Introduction
In layman’s terms, Insider trading is the buying or selling of a security by someone who has access to material nonpublic information about the security.
Insider trading has been a prevalent phenomenon even in the most mature financial markets, particularly in the recent decade when the ubiquity of internet and innovation of financial products have brought new dimensions into the clandestine activities which added extra complexity and difficulty to detection, enforcement and prosecution work. Yet, also advancing with the growing sophistication of the illicit activities is the insider trading law in almost all mature jurisdictions, among them are Australia and Hong Kong. Both are prime regional financial centres and both are common law jurisdictions. Their respective regimes share a lot of commonalities, yet this paper observes that the Hong Kong regime in some important respects lag behind Australia’s.
In view of the vastness of the topic, this essay will focus on discussing the following key areas of the regimes which have been subject to debates: (1) rationale for the prohibitions; (2) basic structure of the two regimes; (3) major elements of the prohibitions; (4) insider trading in the takeover scenario.
The Australian insider trading law is set out in Division 3, Part 7.10 of the Corporations Act (‘CA”), and enforced by the Australian Securities and Investments Commission (“ASIC”). The Hong Kong regime is set out in Division 4, Part XIII (civil regime) and Division 2 and Part IV (criminal regime) of the Securities and Futures Ordinance (“SFO”), which are administered by Hong Kong’s Securities and Futures Commission (“SFC”).
Rationales behind the Prohibition
There are traditionally four theories to justify the prohibitions in both jurisdictions, which are (1) the fiduciary duty theory, (2) fraud or misappropriation theory, (3) equal access to information theory and (4) market integrity theory.None of these theories however are free from criticisms. The fiduciary duty theory, for example, cannot be applied to persons who are legally not fiduciaries, such as substantial shareholders. However, the recent approach by the judiciaries in both jurisdictions, it is observed, is based more on the fraud theory and market integrity theory. This is illustrated in two recent high profile insider trading cases in the two jurisdictions. In Australia, in R v. Xiao, where the accused, managing director of a Chinese company, confessed to having engaged in insider trading of shares of two ASX listed companies, of which his company was contemplating a takeover bid. When the NSW Supreme Court handed down a jail term of 8 years, the longest sentence in insider trading cases in Australia, Hall J emphasised that (1) insider trading is a form of cheating or fraud, and (2) “insider trading erodes public confidence in the fair, orderly and transparent operation of the market” and it not only has the capacity to undermine the integrity of the market but also has the potential to undermine aspects of confidence in the commercial world generally. In Hong Kong, in HKSAR v. Du Jun, where the accused was a managing director of Morgan Stanley Asia, which represented the Hong Kong listed subsidiary of a Chinese state-owned conglomerate, in relation to the listed subsidiary’s acquisition of certain Kazakhstan oilfields from its parent SOE, and to carry out oil price hedging. The accused was a member of the Morgan Stanley team for the transaction and learned of the intended acquisition and purchased shares of the listed subsidiary ahead of its announcement to the market, and made huge profits of around HK$23.3 million. The Hong Kong Court of Appeal, while reducing what was also the longest jail term for insider trading cases in Hong Kong, from 7 years to 6.3 years, endorsed the principles in the English case of R v. McQuoid that (1) insider dealing is a species of fraud; it is cheating, and (2) “the principles of confidentiality and trust, which are essential to the operations of the commercial world, are betrayed by insider dealing and public confidence in the integrity of the system which is essential to its proper function is undermined by market abuse”.
It is submitted that the fraud theory fits well into both cases, given the defendants were one way or another connected with the companies whose listed securities were the subject of insider trading. But what about the scenario where an unrelated third party who comes into possession of inside information by accident or mistake (for example, a recipient by mistake of an email from the CEO of a company who is planning a takeover bid for a listed company) who then conducts insider trading in reliance on those inside information? In this scenario, the insider does not stand in a fiduciary position or any position of trust and confidence or indeed does not have any relation at all, whether to the acquirer or target of the takeover. And who could be the victim of fraud, if at all? It is interesting to note in this connection the US case of Chiarella v. United States 445 U.S. 222 (1980), where the defendant was employed as a “markup man” by a printing company, and he worked on documents involving five corporate takeover bids. Although the documents were coded, he was able in each case to decipher the code, identify the target corporation, and purchased stock of the targets before public announcement of the takeover bids. After each bid was announced, he sold his purchased stock and made a profit. In reversing the defendant’s conviction, the US Supreme Court concluded that, however improper his behavior, he was not guilty of fraud in the traditional sense, as the court reasoned that failure to disclose by corporate insiders is fraud because of their fiduciary obligation to the corporation’s shareholders, but the defendant had no relationship with the target shareholders from whom he bought stock – he was not their agent, he was not a fiduciary, he was not a person in whom the sellers had placed their trust and confidence. He was, in fact, a complete stranger who dealt with the sellers only through impersonal market transactions. If the conducts of the defendant in this case did not amount to fraud, it seems that the hypothetical case mentioned above is even a step further away from fraud, because unlike the defendant in the Chiarella case, he was even not related to a third party who is related, contractually or otherwise, to the acquirer or target of a takeover bid!
