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Introduction – On 26 January 2017, the Securities and Futures Commission (“SFC“) commenced legal proceedings in the Court of First Instance (“Court“) to seek disqualification and compensation orders under section 214 of the Securities and Futures Ordinance (“SFO“) against Mr. Tse On Kin (“Mr. Tse“), former chairman and executive director of Kong Sun Holdings Limited (“Kong Sun“) and China Sandi Holdings Limited (“China Sandi“) (previous name was China Grand Forestry Green Resources Group Limited), for fraudulently obtaining a secret profit out of the companies’ share placements in 2009.
The wrongful actions – The SFC’s investigation revealed that Mr. Tse orchestrated a fraudulent scheme to use a nominee company (falsely declaring its independence) to apply for 100 million and 19 million shares placed by Kong Sun in or around June 2009 and China Sandi in or around November 2009 respectively, at a discounted price, with the intent of making a secret personal profit out of the share placements.
To this end, he procured and permitted the nominee company to make false and misleading representations to the placing agent to secure the share allotment. He also procured and permitted Kong Sun and China Sandi to make false and misleading representations (a) to the Stock Exchange of Hong Kong Limited (“Exchange“) to induce the latter to grant listing approvals with respect to the placing shares; and (b) in the public announcements of these companies.
Mr. Tse made a profit of about HK$2 million with respect to the Kong Sun shares, and a loss of about HK$200,000 with respect to the China Sandi shares.
Factors affecting disqualification period – As a starting point the Court considered the following brackets for reference:
The Court also took into account a wide range of factors, including (a) the age; (b) state of health and character of the offender; (c) the nature of the breaches; (d) the honesty and competence of the offender; (e) the length of time he has been in jeopardy; (f) any admission of liability; (g) his general conduct before and after the offence; (h) the periods of disqualification of his co-directors that may have been ordered by other courts; and (i) the interests of shareholders, creditors and employees.
Reasoning – The Court agreed with the SFC’s submission that Mr. Tse’s conduct fell on the borderline between the top bracket and the middle bracket for the following reasons:
(a) Tse’s conduct was fraudulent and dishonest. This brought the case near the top bracket;
(b) Tse carried out the fraudulent scheme not only once but twice with two different companies in which he held important positions;
(c) the fraudulent misrepresentations were not only made to the placing agent, Kong Sun and China Sandi, but also to the Exchange;
(d) Tse obtained a secret personal profit out of the share placement;
(e) on the other hand, Kong Sun and China Sandi did not suffer any financial loss.
Consequence – A disqualification order was made against Mr. Tse, disqualifying him for 10 years from being, or continuing to be, a director, liquidator, receiver or manager of any corporation in Hong Kong, and taking part in the management of any corporation in Hong Kong. He was also ordered to pay a compensation of $2,185,784.1 to Kong Sun, being the profit that he made in breach of his fiduciary duty owed to Kong Sun, and the SFC’s costs in the proceedings.
Please access SFC’s press release and the judgement for more details.
The Securities and Futures Commission (the “SFC“) has recently suspended the licence of a former account executive (the “Former Account Executive“) of a licensed corporation (the “Licensed Corporation“) for 15 months in relation to (i) failure to obtain written authorization prior to allowing a third party to operate a client’s securities account and (ii) carrying out his personal trades in the client’s securities account.
The background is that a client opened a securities account (the “Account“) with the Licensed Corporation in 2009, at which time the client verbally authorized a third party (the “Third Party“) to place orders and make investment decisions on his behalf and to communicate with the Former Account Executive directly as regards matters concerning the Account. However, written authorization of such was never procured by the Former Account Executive or the Licensed Corporation.
Further, the Former Account Executive permitted the Third Party to place his personal trades in the Account for convenience, holding the belief that the Third Party and the account holder would agree among themselves on the apportionment.
Besides, the Former Account Executive carried out more than 260 pairs of cross trades (the “Cross Trades“) in an attempt to delay settlement of his personal trades, involving approximately $3 million, and to generate client transactions when business was slow. This was achieved by selling on the T+1 day the shares bought on the T day to the client and buying them back on the same day immediately, such that he would only have to settle difference between the purchase price and the sale price on the T+2 day, and settlement of the purchase price could wait until the T+3 day. By repeatedly doing so, the Former Account Executive could roll over payment of the purchase price of the subsequent Cross Trades with the effect of delaying settlement of his trades. Eventually the Cross Trades materialised in loss-making transactions of around $70,000, which was borne by the Former Account Executive himself without causing any financial impact on the client.
By way of the above, the Former Account Executive violated paragraph 7.1(a) of the Code of Conduct and constituted a breach of General Principle 2 of the Code of Conduct.
