FEDERAL COURT OF AUSTRALIA

Australian Securities and Investments Commission, in the matter of Sino Australia Oil and Gas Limited (in liq) v Sino Australia Oil and Gas Limited (in liq) [2016] FCA 934

ORDERS

THE COURT DECLARES THAT:

1.    The First Defendant contravened s 728(1)(a) of the Corporations Act 2001 (Cth) (“the Act”) by offering shares in it under a Replacement Prospectus dated 26 April 2013 (“the Replacement Prospectus”) which contained the following misleading or deceptive statements:

(a)    “Sino Australia has two current patents to operate its enhanced oil and gas Technology (RHD) presently operating in China” (page 2);

(b)    “SAO holds 2 patents for Enhanced Oil Recovery” (page 8);

(c)    “Sino Australia Oil provides patented, proven and cost-effective EOR drilling technology. The Company owns two patented sidetrack drilling techniques” (page 20);

(d)    “ … the Company is seeking to enter the Australasian oil and gas markets and introduce its proven patented technologies to these markets through both licensing and operations to existing oil and gas companies” (page 20);

(e)    “Zhaodong Huaying Oil Drilling Service Company (PRC) received published patent notification for Radial Hydraulic Jet Drilling Technology and Radial Drilling System Working Status Monitoring Device on 18 January 2012 and 28 March 2012 respectively. Both patents were granted by The Intellectual Property Office of the People’s Republic of China … These patents differentiate and protect the Company as they provide the Company exclusive rights to utilize the technology … ” (page 22);

(f)    “According to the copies of patents provided from Zhaodong, the Company has two inventive patents” (page 23);

(g)    “Zhaodong holds the two current patents” (page 24); and

(h)    “The Sino Australia patented technology is of extreme importance to the company’s ability to trade” (page 35).

2.    The First Defendant contravened s 728(1)(a) of the Act by offering shares in it under the Replacement Prospectus which contained the misleading or deceptive statements at pages 71 to 72 that it had service contracts with 16 customers, covering 1,260 wells, with a combined value of RMB360,865,000.

3.    The First Defendant contravened s 728(1)(a) of the Act by offering shares in it under the Replacement Prospectus which contained the misleading or deceptive statements at pages 3 to 4, 45, 47 and 49 that it had cash and cash equivalents as at 30 June 2012 including $3,114,000 from the proceeds of certain convertible notes.

4.    The First Defendant contravened s 728(1)(b) by offering shares in it under a Third Supplementary Prospectus dated 25 October 2013 (“the Third Supplementary Prospectus”) which omitted to disclose that circumstances had arisen the consequence of which was that the profit forecast of $13.66 million given in the Replacement Prospectus at pages 3 and 40 for the financial year January to December 2013 would not be achieved.

5.    The First Defendant contravened s 728(1)(b) of the Act by offering shares in it under the Third Supplementary Prospectus which omitted to disclose the loan of A$937,000 made to its subsidiary company Daqing Huao Shangfeng Oil Field Technology Limited Company by the sole director of that subsidiary company, Ms Ma Liang.

6.    The First Defendant contravened s 728(1)(c) of the Act by offering shares in it under the Replacement Prospectus, a Supplementary Prospectus dated 26 July 2013 (“the Supplementary Prospectus”), a Second Supplementary Prospectus dated 9 August 2013 (“the Second Supplementary Prospectus”) and the Third Supplementary Prospectus which omitted to disclose that circumstances had arisen the consequence of which was that the profit forecast of $13.66 million given in the Replacement Prospectus at pages 3 and 40 for the financial year January to December 2013 would not be achieved.

7.    The First Defendant contravened s 1041H of the Act by providing to its auditors false information concerning the profit and loss of its subsidiary Zhaodong Huaying Oil Drilling Services Company Limited (“Huaying”) in the financial year January to December 2012.

8.    The First Defendant contravened s 1041H of the Act by providing to its auditors false information concerning the assets and liabilities of its subsidiary Huaying at 31 December 2012.

9.    The First Defendant contravened s 1041H of the Act by providing to its auditors false information concerning the profit and loss of its subsidiary Huaying in the financial year January to December 2013.

10.    The First Defendant contravened s 1041H of the Act by providing to its auditors false information concerning the assets and liabilities of its subsidiary Huaying at 31 December 2013.

11.    The First Defendant contravened s 1041H of the Act by providing to its auditors false information concerning the profit and loss of its subsidiary Huaying in the financial year January to December 2014.

12.    The First Defendant contravened s 1041H of the Act by providing to its auditors false information concerning the assets and liabilities of its subsidiary Huaying at 31 December 2014.

PURSUANT TO S 1317E OF THE ACT, THE COURT DECLARES THAT:

13.    The First Defendant contravened s 674(2) of the Act by failing, between 13 December 2013 and 1 April 2014, to notify the ASX that circumstances had arisen a consequence of which was that the profit forecast of $13.66 million given in the Replacement Prospectus at pages 3 and 40 for the financial year January to December 2013 would not be achieved.

14.    The Second Defendant was involved in the First Defendant’s contravention of s 674(2) of the Act and thereby contravened s 674(2A) of the Act.

15.    The Second Defendant contravened s 180(1) of the Act in the period July to October 2013 by approving the Replacement Prospectus, the Supplementary Prospectus, the Second Supplementary Prospectus and the Third Supplementary Prospectus without understanding the English text and without obtaining Chinese language translations of them.

16.    The Second Defendant contravened s 180(1) of the Act in 2013 and 2014 by failing to acquaint himself with the disclosure requirements for publicly listed companies under Australian law.

17.    The Second Defendant contravened s 180(1) of the Act in the period July 2013 to January 2014 by failing to disclose to the Board of the First Defendant that circumstances had arisen the consequence of which was that the First Defendant’s profit forecast of $13.66 million given in the Replacement Prospectus at pages 3 and 40 for the financial year January to December 2013 would not be achieved.

