SECURITIES AND FUTURES COMMISSION v. “C”AND OTHERS

HCMP 727/2008

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

MISCELLANEOUS PROCEEDINGS NO. 727 OF 2008

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DECISION

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1.  There are 2 summonses before me:

(i) the summons dated 17 June 2016 (“China United’s Summons”) issued by China United Telecom Limited (“China United”) for: (a) joinder as intervener in this action; and (b) variation of the injunction order granted by Kwan J (as she then was) on 16 April 2008 (“the Injunction Order”) as varied by me on 1 June 2015 (“the Amended Injunction Order”); and

(ii) the summons dated 26 August 2016 (“the Joinder Summons”) issued by the Plaintiff, the Securities and Futures Commission (“the SFC”), for the joinder of China United as a defendant and for amendments to its Re-Re-Amended Originating Summons and Amended Statement of Claim.

BACKGROUND

2.  On 16 April 2008, the SFC applied for and obtained the ex parte Mareva injunction order against the 1^st to 4^th Defendants (“the Injunction Order”).  It is the SFC’s case that the 1^st Defendant, one Mr Lu (“Lu”), and an acquaintance (“Y”) had engaged in insider dealings.  The 2^nd Defendant was Y’s wife.  The 3^rd and 4^th Defendants were wholly-owned companies of Lu.

3.  The substantive matter was to be heard before the Market Misconduct Tribunal (“the MMT”).  The Injunction Order was obtained in anticipation of the possible finding by the MMT that Lu and others were culpable of insider dealing of shares in Asia TeleMedia Ltd (“ATML”), which was a company listed on the stock exchange of Hong Kong.  The SFC seeks restoration and other ancillary orders under s 213(2) of the Securities and Futures Ordinance, Cap 571 (“the SFO”) with a view to compensating the losses suffered by the counterparties to the insider dealing trades.

4.  Although Kwan J subsequently discharged the Injunction Order on 22 October 2008, it was re-imposed by the Court of Appeal on 22 May 2009.  The matter went to the Court of Final Appeal and it discharged the Injunction Order against the 4^th Defendant only.

5.  The Injunction Order covered 675,950,000 shares in ATML held in China United’s name (“the Shares”).  China United had been the majority and controlling shareholder of ATML, and Lu was at all material times the sole director of China United.

6.  On 22 September 2010, the SFC amended its Statement of Claim to add Y as the 5^th Defendant.

7.  Since the making of the Injunction Order, ATML had been taken out of liquidation.  Its issued shares including the Shares were consolidated and substantially diluted.  ATML also changed its name.  The Shares became 13,519,000 shares in Reorient Group Ltd (“Reorient”).

8.  The price of the Shares remained low for a long time.  In April 2015, it shot up multifold upon rumours of Mr Ma Yun of Alibaba and others investing in Reorient.  This resulted in the application by China United for release of the Shares and payment of the consequential fund raised by the Shares into court.

9.  There was no serious objection to the application.  By the Amended Injunction Order dated 1 June 2015, I allowed the release of the Shares so that China United could raise fund with the Shares and pay the fund into court.  Eventually, the sum of $43,661,568 was paid into court on 18 June 2015 (“the Fund”).

10.  China United then became embroidered in litigation with the party who provided the Fund.  The dispute was settled and China United took out the China United’s Summons on 17 June 2016.

11.  In the meantime, the SFC’s case against Lu and 3 others was heard before the MMT.  By a report dated 26 November 2015 (“the MMT Report”), the MMT made no findings in relation to Lu because he had been hospitalised and did not have a reasonable opportunity to be heard at the trial.  The MMT determined that the other 3 individuals had not engaged in insider dealings. The SFC appealed.  Leave to appeal against the MMT’s decision in relation to 2 of the 3 individuals has been granted but no hearing date was fixed at least at the time of the present hearing in September 2016.  The SFC intends to restart the proceedings against Lu, but there has been no substantial progress in this regard.

CHINA UNITED’S CASE IN SUPPORT OF THE VARIATION APPLICATION

12.  About 8 years after the making of the Injunction Order, China United now applies to vary the terms so that it can obtain the Fund paid into court on 18 June 2015 (“the Variation Application”).

