Front-Loaded Regulation: The Implications for Listed Companies
Timothy Loh, Managing Partner, and Greg Heaton, Senior Consultant, Timothy Loh LLP, argue that the SFC’s new front-loaded regulation signals an increasing level of oversight and intervention by the SFC in the regulation of listed companies.
In July 2017 Ashley Alder, the Chief Executive Officer of the Securities and Futures Commission ("SFC"), formally introduced a new approach to regulating companies listed, or applying to be listed, on the Stock Exchange of Hong Kong ("SEHK"). The new approach, called 'front-loaded regulation', emphasises 'earlier, more targeted intervention' to pre-empt or limit investor losses from major corporate misfeasance and market misconduct.
Front-loaded regulation does not disturb the SEHK’s role as the frontline regulator of listed companies, a role which many market participants had argued forcefully should be maintained in the course of a joint SFC-SEHK consultation on decision making and governance in listing regulation. However, it gives new life to long-standing powers of the SFC under the Securities and Futures (Stock Market Listing) Rules ("SMLR") to directly regulate listed companies. These rules and their predecessor, the Securities (Stock Exchange Listing) Rules, have for almost 30 years given the SFC the power to object to any listing or to suspend or cancel a listing on various grounds, including:
- where materially false, incomplete or misleading information has been included in any prospectus or other document issued in connection with a listing or in any announcement or other document issued by an issuer in connection with its affairs
- where it is necessary or expedient in the interest of maintaining an orderly and fair market, or
- where it is in the interest of the investing public or it is appropriate for the protection of investors.
Expansion of enforcement powers
Traditionally, the SFC has relied on enforcement powers that can only be exercised through a court or the Market Misconduct Tribunal ("MMT"). The SFC has now, in effect, explicitly added the power to suspend a listed company or to cancel the listing of a listed company as additional tools in its arsenal. The power to suspend, in particular, is likely to be highly effective because:
- no approval from a court or any tribunal is required for the SFC to use it, and
- though the SFC has indicated that it will 'normally' give a listed company a reasonable opportunity to be heard before it exercises this power, it is not obliged under the SMLR to do so.
So far, the SFC has reported that it has used its power of suspension as 'exceptional early protective action', usually taken during an investigation to maintain the status quo pending:
- further investigation
- the taking of a specific remedy, or
- the imposition of a specific sanction.
In this latter respect, where a listed company has acted in a manner prejudicial to its investors, the SFC has traditionally sought court orders to require the listed company to sue its officers or to disqualify its officers from being directors in the future.
Regrettably, because the power of suspension is not subject to any approval from a court or tribunal, the basis upon which this power is exercised and the arguments raised against it are not transparent. There is no right to appeal a decision by the SFC to suspend a listing to an independent tribunal such as the Securities and Futures Appeals Tribunal ("SFAT"). In contrast, decisions of the SFC under the SMLR to object to a listing can be appealed to the SFAT.
However, a listed company which objects to a decision by the SFC to suspend dealings in its securities may make representations to the SFC. Such representations are to be heard by the directors of the SFC. In this case, any director of the SFC who originally made the decision to suspend may not participate in the deliberations or voting in connection with the hearing of the objection but may explain his decision. The listed company is entitled to be represented by its lawyer in the hearing of its objection.
A further consequence of front-loaded regulation is that it may enable the SFC to supplement the SEHK listing rules. The SFC’s powers of suspension may be exercised, not only when the issuer has disclosed false information, but also whenever the SFC believes that it is 'appropriate for the protection of investors'. The latter is potentially capable of a very broad interpretation.
In May 2017, the SFC issued a Guidance note on directors’ duties in the context of valuations in corporate transactions. Earlier, in June 2012, the SFC issued its Guidelines on Disclosure of Inside Information. These documents were issued in the context of the SFC’s powers under the Securities and Futures Ordinance ("SFO") in respect of conduct unfairly prejudicial to shareholders of listed companies and the requirement for listed companies to disclose inside information. Significantly, they were issued to provide guidance on the SFC’s expectations of listed companies for the purpose of exercising specific statutory powers. It is not a great leap to imagine that, on the same basis, the SFC would issue guidance on what it regards as 'appropriate for the protection of investors'.
