WOO HING KEUNG, LAWRENCE v. CEF BROKERAGE LTD

CACV 148/2007

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF APPEAL

CIVIL APPEAL NO. 148 OF 2007

(ON APPEAL FROM HCCL 39 OF 2004)

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JUDGMENT

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Hon Cheung JA :

Grey market trading

1. When a company offers its shares to the public, the shares will be traded in the Hong Kong Stock Exchange (‘the Exchange’) when they are formally listed.  However, even before the date of public trading, many of these shares will be traded amongst investors.  This is known as ‘grey market’ trading. 

2. The Exchange in its website advised the public that the legal enforceability of a grey market trade comes merely from the agreement between the two parties.

The plaintiff’s claim

3.  The plaintiff was a customer of the defendant which is engaged in the business of stockbrokerage.  The plaintiff signed a Client Agreement with the defendant on 5 February 1996.  He was allowed by the defendant to trade on a margin account.  He claimed that he had on 30 September 1997 sold through the defendant 1,400,000 China Telecom (‘CT’) shares in the grey market.  The CT shares were offered by CT to the public for subscription on 16 October 2007 and the shares would be publicly traded in the Exchange on 23 October 1997.  However, due to the Asian financial crisis which occurred at that period of time, when the CT shares became formally traded on 23 October 1997 many of the buyers who had agreed to acquire the shares from the plaintiff defaulted and refused to take up the shares.  

4. The plaintiff claimed that his broker, the defendant, was personally liable to honour the transaction.  The plaintiff claimed that the defendant was required to ‘cross’ the transaction by inputting the details of the transaction into the ‘Automatic Matching System’ (‘AMS’) of the Exchange.  The plaintiff sued the defendant in the Court of First Instance for damages in the sum of slightly over $9 million.  After a seven-day trial Stone J rejected the plaintiff’s claim.  The plaintiff now appeals.

Finding of fact

5. Stone J found that on 30 September 1997 the plaintiff approached Mr. David Wong (‘Mr. Wong’) of the defendant and asked if he would look for potential purchasers interested in buying CT shares on the listing day.  On the same day Mr. Wong informed the plaintiff that he had found buyers for 400,000 CT shares at $20 per share.  Later on Mr. Wong informed the plaintiff that he had found further buyers for 1,000,000 CT shares at $19 per share.  The Judge found that an agreement for the sale and purchase of 1.4 million CT shares was reached on that day.  However, the Judge rejected the plaintiff’s contention that Mr. Wong in the telephone conversations had accepted or agreed to the defendant assuming personal liability in the event of any default by the buyers. 

6. Despite the absence of an express agreement for the defendant to assume personal liability for the transactions, the case of the plaintiff advanced in this appeal is that there was an express agreement for the defendant to assume personal liability of the transaction. 

The steps towards personal liability

7. Mr. Westbrook, S. C., counsel for the plaintiff, relied on a four-stage approach to establish liability against the defendant.

Stage 1

8. By paragraphs 1 and 6 of the Client Agreement the defendant undertook to execute share transactions for the plaintiff subject to the rules and regulations of the Exchange (‘the Rules’) and Hong Kong laws.  The relevant Rules are :

‘1.	Instructions
	I shall from time to time instruct you to purchase and/or sell Investments on my behalf.  On receipt of such instructions, you shall, so far as you consider it reasonably practicable, purchase and/or sell Investments in accordance with those instructions, provided always that (i) any such dealings do not contravene any applicable laws or regulations and (ii) you shall have an absolute discretion to accept or reject purchase instructions.
6.	Relevant Rules and Regulations
	All transactions in Investments made for or on my behalf in Hong Kong shall be subject to the relevant provisions of the constitution, Rules, regulations, bye-laws, customs and usages of The Stock Exchange of Hong Kong Limited (“the Exchange”) and the Hong Kong Securities Clearing Company Limited (“HKSCC”) and of the Laws of Hong Kong as amended from time to time.  The Rules of the Exchange and HKSCC, in particular those rules which relate to trading and settlement, shall be binding on both yourself and myself in respect of transactions concluded on my instructions.’

