Rules, conceded Charles Grieve, Senior Director of Corporate Finance, Securities and Futures Commission, at this year’s Annual Corporate and Regulatory Update (ACRU) seminar, will always be a fairly blunt instrument with which to encourage better corporate governance. However subtly they are framed, compliance with the rules will rarely be a simple question of following instructions. Fortunately, the Institute’s latest ACRU forum, held on 31 May 2013, provided valuable advice from regulators on the interpretation of Hong Kong’s ever-changing rulebook.
It is a challenging time to be a compliance professional in Hong Kong. Firstly, there is the tricky question of dealing with the new inside information disclosure regime in the Securities and Futures Ordinance. Then there is the new code provision on board diversity to consider, along with the Exchange’s proposed changes to Hong Kong’s connected transaction rules, and, to cap it all, the major overhaul of Hong Kong’s companies legislation about to be implemented when the new Companies Ordinance comes on stream.
The Institute’s latest Annual Corporate and Regulatory Update (ACRU) seminar highlighted the many questions company secretaries have about ensuring compliance with Hong Kong’s revised rulebook. Can a listed company delay disclosure of inside information pending board approval of its relevant announcement? Is it permissible to disclose inside information to an auditor before disclosing publicly? Will this or that person be caught under the new definition of ‘connected person’ in Hong Kong’s connected transaction rules?
Speakers from the Securities and Futures Commission, Hong Kong Exchanges and Clearing, the Companies Registry and the Hong Kong Monetary Authority were on hand to guide practitioners through these compliance challenges.
Inside information disclosure
In January this year the Securities and Futures (Amendment) Ordinance brought in a new statutory regime for the disclosure of price-sensitive information by companies listed in Hong Kong. In session one of this year’s ACRU seminar, Jennifer Lee, Director of Corporate Finance, Securities and Futures Commission (SFC), highlighted some of the common problems encountered by companies in complying with the new regime.
She started by saying that the new regime has significantly raised the number of inside information announcements by listed companies (such announcements increased by 43% during the four-month period ending 30 April 2013 compared with the same period last year). Moreover, the SFC has also seen an increase in listed companies’ profit alerts and profit warnings. Ms Lee believes that these increases clearly indicate that the new inside information regime has ‘raised disclosure awareness’.
There has been a degree of misconception about the confidentiality requirements of the new regime, Ms Lee said. ‘Some companies believe that if they keep inside information confidential they will be excused the obligation to disclose – this is not the case.’ She clarified that this is only true where the inside information is covered by one of the safe harbours listed in the Securities and Futures Ordinance (SFO). These safe harbours are void once confidentiality is breached, but if the inside information is not covered by the safe harbours then companies must disclose whether or not confidentiality has been maintained.
Another area of confusion in the new confidentiality requirements relates to which parties can be entrusted with the inside information before it is disclosed publicly. Can companies, for example, disclose such information to auditors or to controlling shareholders? What if, for example, a parent company requests inside information from a subsidiary for filing its accounts? Ms Lee stressed that in these cases, unless the inside information is covered by one of the safe harbours, it must be disclosed publicly at the same time as it is disclosed to the other parties mentioned.
If the inside information is covered by one of the safe harbours, it can be selectively disclosed to certain parties as long as confidentiality agreements are put in place. If a company is negotiating with a counter-party, for example, there should be contractual confidentiality agreements in place for everyone involved – including the counter- party’s advisers. Ms Lee added that where lawyers are bound by adequate professional confidentiality obligations then separate contractual confidentiality agreements for them are not necessary.
What is inside information?
Companies have also had some difficulty in defining inside information. Charles Grieve, Senior Director of Corporate Finance, SFC, said that the key consideration is whether the market will be surprised by the information. ‘Ask yourself how the market will react,’ he said, ‘if investors are going to yawn you don’t have to make an announcement.’
