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Civil Enforcement of Securities Violations in Hong Kong

Section 213 of the Securities and Futures Ordinance

On May 10, 2013, the Court of Final Appeal entered a judgment to dismiss Tiger Asia’s jurisdictional objection to the Commission’s use of the section 213 procedure which was seemed to affirm the SFC’s ability to issue civil proceedings to obtain protective and remedial orders against persons asserted to have contravened the market misconduct provisions, independent and irrespective of whether criminal or tribunal proceedings are pending or contemplated. And the introductions and relevant cases of section 213 is outlined as follows:

1.      Q: Why the Tiger Asia case attracts so much attention?

A:  Because the challenge of Tiger Asia has caused many controversies on whether the Commission independently to bring civil proceedings in respect of market misconduct according to the Securities and Futures Ordinance. The resolution of this problem has been found, but was in any event a distraction which has tended to obscure the broader significance of the section 213 procedure and its emergence as a central component of the Commission’s enforcement strategy.

2.      Q: What’s the jurisdiction of section 213?

A: Instead of being limited to insider dealing and market manipulation, the section 213 is broadly applicable to prevent and remediate breaches of Hong Kong’s securities laws. It has been applied to a very wide range, from brokerage failure to listed company prospectus liability to the sale of hotel units – which share the common feature of investor protection and an alleged breach of securities legislation. All the reasons to expect that the jurisdiction will now be exercised or threatened robustly, frequently and across a wider range of alleged infringements are listed as follows:

                           IPO prospectus liability, against issuers, directors and sponsors.

                            Liability under the new statutory regime for disclosure of inside information.

                            Insider dealing and market-manipulation.

                            Fraud and misappropriation of assets.

3.      Q: What’s the background of the application of section 213?

A: Despite of the absence of a class action regime, and legal constraints on litigation funding, have to date prevented the emergence in Hong Kong of class or representative actions for alleged securities violations, the Commission has the mandate and legal ability under section 213 to issue civil proceedings to seek recovery on behalf of investors and, although ultimately limited by resource constraints, increasingly will do so. Put simply, civil proceedings will become a more prominent feature of regulatory enforcement in Hong Kong.

 

4.      Q:What are the relieves provided in section 213?

A: Section 213 empowers the Hong Kong Courts on the application of the Commission to make a broad range of orders designed to remedy and prevent the recurrence of breaches of the Securities and Futures Ordinance, licensing terms and conditions and certain parts of the Companies and Anti-Money Laundering legislation. The legislation allows interim injunctive relief to be obtained when it appears to the Commission that a breach had or might occur. It allows final orders to be made, such as unwinding transactions and appointing receivers to collect and distribute assets, based on the Court’s determination that a contravention has in fact occurred.

5.      Q:  How did the courts describe the purpose of section 213 in the Tiger Asia case?

A: The Court of Final Appeal described the purpose of section 213 in the Tiger Asia decision given consideration to the context of market misconduct as follows:

“Section 213, on the other hand, provides remedies for the benefit of parties involved in

the impugned transactions. They include injunctions and the appointment of receivers to

secure property with a view to recovery by the victims of market misconduct, orders that

particular transactions be unwound, orders declaring particular transactions to be void or

voidable. In these proceedings, the SFC acts not as a prosecutor in the general public

interest but as a protector of the collective interests of the persons dealing in the market

who have been injured by market misconduct. Proceedings under s 213 are the public

law analogue of actions for damages by individuals under s 305 rather than a substitute

for a criminal prosecution or proceedings before the Market Misconduct Tribunal. They

are plainly civil proceedings and therefore do not attract the protection afforded to

criminal defendants.”

The above description shows clearly the support to the Commission’s ability to act in a representative capacity on behalf of a class of investors when bringing section 213 proceedings.  And so does the Court of Appeal judgment in the Tiger Asia litigation :

“Notwithstanding the availability of civil remedies to individual investors, there may be

cases where investors cannot be expected to take proceedings individually to enforce

their legal rights … There may be circumstances where it would be eminently reasonable

for proceedings to be taken by the Commission under s 213 for the investors’ benefit.”

