In our view the judgment in the Court of First Instance on PCCW's scheme of arrangement and the alleged vote-rigging provides ample grounds for appeal. We look at the ruling in detail and where the SFC may be taking this case on Thursday at the Court of Appeal.

PCCW - Grounds of Appeal
13 April 2009

Background

Readers may recall that back on 1-Feb-09 Webb-site.com ran a story reporting compelling evidence of an attempt to rig the vote in the proposed Scheme of Arrangement (SoA) to privatise PCCW Ltd (PCCW, 0008), involving hundreds of agents of Fortis Insurance Company (Asia) Ltd (Fortis Asia). We first reported the allegations to the SFC early on 15-Jan-09 after receiving an anonymous tip-off via the contact page on Webb-site.com. After inspecting the share register on 29-Jan-09 (the first working day after Chinese new year, and the penultimate working day before the register closed for the shareholder meeting), we had the evidence to support these allegations, and filed it with the SFC. They could have inspected the register themselves, but hadn't.

After our second filing, the SFC started taking the allegations seriously, and on 30-Jan-09 commenced an inquiry under Section 179 of the Securities and Futures Ordinance (SFO). At the shareholder meeting on 4-Feb-09, they seized the voting records, and the next day they commenced an investigation under Section 182 of the SFO. To give credit where it is due, they really seem to have pulled the stops out on this, interviewing 95 persons so far. The SFC sought permission from the Court of First Instance to intervene in the proceedings to sanction the SoA, which permission was granted on 24-Feb-09. This was the first time the SFC had used its right under Section 385 of the SFO to apply to the court to intervene in proceedings after consulting the Financial Secretary. The SFC was given 21 days to put its case together by 17-Mar-09 ahead of a 2-day court hearing which began on 1-Apr-09.

Justice Susan Kwan Shuk-hing issued her 187-paragraph Ruling on 6-Apr-09, in which she approved the scheme. The SFC immediately asked for a stay of her ruling pending appeal, which she declined, so they went straight to the Court of Appeal, which granted a stay for 10 days, which would allow the appeal to take place without rendering the outcome academic. Without a stay, the SoA would have taken effect the next day. Given the 4-day Easter weekend, the appeal team certainly has its work cut out to get ready for the hearing on Thursday 16-Apr-09. Let's hope they've been busy.

In this article, we review the Ruling and suggest some of the grounds for appeal which the SFC should be pursuing at the Court of Appeal. First let's note from para 60 of the Ruling:

"The investigation of the SFC into the voting allegations is part of a wider and ongoing investigation into the affairs of the Company and whether there has been misconduct or the commission of offences under [the SFO]. So far, the SFC has been able to interview 95 persons, potential witnesses in the matter may exceed 700."

Share trading and share registration are not linked

The judge seems to think that share trading and registration of shares in Hong Kong go hand-in-hand. She writes in para 39 of the Ruling:

"The fact that there was such a substantial increase in the trading volume and registration of shares of the Company after the announcement of the privatisation proposal is not unusual. Increase in the trading volume and registration of shares is a common phenomenon after a scheme for privatisation is announced, especially where there is a large differential between the market price and the offer price."

She's only half right. For sure, there is an increase in trading volume around corporate events, including privatisations. But all share trading in almost all HK-listed stocks is settled by electronic book-entry between participants in the Central Clearing and Automated Settlement System (CCASS) run by Hong Kong Securities Clearing Co Ltd (HKSCC), a wholly owned subsidiary of Hong Kong Exchanges and Clearing Ltd (0388), so there is no consequential change in the registered shares held by its nominee, HKSCC Nominees Ltd (HKSCCN). Until PCCW, there was no evidence of a big increase in share registration after a privatisation is announced, as we will show below. The judge goes on to rely on this misconception later in the Ruling where we get into a discussion of geese and ganders.