18.    The Second Defendant contravened s 180(1) of the Act in the period 13 December 2013 to 13 March 2014 by seeking to cause the First Defendant to transfer approximately AUD$7.5 million standing in its account numbered 342011-475068001 to an account in China of its subsidiary Huaying without providing the Board of the First Defendant with a proper explanation for the transfer and without complying with the Chinese regulatory requirements necessary to ensure that the funds would be recoverable by the First Defendant from Huaying.

19.    The Second Defendant contravened s 180(1) of the Act in the period July 2013 to April 2014 by causing or permitting the First Defendant to contravene s 728(1)(a) of the Act.

20.    The Second Defendant contravened s 180(1) of the Act during July 2013 to April 2014 by causing or permitting the First Defendant to contravene s 728(1)(b) of the Act.

21.    The Second Defendant contravened s 180(1) of the Act during July 2013 to April 2014 by causing or permitting the First Defendant to contravene s 728(1)(c) of the Act.

22.    The Second Defendant contravened s 180(1) of the Act during July 2013 to April 2014 by causing or permitting the First Defendant to contravene s 674 of the Act.

23.    The Second Defendant contravened s 180(1) of the Act during July 2013 to April 2014 by causing or permitting the First Defendant to contravene s 1041H of the Act.

Note:    Entry of orders is dealt with in Rule 39.32 of the Federal Court Rules 2011.

REASONS FOR JUDGMENT

DAVIES J:

1    The plaintiff (“ASIC”) has applied for declarations of contravention of the Corporations Act 2001 (“the Act”) against the first defendant (“Sino or “the company”) and the second defendant (“Mr Shao”), the former executive director and chairman of the company. If made, ASIC, in a separate hearing, will seek civil penalty orders against the company and an order disqualifying Mr Shao from acting as a director for a period of time. Only the declarations of contravention are sought at this stage.

background

2    Sino is the Australian holding company of a Chinese operating company which claims to provide enhanced oil and gas recovery services to the oil and gas industry in China. The Chinese operating company is Zhaodong Huaying Oil Drilling Services Company Limited (“Huaying”).

3    On 28 February 2013, Sino issued a prospectus for an initial public offering on the Australian Stock Exchange, inviting subscribers to apply for fully paid ordinary shares in the company. On 26 April 2013, Sino issued a Replacement Prospectus. The company issued the following further prospectuses:

(a)    a Supplementary Prospectus on 26 July 2013;

(b)    a Second Supplementary Prospectus on 9 August 2013;

(c)    a Third Supplementary Prospectus on 25 October 2013.

4    Mr Shao signed the Replacement Prospectus and the director’s declaration attached to each subsequent prospectus document before lodgment.

5    On 11 December 2013 Sino was admitted to the official list of the Australian Stock Exchange and announced that it had raised AUD$12,829,318 from the initial public offering.

6    On 12 December 2013 the company’s securities became admitted for quotation and it became a listed disclosing entity within the meaning of s 111AL(1) of the Act and therefore subject to the continuous disclosure obligations of s 674 of the Act.

7    On 13 December 2013, Mr Shao sought the authorisation of Mr Johnson, one of the two Australian resident directors (the other being Mr Faulkner), to transfer almost all the remaining proceeds of the float (approximately $7.5 million) out of Australia to a bank account of Sino in China, of which neither Mr Johnson nor Mr Faulkner had any knowledge. In late December 2013 and again in January 2014, Mr Shao repeated the request to Mr Johnson and Mr Faulkner. Mr Shao gave them various explanations for why the money had to be transferred and, ultimately, when they refused to cooperate, he moved to have them replaced as directors. They then approached ASIC with concerns about the governance of the company.

8    On 13 March 2014, ASIC sought and obtained an injunction to restrain the company, Mr Shao and various other defendants from dealing with the proceeds of the initial public offering pending an investigation by ASIC.

9    On 13 March 2014, ASIC commenced its investigation into the company and Mr Shao under s 13(1) of the Australian Securities and Investments Commission Act 2001 (Cth) (“the ASIC Act”).

10    On 21 November 2014, ASIC filed an application seeking substantive relief in this proceeding, including declarations, a penalty against the company and a disqualification order against Mr Shao.

11    In April 2015, ASIC received information from a foreign regulatory agency casting serious doubt on whether the company had any substantial business in China. ASIC sought an explanation from the company which was never provided.

12    Shortly afterwards, on 4 May 2015, Sino appointed voluntary administrators and terminated its solicitors’ retainer. Since that time, neither Sino nor Mr Shao have actively participated in the litigation.

13    On 21 May 2015, the Court appointed Peter McCluskey as provisional liquidator to the company. Mr McCluskey was ordered to deliver a report to the Court responding to certain questions.

14    On 4 September 2015, the provisional liquidator delivered and filed his report (“the McCluskey Report”).

15    On 27 November 2015, ASIC filed an amended statement of claim and an amended interlocutory process extending its claim, and the relief it seeks, to include the matters disclosed by the McCluskey Report.

16    Both the company and Mr Shao failed to file an amended defence.

17    On 4 March 2016, the Court ordered that the company be wound up on just and equitable grounds and Mr McCluskey was appointed liquidator.

18    On 10 June 2016, the liquidator filed an interlocutory application for a compensation order against Mr Shao.

claims overview

19    In summary, ASIC alleged that the company contravened various provisions of the Act by reason of:

(a)    false statements in the prospectus documents in relation to patents claimed to be held by the company;

(b)    the failure to make disclosure of material information concerning the profit downgrade for the 2013 calendar year from the profit forecast in the Replacement Prospectus;

(c)    omissions from, and misleading and deceptive statements in, the prospectus documents in relation to a loan and certain service contracts; and

(d)    false statements in the Replacement Prospectus, and the provision of false information to its auditors, with respect to certain financial information; and

(e)    misleading and deceptive conduct in respect of the company’s and Huaying’s financial position.

