By Barbara Chiu King & Wood Mallesons Dispute Resolution Group
The Securities and Futures Ordinance (Cap. 571) (“SFO”) regulates the securities and futures market in Hong Kong, and provides a comprehensive civil and criminal regime to address misconduct in the financial market. In addition, sections 40 (Civil liability for misstatements in prospectus) and 40A (Criminal liability for misstatements in prospectus) of the Companies (Winding Up and Miscellaneous Provisions) Ordinance (Cap. 32) (“CWUMPO”) also impose civil and criminal sanctions for misstatements made in a prospectus for the protection of public investors.
In this article, we will focus on SFO sections 277 (Disclosure of false or misleading information inducing transactions), 298 (Offence of disclosure of false or misleading information inducing transactions) and 384 (Provision of false or misleading information) concerning the disclosure of false or misleading information and CWUMPO sections 40 and 40A.
1. Legal principles
1.1 Sections 277 and 298 – Disclosure of false or misleading information inducing transactions
Section 298 is the basis for criminal sanction, and its equivalent civil sanction is set out in section 277. Under sections 277 and 298, liability arises where a person discloses, circulates or disseminates, or authorises or is concerned in the disclosure, circulation or dissemination of false or misleading information which is likely to induce subscription, sale or purchase of securities or dealing in futures or increase, reduce, maintain or stabilize price, and the person knows that, or is reckless or negligent (for civil proceedings only) as to whether, it is false or misleading.
Prosecution is required to prove that the information in question was false or misleading as to a material fact, or was false or misleading through the omission of a material fact.
1.2 Section 384 – Provision of false or misleading information
Section 384 provides that it is an offence for any person, in purported compliance with a statutory requirement to provide the Securities and Futures Commission (“SFC”) or the Hong Kong Stock Exchange (“HKEx”) with information that is false or misleading in a material particular. This offence may be prosecuted by the SFC in the Magistrates Court or by the Department of Justice on indictment. The maximum penalty on indictment is 2 years imprisonment and a fine of HK$1 million.
Under section 384, the prosecution has to prove:
a. The person is in purported compliance with a requirement to provide information imposed by or under any of the relevant provisions;
b. Such person provided information to a specific recipient; and
c. Such information was false or misleading in a material particular and that he knew or was reckless as to whether the information was false or misleading.
In determining whether a statement was materially misleading, the primary question is twofold:
a. Whether the impugned statement had a tendency to convey a meaning inconsistent with the true state of affairs?
b. Whether the natural and probable result of the impugned statement would be to induce the reader to act in belief that is inconsistent with the true state of affairs?
It should be noted that the law requires that the misstatement must be false “as to a material fact” or is false “through the omission of a material fact”. Accordingly, minor misstatements or errors would not attract liability under the aforementioned sections.
1.3 Civil and criminal liabilities for misstatements in prospectus under the Companies (Winding Up and Miscellaneous Provisions) Ordinance (Cap. 32)
Section 40 imposes a civil liability to pay compensation for losses suffered by those who subscribed to shares or debentures after relying on untrue statements included in a prospectus. The liability to compensate is imposed by section 40(1) on the following classes of persons (subject to a number of defences provided under section 40(2)):
a. Every person who was a director of the company at the time the prospectus was issued
b. Every person who has agreed to be named in the prospectus as a director or who has agreed to become a director
c. Every person who is a ‘promoter’ of the company (as defined in section 40(5)(a))
d. Every person who has authorised the issue of the prospectus (but not including the Commission or its delegate: section 40(1A))
In contrast, section 40A imposes a criminal liability for such misstatements in relation to prospectuses issued by a company incorporated in Hong Kong. In general, where a prospectus includes an untrue statement, any person who has authorised the prospectus will be liable to imprisonment and a fine unless it can be shown that the statement was immaterial or that there were reasonable grounds to believe, and that the person did believe, that the statement was true (section 40A(1)). Where a breach of section 40A has been proved on indictment, a fine of up to HK$700,000 and three years’ imprisonment may be imposed. Where the matter is tried summarily, a fine of up to HK$150,000 and 12 months’ imprisonment may be imposed.