Vote-splitting is not common

Christopher Howe, Managing Director of Anglo Chinese Corporate Finance, Ltd was engaged by Pacific Century Regional Developments Ltd (PCRD) to provide an independent expert opinion. As far as we are aware, the SFC did not provide any opposing evidence or an expert witness of its own. Para 41 of the Ruling states:

"Mr. Howe further explained that it is not uncommon for "Arbs" to protect their investment when a transaction they invest in is implemented by a scheme of arrangement by splitting their shares into board lots or acquiring odd lots and registering their interests in their own name or those of their nominees to increase the number (as opposed to the value) of their votes at a meeting of shareholders held to consider a privatisation proposal under a scheme of arrangement."

As we will show, vote-splitting is indeed uncommon. The Ruling continues by quoting statistics on just one case, Shaw Brothers (Hong Kong) Ltd, which presumably were provided by Mr Howe:

"A useful comparison is the recent privatisation of Shaw Brothers (Hong Kong) Limited. There was also a substantial increase of approximately 77% (235) in the number of registered shareholders between the date of the announcement of the scheme (on 22 December 2008) and the date of the closure of the register of members (20 February 2009). Among those newly registered shareholders, 78.8% (175) held one board lot of shares. In terms of head-count, 237 minority shareholders voted at the meeting and 231 voted for the scheme."

Webb-site.com regards that comparison as irrelevant, because the Shaw Brothers meeting took place well after news of the PCCW vote-rigging scandal broke on 30-Jan-09, so the vote-splitting at Shaw Brothers could well have been inspired by what was going on at PCCW, whether or not it involved some of the same vote-splitters.

To counter this, Webb-site.com has dug up the voting announcements on every privatisation by scheme of arrangement prior to PCCW which we can find since the start of 2005, and below are the numbers of shareholders who voted on each of these 18 deals. Note that in most cases, HKSCCN voted both ways, which is why the number of votes cast is often 1 more than the number of voters. We also indicate whether the scheme was passed or failed, and the reason for it:

Date Name Voters For Ag. P/
F
16-Oct-08 CITIC International Financial Holdings Ltd (CIFH) 170 160 10 P
17-Sep-08 China Netcom Group Corporation (Hong Kong) Ltd 99 98 2 P
17-Apr-08 Pacific Century Premium Developments Ltd 31 10 22 F75, F10
25-Feb-08 Lei Shing Hong Ltd 32 32 1 P
10-Aug-07 Tom Online, Inc. (TOI) 75 59 16 P
27-Jun-07 Shimao International Holdings Ltd 1 1 0 P
15-Dec-06 China National Aviation Co Ltd 38 38 1 P
13-Nov-06 Winsor Industrial Corp Ltd 49 48 1 P
18-Oct-06 Wong's Kong King International (Holdings) Ltd 23 18 6 F75
11-Sep-06 Egana Jewellery & Pearls Ltd 17 17 1 P
6-Sep-06 SNP Leefung Holdings Ltd 49 49 0 P
15-Jun-06 China Resources Cement Holdings Ltd 20 18 3 P
3-May-06 Asia Aluminium Holdings Ltd 20 17 3 P
20-Jan-06 Henderson Investment Ltd (HI) 153 111 42 F10
13-Jan-06 New World TMT Ltd 20 16 5 P
22-Jul-05 Henderson China Holdings Ltd (HCH) 137 98 41 P
29-Jun-05 Hutchison Global Communications Holdings Ltd 14 14 1 P
5-Jan-05 Kwong Sang Hong International Ltd (KSH) 77 63 15 P
Average   56.9 48.2 9.4  

Key:
P = Pass, F=Fail
F75 = failed because less than 75% of shares voted were in favour
F10 = failed more than 10% of all independent shares were voted against

The table shows that the average number of voters in these meetings was just 57, of which 48 were in favour and 9 against. On only two occasions did the number in favour reach triple-digits. One of those had the largest number of votes against (42). It is possible, of course, that some small-scale vote-splitting was done in some of these transactions, but given the small numbers of votes cast, it certainly wasn't a common practice. If it had been, then the SFC would doubtless have intervened before, as they did in 1992 in the Chinese Estates case (pre-CCASS), when there were 491 newly registered holders among the 644 in favour of that scheme, of whom 527 held just one board lot, and there were 214 shareholders opposed, of whom only one held a single lot.

