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6 July, 2016
This Hong Kong regulatory update provides a brief overview of the principal Hong Kong regulatory developments in the preceding three months relevant to companies listed or proposed to be listed on The Stock Exchange of Hong Kong Limited (HKEx) and their directors, management and advisers. The updates include HKEx announce- ments and rule or guidance changes, Securities and Futures Commission (SFC) deci- sions and updates, and both HKEx and SFC enforcement-related news. In this update we cover:
- HKEx issues a guidance letter on “shell company” listings
- New listing decision regarding reliance on unrealized fair value gains to meet the profit requirement in a spin-off proposal
- New listing decisions regarding reverse takeovers
- New listing decisions regarding su ciency of operations or assets after a major disposal as required under Rule 13.24 of the Hong Kong Listing Rules
- New listing decisions explaining the reasons for rejection and return of certain listing applications in 2015
- HKEx issues a guidance letter for issuers subject to market commentaries or rumors
- HKEx issues a guidance letter on bonus issues of shares
- HKEx publishes its latest listing committee report
- HKEx reports on its review of listed issuers’ corporate governance practice disclosure in annual reports for the year ended March 2015
- SFC reminds issuers to keep trading suspensions to the minimum
- Guidance on mandatory o er obligation waivers in acquisitions of voting rights by members of a concert group
- SFC issues a corporate regulation newsletter regarding publishing announcements and disclosure of inside information by listed companies
Recent enforcement actions and penalties
Of particular note are the guidance letters and listing decisions — with respect to shell listings, reverse takeovers and sufficiency of assets — which underscore a heightened push by Hong Kong’s regulators to actively monitor the quality of companies listed on the HKEx.
HKEx Issues a Guidance Letter on “Shell Company” Listings
The HKEx issued guidance letter (GL68-13A), setting out its guidance on the suitability for listing of companies that are, in the HKEx’s view, potentially “shell companies.” Based on its analysis of recent listings, the HKEx has identi ed shell companies as possessing one or more of the following characteristics:
- small market capitalization after listing;
- only marginally meeting the listing eligibility requirements;
- fundraising disproportionate to its listing expenses (i.e., a high proportion of the listing proceeds used to pay listing expenses);
- possessing a pure trading business with a high concentration of customers;
- asset-light businesses where a majority of the assets are liquid and/or current assets;
- a super cial delineation of business from the parent whereby the company’s business is arti cially delineated from the parent by geographical area, product mix or di erent stages of development; and/or
- little or no external funding at the pre-listing stage.
The HKEx expects companies exhibiting one or more of these characteristics to provide a robust and detailed analysis to substantiate that they are suitable for listing, including with respect to the proposed use of proceeds, future objectives and strategies, pro t and revenue growth, and (for companies oper- ating in potential sunset industries) ability to adapt to changing market demands.
The HKEx may impose additional requirements or conditions on companies with the above characteristics or exercise its discretion to reject the applicant’s listing on the grounds of suitability. While a company may consult with the HKEx on a con dential basis for an interpretation of the listing rules or specific issues raised in this guidance letter, the HKEx has indicated that it will not give speci c guidance on their suit- ability as a whole for the purpose of this guidance letter until a formal listing application is made.
New Listing Decision Regarding Reliance on Unrealized Fair Value Gains to Meet the Pro t Requirement in a Spin-off Proposal
The HKEx recently published a new listing decision LD93- 2016 regarding reliance on unrealized fair value gain to meet the pro t requirement in a spin-o proposal. In this listing decision, a listed company (Company A) was engaged in a number of businesses, including the manufacture and sale of certain household products (the Manufacturing Business) and property investment (the Property Business). Company A proposed to inject the existing Manufacturing Business into a new company (Newco) and seek a separate listing of the Manufacturing Business on HKEx. After the proposed spin-o of the Property Business, Company A (excluding Newco) (the Remaining Group) would continue to carry out the Property Business and the other businesses.
When considering the spin-o proposal, HKEx noted that:
- the Remaining Group’s pro ts during the track record period were mainly attributable to unrealized fair value gains on investment properties retained by the Remaining Group;
- the other businesses retained by the Remaining Group oper- ated at a loss or generated minimal pro ts;
- the Remaining Group held a number of properties in commercial, industrial and residential buildings in Hong Kong and the PRC for leasing and capital appreciation purpose and did not carry out any property development or construction during the track record period; and
- the Remaining Group generated rental income in the range of about HK$15 million to HK$30 million.
The HKEx rejected the proposed spin-o , concluding that the Remaining Group was not suitable for listing by virtue of its reliance on fair value gains on investment properties to meet the minimum pro t requirement. In particular, the HKEx noted the following reasons:
- as explained in prior guidance issued by the HKEx, compa- nies relying on unrealized fair value gains must demonstrate that they had a substantive property business during the track record period and that the business is sustainable going forward;
- the Remaining Group’s Property Business (which gener- ated annual rental income of about HK$15 million to HK$30 million in the latest three years) was not considered substantive;
- the Remaining Group did not have any property projects under development or signi cant recurring income to demonstrate the sustainability of the Property Business; and
- the plan to expand the property portfolio submitted by Company A was preliminary and did not demonstrate that the Property Business would generate a signi cant level of recurring income in the future and that the Remaining Group had a substantive and sustainable property business.
