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Market misconduct under the Securities and Futures Ordinance

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Market misconduct under the Securities and Futures Ordinance

INTRODUCTION

The Securities and Futures Ordinance (“SFO”) which came into effect on 1 April 2003 establishes dual civil and criminal regimes (under Parts XIII and XIV respectively) in respect of all types of market misconduct. The SFO’s market misconduct provisions represent a considerable extension of the previous law on market manipulation and disclosure of false or misleading information concerning securities and futures. While some of the provisions evolved from legislation replaced by the SFO, the law was modelled largely on Australian law.

Market misconduct” regulated under Parts XIII and XIV comprises 6 offences:

  • insider dealing
  • false trading
  • price rigging
  • disclosure of information about prohibited transactions
  • disclosure of false or misleading information inducing transactions
  • stock market manipulation.

Parts XIII and XIV of the Securities and Futures Ordinance contain virtually identical civil and criminal provisions in relation to the above.

In addition, Part XIV of the Securities and Futures Ordinance creates 3 criminal offences:

  • use of fraudulent or deceptive devices in transactions in securities, futures contracts or leveraged foreign exchange trading
  • disclosure of false or misleading information inducing others to enter leveraged foreign exchange contracts
  • falsely representing dealings in futures contracts on behalf of others.

Under the SFO the civil regime was considerably extended so that the remit of the Hong Kong Market Misconduct Tribunal (“MMT”) (which replaced the Insider Dealing Tribunal (“IDT”)) extends to all types of market misconduct and not just insider dealing, as previously and the criminal regime was expanded to cover all forms of market misconduct (including insider dealing, previously subject to civil proceedings only) and the 3 offences created by Part XIV.

The purpose of this memorandum is to provide an overview of the provisions of the SFO as they relate to market misconduct (with the exception of insider dealing which is covered in a separate note) and the offences created by Part XIV. The scope of the regime is wide. The market manipulation provisions (i.e. false trading, price rigging and stock market manipulation) apply both to conduct in Hong Kong and elsewhere which affects securities or futures traded on an exchange or through an automated trading system (“ATS”) in Hong Kong and to conduct in Hong Kong which affects securities or futures traded on an overseas market.

Other significant changes effected by the SFO are that:

  1. the range of sanctions which the MMT can impose is wider than those available to the IDT;
  2. the maximum criminal sanctions were increased and harmonised;
  3. the SFO creates a right of civil action in favour of a person who has suffered financial loss to seek compensation from a person who has committed market misconduct or a Part XIV offence; and
  4. the SFO imposes a duty on officers of a corporation to take reasonable measures to ensure that the corporation does not contravene the market misconduct provisions.

HONG KONG MARKET MISCONDUCT

Previously, the criminal offences contained in the Securities Ordinance (“SO”) and the Commodities Trading Ordinance (“CTO”) governing certain forms of market manipulation and disclosure of false or misleading information were limited in scope. Further, the beyond reasonable doubt standard of proof and restrictive criminal evidence laws often made it difficult to secure criminal prosecutions. Hence, the SFO’s provisions create virtually identical civil and criminal provisions covering a far wider range of conduct.

False Trading in Hong Kong (Sections 274 and 295)

False trading occurs when:

  1. a person, in Hong Kong or elsewhere, does anything or causes anything to be done, with the intention that, or being reckless as to whether, it creates, or is likely to create, a false or misleading appearance:
    1. of active trading in securities or futures contracts traded on an exchange or through an ATS in Hong Kong; or
    2. with respect to the market for, or the price of, securities or futures contracts traded on an exchange or through an ATS in Hong Kong. Such conduct by a person in Hong Kong which has a similar effect on securities or futures traded on an overseas market may also amount to false trading.
  2. a person, in Hong Kong or elsewhere, is involved, directly or indirectly, in one or more transactions (whether or not any of them is a dealing in securities or futures) with the intention that, or being reckless as to whether, they create or maintain, or are likely to create or maintain, an artificial price for securities or futures contracts traded on an exchange or through an ATS in Hong Kong.
  3. again, the same conduct but by a person in Hong Kong which has a similar effect on securities or futures traded on an overseas market may also constitute false trading.
  4. it is not necessary for the transaction or transactions concerned to be in securities or futures. These provisions therefore prohibit a range of conduct that occurs off a market that affects prices on a securities or futures market, most importantly cross-market manipulation (i.e. conduct in one market which has a manipulative effect in another market) and cornering (i.e. monopolising or restricting supply of an asset so as to manipulate its price).

