Introduction

Under the Securities and Futures Ordinance (Cap. 571) (“SFO”), no person shall carry on a business in a regulated activity unless he is licensed or registered for the regulated activity or otherwise exempted under the SFO.

“Dealing in securities” is a kind of regulated activity, the conduct of which will require a Type 1 license. Under the SFO, the definition of “securities” includes interests in any collective investment scheme but the definition expressly excludes any shares of a private company incorporated in Hong Kong (the “Exclusion”).

Is SFC license required if one operates a collective investment scheme by using a Hong Kong private company (as shell company) to hold the investments on investors’ behalf?  Are the interests purchased by investors the shares of the Hong Kong private company which are excluded from the definition of “securities”? A recent case 律政司司長 (Secretary of Justice) v IPFUND Asset Management Limited [2023] HKCA 925 may shed some light on the above issues.

Background

It was not disputed that at all material times IPFUND Asset Management Limited (“IPFUND”) did not have any SFC license.

At the material times in 2011, the sole director (“Director”) of IPFUND arranged a number of investors to participate in 16 investment projects in commercial properties in the following manner:

1.       The Director would source suitable commercial properties and set up a Hong Kong private company as a shell company to acquire and hold each commercial property.

2.       Upon entering into the preliminary sale and purchase agreement, staff members of IPFUND would send details of the properties to potential investors and invite them to participate in the investment.

3.       The Director would then determine how the interest in the property should be split among investors, payment amounts and security deposits payable by each investor. The shares of the shell company were not transferred to the investors, but were held by a registered shareholder on trust for the investors.

4.       IPFUND would arrange the properties to be sold as soon as possible (without consulting the investors about the re-selling price) so that the shell company could re-sell as a confirmor and avoid the need to obtain a mortgage by the shell company.

5.       If IPFUND failed to re-sell the property as a confirmor and require a mortgage, IPFUND would require the relevant investors to execute a declaration of trust and shareholders’ agreement, both of which provided that the registered shareholder of the shell company holds the shares of the shell company on trust on behalf of the investors. Each investor would be allocated number of shares in the shell company proportional to their respective shares in the underlying property.

6.       After a successful re-sale of the property, IPFUND would calculate the profit to be distributed by subtracting all the costs incurred from the re-sell price. IPFUND would take 5% of the profit as “consultation fee” and then distribute the remaining profit to investors proportional to the investors’ shares of the interest in the property.

Judgement in the Court below

IPFUND was charged with the offence of carrying on a business in a regulated activity and an alternative charge of holding himself out as carrying on a business in a regulated activity.

The key question is whether the investors were investing in the shares of the shell company, or the interests (via the shell company) in the real properties. The prosecution argues it is the latter, and hence IPFUND was operating a collective investment scheme; whereas IPFUND argued that it is the former, meaning that the investors were only investing in the shares of a private shell company, in such case the express Exclusion applies and the scheme was not a collective investment scheme.

The District Court agreed with IPFUND. The Secretary for Justice appealed to the Court of Appeal.

Appeal to the Court of Appeal

The Court of Appeal disagreed with the District Court that the interests purchased by the investors were shares of the shell companies for the following reasons:

1.       The target of the investors in the investment scheme was clearly the interest in the property and the profits generated from reselling the property but not the shares of the shell company. For example, if the investors intended to transfer their shares of the interest in the property, the transfer document prepared by the staff of IPFUND would indicate that the buyer and seller has bought and sold share of interest in the property.

2.       The shares of the shell companies would only be allocated to the investors by way of trust in the situation where the shell companies could not re-sell the property as confirmor and require mortgage from the bank. It is not disputed that only in some of the property investments had the investors been allocated shares of the shell companies.

3.       Under the common law, a company is a separate legal entity, so its shareholders do not have any legal or equitable interest in the property held by the company. The shareholder is only entitled to the profits generated by the company and also the remaining assets of the company in case of liquidation. Therefore, it was not quite possible that the investors would subscribe for shares of the shell companies.

On the basis of the above, the Court of Appeal concluded that the District Court wrongly held that what the investors purchased were shares of the shell companies. Hence, the operation of IPFUND involved “dealing in shares”, which is a kind of regulated activity that requires an SFC license.

Takeaways

The Court of Appeal did not rule out the possibility that some collective investment schemes operated in the form of Hong Kong private company, through careful structuring, may remain excluded from the definition of “securities” because of the “private company” exclusion. For instance, the SFO does provide an express exclusion for arrangements not operated by way of business. Hence not all persons using private Hong Kong companies to co-own real properties will be caught by the definition of collective investment schemes.

However, the important point here is that the Court is apparently prepared to see through the arrangement involving private companies, to conclude that the “real intention” of IPFUND was to deal in the interests of the commercial properties. In the circumstances, persons who are considering operating investment schemes via private Hong Kong companies should carefully consider whether their arrangement may be seen as a collective investment scheme under the SFO.