New legislation in Hong Kong introduces a statutory regime for the disclosure of price-sensitive information by companies listed in Hong Kong. The regime substantially expands the existing framework and imposes personal liability on officers of such companies, including company secretaries. In this article, Timothy Loh, Principal, Timothy Loh Solicitors, provides an overview of the new legislation and offers suggestions on compliance.
The Securities and Futures (Amendment) Ordinance 2012 introduces a statutory regime mandating that companies listed on the Stock Exchange of Hong Kong (the Exchange) disclose price- sensitive information. This legislation, which is accompanied by guidelines (see the Guidelines on Disclosure of Inside Information on the SFC website) took effect on 1 January 2013.
The new disclosure regime will supplement existing disclosure requirements under the Listing Rules. The latter have sometimes been regarded as inadequate because sanctions for breach have historically been limited. However, given a more aggressive approach recently by the SFC and the courts in interpreting the Securities and Futures Ordinance (SFO), it is clear now that the pre-existing disclosure regime was not as inadequate as some once thought. As a result, the new disclosure regime will, in fact, only provide another tool (albeit an important tool) for ensuring market transparency.
Taken together, the pre-existing and the new disclosure requirements will mean that officers of listed companies now face an array of possible sanctions for failing to properly disclose price- sensitive information. It is therefore incumbent upon listed companies and their officers to establish policies and procedures to ensure compliance.
The new disclosure regime
The new disclosure regime establishes obligations for listed companies to make disclosure and for their officers personally to ensure that disclosure takes place properly. At the heart of the new disclosure regime is the definition of ‘inside information’. This term determines what constitutes price-sensitive information and therefore what needs to be disclosed and when. For companies, the regime provides that, unless exempted, a listed company must, as soon as reasonably practicable after any inside information has come to its knowledge, disclose that information to the public.
The new legislation broadly adopts the existing definition of inside information (previously known as ‘relevant information’) from the market misconduct regime. As a result, ‘inside information’ means, in relation to a listed company, specific information that meets all of the following three conditions. The information must be:
- relevant – it must be about the company, a shareholder or officer of the company or the listed securities of the company or their derivatives
- non-public – it must not be generally known to persons who are accustomed to, or would be likely to, deal in the listed securities of the company, and
- price-sensitive – if generally known to such persons the information must be likely to materially affect the price of those securities.
In practice, what constitutes inside information is often a difficult question of judgement. Information which may constitute inside information in one context may not constitute inside information in a different context. For example, a HK$50 million transaction may be significant for one listed company but may be insignificant for another substantially larger listed company. Equally, information may be of an uncertain nature and its materiality therefore difficult to ascertain. Reasonable men may differ as to whether any specific piece of information may, by itself or in conjunction with other information, be likely to affect the price of a company’s securities in a material way. For example, where a listed company is in discussions about a possible transaction, the extent to which those discussions have progressed will be critical in determining whether information about that possible transaction constitutes inside information. There is no bright line test as to when the discussions will have progressed far enough to constitute inside information.
The SFC has issued guidance as to what constitutes inside information and such guidance is admissible in court, but it will not bind a court. Thus, in the end, in the event of any doubt as to what constitutes inside information, it will almost always be beneficial to seek independent professional advice. This is particularly so given that, as discussed below, (i) the new disclosure regime is not triggered unless a reasonable person would consider that the information in question is inside information, and (ii) the failure to seek such advice may be regarded as negligent, thus exposing officers to potential personal liability.
It is unclear to what extent a listed company’s financial position may constitute inside information ahead of the release of its financial results. Take for example a listed company whose financial year ends on 31 December. By mid- January, the company may have a fairly good idea of its financial results for the previous financial year but the financial results will not be finalised until an audit is completed. The audit itself may not be completed until March. Does information as to the financial results as set out in
the management accounts constitute inside information? At least to the extent that the financial results may differ markedly from market expectations, it may be argued that such information may constitute inside information, otherwise a person would be permitted to trade on the basis of this information. If this is correct, then under the new disclosure regime, a listed company must disclose this information, possibly in the form of management guidance, even before the financial results have been audited.
Knowledge of inside information
As set out above, the new disclosure regime is triggered only when inside information has come to the knowledge of a listed company. In this regard, inside information has come to the knowledge of a listed company if two conditions are satisfied.
- Officer knowledge. The information has, or ought reasonably to have, come to the knowledge of an officer of the company in the course of performing functions as an officer of the company. Significantly, liability may follow if an officer ‘ought reasonably’ to have known about the information and thus, it is no defence to deny actual knowledge.
- Objective test. A reasonable person, acting as an officer of the company, would consider that the information is inside information in relation to the company. As a result of this condition, it seems that a good faith determination that information is not inside information does not discharge liability for breach of the new disclosure regime if it is subsequently held that such information was inside information.