20    ASIC has alleged that Mr Shao was involved in the company’s failure to make continuous disclosure and that he breached his duties as director of the company.

the acts and conduct of the company

The patent statements

21    ASIC alleged that the company contravened s 728(1)(a) of the Act in respect of false representations that it made in the Replacement Prospectus in respect of certain patents that it and its subsidiary, Huaying, claimed to hold.

22    Section 728(1)(a) provides that a person must not offer securities under a disclosure document if there is a misleading or deceptive statement in the disclosure document.

23    Sino and Mr Shao admitted that the following representations were false:

(a)    “[Sino] holds two current patents for Enhanced Oil Recovery”

(b)    “[Sino] provides patented Enhanced Oil Recovery drilling technology”

(c)    “[Sino] is seeking to enter the Australasian oil and gas markets and introduce its proven patented technologies to these markets through both licensing and operations to existing oil and gas companies”

(d)    “The [company’s] patented technology is of extreme importance to the company’s ability to trade”

(e)    “The Intellectual Property Office of the People’s Republic of China (“SIPO”) had granted Huaying two patents which give the company exclusive rights to utilize the technology”

(f)    “Huaying has two inventive patents”

(g)    “Huaying holds two current patents”

24    Based on the admissions I find that Sino contravened s 728(1)(a) of the Act by making those false representations.

Profit forecast and continuous disclosure

25    ASIC alleged that Sino (and Mr Shao) failed to disclose that the company’s profit for the 2013 calendar year would be significantly less than the forecast in the Replacement Prospectus.

26    The Replacement Prospectus stated that the company’s net profit after tax for the financial year ending 31 December 2013 was expected to be $13.66 million. On 1 April 2014, the company announced that its actual profit for the period was $8.396 million. This was recorded in the company’s Appendix 4E (Preliminary Final Report) for the year ended 31 December 2013 (“the Appendix 4E Report”).

27    ASIC alleged that following the issue of the Replacement Prospectus, the following material circumstances occurred which adversely affected the company’s likely future net profit after tax for the financial year ending 31 December 2013 and contributed to the decrease in net profit:

28    The first circumstance was that in about June 2013, the company (through its operating subsidiary Huaying) began to provide services to customers in remote areas in China which resulted in increased staff costs and transportation costs. This was admitted by Mr Shao in his examination conducted under s 19 of the ASIC Act (“s 19 examination”). Mr Shao’s statements at his examination are admissible in evidence against him either pursuant to s 76 of the ASIC Act and against the company pursuant to s 87 of the Evidence Act 1995 (Cth): Australian Securities and Investments Commission v Astra Resources PLC [2015] FCA 759 at [124]–[126]. Further, although Sino and Mr Shao denied the allegation in their defences they instead admitted that:

… In the second half of 2013, … Huaying … expanded its business and revenues by providing services to customers in the Chinese Xinjiang and Changqin oilfields at lower profit margins than those that it realised from its pre-existing business.

29    The second circumstance was that between July 2013 and 12 December 2013 the company incurred additional equipment lease expenses of $2.6 million because of delay in receiving delivery of capital equipment. This was admitted by Mr Shao in his s 19 examination. Furthermore, although Sino and Mr Shao also denied this allegation in their defences, their denials are contradicted by the operational and financial review in the Appendix 4E Report. The operational and financial review included the following statement:

… the planned purchase of two additional drilling rigs in July 2013 was delayed until 2014, resulting in a net increase of equipment lease expense of $2,620,890 in the second half of 2013.

30    The third circumstance was that from about August or September 2013, the company began experiencing delays in receiving payments from its Chinese state-owned enterprise customers. This was admitted by both Sino and Mr Shao. The Appendix 4E Report and Annual Report lodged by the company also confirmed the delay in receiving payments from state-owned enterprises since the middle of 2013.

31    The fourth circumstance was that there were successive delays during the initial public offering (which did not close until 12 December 2013) resulting in increased costs of approximately $1 million. Sino and Mr Shao denied this allegation but their denials are contradicted by the notice that the company gave to the ASX on 15 April 2014 which referred to:

… the variation in prospectus issue expenses which are $1 million more than expected …

Mr Shao also admitted the $1 million increase in cost associated with the delay of the closing in his s 19 examination.

32    ASIC further alleged that those circumstances adversely affected the company’s likely future net profit after tax for the financial year ending 31 December 2013 and contributed to the 39% decrease in actual net profit compared to the forecast in the Replacement Prospectus. Sino and Mr Shao admitted that the first, second and fourth circumstances did affect the company’s likely future net profit after tax but not the third circumstance. Nonetheless, it may reasonably be inferred that the third circumstance was likely to affect the company’s likely future net profit after tax as it was represented in the Replacement Prospectus that all of the company’s customers were either state-owned enterprises or their wholly-owned subsidiaries. Furthermore, the delay in payment from the state-owned enterprises was the first adverse event referred to in the “Commentary on Full Year Results” in both the Appendix 4E and Annual Reports, which is further evidence that the company considered that the payment delay contributed to the profit downgrade. Mr Johnson and Mr Faulkner, the two Australian-based directors, also confirmed that Mr Shao had told them this. Both of them said in their s 19 examinations that Mr Shao had told them the delay in payment by the state-owned enterprises had caused cash flow issues for the group. ASIC may rely on their s 19 examinations pursuant to s 77 of the ASIC Act.

33    Sino and Mr Shao both admitted that the company did not disclose either in its prospectus documents or to the ASX any of those four circumstances or the profit downgrade of 39% until it lodged the Appendix 4E Report on 1 April 2014. The failure to make those disclosures was a contravention of s 728(1)(b) and of s 728(1)(c) of the Act. Sections 728(1)(b) and (c) provide as follows:

728 Misstatement in, or omission from, disclosure document

Misleading or deceptive statements, omissions and new matters

(1)    A person must not offer securities under a disclosure document if there is:

(a)    …

(b)    an omission from the disclosure document of material required by section 710, 711, 712, 713, 713C, 713D, 713E, 714 or 715; or

(c)    a new circumstance that:

(i)    has arisen since the disclosure document was lodged; and

(ii)    would have been required by section 710, 711, 712, 713, 713C, 713D, 713E, 714 or 715 to be included in the disclosure document if it had arisen before the disclosure document was lodged.

