SECURITIES AND FUTURES COMMISSION v. QUNXING PAPER HOLDINGS CO LTD AND OTHERS

HCA 2428/2013

[2018] HKCFI 271

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

ACTION NO 2428 OF 2013

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J U D G M E N T

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I. Introduction

1.  This is an action brought by the Securities and Futures Commission, alleging that Qunxing Paper Holdings Co Ltd (“Qunxing”), a company listed on the Main Board of the Stock Exchange of Hong Kong, had made false or misleading statements in its announced financial results and thereby contravened various statutory provisions.  It is alleged that a subsidiary, Best Known Group Ltd (“Best Known”), as well as the Chairman, Mr Zhu Yuguo (the 3^rd defendant), and his son the Vice‑Chairman, Mr Zhu Moqun (the 4^th defendant), were persons involved in those contraventions.  The Commission seeks various declarations and, more importantly, orders under s 213 of the Securities and Futures Ordinance (Cap 571) (“SFO”) with a view to compensating public investors who had acquired shares or warrants in Qunxing.

2.  Qunxing’s and Best Known’s defence had been struck out and the 3^rd and 4^th defendants have not responded to the action.  The question for me is therefore whether the Commission has proved its case by the admissible evidence it has adduced and, if so, what orders should be made by way of relief.

II.       Facts

3.  In my judgment, the Commission’s factual case is made out on the evidence.  The facts that I find proved to the requisite standard are as follows.

Fund raising and shareholding structure

4.  Founded by the 3^rd defendant, his wife Sun Rui Fang and their son the 4^th defendant (together the “Zhus”), the underlying business of the group headed by Qunxing was in the manufacture and sale of decorative base paper products and printing paper products in the Mainland. 

5.  On 17 September 2007, Qunxing, a company incorporated in the Cayman Islands, issued a prospectus (“IPO Prospectus”) for the placing and public offer of its shares inviting applications from the public to subscribe for its shares.  The offer price was HK$5.35 per share (with a nominal value of HK$0.10 each).  Both the international placing and the Hong Kong public offer were very significantly over‑subscribed. Eventually 150m shares were issued under the public offer, and 195m shares were placed to international placees.  Gross proceeds raised amounted to approximately HK$1,846m (345m x HK$5.35).

6.  On 2 October 2007, Qunxing’s shares began to be listed on the Main Board of the Stock Exchange of Hong Kong (stock code 3868).  At that time, the total number of issued shares was 1,045m, with the Zhus holding 67% via their own BVI company named Boom Instant Ltd (“Boom Instant”).

7.  On 17 December 2010, Qunxing made an open offer of new shares at HK$0.66 per share (on the basis of 1 new share for every 2 existing shares), which was slightly under‑subscribed by public shareholders, and raised about HK$112.46m from public shareholders who were allotted 170,394,744 new shares.

8.  Shortly afterwards further funds were raised, through a subscription agreement dated 14 January 2011 with an investor named Victory Asset Management Ltd (“Victory Asset”) which subscribed for 206.56m unlisted warrants of Qunxing at HK$0.05 per warrant.  The exercise price was HK$2.95 per share.  Victory Asset did not exercise its right to subscribe for any shares; the exercise period of 12 months had long expired.

9.  On 30 March 2011, as a result of a disclaimer of opinion by Qunxing’s then auditors, KPMG, regarding its 2010 annual results, trading of the shares on the Stock Exchange was suspended.  The last trading price before suspension was HK$2.18 per share.  The 2010 results were published the next day.  KPMG resigned as auditors on 8 June 2011.

10.  Between March 2011 and the present, there were 1,586,391,450 shares in issue, of which 1,075,207,718 shares (67.78%) were held by Boom Instant and 511,184,232 shares (32.22%) by public shareholders.

11.  Between 2008 and 2013, Qunxing paid cash dividends to its shareholders totalling RMB 471m, of which the Zhus, as majority shareholders via Boom Instant, would have received about RMB 329m.

The 3^rd and 4^th defendants

12.  The 3^rd and 4^th defendants were at all material times the executive directors and decision‑makers of Qunxing (being its Chairman and Vice‑Chairman respectively) until their resignation on 21 March 2014.  The 3^rd defendant was also the chairman and legal representative of Shandong Qunxing and the 4^th defendant a director.  They resided in Shandong and attended to the daily operations of the business operations.  There is consistent evidence from the financial controller, an independent director, and the company secretary of Qunxing that the 3^rd defendant with the assistance of the 4^th defendant made all the management decisions for Shandong Qunxing and they together were the decision‑makers intimately involved in managing the affairs of Qunxing.