This case serves as a reminder of the risks relating to “unauthorised trades”. Licensed corporations are required to have internal controls in place to reduce the risk of unauthorised trading, such as blatant conduct by an account executive who conducts his personal trades through his clients’ accounts without the clients’ knowledge. There were also many cases and disputes relating to alleged verbal authorisations, and the lack of a written authorisation is a red flag, which points to misconduct by licensed persons.
On 27 December 2023, the Financial Services and the Treasury Bureau (the “FSTB”) and the Hong Kong Monetary Authority (the “HKMA“) published the Consultation Paper on the Legislative Proposal to Implement the Regulatory Regime for Stablecoin Issuers in Hong Kong (the “Consultation Paper“). Prior to this consultation, the HKMA issued a Discussion Paper on Crypto-assets and Stablecoins in January 2022 (the “2022 Discussion Paper“), with its Conclusion issued in January 2023, whereby respondents generally supported the HKMA’s proposal of bringing stablecoins into the regulatory perimeter and the HKMA indicated its expected key regulatory scope and requirements.
What are stablecoins and what prompted the regulatory concern?
Stablecoins are a sub-set of crypto-assets (or known as virtual assets, which are digital representations of value that are cryptographically secured, typically through the use of distributed ledger technology (DLT), like blockchain) that aims to maintain a stable value with reference to certain asset(s), typically fiat currencies like the U.S. or Hong Kong dollar. They have been gaining popularity in the wider market for several reasons, including their commitment to minimize price volatility, enabling faster and more cost-effective cross-border payments, and increasing financial inclusivity by providing access to digital payments for the unbanked population.
The collapse of TerraUSD in 2022 highlighted the urgency to introduce a regulatory regime of stablecoins in Hong Kong, with fiat-referenced stablecoins (“FRS“) being a priority for regulation and legislative guidance as they are more likely to be used in day-to-day payments and have linkages with the traditional financial system, thereby creating more direct and imminent monetary and financial stability risks than other types of stablecoins or other crypto-assets.
Proposed new licensing regime for fiat-referenced stablecoins (FRS) issuers
Against the above background, and taking into account the market conditions and needs in Hong Kong, the FSTB and the HKMA propose to introduce a new piece of legislation to implement a licensing regime for FRS issuers with the following key features:
(1) requiring all FRS issuers who (a) issue an FRS in Hong Kong; (b) issue a Hong Kong dollar-referenced stablecoin; or (c) actively market their issuance of FRS to the public of Hong Kong, to be licensed by the HKMA;
(2) requiring that FRS can only be offered by specified licensed entities, including licensed FRS issuers[1], authorised institutions[2], licensed corporations[3] and licensed virtual asset trading platforms (“VATP“), and for FRS not licensed by the HKMA, they can only be offered by specified licensed entities to professional investors;
(3) prohibiting the advertising of:
(a) a person’s issuance of FRS unless the person is licensed by the HKMA; or
(b) a person’s offering of FRS unless the person is a specified licensed entity;
(4) providing the necessary supervisory and investigation powers for the authorities to adjust the parameters of in-scope stablecoins and activities having regard to the rapid virtual assets market development;
(5) subjecting regulated activities without a licence to criminal and civil offence and sanction provisions, and setting up of an appeal tribunal mechanism to ensure there are checks and balances to the HKMA’s powers; and
(6) providing a transitional arrangement to facilitate the implementation of the regulatory regime.
Respondents to the earlier 2022 Discussion Paper expressed concerns about potential overlap between the proposed regime and other financial regulatory regimes in Hong Kong, including the licensing regime for VATP operators, administered by the Securities and Futures Commission (the “SFC“) under the Anti-Money Laundering and Counter-Terrorist Financing Ordinance (Cap. 615). More information on this regime can be found in our prior news updates dated 25 April 2023 and 16 August 2023.
To address these concerns and prevent regulatory arbitrage, the FSTB and the HKMA will collaborate with the SFC and other stakeholders to formulate the specific details of the stablecoin regime.
The proposed regime aims to strike a good balance between safeguarding financial stability and embracing innovation. The public is encouraged to provide feedback on the proposals by 29 February 2024.
Access the full Consultation Paper here for more details.
[1] A licensed FRS issuer can only offer FRS it issues.
[2] An authorized institution means a licensed bank, a restricted licence bank or a deposit-taking company under the Banking Ordinance (Cap. 155).
[3] A licensed corporation means a corporation (that is not an authorized institution) which is granted a licence to carry on one or more regulated activities under sections 116 and 117 of the Securities and Futures Ordinance (Cap. 571). When offering FRS, licensed corporations must hold a licence for Type 1 regulated activity (dealing in securities) and be permitted by the SFC to carry out dealing in virtual assets.