New Listing Decisions Regarding Reverse Takeover
The HKEx published three listing decisions regarding reverse takeovers, namely LD94-2016, LD95-2016 and LD96-2016. These decisions highlight the heightened risk of signi cant acquisitions being viewed as reverse takeovers, together with the subjective and somewhat unpredictable nature of HKEx decisions in this area. In these listing decisions, the HKEx applied the following criteria from the principle based test outlined in its Guidance Letter GL78-14:
- the size of the transaction relative to the size of the listed company;
- the quality of the business to be acquired — whether it can meet the trading record requirements for listings or whether it is unsuitable for listing (e.g., an early stage exploration company);
- the nature and scale of the listed company’s business before the acquisition (e.g., whether it is a listed shell);
- any fundamental change in the listed company’s principal business (e.g., the existing business would be discontinued or very immaterial to the enlarged group’s operations after the acquisition);
- other events and transactions (historical, proposed or intended) which, together with the acquisition, form a series of arrangements to circumvent the reverse takeover rules (e.g., a disposal of the listed company’s original business simultaneously with a very substantial acquisition); and
- any issue of restricted convertible securities (i.e., highly dilutive convertible securities with a conversion restriction mechanism to avoid triggering a change of control under the Takeovers Code) to the vendor which would provide it with de facto control of the issuer.
LD94-2016
In LD94-2016, the issuer (Company A) proposed to subscribe for an interest as a limited partner in a fund (the Fund) with commitments of about HK$4.5 billion (which was about 80 percent of the size of the Fund). Company A would have no control over or right to participate in the management of the Fund and the investments to be made by the Fund. The proposed subscription represented about 80 percent of the asset value and over 900 percent of the market capitalization of Company A. Company A intended to nance the subscription using a loan facility granted to it by its controlling shareholder and its internal resources.
Decision
HKEx noted that the proposed subscription in the Fund would fall outside the bright line tests for reverse takeovers in Rule 14.06(6). Applying the principle based test with reference to the criteria set out in its Guidance Letter GL78-14, the HKEx considered the proposed subscription in the Fund would be a reverse takeover under Rule 14.06(6) of the Listing Rules because:
- the subscription was of a signi cant size to Company A based on the asset ratio of 80 percent and the consideration ratio of 900 percent and the investment in the Fund would represent a signi cant part of Company A’s assets;
- the subscription was a means to circumvent the new listing requirements (the Fund was newly set up and did not have any investments or assets and had no track record to meet the pro t requirement under Rule 8.05); and
- the fact that Company A would have no control over or right to participate in the management of the Fund or the investments to be made by the Fund raised a concern about suitability for listing.
LD95-2016
In LD95-2016, the issuer (Company B) was principally engaged in the manufacture and sale of household products. Company B proposed to acquire a target (the Target), which was newly set up by Mr. X to hold certain inventories, machin- ery and equipment for the production of beverage products (the Target Assets). As the Target had not yet obtained a license for manufacturing beverage machinery and equip- ment for manufacturing beverage products, it would enter into supply and sales contracts with a PRC Company (the PRC Company) pursuant to which the PRC Company would manufacture beverage products for the Target using the Target Assets and the Target would sell the beverage products to the PRC Company.
The asset and consideration ratios for the transaction were about 300 percent and 200 percent, respectively. Company B would satisfy the consideration by issuing new shares and convertible bonds (with a conversion restriction that prevented Mr. X from holding a 30 percent interest or higher) to Mr. X. As a result, Mr. X would become the single largest shareholder (28 percent) of Company B upon completion of the acquisition. Assuming full conversion of the convertible bonds, Mr. X would hold about 78 percent of Company B’s issued share capital.
Decision
The HKEx noted that the proposed acquisition would fall outside the bright line tests for reverse takeovers in Rule 14.06(6). Applying the principle based test with reference to the criteria set out in its Guidance Letter GL78-14, the HKEx determined that the proposed acquisition would be a reverse takeover under Rule 14.06(6) of the listing rules because:
- the proposed acquisition was a means to circumvent the new listing requirements as:
the Target did not meet the new listing requirements and had no trading record to meet the pro t requirement under Rule 8.05(1); and the Target would be unsuitable for listing under Rule 8.04 as it would heavily rely on the PRC Company for both the production and sale of its products and would be unable to carry on its business independently;
- the value of the Target Assets was signi cant to Company B, representing about three times the value of Company B’s assets, and would represent a fundamental change to Company B’s existing businesses; and
- the proposed acquisition would be a means for Mr. X (who would become the single largest shareholder of Company B) to list the Target by injecting it into Company B.
Subsequent to this decision, Company B submitted a revised proposal as follows:
- -Company B will acquire only a 30 percent interest in the Target;
- consideration would be reduced accordingly and satis ed by the issue of the consideration shares and promissory notes to Mr. X; and
- the asset and consideration ratios would be about 80 percent and 90 percent, respectively.
Notwithstanding the fact that the revisions would result in the transaction being a “major” transaction as opposed to a “very substantial acquisition” under the listing rules, the HKEx considered that the revised proposal would still be a reverse takeover under Rule 14.06(6) because:
- as set out in the Guidance Letter GL78-14, HKEx does not prescribe an absolute threshold in determining whether the size of a transaction is extreme;
- when assessing the impact of an acquisition on an issuer, HKEx would take into account the nature and scale of the listed company’s existing business after the acquisition, and whether the acquisition would result in a fundamental change to that business;
- the revised proposal would still be signi cant for Company B and was a means to circumvent the new listing require- ments as the Target’s business was completely di erent from Company B’s existing business and was not suitable for listing; and
- the revised proposal was an extreme case based on a combi- nation of these criteria.
LD96-2016
In LD96-2016, the listed company (Company C) was prin- cipally engaged in trading of food and beverage products. Company C proposed to acquire a target (Target D) from another company (Company D). Target D was engaged in the production and sale of certain types of organic fertilizers and sold its products to end users through its own sale team and a number of distributors and had recorded pro ts of between HK$15 million and HK$20 million in the last three years. Company D was the sole supplier of a major raw material (the Material) necessary for producing Target D’s products and produced the Material using a unique technology developed and owned by it. Target D intended to produce the Material itself and expected to master the technology to do so within three years.
