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— Judgment Call —
The recent decision of Hong Kong's Court of Final Appeal in To Shu Fai v Securities and Futures Commission [2009] HKCU 423 is interesting for a variety of reasons. By far the most significant practical issue arising from the decision and the implication this has for listed companies and their directors is that the court has cleared the way for the Securities and Futures Commission, or SFC, to take enforcement action, in the form of criminal proceedings, against listed companies and their officers who issue announcements containing false or misleading statements or information. The facts of the To Shu Fai case are relatively straightforward. To, the chairman and an executive director of Daido Group Ltd., a company listed on the Stock Exchange of Hong Kong Ltd., had in July or August 2003 instructed a director of TKR Finance Ltd. to sell 200 million Daido shares that To indirectly controlled.
The sale was effected on Oct. 16, 2003. The proceeds of the sale were, with the prior approval and at the instruction of To, paid to TKR Finance to satisfy loans previously advanced by TKR Finance to To to finance, in part, his acquisition of control of Daido. TKR Finance held a charge over all the shares To acquired in Daido. The sale of the 200 million shares in Daido on Oct. 16, 2003, as compared to the daily average of about 350,000 shares over the previous 10 days, resulted in the Stock Exchange contacting Daido's company secretary during that afternoon, inquiring whether there was any reason for the sudden increase in the volume of trading in the shares of Daido. The company secretary contacted all the Daido directors and relayed the query. All the directors, including To, responded that they were not aware of any reason for the sudden increase in the volume of share trading. At the request of the Stock Exchange, Daido issued the following public announcement, dated Oct. 16, and for which all directors confirmed they were jointly and solely responsible: "The board of directors of Daido Group Limited has noted the increase in the trading volume of the shares of the company today and wishes to state that it is not aware of any reasons for such increase. The board of the company also confirms that there are no negotiations or agreement relating to intended acquisitions or realizations which are discloseable under paragraph 3 of the Listing Agreement, neither is the board of the company aware of any matter discloseable under the general obligation imposed by paragraph 2 of the Listing Agreement, which is or may be of a price-sensitive nature." Given that To sold 200 million Daido shares Oct. 16, 2003, the announcement was clearly false. Both To and Daido were convicted following prosecutions by way of summons in the magistracy of knowingly or recklessly providing false or misleading information to the SFC, in contravention of Sections 384(1) and (6) of the Securities and Futures Ordinance, Cap 571 (SFO). Both convictions were upheld on appeal to the Court of First Instance. With leave from the Appeal Committee, only To appealed against his conviction to the Court of Final Appeal. Despite Daido's absence as an appellant in the To Shu Fai appeal, the Court of Final Appeal was of the view that it was still necessary to consider the conviction against Daido in order to dispose of To's appeal. Section 384(1) of the SFO provides: "(1) Subject to subsection (2), a person commits an offence if: (a) He, in purported compliance with a requirement to provide information imposed by or under any of the relevant provisions, provides to a specified recipient any information which is false or misleading in a material particular; and (b) He knows that, or is reckless as to whether, the information is false or misleading in a material particular." A person who commits an offense under Section 384(1) is liable on conviction on indictment to a fine of HK$1 million and to imprisonment for two years and, on summary conviction, to a fine of HK$50,000 and to imprisonment for 1 year. The Court of Final Appeal endorsed the magistrate's and the Court of First Instance's finding that (i) anyone in To's position and with his knowledge would have suspected that the sudden and sharp increase in the trading volume of Daido shares could have something to do with the imminent anticipated sale of Daido shares by TKR Finance and (ii) Daido's knowledge regarding the announcement emanated from To, its chairman and director and that its state of mind was that of To. Accordingly, To's conviction was upheld. What is interesting about the case is that the proceedings against Daido and To were not initiated by the Stock Exchange, but by the SFC. The Oct. 16 announcement was submitted to the Stock Exchange and it is clear that as the announcement's recipient, the Stock Exchange would have been entitled to initiate proceedings against both Daido and To for breach of Section 384(1) of the SFO. On what basis, was the SFC empowered to initiate the prosecution of both Daido and To? Since April 2003, whenever a listed company files a copy of any announcement, statement or circular pursuant to the listing rules, a copy of that announcement must, by virtue of Section 7(1) of the Securities and Futures (Stock Market listing rules), (SFO listing rules) also be filed with the SFC within one business day following the day on which the announcement is made or issued. This is known as the "dual-filing" regime, which was one of the many new provisions that were ushered in with the enactment of the SFO in 2003. A listed company will be deemed to have complied with Section 7(1) if it files the announcement with the Stock Exchange and has authorized the Stock Exchange in writing to file with the SFC a copy of the relevant