It appears that the market integrity theory is the most convenient and all-embracing justification for prohibition on insider trading, which could encompass all other theories (as a mature financial market certainly cannot tolerate insider trading activities that involve breach of fiduciary duty, misappropriation of valuable and confidential corporate information by its officers or asymmetric access to price sensitive information) .
Basic Structures of the Two Regimes
The regimes in both jurisdictions entail both criminal and civil sanctions, which mean that breach of the respective insider trading law could result in either criminal or civil consequences.In Hong Kong, civil proceedings are usually commenced in a special tribunal called Market Misconducts Tribunal (“MMT”), which is vested with the jurisdiction to deal with not only insider trading but also other kinds of market misconducts such as stock market manipulation, false trading, price rigging etc. The standard of proof in the MMT is civil and thus proof on the balance of probabilities is sufficient. What is peculiar in MMT proceedings is that they are inquisitorial, instead of adversarial, in nature and the object of MMT proceedings is to determine whether market misconduct has taken place, the identity of person engaged and the amount of profit gained or loss avoided as a result of the misconduct. The orders that the MMT can make include an order of disgorgement of profit to the government, disqualification order, cold shoulder order and cease and desist order. Only the SFC may commence proceedings in the MMT. Proceedings in MMT are analogous to the civil penalty regime under s.1317E(1)(jf) – (jg) of CA. If a court is satisfied that the prohibitions on insider trading law under s.1043A(1) and (2) are contravened, it must make a declaration of contravention and it may also ask the trader to pay the Commonwealth a pecuniary penalty. The standard of proof is also civil, that is, proof on balance of probabilities only, and only ASIC is entitled to make an application for a declaration of contravention of a civil penalty provision. It therefore appears that the major difference between the MMT proceedings in Hong Kong and the civil penalty proceedings in Australia is that the former is inquisitorial in nature and instituted in a special tribunal, whereas the latter is still an adversarial proceeding and commenced in a court, whether the Federal Court or state supreme court.
The criminal regimes in both jurisdictions do not differ much. As in other criminal proceedings, the standard of proof in both jurisdictions is proof beyond reasonable doubts, which is difficult and high for such clandestine offences as insider trading. The SFC has made clear its position that it will “give priority to criminal proceedings over MMT proceedings where the conduct in question can be established to the criminal standard of proof and it is in the public interest to prosecute the case”. The SFC is empowered to summarily prosecute insider trading offences, but if they are to be prosecuted as indictable offences, the prosecution decision has to be made by Hong Kong’s Director of Public Prosecution. This appears also to be more or less the same in Australia. In Australia, ASIC’s position seems to be less robust than SFC – ASIC does not prefer criminal proceedings to civil when it says that “[d]epending on the seriousness and consequences of the corporate wrongdoing, we pursue the regulatory and enforcement sanctions and remedies best suited to the circumstances of a case and what we want, and are able, to achieve….. We have the choice of pursuing punitive, protective, preservative, corrective or compensatory actions, or otherwise resolving matters through negotiation or issuing infringement notices.”
Obviously, the sanctions, whether criminal or civil, described above are aimed at penalising the traders, but do not compensate the victims. As far as compensating the victims is concerned, both regimes contain provisions to enable the victims of insider trading to claim against the relevant traders. In Hong Kong, it has been held that MMT proceedings do not affect civil liabilities. Section 281 and 305 of the SFO allow persons who suffer pecuniary damages to recover compensation from the persons who commit market misconducts including insider trading. Additionally, Hong Kong’s High Court is empowered under s.213 to grant, on the application of SFC, a series of civil remedies including injunctions, specific performance orders, prohibition orders, annulment orders etc. against the traders. In Australia, civil compensation order under s.1317HA of CA is also available to victims of insider trading and ASIC may also bring an action for damages under s.1043L(2) or (5) for the benefit of and in the name of the issuer of securities. Like its counterpart in Hong Kong, s.1043O of CA empowers the court to make orders similar to those under s.213 of the SFO.