The consideration would be settled by issuing convertible bonds to Company D (with a conversion restriction that prevented Company D from holding a 30 percent interest or higher). Assuming full conversion of the convertible bonds, Company D would hold over 50 percent of issued shares of Company C. The revenue, consideration and equity ratios of the proposed transaction were between 100 percent and 150 percent while the asset ratio was about 90 percent. Company C submitted that Target D would meet the minimum pro t requirement under Rule 8.05 and that the size of the acquisi- tion was not extreme.
Decision
The HKEx noted that the proposed acquisition would fall outside the bright line tests for reverse takeovers in Rule 14.06(6). In determining that the proposed acquisition would constitute a reverse takeover, the HKEx noted:
- the proposed acquisition was a means to circumvent the new listing requirements because Target D was unsuitable for listing as it relied on Company D’s supply of the Material, which was critical to its business operations, and it was uncertain if and when it would be able to manufacture the Material itself;
- Target D’s business would be signi cant to Company C after the acquisition as Company C was operating at a loss in recent years and only operated a trading business that had a low level of activities and generated minimal gross pro t, and Target D’s business also would represent a fundamental change in Company C’s principal business; and
- the acquisition would be a means for Company D (who would acquire de facto control of Company C using restricted convertible securities) to list Target D by injecting it into Company C.
New Listing Decisions Regarding Suf ciency of Operations or Assets After a Major Disposal as Required Under Rule 13.24 of the Hong Kong Listing Rules
The HKEx recently published new listing decisions regarding Rule 13.24 of the Listing Rules, which requires companies to retain su cient operations or assets to justify their continued listed status after a major disposal.
LD97-2016
A listed company (Company A) and its subsidiaries (the Group) were engaged in property construction and related businesses (the Construction Business). The Group recently had diversi ed into property management (the Property Business) and the trading of nancial products (the Trading Business, together with the Property Business, the Remaining Businesses). Company A proposed to sell the Construction Business to Mr. A, who was the former controlling share- holder of Company A prior to selling his interest in Company A to the existing controlling shareholder (Disposal A). Company A submitted that: (i) the Construction Business had been operating at a loss over the last two years; (ii) Disposal A would allow the Group to diversify into other businesses with growth potential; and (iii) the sale proceeds would be used by the Group as general capital. Disposal A would reduce the Group’s revenue and assets by about 70 percent and would constitute a major transaction subject to shareholder’s approval.
The HKEx noted that the Rule 13.24 requirement for maintain- ing su cient level of operations and assets of su ciency value is a qualitative test and is assessed on a case-by-case basis. The HKEx concluded that Company A would not have su cient operations or assets for the following reasons:
- the Construction Business was Company A’s main business since its listing and accounted for 70 percent of Company A’s revenue and assets, and Disposal A would substantially reduce Company A’s scale of operations and assets;
- the scale of the Remaining Businesses was insu cient to justify a listing; and
- the Group would not have su cient assets to justify a listing after Disposal A as:
- the assets of the Remaining Businesses were mainly cash and trade receivables, and the operations of these assets could not generate su cient revenue and pro ts to justify a listing; and
- the Property was the only other asset of the Group and it had a value of only HK$20 million.
LD98-2016
In LD98-2016, a listed company (Company B), through its subsidiary (Subsidiary B), was principally engaged in the event operation and entertainment business.
Company B proposed to (i) sell a 25 percent interest in Subsid- iary B to a buyer (Disposal B); and (ii) grant a call option (the Call Option) to the buyer over the remaining 75 percent interest in Subsidiary B exercisable 24 months after Disposal B. Company B intended to diversify into other businesses in the meantime. Disposal B would be a discloseable transaction for Company B and, together with the grant of the Call Option, would be a very substantial disposal with the revenue and assets ratio of nearly 100 percent.
Company B submitted that it would be able to meet Rule 13.24 upon completion of the proposal because:
- until and unless the buyer exercised the Call Option, Company B would continue to control Subsidiary B and therefore its business operations and assets; and
- the Call Option was not exercisable until 24 months after Disposal B. By the time it was exercised, Company B would have had time to expand into other businesses.
In concluding that Disposal B rendered Company B unable to comply with Rule 13.24, the HKEx noted:
- the exercise of the Call Option was entirely at the buyer’s discretion. By granting the Call Option, Company B was prepared to lose its ownership and control over its principal business. Whether and when the buyer would exercise the Call Option was irrelevant; and
- Company B stated its intention to carry out other businesses, but could not demonstrate that it would have a new business suitable for listing upon completion of the proposal.
LD99-2016
In LD99-2016, the listed company (Company C) and its subsidiaries (the Group) were engaged in the manufacturing and distribution of multimedia and communication products. One of the Company C’s subsidiaries, Subsidiary C, was engaged in manufacturing and distributing communication products of a major brand of the Group and accounted for about 90 percent and 75 percent of Company C’s revenue and assets (the Disposal Business). Subsidiary C was operating at a loss in the latest nancial year and recorded a pro t over HK$30 million in each of the past few years. It was proposed that Company C and Mr. X would enter into the following transactions:
Company C would sell Subsidiary C to Mr. X (a controlling shareholder of Company C) for cash (Disposal C).
Disposal C would constitute a very substantial disposal and connected transaction, subject to independent shareholders’ approval; and
- Mr. X would sell his entire shareholding in Company C to a third party, Mr. Y, who would then make an o er to acquire all the remaining shares in Company C from other sharehold- ers, and the transaction was a condition to the completion of Disposal C.