Note 1:    The person may make further offers after making up the deficiency in the current disclosure document by lodging a supplementary or replacement document.

34    Section 710(1) of the Act provides that, relevantly:

(1)    A prospectus … must contain all the information that investors and their professional advisers would reasonably require to make an informed assessment of the matters set out in the table below. The prospectus must contain this information:

(a)    only to the extent to which it is reasonable for investors and their professional advisers to expect to find the information in the prospectus; and

(b)    only if a person whose knowledge is relevant (see subsection (3)):

(i)    actually knows the information; or

(ii)    in the circumstances ought reasonably to have obtained the information by making enquiries.

…

35    The evidence showed and I find that each of the four circumstances were likely to (and did) significantly affect the company’s profit and was thus information which an investor would reasonably have required in order to assess the company’s financial position and was information that was within the scope of s 710(1). Furthermore, based on the admissions of Mr Shao, it was information known to him. Accordingly, to the extent that this information was available at the time of issue of each of the prospectus documents, there was an omission of material required by s 710 (s 728(1)(b)) and to the extent that this information was only available afterwards, it was a new circumstance that would have been required by s 710 (s 728(1)(c)).

36    In addition, by failing at any time between 12 December 2013 (the listing date) and 1 April 2014 (when the Appendix 4E Report was filed) to disclose that a variation to the forecast profit was likely, the company contravened s 674(2) of the Act.

37    Sections 674(1) and (2) of the Act provide, relevantly:

(1)    Subsection (2) applies to a listed disclosing entity if provisions of the listing rules of a listing market in relation to that entity require the entity to notify the market operator of information about specified events or matters as they arise for the purpose of the operator making that information available to participants in the market.

(2)    If:

(a)    this subsection applies to a listed disclosing entity; and

(b)    the entity has information that those provisions require the entity to notify to the market operator; and

(c)    that information:

(i)    is not generally available; and

(ii)    is information that a reasonable person would expect, if it were generally available, to have a material effect on the price or value of ED securities of the entity;

the entity must notify the market operator of that information in accordance with those provisions.

38    The company was a listed disclosing entity. The company and Mr Shao admitted that from 12 December 2013, the company was required to disclose market sensitive information to the ASX immediately by operation of ASX Listing Rule 3.1 and s 674 of the Act.

39    Listing Rule 3.1 provides that:

Once an entity is or becomes aware of any information concerning it that a reasonable person would expect to have a material effect on the price or value of the entity’s securities, the entity must immediately tell ASX that information.

40    Sino and Mr Shao both admitted that the difference between the profit forecast published by the company on 26 April 2013 and the actual profit reported on 1 April 2014 (being a difference greater than 10%) was information that a reasonable person would expect to have a material effect on the price or value of the company’s securities and market sensitive information. In their defences, however, they denied that s 674(2) was contravened although they admitted that the Replacement Prospectus stated that the company’s net profit after tax for the financial year ending 31 December 2013 was expected to be $13.66 million and the “actual total comprehensive income net of tax was $12.69 million”. It is not at all clear what was intended by this defence which does not provide an answer to the s 674(2) contravention claim.

Loan agreement

41    ASIC alleged that in about August 2012 Huaying entered into a loan agreement with Ms Ma Liang, the sole director of a subsidiary of Sino, Daqing Huao Shengfeng Oil Field Technology Ltd Company (“Daqing”), which required Ms Ma to advance the sum of ¥6.2 million to Huaying and Huaying to repay the loan amount by 31 December 2013. Sino and Mr Shao admitted the loan, though documents obtained by ASIC showed that the loan was made by Ms Ma to Daqing. Daqing is the immediate holding company of Huaying.

42    ASIC submitted that the existence of this loan was information that an investor or professional advisor would reasonably require within the terms of s 710 of the Act. There is also evidence that Mr Shao knew of the existence of the loan. I accept ASIC’s submission and as the loan was not disclosed in any of the prospectus documents, I find that the company contravened s 728(1)(b) in failing to make that disclosure.

Service contracts

43    ASIC alleged in the amended statement of claim that the company contravened s 728(1)(a) of the Act with respect to the disclosure of material contracts in the Replacement Prospectus. Section 728(1)(a) provides as follows:

(1)    A person must not offer securities under a disclosure document if there is:

(a)    a misleading or deceptive statement in:

(i)    the disclosure document; or

(ii)    any application form that accompanies the disclosure document; or

(iii)    any document that contains the offer if the offer is not in the disclosure document or the application form …

The Replacement Prospectus contained a table setting out “material contracts”. The table listed 16 service contracts servicing 1,260 wells with a worth of around RMB360,865,000 for the 2012 calendar year. ASIC alleged that the disclosure of those contracts was misleading or deceptive because a number of those contracts either did not exist or the Replacement Prospectus incorrectly identified the number of wells supported. No defence was filed to these allegations.

44    I am satisfied on the basis of the following evidence before the Court that the company did contravene s 728(1)(a) with respect to the disclosure of its service contracts. Under a request for assistance that ASIC made of a foreign regulatory authority (“the Authority”), ASIC received information from that authority that indicated that the Authority had only been able to verify the existence of seven contracts for 15 oil wells. In April 2015, ASIC wrote to the company’s then solicitors seeking an explanation for the significant discrepancies between the information concerning the contracts listed in the Replacement Prospectus and the information that had been provided by the Authority. ASIC received no response to that letter. Nor did the company or Mr Shao file any material either to verify that the listing of the service contracts in the prospectus documents was accurate or to explain the discrepancies. Furthermore, the provisional liquidator also investigated and sought to verify each of the service contracts identified in the Replacement Prospectus and he was only able to verify 10 contracts in respect of 187 wells. On the basis of that evidence, I am satisfied that the summary of the service contracts in the Replacement Prospectus was misleading and deceptive and in contravention of s 728(1)(a) of the Act.

