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HCMP 2477/2002
IN THE HIGH COURT OF THE
HONG KONG SPECIAL ADMINISTRATIVE REGION
COURT OF FIRST INSTANCE
MISCELLANEOUS PROCEEDINGS NO. 2477 OF 2002
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IN THE MATTER of Law Siu Kong Christopher trading as Lawsons Securities Company (Administrators Appointed) |
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IN THE MATTER of the Securities Ordinance, Chapter 333 |
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Before: Hon Kwan J in Chambers
Date of Hearing: 22 February 2006
Date of Decision: 22 February 2006
Date of Handing Down of Reasons for Decision: 24 February 2006
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REASONS FOR DECISION
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1. This is an application by the joint and several administrators (“the Administrators”) of Law Siu Kong Christopher (“Mr. Law”) trading as Lawson Securities Company (“Lawsons”) for directions as to the disposals of securities held in the name of Lawsons with the Central Clearing and Settlement System (“CCASS”) on behalf of Lawsons’ clients. The Administrators were appointed by an order made on 18 July 2002 on an application of the Securities and Futures Commission (“the SFC”). The present application is made under the liberty to apply provision in the order of appointment. These are the reasons for the orders and directions made at the hearing.
The background
2. Lawsons was a sole proprietorship operated by Mr. Law in Hong Kong. It was registered as a dealer on the Hong Kong Stock Exchange and as a registered securities dealer with the SFC. It provided brokerage services (and in a few cases margin facilities) to some 440 clients. The securities trading transactions Lawsons conducted on behalf of its clients were conducted through CCASS with which Lawsons held an account and was treated by CCASS as principal. In turn, vis-à-vis its own client, Lawsons was supposed to keep a proper record of their individual transactions and accounts of their respective stock and cash position.
3. On 7 June 2002, the SFC issued a restriction notice on Mr. Law under sections 39 and 40 of the Securities and Futures Commission Ordinance, Cap. 24, which were then in force. This was consequent upon an inspection of the SFC, which had identified serious deficiencies in the operations of Lawsons, including the possible misappropriation of clients’ assets, and discrepancies of approximately HK$34 million between Lawsons’ records and those maintained in Lawsons’ account at CCASS.
4. As mentioned earlier, the Administrators were appointed by the court on 18 July 2002. Mr. Law was adjudged bankrupt on 2 April 2003 and on 26 April 2003 the Administrators were appointed as trustees in bankruptcy of Mr. Law under section 100A of the Bankruptcy Ordinance, Cap. 6, when the court made a regulating order under this provision.
5. The Administrators have established that, as at the cessation of Lawsons’ business, there was a shortfall of approximately HK$20 million worth of shares. Their investigations identified a number of “dummy” accounts, which appeared to have been used by Lawsons’ brokers to conduct unauthorised trading by which clients’ shares were misappropriated. The Administrators are of the view that the shortfall of securities held in Lawsons’ CCASS account arose as a result of the unauthorised trading of clients’ stock, and was not due to any other reason, such as the pledging of margin clients’ stock to obtain bank financing.
6. Lawsons’ clients were eligible for compensation out of the Unified Exchange Compensation Fund (“the UECF”), which is administered by the SFC. To date, 264 clients, out of the 440 clients recorded in the books of Lawsons, have submitted claims totalling HK$28.8 million. The claims were adjudicated down to HK$22.4 million. Compensation payments from the UECF are limited to HK$150,000.00 per client. The time limit for submitting compensation claims against the UECF has now expired.
7. Of the 264 clients, 229 clients had claims accepted for less than the HK$150,000.00 limit and were thus fully compensated. They no longer have any economic interest in the shares held in Lawsons’ account at CCASS. There are 35 clients who have not been fully compensated and retain an economic interest in the distribution of the assets held in Lawsons’ CCASS account.
8. The securities now controlled by the Administrators on account of Lawsons have a current value of HK$1,834,350.00 as at 30 November 2005, representing a shortfall of some HK$20 million compared to Lawsons’ records showing HK$22,887,246.00 of clients’ shares being held as at 6 June 2002. In simple terms, the value of the shares on hand is approximately 8% of clients’ claims as per Lawsons’ records.
