Introduction

As explained in our December 2020 Regulatory & Compliance newsletter, the Carecraft Procedure in section 214 of the Securities and Futures Ordinance (Cap 571) (“SFO”) is one of the forms of cooperation with the Securities and Futures Commission (the “SFC”). A recent case of SFC v Chiu and another [2021] HKCFI 302 once again demonstrates the use of this consensual procedure concerning disqualification orders, in which the SFC sought orders under section 214 of the SFO for the disqualification of the 1^st and 2^nd respondents from acting as among others a director or being concerned in the management of any company in Hong Kong.

Background

The 1^st respondent was the managing director and chief executive officer of a company listed on the Main Board of the Hong Kong Stock Exchange (the “Company”), and the 2^nd respondent was the company secretary and the financial controller of the group consisting of the Company and its subsidiaries.

Between March and September 2007, money in three tranches totalling HK$61 million was transferred from the Company’s bank accounts into the bank accounts of its chairman (the “Chairman”), who is the father of the 1^st respondent, on the instruction of the 1^st respondent and with approval by the 2^nd respondent. The Chairman used part of the money for share  purchases, and then allocated some of the shares acquired to the Company in arbitrary proportions. There had not been any agreement between the Chairman and the Company on the apportionment of the shares acquired between them. In November 2007 and April 2008, approximately HK$62.1 million was repaid by the Chairman to the Company. In the 2007 annual report of the Company (“2007 Annual Report”), the transfer of the total amount of HK$61 million to the Chairman was misleadingly disclosed as an “amount due from a director” without a fuller explanation or disclosure as to such basis.

Based on the agreed facts, the 1^st and 2^nd respondents accepted that the following constitutes misconduct in the Company’s business and affairs in a manner involving “other misconduct” under section 214(1)(b) of the SFO:

1.        the 1^st and 2^nd respondents made, approved or effected the transfers of money without proper authorisation by the board of directors of the Company;

2.        lacking any agreement on the apportionment of investments and profits or losses, the 1^st respondent breached his fiduciary duty to the Company by failing to act in the best interest of the Company and to avoid putting himself in a position where his duties and interests might conflict;

3.        the 1^st and 2^nd respondents failed to procure or demand the return of the funds that had not been used for subscription of shares in a timely manner; and

4.        the 1^st respondent made a false and/or misleading disclosure of the HK$61 million as an “amount due from a director” in the 2007 Annual Report, resulting in the members of the Company not having been given all the information with respect to the Company’s business or affairs that they might reasonably expect.

The 1^st and 2^nd respondents sought the disposal of proceedings by way of the Carecraft procedure and agreed to propose an order for disqualification for a period of 4 years in the case of the 1^st respondent, and 3 years in the case of the 2^nd respondent.

Disqualification order

The Court held that the transfers out of the Company’s funds without proper authorisation (particularly to the Chairman personally), the conflict of interests between the 1^st respondent’s duties to the Company and his interests because of his relationship with the Chairman, the Company’s exposure to unnecessary counterparty risks due to the funds held by the Chairman, and the misleadingly inadequate disclosures in the 2007 Annual Report clearly constituted “other misconduct” within the meaning of section 214(1)(b) of the SFO.

Regarding the terms of the disqualification order, the Court considered that 1 to 5 years is applicable to this case. Although there are a number of contraventions, they arose from the same series of transactions which began from poor corporate governance and ended with ill-advised attempts to deal with the irregularities. The Court emphasised that the transfers of money were not embezzlement or misappropriations for the 1^st and 2^nd respondent’s personal gain and no dishonesty was involved. The Company did not suffer any actual financial loss. The misleading disclosure of the HK$61 million as a loan although deprived the shareholders the opportunity to scrutinise the conduct of management, it was done collectively by the board with the concurrence of the auditors. The events took place a long time ago, the respondents cooperated with the SFC and they were no longer holding any office in the Company. In the circumstances, the Court made disqualification orders against the 1^st and 2^nd respondents for the periods of 4 years and 3 years respectively, considering the lower degree of responsibility on the part of the 2^nd respondent.

“Carving out” from the disqualification order

The 1^st respondent also applied for an order that notwithstanding the disqualification order to be made against him, he be permitted to continue to be a director of the property or business and be concerned in and take part in the management of six entities. The SFC has given its consent, subject to the determination of the Court.

In deciding whether this discretionary power should be exercised, the Court would consider, among other things, (i) the structure of the companies to be “carved out” from the disqualification order, (ii) the nature of their businesses and the interests of their shareholders, creditors and employees, and (iii) the risks to those persons or to the public involved in the applicant’s assuming positions on the board or in management.

The Court took into account that five out of the six companies are non-profit making companies limited by guarantee or owned by the Government and the 1^st respondent had minimal involvement in the daily operations or financial affairs of these companies. For the sixth company, it is a private company, set up with the objective of rebuilding a brand which is closely related to the 1^st respondent’s family, and has no corporate relations with the Company nor any listing plans. Having regard to all the above circumstances and the 1^st respondent’s undertaking to inform the six entities of the Court’s Order imposed against him, the Court granted leave to the 1^st respondent in relation to the six entities.

Conclusion

The case demonstrates how respondents in an action brought by the SFC should make use of the Carecraft Procedure to agree on the facts and jointly propose terms of the orders to be granted by the Court, so that the respondents could get more lenient sanctions while shortening the duration of the proceedings. More importantly, in addition to the use of the Carecraft Procedure, the Court has a discretionary power to allow respondents to hold office in other companies or entities, upon having regard to factors including the nature and structure of such entities.