On 2 August 2023, the Court of Appeal (“CA”) delivered a decision in 律政司司長 訴IPFUND Asset Management Limited及另一人 (the “IPFUND case”) 1, which reversed the decision of the District Court delivered on 22 April 20162 and effectively closed a significant loophole to the licensing requirements under the Securities and Futures Ordinance (Cap.571) (“SFO”).
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These basic matters aid our understanding of the main arguments in the IPFUND case:-
– There are 10 types of “regulated activities” under the SFO3. Carrying on or holding out as carrying on a business4 in a regulated activity without the corresponding license from the Securities and Futures Commissions (“SFC”) is an offence under the SFO.
– Many of the “regulated activities” (e.g., Type 1 – dealing in securities) are defined directly or indirectly by references to “securities”, which in turn is defined in Schedule 1 to the SFO.
– “Securities”, as defined in the SFO, includes interests in any collective investment scheme (“CIS”) but does not include shares in a private company5.
– The definition of CIS6 is the subject of numerous case authorities and warrants an article of its own. For the present purposes, the readers only need to know that a CIS is not restricted or defined by asset type (i.e., bonds, stocks, money or land etc.) and investors to a CIS do not have day-to-day control of the assets in the CIS.
In the IPFUND case, the 1st Defendant (“D1”) was the 2nd Defendant’s (“D2”) corporate vehicle to implement an arrangement (“Arrangement”) whereby landed properties would first be acquired with funds from multiple investors, the acquired properties would then be sold for profit, and the profits of sale (less the two Defendants’ (“Ds”) own charges) would be split among the investors in accordance with their respective stakes. More specifically, each purchase would be carried out through a shelf company (incorporated as a Hong Kong private company) for the singular purpose of holding the acquired property until sale, each shelf company would have nominal shareholder(s) having some back-to-back instruments purportedly acknowledging the investors’ beneficial interest in the shares of the shelf company, and each shelf company would only subsist until either the purchase was cancelled or the sale was completed.
Ds were charged with carrying on and/or holding out as carrying on a business in a regulated activity (i.e., Type 1 regulated activity) on the premises that (i) the Arrangement was a CIS, and (ii) by selling interests in a CIS to the investors, Ds were dealing in securities.
At first instance, the District Court found the Arrangement to be a CIS, but acquitted Ds on the finding that the investors bought shares in private companies (i.e., the shelf companies) instead of interests in a CIS.
Even though each case turns on its own facts, the decision of the District Court left a huge question mark on whether the licensing requirements under the SFO may be circumvented by the use of private companies one way or another. Such is the government’s determination to close the loophole that it pursued the appeal for over 5 years without even asking for the reversal of Ds’ acquittal.
On appeal, the CA canvassed various technical issues, such as whether shares in a private company are excluded from the definition of CIS7 and whether the shelf companies in the Arrangement were de facto private companies8 , but the critical issue is this:-
What interest have the investors acquired from Ds?
One would have thought it is intuitive that, in respect of a CIS built and run with funds from investors, the investors must have acquired some interest in the CIS. But the special features in the Arrangement have required both Courts to perform some mental gymnastics.
Ultimately, the CA looked beyond the mere form of the shelf companies as private companies and considered the overall circumstances of the Arrangement, including (among other things) the singular purpose and short lives of the shelf companies and how the investors were paid splits of profits of sale rather than dividends, and concluded that the investors in fact purchased interest in a CIS and not shares in private companies9 .
In other words, where the licensing requirement in respect of a CIS is in question, we ought to stick to the principle of substance over form.
Please contact our Partners Ms. Cornelia Chu and Mr. Dominic Lau for any enquiries or further information.
This news update is for information purposes only. Its content does not constitute legal advice and should not be treated as such. Stevenson, Wong & Co. will not be liable to you in respect of any special, indirect or consequential loss or damage arising from or in connection with any decision made, action or inaction taken in reliance on the information set out herein.
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#1[2023] HKCU 3281
#2[2016] HKCU 1436
#3 Different types of regulated activities are defined in in Schedule 5 to the SFO.
#4The District Court judge held that D1 and D2 operated the Arrangement by way of business (because of the leasing of office, D1’s description of its business in its business registration application and website, the number and continuity of the investment schemes as well as the consultancy fee charged by D1.
See footnote 2 judgement at §148,160 and 194.
5Schedule 1 to the SFO.
6CIS is broadly defined in Schedule 1 to the SFO. Generally speaking, CIS has four elements: (1) the scheme must involve an arrangement in respect of property; (2) participants do not have day-to-day control over the management of the property even if they have the right to be consulted or to give directions about the management of the property; (3) the property is managed as a whole by or on behalf of the person operating the arrangement; and/or the contributions of the participants and the profits or income from which payments are made to them are pooled; and (4) the purpose of the arrangement is for participants to participate in or receive profits, income or other returns from their acquisition or management of the property.
See footnote 5.
7In considering the applicability of the private company shares exemption, the CA’s approach was to determine what kind of interest the investor was acquiring, and if the purpose of investor was not, or was not intended to be, to acquire, dispose of, or subscribe for shares in a private company, the private company shares exemption should not apply to ‘dealing in securities’.
See footnote 1 judgement at §118.
8The CA held affirmatively for the reason that the articles of association of all shelf companies involved contain a provision that complies with section 11(1) of the Companies Ordinance (Cap.622) (i.e. a private company’s articles of association shall limit the number of members to 50).
See footnote 1 judgement at §129.
9See footnote 1 judgement at §95-114.