1. An overview of the Securities Regulators in Hong Kong

As a major international finance center, Hong Kong has a sophisticated regulatory regime. Hong Kong listed companies are primarily supervised and monitored by the Securities and Futures Commission (SFC) and the Hong Kong Exchanges and Clearing Limited (HKEX). The SFC and HKEX are increasingly deepening their collaboration and working with other law enforcement agencies, such as the Accounting and Financial Reporting Council (AFRC), the Hong Kong Police Force, and the Independent Commission Against Corruption (ICAC), to investigate potential misconduct and take disciplinary and enforcement actions. As to the general purview of the main regulators for Hong Kong listed companies:

• 1. The SFC has a wide statutory power of investigation and enforcement to examine cases of corporate misconduct. While it also plays a separate role in licensing and regulating financial activities and in supervising the conduct of financial institutions and licensed corporations, its Enforcement Division undertakes substantive investigations into breaches of Hong Kong’s Securities and Futures Ordinance (SFO), including market misconduct and other statutory offenses.
  2. The HKEX is the key body for regulating listed companies in Hong Kong. The HKEX’s roles include establishing, promulgating, and administering the Hong Kong Listing Rules. From a regulatory perspective, this often involves investigation of noncompliance with the Listing Rules requirements and breaches of directors’ duties and taking disciplinary actions, if required.

In addition to the SFC and HKEX, the AFRC, while primarily regulating the conduct of accounting professionals, including certified public accountants and auditors, also has a statutory mandate to make inquiries into Hong Kong listed companies whose financial reporting are potentially noncompliant with regulatory requirements. These regulators also collaborate with their overseas counterparts to extend regulatory cooperation with the overall aim to better maintain the integrity of the Hong Kong securities market.  

2. SFC and HKEX — General Nature of Regulatory Investigations

Where there is potential noncompliance by a Hong Kong listed company under the Listing Rules and the SFO, it is common for the SFC and the HKEX to collectively take an interest in the listed company’s business affairs and conduct parallel investigations. As noted above, the regulators’ respective mandate and investigative powers are different, so it is worthwhile for listed issuers and their directors to have an appreciation for the different approaches that the regulators may adopt in conducting their investigations.

1. SFC The SFC’s investigative powers are based on the SFO, and the SFC can compel subjects of an investigation or any persons believed to possess relevant evidence to produce records and documents, provide written explanations, attend in-person interviews, and to render all reasonable assistance to facilitate the SFC’s investigations. The SFC is also able to apply for a search warrant from the court to conduct unannounced dawn raids to search and seize records and documents from specified premises. Where the SFC is investigating a listed company, it is commonly looking to identify potential misconduct related to audit issues, improper commercial transactions, market misconduct behavior, breaches of disclosure requirements, and other activities contrary to the interests of the investing public. Failure of issuers and directors to cooperate with the SFC’s investigation may constitute a criminal offense. Upon establishing that there has been a breach of statute or regulatory requirements, depending on the nature of the offense, the SFC may initiate civil proceedings before the Market Misconduct Tribunal or commence criminal or civil proceedings in court against the parties responsible for the misconduct and to seek appropriate remedies and sanctions against the wrongdoers, including but not limited to disqualification orders, compensation orders, fines and criminal sentences.
2. HKEX The HKEX’s investigative powers are derived from the Listing Rules. The HKEX has the authority to review, on an ongoing basis, whether listed issuers continue to meet the necessary requirements for them to remain suitable for listing and, if not, to take steps to cancel their listing. The focus of the HKEX’s inquiries generally revolves around potential breaches of the Listing Rules, and queries may be directed to the issuers and their directors to provide written submissions and supporting documents. Upon establishing that there has been a breach of the Listing Rules, the HKEX may bring disciplinary actions and impose appropriate sanctions on listed issuers, their directors, and senior management, such as a private reprimand, public criticism, public censure, director unsuitability statement, or prejudice to investors’ interests statement. The HKEX may also refer the matter to the SFC, other regulatory authorities or professional bodies for further action.

 