The timing of disclosure
The SFO requires companies to disclose inside information ‘as soon as reasonably practicable’, but there has been some confusion about what this means in practice. Many questions were raised during the Q&A session at the end of session one about the timing of disclosures. One question from the floor asked whether companies can try to remedy the problem before disclosure. ‘This is a dangerous misconception,’ Ms Lee said. ‘Companies need to disclose when they become aware of the problem before working out rectification – seeking mitigation does not justify delay.’
Another attendee asked whether a delay is permissible for the figures in an inside information announcement to be confirmed. Ms Lee clarified that so long as the figures are reasonably accurate, they should be disclosed. The announcement should not be delayed in order to get an exact figure.
Another question related to whether disclosure can await board approval of an inside information announcement. Mr Grieve cited a case where a company delayed publication of an inside information announcement because it was waiting for its board to approve the announcement at its next monthly board meeting. If a company wants its board to approve an inside information announcement, it should call an extraordinary meeting, he said. Edith Shih, HKICS President and chair of session one, pointed out that in such cases a written resolution can be sought.
Preparing for the new Companies Ordinance
The new Companies Ordinance was passed by LegCo on 12 July 2012 and is expected to come into operation in 2014 after the enactment of subsidiary legislation. Three speakers from the Companies Registry addressed the compliance requirements of the new ordinance in session two of the ACRU seminar.
Phyllis McKenna, Deputy Principal Solicitor (Company Law Reform), Companies Registry, gave an introduction to the new ordinance, which she pointed out is the longest piece of legislation ever enacted in Hong Kong. Its sheer size and complexity is no doubt somewhat daunting, but Ms McKenna focused on the main changes of interest to company secretaries.
The new definition of ‘responsible person’
The question on many company secretaries’ minds will be whether they are more likely to be prosecuted for summary offences of the ordinance when the new definition of ‘responsible person’ in the new Companies Ordinance becomes effective. Ms McKenna’s presentation indicated that the new ordinance will lower the prosecution threshold for ‘responsible persons’ who have breached such offences.
Ms McKenna explained that the old Companies Ordinance attributed criminal liability to officers who breached various summary offences if they ‘knowingly and wilfully’ authorised or permitted the breach. The evidential burden was therefore set very high because of the requirement to prove ‘wilfulness’ and
the government was seeking more accountability in this area. A ‘responsible person’ is defined in the new Companies Ordinance as an officer of a company who authorises or permits, or participates in, the contravention or failure. The effect of the new formulation is to lower the prosecution threshold to remove the ‘wilful’ element.
The abolition of memorandums of association and ‘par value’
Do company secretaries need to take action ahead of the abolition of memorandums of association and the concept of ‘par value’ in the new Companies Ordinance? Ms McKenna explained that both of these changes do not require compliance action from companies since deeming provisions ensure that any reference to a memorandum of association is a reference to Articles of Association, and that contractual rights defined by reference to par value and related concepts will not by affected by the abolition of par.
However, she added that companies may wish to take this opportunity to review their constitutional documents to see if there are any changes that they wish to make as a result of the new Companies Ordinance. ‘We are advising companies to look at this and decide whether they want to change their articles,’ she said.
Empowering the Companies Registrar
The new Companies Ordinance empowers the Companies Registrar to compound specified offences so
as to encourage compliance with the provisions of the new ordinance and optimise the use of judicial resources. The specified offences include the failure to file annual returns. The Registrar is empowered to give companies a notice in writing setting out particulars of the suspected offence and the conditions upon which no prosecution action will be taken. These will include the amount of the compounding fee to be paid (set at HK$600) and the period within which conditions must be complied with. If either the fee is not paid or the conditions are not complied with, the Registrar may proceed with prosecution action. The payment of compounding fee is not an admission of liability.
Restriction of corporate directorships
Section 457 of the new Companies Ordinance requires a private company (other than one within the same group as a listed company) to have at least one director who is a natural person. Corporate directorships remain prohibited for public companies, companies limited by guarantee and private companies which are members of a group of companies of which a listed company is a member (Section 456). Kitty Tsui, Acting Assistant Principal Solicitor of Legal Services Division, Companies Registry, explained in her session two presentation that existing private companies with no natural person director will be given a grace period of six months after commencement of new Companies Ordinance to comply with the new requirement (Schedule 11, Section 89).