Publication of financial results

13.  In the IPO Prospectus and in the annual reports and results announcements between 2007 and 2011, Qunxing published its financial results including the following (denominated in RMB):

	IPO Prospectus	Annual Reports and Results Announcements (RMB)
Results for the year	2006	2007	2008	2009	2010	2011
Publication date	17.9.2007	17.3.2008	18.3.2009	17.3.2010	30.3.2011	14.3.2012
Turnover	950,844,000	1,125,524,000	1,496,360,000	1,530,321,000	2,058,916,000	2,003,651,000
Gross profit	184,117,000	283,469,000	405,516,000	424,804,000	519,785,000	326,910,000
Profit from operations	163,317,000	371,637,000	396,681,000	375,862,000	455,973,000	--
Profit before taxation	142,692,000	350,572,000	383,361,000	371,694,000	455,973,000	256,183,000
Profit for the year/ period	93,937,000	350,572,000	383,361,000	324,087,000	397,506,000	221,968,000
Earnings per share	0.13	0.42	0.37	0.31	0.38	0.14

Falsity in published financial results

14.  The Commission initiated an investigation into Qunxing in April 2011.  At around the same time, Qunxing itself appointed an independent professional adviser, Zhonglei Risk Advisory Services Ltd, to perform an internal control review and investigation of the audit issues highlighted by KPMG.  The Stock Exchange was not satisfied with the review and Qunxing decided to commission a further review by JLA Asia Ltd in November 2011. 

15.  Having found irregularities in the financial results published by Qunxing, the Commission commenced the action herein on 12 December 2013 and obtained interim orders, inter alia, to freeze the assets of Qunxing and Best Known up to the value of HK$1,968m.

16.  The Commission’s case is that a false and misleading picture was given in relation to Qunxing’s financial position both before and after the IPO. 

Overstated sales

17.  In particular, the sales to Shanghai On Hing Paper Co Ltd (“Shanghai On Hing”) and Changzhou Cuiqiao Cheunguang Paper Co Ltd (“Cuiqiao”) were materially overstated. 

18.  Shanghai On Hing was held out by Qunxing to be a top customer of Shandong Qunxing Paper Ltd (“Shandong Qunxing”), which was a wholly owned subsidiary of Qunxing held via Best Known and the sole operational arm of the group.  In fact, Shanghai On Hing was not a customer of Shandong Qunxing from 2006 onwards, and had ceased business operations in early 2008.  Certain records and documents provided by Qunxing to its auditors KPMG pertaining to the purported purchases and payments by Shanghai On Hing had later transpired to be fictitious.  The purported employees of Shanghai On Hing made available to the auditors and external reporting accountants also turned out not to be employees of Shanghai On Hing or its group.

19.  Shanghai On Hing (until early 2008) and a sister company called Huidong (after 2007) did place orders with a supplier called Kangmu, which was not part of the Qunxing group but a company owned by the 3^rd defendant personally.  However, since Kangmu occasionally received sales invoices from Shandong Qunxing and made payment accordingly, I would accept these were arguably Shandong Qunxing’s sales and therefore take the lower end of the overstated amounts pleaded by the Commission.

20.  Cuiqiao was held out to be one of the top 10 customers of Shandong Qunxing from 2007 to 2010 and the top customer in 2011.  In fact, its purchases from Shandong Qunxing were only about half of what was included in the reported results.  Further, certain bank payment records provided by Qunxing during the investigation were later found to be fictitious.  The purported employee of Cuiqiao made available to the auditors and external reporting accountants turned out to someone who had already left Cuiqiao before the meetings.

21.  I find that the scale of the overstatement of turnover was as follows:

Year	Turnover as reported in IPO Prospectus or Annul Reports or Results Announcements (RMB)	Amount of sales overstated in relation to Shanghai On Hing (RMB)	Amount of sales overstated in relation to Cuiqiao (RMB)	Percentage of turnover overstated
2006	950,844,000	107,868,158		11.34%
2007	1,125,524,000	217,610,958		19.33%
2008	1,496,360,000	217,042,845		14.50%
2009	1,530,321,000	170,091,413	13,685,750	12.01%
2010	2,058,916,000	204,612,960	35,289,427	11.65%
2011	2,003,651,000	51,336,920		2.56%

22.  As a result, the gross profit, profit from operations, profit before taxation, profit for the year/period and earnings per share as published in the IPO Prospectus, annual reports and results announcements (as set out in the table in §13 above) were also overstated.

Bank borrowings

23.  In addition, the annual reports and results announcements for the years 2009 to 2012 failed to disclose the bank borrowings of the group.

Year	Bank borrowings reported in annual reports and results announcements	Number of undisclosed bank loans	Total amount of undisclosed bank loans outstanding at the end of year (RMB)
2009	Nil	7	389.2m
2010	Nil	12	849.2m
2011	Nil	28	1,519.2m
2012	Nil	22	1,594.2m

24.  These loans were between 4 times and over 14 times of the recorded liabilities at the end of the relevant periods and were clearly material to the current liabilities and total liabilities of the group.  The amount of bank loans was also used to calculate a number of key financial ratios discussed in the “Management Discussion and Analysis” section in Qunxing’s annual reports. 

Restructuring of Shandong Qunxing

25.  Shandong Qunxing applied in the Mainland for restructuring under the Enterprise Bankruptcy Law on 21 February 2014, which was premised on its inability to pay its debts or a predominant likelihood that it would lose the capacity to pay off its debts.  This implied a sudden deterioration of the financial position of Shandong Qunxing between the date of its interim report as at 30 June 2013 (published on 27 September 2013), showing cash and cash equivalents of RMB 655.3m, and February 2014.  The application, approved and submitted by the 3^rd and 4^th defendants on behalf of Shandong Qunxing, was accepted by the Intermediate People’s Court of Binzhou City on 24 February 2014.  None of this was disclosed to the investing public in Hong Kong.  It has since transpired that Shandong Qunxing was grossly insolvent.  At the creditors’ meetings held in November 2014, the auditors of Shandong Qunxing reported that its assets and liabilities were RMB 530m and RMB 5.37 billion respectively.