Upon completion of Disposal C, Company C would continue its existing business in manufacturing and distributing multi- media and communication products, excluding the product line owned by Subsidiary C (the Remaining Business). Company C submitted that it would be able to meet Rule 13.24 upon completion of the Disposal based on the following:
- the Remaining Business recorded revenue and pro t of over HK$200 million and HK$4 million, respectively, for the latest nancial year;
- subsequent to the disposal the Group would have total assets of about HK$450 million, including trade and other receivables, cash, inventories, xed assets and trademark;
- based on Company C’s pro t forecast, the Remaining Busi- ness would continue to record pro t and grow steadily;
- the Remaining Business comprised distinct product lines and operated independently from the Disposal Business with its own manufacturing and distribution teams; and
- Disposal C would improve the Group’s nancial performance by disposing the business that is operating at a loss.
The HKEx considered that Company C would not have su – cient operations or assets to meet Rule 13.24 upon completion of Disposal C for the following reasons:
- Disposal C would reduce substantially Company C’s scale of operations and assets;
- the Remaining Business recorded only minimal pro t for the latest nancial year and was loss making in the past few years and did not have a proven track record. Company C’s pro t forecast also failed to show substantial improvement after Disposal C;
- the assets of the Remaining Business would be insu cient to meet Rule 13.24 because they could not generate su cient revenue and pro ts to justify a listing. The other asset of the Group would be the cash proceeds from Disposal C, but Company C could not demonstrate how the cash retained would enable it to substantially improve its operations; and
- Disposal C formed part of the arrangements between Mr. X and Mr. Y and was made to facilitate the sale of a controlling interest in Company C. The Disposal Business accounted for the bulk of Company C’s existing businesses and had been pro table in the past except in the latest nancial year. Company C failed to support its case that Disposal C would improve its nancial performance or demonstrate that the Remaining Business was viable and sustainable.
New Listing Decisions Explaining the Reasons for Rejection and Return of Certain Listing Applications in 2015
In April 2016, the HKEx published two listings setting out the reasons for rejection and return of certain listing applications in 2015, a summary of which is set out below:
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Company |
Reasons for Rejection |
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A mining company whose principal operations and assets were in a high risk jurisdiction |
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A company in a gambling- related business that received income from casino operators for introducing VIP players to designated VIP rooms at the casino operators’ venues |
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A company providing services in the construction industry |
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Rejected Cases (continued)
|
Company |
Reasons for Rejection |
|
A mining company, which commenced commercial production in 2014, recorded immaterial revenue in 2014 and the rst half of 2015 and applied for a waiver from strict compliance with the pro t requirement of Rule 8.05 under Rule 18.04 |
The company failed to demonstrate that the mine had a clear path to commercial production and a demonstrable path to pro tability based on the following factors:
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A property investment company |
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An exhibition organizer |
One of the directors was not considered suitable for the following reasons:
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A company providing printing services |
Taking into account the following factors, there were concerns on the sustainability of the business:
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Returned Cases
|
Company |
Reasons for Return |
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A company providing conferencing services |
|
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A company providing conferencing services |
Omission of the following material information in the application relating to a director, who was also the company’s chairman and controlling shareholder (Director I), that the HKEx considered material: – acompulsorywindingordergrantedbythecourtagainstacompanyinwhichDirectorIwasan executive director and a minority shareholder; and – certainnoncompliancesofthelistingrulesbytwoHongKong-listedcompaniesduringtheperiod when Director I was a director of these companies. |
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A company in the catering business |
Failing to provide, at the time of ling its Form 5A, a pro t forecast memorandum covering the period up to the year ending [year T+1] as required under GEM Rule 12.22(14b) based on its proposed |
HKEx Issues a Guidance Letter for Issuers Subject to Market Commentaries or Rumors
In April 2016, the HKEx issued a guidance letter (GL87-16) to provide guidance to listed companies subject to market commentaries or rumors. The main principles set out in this guidance letter are summarized below:
Address False or Disorderly Market Concerns
- the HKEx may inquire if it is concerned that certain allega- tions regarding a company may disrupt orderly share trading.
- If the allegations have, or are likely to have, an e ect on the issuer’s share price such that, in the view of the HKEx, there is or there is likely to be a false or disorderly market in the company’s securities, the company must make a clari cation announcement promptly, and this obligation exists whether or not HKEx makes an inquiry.
- If the company cannot promptly publish the clari cation announcement, it must apply for a trading halt to prevent the possible development of a false or disorderly market.
- If trading is halted, the duration should be for the shortest possible period, and the company must ensure trading resume as soon as practicable following publication of a clari cation announcement.
- The clarification announcement should (i) make reference to the allegations; (ii) inform the market about the company’s position regarding each allegation; (iii) contain particulars to address, or to refute, the allegation; and (iv) disclose any inside information required to be disclosed under Part XIVA of the Securities and Futures Ordinance (or an appropriate negative statement).
- The HKEx may require the company to provide further information and halt trading pending further clari cation if it believes that the clari cation announcement would not address the concerns on false or disorderly market.
Continuing Reviews or Investigation
- After publication of the clari cation announcement, the HKEx may follow up with the company as it considers neces- sary on matters that have arisen out of the allegations and may even require the company to provide further information to support its denials of allegations, to review or investigate the claims and documents used to support the allegations.
- The company is expected to identify and correct any weak- nesses in its internal controls and adopt good corporate governance practices.
- Where any follow up action reveals that an announcement or document was materially inaccurate or misleading, or that there are serious concerns about the company’s compliance with Listing Rules, the HKEx may (i) suspend share trading pending further clari cation, or (ii) make a referral to an appropriate law enforcement agency (e.g., the SFC) for further action.