13.  China United is a BVI company.  According to its existing sole director, one Madam Chu (“Chu”), China United was at all material times the beneficial owner of the Shares.  Although Lu was at some stage the sole director of China United, he resigned as a director on 26 September 2014.

14.  Chu claims that the Shares were purchased by China United using its own money.  The fund for China United’s initial acquisition of its controlling stake in ATML did not come from Lu, rather the fund was obtained by way of a loan of RMB 30 million from one Zhongguang Meiti Chuanbo Co Ltd (“ZMC”).

15.  According to the announcement and circular issued in relation to the acquisition, China United was owned 50% by one Mr Leung (“Leung”), 20% by Leung’s wife and 30% by Excel Ocean Ltd which was equally owned by Lu and one Dr Gu (“Gu”).

16.  Each of these individuals was a person of substantial means and experience.  All would be appointed to the board of ATML: Leung as chairman, Leung’s wife as an executive director, Lu and Gu as executive directors and co-chief executive officers.

17.  According to a news article, Leung, Gu and Lu were 3 of the 4 partners building a small empire in telecommunications in the Mainland.  The 4^th partner, one Mr Zuo (“Zuo”), was a former official in the Guangdong Telecommunications Bureau.  They established a group which consisted of, inter alia, 5 companies listed in the Mainland, 2 companies listed in Hong Kong and various private companies including China United.

18.  Mr Li, counsel for China United, submits that the sequence of events reflect a classic case of a group of individuals taking over a listed company, i.e. ATML.  The history shows that China United was the beneficial owner of its shares in ATML, and it was not a nominee of Lu.  Lu was only one of the multiple persons interested in China United, and in that sense was indirectly interested in the shares in ATML.  He had no beneficial interest in the Shares.

19.  The investment was not a successful one.  Over time, Gu existed the consortium.  Leung also reduced his interest.  ATML failed and went into liquidation.  Lu became ill and Chu was appointed as a director of China United on 26 January 2012.  Lu also resigned as a director of China United on 26 September 2014.

20.  These allegations form the basis of the Variation Application.    

MERITS OF THE VARIATION APPLICATION

21.  Having carefully considered the submissions of China United, I do not accept that there is sufficient reason for the court to vary the terms of the Injunction Order so as to allow China United to obtain the Fund paid into court.  The reasons are 4 fold:

(i) there was no change in circumstances or good reasons to justify the Variation Application;

(ii) there was serious delay in making the Variation Application;

(iii) there is substantial evidence to show that the Shares were beneficially owned or at least controlled by Lu at the material times; and

(iv) the SFC has an arguable case that China United was “involved in” Lu’s insider dealing activities, which would entitle the court to make restoration or other ancillary orders against it under s 213(2) of the SFO.

22.  I will deal with these reasons in turn.

(i)  No change in circumstances or good reasons to justify the Variation Application

23.  It is clear that the Injunction Order is interlocutory in nature.  Pending the finding by the MMT of any conduct of insider dealings on the part of Lu, the court may make restoration and other ancillary orders under s 213(2) of the SFO with a view to compensating the losses suffered by the counterparties to the insider dealing trades.  In order to ensure that there are sufficient funds and assets to satisfy any restoration or other ancillary orders, the court made the Injunction Order back in 2008 to preserve the assets owned or controlled by Lu.

24.  The legal principles applicable to an application to vary an interlocutory injunction are well-established.  The court would generally only consider varying or discharging an interim injunction on good grounds or due to a change in circumstances or facts coming to light that could not reasonably have been found out beforehand.[1]

25.  In re-imposing the Injunction Order, the Court of Appeal must have been satisfied that there is a good arguable case that the Shares were part of Lu’s assets.  There was plainly no relevant change of circumstances since the making, discharging and re-granting of the Injunction Order.  The facts put forward by China United in support of the Variation Application were also available back in 2008 and 2009 when the justification for the granting of the Injunction Order was repeatedly debated before the courts.  Neither is there any other good reasons to justify the variation of the Injunction Order.  Hence, the Variation Application should fail on this ground alone.