26.  When the Commission made enquiries with it about the restructuring application, Qunxing suddenly announced on 21 March 2014 the resignation of all its directors, including the 3^rd and 4^th defendants. In those circumstances, interim receivers and managers were appointed for Qunxing by the Court of First Instance on 28 March 2014 on the application of the Commission.

27.  A restructuring proposal for Shandong Qunxing was approved by the relevant Mainland court in December 2014.  The prospects of Qunxing and Best Known being able to receive any value for its equity in Shandong Qunxing (or for a small inter‑company balance due from Shandong Qunxing) are, in all probabilities, negligible. 

28.  The present available assets of Qunxing and Best Known are cash in Hong Kong, in the sums of approximately HK$81.94m and HK$30.24m respectively, totalling HK$112.2m.  Apart from the investors proposed to be compensated by the orders sought herein, there are no other known creditors.  Qunxing no longer has any office, staff or business.

III.     Relevant statutory provisions

29.  S 213 of the SFO provides as follows:

“(1) Where —

(a) a person has —

(i) contravened —

(A) any of the relevant provisions;

(B) any notice or requirement given or made under or pursuant to any of the relevant provisions;

(C) any of the terms and conditions of any licence or registration under this Ordinance; or

(D) any other condition imposed under or pursuant to any provision of this Ordinance;

(ii) aided, abetted, or otherwise assisted, counselled or procured a person to commit any such contravention;

(iii) induced, whether by threats, promises or otherwise, a person to commit any such contravention;

(iv) directly or indirectly been in any way knowingly involved in, or a party to, any such contravention; or

(v) attempted, or conspired with others, to commit any such contravention; or

(b) it appears, whether or not during the course or as a result of the exercise of any power under Part VIII, to the Commission that any of the matters referred to in paragraph (a)(i) to (v) has occurred, is occurring or may occur,

the Court of First Instance, on the application of the Commission, may, subject to subsection (4), make one or more of the orders specified in subsection (2).

(2) The orders specified for the purposes of subsection (1) are—

(a) an order restraining or prohibiting the occurrence or the continued occurrence of any of the matters referred to in subsection (1)(a)(i) to (v);

(b) where a person has been, or it appears that a person has been, is or may become, involved in any of the matters referred to in subsection (1)(a)(i) to (v), whether knowingly or otherwise, an order requiring the person to take such steps as the Court of First Instance may direct, including steps to restore the parties to any transaction to the position in which they were before the transaction was entered into;

(c) an order restraining or prohibiting a person from acquiring, disposing of, or otherwise dealing in, any property specified in the order;

(d) an order appointing a person to administer the property of another person;

(e) an order declaring a contract relating to any securities, structured product, futures contract, leveraged foreign exchange contract, or an interest in any securities, structured product, futures contract, leveraged foreign exchange contract or collective investment scheme to be void or voidable to the extent specified in the order;

(f) for the purpose of securing compliance with any other order made under this section, an order directing a person to do or refrain from doing any act specified in the order;

(g) any ancillary order which the Court of First Instance considers necessary in consequence of the making of any of the orders referred to in paragraphs (a) to (f).

……

(4) The Court of First Instance shall, before making an order under subsection (1), satisfy itself, so far as it can reasonably do so, that it is desirable that the order be made, and that the order will not unfairly prejudice any person.

……

(8) Where the Court of First Instance has power to make an order against a person under subsection (1), it may, in addition to or in substitution for such order, make an order requiring the person to pay damages to any other person.

……”

30.  S 277 of the SFO provides:

“277. Disclosure of false or misleading information inducing transactions

(1) Disclosure of false or misleading information inducing transactions takes place when, in Hong Kong or elsewhere, a person discloses, circulates or disseminates, or authorizes or is concerned in the disclosure, circulation or dissemination of, information that is likely —

(a) to induce another person to subscribe for securities, or deal in futures contracts, in Hong Kong;

(b) to induce the sale or purchase in Hong Kong of securities by another person; or

(c) to maintain, increase, reduce or stabilize the price of securities, or the price for dealings in futures contracts, in Hong Kong,

if —

(i) the information is false or misleading as to a material fact, or is false or misleading through the omission of a material fact; and

(ii) the person knows that, or is reckless or negligent as to whether, the information is false or misleading as to a material fact, or is false or misleading through the omission of a material fact.”

31.  S 298 of the SFO provides:

“298. Offence of disclosure of false or misleading information inducing transactions

(1) A person shall not, in Hong Kong or elsewhere, disclose, circulate or disseminate, or authorize or be concerned in the disclosure, circulation or dissemination of, information that is likely —

(a) to induce another person to subscribe for securities, or deal in futures contracts, in Hong Kong;

(b) to induce the sale or purchase in Hong Kong of securities by another person; or

(c) to maintain, increase, reduce or stabilize the price of securities, or the price for dealings in futures contracts, in Hong Kong,

if —

(i) the information is false or misleading as to a material fact, or is false or misleading through the omission of a material fact; and

(ii) the person knows that, or is reckless as to whether, the information is false or misleading as to a material fact, or is false or misleading through the omission of a material fact.

