If your first contact with Hong Kong’s market regulators is a knock on the door from an investigation team, your engagement with them is already too late. Whether you think of them as shining white knights protecting Hong Kong’s market or, as one regulator described himself at the Institute’s latest Annual Corporate and Regulatory Update seminar, ‘mister nasty’ – it pays to understand regulators’ thinking on disciplinary matters.

The Institute’s Annual Corporate and Regulatory Update (ACRU) seminar is the most popular event in the Institute’s CPD calendar and it is not difficult to see why. The seminar gives compliance professionals
the opportunity to hear directly from regulators about the current compliance challenges they are facing. In addition to the specific compliance issues addressed by the seminar (reviewed in this month’s second cover story on pages 14-20), this year’s ACRU was also a rare opportunity to listen to the regulators’ general views on enforcement and market discipline.

In session three of the seminar, for example, Stephen Jamieson, Vice- President of the Listing Department, Hong Kong Exchanges and Clearing, gave ACRU attendees valuable insights into the Exchange’s strategy for enforcing the listing rules.

Avoiding mister nasty

‘I’ll be giving you advice on how to avoid all contact with the Listing Division enforcement team,’ Mr Jamieson said at the outset. ‘We are mister nasty. We make a case to the Listing Committee that sanctions should be imposed.’ He went on to describe in some detail how the Listing Division goes about fulfilling its role as the frontline regulator of the market.

Will mister nasty go after me?

The short answer is yes. Directors and listed companies are not the only potential targets of the Exchange’s disciplinary action. Mr Jamieson explained that, while they are the primary targets, under Main Board Listing Rule 2A.10/ GEM Listing Rule 3.11, sanctions may also be imposed against:

  • a member of senior management of a listed issuer or any of its subsidiaries
  • an authorised representative of a listed issuer
  • a substantial shareholder of a listed issuer, and
  • a professional adviser of a listed issuer or any of its subsidiaries.

Company secretaries, as members of senior management, are therefore caught under this rule and can be the subject of a disciplinary action by the Exchange. Mr Jamieson cited a recent disciplinary case in which the Company Secretary of a listed issuer, who was not a director, failed to perform the relevant duties to ensure and assist Model Code compliance by the listed issuer and its directors. The case ended with a private reprimand of the Company Secretary and the listed issuer, with the engagement of an independent professional adviser to conduct an internal control review. There was also a private reprimand of the directors and training requirements were imposed.

What will get me into trouble?

Mr Jamieson explained that the Listing Division looks at a number of factors when assessing whether to take action, these include:

  • the seriousness of the breach
  • which rule was breached
  • whether prejudice to investors and shareholders was involved
  • the size of the relevant transactions
  • the duration and the frequency of the breach
  • the mindset of the directors concerned – was it a technical breach of the rules resulting from negligence or oversight, or was it the result of a deliberate or reckless disregard of the rules?
  • whether the company self-reported or admitted the breach
  • the company’s compliance record (as you might expect the Exchange keeps records of those who consistently break the rules)
  • whether there were deficiencies in the company’s internal control system, and
  • whether remedial measures were taken after the discovery of the breach.

Am I obliged to co-operate with investigations?

If an investigation is launched, the Exchange may require written submissions from listed issuers and directors. Mr Jamieson explained that listed issuers are obliged to provide information or documents reasonably required by the Exchange for investigating a suspected breach of, or verifying compliance with, the listing rules. This is both an explicit obligation in the listing rules (Main Board Listing Rule 2.12A/ GEM Listing Rule 17.55A), and a requirement of the ‘Director’s Undertaking’ which is signed by all directors when they take up their position. He added that false or misleading information or documents knowingly or recklessly provided breach Section 384 of the SFO.

Who else do I have to answer to?

