Liu Peter Man Lok v. Ricofull Securities Ltd

DCCJ 6703/2002

IN THE DISTRICT COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

CIVIL ACTION NO. 6703 OF 2002

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BETWEEN

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Coram:  Deputy District Judge Anthony Chow in Court

Date s of Hearing:  24^th to 26^th October 2006

Date of Handing down of Judgment:   6^th November 2006 

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JUDGMENT

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Background:

1.This is a claim by a customer of a securities broker for money paid to one of the broker’s dealer representative for the purchase of shares that the dealer representative pocketed in an elaborate scheme of fraud.

The plaintiff’s case:

2.The plaintiff immigrated to Canada in the late 1980’s and returned to Hong Kong in or around the end of 1995. In around 1996, the plaintiff was interested in investing in shares and opened a cash trading account with the defendant company through Mrs Ho, a long time family friend who was employed by the defendant as dealer representative.

3.At the time he opened the account with the defendant, Mrs Ho gave the plaintiff documents to sign, including: Account Opening Information, Uniform Cash Client’s Agreement (the “UCC Agreement”) and a Chinese document with the heading “有關：委任代表事宜” (the “Authorization Letter”).

4.Between December 1996 and October 2000, the plaintiff gave Mrs Ho a number of instructions to purchase and sell shares. The arrangement was the plaintiff would give Mrs Ho oral instructions to either purchase or sell shares, after his instructions were executed, Mrs Ho would then orally inform the plaintiff. In case of a purchase, Mrs Ho would instruct the plaintiff to deposit funds into her bank account and in case of sells, Mrs Ho would arrange to deposit the proceed into the plaintiff’s account.

5.After every transaction, brought or sold notes would be sent to the plaintiff. The plaintiff also received monthly statements, all apparently issued by the defendant.

6.In or around the end of 2000, the Independent Commission Against Corruption (the “ICAC”) contacted the plaintiff and asked for his assistance in their investigation against Mrs Ho for fraud.

7.Mrs Ho was subsequently prosecuted and convicted in 30 charges of procuring the making of an entry in bank records by deceptions and of thief. One of Mrs Ho’s tricks was to falsely represent to clients, including the plaintiff, that shares had been purchased in accordance with their instructions, and induced them into depositing money into bank accounts controlled by her. In fact the clients’ instructions were never executed and the purchase money was appropriated for Mrs Ho’s own use.

8.Between December 1996 and October 2000, the plaintiff instructed Mrs Ho to purchase the following shares (the “ Shares”):

PAC Centcyber-N	7,116 shares
SHK PPT	3,000 shares
Lamex Holdings	120,000 shares
AWT Holdings/401.com	200,000 shares
China Unicom	4,000 shares
Sunevision	14 shares

9.HK$829,260.84, inclusive of purchase price, brokerage and CCASS fees, were paid by the plaintiff to Mrs Ho. In fact the Shares were never purchased and Mrs Ho had appropriated the money for her own use.

10.The Shares were listed in a monthly statement dated 26/10/2000, as being in the custody and control of the defendant on the account of the plaintiff.

11.Since about November 2000, the plaintiff made numerous demands against the defendant for return the Shares. The defendant has refused such demand.

12.On 18/10/2002, after an investigation conducted by an independent accounting firm, the Securities and Futures Commission (the “SFC”), issued a public reprimand against the defendant in respect of the Mrs Ho saga.

The d efendants' case

13.Mrs Ho was only a dealer's representative and not an employee of the defendant at all material times.

14.Mrs Ho only had actual or apparent authority as a dealer representative of the defendant, but not otherwise. The duties of a dealer representative were:

(1)    Introducing clients to the defendant and receiving instructions on securities from clients, on behalf of the defendant;

(2)    Passing her clients’ purchase or sale orders to the dealing room of the defendant;

(3)    After the dealing room executed the orders, to confirm the transaction with her clients. Ho was not authorized to receive any money given by clients; the defendant’s settlement department did all settlements.

15.Pursuant to clause 3 of the UCC Agreement, the plaintiff should have made all payment in relation to securities dealing by direct payments to the defendant and should not have paid any money to Mrs. Ho.

16.Mrs Ho was an agent of the Plaintiff appointed by the Plaintiff pursuant to the Letter of Authorization and therefore the defendant is not liable to the plaintiff’s loss.

17.The defendant did not gain any advantage by the Letter of Authorization, but bore the risks in relation thereto.

Preliminary Issues:

18.Before proceeding with analysis the various heads of claim and the corresponding defences, it is necessary to dispose of the following issues:

(1) Was Mrs Ho an employee of the defendant?