HKEx Issues a Guidance Letter on Bonus Issues of Shares
The HKEx issued a guidance letter (GL88-16) in April 2016 regarding bonus issues of shares. A bonus issue of shares generally refers to an allotment of new shares by a listed company to its existing shareholders, credited as fully paid out of its reserves or pro ts, in proportion to their sharehold- ings. The main guiding principles in the guidance letters are summarized as follows:
Size of Bonus Issues
- It is the responsibility of listed companies to ensure that their issues of bonus shares are conducted in a fair and orderly manner;
- The HKEx may not grant listing approval for large scale bonus issues of shares where there is reasonable likelihood of disorderly trading during the ex-entitlement period;
- Generally the HKEx is likely to raise concern about the oper- ation of an orderly market when a company proposes a bonus issue of shares of 200 percent or more of the existing issued shares (or a smaller scale after considering the relevant facts and circumstances); and
- The HKEx will only grant approval for large scale bonus issues of shares (i) in exceptional circumstances (e.g., there are regulatory restrictions for the company to e ect a share subdivision under the laws in the place of its incorporation or the requirements of other stock exchange where it is dually listed) and (ii) the company demonstrates that the proposed issue is not likely to give rise to disorderly trading during the ex-entitlement period.
Timetable for Bonus Issues
- Listed companies should follow the guidance set out in the HKEx’s “Guide on Distribution of Dividend and Other Entitlements”; and
- Listed companies also should keep the time interval between the ex-date and the allotment date as short as possible.
Trading Limits
- A bonus issue of shares (or share subdivision) that violates the principle of Rule 13.64 (which provides that the HKEx has the right to require a company to change the trading method or to proceed with consolidating its securities when the market price of its securities approaches the extremity of HK$0.01, which HKEx considers to be any trading price less than HK$0.1
HKEx Publishes Its Latest Listing Committee Report
The HKEx recently has published its listing committee report, which provides an account of work of HKEx’s listing commit- tee in 2015. The statistics highlighted in this report include the following:
Listing Applications
- Number of listing applications considered: 112 (2014: 92)
- Number of applications approved: 109 (2014: 91)
- Number of applications rejected (note that this only represents applications formally rejected by the listing committee and not those that have been returned or rejected by the listing division prior to their submission to the listing committee): nil (2014: nil)
- Decisions deferred pending further information: three (2014: one)
- Applications approved and listed in the year: 94 (2014: 91)
- Applications approved in previous year and listed in the year: 10 (2014: 12)
- Applications listed in the year: 104 (2014: 103)
- Average number of business days taken for issuance of the rst round of comments: 11 (maximum: 16; minimum: six)
Disciplinary Matters
- Average time for completion of an investigation for breaches of the listing rules: nine months (2014: 9.9 months)
- Number of requests for documents/information by the SFC and other law enforcement agencies dealt with and witness statements provided: 61 requests and 7 witness statements (2014: 42 requests and 10 witness statements)
- Disciplinary actions taken: ve (2014: eight)
- Number of cases regarding alleged breaches of the listing rules considered by the listing committee and concluded in the year: six (2014: all subject to public sanction)
- Number of directors against whom action was taken: 31, including 12 independent non-executive directors (INEDs) (2014: 39, including 17 INEDs)
- Number of disciplinary or settlement cases resulting in an Internal Control Review direction: one (2014: one)
- Number of disciplinary or settlement cases resulting in a Retention of Compliance Adviser direction: one (2014: ve)
- Number of disciplinary or settlement cases resulting in a Training of Directors direction: three (2014: ve)
In this report, HKEx also highlighted the following matters that it plans to consider during 2016 and beyond:
- review of the IPO settlement cycle
- review of the Growth Enterprise Market
- review of the overseas company listing regime
- review of Chapter 37 on debt issues to professional investors only
- review of Chapters 2A and 2B (i.e., HKEx’s disciplinary powers and sanctions and procedural issues relating to commit- tee hearings for disciplinary and non-disciplinary review)
- holistic review and regulations in connection with listed company activities including reverse takeovers and cash companies
- review of the handling of long-suspended companies, delistings and related requirements
- review of the requirements in relation to equity fundraisings of listed issuers
- review related to the government’s proposal to improve the regulatory regime for listed companies’ auditors
HKEx Reports on Its Review of Listed Issuers’ Corporate Governance Practice Disclosure in Annual Reports for the Year Ended March 2015
In May 2016, the HKEx published its analysis of corporate practice disclosure in 318 annual reports for the year ended March 2015. The relevant listed companies represent approx- imately 18 percent of all listed companies listed on the HKEx as of 31 March 2015. The report noted that:
- 25 percent of the companies complied with all of the Code Provisions (CPs) of the Corporate Governance Code; and
- 99 percent of the companies complied with 70 or more CPs, out of 75.
The HKEx noted that companies with medium market capital- ization achieved the highest overall compliance rate compared to those with large or small market capitalization. The HKEx expressed concern that there was room for companies to improve the quality of the explanations they provided for the deviations from CPs and noted a certain degree of “boiler- plate” style explanations, which were vague and had been repeated year after year.
The ve CPs with the lowest compliance rates were:
- -separation of the roles of chairman and chief executive;
- non-executive directors being appointed for a speci c term, subject to re-election;
- non-executive directors’ attendance at general meetings;
- chairman’s attendance at annual general meeting; and
- directors appointed to ll a casual vacancy being subjec to election by shareholders at the rst general meeting, and every director being subject to retirement by rotation at least once every three years.
- The HKEx also noted omissions of disclosures of the board diversity policy or a summary of the policy in 28 percent of the 10 percent randomly selected annual reports. The HKEx urged listed companies to take a closer look at their corporate governance reports and rectify any possible omissions in their next report.