Stage 2

9. The sale and purchase of the CT shares fell within the definition of ‘dealing in securities’ set out in sections 2(1) and 2(2) of the Securities Ordinance (‘SO’), Cap. 333.  Specifically Mr. Westbrook relied on the definition in Section 2(2) which includes securities to be issued by the corporation.  Under section 2(1)

‘securities’ means any shares, stocks, debentures, loan stocks, funds, bonds, or notes of, or issued by, any body, whether incorporated or unincorporated, or of any government or local government authority; and includes─
	(a)	rights, options, or interests (whether described as units or otherwise) in or in respect of any of the foregoing;
	(b)	certificates of interest or participation in, or temporary or interim certificates for, receipts for, or warrants to subscribe to or purchase, any of the foregoing; or
	(c)	any instruments commonly known as securities;
but does not include
	(i)	any shares or debentures of any company which is a private company within the meaning of section 29 of the Companies Ordinance (Cap. 32);’

10. Section 2(2) further provides that

‘ In this Ordinance a reference to securities of a corporation is a reference to securities─
(a)	issued, made available, or granted by the corporation;
(b)	proposed to be issued, made available, or granted by the corporation; or
(c)	proposed to be issued, made available, or granted by the corporation when it is formed.

11. Rule 101 of the Rules expressly provides that ‘dealing in securities’ has the same meaning as in the SO. 

Stage 3

12. This in turn imposed the obligation upon the defendant under section 75 of SO to issue contract notes to the plaintiff recording the specified particulars of each contract.  This requirement is reinforced by Rules 535 and 536. 

13. The defendant failed to issue contract notes.  The agreement for the sale of the 1.4 million CT shares was binding on both parties subject to the condition that the Exchange approved the listing of CT.  If the approval was not given, the plaintiff accepted that the agreement would be frustrated. 

Stage 4

14. Subject to exceptions the Exchange requires the sale and purchase of securities to be conducted by way of automatic order under the AMS of the Exchange. 

15. Rule 517(1) stated that

‘ One or more transactions are struck upon completion of matching by the System based on the application of a strict price and time priority methodology.’

16. One of the exceptions to the requirement of matching orders by the AMS is ‘direct business transaction’ which is defined by Rule 101 as the business transacted by a member who acts for both the buyer and seller, whether as principal or agent.  Rule 517(4) provides that special lot and odd lot transactions, transactions concluded outside the trading hall and direct business transactions are exempted from the standard requirement to conclude the transaction through the AMS. 

17. Nonetheless the defendant who was engaged in direct business transaction for the CT shares because he acted for both the plaintiff and the buyers was required to input the details of the transaction.  Rule 526 requires the stockbroker in a direct business transaction to manually input the transaction into the AMS within certain short periods after the transaction is concluded.  The terms of Rule 526 are as follows :

‘(1)	It is the duty of every Member or Dealing Partnership conducting direct business transactions within the trading hours stipulated in Rule 501 to input details of such transactions into the System within 15 minutes after the conclusion of the transactions and in any event not later than 12:30 p.m. for transactions concluded in the morning session and 3:55 p.m. for transactions concluded in the afternoon session provided that no such duty exists for transactions concluded by automatic order matching.  Any transactions not recorded in the System before 3:55 p.m. (or 12:30 p.m. when there is no afternoon trading session) shall be reported to the Exchange within the first 15 minutes of the commencement of trading on the next trading day as transactions concluded on that trading day on which the reporting has been made.
(2)	Direct business transactions conducted after trading hours shall be reported within the first 15 minutes of the commencement of trading on the next trading session as transactions concluded during that trading session on which the reporting has been made.
(3)	The price of every direct business transaction must be within the range of the lowest of four spreads below the previous closing price the lowest bid and the lowest ask price up to the time of the transaction on the day and the highest of four spreads above the previous closing price, the highest bid and the highest ask price up to the time of the transaction on the day.’

18. Rule 522 further provides that direct business transactions once recorded by the system cannot be cancelled by the member unless otherwise directed by the Council of the Exchange. 

