Securities and Futures Commission v. Shum Ka Sang Charlie and Another

HCMP 1014/2008

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

MISCELLANEOUS PROCEEDINGS NO. 1014 OF 2008

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BETWEEN

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Before: Hon Kwan J in Court

Date of Hearing: 22 May 2009

Date of Judgment: 22 May 2009

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J U D G M E N T

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1.These proceedings are brought by the Securities and Futures Commission (“the SFC”) under section 214 of the Securities and Futures Ordinance, Cap. 571 for a disqualification order.  Shum Ka Sang Charlie and Shen Yi, the 1^st and 2^nd respondents herein, were former officers of Wah Sang Gas Holdings Limited (“the Company”).  They have consented to the disposal of the amended petition against them by way of the summary procedure known as the Carecraft procedure (Re Carecraft Construction Company Limited [1994] 1 WLR 172).  For this purpose, each has agreed to the facts set out in a schedule which contains the core facts of the allegations relied on by the SFC and the admissions of each of them.  I annex the schedules to this judgment as Schedules 1 and 2.

2.The 1^st respondent has appeared by counsel today.  The 2^nd respondent has not appeared and is unrepresented.  He resides in the PRC. He has acknowledged receiving notice from the SFC of the hearing today.

3.The shares of the Company were listed on the Growth Enterprise Market (“GEM”) of The Stock Exchange of Hong Kong Limited on 16 March 2000.  The Company has an extensive network of subsidiaries in the PRC which conducted the business of the construction of gas pipelines, the provision of gas fuel supply in the PRC and the sale of liquefied petroleum gas.  Trading in its shares was suspended by the SFC on 6 April 2004 following the preliminary findings of an inquiry of the SFC into the Company’s affairs which revealed suspicious fund flows and profit levels in the subsidiaries in the PRC and a rapid increase in the group’s published turnover and net profits.  It was not until 12 May 2009 that the suspension was lifted, following the acceptance of a restructuring proposal.

4.On 6 April 2004, the State Administration of Foreign Exchange of the PRC (“SAFE”) issued a penalty notice against one of the PRC subsidiaries which alleged the acquisition and remittance of foreign exchange through the subsidiary network based on false profits.  A very substantial fine was imposed.  PricewaterhouseCoopers (“PwC”) were engaged by the Company to investigate the affairs of ten of the eleven subsidiaries mentioned in the penalty notice.  PwC found overstatement of the Company’s historical results and net profits as a result of fictitious transactions and the falsification of records and that the overstatement of profits appeared to have been used to fund dividends. The timing of inter-company transfers indicated that the purpose of the false profits was to satisfy the capital injection requirements of the PRC subsidiaries.

5.In its subsequent financial statements and announcements, the Company has admitted there was falsification of transactions and records and significant overstatement of its financial position.  The reconstructed accounts showed that the Company has been operating at a significant loss since 2004 and adjustments of around $720.4 million were necessary to reduce the net assets of the group as at 31 March 2004.

6.Since 14 February 2004, there have been numerous breaches by the Company of the GEM Listing Rules with regard to delays in announcing its results and the dispatch of quarterly, interim and annual reports and breach of section 336(1) of the Companies Ordinance, Cap.  32 as regards the duty to deliver balance sheets, accounts, directors’ report and auditors’ report.

7.It is accepted by the respondents that the business and affairs of the Company, for which both were responsible, have been conducted in a manner described in section 214(1)(a) to (d) of Cap. 571. I am satisfied on the facts in Schedules 1 and 2 that the jurisdiction of the court to make a disqualification order against them under section 214(2)(d) is engaged and it is appropriate for an order to be made against them.

8.Both had occupied significant management positions.

9.The 1^st respondent was the founder of the group.  He was the chairman, an executive director, the Chief Executive Officer of the Company and the General Manager of the group.  He was the Compliance Officer of the Company for the purpose of the GEM Listing Rules in the year after listing.  He acted as the legal representative and the director of some of the PRC subsidiaries.

10.The 2^nd respondent is the 1^st respondent’s nephew. He was an executive director and the Chief Operating Officer of the Company responsible for the management and implementation of the group’s investment in the PRC and the operation of the group’s business in the PRC.  He was responsible for the overall cash flow of the group.  He was appointed a director of some of the PRC subsidiaries.  He was also the General Manager of the Company’s Tianjin office to whose financial team the 1^st respondent entrusted all financial and accounting matters in the PRC.

11.Both respondents owed to the Company and the group a fiduciary duty to act in good faith and in the best interests, the duty at common law to exercise due and reasonable skill, care and diligence, and various duties under the GEM Listing Rules and under Cap. 32.  As the chairman of a listed company, the 1^st respondent was also responsible for ensuring that the board was provided with timely and reliable financial information to enable the board to monitor the management, to properly assess the Company’s financial position and performance, and to detect any material adverse developments affecting its financial position or performance.

12.The 1^st respondent does not dispute that he had acted in reckless or negligent breach of his duties, as particularised in paragraphs 74 to 82 of Schedule 1 and these breaches were:

(1)  failure to appoint personnel of appropriate qualification or experience to handle financial transactions and accounting matters;

(2)  failure to discharge duty of supervision;

(3)  failure to ensure the board was provided with timely and reliable information;

(4)  instructing the Chief Financial Officer and Financial Controller in Hong Kong not to deal with the group’s operational and financial matters and to leave them in the hands of the Tianjin office which was under the supervision of the 2nd respondent;

(5)  failure to take action or strengthen controls despite serious warnings given by the audit committee; and

(6)  failure to take action to address the concerns of the audit committee despite being informed that the 2nd respondent was not taking promised follow-up action.

