Lord Nicholls of Birkenhead NPJ
The purpose of the Securities (Insider Dealing) Ordinance, Cap. 395, is to combat the insidious mischief of insider dealing. The Ordinance defines insider dealing in wide terms. For present purposes the definition in section 9 can be sufficiently summarised as follows. Insider dealing takes place when a director or employee of a listed corporation, who has information regarding listed securities of the corporation that is not generally known and that he knows is price sensitive, deals in any listed securities of the corporation. Similarly, if he counsels or procures another person to deal in such listed securities. Insider dealing also takes place when a person who is contemplating or has contemplated making a take-over offer for a listed corporation, and who knows that the information that an offer is contemplated or is no longer contemplated is price sensitive, deals in listed securities of that corporation or counsels or procures another person to do so. Insider dealing may also take place where price sensitive information, or information that a take-over is contemplated or has been abandoned, is disclosed to another person, and where the recipient of such information deals in listed securities of the corporation in question or counsels or procures another person to do so.
The Ordinance has not made insider dealing a criminal offence. Instead, the Ordinance has established procedures whereby those who engage in insider dealing may be subjected to penalties, including potentially swingeing financial penalties. When it appears to the Financial Secretary that insider dealing in relation to a listed corporation may have taken place, he may require the Insider Dealing Tribunal, which is chaired by a judge, to inquire into the matter. The object of the inquiry is to determine whether insider dealing in relation to a listed company has taken place, the identity of every insider dealer, and the amount of any profit gained or loss avoided as a result of the insider dealing.
At the conclusion of the inquiry the tribunal has power, under section 23, to make all or any of three types of order in respect of a person identified by the tribunal as an insider dealer.
First, the tribunal may disqualify him from acting as a director or being concerned in the management of a listed company or any other specified company, for up to five years.
Secondly, the tribunal may order that the insider dealer 'pay to the Government an amount not exceeding the amount of any profit gained or loss avoided by that person as a result of the insider dealing' (section 23(1)(b)).
Thirdly, the tribunal may make an order imposing on the insider dealer 'a penalty of an amount not exceeding three times the amount of any profit gained or loss avoided by any person as a result of the insider dealing' (section 23(1)(c)). Thus, as can be seen, the formula of 'profit gained ..... as a result of the insider dealing' is common to both forms of financial orders. An order under section 23(1)(a) or (c) may also be made against an officer of a corporation identified as an insider dealer (under section 24). The aggregate amount of all the penalties imposed under section 23(1)(c) and section 24 may not exceed three times the profit gained or loss avoided by all persons as a result of the insider dealing.
This appeal concerns the interpretation of section 23(1)(b) and (c), and the proper manner of calculating in one particular circumstance the amount of profit gained by an insider dealer. The Ordinance gives no specific guidance on how the calculation is to be made.
In the present case Ms Shek Mei Ling and four others were identified as insider dealers by the tribunal after an inquiry into suspected insider dealing in relation to the listed securities of a garment manufacturing company known as Hong Kong Worsted Mills Ltd ('Worsted'). The material facts can be stated shortly. By early May 1993 Shek became aware that her employer Ng Kwong Fung was acting for the Beijing Municipal Treasury Department in identifying a suitable company for acquisition and that Worsted had been mentioned in this context. Between 6 and 11 May Shek, using borrowed money, bought 100,000 shares in Worsted for a total of HK$408,873, at an average cost of $4.08 per share. On 31 May Worsted announced that its majority shareholder had received an approach from an independent third party to acquire a controlling interest in Worsted. The identity of the third party was not disclosed. On 3 and 4 June Shek sold all her shares for a total of $640,619, at an average price of $6.40 per share, and thereby made a profit of $231,745 on her dealings. On 17 June a public announcement was made that the majority shareholder had agreed to sell its shares in Worsted to a state-owned company which was an investment vehicle of the Beijing municipal government. The price was net asset value plus a premium of $100 million. Dealings in the shares of Worsted were suspended, at $9.50. Trading resumed on 22 June, and at the end of that day Worsted shares closed at $15.10. The average price of Worsted shares over the following few days, between 22 June and 30 June, was $16.80.