(2) Subject to subsections (3) to (5), a person who contravenes subsection (1) commits an offence.”

32.  S 384(1) of the SFO provides:

“384. Provision of false or misleading information

(1) Subject to subsection (2), a person commits an offence if —

(a) he, in purported compliance with a requirement to provide information imposed by or under any of the relevant provisions, provides to a specified recipient any information which is false or misleading in a material particular; and

(b) he knows that, or is reckless as to whether, the information is false or misleading in a material particular.”

33.  S 342F of the Companies (Winding Up and Miscellaneous Provisions) Ordinance (Cap 32) provides:

“342F. Criminal liability for misstatements in prospectus

(1) Where a prospectus relating to shares in or debentures of a company incorporated outside Hong Kong (whether the company has or has not established a place of business in Hong Kong) which is issued, circulated or distributed in Hong Kong after the commencementof the Companies (Amendment) Ordinance 1992 (86 of 1992) includes any untrue statements, any person who authorized the issue, circulation or distribution of the prospectus in Hong Kong shall be liable to imprisonment and a fine, unless he proves either that the statement was immaterial or that he had reasonable grounds to believe and did up to the time of the issue, circulation or distribution of the prospectus in Hong Kong believe that the statement was true.”

IV.      Contraventions of statutory provisions

34.  Based on the above findings, I am satisfied that Qunxing had committed market misconduct in the context of s 277 of the SFO:

(1) As shown by the expert evidence of Ms Winnie Pao, the false information about the financial results of Qunxing was likely (a) to induce investors to subscribe for shares in Qunxing and the buying and selling of such shares, and (b) to maintain, increase, or stabilize the price of Qunxing shares.

(2) The information was false or misleading as to a material fact, or is false or misleading through the omission of a material fact.  The expert evidence of Mr Cheung Yuk Lam established the materiality of the relevant misstatements.

(3) Qunxing disclosed, circulated or disseminated, or authorized or was concerned in the disclosure, circulation or dissemination of, such information.

(4) As was demonstrated by the evidence, Qunxing was in the close control of the 3^rd and 4^th defendants who, I infer, knew that the information was materially false or misleading.  This knowledge is to be attributed to Qunxing for the purpose of s 277, applying the principles summarised in Moulin Global Eyecare Trading Ltd v Commissioner of Inland Revenue (2014) 17 HKCFAR 218 at §106.

(5) Accordingly, Qunxing had engaged in disclosure of false or misleading information inducing transactions within the meaning of s 277(1).

35.  On the same basis, I also find that Qunxing had committed an offence under s 298 of the SFO.

36.  In the context of s 384 of the SFO, I find that Qunxing had committed an offence in that:

(1) Qunxing provided the IPO Prospectus, annual reports and results announcements to the Commission (a “specified recipient” under s 384(8)(a)) in purported compliance with the requirements under the Securities and Futures (Stock Market Listing) Rules (Cap 571V). 

(2) The information provided was false or misleading in a material particular.

(3) Based on the knowledge of the 3^rd and 4^th defendants attributed to it, Qunxing knew that the information was false or misleading in a material particular.

37.  I also find that Qunxing breached s 342F of the Companies (Winding Up and Miscellaneous Provisions) Ordinance in that:

(1) The IPO Prospectus was a prospectus relating to shares in a company incorporated outside Hong Kong and was issued, circulated or distributed in Hong Kong.

(2) The IPO Prospectus included untrue statements.

(3) Qunxing was a person who authorized the issue, circulation and distribution of the IPO Prospectus in Hong Kong.

(4) The statements were not shown to be immaterial; nor was it proved that Qunxing had reasonable grounds to believe and did believe that they were true.

38.  It follows that for the purposes of s 213 of the SFO, Qunxing has contravened “relevant provisions”, as defined in Schedule 1 to the SFO to include the provisions of the SFO and of Parts II and XII of the Companies (Winding Up and Miscellaneous Provisions) Ordinance (Cap 32), so far as those Parts relate, directly or indirectly, to the performance of functions relating to prospectuses.  Accordingly, Qunxing is a person that falls within the ambit of s 213(1)(a)(i)(A) and s 213(2)(b) of the SFO.  Declarations will follow, the precise terms of which I leave to the Commission to work out and submit to the court for approval.

V.      Position of the 2^nd, 3^rd and 4^th defendants

39.  On the evidence, I am also satisfied that the 2^nd, 3^rd and 4^th defendants had directly or indirectly been knowingly involved in, or a party to, the contraventions by Qunxing (s 213(1)(a)(iv)), or had been involved in the contraventions whether knowingly or otherwise (s 213(2)(b)).  They are therefore persons falling within the ambit of s 213(1)(a)(iv) and s 213(2)(b) of the SFO.  There will also be declarations accordingly.

