Court of Final Appeal quashes convictions of warrant traders for market manipulation
by Joseph Kwan
Background
Fu Kor Kuen Patrick("Fu") and Lee Shu Yuen Francis ("Lee"), were convicted by the District Court of 20 counts of creating a false and misleading appearance of active trading in 20 different derivative warrants issued by Macquarie Bank Ltd, contrary to sections 295(1) and 295(6) of the Securities and Futures Ordinance ("SFO"). In May 2010, Fu and Lee were sentenced to 33 months and 36 months imprisonment respectively and each ordered to pay HK$694,498 to the Securities and Futures Commission for investigation costs.
On 23 December 2010, the Court of Appeal dismissed Fu and Lee's appeals against conviction, holding that the purpose of the market manipulation provisions is to keep markets free of manipulation and that breach of those provisions is serious, even in the absence of proof of loss to investors. However, the Court of Appeal held that the prison sentences were manifestly excessive and reduced them to 20 months and 21 months, respectively.
The alleged wrongdoing
It was alleged that Fu and Lee, traded between themselves various derivative warrants issued by Macquarie Bank Ltd, in a pre-determined manner, in approximately the same quantities and prices, in a repetitive fashion. The "ping pong" trading resulted in the inflation of the turnover for Macquarie-issued warrants by 80% (or over HK$450 million in value), with the result that potential investors were misled into thinking that the warrants were heavily traded by genuine buyers and sellers, when in fact the opposite was true.
The reason for the trading was because of commission rebates on trading offered by Macquarie Equities (Asia) Ltd ("MEAL"). The commission rebates had the effect of reducing transaction costs for investors and the high volume of trading by Fu and Lee meant that the commission rebates they earned exceeded their transaction costs, enabling them to earn a net profit of approximately HK$1 million. This was the first indictable prosecution under the SFO for manipulating derivative warrants.
Court of Final Appeal's Decision
On 24 May 2012, the Court of Final Appeal allowed Fu and Lee's appeals against conviction. Their convictions were quashed and sentences set aside (although by that time, they had already served their sentences).
It was not in dispute that Fu and Lee had engaged in their circular trading, with the objective of earning the commission rebates on offer or that by doing so they created a false and misleading appearance of active trading. However, the Court of Final Appeal held that the trial judge and Court of Appeal had been in error in finding that Fu and Lee's purpose (or one of their purposes) in trading was to create a false and misleading appearance of active trading.
Defence under Section 295(7) of the Securities and Futures Ordinance
The crux of the appeal before the Court of Final Appeal was the construction of section 295(7) of the Securities and Futures Ordinance, which provides a defence to a person who can prove that the purpose for which he committed the act was not (or where there was more than one purpose, the purposes did not include) creating a false or misleading appearance of active trading in securities. In this case, the Court of Final Appeal found that Fu and Lee's purpose had been to earn commission rebates and, although the result of their operation was the appearance of active trading, it was not their purpose.
Burden of Proof
The Court of Final Appeal held that Fu and Lee bore a persuasive burden of proof (to be discharged on a balance of probabilities) under section 295(7) to establish that they had an innocent purpose when their trading created a false appearance of active trading. The trial judge, they held, had been in error in holding that the prosecution carried the persuasive burden of proof. It was also held that the Court of Appeal was wrong in holding that the section 295(7) defence was irrelevant.
Apart from the matter of burden of proof, the Court of Final Appeal held that the trial judge's factual reasoning was open to criticism. It made a distinction between "the purpose" in section 295(7), which is the objective which the Defendants sought to achieve by engaging in the conduct in question, as opposed to "motive", which was the reason for which the Defendants were acting in pursuit of the objective. It said that the existence of at least a primary purpose that was not a proscribed purpose was obvious once the primary facts relating to the trading appeared. The question, then, was whether that was their sole purpose, or whether they had the secondary purpose, contended for by the prosecution.
The Court of Final Appeal found that the purpose of pursuing commission rebates (a purpose which was consistent with a defence under section 295(7)) was obvious once the primary facts were established. There was no secondary purpose to the trades, since the price of the warrants remained fairly stable on those days they were traded. At the end of the day, they exited by selling the warrants to MEAL at about the price at which they were brought. Fu and Lee, it held, had made out the defence. In this case, Fu and Lee had not given evidence and the Court of Final Appeal remarked that in most cases a defendant will need to give evidence in order to discharge the persuasive burden of proof, as arguments advanced by counsel, or developed on the basis of expert witnesses, will not suffice where the existence of an innocent purpose remains speculative. However, the Court of Final Appeal said that the reason for Fu and Lee's behaviour was plain in this case, namely, to make a profit from the rebate scheme, and their convictions should be quashed and sentences set aside.
