On 12 October 2018, the Court of Final Appeal (CFA) - in a majority of four to one - allowed the Securities and Futures Commission’s (SFC) appeal against the Market Misconduct Tribunal’s (MMT) findings that two former executives of Asia Telemedia Limited (ATML) (the respondents) had not engaged in insider dealing under the Securities and Futures Ordinance (SFO).
The background of the present case and the decision by the MMT were discussed in a previous article. The present article focuses on the decision by the CFA (FACV 5/2018;  HKCFA 44).
The Majority Decision by the CFA
Mr. Justice Ribeiro PJ and Mr. Justice Fok PJ gave a joint judgment (the Joint Judgment) with which Chief Justice Ma and Lord Neuberger of Abbotsbury NPJ agreed and supplemented by their respective judgments. Mr. Justice Tang PJ, on the other hand, gave a dissenting judgment.
Section 271(3) of the SFO provides that an insider dealer shall not be regarded as having engaged in market misconduct if he can establish that the purpose for which he dealt in the listed securities was not, or where there was more than one purpose, the purposes for which he dealt in the listed securities, did not include, the purpose of securing or increasing a profit or avoiding or reducing a loss, by using relevant (i.e. inside) information (the “innocent purpose defence”).
The focus in this appeal was the construction of the phrase “using relevant information”.
In the Joint Judgment, their Lordships held that “using relevant information” in section 271(3) simply means making one’s decision to buy or sell the listed securities because of the quoted market price, knowing that price to be either artificially high or artificially low because the inside information is not generally known to those accustomed or likely to deal in the securities (para. 49). It is the turning of the possession of that knowledge of the price sensitive information into action which constitutes the use of the inside information (para. 50). The Joint Judgment opined that this construction is consistent with the concept of “consciously making use of relevant information” and the inside information must be a “factor” in the insider’s participation in the transaction or must have “played a role in his decision-making”.
While their Lordships accepted and did not disturb the findings of the MMT, their Lordships examined the MMT’s reasoning for exonerating the respondents, namely:-
Their Lordships held that the MMT erred in law in exonerating the respondents under section 271(3) under both reasoning.
As to the first reasoning, their Lordships held that the selling of shares to secure profits from the unexpected surge in the ATML’s share prices in fact confirmed that their purpose was to secure a profit.
As to the second reasoning, the “behind closed doors” justification, their Lordships held that the respondents’ subjective belief as to whatever might prospectively happen in the future to resolve the company’s dilemma was not relevant. The proper question to ask is whether it was part of their purpose to use inside information to secure profits.
Their Lordships explained that inside information is, by definition, always “behind closed doors”. That the information does not in fact enter the public domain does not negate its status as inside information, so long as it can be shown that if it were disclosed, it would affect the share price. When a person with price sensitive information deals in the securities for financial advantage, he is “using relevant information” at that very time and hence his subjective belief in a prospective resolution of the company’s problem in the future is irrelevant as a matter of law. Even if such belief was genuinely held by the respondents (which their Lordships accepted), it did not demonstrate that they did not use the price sensitive information they possessed.
Their Lordships were also of the view that the respondents sold ATML’s shares by taking advantage of their knowledge that the prices and profits they were securing were significantly greater than they ought to have been and which would no longer be achievable had the information been known to the market. By doing so, they were “using relevant information” as construed above.
Their Lordships acknowledged that in holding so, a connected person in possession of price sensitive information may be put at a disadvantage compared to others who may deal in the same securities (such as the other employees of ATML who exercised their options and sold shares when the price was surging in the present case), but such restriction, as their Lordships described as analogous to the restrictions placed on trustees and fiduciaries from self-dealing or profiting from their positions, is a reasonable price for achieving a fair and level playing field in the market. In allowing the appeal, the CFA set aside the orders made by the CA and the MMT, and remitted the matter back to the MMT to deal with the question of the appropriate sanctions, on the basis that the two respondents are found to be culpable of market misconduct by insider dealing.
The CFA gave two example scenarios in which the innocent purpose defence might arise:
The CFA also noted that the phrase “make use of the information” in sections 270(1)(c) and (d) of the SFO (tipping prohibition) bears the same meaning as “using the relevant information” in the innocent purpose defence in section 271(3).
By virtue of this decision, the innocent purpose defence in section 271(3) will be construed narrowly. The CFA opined that this defence is not easy to establish. The two examples given by the CFA, namely, dealing pursuant to a prior contractual obligation or a Court order, appear to suggest that in practice, the person would only be able to make out this defence if he or she was compelled or had no choice to deal in the securities.