Saturday, February 19, 2011

Ahead of Legislation, Hong Kong Securities and Futures Commission Issues Guidelines on Disclosure of Inside Information

As the Government readies legislation on insider trading, the Hong Kong Securities and Futures Commission set out draft guidelines on the disclosure of inside information, which have been well received by the corporate and investor communities. The Commission will issue final guidelines after the legislation is enacted later this year.

According to the SFC, there are three key elements in the concept of inside information: the information must be specific, must not be generally known, and must be likely to have a material effect on the price of the corporation’s securities.

Specific information is information capable of being identified, defined and unequivocally expressed, said the Commission, and carries with it such particulars as to a transaction or event as to allow that transaction or event to be identified and its nature to be coherently described and understood. It is not necessary that all details of the transaction or event be precisely known. Information may still be specific even though it has a vague quality and may be broad which allows room, even substantial room, for further particulars. For instance, information that a company is having a financial crisis would be regarded as specific, as would contemplation of a forthcoming share placing even if the details are not known

Information on a transaction contemplated or at a preliminary state of negotiation can be specific information, said the Commission, but vague hopes and wishful thinking may not be specific information. The fact that a transaction is only contemplated or under negotiation and has not yet been subjected to any formal final agreement does not necessarily cause the information concerning that contemplated course of action or negotiation to be non-specific. However, vague hope or wishful thinking that a transaction will occur or come to fruition does not amount to sufficient contemplation or preliminary negotiation of that transaction. To constitute specific information, a proposal, whether described as under contemplation or at a preliminary stage of negotiation, should have more substance than merely being at the stage of a vague exchange of ideas or a fishing expedition.

Regarding the ``not generally known’’ element of inside information, the SFC noted that rumors, media speculation or market expectation as to an event or a set of circumstances of a company cannot be equated with information which is generally known to the market. There is a clear distinction between actual knowledge of the market about a hard fact and speculation or expectation of what might have happened about a corporation, which obviously requires proof.

The test of whether the information is likely to materially affect the stock price is a hypothetical one that must be applied at the time the information becomes available. The exercise in determining how the general investor would behave if he or she is in possession of that piece of information has necessarily to be an assessment.

The Commission said that fixed thresholds of price movements or quantitative criteria alone are not a suitable means of determining the materiality of a stock price movement. For example, the volatility of blue-chip securities is typically less than that of small, less liquid stocks. In determining materiality, factors to be considered are the anticipated magnitude of the event, the relevance of the information, the reliability of the source, and market variables that affect the price of the listed securities.

All that said, the Commission advised that companies should take into account that the materiality of the information in question will vary widely from entity to entity, depending on a variety of factors such as the company’s size, its course of business and recent developments, as well as market sentiment about the company and the sector in which it operates. For example, a bank’s cancellation of a credit line which is material to an entity facing liquidity problems may be immaterial to a highly liquid entity.

The guidelines state that a corporation must disclose any inside information to the public as soon as practical, which means that the company should immediately take all necessary steps that are reasonable in the circumstances to disclose the information to the public. Before it is publicly disclosed, the company should ensure that the information is kept strictly confidential. When the company believes that the necessary degree of confidentiality cannot be maintained or that confidentiality may have been breached, it should immediately disclose the information to the public.

If a company needs time to clarify the details of, and the impact arising from, an event or a set of circumstances before it is in a position to issue a full announcement to properly inform the public, said the SFC, the company should consider issuing a holding announcement detailing as much of the subject matter as possible and setting out reasons why a fuller announcement cannot be made. The company should make a full announcement as soon as possible.
The Commission also emphasized that no analyst, investor or journalist should receive a selective release of inside information. The guidelines indicate that a company must ensure that only public information is given when answering an analyst’s questions or reviewing an analyst’s draft report. It is inappropriate for a question to be answered, or draft report corrected, if doing so involves providing inside information. Further, when analysts visit the company, noted the SFC, care should be taken to ensure that they do not obtain inside information.

The Commission recognizes that sometimes analysts may draw out data or misinterpret historical information. In such cases, it is appropriate for the company to clarify historical information and correct any factual errors in analyst assumptions which are significant to the extent that they may mislead the market, so long as any clarification is confined to drawing the analyst’s attention to information that has already been made available to the market. If the company is aware of inside information that would correct a fundamental misconception in the report, it should consider making public disclosure of such information and at the same time correcting the report.

Publications by third parties such as regulators or rating agencies may affect the price of, or market activity in the company’s securities. If such events when they become public knowledge are expected to have significant consequences directly affecting the corporation, said the SFC, this may be inside information that should be disclosed by the company with an assessment of the likely impact of those events. Similarly, while companies are not expected to disclose general external developments, such as foreign currency rates, the market price of commodities or changes in a taxation regime, noted the SFC, if the information has a particular impact on the corporation this may be inside information that should be disclosed with an assessment of the likely impact of those events.

In the view of the SFC, a company should be aware that inside information requiring disclosure may emerge during the preparation of periodically filed financial statements. In this instance, the company cannot defer releasing inside information until the prescribed structured document is issued. Separate immediate disclosure of the information is necessary.