SFC’s power to transfer compelled answers and materials to foreign regulators confirmed by court: AA v SFC (HCAL 41/2016)

On 11 February 2019, the Court of First Instance, presided by Mr. Justice Zervos JA, confirmed the power of the Securities and Futures Commission (SFC) to transfer answers and materials obtained under s.181 of the Securities and Futures Ordinance (SFO) to foreign regulators. Market operators should be aware of the domestic regulatory oversight on them even when they are operating overseas.  

The judgment also confirmed that s.181 of the SFO does not abrogate the privilege against self-incrimination and such privilege will constitute a “reasonable excuse” for non-compliance. This same reasoning is also applicable to s.180 of the SFO.

Background

The proceedings concern a series of share transactions conducted in September 2013 by the 1st Applicant (which is a corporation licensed with the SFC, and whose 95% majority shareholder and responsible officer is the 2nd Applicant) in relation to a Japanese company listed on the Tokyo Stock Exchange, and the subsequent investigation of those transactions by the SFC in Hong Kong and the Japanese Financial Services Agency (FSA) and the Securities and Exchange Surveillance Commission (SESC) in Japan, which are the market regulators in Japan.  During the course of the Hong Kong investigation, information and materials were obtained from the Applicants under compulsion by the SFC (compelled materials) which were provided to and used by the Japanese regulators in proceedings in Japan.

On 6 September 2013, it was announced by Nikkei Inc. that, with effect from 26 September 2013, Nitto Denko would become a constituent stock of the Nikkei. The 1st Applicant actively traded in Nitto Denko shares thereafter. It made a profit of at least JPY6,312,000,000.

On 25 April 2014, the SFC received a report from a licensed corporation regarding suspected market manipulation activities conducted by the fund (Fund) managed by the 1st Applicant in Nitto Denko shares.

On 5 May 2014, the SFC issued a letter under s.181(1) of the SFO requiring the 1st Applicant to provide certain information about the Fund. The letter did not contain any reference to the 1st Applicant’s right of silence or warning against self-incrimination. The 1st Applicant and its then solicitors provided the information requested and did not make any claim of privilege against self-incrimination on behalf of the 1st Applicant.

On 8 August 2014, the SFC issued a notice under s.183(1) of the SFO to the 1st Applicant requiring it to produce documents and provide written answers regarding the Nitto Denko transactions. The 1st Applicant provided the information requested together with additional information on a voluntary basis.

On 22 October 2014, the SFC issued a notice under s.183(1) of the SFO requiring the 2nd Applicant to attend an interview at the SFC. It was stated in the notice that the SFC had received from the Japanese regulators a request for assistance in relation to an investigation into suspected market manipulation by the 1st Applicant involving the shares of Nitto Denko. The SFC was of the opinion that, in accordance with s.186(3)(b) of the SFO, the assistance would enable or assist the Japanese regulators to perform their functions and it was not contrary to the interest of the investing public or to the public interest that the assistance should be provided. The SFC sought consent from the 2nd Applicant for officers of the Japanese regulators to be present at the interview. The 2nd Applicant agreed that the Japanese regulators could be present as observers at the interview.

At the interview, the 2nd Applicant claimed privilege against self-incrimination in respect of his answers.

By an agreement between the SFC and the Japanese regulators under the International Organization of Securities Commission (IOSCO) Multilateral Memorandum of Understanding (MMoU), information in relation to the SFC’s investigation of possible market manipulation in Japan by the 1st Applicant provided by the SFC to the Japanese regulators would be used by the Japanese regulators for administrative or regulatory purposes only.  It would not be used by them for criminal investigation or criminal proceedings.

On 5 December 2014, SESC published an announcement that it had made a recommendation to the Prime Minister of Japan and the Commissioner of the FSA to issue an administrative monetary penalty in light of its findings of the 1st Applicant’s market manipulation concerning the trades of Nitto Denko shares.  

On 11 June 2018, the FSA imposed a monetary penalty on the 1st Applicant in the sum of JPY 684,240,000.

The Applicants contended that: (1) the SFC acted unlawfully in obtaining and transmitting the compelled materials to the Japanese regulators; and (2) s.181 of the SFO contravened Articles 10 and 11(2)(g) of the Hong Kong Bill of Rights Ordinance (BOR) and was unconstitutional.

The Applicants also alleged that the suggested penalty was leaked to the Japanese media prior to the announcement, but the source of the leak could not be identified.