While the Exchange is the frontline regulator of listed companies, there are many other regulatory bodies in Hong Kong that could come knocking at your door. These include the Independent Commission Against Corruption (ICAC), the police, professional bodies, the Financial Reporting Council and, of course, the Securities and Futures Commission (SFC). There has been some market concern about possible duplication of regulatory enforcement actions, particularly between the SFC and the Exchange. Mr Jamieson said that the Memorandum of Understanding between the SFC and the Exchange seeks to ensure that any such duplication is avoided. Basically breaches of the law are handled by the SFC and breaches of the listing rules are handled by the Exchange. Moreover, the SFC has a statutory duty to supervise and monitor the Exchange’s performance of its listing- related functions and responsibilities.

Who makes the decisions?

While the Listing Division acts as the ‘prosecutor’ in disciplinary matters, it is the Listing Committee that makes decisions on whether the listing rules have been breached. This means, Mr Jamieson said, that those regulated by the Exchange are subject to a ‘trial by peers’ because the Listing Committee comprises representatives of market participants. Currently, eight individuals represent the interest of investors and 19 individuals are representatives of listed issuers and market practitioners (including professional advisers). There is a quorum of five for disciplinary matters.

What sanctions can be imposed?

Under Main Board Listing Rule 2A.09/ GEM Listing Rule 3.10, if the Listing Committee finds that there has been a breach of the listing rules, it may impose the following sanctions:

• public censure

• public statement involving criticism

• private reprimand

• remedial action to be taken within a stipulated period

• declaration that retention of office by a director is prejudicial to interests of investors

• reporting the offender’s conduct to another regulatory body, and

• any action as the Listing Committee thinks fit.

Mr Jamieson added that a private reprimand can be disclosed to other regulators. Moreover, in recent years the focus of both the Exchange and the SFC has been to ensure that remedial action is taken. This is the ‘dual track’ approach where both punishment and remedial action are sought. In appropriate cases, for example, the Exchange will direct that a compliance audit by external auditors is undertaken and that directors attend training.

What can I do to avoid disciplinary action?

Mr Jamieson emphasised that the best way to avoid contact with ‘mister nasty’ is to ensure effective internal controls. ‘The main point I would like you to take away today,’ he said ‘is that listed companies need adequate internal controls. I cannot stress enough that all directors and senior management should take steps to ensure that issuers have sound and effective systems in place to support and achieve listing rule compliance.’

He pointed out that the Corporate Governance Code contains code provisions to the effect that directors should at least annually review the effectiveness of their internal control systems, covering all material controls, including operational and compliance controls and risk management functions. He also urged company secretaries to go to the Exchange website to look at previous disciplinary cases. ‘You will see that internal controls are a key element,’ he said. ‘Past disciplinary decisions illustrate that the Listing Committee takes a very serious view of those directors who fail in this respect.’

It is now fairly common for the Listing Committee to require companies in breach of the listing rules to appoint an independent professional adviser to conduct internal control review and to make recommendations for internal control improvements within a specified period (for example two months) from the publication of the relevant sanction. The independent professional adviser will provide the Listing Division with written reports both on the recommendations made and the actions taken to remedy the situation.

In addition to internal controls, Mr Jamieson stressed the importance of director training. ‘It is quite extraordinary the lack of knowledge of the listing rules displayed by some directors,’ he said. The Corporate Governance Code contains code provisions requiring directors to receive briefings and the professional development necessary to ensure that they have a proper understanding of their company’s operations and business. ‘Directors should be fully aware of their responsibilities under the listing rules, all relevant legal and regulatory requirements and the listed issuer’s business and governance policies,’ Jamieson said.

He added that the listing rules and corporate governance obligations change and develop over time so directors and senior management need to keep abreast of these changes through regular training in the interests of good corporate governance and the performance of their obligations to the Exchange and the wider financial market.

Once again, previous disciplinary cases are a useful resource for company secretaries seeking to understand the Exchange’s enforcement policies in this area. It is now common for the Listing Committee to require directors to undergo training on listing rule compliance, directors’ duties and corporate governance matters as part of disciplinary actions. The training is often supplied by professional bodies such as the HKICS, the Hong Kong Institute of Directors or other bodies acceptable to the Listing Department. The training has to be completed within a specified period (for example 180 days) from the publication of the relevant sanction and the training provider has to provide the Listing Department with a written certification of completion.

