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No statutory definition of promoter is given in English company law; however definition is given in case law. “The term ‘promoter,’ “ said Bowen L. J. In Whaley Bridge Calico Printing Co v Green (1880) “is a term not of law but of business…” On the other hand, promoters, as described in Cockburn, C.J in Twycross v Grant (1877) refers to “one who undertakes to form a company with reference to a given project and to set it going, and who takes the necessary steps to accomplish that purpose”. However, the term promoter does not include those who act merely in professional capacity acting on the instructions of a promoter for example a solicitor or an accountant. In this case, it is obvious that Candy and Caramel are promoters by setting up the business and entering into pre-incorporation contract.
A promoter stands in a fiduciary relation to the company it promotes and to those persons whom he induces to become shareholders in it. Therefore, Candy and Caramel have fiduciary duty towards Chocolicious Sdn Bhd. to act in good faith and to ensure that there is no conflict of interest. This is a position akin to quasi-trusteeship and the most important implication is that the promoter cannot make a profit from establishing the company, without full disclosure of that profit to either an independent board of directors.
In Erlanger v New Sombrero Phosphate Co.(1878), it was held that the contract should be void because the prospectus that offered the company’s shares to the public did not disclose the promoter’s profit. Lord Halsbury in the case of Gluckstein v Barnes (1900) states that the promoter of the company were under a duty to make explicit declarations of the profit they make from resale of the property.
The position in Malaysia is the same as the rationale in the above cases: Habib Abdul Rahman v Abdul Cader (1808-1890) 4 Ky 193 (Straits Settlement Supreme Court). This liability can be avoided and business transaction between promoter and his own company can be taken place as long as first, the promoter discloses the transaction in Memorandum of Association and Articles of Incorporation and second, the board of directors approve the transaction. The selling of nuts to Chocolicious Sdn Bhd happened before the prospectus was issued and should be disclosed. In relation to selling the consignment of nuts to Chocolicious Sdn. Bhd. for RM 45,000, it is not clear whether Candy disclose the profit of RM20,000 or not.
If Candy did not disclose, the company may rescind the contract (Erlanger v New Sombrero Phosphate Co.) or in certain circumstances, company may be able to claim the secret profit obtained by the Candy (Gluckstein v Barnes). The company may also file suit for damages for the breach of fiduciary duties if the misrepresentation is fraudulent as in the case of Re Leeds & Hanlet Theater(1902) 2 Ch 809.
A pre-corporation contract is one which is entered into when the company is in the process of being incorporated but is not yet completed. At common law such contracts were held to be void, as the company is not yet in existence. However, the person who purports to contract on behalf of the unborn company may be held personally liable and may be able to sue on the contract depending on the nature of the contract: Kelner v Baxter (1866) (The Modern Law Review). Further such pre incorporation contract cannot be ratified after its incorporation by its agent since there is no principal in existence as illustrated in Natal Land & Colonisation Co v Pauline Colliery Syndicate (1904). Other cases that illustrate this principle include Newborne v Sensolid Ltd (1955) and Kepong Prospecting Ltd & Ors v Schmidt (1968) and Black v. Smallwood & Cooper (1966) in Australia. If the company wants to take benefit of the contract, it must enter into a new contract on the same terms as the pre-incorporation contract. This process is known as novation. The first problem with common law’s position is unnecessary costs. This is because to deal with the risk of a potentially unenforceable contract, both parties will have to take costly precautions. Second, the promoters might then incorporate the corporation but fail to put any assets in the corporation, leaving creditors to sue an empty shell company. For example in Black v Smallwood(1966) the outsider entered into a pre incorporation contract only to find that no one was under an obligation to perform the contract.
Malaysian position is more favourable. The law allows a company to ratify any contract or other transaction incurred before incorporation. The Malaysian position is governed by S35 (1) and (2) of the Companies Act 1965. This section puts an innocent outsider in a far more satisfactory position than under the common law by enabling the outsider to enforce the contract.
S35 (1) of the Companies Act 1965 states that any contract or transaction purporting to be made by a company prior to its formation may be ratified by the company after its formation. Once ratified the contract becomes valid and binding between the parties. Both the company and other party will be able to enforce it. Therefore the pre-incorporation contract between Candy and the Brazilian company may be ratified by the company after its formation. After such ratification, Chocolicious Sdn. Bhd. shall become bound by the contract. If either party breached the contract, legal proceedings can be taken place as illustrated in Cosmic Insurance Co. Ltd v Khoo Chiang Poh. This case concerned S41 of the Singapore Companies Act which is equivalent to S35.