Note that among the larger figures in the table above:

If you take out CIFH, HI, KSH, HCH and TOI from the above table for the reasons given, then the average number of voters in the remaining 13 cases was just 32, with 29 in favour and 4 against.

PCCW inherited most of its registered shareholders from Cable & Wireless HKT Ltd (HKT) upon the takeover in 2000, as this was partly a share swap. HKT in turn inherited its shareholder base from Hong Kong Telephone Company Ltd (HK Telephone) on 22-Jan-1988, when HK Telephone and Cable and Wireless (Hong Kong) Ltd were merged and each share in HK Telephone was swapped for two shares of HKT. HK Telephone was incorporated in 1925 and listed so long ago nobody seems to know when, but it was in the Hang Seng Index when that was established in 1964. So it had a large registered shareholder base before the privatisation proposal was announced.

When PCCW took over HKT by SoA, the announcement of the HKT meeting results didn't bother to state the numbers of shareholders who voted, or even the numbers of shares voted. Fortunately, however, para 19 of the Ruling sanctioning that scheme states that 1,704 shareholders voted, of whom 97.36% were in favour, which implies that 1,659 were in favour and 45 against. By comparison, at the PCCW meeting on 4-Feb-09, there were 2,263 votes (an increase of 604), of which 1,404 were in favour and 859 were against. These figures were actually 6 higher (1 in favour, 5 against) than the numbers in the announcement of results on 5-Feb-09, which says something about the accuracy of Computershare's counting and checking. The miscount was discovered during the vote-rigging investigations and attributed to a "clerical error" caused by "manual counting at the Court Meeting venue".

So we can conclude this section by stating that there is no evidence that vote splitting was common before PCCW. However, if the Ruling is upheld on appeal, then vote-splitting will certainly be common in future, because proponents and opponents of privatisations will engage in a chaotic paper chase to approve or block the deal by legal, court-endorsed vote-splitting. This is not the way privatisations should be decided, but until the law is amended to remove the headcount, that is the way it may be, if the Ruling is upheld.

Voting analysis

Pre-existing shareholders were overwhelmingly opposed, by headcount

Consider the statistics in para 61 of the Ruling, which relates whether holders were registered before or after the proposed privatisation was announced on 30-Oct-08:

When were they registered? For Against Total
Registered before 30-Oct-08 116 829 945
Registered after 30-Oct-08 1288 30 1318
Total 1404 859  2263

It is clear from this that of those holders who voted against, 96.5% of them were shareholders before the proposal was announced, and for those who voted in favour, 91.7% of them became shareholders after the proposal was announced. 87.7% of the pre-existing registered shareholders who voted were opposed to the scheme.

The first meeting would probably have failed if not adjourned

From para 61 of the Ruling, of the 1,288 newly-registered holders in favour, there were 940 registered after 30-Dec-08, the day the first meeting was adjourned to receive an increased offer. Therefore 348 were registered between 30-Oct-08 and 31-Dec-08. This gives us a clear indication that, if the first meeting had gone ahead, the headcount would probably have voted it down, even if the share count was in favour. The likely outcome would have been as follows (conservatively ignoring the 30 opposing voters who registered after 30-Oct-08):

What if the first meeting had gone ahead? For Against Total
Registered before 30-Oct-08 116 829 945
Registered from 30-Oct-08 to 30-Dec-08 348 NA 348
Total 464 829 1293

So as we can see, if the vote had gone ahead, 64.1% would likely have been opposed, and possibly more, because the offer price was lower then. Based on the flood of newly-registered holders who eventually voted in favour, there was probably some vote-splitting going on before the first meeting, but it wasn't enough. By the time of the first meeting, the Registrar would already have a very good idea of how the vote would go from the proxies which had been mailed in. We assume that PCCW and, by extension, the Offeror, had access to this information. Perhaps this is why the meeting was adjourned, and the only credible way to do that was to table an increase in the offer.