The validity of such guidance is unclear. Under the SFO, quite apart from the SFC’s power to require the SEHK to make or amend particular listing rules, the SFC has the power to make its own rules in relation to listing. However, in so doing, it must consult with the Financial Secretary and the SEHK. It does not appear that any similar requirement for consultation would apply in the case where the SFC simply issues guidance as to how it plans to exercise its discretion to suspend a listed company.
Though the SFC’s new front-loaded regulation appears to be an evolving approach whose implications for listed companies are not fully known, it seems probable that it signals an increasing level of oversight and intervention by the SFC in the regulation of listed companies. Whilst it is always inherently difficult to make predictions, this oversight and intervention will, in our view, take place through the issuance of guidance as to expected standards of conduct and through gradual enforcement action under the SMLR. We say this for two reasons.
First, the SFC has repeatedly expressed concerns about the quality of regulation of listed companies under the current framework, known as the dual-filing system, under which listing applications are reviewed by both the SEHK and the SFC. These concerns were expressed as long ago as 2003, when a three-member expert group appointed by the Financial Secretary issued a report (Expert Report) recommending that the regulatory functions of SEHK be transferred to the SFC. This was intended to clear the conflict of interests of the SEHK as both a regulator and a profit-making entity, and to improve the quality and efficiency of listing applications. The recommendations of the Expert Report were supported by the SFC but faced significant opposition, and ultimately were not adopted.
Most recently, in November 2016 the SFC and SEHK issued a Joint Consultation Paper on Proposed Enhancements to the Exchange’s Decision-Making and Governance Structure for Listing Regulation, which proposed greater SFC participation in listing policy and in the review of decisions of the listing committee. These proposals were abandoned following fierce opposition.
The failure of these consultations to result in any significant changes, and the fact that the SFC has responded to these failures by reverting to the SMLR, suggests that the SFC will henceforth continue to expand its role through application of the SMLR on an incremental basis.
A second reason why it seems likely that the SFC will continue to expand its role through the SMLR is that such an expansion seems consistent with the prevailing trend in which the SFC has been taking an increasingly active role in deploying its statutory powers – statutory powers which the SEHK does not have – to regulate listed companies. This trend is particularly notable in the rise in the number of SFC investigations now focused on listed companies as a proportion of all investigations. As is often the case with regulation, there is a natural tendency to continuously move towards a higher degree of regulation and the present trend shows no signs of abating.
One sign of things to come was the introduction in 2013 of the statutory requirement to disclose inside information. This requirement in effect moved the regulation of the key post-listing obligation, namely the duty to disclose information on a continuous basis, from the SEHK to the SFC. Once the new requirement came into effect, the SFC promptly commenced three actions before the Market Misconduct Tribunal, one each against AcrossAsia, Mayer and Yorkey, letting it be known that it was the new cop on the block.
Another sign of things to come is the SFC’s not infrequent use of its statutory powers to seek remedies through the courts for listed company misconduct. These remedies include requiring the listed company to pay compensation to investors or to sue directors or former directors who have engaged in misconduct, or disqualifying directors from serving as such. The SEHK does not have equivalent powers to compel persons to cooperate with its investigations, nor does it have an equivalent ability to seek these types of remedies. The powers of the SFC to suspend or cancel listings go hand in hand with these other statutory powers and there seems to be no obvious reason why the SFC would not deploy its powers to suspend or cancel in appropriate circumstances.
In ramping up the use of its existing powers, the SFC has sought to improve collaboration among its operational divisions. Specifically, the SFC has formed an 'ICE' team composed of officers from the Intermediaries, Corporate Finance and Enforcement divisions, tasked with identifying and responding to problems relating to listed companies, especially in the Growth Enterprise Market ("GEM"). Using the supervisory tools of the Intermediaries division, the SFC undertook a thematic review of price volatility of listings on GEM, focused on placing agents whose practices purportedly resulted in a high concentration of shareholdings among a small number of placees. Subsequently, the Enforcement division launched investigations into a number of listing sponsors. ICE has also attempted to identify and disrupt groups of interrelated companies that allegedly work together to defraud minority shareholders through market manipulation and by entering into apparently legitimate transactions that do not make genuine business sense. In one recent operation, SFC used 136 officers from three SFC divisions to search multiple premises.
The result of the foregoing is that, over the long term, it seems likely that the core of the regulation of listed companies will move from the SEHK to the SFC.
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This article was originally published in the January, 2018 edition of CSj, the publication of the Hong Kong Institute of Chartered Secretaries (http://csj.hkics.org.hk).
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