SFC Reminds Issuers to Keep Trading Suspensions to the Minimum
The SFC reiterated the importance to keep trading suspension to the minimum in its March Takeovers Bulletin. In addition to what has already been addressed in HKEx’s Guidance Letter 83-15 (which sets out a number of “good practices” for trading halts), the SFC set out certain good practices in relation to suspensions of trading, including to:
- consult the SFC’s executive (the Executive) early if takeover matters are involved;
- appoint professional advisers;
- maintain con dentiality;
- comply with statutory requirements, such as disclosure of inside information and disclosure of interests; and
- prepare draft announcements ahead of time so that the announcements are ready to be issued promptly if the need arises.
In addition, companies should:
- not sign transactional documents until the parties are ready to announce;
- include all required contents in announcements and circulars; and
- make sure that the rst draft submitted to the SFC is comprehensive.
Guidance on Mandatory Offer Obligation Waivers in Acquisitions of Voting Rights by Members of a Concert Group
The SFC revisited Note 1 to Rule 26.1 of the Takeovers Code. The note states that when changes in the make-up of a concert group that e ectively result in a new group being formed or the balance of the group being changed signi cantly, the executive will apply a set of criteria and require a general o er to be made even when no single member holds 30 percent or more. The SFC stresses in the guidance that Rule 26.1 is strictly regulated. Transfer of voting rights by one member to another in a concert group, causing the purchaser’s sharehold- ing to cross a threshold, will “normally” result in an obligation to make a general o er for the outstanding shares.
If an exemption is to be made to the rule under Note 1, a comprehensive submission should be made to the executive early. Exemptions usually will be granted if (i) the acquirer is a member of a group of companies and one member of that group acquired the voting rights from another member; or (ii) if the group contains the individual, his close relatives, trusts and companies controlled by him, his close relatives or related trusts, and the acquirer has acquired to voting rights from another member of such group of persons.
When considering whether a whitewash waiver is to be granted under such circumstances, the SFC would consider a number of factors, including (i) whether the leading shareholder has changed; (ii) the price paid for the shares acquired; and
(iii) the relationship between the sponsors acting in concert and how long they have been acting in concert. Applicants for whitewash waivers also are reminded to allow su cient time for the executive to raise enquiries and analyze the responses.
SFC Issues a Corporate Regulation Newsletter Regarding Publishing Announcements and Disclosure of Inside Information by Listed Companies
In March 2016, the SFC issued a corporate regulation news- letter (Issue No. 3) regarding publishing announcements and disclosure of inside information by listed companies. The highlights of this newsletter include the following:
How Inside Information Should be Disclosed
- The SFC noted that posting press releases on corporate websites could make investors who spotted those press releases better off than investors who were not aware of them despite following the listed companies on HKExnews.
- The SFC emphasized the signi cances of announcements/ press releases and the importance of providing su cient context for readers to understand its impact on the company’s a airs.
- The SFC reminded listed companies to ensure simultaneous dissemination of inside information on their websites and the HKExnews system.
- The SFC reminded the o cers of listed companies of the responsibility for preventing a breach of con dentiality as required under section 307G of the Securities and Futures Ordinance (the SFO) and speci cally made reference to the leakage of Twitter’s nancial results caused by a data mining company using a “web-scraper” software.
- The SFC also noted that the use of social media by key executives for updating the market about their company’s operating performance and latest developments could lead to shareholders who do not follow the executives on social media being denied the chance to take the information into account when considering their investment decisions.
Incomplete or Misleading Statements
- The SFC reminded listed companies of the requirement in Section 307B of the SFO to ensure that inside information disclosed must not be false or misleading as to a material fact, or false or misleading through the omission of a material fact.
- The SFC cited three examples of instances where corporate communications contained piecemeal, unbalanced or inaccu- rate information, which could make them su ciently false or misleading to be regarded as a breach of the SFO:
- A listed company announced that it had signed a major contract without disclosing any details of the terms (the share price of the company rose signi cantly after the announcement) and later published the nancial state- ments, which revealed that the pro t generated from this contract was minimal (after which the share price drifted downwards).
- A listed company posted its operating statistics on its corporate website, which showed an increase in sales volume. A few days later, the company published a warn- ing disclosing a signi cant drop in its net pro t for the year despite the increased sales volume, due to a substan- tial fall in its selling price.
- A senior executive of a company mentioned the product sales target in a call with analysts and the target indicated a substantial slowdown of business. The company subse- quently issued an announcement clarifying that the sales target quoted by the executive was a personal view and the company had not prepared such a gure.
- The SFC noted that sometimes companies make statements of serious and questionable validity, which could be regarded as false or misleading as to a material fact, or false or misleading through the omission of a material fact in most extreme cases. In particular, the SFC speci cally noted that it would be misleading to describe an issue of bonus shares to be “a reward” or having the e ect of “widening the capital base of the company.”
- The SFC reiterated the importance of accurate, clear and balanced disclosure without glossing over or omitting any material facts, which should contain su cient details for investors to make a reasonable and realistic assessment of the company’s a airs.
Companies Listed in Multiple Jurisdictions
- The SFC stressed the importance of imposing simultaneous suspensions in di erent jurisdictions.
- Where a suspension is requested on the grounds that the listed company has inside information to disclose, the SFC may take action to determine what the inside information is and the reasons why it cannot be disclosed immediately.
- The SFC may either write formally to request or use statu- tory powers to ask the listed company to provide the details of the information that cannot be announced immediately.
- It is possible for the trading of securities listed in Hong Kong to resume while the trading of other securities in other jurisdictions remains suspended if there is no further inside information to be disclosed or the inside information is announced.