The tribunal held that the profit gained by Shek as a result of the insider dealing was $1,262,643. This sum comprised the profit she would have realised, after deduction of sale expenses, had she sold her shares at $16.80 per share. The tribunal made an order against Shek for payment of $600,000 under section 23(1)(b) and $1.2 million under section 23(1)(c). The tribunal also made financial orders against the three others. All four appealed against these orders. The Court of Appeal, comprising Nazareth V-P, Mortimer V-P and Rogers JA, dismissed the appeal of the three others, but allowed Shek's appeal. The court held that the tribunal had erred in its calculation of the profit gained by Shek. The correct measure of her profit was the amount of $231,745 she actually realised. The court substituted for the tribunal's orders against Shek an order for payment of $231,745 under section 23(1)(b) and $150,000 under section 23(1)(c). From that order the tribunal appealed to this Court.
The sequence of events in the present case is unusual. An insider dealer may derive profit from insider dealing in many ways. For instance, where the insider dealing comprises disclosure of information, or counselling someone else to buy shares, the insider dealer may be paid for the information or advice. The present case concerns dealing in shares. Here, the insider dealer sold her shares before the price sensitive information had become fully available to the market. In the nature of things, this is exceptional. The insider dealer who buys shares improperly by misusing confidential information seeks thereby to steal a march on the market. Fulfilment of this object normally requires retention of the shares until the market has had an opportunity to receive all the hitherto confidential information and respond favourably to it. That is not what happened here. Nevertheless, in order to identify the proper approach to calculation of the profit gained by Shek in this unusual case it is necessary to consider the position generally.
The basic scheme of the Ordinance is clear enough. The purpose of an order under section 23(1)(b) is to strip from the insider dealer the amount of the profit gained by him as a result of the insider dealing. He is not to be allowed to retain his ill-gotten gains. An order under section 23(1)(c) goes further than this. Although not so described, an order under section 23(1)(c) is comparable to a fine. Its purpose is to deter insider dealing, and it seeks to do so by leaving a person who engages in such conduct substantially out of pocket. The amount of the penalty can be up to treble the amount, not of the benefit gained by the insider dealer himself, but of the benefit gained by the insider dealer and anyone else as a result of the insider dealing. Thus, an insider dealer can be subjected to a substantial penalty order even though he himself gained no profit.
To be within the scope of a financial order there must be a 'profit' that is 'gained' by the person in question, whether the insider dealer or someone else, and it must have been gained 'as a result of the insider dealing'. A comparable limitation applies to a 'loss avoided'. As a matter of statutory interpretation, two points seem clear. The first point can best be explained by taking the simple case of a person connected with a company who acquires confidential price sensitive information and buys shares in anticipation of a rise in the market price. In due course, when the information becomes public knowledge, the price rises and the insider dealer sells the shares. Prima facie the difference between the purchase and sale prices, neither more nor less, is the amount of the profit gained by the insider dealer as a result of the insider dealing. That is the natural reading, in this context, of the phrase 'profit gained by [the insider dealer] as a result of the insider dealing'. The insider dealing comprised the improper purchase of the shares. Prima facie the profit, if any, gained by the insider dealer as a result of this dealing is the profit, if any, he made when he sold the shares.
I must amplify the qualification 'prima facie'. Markets do not operate in a sterile vacuum. The difference between the purchase and sale prices is likely to be affected, for better or worse, by many factors beside the disclosure of this information. The longer the period of time that elapses between the purchase and the sale, the more likely it is that there will be fluctuations in the market price for other reasons. The factors involved may be general, affecting share prices of most companies or most companies in the relevant sector of the market, or they may be peculiar to the particular company but unrelated to the price sensitive information. In one sense, any increase in the insider dealer's profit due to favourable extrinsic factors such as these might be said not to form part of the insider dealer's profit gained 'as a result of ' the insider dealing. On this approach, when calculating the insider dealer's profit for the purposes of section 23, the profit made on the sale should be adjusted, downwards or upwards, to reflect the extent to which the sale price was increased or diminished by favourable or unfavourable extraneous factors.