announcement. Before permission is granted for the securities of a company to be admitted to the Stock Exchange, one of the documents the listing applicant will invariably be required to sign is a written authorization to the Stock Exchange to file announcements with the SFC. While Daido had previously authorized the Stock Exchange to file with the SFC on its behalf all relevant documents required to be filed under Sections 7(1) and (2) of the SFO listing rules, the prosecution admitted that the Stock Exchange had not, as a matter of fact, forwarded a copy of the relevant Oct. 16 announcement to the SFC. The Court of Final Appeal was, therefore, required to consider whether the announcement had, for the purposes of Section 384(1) of the SFO, been "provided" to the SFC. If it had not been provided to the SFC, then the conduct that would constitute the actus reus [guilty act] of Section 384(1), when read in conjunction with Section 7(1) of the SFO listing rules -- providing a copy of the October 16 announcement to the SFC -- would be absent, and hence the criminal act complained of would not have been established. The court swiftly dealt with this issue by stating that the word "provide" should be construed in accordance with its ordinary and natural meaning, which is to "supply, furnish for use or make available." Further, Mr. Justice Chan PJ and Mr. Justice Ribeiro PJ went on to say: "What constitutes 'providing' for the purpose of Section 384(1) must be decided on the facts of each case, adopting the ordinary and natural meaning of the word and applying a pragmatic and common sense approach to the facts ... There is thus no good reason for not accepting that the filing of a copy of the [October 16 announcement] with the [Stock Exchange] in pursuance of [the] statutory mechanism [contemplated by Section 7(1) of the SFO listing rules] constitutes 'providing' a copy with the SFC within the meaning of Section 384(1)." At first blush the To Shu Fai case is not remarkable -- a listed company published a false announcement and both the company and its executive chairman were held accountable. However, from a practical perspective, the case is important in that the criminal convictions of both Daido and To were the first of their kind for providing false and misleading information under the dual-filing regime introduced by the SFO in 2003. To date, where the Stock Exchange has taken action against listed companies and their directors for noncompliance with the Stock Exchange listing rules by, for example, failing to adhere to a particular deadline under the listing rules or by issuing an announcement containing false or misleading information, such action has largely been confined to the initiation against the company and its directors of disciplinary proceedings under the Rules of the Stock Exchange. The sanctions that may be imposed on listed companies and their directors in such circumstances range from the issue of private reprimands to suspending or canceling the listing of a company's securities. Generally, however, the sanctions that have been imposed with respect to Stock Exchange initiated disciplinary proceedings have not been particularly severe and more akin to a slap on the wrist. Sanctions have often ranged from a private reprimand to the issue of a public censure -- a far cry from a criminal conviction. As a result, doubt has been expressed as to efficacy of such disciplinary proceedings. To a large extent, the Stock Exchange has not been able to seek to impose wider and more stringent sanctions against those who flout the listing rules simply because most of the listing rules lack statutory backing. However, the introduction of the dual-filing regime under the SFO listing rules on April 1, 2003, has provided a limited form of statutory backing. Indeed, Section 384(1) of the SFO, read in conjunction with Section 7 of the SFO listing rules, is one such example and since April 2003 the door has been open for the Stock Exchange to initiate criminal prosecutions against those who recklessly publish false or misleading announcements. It would appear that if the Stock Exchange does not initiate such proceedings, the SFC will. In a press release issued by the SFC's Mark Steward on March 26 following the Court of Final Appeal decision, Steward stated: "Listed companies and their directors should be under no illusions. Statements that they make to the market through the stock exchange must be accurate and truthful. Equally important is that the [To Shu Fai] case provides authoritative confirmation that criminal prosecution is a real rather than a theoretical risk. This decision will pave the way for more enforcement action, where appropriate, against listed companies and their directors who provide false or misleading information to the SFC or the [Stock Exchange]." The message is crystal clear -- listed companies and their directors can ill afford to issue announcements without taking the time to thoroughly verify the contents of their announcements. While the object of such a verification exercise is to ensure the accuracy of the information contained in an announcement, it is possible, even after undertaking a verification exercise, for errors to be made. However, if one is able to demonstrate that reasonable efforts have been undertaken to verify the contents of an announcement, absent actual knowledge that the announcement is false or misleading, this could constitute a defense to a Section 384(1) prosecution because the element of recklessness would be lacking. The failure to undertake such an exercise will certainly expose the company and its directors to criminal prosecution. Michael P. Phillips is a partner with Luk & Co., in association with Winston & Strawn LLP. |
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