Landmark decision expands insider dealing regime
Mark Johnson, Partner, Debevoise & Plimpton, looks at the recent decision by the Court of First Instance in The Securities and Futures Commission v Young Bik Fung and Others which has expanded the insider dealing regime in Hong Kong.
The Court of First Instance has recently handed down a landmark decision in the case of The Securities and Futures Commission v Young Bik Fung and Others (HCMP No 2575 of 2010) on 15 January 2016. Under the Hong Kong market misconduct regime, insider dealing is typically enforced under Sections 270 or 291 of the Securities and Futures Ordinance (SFO). However, these provisions are expressly subject to a territorial limitation, in that these provisions can only be used to prosecute insider dealing in relation to securities listed on the Hong Kong Stock Exchange. The Young Bik Fung case is of significance because it is the first case in which a Hong Kong court has accepted the use of Section 300 of the SFO (which prohibits the use of fraudulent or deceptive devices in a transaction involving securities) in relation to insider dealing in securities listed overseas.
By way of background, the Securities and Futures Commission (SFC) brought two cases against Ms Young, the first of which concerned the takeover of Hsinchu International Bank Co Ltd, a bank listed in Taiwan, by Standard Chartered Bank group (SCB) (the Tender Offer); and the other concerned the privatisation of Asia Satellite Telecommunications Holdings Ltd by its major shareholder, CITIC Group (the Privatisation).
The focus of this article will be on the Tender Offer, in respect of which the court made its important interpretation on the territorial scope and applicability of Section 300 of the SFO. It is important to note that the court’s interpretation of Section 300 was in the context of a compensation claim by the SFC under Section 213 rather than in relation to a prosecution under Section 300.
There were four defendants in the Young Bik Fung case. Betty Young, the first defendant, was a solicitor employed by a law firm engaged by SCB. At the material time, Betty was seconded to SCB, spending the majority of her time working on the Tender Offer. The second defendant, Eric Lee, was a solicitor employed by a law firm engaged by CITIC in respect of the Privatisation. Betty and Eric were in a relationship and cohabited between 2003 and 2006. The third and fourth defendants, Patsy Lee and Stella Lee, are Eric’s sisters. Through Eric, Betty became acquainted with Patsy and Stella.
The Tender Offer case
The basic facts of this case were undisputed and they are summarised as follows.
In 2006, SCB was in confidential negotiations with Hsinchu Bank to takeover the latter by making a recommended tender offer for all its shares, and in respect of which the management of Hsinchu Bank would recommend its shareholders to accept the offer.
SCB’s Group Legal Department in Hong Kong was involved in handling and managing the legal and regulatory work. In April 2006, Betty was seconded by her then employer to SCB to work on the Tender Offer. In the course of Betty’s secondment, she was an ‘insider’ who had access to highly confidential materially price-sensitive information (MNPI).
In August 2006, SCB and Hsinchu Bank started negotiations on the price of the Tender Offer. By 14 September 2006, the proposed tender price of New Taiwan dollars (NT$) 24.50 per share was approved by SCB and inserted into a draft press release which was circulated internally, when Hsinchu Bank’s shares were then trading at around NT$14 per share. Such information constituted MNPI in relation to Hsinchu Bank’s shares until the public announcement of the Tender Offer was published on 29 September 2006.
Prior to the public announcement of the Tender Offer, on 20 September 2016, Patsy opened a new securities account with a local securities brokerage, which allowed her to trade in shares listed on the Taiwan Stock Exchange. Between 21 and 29 September 2006, the four defendants put together substantial funds and injected them into the said account. Patsy used those funds to make a total of six purchases of Hsinchu Bank shares, acquiring a total of 1,576,000 shares at an average price of NT$16.99 per share and at an aggregate cost of NT$26,782,000.
In the afternoon of 29 September 2006, SCB announced the Tender Offer. The offer price was at a substantial premium to the market price. For the defendants, the offer price was 44% above the average price of their acquisitions, generating a total profit of approximately HK$2,685,000.
The court found that Betty had shared her knowledge of the Tender Offer with Eric, and they both decided to trade with such knowledge by arranging for Patsy to open an account in Patsy’s name to create some distance between themselves and the trading.
Points of law
As mentioned above, the SFC had to rely on Section 300 of the SFO, instead of the usual insider dealing provisions under Sections 270 and 291 of the SFO, in the Tender Offer because Hsinchu Bank’s shares were listed outside Hong Kong on the Taiwan Stock Exchange.