VI.      Relief for the benefit of investors

The orders sought

40.  I turn to the question of financial relief, which seems to me to be more complicated.  The Commission seeks primarily an order under s 213(2)(b) requiring the defendants to make payments to the public shareholders and to Victory Asset, with a view to restoring them to the positions in which they were before their subscription or purchase of Qunxing’s shares or warrants.  Broadly described, the proposed scheme involves the following:

(1) Only Victory Asset and the shareholders of Qunxing as at 26 August 2013[1] would be encompassed within the scheme.  There were in total 26,906 such shareholders[2] including those holding shares in their own name or beneficially, ascertained after enquiries made to Qunxing’s share registrar Tricor, CCASS and 361 market intermediaries (banks or brokerage firms).

(2) For each investor, the actual cost incurred in acquiring the securities would as far as possible be calculated as follows. Where the shares were acquired in the IPO in September 2007 or the open offer in December 2010, the subscription price of HK$5.35 or HK$0.66 per share respectively would be used.  Where shares were purchased on the market in cash, the price paid would be treated as the cost.  Where shares were transmitted or transferred not for cash, the daily market closing price as at the date of transmittance or transfer would be adopted.  Where there is insufficient trading information to ascertain the actual acquisition cost (which is the case in relation to 2,051 shareholders), the last trading price of HK$2.18 per share would be adopted.  Dividends received by the investors would be deducted from the cost, and incidental expenses would be added.

(3) For Victory Asset, the actual cost of HK$10.328m would be taken as the cost incurred in acquiring the warrants.

(4) The defendants would be ordered to pay these amounts in order to restore the investors to their original position.  The estimated total sum payable thus to the shareholders and Victory Asset is approximately HK$1,419.58m, although the assets available in Qunxing and Best Known only amounted to about HK$112.2m.

41.  Alternatively, the Commission seeks an order under s 213(8) requiring the defendants to pay damages to the public shareholders and Victory Asset. 

42.  Ancillary orders are sought to appoint Mr Bruno Arboit, who had already done a substantial amount of analysis and given evidence herein on the losses suffered by the investors, to receive the assets of Qunxing and Best Known and to make payments therefrom pro rata to the investors.  His function would include calculating the precise amount payable to each shareholder, notifying them, receiving the funds to be distributed, preparing cheques for payment to the shareholders and dealing with any relevant queries and disputes raised by them.

43.  I am grateful to counsel for the Commission and their team for their research and submissions, made partly in answer to the questions I raised.  Conscious of the fact that I have heard no opposing submissions and that the contentions advanced involve the application of s 213 in a novel manner, I shall seek to explain my decision as follows.

Nature of s 213 remedy

44.  Civil remedies both at common law and under the SFO and the Companies (Winding Up and Miscellaneous Provisions) Ordinance are potentially available to investors for losses suffered in reliance on false information.  Thus, in connection with the provisions which were contravened in this case, ss 281 and 305 of the SFO provide for liability to pay compensation to an investor by way of damages for any pecuniary loss sustained as a result of market misconduct, which includes the disclosure of false or misleading information contravening ss 277 and 298 respectively.  Ss 40 and 342E of the Companies (Winding Up and Miscellaneous Provisions) Ordinance provide for liability to pay compensation to subscribers for loss sustained by reason of untrue statements contained in a prospectus that contravenes s 342F.  There are also general provisions in s 108 of the SFO for liability to pay compensation by way of damages for pecuniary loss sustained as a result of reliance on a fraudulent, reckless or negligent misrepresentation, and in s 391 of the SFO for liability to pay damages for pecuniary loss sustained by a person as a result of acting in reliance on a false or misleading communication concerning securities or futures contracts.

45.  Unlike s 213, however, these provisions may only be invoked by the persons themselves who have sustained the loss in question, not by the Commission.  S 213, in contrast, confers a right of action on the Commission as plaintiff.  As s 213(1) provides, the orders under subsection (2) may be made “on the application of the Commission”, not of any other person.  S 213 is “complementary” to the civil liabilities created by ss 281 and 305, and the orders under s 213(2) are:

“by their nature designed to ensure that the relevant provisions are complied with (section 5(1)(d)), maintain and promote confidence in the industry (section 5(1)(g)), protect investors (section 5(1)(l)) and suppress illegal practices (section 5(1)(n))” (Securities and Futures Commission v Tiger Asia Management LLC [2012] 2 HKLRD 281 at §35 per Tang VP (as he then was)).

46.  Insofar as financial awards are provided for, the purpose of s 213 is of course to provide remedies for the benefit of investors, not for the benefit of the Commission.  In Securities and Futures Commission v Tiger Asia Management LLC (2013) 16 HKCFAR 324, at §16, Lord Hoffmann NPJ, distinguishing s 213 from criminal proceedings or proceedings in the Market Misconduct Tribunal, said:

“Section 213, on the other hand, provides remedies for the benefit of parties involved in the impugned transactions. They include injunctions and the appointment of receivers to secure property with a view to recovery by the victims of market misconduct, orders that particular transactions be unwound, orders declaring particular transactions to be void or voidable. In these proceedings the SFC acts not as a prosecutor in the general public interest but as protector of the collective interests of the persons dealing in the market who have been injured by market misconduct. Proceedings under s 213 are the public law analogue of actions for damages by individuals under s 305 rather than a substitute for a criminal prosecution or proceedings before the MMT.”