2. Our experience
We have advised listed companies / senior executives belonging to various business sectors during different stages of regulatory investigations. We provide strategic planning and advice in relation to investigations conducted by the relevant regulators and enforcement agencies including SFC, Independent Commission Against Corruption and Commercial Crime Bureau and assistance in defending any charges that may arise from such investigations. We have advised on a wide range of issues and areas of law, including disclosure of false / misleading information inducing transactions, disclosure of inside information, continuous disclosure obligations and legal professional privilege.
Based on our experience, it is most common to see investigations initiated by the SFC to be in relation to, inter alia, SFO sections 277, 298 and 384 regarding disclosure of false / misleading information in the listed companies’ documents including prospectus, announcements and circulars. Whenever the SFC receives complaints regarding potential market misconduct and/or breach of relevant SFO provisions on the part of a listed company / relevant persons and the SFC has reasonable grounds to form a prima facie case against the listed company / relevant persons, they will initiate investigations under SFO section 182 and exercise the investigatory power vested upon them under SFO section 183 to request the listed company and/or the senior executives / relevant persons to produce relevant documents and to attend interviews with SFC investigators for the purpose of gathering information. It is the usual practice of the SFC to either make such a request in writing or apply to court for a search warrant to seize the relevant documents located in the office premises of the listed company and/or its legal representatives. It is a criminal offence if any request made under SFO section 183 is not complied with without any reasonable excuse.
At the outset of the SFC investigation, clients should take note of the following:
a. Obligation of secrecy
i. SFO section 378 imposes obligations of secrecy upon any persons assisting the SFC in carrying out their investigations.
ii. Such persons must not disclose anything about the investigation to anyone, failing which, will constitute a criminal offence.
b. No right to silence
i. SFO section 183 explicitly requires that a person must attend before the investigator at the time and place the investigator requires upon notice from the SFC, and answer any question relating to the matters under investigation that the investigator may raise with him.
ii. Section 184 states that it is an offence to fail to answer, without reasonable excuse, a question raised by the investigator.
iii. In other words, a person under investigation by the SFC is not entitled to refuse to answer any question and exercise his right to silence.
c. Legal professional privilege (“LPP”)
i. LPP is expressly preserved and protected under SFO section 380(4). We normally advise clients to designate a particular group of persons (e.g. the legal department of the company) to give instructions to and communicate with lawyers/legal advisers. It is of paramount importance that legal advices are disseminated to persons other than the board of directors only if absolutely necessary, so as to avoid any possibility for potential waiver of LPP.
ii. In a 2011 case, the Court of Appeal of the High Court of HKSAR unanimously held that partial waiver of LPP is recognised in Hong Kong. We will advise clients that, when under SFC investigations, it is now open for them to only assert, if necessary, a limited waiver of LPP in favour of the SFC for the purposes of the investigations. We will also advise clients to keep a clear written record at the outset on the conditions of the limited waiver of LPP with the SFC to avoid any confusion as to the extent of the limited waiver.
In recent years, we have observed the SFC take a more rigid and proactive approach in their investigations and prosecutions. They have increasingly taken a hard stance on market misconducts involving disclosure of false or misleading information/misstatements in prospectus. Very often, those investigations lead to criminal prosecution and cases that might involve corruption or fraud may be referred to other law enforcement agencies, including Independent Commission Against Corruption and Commercial Crime Bureau, for further investigation.
Given the potentially dire consequences of SFC’s investigations and the fact that a person under SFC investigations cannot exercise his right to silence, a listed company or its directors (executive/non-executive or independent) should immediately engage their own lawyers for advice on the potential civil or criminal liabilities and prepare for SFC’s request for documents and interviews.