19. Rule 544 deals with transactions which will be recognised by the Exchange

	‘Transactions not Recognized
	(1)	The Exchange will only recognize those transactions which are duly recorded or concluded through the System within the trading hours stipulated in Rule 501 or otherwise recorded in the System pursuant to these Rules.
	(2)	Save and except direct business transactions, conducted in accordance with Rule 526, Members and Dealing Partnerships shall cause transactions in securities listed on the Exchange whether conducted during trading hours or after trading hours but not traded in the Trading Hall to be input into the System at the earliest opportunity.  Any such transactions not so recorded shall not be recognized.
	(3)	Any transaction relating to any dealing in any securities the subject matter of a new issue or placement for the purpose of qualifying for a listing shall not be recognized until such securities have been granted a listing by the Exchange.
	(4)	The Exchange will not entertain disputes between Members or Dealing Partnerships in connection with or arising from any transactions that are not recognized.

20.  By Rule 527, under no circumstances may a member of the Exchange repudiate a transaction made in accordance with the Rules.  Mr. Westbrook submitted Rule 526 which imposed the obligation to input the transaction into the AMS established the liability of the defendant.

Basis of liability

21. At the outset it is important to point out that the case by the plaintiff against the defendant was based entirely on agency.  The plaintiff has never advanced a case that the transaction between the plaintiff and the defendant was based on a principal to principal basis. 

22. An agent is not normally personally liable on contracts entered into by the principals through him (see : The Santa Carina [1977] 1 Lloyd’s Rep. 478 and Wilson v. Avec Audio Visual Equipment Limited [1974] 1 Lloyd’s Rep. 81 at 83). 

23. The plaintiff’s case is built on the basis that the Rules require the defendant to input the transaction into the AMS and this triggered a corresponding obligation to make good any default by the purchaser.

My view

24. I understand that the Exchange will only recognize those transactions that had been input into the AMS and that on the settlement day, a broker is required, at the risk of being disciplined by the Exchange if he does not do so, to settle the transaction personally, if his customer does not do so, by taking delivery of the shares from the seller or supplying the shares to the buyer.  However, I have difficulties with the plaintiff’s case that the broker (i.e. the defendant) was required to input the transaction into the AMS when the shares became publicly traded. 

25. By Rule 544(3) the Exchange will not recognise transactions relating to new issues until such securities have been granted a listing by the Exchange.  While Rule 544(1) provides that the Exchange will only recognize transactions that are concluded through the AMS, as the Judge rightly concluded, the provisions of Rule 544 do not impose an obligation on the defendant to input the transaction which was concluded on 30 September 1997 when formal trading of the CT shares would only take place in the Exchange on 23 October 1997.  This is accepted by Mr. Westbrook who in this appeal based his case entirely on Rule 526. 

26. I do not consider Rule 526 will assist the plaintiff at all.  Rule 526 deals with direct business transactions by a broker acting for both the buyer and seller.  In such a sale, one can see why the provision that a transaction is ‘struck’ upon completion of matching of ‘sell’ and ‘buy’ orders in the AMS (under Rule 517(1)) is not appropriate.  This is because the transaction is already ‘struck’ when the broker found a willing seller and buyer without going through the matching system.  Nonetheless Rule 526 still requires the broker to input the transaction into the AMS.  This may well be as Mr. Huggins S.C. (who appeared together with Mr. Godfrey Lam as counsel for the defendant) submitted that the requirement of transparency by the Exchange demands such a step to be taken.  However, it is important to bear in mind that in this context a ‘transaction’ means ‘an agreement for the acquisition or disposal of securities’.  This is clearly provided by Rule 101 of the Rules.  This means on the plaintiff’s case, on 30 September 1997 a transaction was struck when the ‘transaction or agreement’ was reached by the plaintiff to sell 1,400,000 CT shares.  On this basis since the CT shares had not by then been listed and the Exchange will not recognize such a transaction, the defendant was not in a position to input the concluded transaction into the AMS. 

27. Mr. Westbrook does not argue otherwise.  However, he submitted that common sense should apply and Rule 526 requires the defendant to make the input on 23 October 1997.

