In recent years, Hong Kong’s Securities and Futures Commission (SFC) has adopted a decidedly proactive approach to enforcement, intervening at an early stage when the SFC perceived harm to investors. Restrictions notices (RNs)—an administrative measure that can be used to freeze assets of licensed corporations (LCs) and their clients while an investigation is underway—have become a frequently used tool by the SFC for achieving this objective. The number of licensed corporations receiving restriction notices rose from four in 2017–8 to 38 in 2020–21.

Recently, the High Court of Hong Kong dismissed a constitutional challenge to the SFC’s power to issue RNs. Given this backdrop, private equity funds with a presence or operations in Hong Kong need to understand the asset freezing powers of the SFC, know how they might position themselves to minimize their exposure, and be aware of their options if they become affected by such freezing orders or measures.

Section 213 of the Securities and Futures Ordinance (Cap. 571)

To understand the SFC’s current use of RNs, it is necessary to step back and examine the tool the SFC traditionally relied upon when it sought to preserve assets pending investigation: Section 213 of the Securities and Futures Ordinance (SFO).

Section 213(1) of the SFO provides that the SFC may apply to the Court for what is in effect a freezing injunction when a person has contravened the SFO or other relevant provisions (or has taken part or been involved in such contravention), or it appears to the SFC that such conduct is occurring or may occur. In deciding whether to grant the injunction, the Court must satisfy itself, so far as it can reasonably do so, that it is desirable that the injunction be granted and that granting the injunction will not unfairly prejudice any person. Section 213(6) further provides that where the Court considers it desirable to do so, it may grant an interim order while it considers an application made by the SFC under section 213(1).

Given the SFC may make an application under section 213(1) based merely on suspicion, and the Court may grant the orders sought if the Court deems such orders to be “desirable,” it might appear at first glance that the threshold the SFC must overcome when making an application under section 213 is quite low.

However, the Court has held that before any interlocutory injunction (such as that under section 213) can be granted, a prima facie case of contravention of a relevant provision must be established and that there must be an appreciable—not merely fanciful—risk that without the injunction, proper compliance of the relevant statute would be frustrated. The Court has also stated that the traditional equitable principles governing the granting of interlocutory injunctions also apply to govern the granting of such injunctions under section 213. In other words, there must be a serious question to be tried and a risk of dissipation of assets, and the balance of convenience must lie in favor of granting the injunction.

The threshold is thus meaningful—and sufficiently meaningful to prevent the SFC from securing and preserving assets at early stages of its investigations when there is often insufficient evidence to persuade the Court to grant interlocutory injunctions under section 213. As a result, the SFC has resorted to administrative measures—most frequently, the RN.

The Restriction Notice

In February 2021, several individuals brought judicial review proceedings to challenge the legality of the RN regime (Tam Sze Leung & Others v Secretary for Justice and the Securities and Futures Commission [2022] HKCFI 2330). In those proceedings, which were ultimately dismissed, the SFC admitted that it sees the RN regime as offering crucial flexibility to the SFC, “particularly at the early stages of any investigation when there is limited available information and evidence which is highly unlikely to be sufficient to pursue [a section 213 application] to Court.”

The SFC’s power to impose RNs stems from sections 204 and 205 of the SFO, which provide that the SFC may by notice in writing prohibit LCs from (amongst other things) disposing of or dealing with, or assisting, counselling or procuring another person to dispose of or deal with, any “relevant property” in a specified manner or other than in a specified manner. LCs are corporations licensed by the SFC to undertake regulated activities such as asset management; whereas “relevant property” is defined as including any property held by the LC on behalf of its clients. Section 207 qualifies sections 204 and 205 by setting out the circumstances where the power may be exercised, including when it appears to the SFC that doing so would be “desirable in the interest of the investing public or in the public interest.”

Several points are immediately evident from this. To start, the RN regime is very broad in both its effect and application. The RN regime enables the SFC to freeze not only assets belonging to LCs, but also those belonging to LC clients, and the phrase “desirable in the interest of the investing public or in the public interest” provides the SFC with a very broad basis for intervention. There is no limit to the amount of assets that can be frozen by an RN or to the length of the freezing order. Further, the threshold for invoking this power is very low—only that it appears to the SFC that it is “desirable” in the interest of the investing public or in the public interest for the power to be invoked. There is no requirement for prior scrutiny by the Court or an independent tribunal, and after the RN is issued, there is no legal requirement for periodic review.

Implications for Private Equity Firms

In light of the above, PE funds with operations in Hong Kong may want to consider steps to minimize the risk of its assets being frozen by the SFC. Where possible, PE funds may consider holding funds in bank accounts instead of accounts maintained with LCs. Doing this keeps the funds outside the scope of the RN regime, meaning the SFC must either (i) resort to a section 213 application if it wishes to freeze the funds, which would at least need to be scrutinized by the Court and would give the affected party an opportunity to argue at the first instance against the granting of the injunction, or (ii) use another administrative measure, such as a letter of no consent, to freeze the funds.

If holding assets in accounts maintained with LCs is unavoidable, PE funds may consider segregating the assets into different accounts based on, for example, the asset’s purpose, transaction or source, so that in case of freezing, it is less likely that all of the assets would be affected.

If, unfortunately, an interlocutory injunction under section 213 or an RN is imposed, there are four steps PE funds may be able to take to minimize the impact:

• Interlocutory injunction orders made by the Court under section 213 almost always come with a proviso that the injunction may be varied by agreement between the parties or by application to the Court. So if, for instance, there has been a material change in circumstances since the granting of the injunction, or there is a genuine need on the part of the affected PE fund to use some of the frozen money, the PE fund may invite the SFC to agree to a discharge or variation of the injunction, failing which the PE fund may also consider applying to the Court for such relief.

• Section 208 allows LCs or individuals affected by RNs to write to the SFC to seek its consent to deal with the frozen assets in a certain specific way or for the withdrawal, substitution or variation of the prohibitions or requirements imposed by the RNs. Should this fail to yield the desired result, the LC or individual may further apply to the Securities and Futures Appeal Tribunal for a full-merits review of the RN on a de novo

• In some cases, such as where the amount frozen exceeds what is necessary or proportionate under the circumstances, it may be possible to persuade the SFC to vary the freezing order or measure. For instance, where an injunction initially covers all the funds in an account, the SFC can sometimes be persuaded to vary the injunction so that it only prevents the amount of funds in that account from falling below a specific sum (which is usually linked to the amount of damages that the SFC thinks it can recover in legal proceedings).

Where the PE fund has advance notice of the SFC’s intention to freeze its assets, the PE fund may attempt to replace the injunction sought by the SFC with voluntary undertakings which better protect the fund’s interests. This is more likely to happen in the context of a section 213 application for an interlocutory injunction, where the application may be made inter partes in circumstances where there is insufficient urgency or risk of dissipation of assets.