It is not clear under the SFO who might qualify as an ‘officer’ for the purpose of the new disclosure regime. The SFO does provide that an officer will include a director, manager or secretary or any other person involved in the management of a listed company, but does not go on to define a ‘manager’ or a ‘person involved in the management of a listed company’. In an attempt to clarify, the SFC has suggested in its Guidelines on Disclosure of Inside Information that a ‘manager’ will normally refer to a person under the immediate authority of the board who is charged with management responsibility affecting the whole of the corporation or a substantial part of the corporation.
Broadly, at present, there are three categories of exemption from the disclosure requirement. All these exemptions will apply on a case by case basis.
- The disclosure is prohibited by Hong Kong law. A listed company is not required to disclose inside information if and so long as the disclosure is prohibited under, or would contravene, a restriction imposed by Hong Kong legislation or an order of a Hong Kong court. In this regard, a mere contractual restriction on disclosure would seem insufficient to invoke exemption as such a restriction would not originate from Hong Kong legislation; however, to the extent that such a restriction were enforced by a Hong Kong court through an injunction, it would seem sufficient to invoke exemption.
- The disclosure is prohibited by foreign law. The SFC may, on an application by a listed company, waive a disclosure requirement if disclosure is prohibited under, or would contravene, any restriction imposed by legislation outside of Hong Kong, or any order of a court outside Hong Kong, or would contravene any restriction imposed by any law enforcement agency or other government authority outside of Hong Kong.
- The information is confidential.
A listed company is not required to disclose inside information if the information concerns an incomplete proposal or negotiation or the information is a trade secret. However, to qualify for exemption, the company must take reasonable precautions to keep the information confidential and confidentiality must in fact be kept. If confidentiality is breached, a listed company must as soon as reasonably practicable after it becomes aware of the breach disclose the information. In this case, it will not be liable if, despite the breach, it had taken reasonable measures to maintain confidentiality. A listed company may, without breaching confidentiality, disclose the inside information to a person who requires the information to perform his functions and who is under a duty to keep the information confidential (for example a legal adviser).
Whilst the SFC has the power to create further exemptions in consultation with the Financial Secretary, at present, it may be that the regime is overly rigid given the absence of an ad hoc power for the SFC to waive or defer disclosure subject to conditions. This leaves no room for competing public policy considerations (for example safety or public order) which may be applicable to relax a disclosure decision but which may be inapplicable to relax a trading prohibition. The absence of discretionary exemptive relief means that disclosure decisions will be based solely on a judgement as to whether information does or does not constitute inside information rather than on a judgement as to whether information should or should not be disclosed. This may pervert the meaning of inside information so that there may be cases where a person can trade on inside information in circumstances where, from a policy perspective, he should be prohibited from so doing and conversely, there may be cases where a listed company must disclose inside information where from a policy perspective such disclosure may be premature.
Where a listed company is obliged to disclose inside information, it may do so in any manner that can provide for equal, timely and effective access by the public to that inside information. Under the new disclosure regime, a listed company will be deemed to have disclosed information in a manner that provides for equal, timely and effective access if it disseminates the information through the Exchange.
False or misleading disclosure
A listed company is taken not to have complied with its disclosure obligation if both the following conditions are met:
- the company discloses information that is false or misleading as to a material fact, or is false or misleading through the omission of a material fact, and
- an officer of the company 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.
Holding announcements and suspensions
Where a listed company needs more time to clarify its position before disclosing information, the SFC has suggested in its Guidelines on Disclosure of Inside Information that the company should consider issuing a holding announcement which details as much of the subject matter as possible and sets out reasons why a fuller announcement cannot be made.
The requirement for equal, timely and effective access may, in practice, require that listed companies seek a suspension of trading in their securities pending the disclosure of inside information. Failure to do so may result in unequal disclosure.
Officers of listed companies who fail to comply with disclosure obligations may bear personal liability. Under the new legislation, every officer of a listed company must take all reasonable measures from time to time to ensure that proper safeguards exist to prevent a breach of disclosure requirements. If a listed company breaches disclosure requirements, an officer may be personally liable if (i) his intentional, reckless or negligent conduct resulted in the breach, or (ii) he failed to take all reasonable measures from time to time to ensure that proper safeguards existed to prevent breaches. As defined under the SFO, in relation to a corporation, an ‘officer’ means ‘a director, manager or secretary of, or any other person involved in the management of, the corporation’. Company secretaries are therefore exposed to potential personal liability.
It is significant to note that an officer may bear personal liability even if he has no intention to mislead the investing public. Negligence itself will suffice if it resulted in a breach, as will a failure to take all reasonable measures to ensure that proper safeguards are in place.
