No More ‘Manna Found on the Desert Floor’ for Insiders: The s. 271(3) Defence Revisited
In SFC v. Yiu Hoi Ying Charles, Wong Nam Marian and the Market Misconduct Tribunal  HKCFA 44, the Final Court of Appeal has issued a broadside against the wide application of the ‘no-profit’ defence in insider trading cases. The defence has now been explicitly narrowed: an offence will be committed where shares are traded for the purpose of profit and price sensitive information is held.
In May 2016 the Market Misconduct Tribunal considered a case brought by the Securities and Futures Commission against the Director of Finance and Company Secretary of a listed company. Yiu Hoi Ying Charles and Qong Nam Marian were alleged to have engaged in insider trading under the Securities and Futures Ordinance.
Insider dealing is defined in s. 270(1) of the SFO. The offence is committed where a person ‘connected with the corporation and having information which he knows is relevant information in relation to the corporation… deals in the listed securities of the corporation…’
The facts were as follows. In July 2002 Asia TeleMedia Limited (“ATML”) owed a third party 83 million dollars and was insolvent. The third party served five statutory demands on ATML between 2002 and 2006. Each statutory demand was negotiated – and the third part did not serve any winding-up petitions. ATML remained listed.
In February 2007 the third party sold the debt owed by ATML to another company. This new company demanded payment of the debt and served a statutory demand. The company also told ATML that it would serve a winding-up petition if payment of the debt was not made. The sale of the debt, and the statutory demand, were not made public.
In the meantime shares in ATML unexpectedly spiked. Marian and Charles both exercised share options and then sold shares in ATML, making profits of more than 5 million dollars net a piece. In June 2007 the new company served a winding-up petition, the debt went public, and the value of ATML shares nosedived.
Marian and Charles raised the defence available under s. 271 (3) of the SFO, the text of which is available here. S. 271 (3) provides a defence where a person ‘establishes that the purpose for which he dealt in… the listed securities or derivatives… did not include, the purpose of securing or increasing a profit or avoiding or reducing a loss’. They claimed that their only purpose in selling their shares was to make a profit from an unexpected surge in the value of AMTL shares, and that developments involving ATML debt had no bearing on their decision to sell.
The MMT found that the statutory demand, and the potential for a winding-up petition, was ‘inside information’. It also found that the two knew that if the information went public, it was bound to damage the value of ATML shares.
The MMT nonetheless held that the defence under s. 271(3) was made out. It found that the sole motivation of the two in selling their shares was to exploit the surge in prices, that they did not anticipate that the demands being made by the new company would be made public and that they thought the dispute with the new company would be resolved behind closed doors. There was therefore no decision indicating a ‘conscious intent’ to misuse the price sensitive information in their possession; the only motivation was to take ‘their share of manna found on the desert floor’.
The Court of Appeal agreed, albeit citing ‘very peculiar facts’. On the face of their judgment it was no offence to trade in securities, whilst holding price sensitive information and not disclosing it to buyers. The case was appealed to the Court of Final Appeal on the issue of whether Charles and Marian were entitled to rely on the s. 271(3) defence (a copy of the judgment, delivered on 12 October, is available here).
In the majority judgment given jointly by Mr Justice Ribeiro PJ and Mr Justice Fok PJ, the conduct of Charles and Marian did amount to the ‘insidious mischief’ of insider trading. The fact that both defendants thought that the price sensitive information they held would never become public was irrelevant. Both had used ‘relevant information’, and they had used it at ‘the very time’ that they traded their shares for a profit.
The Court balked at the idea that s. 271(3) allowed an insider to avoid liability by relying on a subjective belief – saying in effect ‘I traded in shares knowing that their price would be affected by undisclosed price sensitive information which I had, but that is okay because I believed the market would never find out’.
The Court also explicitly narrowed the ambit of s. 271(3). The defence only arises where the insider positively establishes an innocent purpose in trading shares whilst holding price sensitive information. The two examples given by the Court of when it might arise show how limited this new ambit is. The Court imagined two scenarios where the defence would apply: where a person is subject to a prior obligation to sell shares (whether for profit or not), or where a person sells shares in compliance with an order of the Court.
These obscure examples provide little comfort to those wishing the raise the defence based on a subjective belief about what would happen to the value of shares in future. All that is now required to found a conviction is that a person’s purpose in selling shares was to secure profit, when they possessed price sensitive information.