Abstract
In the Hong Kong Court of Appeal decision The Securities and Futures Commission v Young Bik Fung and others, the Court applied s. 213(2)(b) of the Securities and Futures Ordinance (SFO) to restore two transactions of shares entered into by an investor who invested based on ‘information, advice or tips’ given by an insider, despite the investor did not know that the advice was based on inside information and was not guilty of insider trading. Nevertheless, the investor was ordered to repay the profits made as if the transactions had not been made. It is suggested that the restoration order in Hong Kong has the widest scope of application among the major common law jurisdictions, because Hong Kong is the only jurisdiction where a person who has not committed any market conduct can nevertheless be subject to a restoration order. The Court justified such wide scope of application with reference to the paramount policies of minimizing market misconduct and ensuring no benefits is obtained from insider dealing by anyone. By a comparative law analysis, it is argued that s. 213(2)(b) SFO has been wrongly interpreted. The paramount policies should not be blindly applied without giving proper consideration to other established principles of law, such as the fundamental right to property of the unknowing investor.
Introduction
In the Hong Kong Court of Appeal decision The Securities and Futures Commission v Young Bik Fung and others, 1 the Court applied s. 213(2)(b) of the Securities and Futures Ordinance (‘SFO’) 2 to restore two transactions of shares entered into by a person after receiving ‘information, advice or tips that were sourced from, or based upon, inside information, albeit she was unaware of that’. 3 The defendant 4 was ordered to repay the profits made, and hence restoring the parties to the position as if the transactions had not been made.
For the sake of conceptual clarity, the situation to be discussed is about an investor-defendant who was not personally liable for insider trading. Instead, the scenario to be discussed is about an investor who invested based on ‘information, advice or tips’ given by an insider, but without the investor knowing that the advice was based on inside information. The interesting issue that follows, which is the thrust of this article, is whether the ‘innocent and unaware’ investor has to give up the profits under s. 213(2)(b).
First, the facts and the decision will be explained. Second, the current understanding of the application of s. 213(2)(b) SFO after this case will be discussed. It is noteworthy that this case means that the restoration order in Hong Kong has the widest scope of application among the major common law jurisdictions, because Hong Kong is the only jurisdiction where a person who has not committed any market conduct can still be subject to a restoration order. Third, the potential impact of the judgment on affecting the certainty of future financial transactions will be discussed. It will be submitted that s. 213(2)(b) has been wrongly applied, because a comparative law analysis will show that the Court has misinterpreted the scope of s. 213(2)(b) and also its legislative intent. In addition, the Court failed to take into account the fundamental right of ownership and right to property. The judicial reasoning also failed to consider principles of unjust enrichment, which is highly relevant given the restitutionary nature of a restoration order. It will be concluded that despite the suggested errors in law, the decision is unlikely to be overturned because of the Hong Kong Court’s reinforced emphasis on the overarching policies to ‘minimise crime and misconduct in the securities industry’ 5 and to ensure ‘no benefits are obtained from insider dealing by anyone’. 6 Nevertheless, it will be suggested that the policies should not be blindly applied without giving proper consideration to other established principles of law, especially the constitutional right to private ownership under the Basic Law.
Background of the case
There were four defendants in this case. Two of them were lawyers (Eric and Betty) who obtained inside information on the intended takeover and intended privatization of two separate listed companies. The other two defendants were the sisters of Eric, namely, Patsy and Stella. The two lawyers and Patsy purchased the shares of those companies knowingly based on inside information. The 4th defendant (Stella) was recommended by Eric and Patsy, respectively, to purchase the shares of the companies, but without knowing that the ‘recommendation’ was in fact based on inside information. Hence, Stella did not knowingly participate in any insider dealing. 7 Stella was also unaware of the insider dealings perpetrated by Eric, Betty and Patsy.
The issue that faced the Court was whether despite Stella was not being guilty of insider dealing, she could nonetheless be ordered to restore the transactions by repaying the profits made under s. 213(2)(b) SFO. Stella had already sold the shares and made a profit of HK$210,000. 8
Section 213 is ‘designed to provide substantive relief to address specific types of wrongdoing’ such as insider trading under the SFO.
9
Hence, if there is a breach of the SFO,
10
the relevant regulator, namely, the Hong Kong Securities and Futures Commission, can apply to the Court for remedial orders. Section 213(2) lists a range of remedies, such as prohibition orders stopping the wrongdoing under s. 213(2)(a) or restoration orders under s. 213(2)(b) as in the present case. In other words, in order to ask the Court for an order from the range of remedies available under s. 213(2), it must first be established under s. 213(1) that there is a wrongdoing infringing the SFO.