Financial information

45    ASIC alleged in the amended statement of claim that the company contravened s 728(1)(a) of the Act with respect to the inclusion in the financial statements of the company in the Replacement Prospectus in the item “cash and cash equivalents as at 30 June 2012” of $3,114,000 from the proceeds of certain convertible notes. This item was investigated by the provisional liquidator who found no evidence that the proceeds from the convertible notes were ever paid into the company’s Australian bank accounts and was unable to ascertain where the proceeds went. I am satisfied on the strength of the provisional liquidator’s investigations that the company did not receive $3,114,000 from the proceeds of convertible notes. I find that the accounting for the proceeds as cash or cash equivalent in the company’s forecast statement of financial position was a misleading or deceptive statement and in contravention of s 728(1)(a) of the Act.

Representations to the auditors

46    Finally, ASIC alleged that the company made certain representations to its auditors, Grant Thornton Australia Limited (“Grant Thornton”), in the course of Grant Thornton’s work in preparing the company’s audited financial statements for the years ended 31 December 2012, 31 December 2013 and 31 December 2014 concerning Huaying’s net asset position and net profit position, which differed from Huaying’s net asset position and net profit position for those years as recorded in Huaying’s management accounts for those years. The discrepancies were as follows and were disclosed by the provisional liquidator’s examination of Huaying’s management accounts for those years.

47    The representations to the auditors are reflected in the consolidated work papers of Grant Thornton which the provisional liquidator also reviewed. I accept on the basis of the provisional liquidator’s review of Huaying’s management accounts that the representations to Grant Thornton were false.

48    ASIC alleged that by providing false information about Huaying’s financial position to its auditors, the company engaged in misleading or deceptive conduct contrary to s 1041H of the Act. Section 1041H(1) provides, relevantly:

A person must not … engage in conduct, in relation to a financial product or a financial service, that is misleading or deceptive or is likely to mislead or deceive.

49    “Financial product” is defined to include securities (s 764A(1)(a)), which is further defined to include shares (s 761A of the Act). Shares in the company were thus “a financial product”.

50    In Australian Securities and Investments Commission v Narain (2008) 169 FCR 211; [2008] FCAFC 120, it was held that a publicly listed company and its managing director engaged in misleading or deceptive conduct in relation to a financial product by making false statements about the business of the company which were likely to affect its share price. So too here, the impugned representations concerned the financial performance of Sino’s operating subsidiary and were therefore likely to affect the value of its shares. I accordingly accept that the provision of such false information to the company’s auditors was conduct “in relation to a financial product”: see also Australian Securities and Investments Commission v ActiveSuper Pty Ltd (in liq) (2015) 235 FCR 181; [2015] FCA 342 at [349] and Ambergate Ltd v CMA Corporation Ltd (admins apptd) (2016) 110 ACSR 642; [2016] FCA 94 at [56]; Australian Securities and Investments Commission v Macro Realty Developments Pty Ltd (2016) 111 ACSR 638; [2016] FCA 292 at [28]. I find that by providing false information about Huaying’s financial position to its auditors, the company engaged in misleading or deceptive conduct contrary to s 1041H of the Act.

Conclusion

51    Each of the contraventions of the Act by the company alleged by ASIC have been proven and the declarations of contravention sought by ASIC should be made.

the acts and conduct of mr shao

The s 674(2A) contravention claim

52    ASIC alleged that Mr Shao was involved in the company’s contravention of s 674(2) of the Act with respect to the profit forecast and thereby contravened s 674(2A). Section 674(2A) provides that:

A person who is involved in a listed disclosing entity’s contravention of subsection (2) contravenes this subsection.

53    Section 79 of the Act defines “involved” as follows:

A person is involved in a contravention if, and only if, the person:

(a)    has aided, abetted, counselled or procured the contravention; or

(b)    has induced, whether by threats or promises or otherwise, the contravention; or

(c)    has been in any way, by act or omission, directly or indirectly, knowingly concerned in, or party to, the contravention; or

(d)    has conspired with others to effect the contravention.

54    Thus, to find that Mr Shao was “involved” in the company’s contravention of s 674(2), the Court needs to be satisfied that Mr Shao: (i) knew that the company’s profit had deteriorated in the second half of the 2013 calendar year; and (ii) knew that this was information which was not generally available and was information which a reasonable person would have expected, if it were generally available, to have had a material effect on the company’s share price. Mr Shao in his defence admitted the second element and made partial admissions about the matters of which he had knowledge.

55    The evidence relied on by ASIC to show knowledge included Mr Shao’s s 19 examination. At his examination on 28 May 2014, Mr Shao was asked what the reason was for the difference between the prospectus forecast and the actual profit as recorded in the Appendix 4E Report, which was a drop of around 40%. Mr Shao (through an interpreter) stated:

… The first reason is it was scheduled that the IPO was successful in July and equipment would be in place to be used in time, but in 2013 we couldn’t achieve the IPO in time or couldn’t achieve the equipment purchasing time or the IPO, so the delay of IPO’s timing increased the rental cost of the equipment. That’s the first reason.

... The second reason is due to the delay of the listings timing we have already trained staff and engineers – operatives and engineers – for the new equipment and they have undertaken long time training in 2012, so the cost of the staff has increased ...

The third reason is because in 2013 we opened the markets which is 7,000 kilometres away and so we needed to send the operatives from (indistinct) Province and that resulted in the huge increase in the staff cost.

56    Mr Shao was asked when that occurred in 2013. His answer was:

We entered the (indistinct) market in June 2013 and also the cost to – the cost for the long distance transfer of the equipment has increased, and also we have a promotional prize for the new market. That net profit decreased from 47 per cent to 42 per cent which is 5 per cent for the promotion prize. The most important reason is the cost – the funding cost during IPO in Australia is much more than we expected. It’s more than $AUD1 million, more than we expected. If we didn’t have all the difficulties I mentioned above in 2013, the income and net profit would be much more than we expected – than the forecast.