A person who engages in an on-market “wash sale” or “matched order” is presumed to have intended, or been reckless as to whether, his conduct creates or is likely to create a false or misleading appearance of active trading, the market for, or price of, the securities (S274(5) and S295(5)). He will have a defence if he can establish that the purposes for which he engaged in the transaction did not include the purpose of creating such a false or misleading appearance (S274(6) and S295(7)). The presumption applies only to “on-market” wash sales and matched orders – that is they are recorded on the relevant exchange or ATS or have to be reported to the exchange or ATS operator under the rules governing the exchange or ATS. For off-market wash sales and matched orders, the prosecution will need to prove the mental element.

Wash sales” are trades in which a person buys or sells securities without there being a change of beneficial ownership (Sections 274(5)(a) and 295(5)(a)).

A “matched order” is where a person offers to sell or buy securities at a price that is substantially the same as the price at which he has made or proposes to make, or he knows an associate of his has made or proposes to make, an offer to buy or sell the same or substantially the same number of securities (Sections 274(5)(b) and (c) and 295(5)(b) and (c)).

Where the offence in question involves conduct in Hong Kong which affects securities or futures traded on an overseas market, the prosecution must prove that such conduct is also unlawful in the country in which the market is situated (Sections 282(3) and 306(3)). The same applies to price rigging and Hong Kong stock market manipulation where the conduct in question takes place in Hong Kong but affects securities or futures traded on an overseas market.

An “associate” is defined to include a person’s spouse or reputed spouse, brother, sister, parent, step-parent, natural or adopted child or step-child, any corporation of which a person is a director, any partner or employee of a person and in the case of a corporation, each of its directors and its related corporations and each director or employee of any of its related corporations.

Price Rigging in Hong Kong (Sections 275 and 296)

Price rigging occurs when a person in Hong Kong or elsewhere:

  1. engages, directly or indirectly, in a wash sale of securities which has the effect of maintaining, increasing, reducing, stabilising, or causing fluctuations in, the price of securities traded on an exchange or through an ATS in Hong Kong; or
  2. engages, directly or indirectly, in any fictitious or artificial transaction or device with the intention that, or being reckless as to whether, it has the effect of maintaining, increasing, reducing, stabilising, or causing fluctuations in, the price of securities, or the price for dealings in futures contracts, that are traded on an exchange or through an ATS in Hong Kong.

The same conduct by a person in Hong Kong which affects securities (or, in the case of paragraph 2, securities or futures contracts) traded on an overseas market will also constitute price rigging if such conduct is unlawful in the country in which the relevant market is situated.

A person will have a defence in relation to 1 above (and also where the conduct is in Hong Kong and affects securities traded on an overseas market) if he can establish that the purposes for which the securities were sold or purchased did not include the purpose of creating a false or misleading appearance with respect to the price of securities (Sections 275(4) and 296(5)).

Hong Kong Stock Market Manipulation (Sections 278 and 299)

These provisions relate only to transactions in securities.

Stock market manipulation occurs when, in Hong Kong or elsewhere, a person enters into or carries out, directly or indirectly, 2 or more transactions in securities of a corporation that by themselves or in conjunction with any other transaction:

  1. increase, or are likely to increase, the price of any securities traded on an exchange or through an ATS in Hong Kong, with the intention of inducing another to purchase or subscribe for, or to refrain from selling, securities of the corporation or those of a related corporation;
  2. reduce, or are likely to reduce, the price of any securities traded on an exchange or through an ATS in Hong Kong, with the intention of inducing another to sell, or to refrain from purchasing, securities of the corporation or those of a related corporation;
  3. maintain or stabilise, or are likely to maintain or stabilise, the price of any securities traded on an exchange or through an ATS in Hong Kong, with the intention of inducing another to sell, purchase or subscribe for, securities of the corporation or those of a related corporation, or to refrain from so doing.

The same conduct in Hong Kong which affects securities traded on an overseas market will also amount to stock market manipulation if the same conduct is unlawful in the country in which the relevant market is situated.

A broker’s failure to question or consider the consequences of a client’s instruction that insinuates a clear intention to manipulate a stock price could result in licence suspension.

