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HKEX’s new internal controls/risk management disclosure: are you ready?

HKEX published its latest review of listed issuers’ corporate governance practices, as disclosed in 2015 annual reports of June year-end companies. (click here for full report; press release) This is a continuing exercise, having completed review of 2014 December and 2015 March year-end companies.

What you should do/watch out for:

• Based on disclosure pursuant to “old” requirements, we observe that improvement in the reporting (hence underlying board and company processes) of considerable listed companies may be needed
• For accounting periods on or after 1 January 2016, more rigorous disclosure will be required for internal controls and risk management
• The board is responsible for ensuring that the issuer maintains sound and effective internal controls to safeguard shareholders’ investment and the issuer’s assets–an ongoing responsibility
• It should at least conduct an annual review of the adequacy of internal controls
• Disclosure of the process used to “identify, evaluate and manage significant risks” also needed
• Over 40% of the reviewed companies have not disclosed the frequency of board review. Over 50% of the companies disclosed that their boards only conduct a review annually

 
 
There are also notable HKEX/SFC enforcement cases in September.

HKEX Listing Committee censures Mingyuan Medicare Development Company Limited for failing to disclose and obtain prior shareholders’ approval for a payment of RMB 396 million to an unrelated entity, whereby the parties agreed to exchange the sum into Hong Kong dollars within three months, at an agreed exchange rate. No interest was payable, and no security/ collateral was provided. Such transaction amounted to financial assistance, and given its size, a “major transaction” (Chapter 14) which requires disclosure and shareholder approval.

Some directors are also censured for breach of Directors’ Undertakings, for the lack of due diligence and internal controls regarding approving the transaction. These include a director who claimed to have “resigned” before the transaction.

What you should know:

• The company did not conduct any due diligence on the proposed arrangement or take any steps to verify the alleged connections with government officials understood by the initiating executive director
• As in previous cases, the directors were also found liable for failing to ensure adequate internal control procedures regarding (i) approval of the arrangements, (ii) compliance with the Listing Rules, hence breaching their Directors’ Undertakings
• Is “resignation” good enough? Former CEO and ED claimed that he “first resigned” before the transaction but agreed to stay on pending a replacement; informed the company he would “only review and give advice to the board but would no longer take part in the decision-making process”; he did not attend board meetings for over a year and was not provided with information
• No public announcement of such “resignation” was made till the transaction itself was disclosed in the annual results announcement
• He was criticized for breaching his Director’s Undertaking – An ED and CEO had clear obligations as a matter of law to the company to act in its best interest and use his skills for its benefit. His conduct and failure to act demonstrated a clear derogation and abdication of his responsibilities

What you should do/watch out for:

• Directors’ duties represent a recurring theme in HKEX’s enforcement actions. A director has clear obligations in law to the company until his resignation and disclosed to shareholders. Any “derogation and abdication of responsibilities” would amount to breach of Directors’ Undertakings.

 
 
SFC brought proceedings in the Market Misconduct Tribunal (“MMT”) for “false trading” (a form of market misconduct). (Click here for SFC Press release, MMT notice)

It is an interesting case, illustrating how different trading actions would potentially constitute “false trading”, in light of prevailing circumstances.

Between August 2009-March 10, the company launched two fundraising exercises to finance certain proposed acquisitions, firstly a “share placement”; then an issuance of “convertible bonds”.

During this period, two executive directors and a major shareholder traded substantial amounts of the company’s shares, using many securities accounts in the names of themselves and others. One of them provided a majority of funding.

The SFC alleges that during different phases, the EDs tried to create a false or misleading appearance of active trading or with respect to the market for, or the price for dealings in its shares which supported and/or benefited the fundraising exercises.(s.274, Securities and Futures Ordinance)

What you should know/watch out for:

• An interesting case; illustrates how different trading actions would potentially constitute “false trading”, in light of prevailing circumstances
• (First phase) share placement and weak market response — alleged share buying activities to boost share price
• (Second phase) – alleged buying and selling of shares to create the impression of “active trading” and liquidity, hence supporting further fund raising
• (Third phase) prior to convertible bond issuance –alleged share selling activities to create a lower price of the shares , hence lowering the conversion price and enhance attraction to potential investors

Other topics and what you should do

Regulators

Legislation