11
In the present case, the requirement of the existence of a wrongdoing was satisfied by the fact ‘that Betty, Eric and Patsy were in breach of section 300(1) and section 291(5)(a) of the SFO’.
12
Those infringements were related to using inside information knowingly to trade under s. 291(5)(a) and the fraudulent trading of the shares under s. 300. For a restoration order to be made under s. 213(2)(b), the Court also has to be satisfied on the three other requirements. Hence, the current law in Hong Kong, as enunciated in the present case, is that there are four requirements in total in order to have a restoration order under s. 213(2)(b):
Section 213(1): A person (not necessarily Stella herself) has contravened the SFO (‘the infringer’); Section 213(2)(b): Stella was involved in the insider dealings of the other defendants, whether knowingly or otherwise; Section 213(4): The Court is reasonably satisfied that it is desirable that the order be made; and Section 213(4): The Court is reasonably satisfied that the order will not unfairly prejudice any person.
On the facts, the Court held that all four requirements were satisfied.
The current understanding of s. 213(2)(b) as in enunciated in the present case
The relationship between the first and the second requirement: The infringer does not have to be the same person as the person subject to the restoration order.
The most notable (and novel) feature of the Court’s (arguably erroneous) current understanding is that the person who contravened the SFO (under the first requirement) does not have to be the same person as the one who is subject to the restoration order (under the second requirement). In the present case, the infringers were Betty, Eric and Patsy, whereas the one who was subjected to the restoration order was not an infringer (Stella). Stella has been held to have committed no breach of the SFO. It is suggested that this wide interpretation would mean Hong Kong has a broader scope and application than Australia and the United Kingdom. In those jurisdictions, the infringer has to be the same person as the one who is subject to the order. This will be elaborated in the following.
For the second, third and fourth requirements
For the second requirement, the Court adopted a purposive interpretation of the word ‘involved’ and emphasized on the policy of combatting effectively acts of market misconduct. 13 Hence, s. 213(2)(b) was not to be construed narrowly, in order to ‘ensure that no benefits are obtained from insider dealing by anyone—whether that person is directly implicated in it or unknowingly caught up in it’. 14 Hence, Stella was taken to be ‘involved’ in the insider trading, even though she had no knowledge that the recommendation was based on inside information, nor the insider dealings perpetrated by the other defendants.
For the third and fourth requirements, the Court again emphasized the primacy of the above-mentioned policies, despite recognizing that the two requirements are to prevent the unfairness resulted from the broad scope of the restoration order in covering an unaware investor.
15
Another key consideration of the Court was that ‘where the person is unknowingly involved in the insider dealing through trading in shares it will be relevant to have regard to the extent to which he acted independently in his decision to trade in the shares’.
16
Although Stella assumed the risks of investing just like any other investors, she was still not entitled to keep the profits of her investment decisions. This was because Stella did not demonstrate a sufficient level of independence in her investment decision. The restoration orders against Stella were not made simply because she was a close relation of the insider dealers. They were made because her investment decisions were influenced, if not prompted by, the provision to her of information, advice or tips that were sourced from, or based upon, inside information, albeit she was unaware of that.
17
Once a court determines that a person has benefited from inside information in the sense that he made investment decisions which were influenced in a significant way by inside information, however conveyed to him, whether as a tip, advice or information then, unless it can be shown that depriving him of his profits will in some way unfairly prejudice him, a restoration order will be appropriate…
18
Potential impact of the decision
It is particularly remarkable that the Court took the investor’s independence as a key consideration in determining whether a restoration order would be made against transactions unknowingly tainted by insider trading. If the defendant Stella was an independent investor, no restoration would be made. In determining independence, the Court’s reasoning is that as long as the transactions were made based on ‘information, advice or tips’ based on inside information, the investor cannot be considered as independent. Hence, it does matter that (1) the investor has assumed normal trading risk as other investors do, and (2) the investor does not know that the ‘information, advice or tip’ was based on inside information.
This reasoning, of treating an investor as not independent simply because he/she has been influenced by ‘information, advice or tips’, has profound implications. To take an example, assuming a financial adviser publicly recommends a particular stock based on inside information, be it through newspaper’s financial column or through private advice to his/her clients, anyone who relies on the advice will theoretically be caught by the restoration order (just because the information is tainted), even if the advisee does not know that the advice is based on inside information.