(2)  What were the authorities of a dealer representative with the defendant in relation to receiving instructions and confirming execution of these instructions? and

(3)  Was Mrs Ho authorized to receive money from the plaintiff on behalf of the defendant?

Was Mrs Ho an employee of the defendant?

19.The fundamental test on this question was established in Market Investigation Ltd. v. Minister of Social Security [1962] 2 QB 173, Cooke J. stated the test as follows: “Is the person who has engaged himself to perform these services performing them as a person in business on his own account? If the answer to that question is ‘Yes’, then the contract is a contract for service. If the answer is ‘No’, then the contract is a contract of service.”

20.In Tong Chun Chung v. Onshine Securities Ltd. HCA 4343/1991, Liu J. (as he then was) applied this test to a securities brokerage dealer representative and concluded:

“A dealer’s representative is defined in s.2 of the Securities Ordinance as a person in the employment of a broker. The defendant had certainly power to direct and control the work of Yeung although a runner’s performance would probably be more productive without very close supervision. A runner would guard his contract jealously to protect his commission earning capacity. However, the defendant company could insist on revelation of such information from his runners, including Yeung, although more often than not it would refrain from doing so. The runners, including Yeung must conform with the basic guidelines in matters of form, procedure and policy. Yeung disclosed in his evidence that the defendant’s observance of its own regulatory procedure irregularities and made references to similar shortfalls in the general practice of other broker firms. Yeung ran a private mobile phone and incurred entertainment expenses, but he was exposed to no real financial risk; nor could it be sensibly maintained that he was in fact running his own business or outfit independently of the defendant. The court was not told of any terms or conditions regarding Yeung’s position as a runner with the defendant, which were decidedly inconsistent with the status of an employee. In my view, without doubt, Yeung was an employee of the defendant.”

21.Here, the defendant’s director Mr Wong Tung Chi, Tony (“ Mr. Wong”), testified that:

(1)   Mrs Ho was appointed by the defendant.

(2)   She had an assigned place of work at the defendant’s office. In Mr Wong's words, Mrs Ho “有位坐”.

(3)   In dealings with Mrs Ho, a customer would rely on the goodwill of the defendant.

(4)   She was remunerated by the defendant, at a commission rate agreed between her and the defendant. The customer would not even be informed of the commission rate.

(5)   Her conduct was subject to the control of the defendant. There were regular meetings, where the defendant ensured Mrs Ho and other dealer representatives were aware of and followed the defendant’s procedures and guidelines.

(6)   The defendant could terminate Mrs Ho’s appointment at any time, if her conduct was unsatisfactory to the defendant.

(7)   She owned duties of loyalty to the defendant and was not allowed to introduce customers to any other securities broker.

(8)   There was no real financial risk to Mrs Ho.

22.The facts surrounding Mrs Ho’s engagement with the defendant are similar to the dealer representative in Tong Chun Chung, nothing the defendant has stated about Mrs Ho’s relationship with the defendant pointed against an employment relationship.Having carefully considered all of the circumstances of this case, I find as a matter of fact that Mrs Ho was the defendant’s employee.

What were the authorities of a dealer representative with the defendant in relation to receiving instructions and confirming execution of these instructions?

23.Mr Wong testified that the defendant’s dealer representatives have the following authorities:

(1)  Receiving instructions to buy or sell shares from customers on behalfof the defendant.

(2)  On behalf of the defendant, r elay verbal confirmations (as to whether purchase or sale instructions had been carried out) to customers. The customer was entitled to rely on the dealer representative’s verbal confirmation as being true.

Was Mrs Ho authorized to receive money from the plaintiff on behalf of the defendant?

24.The defendant’s allegation that Mrs Ho was not authorized to receive money from the plaintiff was based on clause 3 of the UCC Agreement. Mr Chan, counsel for the defendant, argued that clause 3 stated specifically that the plaintiff had agreed to pay all settlement sum directly to the defendant’s account and thus shows Mrs Ho had no authority to receive money from the plaintiff.

25.The relevant part of clause 3 of the UCC Agreement read as follows:

“Unless otherwise agreed, I/We agreed that when you have executed a purchase or sale transaction on my/our behalf, I/we will by due settlement date make payment to you against delivery of credit to my account for purchase securities, or make good delivery of sold securities to you against payment, as the case may be.”

26.There was nothing in clause 3 that mentioned direct payment or payment into the defendant’s account. In fact, there was no mention of what was acceptable or unacceptable form of payment. It just said if defendant purchased shares on plaintiff’s instructions, plaintiff had to pay defendant on or before the settlement date.