The majority of those who held more or less than 1 board lot were opposed

From para 47 of the Ruling, here's how the votes in the final meeting break down:

  For Against Total
Less than 1,000 shares 27 181 208
1,000 shares 777 63 840
More than 1,000 shares 600 615 1215
Total 1404 859 2263

Clearly, the majority of those who held less than one board lot, and the majority of those who held more than one board lot, were opposed to the scheme. Also, note from para 63 of the Ruling that the 600 holders in favour with more than 1,000 shares include 142 persons who became holders after 30-Dec-08 with exactly 3,000 shares each, of whom 136 acquired their shares through Kingston Securities Ltd (Kingston) and the judge accepts that these were subject to buy-back offers, see later in this article. So without them, the majority opposition amongst "larger" small shareholders was even stronger than the figures suggest.

Francis Yuen and Inneo Lam

The SFC alleged a conspiracy between Francis Yuen Tin-fan (Mr Yuen), Deputy Chairman of PCRD, and Inneo Lam Hau-wah (Mr Lam), a regional director of Fortis Asia, to rig the vote. In the last annual report before Fortis Asia Holdings Ltd was privatised, Mr Lam was listed as one of two "Executive Regional Directors", the other being Paul Ng Wing-keung. Below them, there were 28 "Regional Directors".

It is established fact that Mr Lam acquired 500,000 shares through Newpont Securities Ltd on 5-Jan-09, shortly after a phone call with Francis Yuen, and that the shares were withdrawn from CCASS as single board lots. Mr Lam distributed the shares to 5 team heads, and they in turn distributed these to underlings in the insurance agent food chain. The SFC said there were 9 calls between Mr Yuen and Mr Lam between 30-Dec-08 (the day of the first shareholder meeting) and 4-Feb-09 (the day of the second shareholder meeting). The longest lasted 7.5 minutes on 30-Dec-08. Five of the calls were on 5-Jan-09, the day Mr Lam purchased the 500 board lots. This information was obtained by the SFC during its investigation, presumably from phone logs, so the content of those calls remains unknown. There were also 2 SMS messages from Mr Yuen to Mr Lam on 4-Feb-09, shortly before the shareholder meeting, the contents of which are also unknown.

Of the 500 lots, 494 were voted in favour of the Scheme (para 65). Mr Lam claimed that the shares were a bonus to his subordinates. Fortis Asia does not prohibit such inter-agent bonuses, and the agents are all self-employed.

Off-topic: this employment status, common in the industry, is somewhat elegant - the Pacific Century Insurance prospectus in 1999 described them as "full-time, self-employed agents who operate out of its branch network and are contracted to sell the Group's products exclusively". So they spend all day selling only Fortis Asia products from Fortis Asia offices, but are not employed by Fortis Asia. It's probably just a matter of time before (former) insurance agents of one of these insurers start suing their principal alleging an employer-employee relationship and demanding paid leave (including commissions they could have earned if they were working) and all the other trinkets that our interventionist Employment Ordinance provides, including long-service and severance payments. If the minimum wage comes in, then it will otherwise leave all "self-employed" insurance agents outside its scope, as they are now outside the Employment Ordinance. We could then likely see all the estate agencies in Hong Kong laying off their employees and making them self-employed "agents" too. Same goes for travel agents and any other commission-based profession you can think of. Tens of thousands of "agents" will be outside the scope of the minimum wage - which is another reason why it is such a bad idea. But we digress - back to the story!