(ii)  Lateness of the Variation Application

26.  Further, there was substantial delay in making the Variation Application.

27.  The SFC’s position for the last 8 or so years has always been that Lu owned the Shares via China United and had effective control over them.

28.  In the past 8 years, Lu has not sought to challenge the fact that that the Shares formed part of his assets.  In Lu’s own affirmation dated 11 July 2008 filed with a view to discharge the Injunction Order, Lu clearly deposed that: (i) he had the intention in around 2001 to acquire a listed company in Hong Kong; (ii) consequently, he used China United, a company controlled by him, to subscribe for the shares in ATML; and (iii) he thereafter became the controlling shareholder of ATML.  As the evidence now stands, Lu has never disputed that he owned the Shares via China United.

29.  The Injunction Order against Lu was affirmed by the Court of Appeal back in May 2009.  If indeed China United’s present contention is true, namely that the Shares were beneficially owned by it and not Lu, there is no reason nor explanation given as to why it has failed to make the Variation Application years earlier.  Such delay certainly undermines the genuineness of the Variation Application.

(iii)  Substantial evidence to show that Lu owned or controlled the Shares

30.  Further, I agree with Mr Wong SC, counsel for the SFC, that there is ample evidence to support the SFC’s case that the Shares were owned by Lu via China United:

(i) The Registrar of Directors of China United shows that Lu was China United’s sole director at all material times.

(ii) Lu was at all material times the only person authorized to operate China United’s securities account maintained with Mansion House Securities.

(iii) On Lu’s own case, China United sold 49,250,000 shares of ATML at the material times (from 27 April 2007 to 30 May 2007) through its securities account and the sale proceeds were $37,556,519.47.  Lu was the only person who had a free hand in dealing with these very substantial amounts of shares and sale proceeds.

(iv) A sum of $23,100,000 out of the net sale proceeds was deposited into Lu’s personal bank account.  After the transfer, only a small sum of $1,357.30 was left in China United’s account with Mansion House Securities as at 8 June 2007.  Lu had in effect transferred all the cash from China United’s account to his own account.

31.  As mentioned above[2],  Lu has never disputed that he owned the Shares via China United.  On the other hand, the evidence filed by China United in support of the ownership of the Shares is far from satisfactory.  Chu was only appointed as a director of China United on 26 January 2012, which was some 10 years after the acquisition of ATML and 4 years after the Injunction Order was granted in 2008.  More importantly, Chu does not claim to have any personal knowledge of China United’s affairs at the material times in 2007 and 2008.  There is not even any suggestion that Chu has ever verified the facts with Lu who was definitely the main controller of China United at the material times.  Nor is there any reference to Lu as the source of the information.

32.  Furthermore, as to Chu’s assertion that China United used its own fund from a loan obtained from ZMC to purchase the Shares, it is clear from the documents before the court that ZMC was at all material times substantially controlled by Lu and was not a company independent of him. Lu was ZMC’s legal representative and executive director, and he was a shareholder, director and general manager of Shenzhen Shi Yinhe Shidai which was a 50% shareholder of ZMC.

33.  Chu suggests that ZMC was part of a group “spearheaded by 4 partners” and was not a “personal vehicle” of Lu.  Chu also claims that the “4 partners” and the “Zhongguang Line” were famous “back in the early 2000s”, and that the “4 partners were all persons of substance and substantial means” and “[none] was a nominee for the others”.

34.  However, whether these “4 partners” were famous persons of substance and substantial means when they invested in ATML in 2002 is neither here or there.  The main question is about the ownership of the Shares in 2008.  Based on the evidence mentioned in §30 above, I agree with Mr Wong that there is a strong case that China United’s shareholding of ATML was fully controlled by Lu in April 2008.

35.  It is also worth noting that Lu made no mention of the “4 partners” in his affirmation made back in July 2008 in support of his application to discharge the Injunction Order.  If the Shares were beneficially owned by the “4 partners” and Lu wanted to get back the Shares, it would be extremely odd that Lu did not mention them in the discharge application.

