Legal update: Magistrate acquitted a broker of illegal short selling on re-trial

Case background

Mr Wong Hung who was licensed to carry on Type 1 regulated activity (dealing in securities) under the Securities and Futures Ordinance (Cap. 571) (“SFO”) was charged by way of summons on 20 counts of illegal short selling.

The Securities and Futures Commission (“SFC”) alleged that on 20 occasions between 6 and 20 January 2012, Wong sold shares of five Hong Kong listed companies through his securities account when the total of all the shares he sold was more than the shares he held, contrary to section 170(1) of the SFO (illegal short selling). Section 170 states:

170. Short selling restricted

(1) Subject to subsections (2) and (3), a person shall not sell securities at or through a recognized stock market unless at the time he sells them—

(a) he has or, where he is selling as an agent, his principal has; or

(b) he believes and has reasonable grounds to believe that he has or, where he is selling as an agent, that his principal has,

a presently exercisable and unconditional right to vest the securities in the purchaser of them.

(2) For the purposes of subsection (1)—

(a) a person shall be regarded as selling securities if he—

(i) purports to sell the securities;

(ii) offers to sell the securities;

(iii) holds himself out as being entitled to sell the securities; or

(iv) instructs any representative of an intermediary that carries on Type 1 regulated activity for the intermediary, to sell the securities;

(b) a person who, at a particular time, has a presently exercisable and unconditional right to have securities vested in him or in accordance with his directions shall be regarded as having at that time a presently exercisable and unconditional right to vest the securities in a purchaser of them;

(c) a right of a person to vest securities in a purchaser of them shall not be regarded as not unconditional by reason only of the fact that the securities are charged or pledged in favour of some other person to secure the repayment of money.

(3) Subsection (1) does not apply to—

(a) a person who acts in good faith, believing and having reasonable grounds to believe that he has a right, title, or interest to or in the securities which he sells within the meaning of subsection (1);

(b) a person who, as a representative of an intermediary that carries on Type 1 regulated activity for the intermediary, acts in good faith on behalf of some other person, believing and having reasonable grounds to believe that such other person has a right, title, or interest to or in the securities which he sells within the meaning of subsection (1) on behalf of such other person;

(c) a sale of securities by an exchange participant acting as a principal, when he acts in the course of his business of dealing in odd lots of securities, in accordance with the rules of the recognized exchange company which operates a stock market, being a sale effected solely for the purpose of—

(i) accepting an offer to purchase an odd lot of securities; or

(ii) disposing of an odd lot of securities, by means of the sale of one board lot of those securities;

(d) a sale of securities effected pursuant to a transaction in an options contract traded on a recognized stock market;

(e) a sale of securities falling within a class of transactions prescribed by rules made under section 397 for the purposes of this paragraph.

(4) A person who contravenes subsection (1) commits an offence and is liable on conviction to a fine at level 6 and to imprisonment for 2 years.

On 25 July 2018, after re-trial, Magistrate Li Chi-ho acquitted Wong. He found that Wong placed a large number of orders each day and did not gain any profit from selling the five stocks. Hence, he could not exclude the possibility that Wong was just careless and did not realise that he was not holding sufficient interests in the five stocks when placing the sell orders.

Illegal short selling

Section 170(1) of the SFO prohibits ‘naked’ or ‘uncovered’ short selling, creating a criminal offence for a person to sell securities at or through a recognised stock market unless at the time of sale, he has a presently exercisable and unconditional right to vest the securities in the purchaser, or believes and has reasonable grounds to believe that he has such a right.

For instance, it would be a criminal offence if a person deliberately sold short, and then went into the market to ‘cover’ the short by buying the securities or arranging to borrow them to settle the sale.

The maximum penalties for contravention of section 170(1) are a fine of HK$100,000 and imprisonment for 2 years

The SFC provided a list of circumstances which it accepts that a seller has a “presently exercisable and unconditional right to vest securities in the purchaser of them” even though the seller does not actually have the securities at the time of placing the sale order, thus falling outside section 170. Please refer to the SFC’s ‘Guidance Note on Short Selling Reporting and Stock Lending Record Keeping Requirements’ dated March 2003.

Russell Bennett

The above is not intended to be relied on as legal advice and specific legal advice should be sought at all times in relation to the above.

If you would like to discuss any of the matters raised in this article, please contact:

Russell Bennett
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Disclaimer: This publication is general in nature and is not intended to constitute legal advice. You should seek professional advice before taking any action in relation to the matters dealt with in this publication.