Recent Enforcement Actions and Penalties
Takeovers Panel Rules on Breach of Takeovers Code by a Subsidiary of Alibaba Group Holding Limited (Alibaba)
In January 2014, Alibaba proposed to subscribe for new shares in 21CN, a company listed on the HKEx, at a price of HK$0.30 per share (the Alibaba Subscription), which would result in Alibaba acquiring a majority interest in 21CN. This triggered an obligation for Alibaba to make a mandatory general o er under Rule 26 of the Hong Kong Takeovers Code, unless a waiver from the executive and the approval of inde- pendent shareholders (commonly referred to as a whitewash waiver) were obtained. At the time the Alibaba Subscription was announced, Chen Xiao Ying (Ms. Chen) was one of the largest shareholders, an executive director and the vice chair- man of 21CN. Ms. Chen’s brother, Chen Wen Xin (Mr. Chen) was not involved in the management of 21CN but held a small shareholding in 21CN. Alibaba claimed that it did not know that Mr. Chen was a shareholder in 21CN at the time.
One of 21CN’s principal operations is the development of a Product Identi cation, Authentication and Tracking System (PIATS) for the health care and other industries. This is the only such system available to the health care industry in the PRC. Mr. Chen was the sole shareholder in a company called Hebei Huiyan Medical Technology Co., Ltd. (OpCo), which was developing a business-to-consumer drug transaction platform on which online pharmacies could sell over-the- counter drugs and related products. OpCo had applied to the China Food and Drug Administration (CFDA) for a permit to allow it to operate an online transaction platform between online pharmacies and consumers for over-the-counter drugs and related products. In late 2013, OpCo was awarded the permits but Alibaba was unsuccessful in its application. On the same day the Alibaba Subscription was announced, Mr. Chen entered into agreements with Alibaba (the OpCo Agreements) providing for the sale of OpCo by Mr. Chen to Alibaba, the transfer to the internet platform operated by OpCo of Alibaba’s over-the-counter-drugs sales business, and the reorganization of OpCo into an o shore shareholding platform in which Mr. Chen would hold a minority interest and which would be the sole vehicle for Alibaba to sell over-the-counter drugs online in the PRC.
The executive was not consulted about the OpCo Agreements at the time it granted the whitewash waiver, and neither 21CN’s shareholders’ circular or announcements referred to OpCo or the OpCo Agreements. The Alibaba Subscription was completed and resulted in a signi cant increase in 21CN’s share price.
Under the Takeovers Code, the grant of a whitewash waiver by the executive is subject to compliance by the person seeking the waiver with a number of the Takeovers Code’s Rules, including Rule 25, which prohibits “special deals” between
an o eror or its concert parties and target shareholders that have favorable conditions that are not to be extended to all shareholders.
The executive referred the matter to the panel to determine (i) whether the OpCo Agreements constituted a special deal under Rule 25, (ii) if they did, whether the whitewash waiver granted to Alibaba in respect of the Alibaba Subscription was invalidated, and (iii) whether a mandatory general o er obli- gation had been triggered for the shares in 21CN not owned by Alibaba and its concert parties and, if so, at what price the mandatory general o er should be made.
The panel emphasized the fundamental importance of the principle of equality of treatment and rejected the contention that the OpCo Agreements were not related to the Alibaba Subscription, given the valuable nature of the permit held by OpCo, which was seen as essential to the development of Alibaba’s over-the-counter-drugs online platform. The panel found that given the proximity of the relationship between Mr. Chen and his sister, Alibaba’s legal advisers should have been concerned that the OpCo Agreements fell within the ambit of General Principle 1 and Rule 25, even if Mr. Chen was not a shareholder and should have consulted with the takeovers executive. Alibaba or its advisers should have been put on notice that Mr. Chen had become a shareholder in 2002 and could have asked whether he was still a shareholder, which they had failed to do.
In this case, it was clear that the sale of OpCo in exchange for cash and a minority interest in Alibaba’s over-the-counter- drugs online platform resulted in Mr. Chen receiving a positive consideration, which was su cient for the Panel to conclude that the OpCo Agreements constituted a special deal and invalidated the whitewash waiver. The question then arose as to the price at which Alibaba should make the mandatory o er. The executive argued that the appropriate o er price should be the market price at the time the whitewash waiver was invalidated, which was HK$5.11 per 21CN share. However, the panel concluded that the starting point for any o er must be HK$0.30 per share, being the price of the Alibaba Subscrip- tion. The panel was mindful that the price at which 21CN’s shares were trading was at a substantial premium to its tangible asset value, and this increase in share price was in large part attributable to the market’s expectation of the value that Alibaba could bring to 21CN. It would not be fair or reason- able to require Alibaba to make an o er at the market price that would result in it paying a substantial amount for the value that was largely attributed to its anticipated contribution to 21CN. Further, any additional value that the panel may have deter- mined should be added to the base o er price of HK$0.30 was unlikely to be material in the context of the prevailing market price or the prices at which 21CN’s shares had traded since the Alibaba Subscription. Hence, the panel decided to waive the mandatory general o er obligation that otherwise would have arisen for Alibaba on the invalidation of its whitewash waiver.
HKEx Censures China Kingstone Mining Holdings Limited (China Kingstone) and Its Directors for Breaching Listing Rules and/or Director’s Undertaking China Kingstone was listed in March 2011 and was engaged in the production and sale of marble and marble-related products in the PRC. China Kingstone’s annual results for the year 2011 and a subsequent announcement disclosed that it had entered into various transactions (Transactions) comprising three entrusted loans (Entrusted Loans), six structured deposits (Structured Deposits), an investment in a company (GJ) and two loans provided to GJ that took place between June 2011 and November 2011. The Entrusted Loans and the Structured Deposits constituted very substantial acquisitions and the investment in and loans to GJ constituted major transactions. A circular was issued in October 2012 for the extraordinary general meeting to ratify the Transactions, but the shareholders voted against the resolutions. Ms. Chen, Mr. Lin, Mr. Liao and Mr. Xiong were the directors of China Kingstone. Ms. Chen asserted that she followed the instructions of Mr. Huang, the then controlling shareholder, when arranging the Transac- tions. She did not procure the company’s compliance with the listing rules as Mr. Huang threatened to replace the board and asserted that any disclosure would cause market over-reaction and share price uctuations. Mr. Lin, Mr. Liao and Mr. Xiong were asked by Ms. Chen to sign the board minutes approving the Transactions after the event. China Kingstone used the IPO proceeds to fund the Entrusted Loans and Structured Deposits, contrary to the stated use of proceeds in its prospectus.
