The Securities and Futures Commission of Hong Kong (the “SFC”) recently initiated proceedings¹ for alleged market misconduct against U.S.-based Andrew Edward Left in connection with his research report (“Left’s report”) published on a U.S.-based Internet website called Citron Research with respect to Hong Kong listed company Evergrande Real Estate Group Limited (“Evergrande”).² According to a press article³, “Evergrande was Left’s first short in the market, and he is not planning another. He has not been to Hong Kong because of the case [and] does not plan to go there”.

Through the proceedings, the SFC once again demonstrated that it is willing to take extraterritorial action. For further information, refer to our eUpdate “How To Trap a Tiger – Regulators’ Nets Tighten Around Tiger Asia on Both Sides of the Pacific” which discusses the proceedings against Tiger Asia Management, a U.S.-based hedge fund, and its affiliates, which took place in Hong Kong and the United States.

The proceedings against Left became another example of the SFC’s recent challenge of market commentators. For further information, refer to our eUpdate “Can an Enforcement Standard Be Discerned from the SFC’s Case Against Moody’s?” which discusses the SFC’s claim that Moody’s misled the public and violated a code of conduct by releasing a report about certain rated companies in 2011.

The outcome of these recent SFC’s proceedings will have material repercussions not only for the defendants, but also for the market at large as they are likely to demonstrate the SFC’s approach to (and standards for) the enforcement of Hong Kong securities laws in and outside of Hong Kong.

Market misconduct under Hong Kong rules

Hong Kong has civil as well as criminal regimes to deal with various offences under the Securities and Futures Ordinance (the “SFO”), including market misconduct.⁴ The civil and criminal regimes are mutually exclusive and proceedings under one mean that there can be no further proceedings under the other.⁵ Criminal proceedings under Part XIV of the SFO can be brought on indictment by either the Secretary for Justice or summarily by the SFC⁶. On conviction on indictment, the offender may be sentenced to imprisonment for up to 10 years or a fine of up to HK$10 million (equivalent to⁷ approximately US$1.3 million).

Civil proceedings under Part XIII of the SFO take place in the Market Misconduct Tribunal (the “MMT”). They are initiated by the Financial Secretary and may follow a report by the SFC or notification by the Secretary for Justice that market misconduct has or may have taken place. The MMT has jurisdiction to hear and determine any question or issue arising out of or in connection with the proceedings instituted under the SFO. In particular, the MMT’s functions include determination of whether any market misconduct has taken place, the identity of any person who has engaged in it and the amount of profit gained or loss avoided as a result of market misconduct.⁸ The MMT is chaired by a judge or former judge of the High Court appointed by the Chief Executive of Hong Kong and assisted by two members who are prominent members of Hong Kong’s business and professional community appointed by the Financial Secretary.

The MMT has wide discretion to impose various types of sanctions, which include disqualification from acting as a director or manager of a listed company or a specified corporation for up to 5 years; disqualification from dealing in securities for up to 5 years; payment to the Government of Hong Kong of the profit gained or loss avoided by the market misconduct; payment of the costs of the investigation and a recommendation that he/she be disciplined by the appropriate professional body.⁹

Details of the SFC’s proceedings against Left

In December 2014, the SFC commenced proceedings in the MMT against Left alleging that his report published in June 2012 on Citron Research contained false and misleading information about Evergrande.¹⁰  According to the SFC’s announcements and the MMT’s rulings, Left’s report stated, among other things, that Evergrande was insolvent and had consistently presented fraudulent information to the investing public, and Left recommended to readers that Evergrande represented “a good short opportunity”.¹¹  The share price of Evergrande fell sharply on the same day following the publication of Left’s report. The SFC also alleged that prior to publishing Left’s report, Left short sold 4.1 million shares of Evergrande which he subsequently bought back, making a notional profit of over HK$2.8 million (equivalent to approximately US$360,785), and that Left made a total realized profit of approximately HK$1.7 million (equivalent to approximately US$219,048).¹²

Under Section 277(1) of the SFO¹³, the SFC can initiate proceedings for the offence of disclosure of false or misleading information inducing transactions against any person who allegedly committed the offence, regardless of a person’s location or citizenship / country of origin. While it must be the case that the information is likely to have an effect in Hong Kong, the disclosure of information may occur anywhere. It also is not necessary for the information disclosed to actually have such an effect as 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 research analysts, market commentators, roadshow participants and communication of information to potential investors in general.