The determinations sought
9. In this application, the Administrators seek the determination of the following questions:
(1) the proprietary entitlement to the securities held by Lawsons in its account with CCASS;
(2) the extent and nature of the right of subrogation of the SFC arising under section 118(a) of the Securities Ordinance, Cap. 333 (since repealed, but continues to apply to the present situation by the savings, transitional and supplemental arrangements in Part 1 of Schedule 10 to the Securities and Futures Ordinance, Cap. 571) in respect of compensation paid to Lawsons’ clients out of the UECF;
(3) the manner in which claims of Lawsons’ clients are to be adjudicated and admitted by the Administrators;
(4) the manner in which the remaining shares held in Lawsons’ CCASS account are to be allocated and distributed to the clients of Lawsons; and
(5) the incidence of fees, costs and expenses incurred by the Administrators and their agents.
The first question – the proprietary entitlement
10. On the documentation signed by the clients and the evidence adduced of the operation of brokerage facilities, I am satisfied that Lawsons was acting as the clients’ agent with the securities being acquired by Lawsons through CCASS upon the instructions of the clients. The contractual provisions were consistent with the beneficial interest in the securities being vested in the clients, irrespective of whether they were cash clients or margin clients. This question was determined in the same way in similar circumstances in CA Pacific Finance Ltd. (in liquidation) & Anr. (No. 1) [1999] 2 HKC 632 at 636I to 637C, 646F to G, 650D to H; Re Forluxe Securities Ltd. & Anr., HCCW Nos. 310 and 311 of 1998, 20 December 2000, Yuen J, paras. 3 and 4; Re Chark Fung Securities Co. Ltd. & Anr. [2002] HKEC 1422, paras. 20 to 22.
11. I hold that Lawsons’ clients retain their proprietary rights in respect of securities purchased for and on their behalf through the CCASS system and that Lawsons held the same as trustees for the clients under individual trusts. The shares therefore do not form part of Mr. Law’s estate in bankruptcy (section 43(3) of Cap. 6; Halsbury’s Laws of England, 4th ed. 2002 reissue, vol. 3(2) para. 428).
The fourth question – the manner of allocation
12. It would be convenient to deal with the fourth question before I come to the second and third questions, as the determination of this would have a substantial impact on the determination of the other questions.
13. On the basis that the clients are prima facie entitled to assert a proprietary claim to the remaining securities held on account of Lawsons at CCASS, the securities ought to be returned to them. This raises the question whether the securities should be returned in specie or whether the Administrators should sell the entire portfolio and distribute the proceeds. The Administrators accept that the starting point is that the shares should be returned in specie. However, for the reasons set out in their supporting affirmation, they seek a direction that they be at liberty to sell the entire portfolio and distribute the proceeds to the clients.
14. The Administrators have been able to divide the different types of securities held by Lawsons into these five categories, depending on their level of deficiency as compared to clients’ claims:
A – the shares available are equal to the shares claimed (116 stocks)
B – there are more claims than shares available (132 stocks)
C – there are no shares at all to meet the claims (241 stocks)
D – the number of shares available exceeds the claims for these shares (10 stocks)
E – there are shares available but no claims in respect of the same (23 stocks)
15. Whilst it is technically possible to allocate the category A shares to clients, the Administrators have considered the position and concluded that this is not practically possible in the circumstances as the costs associated in so doing would be disproportionately high.
16. The majority of the remainder of the lines of stock fall into categories B and C. These 373 lines of stock were valued at HK$602,193.00 as at 6 June 2002 as against clients’ claims of HK$33,339,443.00. Of the 33 lines of stock that fall into categories D and E, 9 are warrants or rights that were allocated to Lawsons’ CCASS account but which were not updated in the respective clients’ accounts. Without further analysis, the Administrators do not know to whom these should be allocated on a proprietary basis.
17. The Administrators have considered the various options available to them in returning the remaining securities, including those discussed in the CA Pacific, Forluxe and Chark Fung cases. If a forensic tracing exercise were to be undertaken, this would involve a review of the timing of each transaction to attempt to identify whose shares were available to be used by Lawsons’ staff at any given point in time and hence which had been dissipated. This would be a substantial exercise, given that there are 440 clients recorded in Lawsons’ records, and more than 2,000 lines of stock.
