Introduction

On 9 March 2015, Harris J handed down the Reasons for Decision in Re China Metal Recycling (Holdings) Limited, HCCW 210/2013, seeking to explain comprehensively the principles by which a public interest petition presented by the Securities and Futures Commission (the “SFC”) to wind up a company listed in Hong Kong under section 212 of the Securities and Futures Ordinance (Cap. 571) (the “SFO”).  The said petition was the first public interest petition of this sort.  This article seeks to outline the principles stated in the Reasons for Decision.

Background to the Petition

Corporate Structure and Listing

China Metal Recycling (Holdings) Limited (the “Company”) was co-founded by Mr. Chun Chi Wai (“Mr. Chun”) and his wife.  Mr. Chun was the Chairman of the Company and, until he was removed by the Provisional Liquidators on 26 July 2013, its former Chief Executive Officer.  On 10 June 2009, the Company issued a Prospectus for a global offering (the “Prospectus”), inviting applications to subscribe for shares in the Company.  On 22 June 2009, the shares of the Company were listed on the Main Board of The Stock Exchange of Hong Kong Limited (the “Stock Exchange”).  The net proceeds from the listing were about HK$1,685 million.  Mr. Chun indirectly controlled 53% of the issued shares of the Company after the listing.

Suspicious Business Activities and the SFC’s Responses

According to the Prospectus, the Company and its subsidiaries (the “Group”) mainly engaged in the scrap metal business with two business models: (i) purchasing scrap metal from suppliers and producing recycled scrap metal products; and (ii) reselling scrap metal which it has purchased without further processing.  Central Steel (Macao Commercial Offshore) Limited (“Central Steel Macao”), one of the wholly-owned subsidiary of the Company, was the sourcing arm of the Group for the acquisition of scrap metal from international markets for its operation in China.  It also claimed to sell scrap metal directly to external customers.  Central Steel Macao contributed a very substantial portion of the Group's profit from 2006 to 2008 and thereafter until 2012, and the financial performance of the Group was heavily reliant on the apparent performance of Central Steel Macao. In some of those years the Group’s business would be at a loss but for the profits made by Central Steel Macao.

On 22 December 2009, the SFC began to investigate into the affairs of the Group, where its initial focus was on whether persons might have engaged in the disclosure of false or misleading information inducing transactions in the shares of the Company.  Following the investigation, the SFC petitioned for the winding up of the Company on 26 July 2013 and provisional liquidators were appointed to take over the Company on the same day.

Public Interest Winding-Up Petition

Section 212 of the SFO provides that if the winding up of a corporation falls within the jurisdiction of the Court of First Instance, and it appears to the SFC that it is desirable in the public interest that the corporation should be wound up, the SFC may present a petition on the ground that it is just and equitable to wind up the corporation. This case is the first one where the SFC has invoked this draconian provision.

Public Interest

In ascertaining what “public interest” refers to, Mr Justice Harris reviewed the objectives and functions of the SFC as set out in sections 4 and 5 of the SFO, which include:

1.        protection for members of the public investing in or holding financial products (the “investing public”);

2.        minimisation of crime and misconduct in the securities and futures industry;

3.        secureness of an appropriate degree of protection for the investing public; and

4.        suppression of illegal, dishonourable and improper practices in the securities and futures industry.

The public interest is not confined to the economic interests of creditors and minority shareholders, the Court will determine the broader interest of market participants as a whole.

Offending Activities Leading to the Order of Winding-up

The Court identified that the dissemination of false or misleading financial information by the Company was in contravention of sections 298, 300 and 384 of the SFO, as well as section 342F of the Companies (Winding Up and Miscellaneous Provisions) Ordinance (Cap. 32) (the “Winding Up Provisions”).  It further held that the more serious and extensive the nature of the matter complained of (e.g. an offence), the greater the public interest is likely to be in restraining or sanctioning it, and therefore the more stringent the remedy necessary to address it.

The appropriate remedy sanction for fraud in the promotion of the company will normally be the liquidation of the company.  For example, in Re Walter L. Jacob & Co. Ltd (1989) 5 BCC 244, it was considered to be in the public interest to wind up a company which “raised substantial sums of money on misleading documentation, and then ceased trading, with the consequence that hundreds of investors have been left with shares of questionable value”.  The Court in particular ruled that the appropriate order in a case where a listing has been obtained by wholly dishonest fabrication of accounts would almost invariably be a winding-up order.

Even if the offending activities have ceased, it does not necessarily mean that a more lenient approach should be taken.  The company should not be left to remain in business despite its previous history; the Court by winding up the company will be expressing its disapproval of the company’s misconduct.