The negligence standard implies that listed companies should seek professional advice when there is any issue as to the appropriateness of the compliance programme, or as to whether information constitutes inside information. Failure to seek such professional advice may be regarded as a basis for a claim of negligence.
It is contemplated that the new disclosure regime will be enforced by the SFC through the Market Misconduct Tribunal (MMT). Thus, the SFC will investigate and, if thought fit, refer the matter to the MMT for adjudication or further investigation. Should the MMT find a breach of disclosure requirements, it may make a number of civil orders.
In the first instance, the MMT has no jurisdiction to impose criminal penalties such as imprisonment. However, where a person has been found by the MMT to have breached disclosure requirements and, as a result, the MMT has ordered that the person must not again breach the disclosure requirements, if the person does breach disclosure requirements again, that person will commit a criminal offence punishable on indictment by imprisonment for up to two years.
Directors and officers liability
If a person (including any company secretary) is identified by the MMT as being in breach of a disclosure requirement, the MMT may make a number of orders including an order to:
- disqualify the person from being or continuing to be a director, or from otherwise being concerned or taking part in the management of a listed company or any other specified company for up to five years, or
- prohibit the person from dealing in securities, futures or leveraged foreign exchange contracts or any interest in them or a collective investment scheme for up to five years.
Of particular concern for directors and chief executives of listed companies (but not other officers such as company secretaries), is that the MMT may also impose a regulatory fine of up to HK$8 million.
Statutory right of action
Independent of regulatory enforcement through the MMT, a person who breaches a disclosure requirement may be liable to pay compensation by way of damages to any other person who sustains any pecuniary loss as a result of the breach. Thus, for example, it seems that if a person relies upon publicly available information to make an investment and the information turns out to be wrong and as a result, the person suffers a loss on his investment, he may sue for that loss. However, liability for compensation will only arise where it is fair, just and reasonable.
The significance of this right of action is that it is a subsidised lawsuit. Under the new disclosure regime, a finding of a breach by the MMT is not only admissible as evidence to prove a breach but, unless the contrary is proved, is conclusive evidence of the breach for the purposes of the right of action.
As a result, a private litigant need not undertake what would normally be expected to be a complex process of establishing liability.
Principal, Timothy Loh Solicitors
Copyright: Timothy Loh Solicitors
For more information, visit www. timothyloh.com. The author can be contacted at: firstname.lastname@example.org.
The SFC’s ‘Guidelines on Disclosure of Inside Information’ are available on the SFC website (www.sfc.org) under Legislation and Regulatory Handbook/ Regulatory Handbook/ Code, Guidelines and Circulars.
SIDEBAR: Action required
What should you be doing to ensure compliance? With the introduction of the new disclosure regime, it is perhaps timely for listed companies to review their policies and procedures to ensure compliance. Appropriate policies and procedures will, amongst other things, enable a listed company to demonstrate that it has in place reasonable precautions to preserve confidentiality of inside information which is not yet ripe for disclosure and to enable officers of a listed company to demonstrate that they have put in place proper safeguards to ensure disclosure as required. A failure in either of these regards may mean that a listed company will be unable to withhold disclosure of confidential information relating to a proposal or negotiation that has not yet reached fruition or that an officer may be more likely to be personally liable for a breach of a disclosure requirement.
The new legislation does not spell out what policies and procedures are required. The references to ‘reasonable measures’ and ‘proper safeguards’ are vague. We suggest a formal written statement setting out the terms of a compliance programme, staff training to ensure knowledge of the programme and programme content broadly as set out below.
• Governance structure for disclosure. This may, for example, include establishing (i) a disclosure committee to determine whether information constitutes inside information and what information will be disclosed, (ii) procedures for monitoring and escalating information which may constitute inside information to the disclosure committee, and (iii) procedures for seeking advice from legal advisers and regulatory bodies as the case may be to determine whether information constitutes inside information.
• Disclosure methodology. Policies and procedures may, for example, include (i) designating one or more spokespersons conversant with regulatory requirements to control the flow, quality and consistency of inside information being disclosed, whether written or verbal, and (ii) developing protocols for the release of information to vet the accuracy of information to be disclosed and to ensure timely and equal access by the investing public. These protocols should address how spokespersons should deal with rumours, analyst reports, conference calls and media requests for inside information.
• Security and confidentiality. Policies and procedures (i) to ensure that inside information which is not disclosed is kept confidential, (ii) to review publicly available information and information disclosed to analysts, the media or in conference calls to determine whether confidentiality has been breached, and (iii) to disclose inside information where confidentiality has been breached.
• Record keeping. Policies and procedures should be adopted to ensure that disclosure committee decisions are defensible and that there is no misunderstanding as to what has been disclosed and when.