Directors’ duty of care, skill and diligence
Section 465(1) and (2) of the new Companies Ordinance states that a director of a company must exercise reasonable care, skill and diligence. This means the care, skill and diligence that would be exercised by a reasonably diligent person with:
- the general knowledge, skill and experience that may reasonably be expected of a person carrying out the functions carried out by the director in relation to the company, and
- the general knowledge, skill and experience that the director has.
Section 466 of the new ordinance preserves the existing civil consequences of breach (or threatened breach) of the duty.Withholding personal information from public inspection
Will company secretaries still need to file their residential addresses with the Registrar of Companies once the new Companies Ordinance becomes effective? Ms Tsui explained that company secretaries will only be required to file a correspondence address with the Registrar. This was in fact the only element of the government’s proposals regarding the withholding of personal information from public inspection which survived the government’s U-turn earlier this year.
The new Companies Ordinance sought to change the arrangements for the disclosure of directors’ identity card numbers on the public register. The plan was to have directors’ partial identity card numbers on the public register (say, A123xxx). Moreover, only directors’ correspondence addresses would be disclosed on the public register. There were many objections to these proposed arrangements and in order to expedite implementation of the new Companies Ordinance, the government has decided to shelve these plans but will revisit the disclosure of directors’ ID card numbers after the implementation of the Companies Ordinance.
Registrar’s directions to appoint company secretaries
The old Companies Ordinance required every company to have a company secretary but there was no offence provision for a failure to appoint one. The new Companies Ordinance empowers the Registrar to issue directions to companies to appoint company secretaries (sections 458 and 476). Non-compliance with the direction is an offence and the company and every responsible person of the company will be liable to a fine. This also applies to the appointment of directors.
Filing requirements of the new Companies Ordinance
The changes to the filing requirements of the Companies Ordinance have received less attention than some of the headline topics discussed above, but Marianna Yu, Deputy Registry Manager of Registration Division, Companies Registry, pointed out that ‘filing requirements are likely to affect the daily work of your company secretarial team’. Her ACRU presentation highlighted the new definition of ‘unsatisfactory document’ in Section 31 of the new ordinance.
A document is deemed ‘unsatisfactory’ if:
- it is not accompanied by the fee payable for the registration the document
- any signature on the document is incomplete or incorrect or is altered without proper authority, or
- the information contained in the document is internally inconsistent or is inconsistent with other information on the Companies Register or other information contained in another document delivered to the Registrar.
Moreover, under Section 35 of the new ordinance, if the Registrar of Companies is of the opinion that a document delivered for registration under an ordinance is unsatisfactory, the Registrar may refuse to accept the document, or refuse to register the document and return the documentto the person who delivered it for registration. Section 41(2) also expressly gives the Registrar powers to rectify a typographical or clerical error contained in any information relating to a company on the Companies Register on an application by the company.
Corporate Governance Code changes
Grace Hui, Senior Vice-President and Chief Operating Officer of Listing Department, Hong Kong Exchanges and Clearing, highlighted the latest amendments to the Corporate Governance Code regarding board diversity. The existing principle regarding board composition has been revised to add the need for a ‘diversity of perspectives’ on the board. Moreover, a new code provision has been added stating that the nomination committee (or board) should have a policy concerning diversity of board members, and should disclose the policy or a summary of the policy in the company’s Corporate Governance Report. The Code changes will become effective on 1 September 2013. This means that annual and interim reports for the period after 1 September 2013 must contain a statement of compliance or an explanation for deviation.
Ms Hui highlighted the implications of these code changes for listed companies. She said the board now needs to consider diversity when reviewing its balance of skills, experience and knowledge. She stressed that diversity includes, but is not limited to, gender, age, cultural/ educational background, or professional experience. Ms Hui pointed out that compliance does not require the board to achieve diversity, but companies need to have a diversity policy and should ideally set measurable objectives to achieve better diversity and monitor any progress on achieving those objectives.
