Introduction

In Securities and Futures Commission v Yiu Hoi Ying Charles and Others (FACV 5/2018, 12 October 2018), the Securities and Futures Commission (the “SFC”) appealed against the decision of the Market Misconduct Tribunal (the “MMT”) that two former senior executives (the “Respondents”) of Asia Telemedia Limited (“ATML”) (now known as Yunfeng Financial Group Limited) had not engaged in insider dealing. The Court of Final Appeal (the “CFA”), in a majority decision of 4 to 1, allowed the appeal and clarifies the ambit of the innocent purpose defence provided in Section 271(3) of the Securities & Futures Ordinance (Chapter 571 of the Laws of Hong Kong). (“SFO”)

Background of the case

In around 2002, ATML borrowed from one Madam Liu Lien Lien (“MadamLiu”) totalling $83,388,308 which ATML promised to repay in instalments. Between October 2002 and April 2006, Madam Liu served five statutory demands on ATML because of its default in repayment but on each occasion, she did not follow up by serving any winding-up petition.

On 1 February 2007, Madam Liu assigned ATML’s debt to a BVI company named Goodpine Limited (“Goodpine”). On 5 February 2007, Goodpine demanded repayment in full of the amount of the debt by 9 March 2007, threatening legal proceedings thereafter (“Goodpine’s Statutory Demand”). ATML did not announce such information to the public.

Between February and May 2007, there was a surge of speculative interest in the ATML shares which sharply drove up their price and trading volumes. Between February and June 2007, the Respondents exercised their share options in ATML, sold their ATML shares and made a net profit of over $10 million in total. On 6 June 2007, Goodpine presented a petition to wind up ATML and the share price of ATML fell very substantially.

Elements of price sensitive information

The CFA outlined the 4 elements constituting “price sensitive information”:

1.the information must be specific;

2.it must be about the corporation or its listed securities;

3.it must be information which is not generally known to those who deal or are likely to deal in those securities, who might for brevity be called “the market”; and

4.if the information were generally known to the market would be likely materially to affect the price of those securities, in other words, the information must be price sensitive.

In the present case, the CFA concurred with the MMT that Madam Liu’s assignment to Goodpine and the StatutoryDemand constituted price sensitive information because such information is specific about ATML which is not generally known to the market, and it is price sensitive in the sense that it would have acted to put pressure on any further upward pressure, and would have resulted in a material decrease, in the share price of ATML.

Elements of insider dealing

The CFA outlined the 5 elements constituting “insider dealing”:

5.the corporation concerned must be publicly listed;

6.the person concerned must be “connected with the corporation”, usually called a “connected person”;

7.he or she must have information which constitutes “price sensitive information”;

8.he or she must know that such information is inside information; and

9.he or she deals with the corporation’s listed securities with such knowledge.

In the present case, the CFA concurred with the MMT that the Respondents knew that Madam Liu’s assignment to Goodpine and the Statutory Demand constituted price sensitive information and that the Respondents knew that ifnewsof Madam Liu’s assignment to Goodpine and the Statutory Demand fellintothepublicdomain,itwouldlikelyhaveamaterialeffectonthepriceoftheATML’sshares. The Respondents were therefore prima facie culpable for market misconduct by reason of insider dealing.

The innocent purpose defence

The defence relied on by the Respondents under section 271(3) of the SFO states that a person shall not be regarded as having engaged in market misconduct by reason of an insider dealing if he establishes that the purpose for which he dealt in the listed securities was not, or did not include, the purpose of securing or increasing a profit, by using price sensitive information. The issue in the present case is whether the Respondents were “using” the price sensitive information at the time when they sold the ATML shares.

The majority of the CFA construed the provision purposively and in context, and held that “using price sensitive information” under Section 271(3) simply means making one’s decision to buy or sell the listed securities because of the quoted market price, knowing that price to be either artificially high or artificially low because the price sensitive information is not generally known to those accustomed or likely to deal in the securities.

By doing so, one is employing the price sensitive information to one’s own advantage in order to steal a march on the rest of the market because if that information generally known, it would be likely to materially affect the price of the listed securities and therefore would have negated the insider dealer’s advantage. Since the statutory purpose of the prohibition on insider dealing is to prevent that particular mischief of taking advantage of price sensitive information to steal a march on the rest of the market, Section 271(3) places a burden on an insider dealer to prove some other purpose in the dealing.

In the present case, the CFA held that the Respondents’ share dealings would appear plainly to have involved “using” the price sensitive information. They sold their shares in ATML taking advantage of their knowledge that the prices and profits they were securing were significantly greater than they ought to have been and which would no longer be achievable if the information about Madam Liu’s assignment to Goodpine and the Statutory Demand were to find its way into the market. By doing so, they were “using the price sensitive information”. Therefore, the Respondents could not rely on the defence under Section 271(3) of the SFO.

The SFC’s appeal was allowed and the case against the Respondents is remitted to the MMT to determine solely the question of sanctions.

Conclusion

To conclude, the CFA expressly stated that the innocent purpose defence under Section 271(3) of the SFO is not easy to establish. It only arises after prima facie culpability is established. It requires the specified person to prove on a balance of probabilities that dealings which prima facie constitute insider dealing were done without in any way involving the prohibited purpose (for instance, where he or she dealt in the securities pursuant to a prior contractual obligation and had to sell whether it entailed realising a profit or a loss; or where a person sells shares in compliance with an order of the Court made, for example, in matrimonial financial relief proceedings).

As pointed out by Lord Neuberger NPJ, the CFA’s conclusion in this case places people in the position of the Respondents at a disadvantage to other people, in that they may be unable to sell or buy shares in the company concerned when they would do so even if they had not got any inside information. From the insider’s perspective, that is the price of being an insider but from the public perception, that is the price of ensuring a perceptibly fair and undistorted market.