Fundamental Elements of Prohibitions
In this section, we will compare the following fundamental elements of the prohibitions in the two jurisdictions:-
- subject matter of insider trading
- information not generally available
- materiality of information
- connection requirement
Subject Matter of Insider Trading
The Australian regime prohibits insiders from trading “Division 3 financial products”. Section 1042A of the CA contains not only a broad definition of Division 3 financial products, but also a non-exhaustive definition, as ss.(e) provides “any other financial products that are able to be traded on a financial market”. The Hong Kong regime prohibits insiders from trading “listed securities” or their “derivatives”. Listed securities, as defined in s.245 of the SFO, has an exhaustive definition, and they must be in relation to a listed corporation.
It therefore can be observed that Division 3 financial products in the Australian regime has a much broader definition than listed securities under the Hong Kong regime, as the former is not necessarily limited to securities in relation to listed companies and could include, for example, a forex derivative such as forex forward. A recent case in Australia could illustrate the difference of the two regimes in this aspect. In DPP v Hill [2012] VSCA 144, where the defendants, Hill and Kamay, were former classmates in Monash University. Hill subsequently joined the Australian Bureau of Statistics (“ABS”) as an analyst with access to ABS’s sensitive and unpublished information about main economic indicators such as labour force, retail trade, building approvals, and private expenditure data, which was not generally available to the public. Hill fed this information to Kamay who used the same to trade margin FX contracts on the foreign exchange derivatives market and made a huge profit of $8 million. The Victoria Supreme Court held that a margin FX contract was a financial product that was a derivative, whose value derived from the value of an underlying currency exchange rate and thus a Division 3 financial product. Both Hill and Kamay were convicted of insider trading. What is peculiar about this case is that first, the financial product concerned is not traditional securities of or relating to a listed corporation, but a totally different product of margin FX contracts, which are not linked to listed securities issued by corporations at all; second, the trader is not an officer of or relating to a listed company, but an officer of a public authority; third, the inside information concerned is not specific to a particular company, but an unpublished sensitive information about Australian economy generally which could trigger material impact on the financial market generally (including the stock market and foreign exchange market). Had the same facts taken place in Hong Kong, the defendants could not have been convicted of inside trading under the Hong Kong regime, as the subject matter of inside trading i.e. margin FX contracts, does not fall within the definition of “listed securities” under SFO, which have a much narrower connotation than “Division 3 financial products”.
Information Not Generally Available
To trigger the insider trading provisions in both regimes, it is important that the information that the insider utilises to conduct trading must first be qualified as “inside information”. One of the major components of the definition of insider information in both regimes is the nature of the information. In the Australian regime, that information must not be “generally available”, and for the Hong Kong regime, the information must not be “generally known to the persons who are accustomed or would be likely to deal in the listed securities of the corporation”. The two regimes therefore share a commonality in this respect, though with different terminology – for the Australian regime, the information must be not generally available, and for Hong Kong’s, it must not be generally known. What is helpful for the Australian regime is that it provides a further detailed definition of “generally available” in s.1042C, while the Hong Kong regime fails to do so and therefore what exactly does “generally known” mean has to be left to case law.
Materiality
Both regimes require the information to have material effect on the price of securities or financial products. The Hong Kong regime, except providing that if the information is generally known it will be likely to materially affect the price of the listed securities, is devoid of further provisions regarding what exactly does “materially affect the price” mean, and therefore reference to case law is necessary.
In the Australian regime, s.1042D of the CA however has helpfully clarified what “material effect on price” in s.1042A means, by providing that “a reasonable person would be taken to expect information to have a material effect on the price or value of particular Division 3 financial products if (and only if) the information would, or would be likely to, influence persons who commonly acquire Division 3 financial products in deciding whether or not to acquire or dispose of the first-mentioned financial products”. Succinctly put, the test under s.1042D is “therefore the influence of information on decision making”. It is submitted that this test is clear, straightforward and succinct.
Connection Requirement
The Hong Kong regime requires a “connection” between the trader and the corporation of which he possesses inside information. This primarily consists of five groups of persons: (i) substantial shareholders, directors, and employees of the corporation, or its related corporation, (ii) persons connected by professional or business relationship, (iii) transaction counterparties privy to inside information, (iv) public officers and specified persons, and (v) persons in group (i) to (iii) within the 6 months preceding the relevant contravention.