In response to the SFC’s allegations, Left argued that, to determine whether his report contained false or misleading information, the MMT were required to enquire into Evergrande’s financial position which would require a review of Evergrande’s records and documents. In October 2015, the MMT dismissed Left’s application.¹⁴ The Chairman of the MMT stated that, at the time when Left compiled his report, the only information available to him was the information in the public domain and as the SFC was obliged to present its case on the basis of that information, so was Left. The Chairman of the MMT added that “the matter fell to be determined on the basis only of what information was in the public domain at the time of the report. It was that information which Mr. Left used to compile his report and it was accordingly on that information that his culpability should be determined.”¹⁵

The substantive hearings of the proceedings were held in early March 2016; however, no ruling has been made public yet. The next hearing is scheduled to be held on June 10, 2016.^​16

Take-away points

The MMT’s rulings in the SFC’s proceedings against Left suggest a number of take-away points:¹⁷

• Market commentators “are entitled, on the information available in the public sphere at the relevant time, to disseminate their analysis of the strengths or weaknesses of a particular listed corporation… no matter the perceived cogency or weakness of the comment.” However, “what they are not permitted to do is to distort that information so that, knowingly or being reckless or negligent as to whether it is the case, what is published constitutes false or misleading information about the corporation”¹⁸  [emphasis added];
• Similar proceedings brought under Section 277 of the SFO should be limited to the assertion that a person created false or misleading information out of what was publicly known about the subject matter at the time of publication; 
• Defendants should not be permitted to go “through the primary documents in the possession of a corporation in the hope that those primary documents could exonerate them”, thereby ignoring information in the public domain at the relevant time despite the fact that that is the information on which their indicted comments arose; and
• The essential mischief that Section 277 of the SFO seeks to avoid “is not of itself the publication of false or misleading information about a listed corporation by a person who knows or is reckless or negligent as to that fact”, but “lies in the fact that such information is likely to induce the investing public to deal in the securities of the listed corporation and thereby innocently undermine and/or distort the open and honest workings of the market” [emphasis added].

1.   The SFC’s notice to the MMT pursuant to Section 252(2) and Schedule 9 of the SFO (Cap. 571) titled “In the matter of Evergrande Real Estate Group Limited and its listed securities (stock code: 3333)” dated December 15, 2014; “SFC commences proceedings in Market Misconduct Tribunal over alleged false research report” by the SFC, December 22, 2014.
2.   Evergrande is a Chinese developer listed on the Stock Exchange of Hong Kong since November 2009.
3.   “Citron’s Left Sees Hong Kong Case as Investor Rights Fight” by Oliver Renick and Eduard Gismatullinm, Bloomberg, February 24, 2016.
4.   The SFO provides for six market misconduct offences that may trigger civil or criminal liability: (i) insider dealing; (ii) false trading; (iii) price rigging; (iv) disclosure of information about prohibited transactions; (v) disclosure of false or misleading information inducing transactions, and (vi) stock market manipulation. The SFO also introduced three offences that are subject only to criminal liability: (i) use of fraudulent or deceptive devices in transactions in securities, futures contracts or leveraged foreign exchange trading; (ii) disclosure of false or misleading information inducing others to enter leveraged foreign exchange contracts; and (iii) falsely representing dealings in futures contracts on behalf of others.
5.  Sections 283 and 307 of the SFO.
6.   The decision as to whether to initiate criminal proceedings in relation to suspected market misconduct is made by the Secretary for Justice in accordance with the Prosecution Code. The Prosecution Code provides for two criteria for the institution of criminal proceedings: (i) that there is sufficient evidence for a criminal prosecution and (ii) that a criminal prosecution is in the public interest. If these tests are not met, suspected market misconduct will be dealt with through civil proceedings before the MMT.
7.   In this eUpdate, we used the exchange rate as of March 16, 2016 which was US$1 against HK$7.76.
8.   Section 252 of the SFO.
9.   Section 257 of the SFO.
10.  See footnote 1.
11.  The MMT’s rulings titled “In the matter of dealings in the listed securities of Evergrande Real Estate Group Limited” dated October 27, 2015 and February 23, 2016. See also footnote 1.
12.  See footnote 1.
13.  Section 277(1) of the SFO provides that a person shall be regarded as having engaged in market misconduct if he/she discloses, circulates or disseminates false or misleading information as to a material fact which is likely to induce another person to deal in securities in Hong Kong or elsewhere, knowing 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.
14.  “Market Misconduct Tribunal dismisses application by Andrew Left of Citron Research” by the SFC, November 2, 2015.
15.  The MMT’s ruling titled “In the matter of dealings in the listed securities of Evergrande Real Estate Group Limited” dated October 27, 2015.
16.  “Scheduled Hearings” by the MMT as updated on March 3, 2016.
17.  See footnote 11.
18.    According to the press article, the Chairman of the MMT said “If you cannot feel free to make comment then it can be said that you don’t have a transparent market” and “you’ve got freedom of speech, but you can’t distort the market with the use of freedom of speech.” See footnote 3.