18. Furthermore, clients’ stocks held in the broker’s account at CCASS are not registered in the name of the ultimate client. When more than one client was holding a stock at the time of dissipation, it may not be possible to determine whose shares were used, if this should be based on first in-first out, first in-last out, or pari passu principles. In view of the fact that there was a highly significant shortfall and there existed a number of dummy accounts, the Administrators do not believe it would be possible to determine definitely exactly whose shares had been dissipated.
19. The Administrators have borne in mind the need to exercise their commercial judgment and not act regardless of expense. Having regard to the small amount of assets held by Lawsons, they consider it important to have regard to the costs of any proposed course of action so that the funds available for distribution to clients are not unnecessarily depleted. Taking a pragmatic approach, they do not think it appropriate to adopt the methods of allocation and distribution in the CA Pacific, Forluxe or Chark Fung cases. I accept their suggestion that the most appropriate way to proceed is to liquidate the entire portfolio and thereafter distribute the proceeds among the claimants in proportion to the total value of that individual client’s claim to shares as against the total value of claims to shares received by the Administrators. I note that this was the method of allocation adopted in the case of Win Successful Securities Limited, HCCW No. 112 of 2000, where the value of the remaining shares held in the broker’s CCASS account was so small that it would most likely be exceeded by the costs of allocating and distributing the shares.
20. I have made directions to give effect to the manner of allocation and distribution as proposed by the Administrators.
The second question – the right of subrogation of the SFC
21. By virtue of section 118 of Cap. 333, the SFC has a statutory right of subrogation to the rights of the clients to the extent which the compensation paid to them out of the UECF bears to the loss claimed by the clients (Re Forluxe Securities, supra. at paras. 37 and 50 to 52). I have made a direction to this effect.
The third question – the manner of adjudication
22. The majority of Lawsons’ clients were cash clients. The Administrators’ investigations indicate there were 13 clients who received financing, of which margin client documentation has been located for 12. I see no reason to draw any distinction between cash clients and margin clients in this situation, given the views of the Administrators that the shortfall in shares arose as a result of unauthorised trading of clients’ shares (Re Chark Fung Securities, supra. at paras 35 to 38).
23. I have made directions on the basis that all clients are to be treated on an equal footing, whether they were cash or margin clients, save that margin clients should be required to repay any amount owed to Lawsons before receiving any distribution. Directions are also given on the mechanics of the exercise of adjudication. The Administrators are only to contact those clients whose claims have not been fully compensated by a payment out of the UECF. I have approved the revised draft notice to be given to these clients. There is also provision for a notice to be advertised. This would afford a client an opportunity to submit a claim to the Administrators within the specified period if he should consider that Lawsons’ books do not properly reflect his position. In default of receiving any further claim from a client within the specified period, the Administrators are at liberty to adjudicate a client’s claim on the basis of Lawsons’ books and records. Lastly, there is mechanism for a client dissatisfied with the adjudication to apply to court within a specified time to vary or reverse the decision of the Administrators.
24. The date for valuation of clients’ claims is fixed at 31 May 2002, being the last day upon which trades were conducted by Lawsons on behalf of its clients.
The fifth question – fees, costs and expenses
25. The court has power to order the Administrators’ fees and expenses be paid out of the trust assets (Re CA Pacific Finance Ltd. (in liquidation) (No. 2) [1999] 2 HKC 652 at 657H to 658B; Re Berkeley Applegate Ltd. [1989] Ch 32 at 48H to 51B).
26. The Administrators are permitted to deduct from the proceeds of sale all expenses incurred by them in maintaining the shares held by Lawsons in its CCASS account since their appointment, including share custodian fees charged by CCASS; all direct expenses incurred in connection with the realisation of such shares and the distribution of the proceeds to clients, including but not limited to brokerage fees; the Administrators’ fees, costs and expenses which are directly related to the preparation of this application and implementation of any consequential order; and the legal costs and disbursements of the Administrators’ legal advisers incurred in connection with this application and the implementation of the order, to be taxed on a solicitor and own client basis.
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(S Kwan)
Judge of the Court of First Instance
High Court |
Mr Chris Dobby, of Messrs Johnson Stokes & Master, for the Administrators
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