The listing committee found China Kingstone to have breached the requirements (i) to comply with the announcement, circular and independent shareholders’ approval requirements in respect of the Transactions, (ii) to consult its compliance adviser when the Transactions were contemplated, and (iii) to disclose a change in the use of the IPO proceeds. The listing committee also found the directors to have breached (i) the requirement under Listing Rule 3.08 to ful ll their duciary duties and duties of skill, care and diligence to a standard at least commensurate with the standard established by Hong Kong law and (ii) the declaration and undertaking given in the form set out in Appendix 5B of the listing rules. The listing committee also found that, given their conduct, the directors willfully and persistently failed to discharge their responsibilities under the listing rules.
As a result, China Kingstone and its directors were publicly censured. In the event that the directors sought to be directors of other listed companies in the future, their conduct in this matter will be taken into account in assessing their suitability under Listing Rule 3.09. The directors also were required to attend 24 hours of training on the listing rules, compliance and director’s duties.
SFC Commences MMT Proceedings Against Mayer Holdings Limited and Its Senior Management over Late Disclosure of Inside Information
In one of the very rst cases brought by the SFC for breach of the inside information provisions of the SFO, the SFC has commenced proceedings in the Market Misconduct Tribunal (MMT) against (i) Mayer Holdings Limited (Mayer) for failing to disclose price sensitive information as soon as reasonably practicable, and (ii) 10 current and former senior executives for their reckless or negligent conduct causing the alleged breach by Mayer of the provisions of the statutory corporate disclosure regime. Trading of Mayer’s shares has been suspended since 9 January 2012.
Between April and August 2012, while auditing Mayer’s nancial statements for the year ended 31 December 2011, the then auditors of Mayer repeatedly communicated with Mayer’s management about issues they identi ed including: (i) the suspicious nature of the disposal of a wholly owned subsidiary of Mayer for HK$15.5 million, (ii) Mayer did not control the projects it bought for HK$620 million in Vietnam and their valuations appeared to have been in ated, and (iii) two subsidiaries of Mayer’s jointly controlled entity had made substantial prepayments of US$10 million and US$4 million, respectively, without security to suppliers, which appeared to be irrecoverable (the outstanding audit issues).
On 23 August 2012, Mayer’s then auditors indicated they would qualify their audit opinion for the nancial statements for the year ended 31 December 2011 if the outstanding audit issues were not resolved. Mayer received a resignation letter from its auditors on 27 December 2013 but only disclosed the resignation letter together with brief details of the outstanding audit issues on 23 January 2013.
The SFC alleged that the auditors’ resignation, the outstanding audit issues, the potential quali ed audit report and the US$10 million prepayment to the supplier were speci c information regarding Mayer that was price sensitive and not generally known to the public at the material time. The information should have been disclosed as it would have been viewed negatively by the investors and were of su cient gravity to a ect Mayer’s share price.
SFC Commences MMT Proceedings Against Yorkey Optical International (Cayman) Limited, Its CEO and Financial Controller for Late Disclosure of Inside Information
On 6 April 2016, the SFC commenced proceedings in the MMT against: (i) Yorkey Optical International (Cayman) Limited (Yorkey) for failing to disclose price sensitive infor- mation as soon as reasonably practicable, and (ii) Mr. Nagai Michio and Mr. Ng Chi Ching, the chief executive o cer and nancial controller of Yorkey, respectively, for their reckless or negligent conduct causing the alleged breach by Yorkey of the provisions of the statutory corporate disclosure regime or their failure to take all reasonable measures to ensure that proper safeguards exist to prevent the alleged breach.
The SFC stated that, contrary to the published expectations of Yorkey’s management of signi cant growth and increasing pro tability for the second half of 2012 as compared to the rst half of 2012, Yorkey in fact sustained material losses in the second half of 2012 and its nancial performance deteri- orated signi cantly and there was a substantial year-on-year decline in its 2012 pro ts on a full-year basis. More specif- ically, Yorkey recorded a net pro t of US$1.25 million in its unaudited interim results for six months ended 30 June 2012 and a net pro t of US$60,000 in its 2012 Final Results. The net pro t of US$60,000 for 2012 represented a decline of 99 percent when compared to the net pro t of US$6.685 million in 2011.
The information about Yorkey’s material losses and the signi cant deterioration in its nancial performance were apparent from the gures contained in the internal manage- ment accounts and such information came to the knowledge of Yorkey and its CEO by mid-January 2013 at the latest, but only was disclosed to the public in Yorkey’s 2012 audited annual results on 25 March 2013.
The SFC alleges that the information about Yorkey’s material losses in the second half of 2012 and the signi cant deterio- ration in its nancial performance was speci c information regarding Yorkey that was price sensitive and not generally known to the public at the material time. Had the information been known to the investing public, it would likely materially a ect Yorkey’s share price. Yorkey’s share price fell 21.25 percent over a three-day period from HK$0.80 on 25 March 2013 to HK$0.63 on 28 March 2013.
For further information, please contact:
Christopher Betts, Partner, Skadden
christopher.betts@skadden.com