47.  This does not mean that s 213 is merely procedural in the provision of financial relief, limited to providing a representative mechanism for enforcing existing individual rights.  In Securities and Futures Commission v C [2009] 4 HKLRD 315, at §35, Le Pichon JA said that the range of remedies contained in s 213(2)

“were created by statute and are intended or designed to provide substantive relief to address specific types of wrongdoing …”

It can be seen, for example, that the statutory remedy in s 213(2)(b) is available against a third party involved in any matter in s 213(1)(a)(i)‑(v) albeit there is no contractual cause of action at common law against such a person for rescission of the transaction.  It has also been held in the UK that similar provisions in ss 6 and 61 of the Financial Services Act 1986 were not mere machinery to enable the Securities and Investments Board to enforce the investors’ substantive rights conferred by other provisions on their behalf: Securities and Investments Board v Pantell SA (No 2) [1993] Ch 256, 263F‑H, 277B‑C.

48.  Indeed, as pointed out in Gray, Regulatory Restitution under Financial Services Legislation [2004] RLR 52 at 53 in relation to UK legislation:

“It is the shortcomings of private law as an efficacious means of ensuring redress and compensation that provide justification for the existence of financial regulators’ powers to apply to the courts, in certain circumstances, to seek restitutionary orders against firms and individuals who are in contravention of the substance of financial regulatory legislation and rules. The fruits of such restitutionary orders may then be applied by the regulators to the benefit of not just one investor who has suffered loss as a result of the contravention but, if need be, a whole class or range of such investors.”

49.  There is a very real risk that the purpose of the legislature in enacting s 213(2) would be defeated if it was regarded as providing merely a machinery for enforcing rights already vested in the investors under the common law or other provisions and that each and every constituent element of these causes of action (such as reliance and inducement) was required to be separately proved for each investor.  Accordingly I accept the submission of counsel on behalf of the Commission, that in making provision for remedies for the benefit of investors, s 213 is not merely procedural.

50.  Instead, s 213 creates a substantive statutory cause of action which is vested in the Commission.  The purpose is to provide a statutory regime whereby the Commission, as regulator, can take action to obtain civil remedies for the benefit of investors, who may otherwise be deterred by cost and other considerations from instituting legal proceedings individually to obtain redress for their relatively small losses: see the Court of Appeal’s decision in Securities and Futures Commission v Tiger Asia Management LLC [2012] 2 HKLRD 281 at §24 per Tang VP.  There is a wider public interest in this because, as Steyn LJ put it in Pantell at p 282B‑C:

“The civil law provides a framework for the redress of individual grievances. But it also fulfils a wider social purpose in setting standards for the markets and in discouraging aberrant behaviour. But if resort to civil remedies is impracticable for most individual investors the sanctions of the civil law cannot play their proper role.”

Persons against whom order under s 213(2)(b) may be made

51.  S 213(2)(b) was a new provision in the SFO[3] although s 213 itself can trace its origin to the Securities Ordinance of 1974: Securities and Futures Commission v Tiger Asia Management LLC (2013) 16 HKCFAR 324, §19.  There appears to be no similar provision in Australia, New Zealand or Canada.  The foreign legislation closest to it in form is s 6(2) of the (UK) Financial Services Act 1986 (considered in Pantell), which was later replaced by ss 380‑382 of the (UK) Financial Services and Markets Act 2000. 

52.  The terms of s 213(2)(b) are very wide indeed.  It confers power on the court to make an order

“requiring the person to take such steps as the Court of First Instance may direct, including steps to restore the parties to any transaction to the position in which they were before the transaction was entered into” (emphasis added).

The latter words referring to the restoration of the parties’ position are of course “classic features of a rescission in equity”: Pantell, p 264B.  In Securities and Futures Commission v C at §36, Le Pichon JA said:

“Section 213(2)(b) enables an order to be made that would restore all the parties to the transaction to their respective former positions. In other words, it is restitutionary in nature and, in conjunction with an order under section 213(2)(c), would provide compensation to those who have sustained losses through the wrongdoing in question, in the present case, insider dealing.”

53.  While the provision is not in terms so limited, it appears that the orders made in previous cases under s 213(2)(b) were all restorative orders (ie orders to restore the parties to a transaction to their pre‑transaction position) where the defendant was a party to the transaction affected by the contravention in question.  In Securities and Futures Commission v Tsoi Bun [2014] 2 HKLRD 1, the defendant had been found guilty of price‑rigging, which had enabled him to buy futures contracts at a depressed price or sell them at an inflated price to the detriment of his counterparties.  He was ordered to pay money to compensate his counterparties in the trades in question.  In Securities and Futures Commission v Young Bik Fung [2016] 1 HKLRD 1249[4], Anthony Chan J made orders under s 213(2)(b) against the defendants who had engaged in insider dealing by acquiring shares, so as to compensate the counterparties who sold them the shares in question.  Securities and Futures Commission v Sun Min [2017] 4 HKLRD 211 was another insider dealing case.  There Harris J made an order under s 213(2)(b), by consent following certain findings made by the Market Misconduct Tribunal, for the defendant to make payment to 51 counterparties in the trades in question, ie those who had sold her their shares before the inside information was published that lifted the share price.  All these are, therefore, cases in which the defendant subjected to a restorative order was himself a party to the transaction which was carried out in contravention of the relevant provisions.  The restorative order was made for the benefit of investors dealing on the market as counterparties to the defendants.