27.The plaintiff testified that the Authorization Letter was proffered by Mrs Ho with the other account opening documents. Given the fact that her duty was to introduce customers to the defendant, proffering account-opening documents for customer’s signature must be within the ostensible authority of Mrs Ho. In fact, during his testimony, Mr Wong admitted it was within Mrs Ho’s actual authority.

28.During his cross-examination, after changing his testimonies no less than three times, Mr Wong finally admitted that the defendant agreed to the terms of the Authorization Letter and conducted its dealings with the plaintiff in accordance to the content of the same.

29.Paragraph 2 of the Authorization Letter stated:

“貴公司可在貴公司認為必要時知會吾等或 /及上述代表注入額外〔孖展〕保證金；與及將上述代表所發出之票據〔支票〕存入吾等在貴公司之證券或期權戶口中。” 

30.In other words, the defendant agreed to accept Mrs Ho’s cheques in settlement of the plaintiff’s purchase orders. Unless the defendant thought Mrs Ho was using plaintiff’s account to do her own trading (and approved it), it must have known that before or immediately after Mrs Ho issued her cheque to settle the plaintiff’s account, the plaintiff would have paid the settlement fund to Mrs Ho.

31.It was implicit in the defendant’s agreement to accept Mrs Ho’s cheques to settle the plaintiff’s outstanding account that it had also agreed the plaintiff could pay his outstanding account through Mrs Ho. I find as a matter of fact that Mrs Ho was authorized by the defendant to receive money from the plaintiff on behalf of the defendant.

Plaintiff’s causes of actions:

32.The plaintiff’s claim was based on four separate causes of action:

(1)    The defendant was in breach of an implied term of agreement in failing to or refusing to account for or deliver up the Shares that the plaintiff had given valid instructions to purchase.

(2)    The defendant was vicariously liable for its employee’s, Mrs Ho's, fraudulent representations in tort.

(3)    The defendant was in breach of an implied term of the agreement and a common law duty of care to the plaintiff for failing to exercise reasonable care in implementing proper internal control mechanisms to prevent loss to the plaintiff.

(4)     The defendant was in breach of trust for failing to or refusing to account for or deliver up the sum of HK$829,260.84, paid to the defendant for the Shares that the defendant did not purchase.

33.I will now deal with each cause of action separately.

Breach of implied term to deliver up or account for shares:

34.The thrust of the plaintiff’s case was that Mrs Ho had the authority to receive instructions to purchase and to receive payments for the Shares on behalf of the defendant. It was not disputed that the plaintiff did give instructions to purchase and paid Mrs Ho for the Shares, it must follow that the defendant is contractually obligated to deliver up or account for the same.

35.The defendant’s defence on this cause of action were:

(1)   The implied terms only applies to shares duly purchased and money actually and duly received by the defendant. Since clause 3 of the UCC Agreement specified that payment must be made to the defendant and plaintiff only made payment to Mrs Ho, the implied term did not apply.

(2)    Even if the defendant was liable to the plaintiff, the defendant is exempted from liability pursuant to the indemnity clause in the Authorization Letter.

36.As I have already found clause 3 of the UCC Agreement did not require the plaintiff to pay the defendant directly and paragraph 2 of the Authorization Letter, by necessarily implication, authorized Mrs Ho to receive money from the plaintiff on behalf of the defendant, the first ground of defence must fail.

37.As to the second ground of defence, when Mr Chan first raised this issue during his cross-examination of the plaintiff, I enquired if it was pleaded and Mr Chan admitted it was not. I then asked if he wanted to amend his pleadings to add this ground of defence and Mr Chan said no and withdrew that question. I was frankly flabbergasted to find this argument reappearing in Mr Chan’s closing submission.

38.It is trite that one is bound by one’s pleaded case. It is often forgotten that the purpose of proper pleading is to ensure the overriding principle that litigation between parties, and particularly the trial, should be conducted fairly, openly, without surprises and as far as possible, so as to minimise costs.

39.Quite apart from a pleading point, if the defendant were allowed to proceed with this defence, especially after Mr Chan rejected the opportunity to amend the defence during trial, would deprive the plaintiff an opportunity to examine the circumstances surrounding the signing of the Authorization Letter, the relative bargaining position of the parties and the rules of construction that should be applied. Allowing Mr Chan to ignore the rules would result in actual and material prejudice to the plaintiff, I therefore refuse to consider this unpleaded ground of defence.

40.Perhaps as a reply to Mr Man making an issue on the defendant’s failure to plead the indemnity clause, in his closing submission, Mr Chan stated the plaintiff had also failed to mention the Authorization Letter in his pleadings too.

