CFA clarifies the proper approach for interpreting “Red Flag” Reports



In Moody’s Investors Service Hong Kong Ltd v Securities and Futures Commission (SFC) [2018] HKCFA 42, the Court of Final Appeal (“CFA”) dismissed an appeal brought by Moody’s Investors Service Hong Kong Ltd (“Moody’s”) in relation to SFC’s disciplinary action concerning a report entitled “Red Flags for Emerging-Market Companies: A Focus on China” (the “Report”).  We had previously issued a newsletter “Do “Red Flag” Reports Constitute Credit Rating?” (July 2017 Issue) which discussed the background facts and procedural history of the case.


In gist, the Report identified five categories of “red flags” as warning signs for examining 61 Chinese companies (the “Companies”). Following the issuance of the Report, the price of shares in many of the Companies fell substantially. SFC subsequently imposed a public reprimand and penalty on Moody’s for breaching the Code of Conduct for Persons Licensed by or Registered with the SFC (the “Code of Conduct”), and the decision was upheld by the Securities and Futures Appeal Tribunal (“SFAT”). The Court of Appeal, while considering the Report itself did not constitute credit rating, found that the preparation and publication of the Report was an activity relating to credit ratings services (i.e. Type 10 regulated activity) pursuant to section 193 of the Securities and Futures Ordinance (Cap. 571) (“SFO”) and dismissed appeal by Moody’s. Moody’s further appealed to the CFA.

Issue before the Court

Part IX of SFO is concerned with “Discipline, etc.”, under which section 193 provided a list of definitions of “misconduct”, covering contraventions of provisions of SFO, of provisions of any relevant licence or registration, or of any other condition. In particular, section 193(1)(d) provides that “misconduct” is “an act or omission relating to the carrying on of any regulated activity for which a person is licensed or registered which, in the opinion of the Commission, is or is likely to be prejudicial to the interest of the investing public or to the public interest”. Section 194 enables SFC to exercise its powers when SFC, among others, concludes that a regulated person “is, or was at any time, guilty of misconduct”.

The issue for CFA to determine is whether the publication of a report having features such as those contained in the Report constitutes “misconduct” within the definition of section 193 of the SFO, such that the SFC has jurisdiction to discipline Moody’s under Part IX of SFO.

The meaning and effect of the phrase “relating to”

Moody’s sought to argue that in the context of section 193(1)(d), the preparation and publication of a document such as the Report, which did not itself involve the provision of credit rating services, could only be said to be “related to” the provision of such services if it had been (or was understood, or would reasonably have been understood to have been) involved in the preparation of credit rating. Otherwise, the law would be uncertain and it would be inappropriate as Part IX of SFO created an offence and involved curtailing freedom of expression.

CFA considered such interpretation of section 193 to be too narrow and specific. Given that “relating to” is a general proposition and with reference to local case laws, it was held that the phrase should contain “the widest possible meaning of any expression intended to convey some connection… between the two subject-matters to which the words refer”. Where the legislature used words which are very general in their natural ambit, the Court would be reluctant to attribute a relatively specific meaning to those words without any cogent reason.

In the present context, Part IX of SFO is part of the scheme introduced to protect members of the public and financial markets against inappropriate or substandard behaviour, and which is directed to sophisticated people, expert and experienced in financial markets who are often in a privileged position. The purpose of SFO to regulate and sanction “regulated activity” and to encourage high standards is clearly in the public interest. Therefore the argument that the phrase “relating to” should hold a narrower meaning would not stand.

Proper approach for interpreting the Report

While Moody’s argued that its personnel did not regard the Report as part of, or connected with, its credit rating service, and instead considered the Report as a pilot or new experiment, CFA dismissed this as a relevant factor to determine the effect of the Report. CFA stated that the question whether the Report can be said to have been “relating to” the provision of credit rating services must, at least primarily, be assessed by reference to how it was, or could reasonably have been expected to be, understood by the people to whom it was addressed i.e. investors and traders in the market for debt and debt-related instruments.  This approach in essence requires one to consider the document by reference to its contents in a practical and realistic sense.

Whether the Report was related to Moody’s Credit Rating Services?

Services provided by Moody’s

First, CFA noted that Moody’s is renowned for providing credit rating services and is only licensed for credit rating services among the 12 types of regulated activity under SFO.   It naturally follows that there must be a substantial risk that many people in the market will assume that any report issued by Moody’s is related to its credit rating services, especially if it is concerned with the soundness of the accounting and governance processes and the quality of earnings of specific Companies.

Contents of the Report

All of the Companies were subject to Moody’s previous published credit ratings. Indeed, the Report emphasized that the “red flag” system it introduced did not represent or justify a departure from the previous ratings accorded by Moody’s to any of the Companies in its previous credit rating reports. However, an acute trader or investor reading the Report would inevitably take the “red flags” into consideration when assessing the Companies’ existing credit rating.  While a clear and convincing disclaimer would be useful to discharge readers to link the “red flags” to the credit rating of the Companies, there was no such disclaimer in the Report.

Further, there were frequent references to the credit ratings of the Companies in the text of the Report. The red flag results were shown against each rating category of “Investment grade”, and it was stated in the Report that the “tripping of many red flags does not represent an immediate rating concern”. These pointers drew strong connection between the red flags and credit rating of the Companies, and suggested that the credit rating of the Companies may change in the future. CFA also considered the Announcement accompanying the Report, which described the contents of the Report as being “supplemental to Moody’s methodological approach to rating non-financial corporates in the emerging markets”. Since the word “supplemental” was used, one would have thought that it also “relates to” the subject matter i.e. credit rating of the Companies.

External factor of the market reaction

Last but not least, according to the SFAT, the market reaction to the Report should have been foreseen by Moody’s. Since the market put great emphasis on the ratings accorded by the major rating agencies to the Company, the only sensible interpretation of the market reaction was that the Report provided a negative qualification to the existing ratings of the Companies.

Based on the above, CFA concluded the Report to be within the ambit of “misconduct” of SFO and dismissed the appeal.


This marked the end of the challenge by Moody’s against SFC’s jurisdiction over the Report since November 2014. The decision of CFA reinforced SFC’s role in penalising inappropriate behaviour or substandard work of licensed persons. Licensed persons, in particular credit rating agencies, should be prudent when analysing and making publications in respect of listed companies to ensure compliance with the provisions set out in the Code of Conduct.


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Important: The law and procedure on this subject are very specialised and complicated. This article is just a very general outline for reference and cannot be relied upon as legal advice in any individual case. If any advice or assistance is needed, please contact our solicitors.
Published by ONC Lawyers © 2019