The proper form and function of expert evidence
In its judgment, the Court of Final Appeal also made observations about the proper function of expert witnesses. It said that the function of experts in cases of this nature was to put forward facts and matters concerning the derivative-warrant market, from which the Court might draw an inference concerning the Defendants' intention and purpose. Here, the parties' experts strayed well beyond their field of expertise because they had made statements of personal belief about Fu and Lee's intentions (i.e. state of mind) and the purpose of their trading activities, which was inadmissible. The expert reports in this case were also not in the proper form, as they failed to state (so that they could be tested against facts admitted or established by the evidence) the assumptions upon which opinions were based.
Comments
Commission rebates were not prohibited by the SFC at the time when the trades in question were executed. They have since been banned by the SFC and thus it would no longer be possible for traders to rely on a defence of commission rebates to justify their ping pong trades. However, the judgment is important, as it gives guidance on the interpretation and burden of proof of section 295(7). This case is also one of the recent cases where the courts rejected a case brought by the SFC.
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Obtaining interim relief in aid of foreign proceedings
by Robert Clark
Prior to the Civil Justice Reforms, the Hong Kong courts could not grant interim relief, such as a mareva injunction, where there were no substantive proceedings commenced (or to be commenced) in Hong Kong. This was considered unsatisfactory because it meant that a plaintiff, suing a defendant in a foreign court (and who had no jurisdictional basis for bringing proceedings for substantive relief in Hong Kong), could not obtain a mareva injunction against any assets that the defendant had in Hong Kong, to prevent him from disposing of them. This meant that a defendant could easily defeat the judicial process by moving his assets from country to country and thereby defeating any judgments obtained against him.
As part of the Civil Justice Reforms (which came into effect on 2 April 2009), a new section 21M was added to the High Court Ordinance, which provides that the Court of First Instance may appoint a receiver or grant other interim relief (such as a mareva injunction) in relation to proceedings which (i) have been or are to be commenced in a place outside Hong Kong; and (ii) are capable of giving rise to a judgment that may be enforced in Hong Kong under any Ordinance or at common law. This means that under section 21M, a receiver can be appointed or other interim relief granted (such as a mareva injunction) as an independent form of relief and without being ancillary or incidental to substantive proceedings in Hong Kong. Accordingly, section 21M can be used where a dispute has no connection with Hong Kong or where another jurisdiction is a more appropriate forum for resolution of the dispute, but where the defendant has assets in Hong Kong. After obtaining a judgment in another jurisdiction, the plaintiff can then apply to enforce the judgment over the defendant's assets in Hong Kong, having obtained an interim injunction to prevent their disposal in the meantime.
In respect of arbitration proceedings, section 45 of the Arbitration Ordinance (Cap 609), provides that the court can grant an interim measure (such as an injunction) in relation to any arbitral proceedings which have been or are to be commenced in or outside Hong Kong. In respect of arbitral proceedings outside Hong Kong, such interim measure can only be granted if the arbitral proceedings are capable of giving rise to an arbitral award that may be enforced in Hong Kong. The court may decline to grant interim measures where they are currently the subject of arbitration proceedings and the court considers it more appropriate for the interim measure to be dealt with by the arbitral tribunal.
The following are examples of cases where the court has granted interim relief under section 21M of the High Court Ordinance and section 45 of the Arbitration Ordinance.
In Muginoho Co Ltd V Vimiu HK Co Ltd, HCMP 107/2012, in which Deacons acted for the Plaintiff, the court granted the Plaintiff an interim injunction under section 45 of the Arbitration Ordinance. In that case, the parties had commenced arbitration proceedings in Japan. Japan being a party to the New York Convention, arbitral awards made in Japan, can be enforced in Hong Kong. The Defendants argued that as the parties had chosen to arbitrate in Japan, they should pursue the matter there. They said that it was inappropriate for the Hong Kong court to grant an injunction, which would pre-empt the decision ultimately to be made by the arbitral tribunal and that the court should not usurp the arbitral tribunal's functions. However, the court held that the amendments brought in by section 21M of the High Court Ordinance and the corresponding amendments to the Arbitration Ordinance were made for the purpose of facilitating foreign proceedings, taking comity into account. It said that the interim measures contemplated by section 45 of the Arbitration Ordinance were temporary measures to maintain or restore the status quo, pending determination of the dispute, or orders aimed at preventing imminent harm or prejudice to the arbitral process.
The court said that notwithstanding that Japanese law was the governing law of the agreement in dispute between the parties, it could not see that an interim injunction to preserve the status quo of the parties would pre-empt the ultimate award which the Japanese arbitral tribunal may grant or usurp its functions. The order of the court, it said, could be made subject to the arbitral award, orders or directions of the arbitral tribunal in Japan.