41.The difference between the defendant’s failure to plead the indemnity clause and the plaintiff’s failure to mention the Authorization Letter in his pleading, is simply the former was a ground of defence relied on and the latter, merely evidence in support of allegations clearly stated in the pleadings.

42.Whilst Paragraph 18/7/7 of Hong Kong Civil Procedure states: “Each party must plead all the material facts on which he means to rely at the trial; otherwise he is not entitled to give any evidence of them at the trial.” Paragraph 18/7/5 of Hong Kong Civil Procedure states: “Every pleading must contain only statement of the material facts on which the party pleading relies, and not the evidence by which they are to be proved.”

43.Accordingly, the plaintiff’s first cause of action should succeed.

44.Although once I find for the plaintiff on one cause of action, it is not necessary for me to consider the other three causes; however for completeness, I will complete my analysis of the other causes as well.

Vicarious liability:

45.The relevant law was succinctly stated by Earl Loreburn in Lloyd v. Grace, Smith & Co. [1912] AC 716 (at page 724). Earl Loreburn wrote:

“If the agent commits the fraud purporting to act in the course of business such as he was authorized, or held out as authorized, to transact on account of his principal, then the latter may be held liable for it.”

46.The test is whether the agent’s fraudulent representation was made within his actual or ostensible authority? All of the cases cited by Mr Chan did not depart from the legal principle stated in Lloyd v Grace, Smith & Co, but factually the courts there found the fraudulent representations were made outside of the agents’ ostensible authorities.

47.It was undisputed that dealer representatives like Mrs Ho, had actual authority to report to customers when their orders were executed and I have already found Mrs Ho had actual authority to receive the purchase money from the plaintiff on behalf of the defendant, the fraudulent representation she made to the plaintiff was clearly within her ostensible authority. 

48.Quite apart from whether Mrs Ho had any authority to receive money on behalf of the defendant, it is important to remember that this cause of action is based on Mrs Ho’s fraudulent representation to the plaintiff that all purchase transactions for the Shares had been executed and in reliance thereto, the plaintiff paid money for the Shares and therefore acted to his detriment.

49.The plaintiff’s case relied only on Mrs Ho’s fraudulent representation that the purchase orders were executed. Whether Mrs Ho was authorized to receive money from the plaintiff was not relevant, because the payment of money was merely the detriment caused by Mrs Ho’s fraudulent representation and not the fraudulent representation itself. Since the defendant admitted reporting to customers that their orders were duly executed was within Mrs Ho’s actual authority, there is no question that Mrs Ho’s fraudulent representation was within her ostensible authority.

50.Accordingly, the defendant is vicariously liable to the fraudulent representation of Mrs Ho.

The independent claim of negligence:  

51.The SFC’s public reprimand stated the independent accountant identified four “specific weaknesses” of the defendant, including:

(a) no written company policies and procedures manual;

(b) inadequate overall management controls including:

(i) weak control over the issue and delivery of trading documents; and

(ii) weak control over account opening procedures and the steps necessary to change client particulars;

(c) inadequate segregation of duties in the form of weak control over client orders and dealings; and

(d) no proper procedures for staff dealing.

52.The defendant stated in the defence that it did not accept the findings of the independent accountant; however the defendant took no steps to protest its findings.

53.Mr Chan argued that was because there was no avenue of appeal in the old Securities Ordinance and when I asked if the defendant considered a judicial review, Mr Chan said it was costly and once the reprimand was made public, it was not worth the trouble. Since all judicial reviews must by definition be preceded by a decision of some public body and it is likely that such decision would have been made public as soon as it was made, if Mr Chan’s rationale was correct, all judicial reviews would be a waste of time.

54.In any event, the defendant has fought hard not to disclose the independent accountant’s report. When the plaintiff’s solicitors seek to discover this report, Mr Lee Sung Yin, another director of the defendant, stated in paragraph 15 of his affirmation in opposition dated 17/12/2005:

“…This is because the plaintiff can rely on the final findings concluded by the independent certified public accounts as stated in the press release in question…in order to show the cause in relation to the present case.” Emphasis added.

55.It is my opinion that the defendant cannot on the one hand refuse to disclose the independent accountant’s report by stating, inter alia, the plaintiff can rely on the conclusion of the report and on the other hand state that it does not agree with the same conclusion, without adducing any evidence in support. Doing so tantamount to having its cake and eat it as well.

56.As in any claim for negligence, the burden is on the plaintiff to show that the defendant owed him a duty of care, that the defendant breached that duty of care and as a result of that breach the plaintiff suffered a lost.