13.The 2nd respondent does not dispute he was reckless or negligent and in serious dereliction and breach of his duties, as particularised in paragraphs 72 to 80 of Schedule 2 and these breaches were:

(1)  failing to properly discharge his duty of supervision over the Company’s daily operations and the financial and accounting matters of the group in the PRC, particularly as general manager of the Tianjin office;

(2)  failing, despite undertaking responsibility for follow-up action, to take any step to address the serious concerns raised by the auditors at the meetings of the audit committee regarding deficiencies in accounting practice and record keeping; and

(3)  obstructing the management of the Company, the audit committee and the auditors from the review and monitoring of the Company’s financial position and performance by failing to ensure the provision of timely, full and accurate financial and accounting records by the PRC subsidiaries.

14.There is agreement between the SFC and the respondents as to the scope and length of the disqualification order.  In each case, it is agreed that the disqualification period should be six years and that each respondent, shall not, without leave of the court,

(1)  be, or continue to be, a director, liquidator, or receiver or manager of the property or business, of the Company or any listed corporation or their subsidiaries or affiliates; and

(2)  in any way, whether directly or indirectly, be concerned or take part in the management of the Company or any listed corporation or their subsidiaries or affiliates.

15.The definitions of corporation, company, holding company, subsidiary and affiliate are set out in Appendix 1 to each of Schedules 1 and 2.

16.It is well established that the court does not simply make a consent order where the Carecraft procedure is adopted.  The court is not bound by the agreement of the parties on the duration and the scope of the disqualification order, but is to make a determination on the appropriate order that should be imposed based on the agreed facts.

17.Mr Scott, SC for the SFC has helpfully referred the court to the relevant authorities on the principles for determining the length of the disqualification period (Re Westmid Packing Services Limited [1998] 2 BCLC 646 at 654 to 655; ASIC v. Adler and Others (2002) 42 ACSR 80 at 97 to 99; Rich v ASIC (2004) 209 ALR 271 at paras. 50 to 58; ASIC v Vizard (2005) 219 ALR 714 at paras 33 to 35 and 48; and ASIC v Beekink (2007) 238 ALR 595 at 604 to 605).  They have been considered in previous decisions in this court and I do not propose to set them out again.  I firmly bear in mind the objectives of the protection of the public and general and personal deterrence in proceedings of this nature.  I will also take into account the personal circumstances of the respondents and the mitigating factors submitted to the court.

18.Mr Scott has emphasised the following features in this case:

(1)  The shareholders of a listed company have been given severely inaccurate and misleading information about the business and financial positions of the Company for about four years following its listing in March 2000.

(2)  The overstatement of the Company’s financial position is very significant.  Adjustments of around $720.4 million were necessary to reduce the net assets of the group as at 31 March 2004.  Trading in its shares has been suspended for five years and only resumed this month.

(3)  There was a high degree of recklessness or negligence in the 1st respondent’s discharge of his duties, as summarised earlier.  As chairman of the Company, he had particular duties to ensure that the board received full and timely information about the financial affairs of the Company, and he failed to carry out this duty even in the face of warnings by the audit committee that this was hindering management in taking effective decisions.

(4)  There was also a high degree of recklessness or negligence in the 2nd respondent’s discharge of his duties, as summarised earlier.

(5)  There have been numerous breaches of the GEM Listing Rules and Cap. 32.

19.Ms Ismail for the 1^st respondent reminded the court that the present case is not a case of dishonesty or personal gain.  She also pointed out that in the report of PwC, it was mentioned that there was no documentary evidence to suggest that the Company’s directors or key management personnel were involved in or had knowledge of the falsification of accounting profits.

20.I would agree with counsel that the case of the respondents would fall within the middle bracket in In re Sevenoaks Stationers Limited [1991] Ch 164, which is applicable to serious cases that do not merit the top bracket and the period of disqualification is in the range of six to ten years.

21.Both respondents seek a restriction of the disqualification order to listed corporations and subsidiaries and affiliates thereof.  They submitted that they depend for their livelihood on their ability to set up and manage other private corporations.

22.The 1^st respondent is 59 years old.  He has an entrepreneurial background.  He is a director of eight private companies, which are owned either by himself or with his wife.  Two of them hold a property and a car for the 1^st respondent and his family.  He relies on these companies to provide income or the means to support himself and his family.  Save for one of the companies which holds 39.73% shares in the Company (to be reduced shortly to 14.43% after restructuring), none of the other seven companies have, or have had, any dealings or connections with the Company or any of its subsidiaries.  His solicitors have provided the latest available financial statements and reports of the operating companies to the SFC.

23.The 2^nd respondent has been appointed the manager of three companies in Tianjin since September 2007.  He needs the income from these positions to support his family.

24.I am satisfied that the period and scope of the disqualification as agreed by the parties would reflect sufficiently the gravity of the misconduct on their part and give recognition to the mitigating factors including their co-operation in the disposal of these proceedings by way of the summary procedure.

25.I therefore make an order in the case of each of the respondents in the terms as mentioned earlier.  The disqualification order will take effect at the beginning of the twenty-first day after the day on which the order is made.

26.I also order the respondents to pay the costs of the SFC in these proceedings as agreed.

Mr John Scott, SC, instructed by Securities and Futures Commission, the Petitioner

Ms Roxanne Ismail, instructed by Messrs Herbert Smith, for the 1^st Respondent

The 2^nd Respondent, acting in person, absent

Schedule 1

Schedule 2