A roadmap to resumption on the Hong Kong Stock Exchange

This article is also available in Chinese in PDF format.

Introduction

The first quarter of the year is the audit season for many listed companies in Hong Kong. 

For the financial year of 2015, as we can see from the chart and statistics below, 5% of the listed companies in Hong Kong were not able (or have yet been able) to secure a clean bill of health from their auditors.

11971 companies were listed on the Hong Kong Stock Exchange (Main board - 1712, GEM board - 259) with respect to the financial year of 2015.

Statistics would suggest that many of the above companies not being able to secure an unqualified audit opinion are “high risk” companies:

• Of the 19 companies which have yet to complete their audit for the financial year of 2015, all of them have been suspended from trading, and 17 are currently placed on the long suspension company list (ie companies that have been suspended for three months or more), and are subject to various resumption conditions imposed by the HKEx. Among those companies, six are currently placed in the delisting process.

• Of the 90 companies which received an adverse/disclaimer/qualified opinion for the financial year 2015:
  • 35 were suspended from trading due to certain irregularities and/or concerns from the regulators,13 remain suspended (and among them, eight are currently placed in the delisting process) and 22 have emerged from suspension and resumed trading after investigation (internal and/or by regulators), addressing the relevant irregularities, restructuring, satisfaction of resumption conditions imposed by the regulators and/or publication of the financial information.
  • 32 of them changed auditors shortly before/after publication of the disclaimer/qualified opinion.

The reasons for a listed company being suspended from trading vary from case to case - some companies were suspended as a result of issues/concerns uncovered by their auditors during the course of their audit. Some companies were suspended as a result of their failure to publish their annual results by the deadline required under the listing rules.

One of the key aims of a listed company which has being suspended from trading (and its shareholders/investors) is to seek resumption of trading as soon as possible.

The purpose of this note is to outline a roadmap to resumption for listed companies that were suspended from trading due to identified irregularities and/or investigations by regulators.

Suspension of trading

A listed company could be suspended on its own volition or at the direction of the regulators (HKEx and the Securities and Futures Commission (SFC)).

The SFC has rarely exercised its power to direct the HKEx, but we are seeing a gradual change. In 2016, we saw at least two instances in which the SFC directed the HKEx to suspend trading of shares in listed companies.

With the SFC’s public announcements of its intention to make corporate governance a top priority, we can expect greater scrutiny on listed companies, investigations into misfeasance and correspondingly a rise in the number of regulatory suspensions.

A roadmap to resumption

When it comes to resumption, the HKEx is likely to have two key concerns.

On the one hand, the HKEx will to keep the period of suspension as short as possible, as it considers that “a continuation of suspension denies reasonable access to the market and prevents its proper functioning” (LR 6.05).

Hence, the HKEx would expect the listed companies to take adequate action to achieve resumption as soon as possible, and if they fail to do so for a prolonged period, the HKEx may delist the company.

On the other hand, the HKEx will diligently seek to ensure that all matters leading to a suspension are properly addressed by the company, so that investors' interest are protected.

Depending on the facts and the underlying issues, the HKEx will impose certain conditions on the listed issuers for resumption of trading, and will not allow any resumption unless and until those conditions are fulfilled satisfactorily.

For listed companies with identified irregularities or under regulatory investigation, in order to resume trading, they must take appropriate steps to fulfil the resumption conditions to the satisfaction of the HKEx as soon as possible. While there is no strict timetable for resumption of trading, if a listed company fails to take adequate action to obtain resumption of trading for a prolonged period, the HKEx may delist them.

Resumption conditions imposed by the HKEx would typically include the following:

• an independent/forensic investigation to be conducted
• remedial measures to be undertaken with a view to addressing all relevant concerns (including issues identified by the auditors and regulators)
• publication of the relevant financial and other material information to the market
• a review of the internal control system, and
• addressing all concerns about the management’s integrity.

As is apparent from the nature of some of the resumption conditions, fulfilling the resumption conditions imposed by the HKEx to its satisfaction is unlikely to be a straightforward task. In many cases, the process may take months or even years.

Some practical points to note

It is therefore important that the listed issuers seek appropriate professional assistance (from forensic experts, internal control consultants and legal counsel) to help them navigate through the entire process.

Based on our experience in advising listed issuers on resumption of trading and regulatory investigations, below are practical points to note when seeking a resumption of trading:

Conducting a forensic investigation

• A forensic investigation would normally be required in cases where accounting irregularities or possible fraudulent activities are identified.
• An independent committee would need to be established by the board to conduct the investigation with assistance from forensic experts and legal counsel.
• Insofar as it is possible, appropriate steps should be taken to ensure that as much as possible the forensic investigation is protected by legal privilege.
• It is crucial that the scope of the investigation be determined carefully, and be reviewed at appropriate stages when further information becomes available. The listed companies should seek the HKEx’s endorsement of the proposed scope of the investigation.
• It is also important that a reputable accounting firm be instructed to undertake the forensic investigation.

