Introduction

Last month, the Market Misconduct Tribunal (the “Tribunal”) found Mr Cheng Chak Ngok (“Mr Cheng”) not guilty of the alleged insider dealing in the shares of China Gas Holdings Limited (stock code: 384.HK) (“China Gas”) following the proceeding brought by the Securities and Futures Commission (the “SFC”) in July 2016. In light of the SFC’s heavy reliance on inferences as main planks of its case, the Tribunal explores the extent to which circumstantial evidence would be strong enough to draw compelling inferences.

Background

In early 2011, ENN Energy Holdings Limited (“ENN”) contemplated acquiring China Gas and tried to find a partner to fund a takeover (the “Takeover”). After which, it approached China Petroleum & Chemical Corporation (“Sinopec”) and Sinopec agreed to form a consortium with ENN. Mr Cheng was involved in and responsible for the Takeover. On 7 December 2011, before ENN and Sinopec issued a joint Pre-Conditional Voluntary General Offer announcement regarding their offer to acquire all of the outstanding shares in China Gas at HK$3.50, representing a premium of 25% to the previous closing price of China Gas’ shares, trading in China Gas’ shares was suspended pending the release of a price sensitive information announcement. On the next day after the announcement was published, being 13 December 2011, trading resumed and the share price jumped 20.4% from HK$2.80, being the previous closing price, to HK$3.37.

Did what Mr Cheng do constitute insider dealing?

Elements of insider dealing

Insider dealing is a subset of market misconduct, which includes other types of offences in public market like false trading, price rigging, stock market manipulation etc. As the incident of our present case happened in late 2011, the legislation then in force was the Securities and Futures Ordinance 2003 (“SFO”). The relevant section that concerns our case is s. 270 of the SFO, which provides that “insider dealing in relation to a listed corporation takes place (a) when a person connected with the corporation and having information which he knows is relevant information in relation to the corporation (i) deals in the listed securities of the corporation”. It is undisputed that Mr Cheng was a connected person, given Mr Cheng’s involvement in the Takeover and his position and seniority in ENN; and that Mr Cheng had the relevant information, being the interest of Sinopec and ENN to form a consortium to acquire the majority stake in China Gas and the price range of each China Gas’ share etc. The issue is therefore whether Mr Cheng dealt in the shares of China Gas.

Did Mr Cheng deal in the shares of China Gas?

The SFC’s case is that Mr Cheng used the securities account of Ms Li Wei (“Ms Li”), a resident of Mainland China and a former consultant of ENN Group in the 2011, to purchase 4,930,000 shares at a cost of HK$13,763,605.60 and then sell those shares for HK$16,752,442.26 during 13 to 16 December 2011. As previously stated in the second paragraph of this newsletter, on resumption of trading the shares jumped 20.4% from their closing price at the time of suspension. As such, the SFC noted that Mr Cheng made a profit of about HK$3 million. Among other issues, two main planks were discussed in depth and are as follows.

First, in relation to the flow of funds, the SFC found that Mr Fong Man Chun Alen (“Mr Fong”) moved funds, as a middleman, between Mr Cheng and allegedly Ms Li and both trading in shares and gambling were facilitated by Mr Fong. Out of the HK$13,763,605.60 of shares purchased from Ms Li’s saving’s account with the Bank of China (Hong Kong) Ltd, HK$10,800,000 of it was transferred from Mr Fong and out of the HK$10,800,000, HK$8 million came from the bank account of a company wholly owned by Mr Cheng. After the HK$16,752,442.26 shares were sold during 13 to 16 December 2011, a total sum of HK$14,170,000 was transferred from Ms Li’s savings account with Bank of China (Hong Kong) Ltd to Mr Fong’s account by three cheques. Mr Fong then transferred HK$615,233 to a money exchange agent to remit RMB500,000 to the personal account of Mr Cheng, in Beijing.

In rebutting the SFC’s case and in particular to the transfer of HK$8 million, Mr Cheng explained that he received a phone call around the beginning of December 2011 from the Vice President of ENN Solar Energy Co. Ltd, Mr Zhao Xiaowen (“Mr Zhao”), for the payment of US$1 million to Ms Li. Mr Cheng was aware that Mr Fong had had dealings with Ms Li before so he knew her bank details. Previously, Mr Cheng held roughly US$1 million with Mr Fong’s account, which was transferred to him for gambling in Macau. Therefore Mr Cheng asked Mr Fong to transfer the said US$1 million to Ms Li.

The Tribunal inclined towards the explanation provided by Mr Cheng, who kept to his main theme despite the challenges from SFC. For good measures, the Tribunal stated that the flow from Mr Cheng to Ms Li via Mr Fong and then back again was short of providing compelling evidence of Mr Cheng’s trading, and the alleged flow back of merely HK$615,233 was even less probative.

Second, in dealing with the terminal used to make bids, the bidding for shares via the securities account of Ms Li emanated from two sources—the computers in ENN’s offices and by smartphone. In relation to the use of computers, it could not be satisfied that Mr Cheng was in the office at the time and date on which each bid was made. In relation to the use of a smartphone, it was noted that various bids were made with the smartphone other than those bids made during the material time. As such, the Tribunal found that the disrupting patterns would chip away at the probative value. In passing, these evidences presented by the SFC were not strong enough to draw compelling inferences that Mr Cheng used the computers or a smartphone to place orders as there are other possibilities from the facts other than it was Mr Cheng who was trading.

“The puzzle incomplete and vague”

While Mr Cheng did in fact have the necessary relevant information and that raised suspicious against him, this itself was not sufficient to find him guilty of market misconduct. As noted by the Tribunal, the SFC could not overcome the vagueness about the actual relationship between Mr Cheng and Ms Li, nor could they illustrate the extent to which Mr Cheng was the only person who had authority and control over her accounts. The Tribunal found that there was no direct evidence and Ms Li’s trading account during the material time was actively trading over stocks apart from China Gas’s. In addition, the Tribunal conveyed that, without evidence received from Ms Li, the picture was a blur—the puzzle incomplete and vague.

What can the SFC learn from the case?

It is noteworthy that at various points of the report, the Tribunal expressed how unfortunate it was as no benefit of evidence or statements were received from the material witnesses including Ms Li and Mr Zhao. Mr Fong also gave no evidence of dealing with any funds relating to share purchases or sales involving the shares of China Gas. The Tribunal did state repeatedly how suspicious the case was and how Mr Cheng’s evidence had much to give pause for thought but also criticised the lack of cogent evidence to connect the parties in the SFC’s case. Given the remarks of the Tribunal, it is unlikely that the SFC had faced anything untoward in their case. The dearth of evidence was why the SFC’s case was weakened, which could have been easily avoided should the SFC be more forward-thinking.