(Adds SFC comment at end)
By Michelle Price
HONG KONG, June 8 (Reuters) - Hong Kong's Court of Appeal found Moody's broke the rules when it published a report about Chinese companies in 2011, rejecting the credit rating agency's appeal against a tribunal ruling last year, Moody's said on Thursday.
The case has been watched closely by the financial industry and corporate governance activists as it is could redefine the limits on what can be written in reports on public companies and potentially curtail the activities of Hong Kong research firms.
The appeal court ruled in favour of a March 2016 ruling by the Securities and Futures Appeal Tribunal (SFAT) that partly upheld action taken against the Hong Kong division of Moody's Investors Service over its "red flags" report.
The SFAT ruled that Moody's breached the Securities and Futures Commission code of conduct by publishing a report in July 2011 that raised concerns about corporate governance at 49 Chinese firms and contributed to a fall in their share prices.
"Moody's is disappointed by the Hong Kong Court of Appeal's decision. Moody's did not engage in misleading conduct and disagrees that the Securities and Futures Commission (SFC) should be able to regulate the content of research publications," Donough Foley, senior vice president, government and public affairs, at Moody's, said in a statement.
"Moody's is reviewing the Court's opinion and is considering its options," the statement said.
The SFC had said Moody's failed to ensure the accuracy of the report and painted a misleading picture of the companies. It was the first action taken by the SFC against a credit-rating firm since it started regulating rating activities in June 2011.
Moody's argued the report did not constitute a credit rating and was therefore not subject to the SFC's jurisdiction but the SFAT rejected the defence.
The Moody's case has fuelled concerns that governments in the region are increasingly trying to muffle negative research. The Indonesian Finance Ministry penalised JPMorgan Chase after it published a negative report on Indonesia.
The appeal court's ruling also comes amid a renewed focus on negative research in Hong Kong, following a flurry of short-sell reports on companies in the city.
"The SFC considers that responsible research, including those issued by credit rating agencies and research houses, can all contribute to the overall market quality and price discovery process and has no intention to suppress legitimate commentaries on listed companies, whether positive or negative," SFC CEO Ashley Alder said in a statement on Thursday.
"The Moody's case is about substandard work by a licensed person who is required to comply with the provisions set out in the code of conduct and uphold high standards of competence. Any person, whether licensed or not, who makes serious allegations about listed companies should be reasonably prudent in making them," Alder said. (Editing by Muralikumar Anantharaman and David Clarke)