However, if Chocolicious Sdn. Bhd. refuses to ratify the contract, by section 35(2), it will be regarded as personally binding between the third party and the person who acted on behalf of the future company, unless there is an express agreement to the contrary. In Phonogram Ltd v Lane (1982) Lord Denning said the words “subject to any agreement on the contrary” in S35(2) mean “unless otherwise agreed” and emphasised that clear words would be required before personal liability is excluded. In this case, Candy signed the agreement as “Candy, acting solely on behalf of Chocolicious Sdn. Bhd.”. Since she purported to act on behalf of the company she shall be personally bound by the contract, although the company do not want o ratify the contract.
According to sec 233(2) of CMSA the person who issues securities will be required to prepare a prospectus. S232 of the CMSA states that a prospectus must include all the information that investors and their professional advisers would reasonably require to make an informed assessment of the merits of investing in the securities and the extent of the risk involved in doing so. Since the relevant person, in this case, the promoter as well as the director of the company actually knows the information, the information of uncertainty of raw material supply must be included. Failure to do so is a violation of S178 of CMSA where a person shall not have any dishonest concealment of material fact.
Chocolicious Sdn. Bhd should form a due diligence committee comprising both of the director and advisers to review the available information about the company and make sure that the prospectus is complete and correct.
According to SC’s Prospectus Guidelines 2007, a prospectus must include the extent of risk involved, in this case, the uncertainty of supply of environmentally friendly raw material to fulfil the requirement of sec 235 of the CMSA. The other listing requirement is not to be vulnerable to specific factors or events. The dependence on the supply of environmental friendly supply must be thoroughly investigated and the analysis should cover the business and financial risk involved the steps taken or will be taken to mitigate the risk should also be covered.
Chocolicious Sdn. Bhd and its shareholders have a contractual relationship. Therefore a shareholder who has bought shares on the basis of misstatement or non disclosure in a prospectus has contractual remedies against the company. Rule of misrepresentation governed by common law is violated in the form of misrepresentation through silence. The non disclosure of the material fact that there is uncertainty in supply creates wrong impression that the business is assumed to be going-concern with least risk in the near future. This misrepresentation might induce the buying of shares. Cases involved are Scott v Dixon (1859) and Gerhard v Bates(1853) where the fraudulent prospectus induced the buying of share, and action can be brought against the company.
To prove that there is an omission, the omitted information must be a material fact. From the fact that the share value of Chocolicious Bhd. has plummeted to RM 1.00 from RM5.00 as soon as the report is published, it is obvious that the fact of uncertainty of raw materials is material and would cause shareholder to lose confidence and interest in Chocolicious Bhd.
The consequences following the omission of material fact is that under sec 245 of the CMSA, the SC may order Chocolicious Bhd. not to allot, issue, offer make an invitation to subscribe for or purchase or sell further securities to which the prospectus relates.
According to sec 246 CMSA, both Candy and Caramel face criminal liability for issuing prospectus which contains material omission. A fine not exceeding RM3 million or imprisonment for a term not longer than 10 years or both will be imposed on Candy and Caramel.
According to sec 249, Candy and Caramel also face civil liability claims from a purchaser or subscriber of the securities. Sec 248 of the CMSA provides that if a person subscribes for securities in the basis of the prospectus that they issued, such a person has the right to recover for loss incurred. According to section 248 of the CMSA the banker is also liable for all the loss or damage due to inclusion of the statement. House of Lords ruled in Potts v Miller (1940) that the measure of damages in an action of compensation is the same as the measure of damages for deceit in Clarke v Urquhart (1930). Once the investors prove that their loss is caused by the material omission in the prospectus he or she will succeed unless Candy and Caramel can establish the existence of any statutory defences.
Candy and Caramel can show the due diligence defense whereby they have made all the reasonable enquiries and reasonable believes that there was no material omission, according to sec 250. They can use reasonable reliance defense, according to sec 251, whereby they have not gained consent to publish the information from the unpublished report of United Nation.
