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SFC raids multiple small caps in Hong Kong's largest financial raid

  • Hong Kong
  • Capital market law


In May 2017, David Webb, an activist investor and former director of the Hong Kong Exchange and Clearing Limited, issued a report titled "The Enigma Network: 50 stocks not to own". This report mapped out a complex web of cross-shareholdings between companies listed on both the Main Board and the Growth Enterprise Market, which Webb had come across through his own research into annual reports and company disclosures. Webb highlighted in his report the high shareholding concentrations, unrealistic valuations, and complex relationships between companies and listed brokerages.  A month later, there was a multi-billion dollarf plunge in nearly three dozen small-cap stocks. A dozen of the stocks that experienced catastrophic crashes were all part of a group of companies of the Enigma Network.

The Securities and Futures Commission (“SFC”) sent 136 agents to search multiple premises, even though what triggered the raids was not disclosed. The raid was related to “nefarious groups of inter-related companies that work in coordination to extract value from unsuspecting investors” according to Head of Enforcement Thomas Atkinson of the SFC. The SFC has criticised crossholdings as borderline market manipulation previously but no high profile prosecution has been made. This time, the SFC is determined to do something as Atkinson said “anyone who has been exploiting investors through this type of scheme should not underestimate our resolve to stop them”.

Apart from taking direct enforcement actions against suspected offenders, we have also seen the SFC exercised its powers to suspend issuers from trading by directing the stock exchange under section 8 of the Securities and Futures (Stock Market Listing) Rules.  Issuers are then required to satisfy the regulators of their continued suitability for listing, often guided by legal and financial advisers.  We have identified a few problem areas which we feel relevant for listed issuers and their directors to manage their regulatory risks. 

  1. Potential breach of regulatory requirements - SFC investigations could lead to finding of breaches of relevant regulatory regimes, imposing civil and/or criminal liabilities onto the company and/or its officers and managers in charge.
  2. Secrecy - Persons subject to an SFC investigation are bound by secrecy obligations whereby they should not disclose any matter coming to their knowledge in the course of the investigation (unless the disclosure is made in permissible circumstances). 
  3. Insurance - Issuers should consider informing their indemnity insurer as soon as possible for potential insurance claims in face of an SFC investigation.
  4. Privilege - In face of a request for disclosure of documents or information, it is important to consider whether privilege can be claimed against documents required to be disclosed to the SFC.

In response to these key risks, we recommend:

  1. Independent legal advice and strategic planning – We recommend engaging independent legal representative early on to advise on the potential liabilities and the appropriate steps to be taken in response to the investigation. It is essential to obtain tailored advice, develop and implement strategies to reduce the scope of the investigation and the civil, regulatory and criminal exposure of the issuers and their officers and managers at the early stage.
  2. Data review - If a data request is made by the regulator, the data should be reviewed prior to disclosure to the regulator, ensuring that only the in-scope data is produced and that privileged materials are withheld from disclosure.
  3. Develop and review compliance programme - It is important to develop a tailored and proportionate compliance programme and ensure it is implemented effectively. The existing programme should be regularly assessed and reviewed so that gaps are promptly identified and remediated by appropriate measures.

Eversheds Sutherland has a long track record in successfully advising share issuers, sponsors, directors and senior management in regulatory investigations including those led by the SFC, Hong Kong Monetary Authority, and Independent Commission Against Corruption. Our deep seated knowledge of the regulators and of the enforcement process means that we can manage regulatory investigations effectively, always bearing in mind the commercial realities of our clients.