Similarly, another example would be where an insider director who openly recommends everyone to buy the stock. Strictly applying the logic of the judgment, the buyers who are ‘influenced, if not prompted by’ the recommendation may also be subject to the restoration order.
Inevitably, this may generate some uncertainty in the financial sector. This may also disrupt the provision and reliance of financial services. Based on this judgment, an investor may legitimately have concern on whether the advice that he/she has received has been tainted with insider information. More worryingly, the investor has no way to verify whether it is tainted or not. If the investor enters into the transaction anyway, he/she may have to surrender the profits made if it turns out that the advice has been tainted, as long as the decision to invest is influenced by the advice given.
On the other hand, one may argue that the upside of the judgment is that the paramount policy of ensuring that ‘no one can benefit from insider trading’ has been upheld. 19 However, it is submitted that it is doubtful whether the Court has applied the policy in an over-broad manner. As outlined above, the judgment has caused uncertainty over future financial transactions and financial advice on (1) whether unaware investors can safely rely on the financial advice and (2) rest assured that their investments will not be restored. It is submitted that the uncertainty can be minimized if the Court does not consider upholding the policy as paramount. What the Court should have done is to apply the law more legalistically, rather than adopting an overly policy-based construction. It is argued that the applicability of the restoration order would not have been over-wide, had the correct principles of law been applied. This is discussed in the following.
Principles of law that should have been considered
As laid out above, s. 213(2)(b) provides a very wide power that a restoration order can be made even if the investor is unknowingly involved in tainted transactions. Reviewing the legislative history of s. 213, the Consultation Document for the Securities and Futures Bill says that s. 213 is ‘consistent with the approach in other jurisdictions, such as Australia where section 1324 of the Australian Corporations Law is of similar effect’. 20 Given s. 213 has very similar wording and structure as the Australian equivalent, it is suggested that s. 213 was created based on the old Australian Corporations Law 1989 (which is now replaced by Australian Corporations Act 2001). With this legislative in mind, it will first be suggested that the Court has wrongly interpreted the second requirement on Stella’s ‘involvement’.
The erroneous understanding of the requirement of ‘involvement’
It has been highlighted above that the Court’s approach is to interpret the second requirement of involvement very broadly in order to uphold the policy of ensuring that no benefits are obtained from insider dealing by anyone, knowingly or unknowingly.
While it is true that whether Stella can be considered to have been ‘involved’ in the insider dealings is a question of fact, it is argued that the word ‘involved’ must be interpreted according to the legislative history, which the Court had not done. Section 213 was borrowed from the Australian Corporations Law 1989. Section 79 of the Australian Corporations Law 1989 has provided a definition on what amounts to ‘involvement’. Hence, whether Stella was ‘involved’ should have been determined by reference to the definition provided under s. 79 of the Australian Corporations Law 1989.
Interestingly, s. 79 corresponds exactly with the wording of s. 213(1)(ii)-(v) SFO. This means s. 213(1) is actually referring to the definition of ‘involved’ under s. 213(2)(b). Thus, for a person to be ‘involved’, he/she must be a person who falls within s. 213(1). In other words, this would suggest that the identity of the infringer under s. 213(1) must be the same as the person who is subject to the restoration order under s. 213(2)(b). This is because a person will only satisfy s. 213(2) for having ‘involved’ in the infringement of SFO if he/she fulfils the definition of ‘involvement’ provided in s. 79 or s. 213(1).
Yet, the Court seemingly did not know that s. 213(1) was actually referring to the definition of ‘involved’. The suggested reason is because the Australian statute contains an individual s. 79 on the definition of ‘involvement’ with a clear heading of ‘Involvement in contraventions’, which is separate from s. 1324 (headed ‘Injunctions’) and 1325 (headed ‘Other orders’) on the list of remedial orders, whereas the Hong Kong one, perhaps ‘conveniently’, effectively combines s. 79 with the list of orders into one single s. 213 headed ‘Injunctions and other orders’. In other words, it could be argued that s. 213 is less clear than the Australian one, because the Hong Kong one combines everything together into one section with one heading only.
As said previously, the Court’s current understanding is that as long as somebody (Betty, Eric and Patsy) has satisfied s. 213(1) by infringing the SFO in one of ways under s. 213(1)(i)-(v), Stella can be made liable under the restoration order under s. 213(2). In order words, the Court’s current understanding is that they do not have to be the same person. Stella herself did not satisfy s. 213(1), because she committed no insider trading herself, nor she knew anything about the insider trading. She did not fall within any of the grounds under s. 213(1)(a)(i)-(v). If the definition of ‘involvement’ under s. 79 Australian Corporations Law 1989 had been used, it would mean Stella has no ‘involvement’.
