First ruling on late disclosure of inside information concerning takeover talks

Since the commencement of Part XIVA of the Securities and Futures Ordinance on 1 January 2013, the Securities and Futures Commission (SFC) has brought proceedings against eight listed companies and their officers for late disclosure of inside information. The Market Misconduct Tribunal (MMT) has found six companies and their officers culpable for breach of the disclosure requirements, while the proceedings of the remaining two cases are still continuing.

Among the six decided cases, the latest case decided in March 2020 is the only one that involved inside information concerning “an incomplete proposal or negotiation”, which is one of the specified categories of information which a listed company would otherwise be permitted to withhold or delay disclosure (Safe Harbour) had it satisfied the following conditions:

  • the company has taken reasonable precautions for preserving the confidentiality of the information; and
  • the confidentiality of the information is preserved.

Background of the case

In this case, the inside information was in relation to the proposed acquisition of all the issued shares of the listed company concerned (Company) by a third party offeror (Offeror). 

The three founders of the Company, who were the Company’s executive directors, together held close to 30% interest in the Company (Founders) and the Offeror had discussions relating to the Offeror’s acquisition proposal since early March 2013. In a meeting held on 27 April 2013, the Offeror and the Founders agreed that an offer price of not less than HK$5.5 per share would be put before the Company’s board of directors for their consideration.

The Company did not disclose the information relating to the acquisition proposal to the public until early August 2013, when it announced that it was in the course of negotiating a possible transaction with a third party which could lead to an offer for all the issued shares of the Company. Then, in mid-August 2013, the Company announced that the Offeror had put forward a proposal of acquiring all the issued shares of the Company by way of a scheme of arrangement, under which all the Company’s shares would be cancelled in exchange for HK$6.3 in cash for each share. 

MMT’s ruling

When did the inside information come into existence?

The MMT considered that inside information in relation to the Company and its shares came into existence as a result of the discussions and agreements between the parties on 27 April 2013 as there was a “commercial reality” to the negotiations which had gone beyond “testing the waters”.

When did the inside information come to the knowledge of the Company?

The MMT considered that the inside information which came into existence at the meeting of 27 April 2013 came to the knowledge of the Company when it came to the knowledge of one of the Founders (who was the chairman of the Company) in the course of his performing functions as an officer of the Company because MMT was satisfied that, based on the evidence, from the outset in making arrangements for and then conducting meetings with the institutional investors after the meeting on 27 April 2013, the chairman did so as an officer of the Company. For the other two Founders (whose functions focused on business operations), despite that they also participated in the same meeting, the MMT considered that they were acting in their personal interests as shareholders of the Company.

Was the Company entitled to rely on the Safe Harbour to delay disclosure?

The MMT considered that there was no plausible explanation for the significant rise in the Company’s share price from its close of HK$4.00 on 26 April to its close of HK$4.85 on 8 May 2013, other than that the confidentiality of the inside information had not been preserved.

There was no evidence at all that the significant share price rise had even been identified, discussed and assessed within the Company. The MMT concluded that the Company did not take reasonable precautions for preserving the confidentiality of the inside information nor take reasonable measures to monitor the confidentiality of the inside information. 

Therefore, the Company was not entitled to rely on the Safe Harbour.

Who are culpable of negligent conduct which resulted in the Company’s breach of the disclosure requirement?

The MMT found that the failure of the chairman and the company secretary (who was also an executive director) to carry out their functions resulted in the Company’s late disclosure of inside information as they failed to provide all the relevant information to other directors, and to monitor whether or not there was a leakage of that information, with particular regard to movements in the price and volume of trading in the Company’s shares.

Did the directors take all reasonable measures to ensure proper safeguards existed to prevent the breach of the Company’s disclosure requirement?

The MMT found that all the four executive directors (including the three Founders and the company secretary) and a non-executive director failed to take all reasonable measures to ensure that proper safeguards existed within the Company to prevent it from breaching its disclosure obligation.

Four other non-executive directors were not found to be in contravention of their duties because the MMT noted that:

-       one of them had proposed to carry out an internal control review, which was however not adopted by the board;

-       an independent non-executive director had identified the Company’s internal control systems as being “somewhat deficient and not up to standards” and endorsed the aforesaid proposal to conduct an internal control review; and

-       for the other two independent non-executive directors, neither of them was a businessman, and they were appointed to the board to bring to the Company their skill and knowledge as academic research scientists. They reposed a considerable degree of trust in and reliance on the experience and professionally qualified executive directors, and the MMT was satisfied that they were entitled to do so.

The MMT will hold a hearing on the making of the consequential orders on 25 April 2020.

Reminder of importance to maintain confidentiality during takeover talks: Takeovers Code implications

The case discussed above illustrated the importance of preserving confidentiality of inside information relating to a takeover talk in the context of the listed company’s statutory obligations to disclose inside information as soon as reasonably practicable. The listed company should have taken reasonable precautions for preserving, and reasonable measures to monitor, the confidentiality of the inside information, and it should disclose the information as soon as reasonably practicable after it becomes aware that the confidentiality of the information has not been preserved.

Listed companies and other parties who are in negotiation concerning an offer subject to the Takeovers Code should also bear in mind the requirements under Rule 1.4 of the Takeovers Code to maintain confidentiality and take all necessary steps to ensure there is no leakage of information prior to the announcement of a firm intention to make an offer.

In the June 2016 issue of the Takeovers Bulletin, the SFC stressed the vital importance that parties maintain confidentiality, and that where confidentiality is maintained, there should not be any rumour or speculation about a possible offer or undue movement in the share price triggering a need to issue a “talks” announcement under Rule 3.7 of the Takeovers Code. The SFC reminded that Rule 3.7 announcements should not be issued as a matter of convenience as the publication of these announcements has an impact on the market price of the listed companies concerned.