Tentative thoughts on shareholder engagement

There has been a trend in recent years for the ACRU forum to go beyond addressing the ‘nuts and bolts’ of compliance – regulators have also seized this opportunity to discuss the thinking behind current legislation and regulation. This was in evidence at ACRU 2013, both in Mr Jamieson’s presentation and the session one presentation by Charles Grieve, Senior Director of Corporate Finance, Securities and Futures Commission (SFC). Mr Grieve discussed an SFC project still very much in the ’embryonic’ stage – assessing whether Hong Kong would profit from having some form of code on shareholder engagement.

With so many compliance challenges vying for company secretaries’ attention at the moment, shareholder engagement might not seem to be very high on the agenda, but Mr Grieve pointed out that corporate governance is a ‘three-legged stool’. Good corporate governance comes from:

  1. companies’ self-discipline
  2. regulation, and
  3. market discipline.

‘You need all three of these legs for the stool to work,’ he pointed out. ‘Self- discipline alone will never work so you need regulation, but regulation is a fairly blunt instrument even where you have best practice codes enforced by comply or explain, so to produce a fair, effective and transparent market you also need market discipline.’

Fostering an ongoing and active dialogue between companies and their shareholders via some form of shareholder engagement code could be one way to improve the effectiveness of market discipline and the SFC is currently sounding out market participants on this. Mr Grieve said that the SFC has received both positive and negative views. Many respondents to this initial soft consultation agree with the principle that investors should be ‘engaged’ and should take a long-term view of their investments. Many investors, for example, have pointed out that engagement adds value to investments – a portfolio is more valuable if the companies in that portfolio have good corporate governance.

On the negative side, some investors were of the opinion that ‘it costs us money so we don’t do it’. Mr Grieve noted that shareholder engagement is also sometimes equated with shareholder activism. ‘Investors don’t have a right to interfere with the management of the company, but they do have a right to make their views known,’ he said.

Mr Grieve said he personally believes Hong Kong would benefit from guidelines on shareholder engagement and wider investor stewardship. ‘It would be good to devise some form of guidance for the market, but it will take a long time to get change’, he said. He also gave some early indications on what sort of code might be appropriate for Hong Kong. Firstly, he believes it would be important for any code to be applicable to all investors. Many of the overseas examples of shareholder codes are targeted at fund managers but Mr Grieve believes the basic principle should be the same for all shareholders – they should actively monitor their investee companies, they should take part in voting at shareholder meetings and they should disclose how they vote.

Finally, he stressed the point that shareholder engagement is potentially a very powerful factor in market discipline. He pointed out that there have been numerous overseas cases reported in the media where shareholders have got together and effected change in their investee companies. Mr Grieve ended his presentation by asking the ACRU attendees whether their companies have disclosed policies on how they handle shareholder engagement issues with their investee companies. Do they know, for example, whether votes are cast, and how votes are cast, at the shareholder meetings of their investee companies? ‘My guess is that most haven’t got a clue’, said Mr Grieve, but he added that ‘if you don’t know the answer to that question you are failing in your duty to uphold corporate governance’.

This year’s Annual Corporate and Regulatory Update seminar was held on 31 May at the Hong Kong Convention and Exhibition Centre. More photos of the event are available in the Institute News section (page 38) and at the Institute’s website (www.hkics.org.hk).

More information relating to the compliance issues discussed at this year’s ACRU is on the websites of the participating regulators: The Companies Registry: www.cr.gov.hk; Hong Kong Exchanges and Clearing: www.hkex.com.hk; The Securities and Futures Commission: www. sfc.hk; The Hong Kong Monetary Authority: www.hkma.gov.hk.

The Institute’s Annual Corporate and Regulatory Update seminar is designed to provide practitioners with first-hand information from regulators about the latest corporate and regulatory developments. It was launched in 2000 and has grown to become one of the most successful forums of the Institute’s CPD calendar. More information on the Institute’s CPD events is available on the HKICS website (www.hkics.org.hk). For enquires, please contact the Institute by email: ecpd@hkics.org.hk, or by phone: (852) 2881 6177.