Ground 1: Whether the compelled materials were used in criminal proceedings

The starting point of the Applicants’ case was that BOR 10 and 11 provided that in the determination of any criminal charge, everyone shall be entitled to a fair and public hearing by a competent, independent and impartial tribunal, and not to be compelled to testify against himself or to confess guilt. The Applicants contended that the penalty imposed by FSA was criminal in nature, and hence the transmission of the compelled materials to the Japanese regulators, which materials were then used in criminal proceedings, was in breach of the BOR.

The Court adopted the criteria laid down in Koon Wing Yee v Insider Dealing Tribunal (2008) 11 HKCFAR 170 in deciding whether a provision is a criminal offence: (1) the classification of the offence under domestic law; (2) the nature of the offence; and (3) the nature and severity of the potential sanction. In Koon Wing Yee, Sir Anthony Mason NPJ stated that a fine which is punitive and deterrent, rather than compensatory, may suggest that the matter is criminal in nature if the penalty is sufficiently substantial.  

The Japanese proceedings were classified as administrative under Japanese law; but the Applicants asserted that the allegation against them was “market manipulation” and they were referred to as “offenders” under the relevant provision. The Court found that the Japanese proceedings are administrative in nature, the formula in determining the penalty was a disgorgement of profits, and the purpose of the Japanese proceedings is not punitive and deterrent in nature. In coming to this conclusion, the Court considered that it would appear from the transaction records that the 1st Applicant earned a profit far greater than the sum of the penalty imposed.

Ground 2: Whether the secrecy provisions were breached in relation to the compelled materials

The Applicants contended that the SFC failed to ensure secrecy of confidential information on the part of the Japanese regulators, resulting in the leaking of information about the allegations of the case, as evidenced by media inquiries on them prior to the announcement on 5 December 2014. They claimed that, as a result of the breach of confidentiality, they have suffered damage.

The Court held that there was no substance in this ground for three reasons:

(1)    the nature of the inquiries did not necessarily constitute a breach of the secrecy provisions. Nor was the source or sources of any alleged leaks to the media identified.

(2)    the Applicants had sought an alternative remedy in relation to this issue by instituting civil litigation against the Government of Japan.

(3)    the evidence before the Court pointed to constant reminders to and assurances from the Japanese regulators of the requirements and obligations in relation to confidentiality of the information and materials provided to them by the SFC.

The Court found that the SFC had taken all reasonable steps to ensure confidentiality and it followed standard practice adopted internationally for such co-operation, as reflected in the relevant provisions of the SFO and the IOSCO MMoU, representing the highest standard of international securities law enforcement cooperation practice. 

Ground 3: Whether section 181 contravenes BOR 10

Under s.181 of the SFO, it is an offence for a person to fail to provide information to the SFC without reasonable excuse. The Applicants argued that BOR 10 is engaged in this case because the person served with a section 181 notice is required to provide the information demanded, on pain of criminal penalty, and that such information would expose the person to self-incrimination in criminal proceedings.

Both the SFC (para. 248) and the Secretary for Justice (para. 264) submitted that s.181 did not abrogate the privilege against self-incrimination and the exercise of that privilege constitutes a “reasonable excuse”.  Other provisions in the SFO, such as s.179(16) and s.184(4) explicitly provide that privilege against self-incrimination is not an excuse for non-compliance but there is no such provision in s.181. The Court agreed with the SFC and the Secretary for Justice (para. 280).  However, the Court also mentioned that the SFC should also warn and caution the recipient of a s.181 notice of the privilege against self-incrimination, which, as the Applicants complained, was absent from the notice.

Commentary

The Court placed heavy emphasis on the importance of effective regulation of the financial services industry and the international co-operation between domestic regulators to ensure that financial markets throughout the world operate honestly and fairly. Market operators should be aware of the domestic regulatory oversight on them even when they are operating overseas. 

The judgment provides a welcomed clarification that s.181 of the SFO does not abrogate the privilege against self-incrimination when being asked by the SFC to provide information.  

The Court accepted the Applicants’ complaint that if the privilege against self-incrimination is available to a person who is subject to a s.181 demand, the SFC should warn and caution such person of the privilege and said “[t]his is something in the future the SFC will need to address”. The Court’s reasoning and comments are equally applicable to s.180 of the SFO, which is frequently invoked by the SFC and the Hong Kong Monetary Authority in relation to their request of intermediaries and banks for information.