Evidence of Suspicious Activities

The forensic accounting expert in the present case performed funds flow tracing exercises on the transfers of funds among Central Steel Macao, its suppliers and customers for the years 2007, 2008, 2009 and 2012.  The exercise revealed that the Company had operated round robin funds flow schemes, unusual and lacking in commercial substance, among Central Steel Macao, its suppliers or purported suppliers (the “Suppliers”), and its customers or purported customers (the “Customers”) in the following manner:

1.        funds sourced from the bank accounts of Central Steel Macao were transferred to the Suppliers’ bank accounts;

2.        a substantial amount of those funds were almost immediately transferred to the Customers’ bank accounts; and

3.        a substantial amount of those funds were then circulated from the Customers’ bank accounts back to the bank accounts of Central Steel Macao in no time.

The gross profits were calculated to be overstated between 49% and 73.22% as a result, whereas the revenues were overstated by 12% to 46.67%.

Further, the evidence of the shipping expert revealed that a large percentage of the purported purchases by Central Steel Macao from its Suppliers and the purported sales to its Customers were not genuine transactions.  The vast of majority of the bills of lading were found unlikely to represent genuine shipments, as seen from discrepancies between those bills and those used in the industry.  There was also evidence that Mr. Chun had fabricated 17 master bills of lading and provided the same to the Company’s auditors.

The SFC adduced evidence that most of the Suppliers and Customers were set up upon the instruction of Mr. Chun or persons associated with him, and they shared the same correspondence channels, company secretarial and auditing services, with the certain subsidiaries of the Company, Mr. Chun and some private companies of his.  Certain Suppliers/Customers in the United States were incorporated in 2010 or 2011, and the same were dissolved in 2013 or 2014 after the commencement of the present proceedings.  For almost each of the Suppliers involved in the round robin funds flow schemes, there was one or more Hong Kong, United States or BVI company with a very similar name to it.  A certain “window company” controlled by Mr. Chun, shown to have significant volume of purported purchases by Central Steel Macao in 2007 to 2009, only had a small volume of business in 2004 to 2008, and no business at all since 2009 until it was closed down in 2011. 

There was evidence that after the SFC commenced its investigation, Mr. Chun instructed an individual to inform persons (including the SFC) that the contact persons of certain Suppliers/Customers were some individuals which Mr. Chun provided by a name list instead of Mr. Chun himself.  A former employee of a Supplier gave evidence that he had more than once been instructed by Mr. Chun to impersonate individuals relating to the Suppliers, or to deploy the company stamp of a Supplier.  A former employee of Central Steel Macao gave evidence of bogus email correspondence including references to previously discussed and agreed transactions, and identical confirmation issued used in multiple purported transactions.  She was told that the Company would like to “make up some proof of contact and confirmation for the purpose of coping with (the request of) the auditor”.

Decision

The Court concluded that those in charge of the Company perpetrated a carefully planned and implemented fraud on a massive scale on the investors, the Stock Exchange and others involved in the listing of the Company, which went directly to the integrity of the listing.  It seemed highly likely that Mr. Chun caused the round robin transactions and the creation of bogus bills of lading to produce significantly better figures, and in turn to advance the flotation and induce investors to subscribe for shares.  There would appear to have been at the very least serious contraventions of section 298 of the SFO and section 342F of the Winding Up Provisions.

The activities of the Company and its subsidiaries and their respective management complained of were not isolated wrongful acts which are unlikely to be repeated.  Neither were they of a wrongdoing which initially was limited in scope but which circumstances caused the instigator to lose control of as it grew like topsy.  The Court held that the present case would appear to fall firmly into the category of cases in which the courts take the view that a winding-up order is appropriate.

The Court further noted that gravity of the present case would take very strong reasons to deflect the Court from making a winding-up order, and the application for a last minute adjournment by independent shareholders citing prospective investor’s interest in purchasing the Company in circumstances which indicates that the prospective investor may be related to the instigator of the fraud (i.e. Mr Chun) fell far short of that.  The Court considered that the realisation of the assets of the Company for the benefit of its creditors, and if there is a surplus, for shareholders, should be carried out in a liquidation under the supervision of experienced liquidator who can ensure transparency and the propriety of the business, rather than by way of a sale to a prospective investor in unusual circumstances.

Implications

As Harris J noted in the beginning of his Reasons for Decision, there have been a number of cases in recent years involving fraud associated with listing of business groups in China.  The SFC, however, has refrained from deploying its weapon to present a winding-up petition under section 212 of the SFO until the present case.  The Court’s favourable attitude towards such petition in the present case may encourage the SFC to more readily deploy this weapon in future, to stop dishonest schemes involving listed companies, and for the Court to appoint independent liquidators to conduct an independent investigation of the company’s affairs in the best interests of the public and to realise value for its stakeholders.