3. Recent enforcement cases and trends

1. Ramp-and-Dump Scams Ramp-and-dump scams involve strategic manipulation of the share price and trading volume of vulnerable listed issuers. Typically, sophisticated cross-border syndicates would artificially ramp up the price of the targeted issuer through spreading favorable news on social media to induce investors to purchase the shares, after which the syndicates would dump all of their shares at an artificially high exit price, causing the share price to collapse and leaving other investors with significant losses. Recently, the SFC, the ICAC, and the Hong Kong Police Force have been working together to target ramp-and-dump syndicates and conducting joint operations to arrest suspected syndicate members, including senior managers of listed companies, accounting professionals, and brokers. In July 2024, in the case of  HKSAR v Sit Yi Ki and others [2024] HKCFI 1937, the Hong Kong courts imposed the heaviest jail sentence, ranging from 52 to 80 months of imprisonment, on market manipulation since the SFO came into effect in 2003 after three perpetrators of a complex cross-border ramp-and-dump syndicate were found guilty of conspiracy to carry out false trading in the shares of shares of Ching Lee Holdings Limited. A more detailed discussion of this landmark case can be accessed at Sidley Austin’s website.
2. IPO Misconduct Another enforcement focus relates to newly listed issuers’ usage of initial public offering (IPO) proceeds in a manner inconsistent with originally disclosed business plans, without making further proper disclosure. Regulators have identified the following alarming scenarios:
   • unusually high expenses not disclosed in listing documents and potentially disguised as IPO consultancy service fees, underwriting commissions, and other listing expenses (see the SFC and HKEX’s Joint Statement on IPO-related Misconduct dated May 20, 2021); and
   • questionable investments or loans using a significant portion of the IPO proceeds without commercial rationale and on unfavorable terms to the issuer (see the HKEX’s Review of Issuers’ Annual Reports 2023 issued in January 2024).
   •  In March 2024, the HKEX took disciplinary action and imposed director unsuitability statements against the former executive directors of Global Uin Intelligence Holdings Limited (stock code 8496) for misappropriation of IPO proceeds for their own use through a sham arrangement that was not disclosed in the issuer’s listing documents (see the HKEX’s Statement of Disciplinary Action dated 5 March 2024). A more detailed discussion of this joint enforcement case can be accessed at Sidley Austin’s website.
3.  Dubious Financial Arrangements Misconduct regarding loans, advances, prepayments, and other similar arrangements made by listed issuers remains under close scrutiny by regulators. On July 13, 2023, the SFC and the AFRC issued a Joint Statement addressing this issue. On April 25, 2024, the HKEX issued its Statement of Disciplinary Action against China Ecotourism Group Limited (stock code 1371) and its current and former directors concerning misconduct in making questionable loans and investments that constituted undisclosed connected transactions, caused significant impairment loss to the issuer, and revealed its inadequate internal controls. On April 30, 2024, the HKEX dedicated the April 2024 edition of its Enforcement Bulletin to the topic, highlighting common red flags at the pre-loan, post-loan, and recovery stages of the lending process. The regulators consider that lending practices of listed issuers should be comparative to the approach adopted by the banking industry to protect investors’ interests. A more detailed discussion of these developments by the Sidley Austin team can be found here and here.
4. INEDs In November 2023, the HKEX published “A Snapshot of INEDs’ Roles and Responsibilities” to remind independent nonexecutive directors (INEDs) of their duties under the Listing Rules and the Corporate Governance Code as an extra pair of eyes, including to oversee the listed issuer’s business decisions, risk management, and internal controls as well as to take proactive steps to ensure the truthfulness and accuracy of the issuer’s financial statements. In the same month, the SFC obtained a three-year disqualification order against a former INED of China Candy Holdings Limited (stock code 8182) in Securities and Futures Commission v. Xu Jinpei and Others [2023] HKCFI 2908 for his failure to discover overstatements in the issuer’s interim and annual reports and to supervise the bank balances provided during the audit process. The former INED was found to be in breach of his fiduciary duties to the issuer and had caused prejudice to investors’ interests. It is expected that INEDs’ compliance with their directors’ duties will continue to be closely scrutinized alongside executive directors of listed issuers. A more detailed discussion can be found at Sidley Austin’s website.

 

4. Common misconceptions and pitfalls for issuers and directors

Directors of Hong Kong listed issuers should generally be aware of the statutory and regulatory obligations as well as their directors’ duties. However, in practice, there can be pitfalls such as the following misconceptions that may become apparent only when noncompliance with the regulatory requirements is discovered.