28. I accept Rule 2(2) extends the meaning of securities to not only those that are already issued but also those that are proposed to be issued but in my view, if the obligation of the defendant arises under Rule 526, then one must see if its terms impose such an obligation.  It does not say that in respect of ‘to be issued’ shares, the obligation to input the transaction is to be deferred until the date of the formal trading.  On the contrary it says the obligation to input arises within 15 minutes after the conclusion of the transaction and in any event on the same day of the transaction.  Although the transaction or agreement might be a conditional one, the condition being the listing being actually approved, it was nonetheless a concluded transaction upon which the obligation would arise. 

29. It is artificial to the extreme to argue that the transaction or agreement was only ‘concluded’ on 23 October 1997.  If that was the case then what was the status of the agreement reached on 30 September 1997?  This highlights the difficulty of the plaintiff in trying to fit his case into Rule 526 when it clearly is not intended to cover transaction of securities which has not been listed.  In my view this is the short answer to the plaintiff’s claim and his case fails on this ground.

Section 75

30. Mr. Westbrook in his submission had also relied on section 75 of the SO.  In my view even if the defendant was under an obligation to issue contract notes, I just do not see how this would advance the case of the plaintiff.  In any event I agree with Mr. Huggins’ submission that section 75 does not apply to private companies. 

31. Under section 2(1) securities does not include any shares of a company which is a private company.  According to the prospectus of the CT, the company was incorporated on 3 September 1997 as a private company, it was only on 8 October 1997 that it was converted into a public company.  Hence when the transaction or agreement was concluded on 30 September 1997 CT was still a private company and section 75 would not apply.  The argument that under section 2(2) of the SO the securities include the securities of a corporation proposed to be issued or proposed to be issued when the corporation is formed would not assist the plaintiff at all.

The defendant’s duty

32. Mr. Westbrook also argued that the duty of a broker is to make a binding contract in enforceable form with the purchaser to take the shares. 

33. The case of Neilson v. James (1882) 9 QBD 546 relied upon by Mr. Westbrook provides the proposition that an agent has a duty to use reasonable efforts to find a purchaser to take the shares in the stock exchange, and to make a contract with him in such a form as would bind the purchaser to take the shares. 

34. This, however, does not mean that the defendant acting as a stockbroker is under a duty to accept a personal liability to the plaintiff for the contracts he had made with the purchasers on the plaintiff’s behalf. 

35. Mr. Westbrook accepted that this common law duty of care will not by itself impose a liability on the defendant. 

36. Mr. Westbrook also relied on the fiduciary duty of a stockbroker.  I think it is sufficient to say that if there was no contractual duty to input the transactions on 23 October 1997 then the plaintiff’s case will not be improved by relying on fiduciary duty. 

Section 76 of the SO

37. Mr. Huggins in the respondent’s notice seeks to affirm the Judge’s decision by relying on section 76 of the SO.  He argued that this section prohibits trading in unlisted securities.  Section 76 provides that,

‘76(1)	Except as provided in regulations, a dealer (including an exempt dealer) shall not transact in Hong Kong, or hold himself out as being prepared to transact in Hong Kong──
	(a)	any dealing whereby the dealer confers on any person an option to purchase from or sell to the dealer ‘any securities listed on the Unified Exchange’; or
	(b)	any dealing in any such securities which is completed later than the end of the next trading day after the dealing was entered into.
(2)	Any dealer who contravenes subsection (1) shall, subject to subsection (3), be guilty of an offence and shall be liable on conviction to a fine of $5,000.’

38. Stone J rejected this argument and held that section 76 is concerned only with listed securities. 

39. As I have dismissed the plaintiff’s case based on Rule 526 it is not necessary for me to express a view on the application of section 76. 

Other grey market trades

40. The evidence revealed that there was substantial grey market trading of the CT shares.  This by itself is not indicative that the defendant was under an obligation to input the concluded transaction into the AMS and thereby assume personal liability to take up the shares.

41. In my view grey market trading is clearly an area that should be regulated.  Other major stock exchange, such as the London Stock Exchange has express rules regulating such trade.  As one of the leading financial centres of the world with substantial listing of new companies, there is no reason for Hong Kong to take a hands off approach in this area.

Conclusion

42. Accordingly the appeal is dismissed with a provisional order that the plaintiff is to pay the defendant the costs of the appeal. 

Hon Burrell J :

43. I agree.

Hon A. Cheung J :

44. I agree.