The submission of “no case to answer” can be made in both criminal and civil trials. The rules are, however, different in these two types of trial. In a criminal trial, after the prosecution has presented its case, the defence counsel can submit there is no need for the defence to present his case as the prosecution’s evidence is insufficient to make out a prima facie case. However, one must exercise caution in making the same submission in a civil trial – the judge may ask the counsel to “elect” upon a submission of no case to answer. This means that unless counsel confirms that he will stand by his submission and call no evidence even if the judge rules against him, the judge will not entertain such a submission.
This is why a submission of no case to answer is rare in civil litigations, let alone in winding-up or unfair prejudice actions. In Re T-Hero Industrial Company Limited [2023] HKCFI 3118, the Honourable Harris J had the opportunity to elucidate the key principles of accepting a no case to answer submission in a winding-up action pursued on just and equitable ground.
Quasi Partnership
In this case, the three petitioners (against the remaining shareholder and the company) advanced the ground that there is a breakdown in mutual trust and confidence among the shareholders in seeking a compulsory winding-up. Their mutual trust and confidence engages equitable considerations, which restrict how the shareholders can exercise their legal rights. To demonstrate that a company is formed in such circumstances, it is necessary to show that the association among shareholders is not a purely commercial one ([18]). In this regard, the petitioners relied on a 2007 Shareholders Agreement which imposed certain restrictions on transfers of shares to say that the rights of the shareholders were circumscribed. However, the Court has difficulty to see these restrictions were intended for an indefinite period especially when all shareholders are also directors and that there has been a fundamental change in shareholding structure in 2012,
“It cannot possibly be that every agreement made after a company is formed about some aspect of the management of its affairs binds shareholder thereafter regardless of how circumstances change. Shareholders of small companies who also act as their directors will frequently agree aspects of its management as its business develops. In nearly all cases they will be intended to regulate the management of the company until such time as circumstances require them to be modified. They cannot sensibly be understood as restrictions on the way a shareholder is to exercise his rights for an indefinite period.” ([22])
No case to answer
A submission of no case to answer in the context of a civil trial can be made on two grounds:
(i) Where the plaintiff’s case, even accepting it at its face value, does not disclose a sustainable cause of action in law; or
(ii) The quality of the evidence given by the plaintiff is such that there is not even a prima facie case for the defendant to answer ([29]).
Further, the Court also has to consider if the claim has no prospect of success and it would be a waste of time and costs to hear the defendant’s evidence ([30]). Once a defendant elects to make a no case to answer submission, he so elects to call no evidence. If however, the Court finds there is a case to answer from the plaintiff, it will proceed to rule, on a balance of probabilities, whether the plaintiff’s case is made out, having regard to the plaintiff’s evidence (including that given under cross-examination) and the available documentary evidence, but without regard to the defendant’s witness statement ([32], where Harris J explicitly adopt the recent authority of the Privy Council in Roopnarine v Attorney General of Trinidad and Tobago [2023] UKPC 30 (27 June 2023) at [27] per Lord Hamblen).
Applying the above principles, the Court ruled that the petitioners failed to make out a case of the breakdown of the quasi partnership. On the evidential ground, other complaints such as exclusion from management were refuted by the contradictory witness statement of one of the petitioners ([47]).
Takeaways
The Court also reiterated that the petitioners are confined to their pleaded complaints in the petition, and as the petitioners were not legally represented, “they had no real understanding of what they needed to establish to obtain a winding up order” ([4]). They also ignored a sensible buy-out offer from the respondent shareholder to insist on a full-blown trial which amounted to an abuse of process. As the Hong Kong courts will now accept a submission of no case to answer in the appropriate circumstances, it would be prudent to take legal advice before commencing legal proceedings, instead doing so at one’s own peril.
See full judgment here.
In a recent Court of First Instance (“CFI“) decision, China Ping An Insurance Overseas (Holdings) Limited v Luck Gain Limited and ors [2023] HKCFI 3315, the CFI has demonstrated how investors with beneficial interest in global notes might be able to proceed against the issuer, notwithstanding the obstacle that such investors do not normally have standing to present a winding-up petition against issuers directly. Such an obstacle is commonly known as the “no look through” principle.
The “No look through” Principle
By way of background, bonds nowadays are rarely issued to investors as a definite note. Instead, a global note representing an entire issuance will be issued, which will then be deposited in a common depositary for the relevant clearing systems. Trading of bonds would then occur through the book-entry system maintained by the clearing systems. What the ultimate investor actually acquires is a portion of the indirect beneficial interest in the global note via their intermediaries, such as banks and brokers holding accounts with the clearing systems. In other words, the ultimate investor derives its interest in the securities through a chain of intermediaries between itself and the issuer.