Candy and Caramel are directors and as such have certain duties to the company. According to S,4(1) Companies Act 1965, the directors of a company are those persons constituting the board and whose duty is to supervise the policy and management of the company. In Malaysia rules regarding directors’ duties have been supplemented by statutory provisions introduced by the Companies (Amendment) Act 2007.
The issue is that of both Candy and Caramel’s breach of directors’ duties which they owed to Chocolicious Sdn Bhd. Candy and Caramel had fiduciary duties at common law as well as duties under S132(1).
S132(1) is introduced in the amended Companies Act 2007. A director of a company shall at all times exercise his powers in good faith in the company’s best interest and for a proper purpose. The phrase ‘best interest of the company” is not statutorily clarified in order to maintain flexibility (Balan and Sujata, 2008). Here Candy’s action may not have been for the best interest of the company.
Candy sold the consignment of nuts to Chocolicious Sdn. Bhd. with a profit of RM20,000. This is a breach of directors’ requirements to act in good faith. On the other hand, since Chocolicious Sdn. Bhd is successfully listed, it will has an aggregate profit of at least RM20 million for 3 – 5 full financial years, thus the RM20,000 is probably not a material quantity and it is probably not detrimental to the company. It is not stated in the case that whether or not she disclose the profit that she made, but for the fact that the amount is not significant, she is not violating S131(2). S131(2) provides that a director does not have to declare his interest in a company contract if the interest is regarded as not material.
With regard to the purchase of the consignment of nuts for RM 45,000, it is clear that the directors have breached their fiduciary duty to act honestly and in the best interest of the company. They have taken a gift of RM20,000. This amounts to a secret profit. Hence they may also be considered to be in breach of their duty not to make secret profits.
Remedies available to Chocolicious Sdn. Bhd could include Candy may have to pay Chocolicious Sdn. Bhd profits made from his personal contracts – Furs Ltd v Tomkies establishes that an undisclosed profit which a director derives from the execution of his fiduciary duties belongs in equity to the company. S1317HA(1) also allows for recovery of profits by Chocolicious Sdn. Bhd and compensation for loss or damage caused by Candy’s breaches of his duties under S132(1).
The Objectives and Principles of Securities Regulation published by the International Organization of Securities Commissions (IOSCO) in 1998 and updated in 2003 states that the three objectives of good securities market regulation are (1) investor protection, (2) ensuring that markets are fair, efficient and transparent, and (3) reducing systemic risk. The regulation of insider trading is one of the steps taken. Thus prohibition of insider trading is to eradicate the potential for conflicts of interest, maintain good corporate governance, and ensure market integrity and equal access.
The passing of the Capital Market & Services Act, 2007 (CMSA) in September 2007 signifies the statutory provisions governing insider trading. Bursa Malaysia Securities Berhad defines insider trading as the purchase or sale of a company’s securities affected by or on behalf of a person with knowledge of relevant but non-public material information regarding that company.
From this definition it can be understood that to constitute insider trading, there are three elements need to be fulfilled.
First: The trading is effected by an insider.
According to S188 (1) of the CMSA, an insider is someone who possesses non-public material information. Thirsty, the director of the bank is in a position to make massive gains from the inside information. Although he is not part of the management of Chocolicious, the fact that he is providing financial assistance to Chocolicious Sdn. Bhd. and has material non-public information makes him liable for insider trading rule.
This is supported in the case of Dirks v. SEC (1984) where “constructive insiders,” who are lawyers, investment bankers and others who receive confidential information from a corporation while providing services to the corporation are also liable for insider trading violations if the corporation expects the information to remain confidential, since they acquire the fiduciary duties of the true insider.
Second: Relevant Information is material and non-public
Relevant information includes matters relating to future, i.e. the uncertainty of the supply of raw materials as being environmentally friendly will affect the future production and supply for chocolates. Section 184 of the CMSA states that information is generally available if it has been made known in a manner likely to bring it to the attention to reasonable investors. It is clearly stated that Thirsty gain information from unpublished United Nations report, thus the information is not available to general public.
Third: Information will affect the price of the company’s securities when it is made available to the public.