 

6.      Q: What are the other purposes of section 213?

         A: Firstly, Section 213 is meanwhile emerging as the primary mechanism for class redress in respect of securities violations, for the present absence of a class action regime in Hong Kong. Regulatory resource constraints may mean that section 213 is typically deployed in cases involving more egregious failures, but having invested in two separate appeals to the Court of Final Appeal to establish this jurisdiction (Tiger Asia and Kayden) it is clear that the Commission intends to use it more broadly and frequently. As Mark Steward, the Commission’s Head of Enforcement, observed in November 2012, section 213 was “a little used provision which we have made a significant part of our strategy.”

                And secondly, the threat of section 213 is expected to become a feature of regulatory dialogue when negotiating with the Commission to settle securities and disciplinary infringements in cases involving investor losses, in much the same way as the investigation or institution of disciplinary proceedings against senior management formed a core part of the dialogue when settling structured product mis-selling investigations prompted by the recent financial crisis. Because it is un necessary to require the institution of court proceedings for the Commission’s use and reliance on section 213. It was and is precisely through this leverage that the Commission has insisted on compensatory payments in circumstances where it does not have any statutory power to require such payments.

7.       Q: What are the situations the section 213 has or may be invoked?

       A:  In the following  four situations, the actual or threatened reliance on section 214 become a regular feature:

·         Fraud and misappropriation of assets. Section 213 has historically been applied by the Commission in these circumstances. There are a series of cases since at least 2004 in which section 213 orders have been sought and obtained involving failed or mismanaged securities brokerages and hedge funds. The Commission’s objective is to freeze assets to prevent misappropriation or dissipation and, in serious cases, to appoint administrators or receivers to manage the business and protect the interests of clients and investors.

·         Market misconduct. The Commission first relied on section 213 in an insider dealing investigation in July  2007 when obtaining interim injunctive orders against Du Jun, the senior investment banker subsequently imprisoned for six years for dealing in the shares of CITIC Resources. It has since sought such orders regularly, both privately and publicly, to freeze the perceived proceeds of market misconduct. Under sections 281 and 305 of the SFO, market misconduct when established also attracts deemed civil liability to compensate any person who has suffered resulting pecuniary loss. This liability can also extend personally to management of institutions and corporations found to have consented or connived in the misconduct. Section 213 has since been deployed in various insider dealing investigations including Tiger Asia (short-selling after confirming participation in share placement), China Forestry (block disposal to institutional investors by CEO and major shareholder shortly prior to announcement of accounting irregularities) and Titan Petrochemicals (alleged disposal by senior employee in the knowledge of impending bond default). We expect increased focus on market manipulation. In a speech delivered in June 2012, Mark Steward commented that sophisticated manipulation is “arguably more revalent and more costly to participants than insider dealing.”

·         Initial Public Offerings. Listed company governance and disclosure has become a core regulatory enforcement priority. Directors, promoters and (pending amendment of the Companies Ordinance, following the recently concluded sponsor consultation) banks or corporate finance houses acting as sponsors are or will be subject to civil liability for untrue statements or material omissions in an IPO prospectus. Absent a class-action regime, section 213 will be the primary mechanism for investor redress. This has already been demonstrated in the case of Hontex International Holdings, in which $832 million of IPO proceeds were frozen in 2010 by a section 213 application. Administrators were subsequently appointed to manage a share repurchase which completed in 2012.

·         Disclosure of Inside Information. The new statutory regime for disclosure of price-sensitive information, effective January 1, 2013, is transformative in respect of regulatory and civil enforcement for late or inadequate disclosure. The listed company and its directors and chief executive are each liable to proceedings before the market misconduct tribunal based on alleged breach of statutory disclosure obligations. An adverse finding carries with it statutorily imposed civil liability under section 307Z of the SFO to any person for losses suffered because of those breaches. This framework directly supports representative claims under section 213. An instructive example is the USD2 billion of currency erivative losses announced by CITIC Pacific in October 2008, some six weeks after the issue was first identified which, when announced, resulted in a 55% fall in share price. Under the statutory disclosure regime, this fact pattern could result in representative section 213 proceedings against the company and/or its directors to compensate investors who had acquired shares after the company first became aware of the exposure.