57    Later, the following questions and answers were given:

Q:    Mr Shao, in your affidavit that you swore last week you indicated that there had been stoppage in relation to payments from state owned enterprises as a result of a government initiative – broad based initiative. Is that the case?

A:    Privilege. It was not stoppage, it was opposed and delayed. However in February and March we still had some funds coming in and it’s not that the government is not giving – is not providing us the fund, it’s that the fund is delayed.

Q:    When did the delay start?

A:    It was not – privilege – it was not proceeding well since – it hasn’t been proceeding well since last August but now we still have some funds coming in.

Q:    So the delays started in around last August?

A:    September.

Q:    Mr Shao, before you said that the companies can apply for loans. Do the companies in China have the capacity to apply for loans?

A:    Yes, the bank has the capacity. Privilege.

Q:    Have the subsidiaries approached the banks for loans?

A:    Yes.

Q:    When was the approach made?

A:    Privilege. At the beginning of this year, because we knew a bad fund flow will impact the production, so since then we have been communicating with the banks.

58    It is clear from those answers that Mr Shao knew, even before the listing, that the actual profit would be impacted by each of the circumstances alleged by ASIC.

59    Mr Shao pleaded the defence available under s 674(2B) of the Act. Section 674(2B) provides that:

A person does not contravene subsection (2A) if the person proves that they:

(a)    took all steps (if any) that were reasonable in the circumstances to ensure that the listed disclosing entity complied with its obligations under subsection (2); and

(b)    after doing so, believed on reasonable grounds that the listed disclosing entity was complying with its obligations under that subsection.

60    ASIC sought particulars of that defence in March 2015 but never received a response and Mr Shao failed to lead any evidence in support of that defence. In the circumstances, that defence has not been made out.

61    I find that Mr Shao was directly or indirectly knowingly concerned in the company’s contravention of s 674(2) of the Act, and thereby contravened s 674(2A) of the Act.

Directors’ duties

62    In addition, ASIC has alleged that Mr Shao breached his duties as director of the company.

63    Mr Shao was, at all material times until 22 October 2014, the managing director, chairman of the Board and chief executive officer of the company and the managing director and chairman of the Board of the operating subsidiary, Huaying. He also admitted to being a person who made, or participated in the making of decisions that affected the whole or a substantial part of the business of Sino and its operating subsidiary Huaying.

64    At all material times, Sino’s Board comprised three directors: the two non-executive directors, Mr Faulkner and Mr Johnson, and Mr Shao.

65    The company’s only operating company and its only source of revenue was Huaying. Moreover, Huaying’s operations were entirely in China. Mr Shao was the only member of the Board of Sino who had direct knowledge of and involvement in the business affairs of Huaying.

66    ASIC has alleged that Mr Shao breached his duties by:

(a)    failing to ensure that he had any, or any sufficient knowledge of the disclosure requirements in ss 710, 728, 674 and 1041H of the Act – this was denied by Mr Shao;

(b)    failing to obtain translations of each prospectus document and ensuring that they reflected all matters required to be disclosed under ss 710 and 728 – Mr Shao admitted that he did not understand the English language and did not obtain a Chinese translation of each prospectus document but denied that he failed to give consideration to whether each prospectus document accurately reflected all matters requiring disclosure under ss 710 and 728 of the Act;

(c)    failing to disclose to the Board, in the prospectus documents, and to the ASX, the changes in circumstances of the company and profit downgrade – Mr Shao denied that he failed to make those disclosures to the Board but admitted that he failed to make those disclosures in the prospectus documents and to the ASX (in the period 12 December 2013 to 1 April 2014);

(d)    attempting to transfer the initial public offering proceeds without giving a proper reason and without proper documentation – this was in essence denied by Mr Shao; and

(e)    causing or permitting the company to contravene certain provisions of the Act, thereby exposing it to the potential jeopardy of civil pecuniary penalties – this was denied by Mr Shao.

Failure to understand documents

67    Mr Shao admitted that he did not understand the English language, whether in oral or written form and did not obtain a full Chinese translation of each prospectus document before signing it or authorising its release. I accept the submission for ASIC that Mr Shao’s failure to obtain a full translation of the prospectus documents before signing or authorising them was a failure to discharge his duties with reasonable care. In Australian Securities and Investments Commission v Healey (2011) 196 FCR 291; [2011] FCA 717 at [22] Middleton J stated:

A reading of the financial statements by the directors is not merely undertaken for the purposes of correcting typographical or grammatical errors or even immaterial errors of arithmetic. The reading of financial statements by a director is for a higher and more important purpose: to ensure, as far as possible and reasonable, that the information included therein is accurate. The scrutiny by the directors of the financial statements involves understanding their content.

These comments are equally apposite to prospectus documents. Mr Shao as chairman of the Board signed off on each of the prospectus documents. As a director of the company, he was under the duty to exercise his powers and discharge his duties with care and diligence. That required him to inform himself fully and comprehensively about the content of the prospectus documents to ensure that the information contained in those prospectus documents was accurate. The failure by Mr Shao to ensure that he could understand, even in the most basic sense, the content of the documents he was signing was a breach of his director’s duties.

Failure to know of the disclosure requirements

68    ASIC alleged (and Mr Shao denied) that he did not:

(a)    have any, or sufficient, knowledge of the disclosure requirements of the Act, including the requirements of ss 710, 728, 674 and 1041H of the Act; and

(b)    give specific consideration to whether each prospectus document accurately reflected all matters requiring disclosure under ss 710 and 728 of the Act.