When exercising its jurisdiction to grant interim relief under section 21M of the High Court Ordinance or s.45 of the Arbitration Ordinance, the general principles governing the grant of an interim injunction still apply, namely whether there is a serious question to be tried, whether damages would be an adequate remedy and whether, on a balance of convenience, it would cause less harm to grant the relief sought. In the Muginoho case, the court held that it had no doubt that if the Plaintiff succeeded in the arbitral proceedings, it would not be adequately compensated in damages. The court saw no reason to refuse the injunction sought and said that clearly the status quo should be preserved, particularly with regard to the fact that the injunction sought was an interim measure in aid of the Japanese proceedings.
In Her Majesty's Revenue & Customs v Shahdadpuri & Anor, HCMP 938/2010, Her Majesty's Revenue and Customs (HMRC) had been granted an ex parte mareva injunction up to ₤40 million, in aid of foreign proceedings in the United Kingdom, under section 21M of the High Court Ordinance against the Defendant ("the Injunction"). HMRC had earlier obtained a worldwide mareva injunction to the extent of ₤40 million against the Defendant ("the English Action"). The Defendant applied to discharge the Injunction, arguing that the English Action was not capable of giving rise to a judgment which could be enforced in Hong Kong because Hong Kong courts had no jurisdiction to enforce the revenue laws of a foreign state, and the Injunction, the Defendant argued, amounted to enforcement directly or indirectly of UK revenue law. The court dismissed the Defendant's application, holding that the requirements of section 21M of the High Court Ordinance had been satisfied and that the action was one in fraud rather than the enforcement of UK revenue law.
Deacons are currently acting in further ongoing proceedings under section 21M. It is noticeable that clients are showing interest in applications under this section and section 45 of the Arbitration Ordinance. We welcome enquiries regarding interim relief in aid of foreign proceedings from overseas!
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The proposed class action regime for hong kong
by Karen Dicks
On 28 May 2012, The Law Reform Commission of Hong Kong published a report proposing that a class action regime be introduced in Hong Kong. The proposals follow responses to its consultation paper published in 2009.
What is a class action?
A class action is a legal procedure whereby claims of a number of individuals against the same defendant(s) are determined in one legal action. One or more "representative plaintiffs" sue on their own behalf and on behalf of a number of other persons (the class) who have the same claim or similar claims as the representative plaintiff, sharing questions of law or fact. Only the representative plaintiff is a party to the legal proceedings, but the class is bound by the outcome of the court proceedings, although they have not taken any active part in the proceedings.
What is the current position in Hong Kong?
Under Hong Kong's existing law there are "representative proceedings", whereby numerous persons having the same interest in any proceedings can bring proceedings by or against any one of them, as representing all or as representing all except one or more of them.
What are the shortcomings of representative proceedings?
Representative proceedings were criticized in the final report of the Chief Justice's Working Party on Civil Justice Reform as being too restrictive and inadequate. While the provisions were considered adequate in cases involving a relatively small number of parties closely concerned in the same proceedings, they were considered inadequate for dealing with large-scale multi-party situations. Further, even where a representation order is made and the case proceeds to judgment, finality is not necessarily achieved because individuals affected by the representation order can challenge enforcement and re-open the proceedings on the basis that facts and matters peculiar to their case exist.
What are the benefits of a class action regime?
The Law Reform Commission's Report identifies the following benefits:
Benefits for Plaintiffs
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Improved access to justice. A single plaintiff's claim may not be economically viable to pursue because of the costs involved, but the aggregate claims of the plaintiff class may be substantial enough to justify a claim.
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Narrowing down disparity between the parties, especially when a plaintiff is a single litigant or consumer up against a governmental body or wealthy multinational corporation.
Benefits to Defendants
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Avoiding multiple related legal proceedings. Defendants will be spared the time, cost and inconvenience of defending identical, related or similar claims, which may stretch over long periods of time and in different jurisdictions.
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Finality of disputes. A class action regime could lead to finality and class-wide resolution of disputes, preferably by settlement, because the ruling or settlement agreement would bind all class members.
Benefits to Society
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Increased judicial economy. A class action regime enables the court to deal with claims involving common issues of law and fact within a single proceeding, instead of determining claims individually. This will save judicial resources.
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Greater access to justice.
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Different or inconsistent rulings on identical or similar claims brought by plaintiffs in separate actions can be avoided.
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Class actions can act as a deterrent to potential wrongdoers, such as corporations and governmental bodies from committing wrongful acts by making it feasible for victims to recover damages from wrongdoers who were previously insulated from having to account for their wrongs because of economic and other barriers to individual proceedings.
What are the potential drawbacks of a class action regime?
The Law Reform Commission's Report also recognises some potential pitfalls of a class action regime, including the risk of promoting unnecessary and unmeritorious litigation and risk of insufficient protection of individual class members' interests, given that they each play a small part in the litigation.