36.  I also agree with Mr Wong that there is some unexplained inconsistency in Chu’s evidence.  Chu’s claim that the “4 partners”, including Zuo, invested in ATML is simply inconsistent with the later claim that the investors of ATML were Lu, Gu and Leung.  Indeed, even on China United’s own case, there is nothing to suggest that Zuo was in any way involved in it or ATML.  As Chu cannot even accurately identify the alleged beneficial owners of the Shares, it certainly undermines the credibility of China United’s case for the Variation Application.  It also shows that Chu may not have full knowledge of the affairs of China United back in 2007 and 2008.

37.  Chu also argues that the directorships held by Gu, Leung and his wife in ATML “reflected the fact that they were all real beneficial owners – in China United and indirectly in [ATML]”.  Yet, according to Chu’s own evidence, Gu withdrew his investment in China United and ATML in July or August in 2003.  Further, Leung and his wife resigned as directors of ATML and ceased to be shareholders in January 2004.  Amongst the “4 partners”, Lu was the only one who remained a director of ATML at the material time in April 2008 and he was also the chairman and chief executive officer of ATML.  Indeed, the disclosure of interest filings confirm that both Gu and Leung ceased to have any interest in ATML after January 2004, and that clearly supports that the Shares were beneficially owned by Lu via China United over which he had full control in 2008.

38.  Furthermore, it is not necessary for the SFC, at least at this stage, to prove conclusively that Lu is the beneficial owner of the Shares.  For the purpose of the Mareva injunction, it is now trite law that the court can grant such injunction against assets held by a third party, which the defendant has no legal or equitable right to, but nonetheless has substantial control over.[3] This is commonly referred to as “the Chabra jurisdiction”.[4]

39.  For the jurisdiction to be exercised, it is not necessary to establish beneficial ownership in a strict trust law sense.  The important issue is substantial control.[5]

40.  As Robert Walker J (as he then was) pointed out in International Credit and Investment Co (Overseas) Ltd v Adham[6], Mareva injunctions are directed “not only to assets directly in the beneficial ownership of those who were enjoined, but also to the assets of companies which they directly or indirectly controlled”.

41.  The test, as Tang VP (as then was) put it in Akai Holdings Ltd v Ho Wing On Christopher[7], is whether there is good reason to suppose that the defendant has substantial control over the assets of the third party.

42.  On the meaning of “good reason to suppose”[8], the plaintiff has to show “something more than a case barely capable of serious argument, even if he does not need to satisfy the court that he has a better than 50% chance of success”.

43.  As mentioned above[9], there is ample evidence to show that the Shares were owned by Lu via China United.  Even if such evidence is not sufficient to establish ownership, this would amount to good reason to suppose that Lu had substantial control over China United and the Shares.

(iv)  China United’s involvement in Lu’s insider dealing activities

44.  Finally, apart from ownership and control, there is another reason for the Injunction Order to cover the Shares held in the name of China United because, arguably, it was involved in Lu’s contravention of the insider dealing provisions for the purposes of s 213(2)(b) of the SFO.

45.  The subject matter of the complaint for the insider dealing trades is that China United sold the shares of ATML it held while Lu was in possession of the insider information.  If Lu is found by the court to be in contravention of s 291(1) of the SFO, in addition to the financial relief sought under the prayer of the Re-Re-Amended Originating Summons and the usual enforcement  proceedings against Lu as an ordinary judgment debtor, it is certainly arguable that the court may, under s 213(2)(b), order China United to take steps to restore the parties to the transactions tainted with insider dealing to the position in which they were before the transactions were entered into, on the ground that China United had been “involved in” Lu’s insider dealings.  Accordingly, even if the Shares were not owned by Lu, the fact that China United was involved in Lu’s insider dealings may be sufficient to make the Shares amendable to the restoration or other orders sought by the SFC in the present action.

46.  In this connection, s 213(2) confers a wide array of powers to the court to make appropriate order to prevent market misconduct activities.  As Le Pichon JA observed in Securities and Futures Commissions v C:[10]

“34. It is noteworthy that the Ordinance conferred on the SFC an array of powers and provided the SFC with a range of remedies, no doubt, to facilitate the attainment of the SFC’s regulatory objectives and render more effective the discharge of its statutory functions. Of its nature, proceedings involving the SFC are necessarily different from actions between private individuals because the SFC is a public body with statutory duties to discharge and there can be no private rights between the SFC and the defendants.

