Introduction

On 7 February 2017, the Market Misconduct Tribunal (the “MMT”) handed down a decision finding Mayer Holdings Limited (the “Company”) and nine of its current and former senior executives having failed to disclose inside information as soon as reasonably practicable as required under Part XIVA of the Securities and Futures Ordinance (Cap.571) (the “SFO”).  This article will discuss the MMT’s findings and highlight certain issues relating to timely disclosure of inside information to which listed corporations should pay attention.

Background

Outstanding Audit Issues

The Company was a Cayman Islands company registered in Hong Kong as an overseas company and was principally engaged in processing and manufacturing different kinds of steel and sheets and steel pipes.  The Company was listed on the Stock Exchange of Hong Kong Limited on 21 June 2004 (Stock code: 1116) but subsequently suspended trading of its listed securities on 9 January 2012.

On 29 February 2012, the Company announced that it had appointed Grant Thornton as its auditors (“GT”).  In the course of auditing the Company’s financial statements for the year ended 31 December 2011, GT identified certain issues, namely (i) the suspicious disposal of a wholly-owned subsidiary of the Company; (ii) that the Company’s projects in Vietnam were not under the Company’s control and their prospects were far less promising than original valued and contemplated; and (iii) that two subsidiaries of the Company’s jointly controlled entity had made substantial prepayments without security to those suppliers which appeared to be irrecoverable (collectively the “Outstanding Audit Issues”).

During April to October 2012, GT had written to the Company requesting the Company’s management to address and respond to the Outstanding Audit Issues.  Having not received any substantive reply from the Company, GT indicated to the Company in August 2012 that it might issue a qualified audit report because of the Outstanding Audit Issues.

Resignation of Auditors

On 27 December 2012, GT sent a resignation letter (the “Resignation Letter”) to the Company giving formal notice of its resignation as the Company’s auditors with immediate effect.  The Resignation Letter also mentioned the reasons for GT’s resignation, namely that despite GT’s continuing efforts to resolve the Outstanding Audit Issues, the Company’s management was unable to provide the information requested by GT on a timely basis.  On 23 January 2013, the Company held a board meeting and published an announcement concerning GT’s resignation as the Company’s auditors.

Relevant Provisions

Under section 307A(1) of Part XIVA the SFO, inside information is specific information that is about (i) the corporation; (ii) a shareholder or officer of the corporation; or (iii) the listed securities of the corporation or their derivatives and is not generally known to the persons who are accustomed or would be likely to deal in the listed securities of the corporation but would, if generally known to them, be likely to materially affect the price of the listed securities.  Pursuant to section 307A(3), which is a unique Hong Kong provision, for the purpose of Part XIVA of the SFO, securities listed on a recognized stock market are to continue to be regarded as listed during any period of suspension of dealings in those securities on that market.

For the disclosure requirements of listed corporations, they are set out under sections 307B and 307C of the SFO, which provide that, among others, a listed corporation must, as soon as reasonably practicable after any inside information has come to its knowledge, disclose the information to the public, in a manner that can provide for equal, timely and effective access by the public to the inside information disclosed.  On the other hand, section 307G of the SFO lays down the circumstances when an officer of a listed corporation is in breach of his disclosure requirement.  In gist, the officer must take all reasonable measures from time to time to ensure that proper safeguards exist to prevent a breach of a disclosure requirement in relation to the listed corporation.

MMT’s Analysis

Inside Information

In deciding the liability of the Company and its senior executives, the MMT first looked at 3 potential categories of inside information, namely (i) the resignation of GT; (ii) the Outstanding Audit Issues identified by GT and GT’s indication that it would issue a qualified audit report; and (iii) circumstances surrounding the substantial prepayment made by one of the Company’s non-wholly owned subsidiary.

For the resignation of GT, the MMT found that it was specific information which was not generally known to the persons who were accustomed or would be likely to deal in the listed securities of the Company.  Relying on expert evidence, the MMT agreed that auditors of a listed corporation are independent professionals who play a very important role by auditing the accounts of the listed corporation.  The resignation of an auditor is typically viewed very negatively by the public as it is a strong signal that the auditor has probably encountered problems during the audit.  This will cast serious doubt on the reliability of the listed corporation’s accounts, or may even suggest the possibility of fraud in the company.  Thus, the resignation of GT as the Company’s auditors is likely to materially affect the price of its shares.  Given section 307A(3) of the SFO, no regard shall be paid to the suspension of trading of the Company.  As such, the MMT held that resignation of GT constituted inside information.

For the second potential category of inside information, the MMT found that it qualified as specific information that was not generally known.  In particular, the MMT found that a clean audit report tends to boost confidence in the accounts of the listed corporation, while a qualified audit report is typically viewed very negatively by the public as it is again a strong signal that the auditor has probably encountered problems during the audit.  As such, the MMT held the Outstanding Audit Issues identified by GT and GT’s indication that it would issue a qualified audit report constituted inside information.

As to the last category of potential information concerning prepayment made by a non-wholly owned subsidiary of the Company, the MMT noted that the amount of prepayment involved could exceed 10% of the Company’s shareholders’ fund in that subsidiary, and that based on GT’s description of the issue, fraud might have been involved.  The MMT thus held that the information would be likely to materially affect the price of the Company’s shares and constituted inside information.

Disclosure Requirements

Having found that the information did constitute inside information, the MMT proceeded to consider whether the Company and/or its senior executives have been in breach of its/their disclosure requirements under the SFO.

For the Company, the MMT found that the Resignation Letter dated 27 December 2012 was addressed to the management of the Company and sent to the Company’s financial controller, whose knowledge is attributed to the Company.  However, the Company failed to make timely disclosure despite being repeatedly reminded in writing of its disclosure requirement by, for example, the Resignation Letter itself, the Company’s legal advisers and the Stock Exchange of Hong Kong Limited.  In the MMT’s view, the period between the date when the Company had knowledge of the Resignation Letter and 23 January 2012 when the Company held its board meeting had exceeded what was reasonably practicable and the Company was therefore in breach of the disclosure requirement under section 307B of the SFO.

For the senior executives of the Company (including the executive directors, non-executive directors and independent non-executive directors of the Company), the MMT found that they had not taken any reasonable measure to ensure that proper safeguards exist to prevent breach by the Company of its disclosure requirement, since there was no internal system in place to implement the disclosure regulation at the time, nor did the Company have any written guidelines in relation to the compliance with disclosure of inside information.  Although some of the Company’ executives did not even know about the inside information at all or only knew at a relatively late stage, the MMT held that they were all in breach of the disclosure requirement under section 307G(2)(b) of the SFO.

Implication

Listed corporations are thus reminded of their duty, not only to make disclosure of any inside information that comes within their knowledge, but also to make timely disclosure of such inside information, which can only be done after identification of certain information as inside information.  As such, if there is any doubt as to whether certain information would constitute inside information, the listed corporation should seek legal advice as soon as practicable to ensure that disclosure, in case necessary, can be made in a timely manner.  What amounts to “timely” disclosure will of course vary from case to case.  As seen from MMT’s decision, the MMT opined that disclosure in that case (i.e. resignation of auditors) is a straight forward matter which could easily have been made within a day or two.

On the other hand, the management of listed corporations should also ensure that there are proper safeguards, e.g. internal guidelines, to prevent breach by the listed corporations of their disclosure requirements.

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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.