She stressed that this should not be a ‘box-ticking’ exercise and the approach to board diversity will differ according to the circumstances of each issuer.
Connected transaction rule proposals
The Exchange is currently consulting on its connected transaction rule proposals. The consultation paper issued on 26 April 2013 sets out proposals to simplify the rules and deal with anomalies. A second consultation paper seeks a better alignment of the definitions of ‘connected person’ and ‘associate’ in
the listing rules. In her session three presentation, Christine Kan, Senior Vice- President of Listing Department, Hong Kong Exchanges and Clearing, pointed out that the majority of Hong Kong companies have controlling shareholders and have subsidiaries and this makes Hong Kong’s connected transaction regime highly important. ‘This will be the last revision of our connected transaction rules for a while so we really want your views,’ she added.
Financial reporting recommendations
Every year the Exchange conducts a review, on a sample basis, of listed companies’ financial reports. Steve Ong, Vice-President of Listing Department, Hong Kong Exchanges and Clearing, recommended that preparers of financial statements in listed companies (including company secretaries) should read the Exchange’s Financial Statements Review Programme reports since they are a useful means to avoid the common pitfalls.
He started by stressing that company secretaries have an important role to play in alerting boards to the need to continuously improve the quality of financial statements. ‘You have a strong influence on the board and finance team – you do have an important role to play,’ he said.
While the latest Financial Statements Review Programme Report (Issued on 25 January 2013 and covering 2012 financial statements) found no significant breaches of the listing rules or accounting standards, it did highlight a number of problem areas. Issuers are generally still not forthcoming in their explanation of significant events and transactions in their annual and interim reports, he said. Additional information should be presented in financial reports to provide a better understanding of the nature and impact of significant events or material balances and transactions. Lastly, Mr Ong urged company secretaries to plan early to ensure that their 2013 annual reports are a success and an improvement on 2012.
Anti-money laundering update
In the final session of the ACRU seminar, Stewart McGlynn, Senior Manager of Anti-Money Laundering, Banking Supervision Department, Hong Kong Monetary Authority (HKMA), gave attendees an update on anti-money laundering compliance in Hong Kong. He started his presentation by saying that company secretaries are an increasingly important sector for anti-money laundering (AML) regulators since globally the focus of AML work has now turned from financial institutions to corporates and corporate services providers. The Financial Action Task Force on money laundering (FATF), for example, is putting pressure on jurisdictions to ensure that effective AML regulations are extended from banks to ‘designated non-financial businesses and professions’ (DNFBPs).
Mr McGlynn also cited other global developments which are impacting AML compliance. For example, there has been a renewed focus on tax evasion. It is well recognised that complex, multi- jurisdictional legal structures which have caused concern among regulators for their use in money laundering, can also facilitate the evasion of taxes. He pointed out that tax evasion is already a predicate offence in Hong Kong and under the revised FATF Recommendations.
He urged company secretaries to build effective AML in-house controls. ‘Have a strategy on AML – be proactive!’ he said.
This will become an increasingly important compliance area for practitioners since the HKMA is significantly raising its oversight of AML risks and the legal framework for trust and company service providers (TCSPs) will be the focus of its next AML guidelines and recommendations. ‘The ease and availability of corporate services is a particular risk in Hong Kong,’ he said.
Mr McGlynn also addressed the issue of suspicious transaction reports (STRs). He said STRs are ‘a fundamental pillar of the AML regime’, but currently the vast majority of STRs are made by financial institutions. He urged company secretaries to be mentally prepared to make STRs. He stressed that STRs are only subjective statements of suspicion. ‘If you are in doubt – report,’ he said. ‘It’s what you suspect that counts. If there is a possibility, which is more than fanciful, that the relevant facts exist then you have an obligation to make an STR.’