57.Whilst no one can dispute the defendant owed the plaintiff a duty of care and that the plaintiff suffered a lost, the only issue in this cause of action is whether the defendant breached that duty of care.

58.In accordance to the conclusion of the independent accountant’s report, the defendant had weak internal controls and it was clearly foreseeable that weak internal controls could lead to frauds against customers of the brokerage firm. Mr Alan Linning, the SFC Executive Director of Enforcement, in the conclusion of the public reprimand against the defendant, stated: “Weak internal controls in a brokerage put the broker’s clients and the broker itself at risk. At worst, they allow brokerage employee to defraud clients.”

59.The defendant owed the plaintiff a duty to ensure it had sufficient internal control to prevent its employees defaulting its client. The defendant was in breach of that duty and as a result of that breach Mrs Ho was able to default the plaintiff.  Defendant was liable to the plaintiff in negligence as well.

60.As to contributory negligence, Mr Chan raised two points: (1) The plaintiff should not have paid money directly to Mrs Ho; and (2) the plaintiff should not have signed the Authorization Letter.

61.In my opinion, neither had any merit. First, I have already found the defendant authorized Mrs Ho to receive money from the plaintiff. Second, how could the plaintiff know he was not supposed to pay money to Mrs Ho, an employee/agent/representative of the defendant? Especially when the Authorization Letter was proffered to him as part and parcel of the account opening documents. The duty was in the defendant to have sufficient internal controls to prevent its staff from defaulting its customers and not in leaving the customers to protect themselves. There was no contributory negligence.

Breach of Trust:

62.Once I found Mrs Ho had authority to receive money from the plaintiff to settle outstanding share purchases, it follows that when Mrs Ho received money from the plaintiff, the defendant was in law deemed to have received the same and when the money was not used to purchase the Shares, the defendant is liable to account for the money as fiduciary and as trustee. Therefore, the defendant is liable under this cause of action as well.

Quantum:

63.In McGregor on Damages (17^th Ed), at paragraph 22-003, the learned author stated the general rule in damages for failing to deliver shares, as follows:

“ The normal measure of damages is the market price of the shares at the contractual time for delivery less the contract price. This represents the amount that the buyer must obtain to put himself in the position he would have been in had the contract been carried out, since to do so he must buy equivalent shares in the market.”

64.Since the date Mrs Ho confirmed the purchase of the Shares were the date that the defendant was contractually required to deliver the Shares to the plaintiff, the proper measurement of damages should be the purchase price of the Shares HK$829,260.84.

65.For the claim in vicarious liability for the fraud of Mrs Ho, Silke JA in Wocom Commodities Ltd. v Texuna International Ltd. [1986] HKC 392, at page 404, quoted McGregor on Damages (14^th Ed), paragraph 1459, and stated:

“Thus the correct measure of damages in the tort of deceit is an award which serves to put the plaintiff into the position he would have been in if the representation had not been made to him, and not as with breach of condition or warranty in contract, into the position he would have been in if the representation had been true.” Emphasis original.

66.If Mrs Ho did not represent to the plaintiff that the Shares had been duly purchased for him, the plaintiff would not have deposited HK$829,260.84 into her account. The proper measurement under this cause of action is thus HK$829,260.84.

67.In the independent negligent claim, the proper measurement of damages is again HK$829.260.84.

68.For the claim in fiduciary duty and trust, the money paid by the plaintiff to the defendant as trustee, to be applied to the purchase of the Shares. In fact the money was misapplied. The defendant must account for the money paid by the plaintiff, which is again HK$829,260.84.

69.Mr Chan argued in his final submission that because the plaintiff retained the Shares and he had expressly accepted the risk of securities dealings, the general rule should not be applied. All purchasers of securities must have either expressly or impliedly accepted that there is a risk the value of their securities may fall. I see no merits in Mr Chan’s argument.

70.Mr Chan also stated that the ICAC had only charged Mrs Ho in relation to one transaction in which the plaintiff paid her HK$264,083.00 and that the proper measure of damages should be that sum only.

71.Which transaction the ICAC decided to charge Mrs Ho with is not relevant to how much the defendant is liable to the plaintiff in any one of the four causes of actions. I see no merits in this argument either.

Orders:

72.Judgment for the Plaintiff in the sum of HK$829,260.84.

73.Costs including all costs reserved to the plaintiff, to be taxed if not agreed.

Representation:

Mr. Bernard Man, instructed by Messrs Hastings & Co., for the Plaintiff

Mr. Simon B.C. Chan, instructed by Messrs S.Y. Chu & Co., for the Defendant