Bearing in mind that s. 213 is drafted based on s. 1324 Australian Corporations Law, which makes cross references to s. 79, it would mean the legislative intention of Hong Kong is that Stella should not be considered to have ‘involvement’, because only those falling within one of the grounds of s. 213(1)(a)(i)-(v) is so. In other words, it is argued that the Court’s interpretation, which is solely based on the broad policy of combatting insider trading, is wrong. This is because it fails to consider the legislative intent as enunciated in the Consultation Document on the Securities and Futures Bill.
Evaluating it from another perspective, if one interprets the wording of s. 213(2)(b) on ‘knowingly or otherwise’, the ‘or otherwise’ cannot be taken to include ‘unknowingly’, because firstly, s. 79(c), or s. 213(1)(a)(iv), makes express reference to ‘knowingly’. To interpret it to include ‘unknowingly’ would be inconsistent with the definition of ‘involvement’ under s. 79. Secondly, one may then ask what then the ‘or otherwise’ mean. It is suggested that it could be taken to mean ‘recklessly and negligently’. To support such interpretation, one of the market misconducts provided in SFO is the disclosure of false or misleading information inducing transactions under s. 277 SFO. It expressly requires that ‘the person knows that, or is reckless or negligent as to whether, the information is false or misleading as to a material fact, or is false or misleading through the omission of a material fact’ (emphasis added). 21
A comparative law analysis showing that the current interpretation of the requirement of ‘involvement’ is unjustifiably wide: Hong Kong is the only jurisdiction where the person subject to a restoration order does not have to be the same person as the infringer.
Among the major common law jurisdictions such as the United Kingdom and Australia, Hong Kong is the only jurisdiction where the person subject to a restoration order does not have to be the same person as the infringer. For the other jurisdictions mentioned, they must be the same person. Hence, it is submitted that the current interpretation of the requirement of ‘involvement’ is unjustifiably wide, indicating that the scope of s. 213(2)(b) is out-of-line to the foreign equivalent.
Even under the present Australian Corporations Act 2001 (which replaced the Australian Corporations Law 1989), there is still a s. 79 provision which reads the same. In other words, under the current Australian law, Stella could not be considered to have ‘involved’ in the insider trading.
Under English law, s. 383 Financial Services and Markets Act 2000 (‘FSMA 2000’) expressly provides that a restitutionary order can only be made against ‘the person concerned’ who has committed the market misconduct. To be exact, s. 383 expressly defines the infringer as ‘the person concerned’ in bracket, and it provides that an order can only be made against ‘the person concerned’. In order words, s. 383 would mean the person who is subject to the restitutionary order must be the same person as the infringer. Section 383 has no effect on an innocent person like Stella who has no involvement.
Nevertheless, s. 383 FSMA 2000 does cover a person who is ‘engaged’ in market abuse. While it is unknown how ‘engaged’ and ‘involved’ are different in meaning and scope, even if Stella is caught by this, she would have a defence under s. 383(3)(a) that she ‘believed, on reasonable grounds’ that her investment did not amount to market abuse. This is because she did not know about the insider trading at all.
In the United States, the SEC has no express statutory authority to seek rescission, restitution, or other forms of equitable monetary relief. The Commission, however, may institute an action for injunctive relief and, once the equity jurisdiction of the district court has been properly invoked, the court has power to grant all equitable relief necessary under the circumstances.
22
The failure to consider the fundamental right to property and principles of restitution
Further, another focus is the safeguarding provisions that follow, which are the ‘desirability’ and ‘absence of unfair prejudice’ requirements under s. 213(4) as laid out above. The Court, again, has adopted a purposive interpretation and has applied a broad reasoning in determining the investor’s independence (see above). It is submitted that in applying these two requirements, the Court failed to consider certain fundamental principles of law, namely, the Court has failed to consider the fundamental right to property. In particular, this is protected under Article 6 of the Basic Law, which protects ‘the right of private ownership of property in accordance with law’. Had this fundamental principle of constitutional importance been considered, the Court would have balanced and limited the application of the scope of policy.
