Unprecedented Order by the Court against Hontex International Holdings Company Ltd for a HK$1.03 Billion Buy-back Offer for False and Misleading Information in Prospectus
On 20 June 2012, the Court of First Instance (in proceedings brought by the Securities and Futures Commission ("SFC") ordered Hontex International Holdings Company Ltd ("Hontex") to make a repurchase offer to about 7,700 investors who had subscribed for Hontex shares in the initial public offering in December 2009 or purchased them in the secondary market during the 3 months after its shares were listed (by then the present action was taken by the SFC).
The orders were the first of their kind made under section 213 of the Securities and Futures Ordinance ("SFO"). The orders were made by agreement between the SFC and Hontex 12 days into the trial. Essentially, Hontex acknowledged, for the purpose of the civil proceedings, that the following information in the prospectus was materially false and misleading:
1. the amounts stated in the IPO prospectus in respect of its turnover for the three years before its listing from 2006 to 2008; and
2. the value of its cash and cash equivalents for the years ended 31 December 2007, 2008 and 30 June 2009.
The SFC alleged that the overstatements in the turnover and cash positions were as much as RMB 974 million and RMB 204 million respectively. Although Hontex did not agree to the extent of overstatements alleged by the SFC, their acknowledgement amounted to an admission of the contravention of section 298 of the SFO. This, in itself, enabled the SFC to seek the present order through the power given under section 213 of the SFO, to compensate the investors.
Section 298 imposes criminal liability on any person who intentionally or recklessly discloses, circulates or disseminates information that is false or misleading as to a material fact and the information is likely to induce another person to subscribe for securities, to sell or purchase securities or to maintain, increase, reduce or stabilise the price of securities.
The Court ordered Hontex to pay a total sum of HK$1.03 billion (HK$832,244,497 of which had previously been frozen by the Court upon the SFC's application). Hontex is required to convene a shareholders' meeting to decide whether to approve the repurchase and, upon approval, take steps to repurchase the shares allotted or purchased. The repurchase price will be at HK$2.06 per share, which was the closing price of the shares on 30 March 2010, when the SFC directed that trading on the Stock Exchange of Hong Kong be suspended. The price is about 4 % less than the offer price of HK$2.15 in Hontex's listing. The repurchase will be managed by Court-appointed administrators under a protocol to be agreed by the SFC.
In addition, the Court ordered Hontex to pay SFC's costs at HK$7,000,000, which is quite a large bill.
Comments on the case
This is an unprecedented order under section 213 of the SFO, the effect of which is to enable the SFC to use the money or "damages" to compensate the investors. This order also illustrates the very wide scope of section 213, the application of which will be challenged by the Respondents in the Tiger Asia case before the Court of Final Appeal.
The Order was made on the basis of an admission of a contravention of section 298. The civil equivalent of section 298 can be found in section 277, although section 277 also covers the situation where a person is negligent as to whether the information is false or misleading.
In agreeing to the order, neither Hontex nor its directors or other defendants admitted to any criminal offence. However, since the SFC has expressly reserved the right to bring criminal proceedings arising from Hontex's IPO prospectus, the market will wait and see if the Department of Justice and the SFC will bring a criminal prosecution after settlement of this civil case. If there are criminal prosecutions, in addition to section 298, they may be made under section 300 of the SFO (employing a fraudulent or deceptive scheme in relation to a listing in Hong Kong) and/or section 384 of the SFO (provision of false or misleading information in purported compliance with a statutory requirement). It may also be under section 342F of the Companies Ordinance which makes it an offence to authorise misstatements in a prospectus. The latter offence carries with it a maximum penalty of 3 years and a fine of HK$550,000 on indictment or 1 year and HK$150,000 on summary conviction.
In April this year, the SFC revoked the licence of Mega Capital (Asia) Company Limited (the sponsor, sole bookrunner and lead manager in Hontex's listing) to advise on corporate finance and fined it a record amount of HK$42 million for failing to discharge its sponsor's duties in relation to the listing application.
The SFC found that Mega Capital had failed in the following duties as sponsor:
1. Inadequate and sub-standard due diligence work
2. Failure to act independently and impartially
3. Inadequate audit trail of due diligence work
4. Inadequate supervision of its staff
Mega Capital was also found to be in breach of the sponsor's undertaking and to have filed an untrue declaration with the Stock Exchange of Hong Kong.
Earlier this month, the SFC also revoked the licence of Mr Hong Hui Lung, a former managing director of Mega Capital, to act as a representative and the approval for him to act as a responsible officer. Hong was found to have breached the following duties as a sponsor, principal and responsible officer:
1. Refusal to accept responsibilities
2. Failure to supervise
Hong was also found to be in breach of the sponsor's undertaking and to have filed an untrue declaration with the Stock Exchange of Hong Kong.
Whilst it is still too early to tell if the Hontex case has come to an end and whether further actions will be taken by the SFC, this case shows that any material false and misleading statements made by a listed company and its directors might result in sanction or penalty under the various provisions of the SFO. It should also be noted that in the SFC's May 2012 consultation paper, the SFC is seeking, amongst other things, to make it clear in sections 40 and 40A of the Companies Ordinance that sponsors have civil and criminal liability for untrue statements (including material omissions) in a prospectus.