LCQ5: Takeovers and Mergers Code

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Following is a question by the Hon Emily Lau and a reply by the Secretary for Financial Services, Mr Rafael Hui, in the Legislative Council today (Wednesday):

Question :

The Securities and Futures Commission ("SFC") last month upheld its previous decision made in January 1994 to publicly reprimand two persons who were involved in the purchase of shares in Shun Ho Resources Holdings Ltd in 1988 and 1989, for breaching the provisions of the Takeovers Code. In this connection, will the Executive Authorities inform this Council whether:

(a) they know the amount of time and money that the SFC has spent in investigating the case;

(b) they have assessed the deterrent effect of public reprimand upon actions in breach of the Takeovers Code; and

Madam President,

(a) Since the Shun Ho case had taken a long time, it would be necessary for me to first set out briefly the proceedings of the case.

In mid-1991, the Securities and Futures Commission ("the SFC") received a complaint that certain parties involved in certain transactions of shares in Shun Ho Resources Holdings Ltd in 1990 and 1991 might have breached the Hong Kong Takeovers and Mergers Code ("the Code"). In end 1991, the Committee on Takeovers and Mergers commenced hearings to enquire into the matter. The SFC subsequently conducted further investigations into the transactions, which were extended to include certain tradings in the shares of Shun Ho in 1998 involving one of the concerned parties. The investigation took about one year to complete and the Takeovers and Mergers Panel ("the Panel") (the successor body of the Committee on Takeovers and Mergers after 1992) made its decision on the case in January 1994. In its decision on the case, the Panel ruled that the transactions had indeed been in breach of the Code and imposed sanctions on the four persons concerned.

Subsequently, these persons appealed to the Takeovers Appeal Committee ("the Appeal Committee") and one of them also applied to the court for judicial review. The judicial review process came to an end in October 1995 when the Privy Council made its ruling in October 1995. In the meantime, all concerned parties agreed to suspend the process of the Appeal Committee.

After the Privy Council released its ruling, one of the concerned persons agreed to abide by the ruling of the Panel and withdrew his appeal to the Appeal Committee. Another appellant also withdrew her appeal to the Appeal Committee in May 1996. The Appeal Committee resumed hearing on the appeals lodged by the remaining two persons in July 1996 and reached its decision on the appeals in April 1999. The decision of the Appeal Committee upheld the sanctions imposed by the Panel.

The Shun Ho case involved a number of different procedures, including the investigations by the SFC; the different steps of Panel hearings; the judicial review and the hearings of the Takeovers Appeal Committee. The investigations by the SFC took approximately one year.

The investigations were conducted by the staff of the SFC which also involved its different departments. Since the same staff were also responsible for other cases under the Code and had to perform other duties of the SFC, it is difficult to work out the expenditure involved. However, insofar as the judicial review and the subsequent review process are concerned, the costs incurred by the SFC amounted to about HK$7.4 million. The SFC recovered $5.5 million from the party concerned subsequent to the ruling by the Privy Council in favour of the Panel and the SFC.

(b) The Hong Kong Code was first introduced in 1975. The existing Code was made by the SFC pursuant to its functions stipulated under the SFC Ordinance. The Code sets out the principles and the generally accepted market standards for the commercial practices on takeovers and mergers in Hong Kong. It also sets out the rules for the implementation and application of such principles. The main objective of the Code is to ensure that all the shareholders who may be affected by a company's takeovers and mergers are treated even-handedly.

The Code is administered by the SFC Executives. Market participants may request the Takeovers and Mergers Panel to rule on matters related to the Code. The Panel may also conduct disciplinary proceedings against market participants suspected to have breached the Code, make rulings and decide on sanctions. The persons concerned may appeal to the Takeovers Appeal Committee against the sanctions imposed by the Panel.

Sanctions against market participants in breach of the Code include, inter alia, public reprimands and "cold-shoulder treatment" (i.e. the person sanctioned will be denied access to services by dealers or advisers including brokers and merchant banks during the sanction period). Where appropriate, the SFC may, within its power, also take further actions such as revoking the intermediary licence of the person concerned. In the Shun Ho case, the intermediary licence of one of the concerned persons was revoked by the SFC following the ruling of the Panel. The Panel also imposed a "cold-shoulder treatment" to another concerned person in the case for a period of five years which remains valid at present.

For market participants, public reprimand is a serious dent in the business reputation of the reprimanded person. It would alert other market participants and enable them to better assess the risk of doing business with the reprimanded person. In a commercial society where information flows efficiently, public reprimands would have a considerable impact on the relevant persons. We therefore believe that this type of sanction does have a certain deterrent effect. SFC's experience also indicates that the relevant persons are willing to spend an enormous amount of time, effort and money to fight their case and defend themselves from possible sanctions. This shows that public warnings or reprimands are effective deterrents.

However, I would like to point out that the existing Code and its enforcement in practice aim essentially to provide clear guidelines and standards for the market, while at the same time maintaining flexibility in enforcement, so as to cater for changing market activities and business circumstances. As a matter of fact, the executives of the SFC responsible for administering the Code ("Takeover Executives") had handled a total of 1,547 cases under the Code in the three year period from April 1995 to March 1998, or on average 500 cases per year. Since 1992, only 40 cases have been found to be necessary to be submitted to the Panel for consideration and only three of them concerned disciplinary matters. This indicates that most of the cases could be handled at the Takeover Executives level. The figures also lends support to the observation that the existing mechanism and sanctions are effective and have sufficient deterrent effect.

(c) The question as to how to combat commercial and market misconduct effectively has been a matter of common concern to governments and market regulators all over the world. Because of the complexity of commercial crimes, there has been increasing opinion that "criminalization" may not necessarily be the most effective way to address the majority of market misconduct behaviour. As a high standard of proof is required for "criminal offences", it is often more difficult to convict complicated commercial crimes and takes a great deal of resources and time to establish a case. As such, the criminal approach to deal with market misconduct may not necessarily have a stronger deferent effect on committed offenders. At present, some overseas market regulatory authorities are already trying to deal with market misconduct by way of civil actions. The Government and the SFC are now examining and conducting a review on the issue. The scope of the review covers all market misconducts. We expect to be able to put forward proposals and consult the Legislative Council and the market before the summer recess.

End/Wednesday, May 26, 1999

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