Hong Kong: Court of First Instance Upholds SFC’s Authority to Issue Restriction Notices Freezing Assets in Share Trading Accounts

Overview

On 26 September 2022, the Hong Kong Court of First Instance (CFI) issued its judgment in Tam Sze Leung & Ors (Applicants) v Secretary for Justice and Securities and Futures Commission HCAL 177/2022 [2022] HKCFI 2330. 

The judgment upheld the statutory power of the Securities and Futures Commission (SFC) to issue Restriction Notices (RNs) under sections 204 and 205 of the Securities and Futures Ordinance (Cap. 571) (SFO) (the RN Regime) to freeze assets in various share trading accounts held by the Applicants with certain SFC licensed corporations on the basis of section 207(e) of the SFO. 

The Applicants had previously successfully challenged the constitutionality of the Joint Financial Intelligence Unit's (JFIU) letter of no consent (LNC) Regime in Tam Sze Leung and others v Commissioner of Police [2021] HKCFI 3118 (Tam Sze Leung (No.1)), where the CFI found the JFIU LNC Regime as operated in that case to be beyond the powers conferred on it by the Organised Serious Crimes Ordinance (Cap. 455) (OSCO). Please refer to our previous Legal Update for a summary of Tam Sze Leung (No.1).

Brief Facts

The Applicants are family members. The SFC began investigating the Applicants and other suspects for a large-scale “Ramp and Dump Scheme”. A “Ramp and Dump Scheme” is a form of unlawful market manipulation where suspected perpetrators use different dishonest means to ramp up the share price of a listed company and subsequently dump the shares onto retail investors at an inflated price.

On 15 March 2021, the SFC issued a number of RNs under sections 204(1)(a) and 205(1) on the basis of section 207(e) of the SFO to 15 SFC licenced corporations (LCs) in relation to share trading accounts held by 26 individuals, including the three Applicants (Accounts).

Section 207(e) of the SFO provides that the SFC may impose a prohibition or requirement under section 204, 205 or 206 in respect of any LC if it appears to the SFC that the imposition of the prohibition or requirement is desirable in the interest of the investing public or in the public interest. This ground is especially important to the SFC since it is the only ground which allows the SFC to issue RNs to target clients of LCs.

Sections 204 to 206 relate to the SFC’s power to impose the following prohibitions or requirements on LCs:

• restriction of business (section 204)
• restriction on dealing with property (section 205)
• maintenance of property (section 206)

As a result of the RNs, more than HK$35 million of the Applicants’ assets were frozen in their accounts held at three securities firms.

The Applicants made a constitutional challenge to the use of RNs by the SFC to freeze assets held by the Applicants in the various trading accounts.

As of the date of the hearing of this matter:

• the RNs remained in effect, i.e. more than 16 months from the date on which they were first issued;
• no charges had been laid against the Applicants alleging market misconduct or other criminal offences under the SFO; and
• no application had been made by the SFC to the Court for an injunction pursuant to section 213 of the SFO.

Key Findings

The Applicants claimed that the RN Regime interferes with the constitutional rights to property under Basic Law Articles 6 (BL6) and 105 (BL105):

1. It is not prescribed by law; and
2. It fails the proportionality test.

Since the Applicants had previously succeeded in Tam Sze Leung (No.1), which ruled that the LNC Regime as operated was ultra vires, the Court stated that it would be helpful to understand the differences between the RN Regime and the LNC Regime before arriving at its decision:

• Section 25A(2)(a) of the OSCO does not expressly create an informal freezing regime, and such informal freezing powers could not be implied into the statute. As a result, the LNC Regime as operated by the police was found to be ultra vires in Tam Sze Leung (No.1).
• However, sections 204, 205 and 206 of the SFO expressly authorise the SFC to control and restrict the dealing with assets held in accounts maintained with securities firms. Therefore, the RN Regime should be examined in its own statutory context under the SFO.