·         Alleged misfeasance by directors of listed companies. Directors or officers who have managed listed companies in a manner alleged to be prejudicial to shareholders are similarly exposed to claims under sections 213 and/or 214 of the SFO. For example, in August 2009, the Commission obtained a section 213 interim injunction against the former chairman of GOME Electrical Appliance freezing HKD1.6 billion based on the allegation that a share repurchase was carried out for the ulterior purpose of stabilizing the share price while the chairman disposed of his shares in order to repay a personal loan. More recently, in March 2012, the High Court made various protective and remedial orders against former directors of Styland Holdings Limited arising from concealed connected transactions causing financial loss to the company.

 The above list is not exhaustive. Besides of  those, there are other circumstances section 213 invoked. For example, the Commission announced on May 13, 2013 that the Cheung Kong Group had agreed to unwind the sale of hotel room units on the basis that the investment was a collective investment scheme regulated under the SFO. The Commission had otherwise threatened to issue section 213 proceedings, demonstrating that this jurisdiction will be broadly interpreted. Collective investment schemes and the distribution of authorized structured products are further examples of  Davis Polk & Wardwell, Hong Kong Solicitors 4situations in which the Commission might have recourse to section 213 to bring civil proceedings to compensate aggrieved investors.

8.      Q:What are the restrictions on the exercise of section 213?

               A: After resolving the question whether the Commission independently to bring civil proceedings in respect of market misconduct according to the Securities and Futures Ordinance. The following one should be resolved might be to clarify the restrictions of the statuary power. The potential areas of concerns or uncertainty are listed as follows:

         Firstly, to what extent could an actionable breach be satisfied and then the Commission can grant interim orders. According to section 213(1)(b), the court has power to grant interim orders when it “appears to the Commission” that an actionable breach has occurred or might occur. And so, the question is how to tell whether an actionable breach occurs or might occur. In the Kayden decision in December 2010, the Court of Final Appeal held that substantive orders would not be made merely on the basis of what appears to the SFC to be the position”, but contrasted this with interim relief. We consider the correct position to be that the court, in the exercise of its discretion, must be atisfied at least to a prima facie standard that the evidence justifies interim relief. This interpretation is consistent with a speech delivered by Ashley Alder, the Chief Executive Officer of the SFC, in May 2012 when he observed in the context of section 213:  “The Court does not proceed on the SFC’s “say so”, and it is extraordinary to think that it might.”

          Secondly, during the SFC’s investigation, when could SFC seek section 213 orders. A practice appears to be developing of obtaining interim relief at the very outset, potentially before a case can be articulated. This may be appropriate in cases where there is justifiable concern that assets may otherwise be dissipated but otherwise risks oppression and unfairness. The analogy with a civil litigant seeking interim injunctive relief can only be taken so far. The SFC is a government agency with a range of powers available to obtain information and ensure that an intrusive pplication is sufficiently justified before it is brought. It can also backfire on the SFC, if the SFC’s characterization of the facts at any early stage proves materially flawed. See, for example, SFC –v- Lee Sung Ho & Others, HCA 2177 of 2011. Where the SFC does not seek interim relief, presumably the SFC would carry out a full investigation into the matter in the usual way, before commencing proceedings.

Thirdly, according to the current situation that representative claims are brought to compensate investors, there should be a transparent and consistent system to identify and compensate investors, especially in relation to dynamic listed markets in which there is a real risk that such schemes may operate in an arbitrary manner.

 

         In conclusion, the foundation of  the Commission’s regulatory mandate and the predominant focus of its regulatory enforcement program is to protect investors. Enforcement activity to date has principally been based on deterrence, including disciplinary sanctions for regulated persons and entities and criminal prosecution. Since the deterrence of itself can not offer a sufficient relief to the Commission, it calls for more activist and muscular approach to civil remediation. And as the Commission rebalances part of its enforcement activity to Hong Kong’s civil court, the section 213 procedure will gain increasing importance.

 

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