In relation to the rights of an ultimate investor against the issuer in a typical global bond structure, the courts of Hong Kong have currently aligned themselves with the position of the United Kingdom, the Cayman Islands and Bermuda by adopting the “no look through” principle in Leading Holdings Group Limited [2023] HKCFI 1770.
Under the “no look through” principle, the ultimate investor would only have rights against their immediate counterparty in the chain of intermediaries, which is usually the banks or brokers who have accounts with the clearing systems. Should the ultimate investor decide to petition for a winding-up against the issuer, the investor would have no standing to do so. The rationale behind is to ensure that all the bondholders would act through the trustees, in order to prevent duplicity of actions (For a detail analysis of Leading Holdings Group Limited, see our previous article).
China Ping An Insurance Overseas (Holdings) Limited
Facts
In China Ping An Insurance Overseas (Holdings) Limited, a principal amount of US$200,000,000 of guaranteed bonds (“Bonds“) was issued by the 1st Defendant (“Issuer“). The Bonds were constituted by a Deed of Covenant, a Fiscal Agency Agreement and a Global Certificate (collectively, “Bond Documents“), and were being cleared and settled through Euroclear Bank S.A./N.V (“Euroclear“). In this regard, the Bonds were structured in the typical way as mentioned above, where a single Global Certificate was issued and held by a custodian (who is the sole registered holder of the Global Certificate), who in turn, held the Global Certificate on behalf of Euroclear.
The Plaintiff holds beneficial interests of the Bonds through Bank of China (Hong Kong) Limited , which is an account holder in Euroclear. In particular, the Plaintiff has subscribed for an aggregate amount of US$190,000,000 of Bonds, constituting (i) an amount of US$50,000,000 of Bonds acquired under a Subscription Agreement entered between the Plaintiff, the issuer and the guarantor (“Subscription Agreement“); and (ii) US$140,000,000 of Bonds further acquired through the market.
Under Clause 4.2 of the Subscription Agreement, the Issuer and the Guarantor were obliged to make satisfactory arrangement to the subscriber (i.e. the Plaintiff) to ensure that Certificates are delivered to the registrar for authentication in accordance with the Fiscal Agency Agreement. The Fiscal Agency Agreement and the Global Certificate in turn provide for the exchange of the Global Certificate for Definitive Certificates if any of the events of default occurs.
Subsequently, the Issuer failed to pay the principal amount of the Bonds, and the demands to exchange the Global Certificate for Definitive Certificates were unanswered. This constituted one of the events of default.
Following an unsuccessful winding up petition against the Issuer due to a lack of standing, the Plaintiff attempted to overcome the obstacle by commenced proceedings for specific performance under Clause 4.2 of the Subscription Agreement to compel the Issuer to issue Definitive Certificates, which would then enable the Plaintiff to enforce the debts directly against it.
Ruling
In a decision in favour of the Plaintiff, the CFI explained that the ordinary and plain meaning of Clause 4.2 of the Subscription Agreement clearly confers the Plaintiff a right to compel the Issuer and the Guarantor to exchange the Global Certificate for Definitive Certificates.
In rejecting the defendant’s argument that Clause 4.2 should be interpreted in light of the Global Note structure in place (and hence finding the Plaintiff successful would be an encroachment to the “no look through” principle), the CFI did not see any inconsistencies between Clause 4.2 of the Subscription, and the underlying Global Note structure as provided by the Bond Documents, which is the natural consequence of the Issuer entering into separate agreements with the Plaintiff. This is the case even if it would mean the risk of duplicity of actions.
Specific performance is granted accordingly, allowing the ultimate investor to then have a direct right to enforce against the Issuer.
Takeaways
The case of China Ping An Insurance Overseas (Holdings) Limited importantly demonstrates that where an entitlement for the exchange of the global certificate for definitive certificates is provided contractually, an ultimate investor may still proceed against the issuer notwithstanding the “no look through” principle. It should be noted that here, the Plaintiff was able to enforce a direct contractual right against the Issuer. Quite often is the case, a beneficial bondholder who is not the registered holder and does not have a direct contractual relationship with the issuer (or otherwise, whose rights are expressly curtailed by the underlying document, often, the indenture), may find him/herself having no standing against the issuer. We would, in that scenario, have to be creative and think out of the box to find a way for such a bondholder to exert pressure on the issuer and work towards a recovery, which we are seeing in a case we are working on.
See the full judgment of China Ping An Insurance here.
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