Ground 1: “Prescribed by Law” Requirement 

The Court agreed with the Applicants that the relevant administrative intervention powers granted to the SFC under the RN Regime are highly intrusive to the individual’s property rights under BL6 and BL105. Nevertheless, the Court concluded that overall, sections 204 and 205 of the SFO, when invoked on the basis of section 207(e) of the SFO, satisfy the “prescribed by law” requirement because:

• there is sufficient guidance from the statutory context to give meaning to “public interest” in section 207(e) of the SFO;
• what constitutes the “public interest” will be determined on a case-by-case basis. The review mechanism in the Securities and Futures Appeals Tribunal (SFAT) provides an infrastructure which assists in the gradual development or clarification of section 207(e). Further assistance or development may come from Court decisions;
• although there is no express time limit for the RN after issuance and periodic review of the RN is not legally required, the actions of SFC as a public authority would be subject to public law control. In addition, the SFAT has the power to review and decide whether the duration of the RN is reasonable;
• there are sufficient safeguards against the SFC’s exercise of powers provided by the SFAT in its full merits review and by the Courts in judicial reviews and/or appeals from the SFAT.

Ground 2: Proportionality 

The Applicants did not submit that the SFC’s administrative powers do not serve any legitimate aim or that they are not rationally connected to that aim. However, they did question whether a reasonable balance had been struck between the encroachment into the constitutionally protected rights of the individual and the societal benefits of such encroachment, when the SFC is not required to account for the progress of its investigation or give a time estimate on when it will proceed with civil or criminal proceedings.

The Court found that the restriction or limitation pursues a legitimate aim of protection of investors, creditors of the LCs and the public interest. The protection of the public interest involves the preservation of monies that might otherwise be dissipated pending the outcome of investigations, and the deterrence, the prevention of dealing in proceeds of an indicatable offence and the confiscation of such proceeds.

A person affected by such a restriction or limitation is entitled to a review and an appeal to an independent tribunal, the SFAT. With the protections provided, the Court was satisfied the restriction or limitation pursues a legitimate aim and is rationally connected to that legitimate aim; it is no more than is necessary to accomplish that legitimate aim; and does not result in an unacceptably harsh burden on the individual.

As a result, the CFI dismissed the Applicants’ application for judicial review.

Key Takeaways

The Court upheld the SFC’s statutory power under the SFO to impose a prohibition or restriction to control and restrict the dealing with assets held in accounts maintained with LCs, which is a powerful tool available to the SFC at a very early stage of its investigation to prevent dissipation of assets.

Nonetheless, the Court also took the opportunity to clarify that:

• where the SFC seeks to issue a RN on the basis that it is desirable in the interest of the investing public or in the public interest to do so, the SFC needs to take into account the potential of an unfavourable outcome and the impact of the prohibition or requirement in the SFC's balancing exercise; and
• even though there is no express time limit for a RN, the SFC cannot maintain it for as long as it wishes, and the SFC should always bear in mind that the longer a RN is maintained, the greater is the intrusion and prejudice.

For individuals and entities that are affected by the prohibition or restriction imposed by the SFC, they should consider whether they can make use of the existing review mechanisms available under the SFO, appeal to the SFAT or apply to the Court for a judicial review. The Court’s well-established approach is that permission to proceed with a judicial review will generally be refused where the applicant has failed to exhaust alternative remedies.

Section 218 of the SFO provides a mechanism for the review by the SFAT of “specified decisions” including decisions made by the SFC in terms of sections 204, 205 and 206 of the ordinance. The SFAT’s decision is based on a full review on the merits and the SFAT may confirm, vary or set aside and substitute the specified decision.

A party dissatisfied with a decision of the SFAT relating to a review of a specified decision may appeal to the Court of Appeal on a point of law.

Individuals and entities affected by a prohibition or requirement should therefore consider first whether they have grounds to use this established review mechanism to challenge the prohibition or restriction before considering the prospect of applying for a judicial review.

Finally, the Court gave the SFC a timely reminder that it cannot simply impose a RN and then sit on it for as long as it wishes while it continues with its investigations. It is to be hoped that the SFC will actively bear in mind the potential prejudice to those affected by RNs in long running investigations of market misconduct. An alternative way in which the SFC could achieve its objectives would be to apply for an interim injunction under section 213 of the SFO in place of a RN at the appropriate juncture. Any party claiming to be prejudiced would have the opportunity to oppose the continuation of the injunction before the Court (having filed affidavit evidence) without being required to appeal to the SFAT or to file an application for judicial review as it would otherwise have to do in order to oppose the continuation of a RN.