO. Section 213 has become another option for the SFC in combating market misconduct.
The Hontex and Tiger Asia cases
In the Hontex case, the SFC alleged that Hontex, a Chinese sports fabric maker, made materially false and misleading statements in its December 2009 prospectus, including an overstatement of its profits. After 12 days of trial in the Court of First Instance, the SFC and Hontex signed an agreed statement of facts, in which Hontex admitted there were overstatements in the prospectus, but did not agree with the amounts alleged by the SFC. Hontex acknowledged in the statement that it was reckless in allowing false and misleading information in the prospects in contravention of section 298(1) of the SFO. The agreed statement did not amount to an admission of any criminal behaviour on behalf of Hontex or its directors.
It was on the basis of the agreed statement that the Court made the order under section 213. The order requires Hontex to pay $197,755,503 into Court within 28 days, which will add to the $832,244,497 that was frozen under interim orders obtained by the SFC. It also requires Hontex to convene a shareholders’ meeting to approve the repurchase of shares of around 7,770 public shareholders of the company.
This is the first order of its kind obtained by the SFC under section 213. The other use of section 213 was in the Tiger Asia case: Tiger Asia Management LLC (“Tiger Asia”) is a New York-based asset management company with no physical presence or employees in Hong Kong. The SFC alleged that Tiger Asia made use of confidential and price sensitive information in relation to placement of shares in December 2008 and January 2009, and made a profit of HK$38.5 million in its dealings in those shares.
The SFC sought orders under section 213, including orders freezing Tiger Asia’s assets, prohibiting them from trading in listed securities and derivatives in Hong Kong in similar circumstances, and unwinding the relevant transactions. The orders were sought on the basis of alleged insider dealing and market manipulation, in contravention of the SFO, in circumstances where there was no criminal conviction against Tiger Asia, nor had the case been heard by the MMT. The orders were sought merely on the basis of the SFC’s investigation.
Tiger Asia challenged the SFC action on the grounds that the court had no jurisdiction to make the orders sought without a criminal conviction or a determination by the MMT. The Court of Appeal ruled in favour of the SFC, holding that section 213 was a free-standing remedy and “provides valuable tools to the [SFC] to protect the investing public” and “much needed ammunition to the [SFC] to protect investors”. This ruling overturned the decision of the Court of First Instance in June 2011 where the SFC’s action were dismissed on the ground that the court had no jurisdiction to determine whether Tiger Asia contravened the SFO. A full text of that judgment can be found here http://legalref.judiciary.gov.hk/lrs/common/ju/ju_frame.jsp?DIS=80460&currpage=T
Tiger Asia has filed an appeal with the Court of Final Appeal and the case is expected to be heard next year.
It is clear from both the Hontex and Tiger Asia cases that the SFC are not afraid to use the section 213 mechanism – and possibly other powers – to obtain remedies which the industry has not seen in the past. Whilst the orders in the Hontex case were on the basis of an agreed statement, which undoubtedly paved the way for the orders, it nevertheless demonstrates that the SFC is not afraid to be creative, especially where the traditional enforcement approaches limit the outcomes or remedies sought by the SFC.
What lies ahead?
The full consequences of this new approach to market misconduct are yet to be seen. However, one issue financial institutions need to tackle sooner rather than later will be the impact it will have on assessing self-reporting requirements under the SFC Code of Conduct. The self-reporting requirements have recently been changed to require firms to not only report breaches of the market misconduct laws within their organisation but also suspected breaches by clients. The difficulty for any institution in terms of self-reporting is making the judgment call on whether the conduct could – on the basis of “reasonable suspicion” – be a breach. An obvious source of guidance is decisions, which are accessible and transparent, made by the Courts or the MMT; however, with the SFC’s new approach and the use of section 213, we may see fewer or less frequent court and MMT decisions. Further, to some extent, institutions will have to anticipate the SFC internal thinking on what constitutes “market misconduct”; therefore making what is already a difficult issue for clients even more complex. It is more important than ever to have a system in place to assess, and self-report, known or suspected breaches.
We regularly advise clients in relation to their self-reporting obligations and can assist with any questions you may have, such as what criteria to use and how to assess materiality.
This is effective 1 December 2012. This change was proposed by the SFC as part of an SFC consultation on changes to the Code to cater for the establishment of the Financial Dispute Resolution Centre (if you are interested in the FDRC, please click here for our Client Alert :http://www.mallesons.com/publications/marketAlerts/2012/Pages/Financial-Dispute-Resolution-Centre-FDRC-in-Hong-Kong-soon-to-commence-operations.aspx),