Addressing audit concerns

• It is important that those audit concerns are properly identified and understood at an early stage, and are taken into account when determining the scope of, and in structuring, the forensic investigation.

Demonstrating adequate internal control system

• It is important that listed issuers establish and maintain an appropriate and effective risk management system. Under the Corporate Governance Code, the board of directors has a duty to ensure that the listed issuer establishes and maintains appropriate and effective risk management and internal control systems, and to oversee the listed issuer’s risk management and internal control systems on an on-going basis.
• As a condition for resumption, the listed issuers would sometimes be required to demonstrate that all material internal control weaknesses/deficiencies have been identified and addressed.
• To satisfy this condition, many listed issuers would commission an internal control consultant to review all its material controls, including financial, operational and compliance controls, in accordance with the relevant international standard (such as the The Committee of Sponsoring Organizations of The Treadway Commission (COSO) internal control framework).

Demonstrating the integrity and competence of directors

• In cases where issues giving rise to suspension involve management and directors’ competence and/or integrity, the HKEx would expect that matters are fully investigated and appropriate steps are taken to ensure that all directors and management meet with the requisite standards going forward.
• Directors owe fiduciary duties to the listed issuer to act honestly, in good faith in the interest of the company as a whole, and act for proper purpose. It is likely that directors failing to discharge their duties would (among others) be investigated by the regulators (HKEx and the SFC) and may be disqualified from their office.

Taking appropriate remedial action

• Insofar as any weaknesses or deficiencies are identified in the investigation and in the internal control review, appropriate steps must be taken to rectify them.
• Remedial action should be taken on a timely basis. Very often, the question is whether the proposed remedial action is effective and/or sufficient to address the relevant weaknesses or deficiencies. Professional advice on remedial action is recommended.

Obtaining approval of resumption from the SFC

• The SFC has the power to direct the HKEx to suspend trading under the Securities and Futures (Stock Market Listing) Rules. In recent years, many listed issuers were suspended as a result of the SFC exercising such power.
• To obtain approval of resumption from the SFC, it is important that issues giving rise to the suspension are properly addressed to the satisfaction of the SFC.
• Accordingly, the listed issuer should, at an early stage, assess the relevant issues identified by the SFC, so that appropriate action can be taken to investigate and address those matters.

Disclosure of information

• The listed issuer should publish regular update announcements to apprise the market of the latest developments in the investigation and the resumption process.
• Pending resumption, the listed issuers are required to continue to discharge their relevant obligations on the disclosure of information to the market.
• As one of the conditions for resumption, the HKEx would generally require a listed issuer to publish an announcement to explain to the market the background leading to the suspension, the relevant findings of the investigation (such as issues identified), the remedial measures undertaken by the listed issuers and whether (and how) the resumption conditions imposed by the HKEx have been fulfilled, and to disclose all relevant financial information of the listed issuer. Such an announcement would need to be vetted by the HKEx before its publication.

What would follow after resumption?

A resumption of trading is unlikely to be the end of the matter - it usually marks the beginning of investigations by the SFC and the HKEx into the listed issuers (and/or their officers) for past breaches of the rules and regulations.

The SFC has a statutory duty under the Securities and Futures Ordinance(SFO) to discipline and prosecute wrongdoers in the securities market. Tackling misconduct by listed companies and their directors who abuse their positions and funds is one of the six key focuses of the SFC’s enforcement work. Depending on the nature of the misconduct, sanctions for breach of the SFO could be criminal, civil and disciplinary in nature.

The HKEx also has a statutory duty to ensure an orderly, informed and fair market for the trading of securities on the HKEx. The HKEx would enforce the listing rules, and would take disciplinary action against the listed companies and their directors for breaches of the listing rules and the personal undertaking given by the directors to the HKEx. Possible sanctions may include public sanction, disqualification, suspension or cancellation of listing.

Accordingly, in cases where matters giving rise to the suspension might involve any wrongdoing or breach of the relevant rules, the likelihood is that the SFC and the HKEx would carry out an investigation after the resumption (if they had not yet done so before resumption), and insofar any wrongdoings/breaches are identified, they would seek to prosecute the listed companies and their directors for those wrongdoings/breaches.

Finally, apart from investigations by the regulators, directors would, as part of their fiduciary duties, need to consider whether there is any need for the company to pursue any legal proceedings against any wrongdoers and/or third parties for recovery of any misappropriated assets or losses suffered by the company as a result of matters giving rise to the suspension. Professional advice is recommended.

Download PDF(English)

Download PDF(Chinese)