This is not the approach adopted in practice by the tribunal, nor do I think it would be correct. I do not believe the Ordinance envisages that any such problematical exercise is to be undertaken for the purpose of section 23. The context of section 23 is dealings with listed securities. References to profit gained are to be read, naturally and consistently with the purpose of financial orders, as references to profits arising from buying and selling in the market, without any allowance for the ordinary incidents affecting market prices. When the insider dealing consists of an improper purchase, the profit gained comprises the difference between the cost of purchase and the net sale price. That is the general rule, although I would not exclude altogether the possibility there might be exceptional circumstances when some allowance would be called for.
The second point which is clear concerns the position where an insider dealer, having bought shares in anticipation of a price rise, chooses to retain them rather than realise his profit when the information becomes public knowledge. Take a case where the insider dealer retains the shares and thereafter, over the period of months or even years that elapses before the tribunal makes a financial order under section 23, he sells the shares either in one parcel or gradually. Or he may still own the shares, or some of them, when the tribunal makes its order. The approach adopted by the tribunal in this type of situation, in my view correctly, is to treat the relevant profit as that gained by the insider dealer when the information was made public and the market had had a reasonable opportunity to digest the information. The gain is to be measured by reference to the market value of the shares at that date. At that date the amount of the insider dealer's profit, whether realised or not, is fixed once and for all. Subsequent changes in market prices are irrelevant for the purpose of a section 23 calculation. They are irrelevant, because such changes are not to be regarded as flowing from the original improper purchase of shares. Rather, they flowed from the insider dealer's decision to retain the shares at a time when the effect of the misuse of the confidential information had become spent and the insider dealer was on an equal footing with every other investor.
The matter can be tested in this way. Had the insider dealer sold the shares when the information became public, his subsequent use of the proceeds would be regarded as irrelevant for the purpose of the section 23 calculation. Successful investment of the proceeds by the insider dealer would not increase the amount of the profit gained as a result of the insider dealing, nor would a disastrous investment decrease the amount. If this is right, it would make no sense that a different principle should apply if the insider dealer chose to leave his profit invested in the wrongfully acquired shares. His position should be no better, and no worse. The subsequent fortunes of the company in whose shares he improperly dealt should no more affect the assessment of the amount of the profit gained for the purpose of section 23 than do the fortunes of any other investment made by the insider dealer with the proceeds of the shares he improperly acquired.
This approach accords with the view taken by the tribunal in previous cases, in the inquiries into dealings in shares in Success Holdings Ltd, Public International Investments Ltd and Parkview Group Ltd. In those cases the tribunal applied what is known as 'the American approach'. Section 21(d)(2)(A) of the Securities Exchange Act 1934, introduced by section 2 of the Insider Trader Sanctions Act 1984, empowered the courts to impose a penalty not exceeding three times the profit gained as a result of the unlawful purchase or sale which constitutes the insider dealing, and provided in section 21(d)(2)(C) that
For purposes of this paragraph 'profit gained' ..... is the difference between the purchase .... price of the security and the value of that security as measured by the trading price of the security a reasonable period after public dissemination of the non public information.
This was the approach adopted by the United States Court of Appeals for the First Circuit in SEC v MacDonald (1983) 699 F 2d 47, in a decision which ante-dated the enactment of this statutory definition.
In the present case the view of the tribunal, chaired by Burrell J, was that in every case the same method of calculation should be adopted, regardless of whether or not the shares had been disposed of, regardless of when they were disposed of, and regardless of the price actually received at the time of sale. Mr. Lunn S C, appearing for the tribunal on this appeal, sought to uphold this approach. He submitted that the act of wrongdoing was complete when the insider dealer improperly bought the shares. At that date the insider dealer caused loss to the seller, by buying from him at a lower price than the price at which the shares would have been available had the confidential information been generally known. The insider dealer at once gained a profit, being the difference between the price paid and the higher price he would have had to pay if the information had been generally known. In practice, the best evidence of the amount of this difference is the difference between the price paid and the market price when the information in fact becomes available generally. The insider dealer ought not to be able to 'unlock' this profit, and diminish the potential amount of a financial order, by selling at a reduced price before the information is published.