Section 185 of the CMSA states that information that would have or tend to have a material effect on the price or value of a company’s securities refers to information that is likely to influence reasonable people who invest in securities in deciding whether to subscribe for, buy or sell that company’s securities. In relation to the information of uncertainty of raw material supply, it is material since the share value of Chocolicious Sdn. Bhd. plummeted to RM 1.00 right after the report was published.
In SEC v. Texas Gulf Sulphur Co. (1966), a U.S. federal circuit court stated that anyone in possession of inside information must either disclose the information or refrain from trading (Haddock). Failure to comply with the rules leads to the trading offence, procuring offence or tipping offence.
In relation to the tipping offence, S188 (3) CMSA states that an insider is also prohibited from communicating inside information to a third party whom the insider knows or ought reasonably to know would either trade or would procure another person to trade on. Thirsty give the tips to her wife with the intention to advise his wife Yummy to sell all her shares in the company. Thus the mere fact of providing confidential information is an offence by itself although Yummy was not able to take any action at the end and no trading occurred.
If a person commits insider trading he may be subjected to certain criminal and civil action. Criminal prosecution includes imprisonment for a term not exceeding ten years and to a fine of not less than RM 1 million. However, there are not much cases being established. The only criminal case involving insider trading in Malaysia is the case of Public Prosecutor v Chua Seng Huat (1999).
Section 201(5) (6) of the CMSA states the civil suits instituted by the Securities Commission. For example in August 2004, the Securities Commission imitated civil enforcement action against Kuala Lumpur City Securities Sdn Bhd and Wan Azmi bin Wan Abdul Rahman, a former employee of Bernas, requiring them to disgorge RM 2,080,000, twice the amount gained by them from the inside trading.
The punishment do not limit to the tipper only. In 1984, the Supreme Court of the United States ruled in the case of Dirks v. SEC that tippees are liable if they had reason to believe that the tipper had breached a fiduciary duty in disclosing confidential information and the tipper received any personal benefit from the disclosure.
In the UK, the relevant laws are the Criminal Justice Act 1993 and the Financial Services and Markets Act 2000, which defines an offence of Market Abuse. The principle is that it is illegal to trade on the basis of market-sensitive information that is not generally known, similar to Malaysian position. This indicates that the Malaysian position is fairly satisfactory. However, it is seen by practical examples that the success of Insider Trading laws in the UK has been pretty low. Most of the defendants have been acquitted on technicalities owing mainly to the rigidity in the definition of Insider Trading and partly because of the inadequate powers granted to the Securities and Investments Board (SIB).
Criticism of insider trading law
While the provision of the law appears satisfactory, the lack of prosecution in this area is of great concern. As of 2010, there has only been one successful prosecution: PP v Chua Seng Huat (1995). This has been a criticism for the unpractical purpose as insider trading is almost impossible to prosecute and the government wastes countless dollars trying. This is because it is hard to establish solid evidence and it requires someone to whistle blow. Unless the tippee suffered huge loss from the wrong inside information, if not it is rarely that the beneficiary will whistle blow. The lack of protection for whistle blowers also a factor in the poor execution of law. Given the inherent difficulties in investigating and proving insider trading cases, the reality is that there is a significant amount of clearly illegal activity that goes undetected or unpunished.
Black v. Smallwood & Cooper (1966) 2
Clarke v Urquhart (1930) 4
Cosmic Insurance Co. Ltd v Khoo Chiang Poh. 3
Dirks v. SEC (1984) 6
Erlanger v New Sombrero Phosphate Co.(1878) 1
Gluckstein v Barnes (1900) 1
Habib Abdul Rahman v Abdul Cader (1808-1890) 4 Ky 193 (Straits Settlement Supreme Court) 1
Kelner v Baxter (1866) 2, 4
Kepong Prospecting Ltd & Ors v Schmidt (1968) 2, 4
Natal Land & Colonisation Co v Pauline Colliery Syndicate (1904). 2
Newborne v Sensolid Ltd (1955) 2
Phonogram Ltd v Lane (1982) 3
Potts v Miller (1940) 4
PP v Chua Seng Huat (1995). 8
Public Prosecutor v Chua Seng Huat (1999). 7
Re Leeds & Hanlet Theater 2
Scott v Dixon (1859) 4
SEC v. Texas Gulf Sulphur Co. (1966) 7
Twycross v Grant (1877) 1
Whaley Bridge Calico Printing Co v Green (1880) 1
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