The 500,000 shares were worth (at the 5-Jan-09 closing price) about $1.75m, so this was indeed a generous gift, given that Mr Lam's own bonus from Fortis was just $5m subject to adjustment, of which $2.5m was paid in Nov-08 and $1.9m in Feb-09. Also, as he has 1,000 agents under him (para 82), he appears to have chosen to give bonuses to only half of the agents under him (at most) rather than all of them, and claims to have chosen 5 team-heads to distribute the shares. The Ruling does not shed any light on why he picked these particular 5 teams to distribute the shares to - have they performed particularly well? Were they not rewarded for that by commissions from Fortis Asia itself?

Mr Lam had also purchased 1.9m shares for his own account, on which he stood to gain about the same amount as the cost of giving away 500,000 shares, if the privatisation succeeded.

The judge rightly states that the Court cannot infer wrong-doing when there are two equally probably inferences from the facts, one of which is an innocent explanation. In para 79 She quotes from Bradshaw v McEwans Pty Ltd (1951), which in turn was quoted in Luxton v Vines (1952), both in the Australian High Court:

"In questions of this sort, where direct proof is not available, it is enough if the circumstances appearing in evidence give rise to a reasonable and definite inference: they must do more than give rise to conflicting inferences of equal degrees of probability so that the choice between them is mere matter of conjecture... But if circumstances are proved in which it is reasonable to find a balance of probabilities in favour of the conclusion sought then, though the conclusion may fall short of certainty, it is not to be regarded as a mere conjecture or surmise"

The SFC submitted that Mr Lam's explanation of bonuses-for-agents was "incredible" and the judge cited 9 reasons set out in para 88 of the Ruling. In turn, she says PCRD gave (coincidentally) 9 matters why this submission should be rejected, set out in para 91 of the Ruling. Amongst these 9 matters, she mentions in item (3) that two of the team heads sold some of the shares they received. Almost as if to bring the total of reasons to 9, the judge cites the same sales in item (7) of her list.

But let's examine that sales claim more closely. When Mr Lam withdrew the 500 lots from CCASS, he would have received certificates in the name of HKSCCN. In order to sell those shares in the market, a holder would have to put them back into CCASS, at which point they could no longer count separately for the headcount vote. But the SFC says that 494 of the lots were voted at the meeting. So at most, only 6 of the lots were sold in the market, or 1.2% of the donated lots. It is possible that that the two team heads sold shares off-market to friends, but this would be highly unusual and suspicious in itself. Off-market sales and purchases normally involve a huge amount of paperwork, including a trip to the stamp-duty office and the registrars. It would have been difficult to turn around 2 transfers in the time available, once from HKSCCN to the team head, and once from the team head to the purchaser. Instead, the HKSCCN certificates could have been sold on by the team heads before being registered into the names of the purchasers. If that is the case, then there is an issue of stamp duty evasion.

The judge concludes in para 93:

"The existing information gives rise to no more than conflicting inferences of equal degrees of probability. This court is not authorised to choose between guesses. In my judgment, we have not moved from the realm of conjecture to the realm of legitimate inference."

and continues in para 94:

"I decline to infer that Inneo Lam had implemented a scheme in splitting up his 500,000 shares to assist in the privatisation of the Company. He did not even vote at the court meeting."

We don't see that whether he voted is relevant - what matters is that almost 500 other people who received those shares voted, not whether he did. Indeed, if he gave away all the 500 lots he withdrew, then he could not have voted them himself. He also bought 1.9m shares for himself, but the Ruling doesn't mention whether he withdrew those from CCASS. Assuming he didn't, then he may have simply given voting instructions to CCASS via his broker, as was his right, assuming he was independent of the offeror. Which brings us on to our next point.

Where do you normally get 500 proxy forms from?

One point the judge did not cite in the SFC's case (if they made this point) is the significance of this evidence in para 66 of the Ruling:

"Inneo Lam's secretary, who is his sister Lam Hau Yuk Herea, had obtained from Francis Yuen's secretary, Lesley Wai, 500 to 600 proxy forms for distribution together with the share certificates."