It is submitted that in applying Article 6 to the two requirements of ‘desirability’ and ‘unfair prejudice’ under s. 213(4), the Court is obliged to apply the usual principles of property. For example, the principles of unjust enrichment would be relevant as analogy, because the restoration order has the effect of restitution. To support the view that the principles of restitution is applicable, it is noteworthy that the Courts have recognized that s. 213(2)(b) ‘is restitutionary in nature’. 23
In the present case, although there was enrichment, there was not an unjust factor. The illegality of insider trading by the other defendants would not affect the transactions by Stella, because they were lawfully entered into with consideration. It must again be stressed that Stella was not convicted of insider trading. Hence, Stella was a lawful bona fide owner of the shares unaware of any illegality. A sudden deprivation without infringing any established principles of law by way of restoration cannot be lawful under Article 6 of the Basic Law. Hence, the argument is that given that the defendant has not been unjustly enriched nor infringed any established principles of law, the right to private ownership under Article 6 would mean that the defendant would be ‘unfairly prejudiced’ under the third requirement if a restoration order is made.
It is submitted that a restoration order can only be made against an unaware and innocent investor if Article 6 is complied with. To comply with the fundamental right to private ownership, it is submitted that the usual rules on property, such as unjust enrichment including the usual defences such as change of position, must be observed. An example where a restoration order would be appropriate is where Stella was given the profits of insider trading by the other defendants, without knowing that they were proceeds of crime. In that situation, given that Stella has not given any consideration for the transaction, a restoration order would be ‘desirable’ and ‘without prejudice’.
The Court’s failure to pay due consideration to the assumption of risk by a normal investor
Apart from this, it is submitted that the Court’s reasoning, of Stella being not independent just because she was ‘influenced, if not prompted by’ the recommendation from the other defendants, was unsatisfactory. The Court failed to pay proper weight to the fact that Stella assumed trading risk as a normal investor. For example, the Court was merely focusing on the entering of the transactions of buying the shares. However, this was not the only limb of the decision-making 24 and risk taken by Stella. The other limb of decision-making and risk taken was the tender of the shares under the takeover and privatization of the two companies. Rhetorically, what if Stella has not tendered the shares? Given the tender of the shares which contributes to the success of the takeover and privatization, can it be said that the bona fide investor Stella was really enriched at the expense of the buyer of the shares?
The future applicability of this case
One may have wondered whether this judgment should be applied narrowly in the future, so that it would be limited to situation where the relationship between the info provider/advisor/tipper and the info receive/advisee/tippee has to be very proximate (as a factual distinguishing factor). On the facts, Stella was the sister of the insider (Eric) and has a linked relationship with another insider (Betty, being the former girlfriend of Eric). This understanding of the judgment is not tenable, because firstly, the Court expressly says that ‘the restoration orders against Stella were not made simply because she was a close relation of the insider dealers’. 25 Secondly, it would be hard to define what a close relationship is. For example, it is arguable whether a financial adviser has a close relationship with his/her clients. Again, this understanding would generate uncertainty in the financial markets. Thirdly, it is submitted that the Court’s overriding emphasis is on the level of independence of the investor, rather than on the relationship. 26 Fourthly, it would be logically dubious, that an unaware investor would be subject to a restoration order simply because of his/her relationship with the information provider–insider. Applying the strict policy of ‘no one benefits from insider trading’ only to those with close relationship is counter-intuitive.
Conclusion
Restoring transactions unknowingly tainted by insider trading would be highly in conformity with the guiding policies to ‘minimise crime and misconduct in the securities industry’ 27 and to ensure ‘no benefits are obtained from insider dealing by anyone’. 28 While enforcing the policies is important, it should not be taken as paramount without having proper consideration of other fundamental principles of laws, such as the constitutional right of private ownership under Article 6 of the Basic Law. In particular, it is submitted that the principles of unjust enrichment would be very relevant, given the restitutionary nature of the restoration order.
In terms of the social impact of the judgment, it has been argued that the judgment would create uncertainty in terms of reliance and provision of financial advices. In any event, given Hong Kong is an international financial centre with investments in Hong Kong from all over the world, the possibility of having a restoration order restoring transactions unknowingly tainted by insider trading does not seem to be in line with the international standard of investment protection. Furthermore, it is suggested that the current interpretation of s. 213(2)(b) would mean Hong Kong has a broader scope and application than the equivalents in Australia and the United Kingdom. Among these jurisdictions, Hong Kong is the only one where the infringer does not have to be the same person as the one who is subject to the order. This would lead to commercial uncertainty due to the wide scope of application of s. 213(2)(b) in the financial market.
Hence, it is submitted that the Court should ensure the right balance between upholding the policy and protecting investments (and hence market confidence) is maintained. At the end of the day, although market misconduct (e.g. insider trading) affects market confidence, the lack of proper investment protection due to failure to consider applicable principles of law will also affect market confidence.