54.  This does not necessarily mean that an order for restoration under s 213(2)(b) can only be made against a party to the transaction to be undone in effect.  The section does not contain any such express restriction, but is “open‑textured”[5]. The width of the section and of the powers it confers on the court are “characterised by their extreme flexibility” and “should not be judicially cut down” (Securities and Investments Board v Scandex Capital Management A/S [1998] 1 WLR 712, 723B, 726B).  Its terms permit an order to be made against a person if he has been involved in any of the matters referred to in s 213(1)(a)(i) to (v) — these categories of persons are not necessarily themselves parties to the transactions in question.  They may be persons who have aided or abetted a contravention or simply a person who has been involved in it. 

55.  In the present case, of the 4 defendants, only Qunxing was a counterparty to the transactions in question, and then only in relation to the IPO and open offer of shares and the issue of warrants to Victory Asset.  Can the type of order sought by the Commission be granted against the 2^nd to 4^th defendants, and against Qunxing in relation to purchases of shares on the market?  It is ultimately a matter of statutory construction.  There seems to me no a priori reason to limit the persons against whom an order may be made under s 213(2)(b) to those who are counterparties to the transactions in question.  The similar section in the (UK) Financial Services Act 1986 expressly enabled a restorative order to be made, not only against a person who has entered into a transaction in contravention of the law, but also against any other person who has been knowingly concerned in the contravention: see Pantell, p 264C‑D.  I consider that the type of order sought can in principle be made against all four of the defendants.

Should the order be made?

56.  Not only is s 213(2) striking in its width, it is also remarkable in that the cause of action it creates appears to be discretionary.  S 213(1) confers a discretion on the court by providing that it “may”, on the application of the Commission, make one or more of the orders specified in subsection (2). The jurisdiction arises once the court finds that the matters set out in s 213(1)(a) have occurred.  The only express fetter on this discretion is subsection (4), which requires the court to satisfy itself on two matters, “so far as it can reasonably do so”, before making an order, namely, (i) that it is desirable that the order be made, and (ii) that the order will not unfairly prejudice any person. 

57.  Desirability and fairness are highly general concepts which do not lend themselves to definition or precise exposition.  A fairly broadbrush approach has to adopted where necessary.  In the present case an order along the lines proposed by the Commission should in my view be made having regard to the following.

58.  In contrast to the previous cases involving s 213, this case is about misstatement.  The crux of the complaint is that Qunxing (with the involvement of the 2^nd to 4^th defendants) had published materially false or misleading information concerning its financial results and condition which was likely to have induced investors to subscribe for or purchase its shares when they would otherwise not have done so, and that they have suffered loss as a result. 

59.  In an ideal world, where every fact is known or is ascertainable without cost and time, a fair and just scheme for compensating them, having regard to the usual principles of the law on misrepresentation, might be: (i) identify each investor who had acquired securities of Qunxing between the IPO and the suspension of trading; (ii) determine in each case in respect of each acquisition whether the investor relied on and was induced by the false information in making the acquisition; (iii) determine in respect of each investor whether he relied on and was induced by the false information in not disposing of the securities acquired at all or until a particular date; (iv) assess the loss suffered by each investor by reference to the acquisition price and the subsequent lower sale price or, if the securities are not yet sold, their true value or price as at an appropriate date; and (v) make appropriate adjustments for dividends, expenses and interest.

60.  But in the real world these facts are either not all ascertainable or are so only at the end of a vastly complex, lengthy and costly process.  To insist on investigating the circumstances of every individual investor and investment might completely destroy the efficacy of the statutory scheme and defeat the legislative purpose.  It is not surprising therefore that there has been no attempt in this case to establish reliance and inducement on an individual basis in the case of each investor.  Despite that proceedings under s 213 are “the public law analogue of actions for damages by individuals under s 305”[6], it is in my view not necessary to bring into s 213(2)(b) all the requirements of a private law cause of action of deceit in the case of each investor, especially where to do so would render the statutory remedy ineffective.  In any event, the expert evidence received by this court was that the false financial information about Qunxing published between the IPO in 2007 and suspension of trading in 2011 (which included the annual results up to 2009) was, on a general level, likely to influence investors to purchase Qunxing shares or at least not to sell them, and to affect the share price accordingly.  Even if an investor did not himself read the IPO Prospectus, annual reports and results announcement, the relevant information would have found its way into market commentaries and would have been reflected in market sentiments about Qunxing’s shares and ultimately in the prevailing share price.