69    In his defence, Mr Shao alleged that he received and relied on the advice given to him by the two Australian directors (Messrs Faulkner and Johnson) and professional advisers in respect of the disclosure requirements of the Act. In one of his affidavits, Mr Shao deposed that he relied on a team of legal and other professional advisers engaged to implement the listing on the ASX to tell him what information they required and to carry out the necessary work. He deposed that he was “trusting in them” and that from his dealings with them he “was satisfied that they knew what they were doing”. He further deposed that from time to time he was asked for information and always made sure that the information requested was provided. In his s 19 examination, Mr Shao said:

… I was completely dependent to the two Australian directors and I depended on their profession to manage this and I don’t really know the Australian policies about disclosure and I was totally dependent on the two directors. If our company didn’t do a perfect job please understand I was not a master of the Australian legal system, the language or the culture …

70    The fact that Mr Shao was not an English speaker or writer and did not understand Australian legal requirements did not mean that he could just leave it all to others and did not excuse him from performing his own duties with reasonable care and diligence. Such a defence was rejected by Goldberg J in Australian Securities and Investments Commission v Citrofresh International Limited (No 2) (2010) 77 ACSR 69; [2010] FCA 27. In that case, counsel for the director submitted that the Court should have regard to his client’s relative lack of experience in the governance of public companies and the fact that his client had engaged the services of a consultant to provide corporate governance advice, assistance on corporate structure, capital raisings, business strategy and to prepare company announcements. Goldberg J at [56] rejected that submission, stating:

[The director] may have had a background in abalone processing and may not have been a professional director with public company experience, but that does not excuse him from exercising the appropriate degree of skill and care required of a company director especially one who was a managing director and chief executive office. Further, he was not entitled to rely on the drafting undertaken by the “experts” who were retained by [the company]. The circumstances required him to have an active participation in the drafting and to exercise a considerable amount of skill and care as the responsible Managing Director and Chief Executive Officer of [the company].

By failing to inform himself about the disclosure requirements, Mr Shao did not discharge the degree of care and diligence that a reasonable person would exercise as director and Chairman of the company.

Profit downgrade

71    Mr Shao’s denial that he failed to disclose the change in circumstances and profit downgrade to the Board is contradicted by the evidence of the two non-executive directors of the Board, Mr Faulkner and Mr Johnson.

72    Mr Johnson gave evidence in his s 19 examination that he was surprised by the $5 million difference between the company’s forecast net profit for the 2013 year and the actual profit announced in the Appendix 4E Report. He stated that the evening before the listing date (12 December 2013) he had been informed by Mr Shao on inquiry “that the revenue numbers were above forecast, the margin was slightly down – and I mean slightly down – but had reached the forecast numbers”.

73    Mr Faulkner similarly gave evidence at his s 19 examination that the actual net profit did not “tally to information” that he and Mr Johnson had received the day before listing when they had enquired as to the company’s performance at that point. He stated that the information they had received at that point (which was to the end of October 2013), plus information “as to where they were trading to at that time” indicated that the company was “on track for the forecast” and that they were advised that “revenues were going to be ahead if not on forecast at that point in time”.

74    The information about deterioration in the company’s profit was clearly a matter of great significance to the Board and should have been disclosed by Mr Shao. In Re One.Tel Ltd (in liq); Australian Securities and Investments Commission v Rich (2003) 44 ACSR 682; [2003] NSWSC 186, the failure by the managing director to inform the board adequately of matters relevant to the company’s financial position was held to be a breach of s 180 of the Act. The director was found to have breached his duty despite the fact that he did not know (but ought to have known) the true financial position of the company. See too Shafron v Australian Securities and Investments Commission (2012) 247 CLR 465; [2012] HCA 18, 481–2 (CLR) and Australian Securities and Investments Commission v Macdonald (No 11) (2009) 256 ALR 199; [2009] NSWSC 287. In both cases, the executive directors of James Hardie Limited were held to have breached their directors’ duties by failing to inform the board of information casting doubt on the viability of a scheme to place the company’s asbestos liabilities in a fully-funded trust.

75    Mr Shao knew of the circumstances affecting the financial position of Sino but nevertheless failed to inform the Board of those circumstances. His failure to do so was a breach of his director’s duties to the company.

Attempted transfer of the initial public offering proceeds

76    Next ASIC alleged that Mr Shao breached s 180(1) of the Act when he attempted to transfer the $7.5 million proceeds of the initial public offering in circumstances where:

(a)    he failed to give his fellow directors a proper explanation for why the transfer was necessary; and

(b)    the proposed transfer of the funds was to be made by way of intercompany loan, which was not also disclosed to the Board; and

(c)    there had not been compliance with regulatory requirements necessary to make the proposed loan recoverable by Sino under Chinese law.

77    Mr Shao admitted that between 13 December 2013 and early January 2014 he requested Mr Faulkner and Mr Johnson to authorise the transfer of $7.5 million of the proceeds to an ICBC bank account in the People’s Republic of China. He also admitted that he told Mr Faulkner and Mr Johnson that the purpose of the transfer was to pay for equipment under equipment contracts dated 1 April 2013, 1 August 2013 and 15 August 2013. In his s 19 examination, Mr Johnson stated that Mr Shao had given “all sorts of different reasons” as to why the proceeds were required to be transferred to China, including that “we were now being told that debtors were not paying.” Similarly, Mr Faulkner, in his s 19 examination, stated that Mr Shao had given “various reasons” for the transfer, including “due to cash flow due to non-payment by state-owned enterprises or delayed payment.”

78    Mr Shao denied ASIC’s allegation that he told Mr Faulkner and Mr Johnson that the transfer was necessary because there were insufficient funds in operating cash flow to pay for the equipment. He also denied the allegation that he proposed that the transfer would be an intercompany loan from Sino to its operating subsidiary Huaying. It is clear on the evidence though that Mr Shao did propose that the transfer would be an intercompany loan from Sino to Huaying. Despite his denial in his defence, that was the evidence that he gave in these proceedings. In his affidavit of 5 May 2014 he deposed that:

56.    Huaying wants to use money raised on the capital raising to pay for equipment. I am seeking to have the funds transferred from Sino Australia to Huaying, the operating entity in China, to enable Huaying to acquire equipment from a third party so that Huaying can service its customers. Huaying has value in existing contracts that it is unable to realise because of a lack of equipment …

…

73.    When money is transferred from Sino Australia to Huaying to pay for equipment or for other working capital requirements the transfer will be booked in the accounts of Sino Australia and Huaying as a loan.

