As a consequence of the complexity of Hong Kong's disclosure of interests regime, local substantial shareholders and global investment houses alike frequently fall foul of its provisions. Even robust monitoring and reporting systems can fail to cater to idiosyncrasies of the Hong Kong regime. It can be exceedingly difficult for investment managers, particularly those in large corporate groups, to keep track of total interests and make proper disclosures within the tight deadline. Some issues that commonly cause problems include determination of the "relevant event," attribution and disaggregation rules, acquiring "knowledge," and quirks of different fund structures.
A breach of the disclosure requirements is a criminal offence punishable by a fine of HK$100,000 and two years' imprisonment. If a party realises it has breached its disclosure obligations, careful handling is required to minimise the risk of prosecution by the Securities and Futures Commission. The SFC encourages self-reporting of any breaches and generally requires corrective disclosures, even for minor and historic errors which might be of little interest to the market. A lack of flexibility in such cases can be unhelpful, given the potential time and costs involved in preparing numerous historic disclosures upon discovery of systemic failures. It suggests an element of blindness to the difficulties large organisations can face attempting to comply with the regime.
Under the Securities and Futures Ordinance, disclosure is required of "relevant events," including:
• first becoming interested in five percent or more of any class of a listed corporation's voting shares;
• thereafter, percentage interests crossing through a whole percentage level; and
• certain changes in the nature interests (a complex concept, which the SFC is proposing to simplify).
"Interests" are very widely defined.For example, a party has an interest in shares when it:
• enters into a contract for their purchase;
• is entitled to control the exercise of any right conferred by holding the shares; or
• has a right to acquire an interest in them.
Interests must also be disclosed in the "underlying shares" of "equity derivatives," including any unissued shares (e.g., pursuant to convertible bonds). However, when calculating percentage interests, these interests are divided by the corporation's total issued shares. This inflates a party's apparent interests for disclosure purposes.
A party having an interest of five percent or more must also disclose all short positions of one percent or more. This is a unique requirement among major jurisdictions and introduces considerable complexities.
Where there are multiple transactions on the same day, the transactions should be put into chronological order to identify the transaction that gave rise to the disclosure requirement. If this is not practicable, the most "significant" transaction can be disclosed. Where the disclosure obligation is triggered by a transaction that forms part of a series of transactions on the same day, the series should be aggregated to calculate the number of shares involved in the relevant event. It is acceptable to calculate percentage levels using end of day figures (even though, as a result, figures in the disclosure notice might not reconcile if a party has multiple transactions on one day).
It is also necessary to differentiate between transaction dates and "relevant event" dates, as interests arise on the dealing date but cease on settlement rather than the dealing date.
Besides direct interests, a party might have corporate, family and "concert party" interests attributed to it.
A corporation's interests are attributed to its "controllers." A party "controls" a corporation if:
• the party is entitled to control the exercise of at least one third of the corporation's voting power at its general meetings; or
• the corporation is accustomed or obliged to act in accordance with the party's directions.
An individual is also deemed to be interested in shares in which his or her spouse or child under the age of 18 has an interest, and interests under "concert party agreements" are attributed to all parties to such an agreement.
Interests do not need to be attributed to the "controllers" of certain investment managers if:
• the investment manager is interested in the relevant shares by reason only of its power to invest in, manage, or deal with interests in the shares on behalf of its customers in the ordinary course of its business;
• any power of the investment manager to vote in respect of the shares is exercisable by the investment manager independently without reference to its "controller" (or "related corporation"); and
• the investment manager exercises its key management functions (investing in, managing, or dealing with the shares) independently without reference to its "controller" (or "related corporation").
The disaggregation exemption is likely to be unavailable in many cases, such as where investment houses have group investment policies, or a manager delegates the investment management function to related corporations. Besides investment management interests, if group companies hold at least one third of a fund's voting shares, they have deemed interests in the shares of listed corporations in which the fund invests (as a "controller" of the fund). Such interests cannot be disaggregated.
Disclosures must generally be made within three business days after the relevant event or, if later, of a party becoming aware of the relevant event.
Usually, a corporation will be considered to have knowledge of a particular fact if its board or CEO has that knowledge. It may also have knowledge if the knowledge is held by people whose acts may be regarded as constituting the acts of the corporation for a particular purpose.
If a corporation's issued share capital changes, a shareholder's interests may cross through a whole percentage level without any change to the number of shares it owns. The shareholder is not considered to be aware of such a relevant event until it actually becomes aware of the change in issued share capital. As a practical matter, it can be difficult to determine accurately a listed corporation's issued share capital, even though this information is necessary for preparing disclosures. The Stock Exchange requires notifications by listed corporations of movements in their issued shares and publishes this information on its website. The information may nonetheless be out of date, as can information from data suppliers such as Bloomberg.
Likewise, a party's interests in underlying shares of equity derivatives can fluctuate, and for some structured products it is impracticable to calculate the underlying shares on a day-to-day basis. Whilst there is no legislative requirement to seek knowledge of facts to enable such calculations, knowledge can at common law be deemed if lack of actual knowledge is a result of deliberately avoiding obvious information. Therefore, some degree of monitoring is usually appropriate.
A corporate fund with substantial shareholdings in listed corporations will have its own disclosure obligations. Interests in the shares will also be attributed to any "controllers" of the fund, such as any investor holding one third of the fund's voting shares. An investor's percentage shareholding of an open-ended fund (in which shares are redeemable at the option of investors) fluctuates, which can affect whether a shareholder has a "controlling" interest and is required to treat the fund's interests as attributable to it.
In a unit trust structure, the assets of the fund are held by a trustee on behalf of unit holders. There is no separate legal entity constituting the investment vehicle, so the "trust" does not have to make disclosures. Because each unit holder has an undivided share of all the assets of the unit trust, it will be deemed to have an interest in all shares held by the trust, even though that may grossly exaggerate the scale of the unit holder's real financial interest. Exemptions may apply.
Limited partnerships established in Hong Kong do not have separate legal personality, so have no disclosure obligations. However, a partnership's interests are attributed to its general partner as if the general partner were a "controller" of a corporation. In some overseas jurisdictions, partnerships (especially limited liability partnerships) are considered to have legal personality separate from that of each of the partners, and thus may themselves have disclosure obligations. Any "controllers" of the partnership may also have disclosure obligations.
The disclosure regime imposes no duty on investment managers to ensure disclosure by their clients. However, a person (e.g., a client) who authorises another person (e.g., an investment manager) to deal on his behalf must ensure that the investment manager notifies him immediately of transactions that may give rise to a duty of disclosure by the client. This does not import a duty on the investment manager to procure compliance by the client, though the investment manager might be obliged contractually - or as a result of reputational or relationship factors - to ensure compliance.
There are plans to rectify perceived shortcomings and ambiguities in the current legislation. Whilst amendments proposed by the SFC in 2005 have yet to be implemented, we anticipate that some recent proposals will take effect in the near future. In particular, electronic submission of disclosure notices to the Stock Exchange will become mandatory. As well as continuing to publish the disclosures on its website, the Stock Exchange will provide copies to the relevant listed corporations - removing the requirement for substantial shareholders to do so.
William Mackesy is a former head of Corporate Finance at Deacons and is the author of Disclosure of Interests in Securities of Hong Kong Listed Companies, the only textbook on this subject. Greg Heaton is an Associate in the Financial Services practice group of Deacons.