A lost customer, a delayed announcement and the CFO's circle
On 3 March the CFO of a Main Board listed issuer is told by its largest customer, representing 35% of revenue, that the supply contract expiring on 30 June will not be renewed. The CFO informs the CEO and the chairman the same day. The board meets on 12 March and resolves to announce on 14 March after market close. On 5 March the CFO tells a friend, a private investor, who sells 200,000 shares on 6 March at HK$12.50. The CFO's wife sells 50,000 shares on 7 March at HK$12.30; the CFO did not tell her, but she saw a board paper on his desk headed "Customer non-renewal - revenue impact". On 14 March the issuer announces; the shares close at HK$9.80 the next day. The CEO says the information was not inside information until the accountant quantified the revenue loss on 11 March, and that the board needed time to consider the announcement.
1. When did inside information arise, and did the issuer breach its Part XIVA disclosure duty?
Read the worked answer
Inside information is specific information about the issuer or its securities that is not generally known and, if generally known, would be likely materially to affect the price of the securities. The customer's decision on 3 March is specific (the largest customer, 35% of revenue, will not renew) and clearly material. The fact that the accountant had not yet quantified the loss by 11 March does not prevent the information from being inside information; quantification affects the detailed announcement, not the existence of the information.
The issuer's knowledge is the knowledge of its directors and officers. The CFO knew on 3 March and informed the CEO and chairman the same day, so the issuer had knowledge then. The duty under Part XIVA is to disclose as soon as reasonably practicable after the information comes to the issuer's knowledge. Waiting until 14 March - 11 days - is difficult to justify. The board's desire to consider the announcement is not a safe harbour. The safe harbour for incomplete proposals or negotiations does not apply because the customer's decision is a fact, not a proposal still being negotiated. The issuer also failed to take reasonable precautions to preserve confidentiality, as shown by the CFO's tip and the board paper left accessible.
The issuer is therefore exposed to Market Misconduct Tribunal proceedings for breach of the disclosure duty, with a possible fine of up to HK$8 million and disqualification orders against directors.
2. Analyse the CFO's, the friend's and the wife's positions under the insider dealing provisions.
Read the worked answer
The CFO is a connected person. He disclosed inside information to his friend, which engages the tipping prohibition, and he may also be liable for counselling or procuring the friend to deal. His position is aggravated by the fact that he knew the information was price-sensitive and that he did not take steps to prevent his wife from dealing. He also faces separate consequences for breach of his duties as a director/officer.
The friend is a tippee. He received inside information from a connected person and knew, or had reasonable cause to believe, that it came from a connected person. Dealing in the shares on 6 March while in possession of that information is insider dealing. The fact that the CFO did not ask him to deal is not a defence if he knew the information was confidential and price-sensitive.
The wife is not a connected person merely because she is the CFO's spouse, but she is liable as a tippee if she dealt while knowing, or having reasonable cause to believe, that the information came (directly or indirectly) from a connected person. Seeing the board paper headed with the revenue impact supports that knowledge. The CFO's failure to tell her does not automatically exonerate him: the SFC may ask whether his conduct, including leaving the paper accessible, amounted to counselling or procuring her dealing, and whether he failed to take reasonable steps to safeguard the information.
3. What enforcement action and sanctions can the SFC seek?
Read the worked answer
The SFC can pursue the matter through several routes:
- Market Misconduct Tribunal (civil): proceedings against the CFO, the friend and the wife for insider dealing, and against the issuer and its directors for breach of the Part XIVA disclosure duty. The MMT can order a fine of up to the greater of HK$10 million or three times the profit gained or loss avoided for market misconduct; a disqualification order for up to five years; a cold shoulder order; a cease and desist order; and disgorgement. For the disclosure breach, the MMT can impose a fine of up to HK$8 million.
- Criminal prosecution: insider dealing is also a criminal offence. On conviction on indictment the maximum is a HK$10 million fine and 10 years' imprisonment.
- Civil action under section 213 of the SFO: the SFC can seek injunctions, disgorgement and other orders to restore affected parties to their position before the conduct.
- Investigation powers: the SFC can require documents and interviews, and can refer evidence to the Police or the Department of Justice for criminal proceedings.
In practice the SFC will focus on the CFO as the source, the friend as the recipient, and the wife as the person who traded on information from the household. The issuer's directors also face personal exposure for the late announcement, and the issuer faces reputational and compliance consequences.