Disclosure of Information about Prohibited Transactions (Sections 276 and 297)

Disclosure of information about prohibited transactions occurs when a person discloses, circulates or disseminates, or authorises or is concerned in the disclosure, circulation or dissemination of, information to the effect that the price of securities of a corporation, or the price for dealings in futures contracts, that are traded on an exchange or through an ATS in Hong Kong, will be affected or is likely to be affected by a prohibited transaction (i.e. any conduct or transaction which constitutes market misconduct or contravenes Part XIV) relating to either the corporation or a related corporation or futures contracts if he, or an associate of his:

  1. has entered into, directly or indirectly, the prohibited transaction; or
  2. has received, or expects to receive, directly or indirectly, a benefit as a result of the disclosure, circulation or dissemination of the information.

These provisions build upon the previous law in Section 135(5) of the SO and Section 62(2) of the CTO. Their aim is to prevent persons involved in market misconduct, their associates or those they have recruited for reward from spreading information about the effect that market misconduct is going to have on the price of a security or futures contract. Those involved in market misconduct may seek to increase their profits by spreading such rumours hoping that ordinary investors will be encouraged to buy or sell, so pushing the price of the securities or futures further in the direction that those involved in the market misconduct intend.

It is a defence if a person can establish that:

  1. the benefit which he or his associate received, or expected to receive, was not from a person involved in the prohibited transaction or an associate of his; or
  2. the benefit which he or his associate received, or expected to receive, was from a person involved in the prohibited transaction or an associate of his, but up to (and including) the time of the disclosure, circulation or dissemination of the information, he acted in good faith.

These defences are intended to cover persons such as journalists and research analysts who may innocently report market misconduct and its effect on prices and innocently receive a benefit for such conduct.

A “related corporation” is defined as follows:

  1. 2 or more corporations are regarded as related corporations of each other if one of them is:
    • the holding company of the other;
    • a subsidiary of the other; or
    • a subsidiary of the holding company of the other;
  2. when an individual:
    • controls the composition of the board of directors of one or more corporations;
    • controls more than half of the voting power at general meetings of one or more corporations; or
    • holds more than half of the issued share capital (excluding any part which carries no right to participate beyond a specified amount on a distribution of either profits or capital) of one or more corporations,

each of the corporations referred to in paragraphs i to iii, and each of their subsidiaries, are regarded as related corporations of each other.

Disclosure of False or Misleading Information Inducing Transactions (Sections 277 and 298)

Disclosure of false or misleading information inducing transactions occurs when, in Hong Kong or elsewhere, a person discloses, circulates or disseminates, or authorises or is concerned in the disclosure, circulation or dissemination of, information that is likely:

  1. to induce another person to subscribe for securities, or deal in futures contracts, in Hong Kong;
  2. to induce the sale or purchase in Hong Kong of securities by another person; or
  3. to maintain, increase, reduce or stabilise the price of securities, or the price for dealing in futures contracts, in Hong Kong, if :
    • the information is false or misleading as to a material fact or through the omission of a material fact; and
    • the person knows that, or is reckless or, for civil market misconduct only*, negligent as to whether, the information is false or misleading as to a material fact or through the omission of a material fact.

* Under Section 298, negligence will not suffice to establish criminal liability.

Defences are available for those who unwittingly disseminate false or misleading information in the course of their business, which involves disseminating information received from others and who are not in a position to check the accuracy of that information. In summary these defences are for:

  1. persons operating a “conduit” style business of issuing or reproducing information supplied by others, such as publishers and printers;
  2. persons whose business involves electronically providing access to third party information, where the information is wholly devised by another person, for example those operating internet websites providing access to third party information; and
  3. broadcasters of information devised wholly by another.

These defences may only be relied upon if the person did not know that the information was materially false or misleading at the time of disclosure. They are narrowly drafted and will only be available in very specific circumstances. In particular, they are only available where the information has been devised entirely by someone else and the defendant and his officers and employees did not in any way modify or exercise control over the information. In the case of paragraph b, it must also be made clear that those re-transmitting the information have not devised it, and do not take responsibility for or endorse its accuracy.

These provisions have significant implications for issuers of securities (whether listed or unlisted) and their advisers. While it must be the case that the information is likely to have an effect (i.e. induce a dealing in, or affect the price of, securities or futures contracts) in Hong Kong, the disclosure of information may occur anywhere. Further, it is not necessary for the information disclosed to in fact have such an effect. It is sufficient if the information is likely to have that effect. Given that negligence as to whether the information is materially false or misleading is sufficient to establish civil liability (and recklessness may establish criminal liability), these provisions are of considerable significance for roadshows, research analysts and the imparting of information to potential investors generally.

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Опубликовано:

2014-05-16