What are the Law Reform Commissions conclusions and recommendations?
The Law Reform Commission's Report concludes and recommends as follows:
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There is a good case for the introduction of a comprehensive multi-party regime in Hong Kong. This should start with consumer cases and then possibly extended to other types of cases.
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A good case has been made out for considering the establishment of a general procedural framework for class actions in the Hong Kong courts. It is crucial that there are procedures for filtering out cases that are not viable and that there are rules in place to ensure fairness, expedition and cost effectiveness. In addition, alternative dispute resolution techniques, such as mediation and arbitration should be fully utilised.
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Class actions should adopt an opt-out approach i.e. unless otherwise ordered by the court, once the court certifies a case suitable for a class action, the members of the class, as defined by court order, would be automatically considered to be bound by the litigation, unless within time limits and in a manner prescribed by the court order, a member opts out.
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The new class action regime should apply to public law cases. The Law Reform Commission had considered whether a class action regime was suitable for public law cases, in view of the special features of public law litigation in Hong Kong by virtue of the Basic Law.
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To prevent class members with sound financial capability from deliberately selecting impecunious plaintiffs to act as class representative, a representative plaintiff' should be required to prove to the court's satisfaction that suitable funding and costs-protection arrangements are already in place at the certification stage. In appropriate cases, the court should be able to order representative plaintiffs to pay security for costs.
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Where a class action involves foreign plaintiffs, an opt-in procedure should be the default position i.e. unless the court orders otherwise, a potential class member must expressly opt in to the class proceedings by taking a prescribed step within a stipulated period and will not be bound by a settlement or judgment unless he opts in. The current court rules on service of proceedings outside Hong Kong should be applicable to foreign defendants and the court should be able to stay class actions involving foreign plaintiffs or defendants on the grounds of forum non conveniens i.e. on the grounds that Hong Kong is not the appropriate forum for resolution of the dispute and that there is another available forum which is clearly and distinctly more appropriate. To assist foreign plaintiffs to consider whether to join in class proceedings commenced in Hong Kong, information on the proceedings should be publicised on a website.
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A legally aided person should not lose his legal aid funding by agreeing to act as representative plaintiff in a class action, but he should only be funded or protected to the extent as if he were pursuing a personal, as opposed to class, action.
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In the long term, a special public fund should be established which can make discretionary grants to all eligible, impecunious, class action plaintiffs and which the representative plaintiffs must reimburse from the proceeds recovered from defendants. Given the recommendation that the class action regime should start with consumer cases, it is recommended that the Consumer Legal Action Fund's resources be increased to make funding available for class actions for consumer claims.
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The class action regime should cover tortious and contractual claims made by consumers in relation to goods, services and immovable property. The existing representative proceedings regime should be retained, at least until the proposed class action regime has been extended to all types of cases. The jurisdiction of the District Court to hear class actions should be deferred for at least five years until a body of law of the Court of First Instance has been established.
The way forward
The Law Reform Commission recommends that a working party or task force, comprising of major stakeholders (including the judiciary and the Department of Justice) be formed to consider the fine detail of the proposed regime, as only after that, can steps be taken to implement the regime by legislation. So we can expect it to be some time before class actions are introduced in Hong Kong, even for consumer cases.
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Landmark ruling ordering Facebook to reveal identities of cyber bullies
by Robert Clark
In a recent landmark ruling, Nicola Brookes obtained an order from the High Court in London compelling Facebook (by way of Norwich Pharmacal order), to reveal the IP addresses and other information about those responsible for subjecting her to abusive messages on Facebook.
Nicola Brookes had posted a comment on Facebook, supporting a former X Factor contestant, Frankie Cocozza, when he had been voted off the show. Her anonymous attackers set up a fake Facebook profile in her name, using her photo, to post abusive and explicit comments and accusing her of being a paedophile and drug dealer.
This is one of the first cases, where an individual has successfully taken legal action against Facebook to reveal identities of cyber bullies. Nicola Brookes, now intends to bring private prosecutions against her abusers. Facebook has confirmed that it will reveal IP addresses and basic subscriber information (including names, email addresses and registration dates), when it is ordered by a court to do so. Ms Brooke's solicitor has said that if the subscriber information turns out to be fake, they would have to obtain a further order for disclosure of information from the internet service providers, as they would hold the bill payers' addresses.
This case is the latest in a number of cases where individuals are taking action themselves against cyber bullies, where the authorities have declined to do so. In April this year, the family of a teenager in the United States filed libel suits against two of their daughter's classmates for creating a fake Facebook page in her name and using it to post obscene comments on others' Facebook pages, making sexual references and posting a racist video on Youtube.