The defendants sought to argue that Section 300 of the SFO should have no application at all because the securities transactions took place (or were completed) outside Hong Kong. The court rejected the argument and it was held that ‘transaction’ is widely defined in Section 300 of the SFO to include any offer or invitation, and that the transaction in question did not have to be completed in Hong Kong. The court took the view that any fraudulent or deceptive conduct employed in making an offer to buy securities in Hong Kong would fall within the scope of Section 300 of the SFO, regardless of whether the securities were traded overseas. In other words, the court retained jurisdiction in the Tender Offer case because the offer to buy the Hsinchu Bank shares, which the SFC argued involved fraudulent or deceptive conduct, took place in Hong Kong, and it matters not whether the trade was in fact executed or completed overseas.
In this context, the court held that the application of Section 300 in the Tender Offer case did not involve an extra-territorial application of the law, and the court held that Section 300 does not have extra-territorial application.
Fraud and deception
Section 300(1) of the SFO is a fraud provision and it provides that it shall be an offence for a person, in a transaction involving securities, to ’employ any device, scheme or artifice with intent to defraud or deceive’, or ‘engage in any act, practice or course of business which is fraudulent or deceptive, or would operate as a fraud of deception’. In other words, Section 300 of the SFO captures insider dealing by identifying fraudulent or deceptive conduct occurring in Hong Kong associated with the overseas trading.
In Young Bik Fung, the court made reference to the fiduciary duties owed by Betty to SCB and in particular, the following:
- an email sent by Betty months before the trading took place in which she acknowledged reading and understanding SCB’s memorandum on inside information which imposed a duty of confidence and prohibited disclosure or use of inside information
- Principle 8.06 of the Solicitor’s Guide to Professional Conduct which prohibits a solicitor from making personal profits by using confidential information acquired in the course of a professional relationship, and
- the common law fiduciary duty to act in good faith and not to act for her own benefit or the benefit of a third person without the informed consent of his principal.
It was held that SCB was defrauded and deceived by Betty’s conduct as Betty’s acknowledgement of the dealing restrictions applicable to her as a person working within SCB on the Tender Offer must be a continuous representation by her that she would not deal in the shares of Hsinchu Bank. It was further held that:
- Betty’s decision and actions to misuse the MNPI secretly constituted a scheme or act of deception as SCB must have been labouring under the belief that Betty was abiding by her representation and therefore, by Betty’s deception, SCB was deprived of the right to take action to protect its MNPI
- SCB acted to its economic detriment by paying the defendants via the Tender Offer for their shares in Hsinchu Bank, when, if they had known the shares had been bought in breach of fiduciary duties owed to it by Betty, they would obviously have refused to pay out to her and her tippees, and
- Eric and Patsy had employed or engaged in the same deceptive or fraudulent scheme or had aided and abetted in Betty’s conduct.
The SFC brought proceedings under Section 213 of the SFO seeking, among other things:
- declarations that the defendants had contravened or were concerned in fellow defendants’ contravention of Section 300 of the SFO in the Tender Offer case, and
- remedial orders for the return of the profits from the defendants’ illicit dealings in the Tender Offer case.
In light of the court’s factual findings, the court proceeded to find that Betty had employed a scheme with intent to defraud or deceive or engaged in an act or practice which was fraudulent or deceptive or would operate as a fraud or deception, and that Eric and Patsy had either employed or engaged in the same scheme, or aided and abetted Betty’s conduct, in contravention of Section 300 of the SFO.
The court found that the SFC had established its case against Betty, Eric and Patsy in respect of the Tender Offer case and directed the parties to endeavour to agree the terms of relief for the court’s approval. Stella was found not guilty under Section 300 of the SFO as the court was not satisfied that Stella had the same ‘guilty knowledge’ as Patsy.
In light of the professional qualifications of Betty and Eric as solicitors, the court also made a direction to send a copy of its judgment to the Secretary General of the Law Society and it is expected that disciplinary action will be taken.
In recent years, the market has seen increasing cross-border securities trading activities and cross-border investigations and enforcement cooperation between regulators in different jurisdictions. The court’s judgment in this case, by giving a wide interpretation of the ambit of Section 300 of the SFO, sends a very clear message to all market participants that the SFC may investigate and prosecute insider dealing in respect of shares listed overseas.
Partner, Debevoise & Plimpton