61.  A prominent omission in the proposed scheme, because it seeks only to compensate holders of shares or securities of Qunxing as at 26 August 2013, is that investors who had already sold or disposed of all their shares by that date would not be compensated, nor would shareholders as at 26 August 2013 be compensated in relation to any shares they had earlier disposed of, however great the loss might have been.  That said, it is relevant to note that no separate proceedings have been brought by any investor against any of the defendants to recover such losses.  Likewise, no attempt had been made to credit any of the shareholders with any profit from an intermediate sale.  Given the substantial average daily turnover in the trading of shares[7], to ascertain all past sales would involve a hideously complicated exercise which is in my view not warranted.  At least in this sense s 213(2)(b) may be said to be a very “blunt instrument”[8] for achieving redress in a case like this. 

62.  The primary purpose of the kind of order sought must be protection of the investing public.  Such protection, where investors have been induced by false or misleading information disseminated in contravention of the provisions referred to above (ss 277, 298 and 384 of the SFO and s 342F of Cap 32) to subscribe for or purchase shares or warrants, should take the form of rescission of the transaction or payment of compensation.

63.  To the extent that the proposed scheme extends to an investor, it does seek to restore him to the position in which he was before he acquired the shares in question (following the latter part of s 213(2)(b)), provided that he is also required in principle to make counter‑restitution such as by delivering up the share certificate or signing an appropriate document or transfer form for that purpose or giving credit for the residual value, if any, of the shares in his possession (see Pantell, pp 280E, 281B‑D, 283E, 286B‑C; Scandex, p 724F‑H).  Such counter‑restitution is probably merely of theoretical interest in this case because the shares in Qunxing are likely to be valueless after the payments ordered are made.  The fact that the scheme does not seek to affect the position of the sellers of Qunxing shares on the market to these investors does not remove the proposed order out of the scope of s 213(2)(b).

64.  Qunxing obtained a very large amount of funds through the IPO, the open offer and the issue of warrants to Victory Asset.  Best Known had also received from Qunxing a substantial part (HK$429.8m) of the proceeds of subscription for shares (though HK$382.36m was transferred back to Qunxing).  Through their company Boom Instant, the 3^rd and 4^th respondents had received dividends of approximately RMB 329m from Qunxing between 2008 and 2013.  Moreover, they were involved in knowingly disseminating materially false and misleading financial information which they must have known would induce investors to acquire shares in Qunxing or retain shares already acquired.  There is a high degree of culpability in the contravention: see Financial Services Authority v Shepherd [2009] EWHC 1167 (Ch), §36.  Requiring them to compensate investors for the false and misleading information published by Qunxing is in my view not unfair to them.  Nor has any defendant appeared in these proceedings to contend that the proposed orders would unfairly prejudice him.

65.  Although s 213(2)(b) does not enforce private law rights, I note that at common law, in a case of fraudulent misrepresentation, the defendant is generally taken to be responsible for all losses suffered as a direct consequence of the tort without any need to prove foreseeability of the loss.  Moreover, the loss is not necessarily measured by reference to the true value of the shares as at the date of acquisition (as opposed to an even lower value at a later date) where the purchaser became locked into the transaction by reason of the fraud perpetrated on him: Smith New Court Securities Ltd v Scrimgeour Vickers [1997] AC 254, 266‑267, 285.

66.  In reality, the focus of these proceedings is the assets still held by Qunxing and Best Known in the total sum of approximately HK$112.2m.  There is no other known asset to pay the investors anything more, and one suspects the Commission is not confident it will be able to recover anything personally from the Zhus. Under the proposed scheme, the shareholders and Victory Asset would have to share pro rata the available assets (ie HK$112.2m less costs of the Commission, the receiver, and the proposed administrator, and miscellaneous expenses) which are sufficient only to meet a fraction of their total losses (an estimated HK$1,419.58m).  But the order would at least have the effect of preventing the assets of Qunxing and Best Known from becoming a surplus on a winding up to be distributed (as to 67.78%) to Boom Instant.

67.  In the ultimate analysis, where one is concerned, as here, with innumerable sale and purchase transactions in relation to Qunxing shares and finite and limited resources for the payment of compensation, a robust approach has to be adopted.  As Deputy Judge Halpern QC of the English High Court said in Financial Conduct Authority v Anderson [2014] EWHC 3630 (Ch) at §13:

“… One of the most striking features of this case is the enormous gap between the losses suffered by depositors and the sums available for distribution. This makes it imperative that any method of distribution is as simple as is possible, consistent with it being fair in a rough‑and‑ready way. There is a real risk that any attempt to achieve perfect justice would itself become a source of unfairness, firstly because it is likely to involve spending disproportionate costs in attempting to fine‑tune the scheme, secondly because it is impossible to understand fully the divergent interests of each class of depositors when they are not separately represented, and thirdly because a complex scheme is likely to be disproportionately expensive to administer.”

68.  In all the circumstances, I consider that it is desirable, and would not cause unfair prejudice to any person, for the proposed order to be made under s 213(2)(b).  It is unnecessary to deal with the alternative claim for an order for damages under s 213(8).  There will accordingly be an order along the lines sought by the Commission as discussed above.  I give liberty to apply in relation to the precise terms of the order to be made.

VIII.   Conclusions and orders

69.  For these reasons, there will be declarations and orders as stated above, with an order nisi that the Commission do have the costs of the action, with a certificate for two counsel, to be taxed if not agreed.