The Ruling makes no comment on this, but to us it screams an obvious question - if there was nothing going on between the two men, then why would Mr Lam's secretary/sister ask Mr Yuen's secretary for 500 to 600 proxy forms? Normally if you need a lot of proxy forms, you ask the registrar of the company (in this case, Computershare). They are the ones in charge of the mailing and collecting of proxy forms, and that is where the bulk supply of forms would be held. Mr Yuen is not Computershare, and is not even a director or employee of PCCW, having left that company on 30-Nov-06. So why would Mr Lam turn to Mr Yuen for the proxy forms? In our view, this shifts the probabilities way beyond "conflicting inferences of equal degrees of probability" if it wasn't there already. The SFC should argue that there is indeed a legitimate inference to be drawn from the mosaic of facts.

The SFC's statement about the source of the proxy forms presumably came from Mr Lam's secretary, because Mr Yuen's secretary has become uncontactable:

"The SFC has not been able to interview Lesley Wai, who applied for long leave on 11 February 2009. She went on leave from 18 February 2009 and her leave period is to end on 9 April. Attempts to contact her in Hong Kong and Canada were not successful."

We hope Mr Yuen's secretary is enjoying her long leave - perhaps she will decide to extend it for another week?

Two parts of the same allegation - Bayesian inference

Since the judge declined to find that there was any scheme of Mr Lam to assist in the privatisation of the Company, she said it was "strictly unnecessary to consider" whether Francis Yuen was involved in the "alleged scheme of Inneo Lam" (para 96) but states in para 97:

"The basis for the allegation of the SFC rests largely on coincidental telephone contacts between Francis Yuen and Inneo Lam on critical dates, being 30 December 2008, 5 January and 4 February 2009"

This again ignores the question of why Mr Lam's secretary/sister was seeking 500-600 proxy forms from Mr Yuen's secretary rather than the registrar. The judge concludes in para 105:

"I decline to infer from the coincidence of timing of telephone communications and SMS messages that Francis Yuen had anything to do with, or had any knowledge of, what Inneo Lam did. There is merely suspicion, wholly unsubstantiated by evidence."

We suggest that it is artificial to consider this as two separate allegations - one that Mr Lam had a scheme, and one that Francis Yuen was involved in a scheme with Mr Lam. It seems to disregard the interconnectedness of the evidence (in particular, the obtaining of blank proxies from Francis Yuen's secretary) that supports an inference that both of them were involved in planning the vote-splitting. She should have considered this as a single allegation, and then compared it with the alternative (innocent) explanation, rather than splitting it into two mutually independent allegations, each of lower probability when examined in isolation than if examined together.

This is what Bayesian inference is all about. Put simply, the probability that Mr Lam had a vote-splitting scheme (rather than a bonus scheme) if he did not have any contact with Mr Yuen (or anyone else from the offeror) is lower than the probability of a vote-splitting scheme if he had multiple contacts with Yuen at key points in he timetable and obtained proxy forms from Mr Yuen's secretary. Similarly, the probability of some conspiracy between the two men, from the phone contacts alone, would be much lower if Mr Lam had not bought 500 board lots and gifted them to his agents, and obtained proxy forms from Mr Yuen's secretary. If Mr Yuen had called someone else at the same times, and that person had not bought, split and registered any shares and had not asked Mr Yuen's secretary for 500 proxy forms, then nobody would be alleging a conspiracy between them.

Preventing share-splitting

Para 147 of the Ruling cites the question asked by Michael Todd QC, flown-in counsel for PCCW:

"As Mr. Todd has asked, how is the company or the court to inquire into the reasons for the splitting of shares every time, with none of the investigatory powers of the SFC? Is the SFC to investigate all transfers of single or small board lots or odd lots between the announcement of a scheme and the court meeting in every proposal for privatisation in future? And if such an investigation is to be expected, with the attendant uncertainty involved, is it not likely to deter or hinder the transfer of shares in a free market once there is an announcement for proposed privatisation?"

