Hong Kong SFC Enforcement Director Outlines Special Remedies to Combat and Rectify Fraudulent Securities Market Misconduct

Fraudulent securities market misconduct is a special kind of fraud causing diffused damage across a wide spectrum of interests and persons and thus demands remedies beyond general deterrence, said Hong Kong Securities and Futures Enforcement Director Mark Steward. In remarks at an Asia Pacific Summit on fraud and corruption, he said that the prescription for tackling securities fraud on the market requires broad civil and criminal remedies to identify wrongdoers, chase down assets and proceeds, identify the nature and quantify the extent of damage or loss, identify victims, and secure remedial outcomes as well as ensure that those who perpetrate and assist in fraud and misconduct, including those who help to hide it from detection, are made to pay for the costs of rectification.

Criminal prosecution of perpetrators, where appropriate, is by no means last but it ought not to be the only measure. The need for civil remedies is also necessary because criminal sanctions are not always available especially if perpetrators are not in the jurisdiction or cannot be brought into the jurisdiction.  This is a real issue in a market as international as Hong Kong’s, he noted.

General deterrence alone is not enough, he explained, because, unlike the theft of valuable property, the damage caused by market misconduct fraud may not even be detectable.  Or if there is loss, its cause in fraud is unlikely to be discernible.  And damage may well continue to impair the investment. That is why identifying the nature and extent of damage caused by fraud is a necessary component of any anti-fraud strategy. 

According to the Director, there are at three distinct components to market fraud. First, market misconduct is perpetrated almost anonymously by market participants whose identities are shielded from other market participants by the automated matching systems of the exchanges. A second related distinction is the anonymity of the victims, which makes the problem of fraud in the markets an acute one. A third distinction is the way market fraud undermines the market’s singular function as a  place where reliable prices are set, a storehouse of value for savings and investments and a place upholding high standards of fairness.   Market misconduct fraud prejudices these functions and impairs the confidence needed to support them, he observed, and may also give rise to tangible losses to innocent investors.

Given the nature of market misconduct, the Commission is deeply engaged in not only sending deterrent messages, he emphasized, but also in remedying the consequences of securities market fraud and misconduct on the well-being of the market’s important functions and to protecting the interests of all market participants. 

This means that, in tandem with traditional deterrent remedies, the SFC is actively pursuing civil sanctions to tackle, not only the wrongdoer, but also the consequences of the wrongdoing so that the reputation of the market as a safe and fair place and a reliable guide to price and value can be restored.

Turning to specific actions, the Director noted that the Hong Kong Court of Appeal recently ruled that the Court of First Instance, in the exercise of its civil jurisdiction, can determine whether a person has contravened a market misconduct provision and that the function of making these types of findings is not the sole preserve of a criminal court or the Market Misconduct Tribunal.  The defendant in that case, a New York based hedge fund, is appealing this decision to the Court of Final Appeal.  The Commission is confident the Court of Appeal decision will be upheld. 

Another action recently reached what the Director called ``a milestone conclusion.’’ The action was to freeze the IPO proceeds of a Cayman Islands entity with a Mainland business, listed in late 2009 raising approximately $1 billion in capital from both institutional and retail investors.  It had no Hong Kong resident directors, said the Director, and is controlled by Taiwanese interests. The SFC was concerned that a number of statements made in its IPO prospectus were not true.

The initial action led to orders freezing approximately $832 million which derived from subscriptions to the IPO prospectus. The Commission then alleged the IPO prospectus included false statements and that the company’s turnover, profitability and cash and cash equivalent balances were grossly overstated in the IPO prospectus. The SFC initiated action to recover the balance and to obtain orders requiring the company to repurchase shares issued or bought by the public shareholders.

After the trial started, the company conceded that its prospectus contained materially false or misleading statements and acknowledged that it contravened section 298 of the Securities and Futures Ordinance, which prohibits the disclosure of information likely to induce a person to subscribe for or purchase shares if the information is materially false and the person knows or is reckless as to whether the information is false.  It is a market misconduct provision, noted the Director.

The company has also agreed to pay the sum of approximately $197 million into court so that, together with the $832 million, there is a total of a little over $1 billion to fund a full repurchase offer to all public shareholders, approximately 7,700 investors, at the suspension price.

This outcome, once executed and accepted by the shareholders, said the Director, will effectively repair the damage caused to those shareholders who were in no position to be able to detect the false information in the prospectus for themselves and who were victims. Under Commission remedial measures, the company will be obliged to return all of the paid up capital it received from its public shareholders as a consequence of the false statements contained in its prospectus at its last traded price.