1. 1. Auditors already considered internal control issues as part of the annual audit, so separate internal control reviews are unnecessary. It is worth noting that the primary mandate of external auditors in an annual audit context is to scrutinize and verify the issuer’s financial accounts. Instead of placing excessive reliance on the lack of adverse findings on internal control issues in an annual audit context, Hong Kong listed issuers should regularly review the internal control system in place with a particular focus on compliance with the regulatory requirements in Hong Kong under the Listing Rules and SFO to ensure it remains effective and continues to serve its purpose, and such a review should be conducted at least annually.  Continuous monitoring and assessment of the internal control system is essential for maintaining good corporate governance.
   2. It is sufficient for there to be a focus on corporate governance concerning the operational side of the business. Even where Hong Kong listed issuers maintain good corporate governance at the business operational level, it is not uncommon for the issuer’s group to lack established and maintained policies and procedures to ensure compliance with the Hong Kong Listing Rules. They may also lack internal controls for detecting red flags and other potential misconduct.  It is also important to ensure that internal policies and systems are effectively implemented.
   3. No disciplinary action will be taken when there is no loss. A common misconception in a disciplinary context is that regulators would not take enforcement action against the issuer or its directors if investors suffered no loss. While investor loss is one of the key factors regulators consider when assessing the severity of the misconduct and the necessity to take disciplinary action, it is more of an aggravating factor than a mitigating factor. The absence of loss would generally be insufficient to exculpate the issuer or its directors of an identified breach or misconduct and avoid potential disciplinary actions and sanctions.
   4. INEDs should not bear responsibility for matters as they are not involved in the daily operation of the company. A frequently raised defense by INEDs in response to allegations of a failure to discharge their directors’ duties is that they were not involved in the daily operation of the company. It is the expectation of the regulators that INEDs must be proactive in raising inquiries regarding the business operations of the company and identifying potential red flags . Additionally, they are expected to regularly review the adequacy of the issuer’s internal controls and corporate governance framework to ensure they are sufficient for achieving regulatory compliance.
   5. Regulatory investigations are just routine procedures, and it is unnecessary to devote time and resources to resolving them. In general, a regulatory investigation may be triggered for a range of underlying reasons, and it may also be pursuant to a regulatory complaint, disclosures in the issuer’s announcements, or a whistleblower’s report. The securities regulators generally commence their inquiries pursuant to a suspicion of potential misconduct or noncompliance. It is paramount that the issuer and its board take inquiries and investigations seriously and cooperate with the regulators. Some common pitfalls for directors in a regulatory investigation context include underestimating the scale, scope, and impact of the investigation; failing to allocate sufficient workforce and resources to resolve the inquiries; and failing to engage and consult professional parties to manage and advise on the process at an early stage.

 

5. Practical tips and insights

A) Cooperation with regulators

1. Providing true and complete information and documents. This includes taking early and proactive steps to preserve evidence and providing full disclosure of the relevant information.
2. Taking a proactive approach by devoting sufficient resources to investigating the matter and responding to the regulatory inquiries. This may involve engaging professional parties, such as legal advisers, forensic investigators, and internal control reviewers as necessary to assist with factfinding and responding to the regulators’ inquiries.
3. Taking appropriate remedial measures. If the issuer identifies any specific issues constituting internal control failures, it should consider implementing remedial measures to enhance its internal controls and procedures. The issuer should conduct an independent internal control review to identify possible internal control failures and the necessary remedial measures.
4. Initiating settlement. If the parties intend to settle, they should approach the regulators as early as practicable. Some of the typical factors that ought to be considered include the strength of the regulator’s cases, the time and costs to be incurred in a prolonged regulatory investigation and potential legal proceedings, possible reputational damage to the company and individuals, and possible penalties to be levied.

 

B) Secrecy obligations, document preservation, recordkeeping, and legal professional privilege

1. 1. 1. Secrecy obligations. Under the SFO, it is a criminal offense for any person to disclose information related to the SFC and HKEX investigations to any other person, save where the disclosure falls under the limited exceptions. Where there is a need for other third parties (e.g. insurers) to know any information in relation to the regulatory investigations, the issuer should seek prior written consent from the regulators for onward disclosure.
      2. Document preservation. In a regulatory investigation context, it is strongly advisable for the issuer and its directors to take steps to preserve all documents and information potentially relevant to matter being investigated, including electronic records and hard copies. Any intentional destruction of any documents may constitute a criminal offense under Hong Kong law.
      3. Recordkeeping. Good recordkeeping practices play an important role in ensuring that the issuer is able to adduce contemporaneous evidence in support of its compliance with the regulatory requirements.
      4. Legal professional privilege. An issuer is not obliged to produce privileged documents to the regulators unless the issuer decides that it is appropriate to waive privilege on a limited basis to facilitate the investigation. Issuers are recommended to seek legal advice to determine whether the relevant materials are covered by legal professional

 

C) Managing SFC interviews

1. 1. 1. Considerations for attending an interview with the SFC. In an investigation conducted by the SFC, it is common for the SFC to invite directors and senior managers to attend formal interviews. Some of the relevant considerations include the importance of maintaining statutory secrecy obligations in relation to the interview and the individual’s right to claim self-incrimination privilege while still needing to answer all questions posed by the SFC.
      2. Preparation for an interview with the SFC. Prior to the interview, it is recommended for the interviewee to thoroughly review all the previous written submissions provided to the SFC and consult with legal counsel to ascertain the issues that may be addressed in the course of the interview. As there is no right to remain silence, if a response is potentially self-incriminating, the interviewee should make a claim to assert privilege against self-incrimination as provided for under the SFO before responding to the questions. The interviewee should answer the questions truthfully and concisely, and avoid addressing irrelevant matters that go beyond the scope of the interview.

Authors: Stephanie Chan, Adrian Tang and Celia Chong (Sidley Austin)