So long as we have the headcount law, the simple answer to this question would be to prohibit withdrawals of shares from CCASS from the date on which the proposal is announced until the date of the meeting, but to allow deposits of shares into CCASS. This would allow anyone (including registered shareholders) to sell, and it would allow anyone to buy shares on the stock exchange, because, as we have explained, all transactions on the exchange are settled by book-entry in CCASS without any transfer of registered shares taking place.

There is still the possibility that pre-existing registered shareholders would split their shares into multiple names to support or oppose a scheme, but this is something that could be monitored much more easily, as off-market trading in registered shares is very rare.

Yes, there is a public policy

In para 151, the judge complains that:

"There is no discernible public policy in Hong Kong regarding share splitting in the context of a scheme for privatisation of a company. Share splitting is not new in Hong Kong. Arbitrageurs have been very active in the stock market here."

We have already dealt with her second point - yes, arbitrageurs are very active in the market, but there is no evidence that they commonly engage in share-splitting. As for her first point, we disagree - there was a clearly discernible public policy when the SFC intervened in the proposed privatisation of Chinese Estates in 1992, filing an affidavit with the Court in Bermuda and alleging vote-rigging. The SCMP wrote on 2-Apr-92:

"The SFC said in a statement issued last night that it had told the Bermuda Court that the Takeovers Committee was "of the view that there are strong prima facie grounds for concern about the fairness of the vote at the February 10 meeting".

So there you have it - an SFC statement, and an affidavit filed in a Bermuda Court, both clearly indicating a public policy against vote-rigging. Even if there wasn't a policy before 1992, there surely was afterwards, and the market was well aware of it.

In our view, the court should not try to bounce this back to the SFC. The judge clearly accepts (para 125) that it has discretion to approve an SoA, sanction is not a formality, and it looks at all the circumstances of the case. It surely has to take account of any evidence of unfairness in the process by which the proposal was approved by the requisite majority of shareholders, particularly when the proposal involves a compulsory purchase of shares from dissenting shareholders.

A wild goose chase?

The judge does accept the SFC's submission in relation to certain other brokers who arranged split votes. She says of Eugene Chuang Yue-chien, the owner of Chung Nam Securities Ltd and Radland International Ltd, in para 109:

"I agree with the submission of the SFC that there are sufficiently cogent reasons to infer that the 132 and 18 persons in whose names the single board lots were acquired through Chung Nam and Radland did so as a result of a plan devised by Eugene Chuang, and this was done to boost the head-count in favour of the Scheme...The purchase of 125 of single board lots would appear to have been financed by Eugene Chuang."

And she says of Pollyanna Chu Li Yuet-wah, the Managing Director of Kingston, in para 116:

"There was a denial of Chu Li Yuet Wah but I do not regard this as credible....Notwithstanding her denial and the denials of some of the interviewees, I accept the submission of the SFC and infer that a scheme was devised by her as stated above. The 175 shareholders are the beneficial owners of the shares, but their shares are subject to a buy-back offer."

However, the judge also sees nothing wrong with this in relation to the SoA, again relying on Mr Howe's evidence (which we have refuted above) in para 120:

"As Mr. Howe had observed, arbitrageurs are very active in the Hong Kong stock market and it is not uncommon for them to adopt the device of splitting their shares into board lots or acquiring odd lots and registering them in the names of others to boost the number of their votes for the head-count requirement."

As we have already shown, vote-splitting is uncommon. In para 152, the judge argues:

"It must also be borne in mind what is sauce for the goose is sauce for the gander. Neither the court nor any other body in Hong Kong has the power to disregard any vote properly cast against a scheme, which may have the result of defeating the resolution such that the court will have no jurisdiction to sanction the scheme. In the absence of such a power, it would not be fair if the court were to start disregarding shares which are voted in favour of a scheme."

With respect, rigging a vote against a scheme would certainly be unfair, and could prevent it ever getting to court for a sanction, but since when do two wrongs make a right? Is the judge arguing that because we couldn't stop such unfairness by those opposed to a scheme, we should accept unfairness by those in favour?