In Australia, on the other hand, the “Griffiths Report” in 1989 has proposed the abolition of the connection requirement which proposal was subsequently accepted and enacted into law, and therefore in the current insider trading provisions of CA, the connection requirement no longer exists. In the Griffiths Report, the committee, recommended and concluded “[t]he offence of insider trading must have its genesis in the use of information derived from within a company. The existing prohibition requiring a person to be connected to the corporation which is the subject of the information unnecessarily complicates the issue. It is the use of information, rather than the connection between a person and a corporation, which should be the basis for determining whether insider trading has occurred.”
It is submitted that the connection requirement is unnecessarily narrow and will create an obvious loophole in the insider trading law, such as where the trader who being not in any way connected with the company concerned acquires the inside information by mistake or accident. Further, it seems that the connection requirement finds its theoretical support in the guilt-based philosophy of breach of fiduciary duties and misappropriation of corporate assets, rather than the guilt-free approach of maintaining market integrity, equality of access to market information (regardless of the trader’s relationship with the source of information), which is the current mainstream philosophy underlying the insider trading law. It also appears that an unrelated trader who acquires inside information innocently and trades on the same is as morally culpable as a person picking up a wallet on the street uses the money therein as if it were his own instead of returning it to its owner or the police. The law would be bizarre and unreasonable if the latter is guilty of theft while the former is allowed to walk free.
Takeover Scenario
The main difference between the Hong Kong regime and the Australian regime in this aspect is that the Hong Kong regime distinctly singles out, and makes a specific provision, for the takeover scenario, while the Australian regime does not. Section 270(1)(b) of the SFO specifically covers the bidder or offeror of a takeover bid. It is not all clear why the Hong Kong regime has to single out the takeover scenario and make specific provision to cover it, but it may be related to the connection requirement as the offeror of a takeover bid may not fall within the 5 types of persons mentioned above; ; secondly, the specific provision in SFO for takeover bids highlights the significance of insider trading activities in takeover cases, which is true in both jurisdictions. The following table illustrates the extent of insider trading activities in takeover cases in Hong Kong:-
Source: Enforcement of insider trading law in Hong Kong: What insights can we learn from recent convictions?
In Australia, in “Casino Capitalism? Insider Trading in Australia”, “[i]t has been said, and other research tends to show, that there is a distinct relationship between takeover activity and the level of insider trading.” The author attributes this phenomenon to two reasons: on the one hand, the large number of people, particularly advisers, involved in the takeovers, and on the other, substantial profits can be derived from insider trading in takeover cases as the bidder will invariably offer considerable premium to induce the target’s shareholders to sell their stake. These are the same as in Australian as in other jurisdictions.
It is interesting to note at this juncture two insider trading cases in the two jurisdictions, which involve takeovers. In SFC v. Young Bik Fung, where the SFC instituted civil proceedings in Hong Kong’s High Court, against an employed solicitor of Linklaters, which was an international law firm acting for the substantial shareholder of a listed company in Hong Kong, in the privatisation (which involved a takeover bid) of the listed company. The facts of the case revealed that the solicitor did not belong to the team of Linklaters that worked on the privatisation but those in the team and that solicitor shared the same printers, photocopiers, secretaries and fax machines and the solicitor’s office was close to those of the partner and members of the firm who worked on the privatisation deal. The court found by necessary inference that the solicitor learned of details including pricing of the privatisation because of his close proximity with his colleagues who handled the deal. He then tipped off his girlfriend (who was also a solicitor but in another law firm) and his sisters, and they then purchased shares in the target listed company before the privatisation was announced to the market and made a profit. There were evidence to show the existence of a “Chinese Wall” in Linklaters to militate against the possibility of accidental leaks of confidential information to people outside the team but such measures the court found were not “fool proof”. The court held that the solicitor was not a “connected person” because “[a]n employed solicitor who was not a member of the team working on the deal would not be in a position “which may reasonably be expected to give him access to relevant information” about that deal.” This case illustrates the danger and deficiency of the antiquated connection requirement which could exonerate an otherwise obvious insider trading case in takeover situation. Had the same facts taken place in Australia and governed by Australian law, there is no doubt that the employed solicitor would be found guilty of insider trading.
