Legal update: Compensation and disqualification order granted against a company officer who did not receive misappropriated funds

Does it excuse misconduct in the eyes of a securities regulator if the company officer did not personally profit from and receive misappropriated funds? John Lee of Tanner De Witt explains that the Securities and Futures Commission of Hong Kong (“SFC”) will still enforce, and the Hong Kong Courts will still impose orders, against company officers who commit serious misconduct even if they did not receive any of the misappropriated funds.

Background

• Mr Chen Ruomao (“Mr. Chen”) is a former executive director and chief financial officer of Changgang Dunxin Enterprise Company Limited (“Changgang Dunxin Enterprise”).

• On 3 December 2015, Changgang Dunxin Enterprise completed a share placement raising net proceeds of approximately HK$108 million (“Share Placement”). The proceeds of the Share Placement were intended to be used to enrich the operational requirements of the group, and for its future investments.

• On 28 January 2018, Changgang Dunxin Enterprise completed a bond placement raising net proceeds of approximately HK$65 million (“Bond Placement”). The proceeds of the Bond Placement were intended to be applied towards the general working capital of the group and deployment of solid waste utilization project.

• The SFC’s investigations found that Mr. Chen allowed the proceeds of the Share Placement and the Bond Placement, totalling approximately HK$163 million, to be misappropriated by the former chairman and executive director (“Former Chairman”) of Changgang Dunxin Enterprise. Mr. Chen then went on to take steps to conceal the misappropriation from the auditors, audit committee and board of directors of Changgang Dunxin Enterprise by providing falsified records purporting to show that the Former Chairman had returned the net proceeds raised to Changgang Dunxin Enterprise.

• Additionally, Mr. Chen was responsible for the overstatement of the cash and bank balance in Changgang Dunxin Enterprise’s financial statements and for Changgang Dunxin Enterprise providing false or misleading information regarding the intended use of the net proceeds from the Share Placement and the Bond Placement.

Legal context

Under the Securities and Futures Ordinance (Chapter 571 of the Laws of Hong Kong), the Court may make orders disqualifying a person from being a director or being involved, directly or indirectly, in the management of any corporation for up to 15 years. Disqualification orders may be issued if the person is found to be wholly or partly responsible for a corporation’s business or affairs having been conducted in a manner, among other things (i) involving defalcation, fraud or other misconduct towards it or its members; (ii) resulting in its members or any part of its members not having been given all the information with respect to its business or affairs that they might reasonably expect; or (iii) unfairly prejudicial to its members or any part of its members.

The Court also has broad powers to make any order it considers appropriate, which has been previously interpreted to include orders for the payment of compensation or restitution by directors. Compensation orders are typically only applicable if the compensation sought is readily ascertainable, such as if the directors have misappropriated or embezzled funds.

Judgment

The Court agreed with the SFC that there was no evidence to suggest that Mr. Chen has received any of the misappropriated funds.

Nonetheless, the Court determined that Mr. Chen’s misconduct was of a very serious nature. The Court noted that his conduct in concealing the misappropriation of funds and failing to alert the auditors, the audit committee and the board led to Changgang Dunxin Enterprise not being able to take steps to recover the HK$163 million misappropriated funds from the Former Chairman. This was the basis on which the Court held it was appropriate and just to make a compensation order of HK$163 million with interest.

The Court noted that Mr. Chen’s conduct did not fall within the top bracket of the disqualification period. However, the Court held that his conduct justified a disqualification period of 10 years, which was the top end of the middle bracket for disqualification periods.

The Court ordered that:

1. Mr. Chen must pay a sum of HK$163 million with interest as compensation to Changgang Dunxin Enterprise;

2. Mr. Chen be disqualified from acting as a director, liquidator, receiver, manager, or being involved in the management of any listed or unlisted corporation for a period of 10 years; and

3. Mr. Chen must pay the SFC’s costs for the court proceedings.

Commentary

This case is an important reminder that a company officer who commits serious misconduct may still be subject to compensation orders and disqualification orders even if they did not receive any of the misappropriated funds. The officer’s receipt of any of the misappropriated funds would aggravate the severity of the misconduct, but it is not a requirement for these enforcement actions by the SFC.

Russell Bennett and John Lee

If you want to know more about the content of this article, please contact:

Russell Bennett

Partner | Email

John Lee

Senior Associate | Email

Disclaimer: This publication is general in nature and is not intended to constitute legal advice. You should seek professional advice before taking any action in relation to the matters dealt with in this publication. This article was last updated on 9 September 2024.