I cannot accept this approach, which seems to me at odds with the language of the section. As already described, the section envisages that the profit gained as a result of an insider dealing is to be calculated by the essentially simple exercise of comparing the actual cost of purchase and the actual sale proceeds. This is subject to a cut-off date, and a calculation by reference to unrealised market value, if the shares were retained after the information had become generally known. The same simple comparison is to be carried out when the sale takes place before the information is fully known. A sale at the earlier date may well yield a smaller profit, but that is not a sufficient justification for rejecting this approach. The Ordinance has adopted 'profit gained' as the yardstick when fixing the maximum amounts of financial orders. Consistently with this, when the profit gained by an insider dealer is less than it would have been had he waited until the information was generally available, the maximum amount of the financial orders is correspondingly less. Had the legislature intended that the amount of profit was to be fixed once and for all at the time of the improper purchase, very different language would surely have been employed, as in the abortive section 140 of the Securities Ordinance 1974.
Thus far I have been addressing the calculation of the amount of profit gained. Section 23(1)(b) and (c) also applies to the amount of any loss avoided as a result of the insider dealing. This could arise if the confidential information were unexpectedly bad news about a company's business. Of necessity, calculation of the amount of a loss avoided is different from calculation of the amount of profit gained. The amount of profit gained by an insider dealer is an actual amount and can be calculated accordingly. By way of contrast, the amount of a loss avoided by an insider dealer is a notional exercise, because ex hypothesi the loss was not actually sustained by the insider dealer: the loss was avoided. Thus, in the case of a dealing in shares, calculation of the amount of loss avoided will typically involve comparison of two elements, one actual (the shares were sold), and the other notional (what would have happened if the shares had been retained). The actual element in the calculation will comprise the amount realised by the insider dealer from the shares sold before the market learned the bad news. The notional element will comprise the market value of the shares at a date which has to be identified as the appropriate date. Failing cogent evidence that, in any event, the shares would have been sold before the market announcement, the date will usually be the date by which the market learned and absorbed the information. This will usually be the appropriate date because it can normally be expected that, save for the misuse of the confidential information, the insider dealer would still have held his shares at that date and, hence, would have suffered loss accordingly. The need to make a notional calculation along these lines in the case of a loss avoided does not, however, cast doubt on making the calculation by reference to actual figures in the case of profit gained.
Nor, I add for completeness, does the American approach, as set out in section 21(d)(2)(C) of the Securities Exchange Act, assist the tribunal's argument in the present appeal. It is true that the definition of 'profit gained' in section 21(d)(2)(C) makes no express exception for the case where the shares are sold before public dissemination of the nonpublic information. Whatever the reason for this, the terms of this definition do not assist materially in interpreting section 23 of the Ordinance which stands alone without the assistance, or limitations, of a legislative definition.
For these reasons, I agree with the Court of Appeal and would dismiss this appeal with costs.
Mr. Justice Litton PJ
I agree with the judgment of Lord Nicholls of Birkenhead NPJ.
Mr. Justice Ching PJ
I agree with the judgment of Lord Nicholls of Birkenhead NPJ.
Mr. Justice Bokhary PJ
I agree with the judgment of Lord Nicholls of Birkenhead NPJ.
Chief Justice Li
I agree with the judgment of Lord Nicholls of Birkenhead NPJ.
The Court, being unanimous, dismisses the appeal with costs.
SEC v MacDonald (1983) 699 F 2d 47
Securities Ordinance 1974: s.140
Securities (Insider Dealing) Ordinance, Cap. 395: s.9, s.23, s..24
Securities Exchange Act 1934: s.21
Trader Sanctions Act 1984: s.2
Mr. Michael LUNN, SC for the Appellant (instructed by Department of Justice)
Mr. Alfred CHAN for the Respondent (instructed by Messrs Boase, Cohen and Collins)
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