79    The proposed loan arrangement was also confirmed in a letter from the company’s then solicitors, Piper Alderman, to ASIC dated 29 March 2014. Piper Alderman stated that:

Mr Shao is seeking to have the funds transferred from the Australian holding company to the operating entity in China to enable the operating company to acquire equipment from a third party to enable the company to effectively service its customers.

The transfer of funds will be booked in the accounts of [Sino] and its operating subsidiary as a loan.

80    Moreover, it does not appear from the evidence that Mr Faulkner or Mr Johnson were ever told by Mr Shao that the transfer would be by way of an intercompany loan to Huaying.

81    Expert evidence led by ASIC established that the proposed loan would not be enforceable under Chinese law without approval from the State Administration of Foreign Exchange (“SAFE”). Ms Rong, the expert, stated the relevant requirements of the Chinese law applicable to foreign currency loans as follows:

(a)    international commercial loan arrangements signed without the approval of SAFE or its branches are invalid; and

(b)    as a consequence of such invalidity:

(i)    SAFE or its branches must not undertake foreign debt registration;

(ii)    a bank must not open a foreign debt special account for such loans; and

(iii)    the loan principal and interest must not be remitted abroad without authorisation.

82    Ms Rong also stated that the consequence of non-compliance with those legal requirements is that if the loan agreement relating to foreign debt was not registered with SAFE, the loan agreement would not be legally binding and even if the borrower repaid the loan in the future, the repayments could not be remitted abroad without authorisation from SAFE, which would be difficult to obtain due to the absence of the required approval and SAFE registration at the remittance of the foreign debt.

83    The failure by Mr Shao to ensure that the loan was documented or registered would have made it irrecoverable and his failure to make sure that there would be compliance with the regulatory requirements to make the loan recoverable by the company under Chinese law was a breach of his duties under s 180(1): see Australian Securities and Investments Commission, in the matter of QLS Superannuation Pty Ltd v Parker (2003) 21 ACLC 888; [2003] FCA 262 at [115]; Cashflow Finance Pty Ltd (in liq) v Westpac Banking Corporation [1999] NSWSC 671 at [369].

84    His conduct is all the more serious because he attempted to transfer the $7.5 million proceeds of the initial public offering without disclosing to the Board that the proposed transfer was to be by way of loan.

Causing or permitting contravention and exposure to penalty

85    Next, it was alleged by ASIC that Mr Shao’s conduct in causing or permitting the company to contravene ss 728, 674 and 1041H of the Act which exposed the company to the risk of proceedings for contraventions of the Act, legal costs and penalties was a breach of his director’s duties under s 180 of the Act. In Australian Securities and Investments Commission v Maxwell (2006) 59 ACSR 373; [2006] NSWSC 1052, Brereton J at [104]–[105] stated:

There are cases in which it will be a contravention of their duties, owed to the company, for directors to authorise or permit the company to commit contraventions of provisions of the Corporations Act. Relevant jeopardy to the interests of the company may be found in the actual or potential exposure of the company to civil penalties or other liability under the Act, and it may no doubt be a breach of a relevant duty for a director to embark on or authorise a course which attracts the risk of that exposure, at least if the risk is clear and the countervailing potential benefits insignificant. But it is a mistake to think that ss 180, 181 and 182 are concerned with any general obligation owed by directors at large to conduct the affairs of the company in accordance with law generally or the Corporations Act in particular; they are not. They are concerned with duties owed to the company …

… In my opinion, if a contravention of s 180(1) is to be established, it must be founded on jeopardy to the interests of the corporation …

This dictum has been applied in a number of subsequent cases: see Australian Securities and Investments Commission v Warrenmang (2007) 63 ACSR 623; [2007] FCA 973 per Gordon J at [27] and Australian Securities and Investments Commission v Citrofresh International Ltd (No 2) (2010) 77 ACSR 69; [2010] FCA 27 at [50].

86    In this case, Mr Shao’s conduct as a director of Sino has exposed it to the imposition of civil penalties for its contraventions of the Act, to the cost and trouble of this legal proceeding and ASIC’s investigation leading to its placement into provisional liquidation and ultimately, into liquidation, and the company’s interests were plainly jeopardised by Mr Shao’s conduct. A director properly discharging his or her duties to the company would have taken steps to avoid this detriment to the company and by failing to do so Mr Shao has breached his duties to the company.

87    ASIC seeks a disqualification order against Mr Shao under s 206E of the Act. To obtain that relief, ASIC must establish that Mr Shao was a director of Sino whilst the company on two or more occasions contravened the Act or that he, whilst a director of Sino, committed two or more contraventions of s 180(1). Secondly ASIC must establish that Mr Shao failed to take reasonable steps to prevent the contraventions and that a disqualification order is justified. Whether a disqualification order is justified is a matter for consideration at the penalty hearing but I am satisfied that the other requirements have been met. Specifically, I find that Mr Shao failed to take reasonable steps to prevent the contraventions, in that he failed to confirm the accuracy of the statements contained in the prospectus documents by reading and understanding the prospectus documents himself before signing off; he failed to educate himself about disclosure requirements under Australian law; he failed to accept the advice of Mr Johnson and Mr Faulkner about the transfer of funds; he failed to ensure that false and misleading information was not provided to the company’s auditors; he was not candid and frank with his fellow directors and he failed to consider the interests of the minority shareholders.

Conclusion

88    For the above reasons, the declarations of contravention sought by ASIC in respect of Mr Shao’s conduct will be also made.

Associate:

Dated:    11 August 2016

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