35.   It is against that backdrop that the range of remedies contained in s. 213(2) has to be considered.  Indisputably, those remedies were created by statute and are intended or designed to provide substantive relief to address specific types of wrongdoing (identified in s. 213(1)) the regulator may encounter in the course of discharging its statutory functions.  Section 213(1) empowers the court to make a range of substantive orders on the application of the SFC if the SFC is satisfied that the contravention of any of the relevant provisions (defined to mean the provisions of the Ordinance and certain provisions of the Companies Ordinance) ‘has occurred, is occurring or may occur’.”

47.  By reason of China United’s involvement in Lu’s trading of the shares of ATML, it is certainly arguable that the court will grant restoration or other ancillary orders against China United if Lu is to be found guilty of insider dealings.  This is also another reason as to why the court should not disturb the Injunction Order.

(v)  Other arguments put forward by China United

48.  I also find that the other arguments put forward by China United has no merit at all.  It is not open to China United to say that the SFC does not have a prima facie case against Lu in light of the MMT’s decision.  The only reason for the MMT making no finding in relation to Lu was because of his hospitalisation in Beijing during the enquiry, and for that reason could not be a given a reasonable opportunity to be heard.  Hence, the MMT was prevented by s 252(6) of the SFO from identifying Lu as having engaged in market misconduct.[11] In fact, the finding by the MMT about the existence of insider information supports the SFC’s case against Lu.[12]  As the SFC decides to proceed with the case against Lu and the delay was not due to the fault of the SFC, the SFC at least has a prima facie case against Lu for engaging in insider dealings.

49.  Chu also claims that “every deposition of ATML shares from China United’s account [in April and May 2007] was shortly followed by a deposit back into the account”.  Chu argues that if the Shares belonged to Lu, “there would have been no reason for [Lu] to ‘replenish’ every deposition of shares from China United’s account”.  In this regard, Lu’s pleaded defence in this Action is that the sale was effected upon the request of a number of ATML’s employees in Beijing and Shenzhen. These employees intended to exercise the options and sell the resulting shares.  They did not have securities accounts in Hong Kong and Lu allegedly agreed to assist them.

50.  After so many years, China United now complains that the SFC had omitted to inform the court at the ex parte stage about the replenishment of shares.  However, if such allegation has any substance at all, one would wonder why China United has not sought to discharge the Injunction Order  much earlier.

51.  In fact, Kwan J had considered such point in her Decision dated 22 October 2008:

“73. The SFC has suspected that these employees might have acted as [Lu’s] nominees in the sale of the shares. As pointed out by [leading counsel for SFC], [Lu] has not provided any contemporaneous evidence to back up his assertion that (1) the payments made for the acquisition of the shares as a result of the exercise of the option had come from the employees; and (2) he had actually made payments to these employees after the sale of the shares.”

52.  Whether the Mainland employees were beneficial owners of the ATML’s shares or were a mere “front” of Lu is a matter that can only be determined at the trial.  It is not good enough at the interlocutory stage for Chu to speculate in her affirmation that there would have been no reason for replenishment of ATML’s shares if they belonged to Lu. In any event, in §31 of her first affirmation filed on 15 April 2008 in support of the application for the Injunction Order, Madam Wong Mei Mei expressly mentioned the allegation by the former company secretary of ATML that the shares might belong to the Mainland staff of ATML.  Further, the statements of the relevant securities account were also exhibited.[13]  Hence, I see no merit in the non-disclosure argument.

53.  For the above reasons, I find that there is no good reason to disturb the Injunction Order re-imposed by the Court of Appeal back in May 2009.  I therefore dismiss the Variation Application.  I also make an order nisi that the costs of the Variation Application be costs in the cause of China United’s claim for the return of the Fund, which shall be made absolute 14 days after the date of the handing down of this Decision.

54.  That leaves only the application by the SFC to join China United as an additional defendant in this action.  The Injunction Order would affect the interest of China United because the Shares were held in its name.  China United has no objection to the joinder even if it fails in the Variation Application.  However, there is some confusion as to whether the other Defendants have been notified of SFC’s joinder application.  As they have the right to be heard, I would adjourn the Joinder Summons pending the clarification of such issue.