In Australia, in Australian Securities and Investments Commission v Citigroup, Citigroup included investment banking and equities trading operations, with a Chinese wall established between these two divisions. The investment banking division was the adviser to Toll Holdings Ltd (Toll) on its takeover bid of Patrick Corp Ltd (Patrick). Manchee, an employee of the equities trading division, purchased shares in Patrick for Citigroup’s own account a day before the planned announcement of the bid through the ASX. When employees of the investment banking division became aware of these purchases, Manchee was instructed to stop further buying of Patrick shares. Manchee responded by selling the Patrick shares purchased earlier that day. There was no evidence to show that Manchee knew of the takeover of Patrick. ASIC’s accusations against Citigroup were mainly two-fold: first, the instruction given to Manchee to stop buying Patrick shares was insider information and the subsequent sales of the Patrick shares amounted to insider trading by Citigroup; second, since senior officers of Citigroup knew of the takeover bid, knowledge of Manchee’s trading in the Patrick shares was attributable to Citigroup so as to make it liable for insider trading. The Federal Court dismissed both claims, because for the first claim, Manchee was not an officer of Citigroup and his knowledge was not attributable to Citigroup, and in any event, the claim had not established that he traded with knowledge that Citigroup was acting for Toll on the takeover of Patrick; the second claim failed because at the time of the Manchee sales, Citigroup had Chinese walls in place that satisfied the requirements of s. 1043F. The Federal Court’s rulings on both claims must be unassailable.
The two cases in both jurisdictions bear some similarities: both cases concern trading by employees of advisers for the bidders in takeovers (albeit in the Citigroup case, the employee was trading on account of his employer) and information barriers were found to exist in both firms. Yet, the Hong Kong traders were found to be buying with express knowledge of the inside information, whereas the other (i.e. Manchee) was not; the Hong Kong claim was brought against the employee of the adviser (and his tippees), but the Australian claim was directed against the adviser itself, which it is submitted must fail if ASIC could not prove knowledge on the part of Manchee but even it could, it is hard to attribute his knowledge to Citigroup unless it could be established that Citigroup’s board or management authorised his trading or that Manchee was an officer. But the Hong Kong claim almost failed because of the technical connection requirement. As the Australian regime has done away with the connection requirement, assuming Manchee had learned of the Toll takeover bid (whether by accident or on purpose) and traded on his own account, there is no question that he would be caught by the insider trading provisions under the Australian regime, but not Hong Kong’s.
Conclusion
To conclude, Hong Kong’s insider trading law lags behind that of Australia in many material aspects, even though some critics still think that the latter is “hopelessly complex”. Complex it may be, the complexity is necessitated by the difficult but inevitable question of what “the insider trading prohibition is concerned with [and which] people and activities … are to fall within it.” In this sense, a more sophisticated and meticulous regime is preferred to an over-simplified one, which creates uncertainties and unpredictability for market participants. Notably, two areas of the Hong Kong regime are deficient, as discussed above. First, the connection requirement is unreasonably antiquated and inconsistent with the current mainstream philosophy (which stresses protection of financial market integrity and equal access to corporate information instead of fiduciary position of the trader) that supports insider trading prohibition, and has to be abolished. Second, the (i) subject matter of prohibition (i.e. listed securities and their derivatives) and (ii) the definition of inside information in the Hong Kong regime are too narrow and cannot cater for the innovation and availability of rapidly changing types of financial products in the market these days. There is no reason that these two concepts have to be linked and restricted to a “listed corporation”. Instead, like the Hill case mentioned above, they could extend to financial products (e.g. margin FX contracts) which have no connection with a listed entity at all. This disparity in the scope of the two jurisdictions’ insider trading law, however, should be understood and appraised with reference to the respective roles and powers of the regulators in the two jurisdictions – ASIC is primarily a regulator of corporations or body corporates in Australia, which is vested with extensive investigation powers in respect of not only financial market but also suspected contravention of Commonwealth or state law concerning management or affairs of or involving fraud and dishonesty relating to body corporates, whereas the SFC is basically only a regulator of Hong Kong’s securities and futures market, with mandate only to “maintain and promote the fairness, efficiency, competitiveness, transparency and orderliness of the securities and futures industry”. Simply put, ASIC is a corporate police, but SFC is but a regulator of securities and futures market only.
(This article is extracted from Edward Tai’s thesis in the subject “Securities and Financial Market Regulation” in the Master of Law programme of the University of New South Wales. All rights are reserved)
（Author, Mr. Edward Tai, consultant of our firm. Born and educated in Hong Kong, he is a solicitor admitted in Hong Kong, Australia (NSW & SA) and England & Wales. He started off his legal career by practicing as a commercial litigator in Hong Kong. After that, he went in-house in different roles of counsel, head of legal and/or company secretary etc. In the last 10 years, he has been mainly focused in the law and commercial practice relating to cross-border M&A, corporate finance and listing compliance. Please contact Edward by his email [email protected]）