Secondly, the "geese and ganders" argument takes a symmetric view of an asymmetric situation. Schemes of Arrangement impose an outcome on all members of a class. If a scheme is approved in a rigged vote, then those who opposed it are permanently deprived of their assets at a price they regarded as unacceptable. This fundamental "right to compensation for lawful deprivation of property" is protected by Article 105 of the Basic Law. That compulsory purchase doesn't happen if a vote is rigged to fail, in which case no property is displaced, and the offeror still has the option of making a general offer which individuals can accept or not, avoiding the headcount of an SoA altogether. So the consequences of possible vote-rigging in either direction are not symmetric. In any case, there is no evidence that anyone has ever split votes to vote against a deal, so is this argument a wild goose chase?

A "benefit" to the class?

After a citation of various cases, the judge says in para 164:

"I am inclined to agree with Mr Yu there is a lack of evidence, let alone strong and cogent evidence, to show that any particular Independent Shareholder who voted at the court meeting was not acting bona fide for the benefit of the Independent Shareholders as a class, namely, to ensure that they can realise their investment in the Company's shares at a premium. Other than the wish to attain the return of HK$4.50 a share, which would go to benefit the whole class, I am unable to discern any collateral interest on the part of those who had voted in favour of the Scheme"

With respect, surely those who voted against the scheme do not see it as a "benefit", otherwise they would have supported it. They presumably thought they would be better off in the long run if their shares were not cancelled at $4.50 each. Imagine, for the sake of argument, that the vote-splitting was done by opponents rather than proponents of the deal. Would the judge still argue that those who received these split votes were voting against the scheme "for the benefit of the class, namely, to ensure that they do not sell out at $4.50 per share"?

The point here is that those who vote in favour regard the scheme as a benefit to them, and those who vote against regard it as detrimental to their interests. The judge seems to be saying that those who vote in favour are conferring a benefit on those who vote against, because the opponents don't know what is good for them! A scheme of arrangement is binding on everyone in the class. It is not that they "can" receive $4.50 per share, as the judge put it, but that they "must" receive $4.50 per share. that is to say, if approved, the scheme imposes a compulsory purchase of shares from those who objected. It's not optional.

Secondly, if a shareholder was voting for the deal but had an indemnity against loss (as the judge accepted was true in some cases) then they did not have any financial interest in the outcome of the vote - so how can it be true that they were voting out of a "wish to attain the return of HK$4.50 per share"? They would get that anyway. As for those recipients of board lots who were acting as nominees, they had not financial interest in the outcome.

Conclusions

In our view, there is plenty of material in the Ruling for grounds of appeal. If the SFC wins, then PCCW will probably take it to the Court of Final Appeal (CFA), given the money at stake. If the SFC loses, there will be pressure on them to throw in the towel, but it will depend on the reasons given by the Court of Appeal. If there are important points of law at stake, then it should go the CFA and clear the air for good, because we need certainty on where the law stands. Either way, this case has highlighted an urgent need to amend the law to remove the headcount requirement, as we have consistently called for. The Government seems less than enthusiastic about this, talking through an anonymous spokesperson on the day of the Ruling about throwing the issue into a broader consultation on the Companies Ordinance in the 4th quarter of this year, which means it is unlikely to pass before 2011. They should accelerate it into a separate consultation and legislative bill - they have done so with urgent items before, such as the bill which enabled the MPF injection for low-income members. Virtually everyone, tycoons and investors alike, would like to see an end to the headcount rule, so it is unlikely to be a contentious proposal.

If the Ruling is upheld on appeal, then until the headcount is removed from law, vote-splitting will indeed become common and chaotic in the future on both sides of transactions. The Ruling would be an endorsement of vote-splitting from the Court, and Webb-site.com could use it to oppose transactions by donating 1 share to each reader as a souvenir of a transaction, in return for a signed proxy form, of course. If ganders can get away with it, then we'll be geese.

© Webb-site.com, 2009


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