Materiality of Inside Information – A Negative Illustration in Warderly Case

On 4 August 2016, the Market Misconduct Tribunal ruled that Mr Lo Hang Fong (Lo), former Company Secretary of Warderly International Holdings Limited (Warderly), and Mr Luu Hung Viet Derrick (Luu), a lender and potential investor of Warderly, had not engaged in insider dealing in the shares of Warderly.

Background

Lo, a solicitor and partner of Stevenson Wong & Co, was Company Secretary of Warderly from the time it was listed, up until he resigned as such on 20 March 2007. Stevenson Wong & Co were Warderly’s solicitors at the relevant time. Lo had 1,597,500 Warderly shares, which he had purchased in 2003 and early 2004. Luu was a lender, substantial shareholder (holding 50 million shares through nominees) and potential investor in Warderly.

Lo sold his Warderly shares in three batches on 28, 29 and 30 March 2007. Luu sold 50 million Warderly shares in various batches on 3, 4 and 30 April and 2 May 2007.

SFC’s Case

The SFC’s case was that Lo and Luu had engaged in insider dealing, contrary to section 270(1) of the Securities and Futures Ordinance, as at the time they sold their shares, they were in possession of price-sensitive information concerning Warderly’s poor financial position, which if made public would have adversely affected Warderly’s share price in a material way and they used that knowledge in their decisions to sell and thereby avoided a total loss of HK$12,564,516.  The five pieces of information are as follows:

(1)   Tightening of banking facilities since July 2006 and the subsequent events such as loans overdue, rescheduled payments, demand letters and writs issued by banks;

(2)   HK$2 million loan to a subsidiary of Warderly on 17 November 2006, repayable within a month;

(3)   Further loan of HK$7.2 million to subsidiaries of Warderly on 11 and 28 December 2006;

(4)   Warderly was unable to repay the loan and interest when they became due on 28 January 2007; and

(5)   HK$10 million loan from Luu in February 2007, secured by 50 million shares pledged by the majority shareholder.

Information likely to materially affect share price

The main issue to be determined by the Tribunal was whether all or any of the five events constituted “relevant information” (now known as inside information), at the time that Lo and Luu sold their shares, which if known by persons accustomed to or likely to deal in Warderly shares, would be likely to materially affect the Warderly share price.

In this regard, the Tribunal noted that expert evidence was of crucial importance.  The test for determining whether or not information was likely to affect a share price is to look at how investors react once the information in question becomes public.  However, here, this could not be done, since the five events were never made public. It was therefore a question of judgment and analysis as to whether the events were likely to materially affect the share price.

As regards the meaning of “materially”, the Tribunal referred to observations made in previous cases, namely that “information that would be likely to cause a mere fluctuation or a slight change in price would not be sufficient, there must be the likelihood of changes of sufficient degree in any given circumstances to amount to a material change “and that it meant not “slight”, “insignificant” or “immaterial”.

Expert Evidence

Experts for Lo and Luu both concluded that at the time they sold their shares, the five events no longer (even if they ever had), constituted “relevant information” because:-

• Whilst each of the five events might have been of contemporaneous interest to the investing public, by January 2007, the decline in Warderly’s share price had effectively discounted their effect.  Had news of the five events been published there would have been little effect on the share price. 

• Warderly’s Annual Report of 23 August 2006 and Interim Report of January 2007 (both public documents) clearly showed a company with serious problems that even the most unsophisticated investor would understand.

• The share price showed a company in dire straits and even by August 2006 the share price was below that of a shell.

• After early February 2007, Warderly’s share price was no longer reflecting the company’s past business.  By then it was trading as a shell company into which new assets and a new business model would be injected.

• Two writs that had been issued against Warderly, which would have been in the public domain, had caused no adverse reaction.

• The spike in share prices on 9 February 2007 and volume of trade thereafter followed a long period of stagnation and was clearly indicative of the company being seen as a shell company ripe for speculative investors.  This continued until suspension of trading in its shares on 14 May 2007.

Tribunal’s Ruling

The Tribunal preferred the evidence of Lo and Luu’s experts to that of the SFC’s as it seemed to be supported by external evidence.  It accepted their evidence that the information regarding the dire financial situation of Warderly was firmly in the public domain at the time Lo and Luu sold their shares and there was support for this view in that the issue of writs which were published in the press were demonstrated from historical data to have shown no adverse impact on Warderly shares at all.

Given the above circumstances, the Tribunal said, certainly by the end of March 2007, none of the five events were or could be shown to be “relevant information”, which if generally known to persons accustomed to or likely to deal in the Warderly shares would have been likely to materially affect the Warderly share price.

Conclusion

In summary, the 5 pieces of information were not material because the fact that the listed company was in dire financial situation was already in the public domain, so even though there was further information (and unknown to the public) regarding the adverse financial situation of the company, it would not have been likely to materially affect the price.  If it was already bad enough, nobody cares if it would get worse.

主要負責人

蘇子敏

合夥人 | 訴訟與爭議解決

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