Regulators attending the Institute’s latest Annual Corporate and Regulatory Update (ACRU), held on 5 June at the Hong Kong Convention and Exhibition Centre, highlighted the role of governance professionals in building and maintaining effective internal controls to ensure listing rule compliance.

The ‘police and thieves’ version of capital market dynamics focuses on the battle between fraudsters out to make illicit gains and regulators trying to make sure they don’t get away with it. Most of the time, however, something far more mundane is going on. Tom Butlin, Head of Enforcement, Listing Department, Hong Kong Exchanges and Clearing Ltd (HKEX), pointed out in his ACRU presentation that many breaches of the listing rules are the result of poor internal controls rather than deliberate fraud.

‘Things can go wrong even in the best of companies,’ he said. He characterised the market as falling into three worlds – green, red and orange. In companies in the green world, directors and management display conduct that supports and fosters full compliance with the listing rules. In companies in the red world, their conduct is non-compliant. But between these two worlds there lies a third – the orange world. In the orange world, Mr Butlin said, directors and management display ‘conduct that creates an environment for non-compliance’.

This, of course, is where governance professionals come in. The work of governance professionals focuses on creating an environment for compliance and key to this is building and maintaining effective internal controls. Mr Butlin pointed out that internal control reviews should be strategically planned with a real focus on identifying deficiencies, rather than a box-ticking exercise. He added that governance professionals should be reading and making use of the various enforcement press releases and the Enforcement Newsletter published by HKEX to keep up to date with compliance and enforcement issues.

Who is responsible for listing rule compliance?

The low level of awareness among some directors of their responsibilities and duties, Mr Butlin said, is one of the biggest hurdles to better listing rule compliance. Once again, governance professionals, in particular company secretaries, should be playing a critical role.

Mr Butlin acknowledged that the role and status of company secretaries can vary among different issuers, but he emphasised that they should be playing a key role in ensuring listing rule compliance. He pointed out that the listing rules require issuers to ‘appoint an adequately qualified company secretary with the requisite knowledge and experience, who is capable of discharging the functions of a company secretary’.

He also highlighted the provisions of Section F of the Corporate Governance Code, which is devoted to the role of company secretary. For example, Section F makes it explicit that company secretaries are responsible for governance matters, should have day-to-day knowledge of the issuer’s affairs and should support the board by ensuring policies and procedures are followed.

‘Good corporate governance relies on company secretaries being involved in governance and compliance matters,’ Mr Butlin said. He added that he regards the most important parts of Section F to be the provisions stating that all directors should have access to the advice and services of the company secretary to ensure that board procedures, and all applicable laws, rules and regulations are followed, and that the company secretary should facilitate the induction and professional development of directors.

‘The skill is identifying deficiencies in the knowledge of directors and proactively engaging to get them the professional development they need,’ Mr Butlin said. He added that, at the very least, company secretaries should be ensuring that directors are aware of their fiduciary duties of skill, care and diligence. Directors are required to act honestly and in good faith in the interests of the issuer as a whole. They should:

• be answerable to the issuer for the application or misapplication of its assets
• avoid conflicts of interest and duty
• disclose fully and fairly their interests, and
• apply such degree of skill, care and diligence as may reasonably be expected of persons of their knowledge and experience.

‘If you are involved in listing rule compliance, I want you to feel slightly uncomfortable in my talk,’ Mr Butlin said. He reminded ACRU attendees that directors sign an undertaking before taking up their roles to the effect that they will comply to the best of their ability with the listing rules, use their best endeavours to procure the issuer’s rule compliance and cooperate in any investigation by the HKEX.

Mr Butlin emphasised the importance of cooperating with HKEX investigations by responding openly and directly to enquiries. He indicated that ‘conduct during an investigation can be just as important as the conduct that gave rise to the investigation in the first place’. He cited some cases of failure to cooperate with HKEX investigations he had come across in his enforcement work. For example, when asked to provide HKEX with copies of its internal control policies and procedures, one issuer answered: ‘Please find attached a copy of the listing rules. This represents our internal control policies and procedures’. This was clearly not an appropriate response to the question posed.

Mr Butlin showed slides detailing the upward trend in enforcement cases and sanctions against directors between 2016 and 2018. He added that this doesn’t necessarily mean that the market has been heading towards lower standards, but nevertheless HKEX is looking for more attention to listing rule compliance among listed issuers and for those involved to take a more proactive and strategic approach to avoid potential breaches.

Why controls matter

The usefulness of systematic internal controls is perhaps most apparent in the tough compliance assignment of inside information disclosure. Benjamin Cheuk, Director, Corporate Finance Division, Securities and Futures Commission (SFC), focused his presentation on this area. Effective compliance with Hong Kong’s inside information requirements, he pointed out, requires first and foremost an effective internal controls system for escalating price-sensitive information to the board.

Of course, any internal controls system cannot work if relevant information is not being generated in the first place. Mr Cheuk therefore emphasised the need for the production of management accounts on a monthly basis. This should be a part of basic corporate governance, he said, since these accounts are a crucial part of companies fulfilling their obligation to disclose inside information, make corporate announcements and issue profit warnings or alerts in a timely manner.

He also warned that, from a liability perspective, not producing management accounts is not an excuse for failing to disclose inside information. Inside information is information which has, or which ‘ought reasonably to have’, come to the knowledge of an officer in the course of performing his or her functions. Regulators will deem that officers ‘ought reasonably to have’ come across relevant price-sensitive information via management accounts.

Mr Cheuk also shared with ACRU participants some best practice tips on how to approach management accounts. These accounts should be prepared on a monthly basis, include all key operating subsidiaries, preferably in consolidated accounts, and be ready for review no later than two weeks from the end of the month.

How good is your system?

The importance of internal controls for inside information disclosure was also explored in a new addition to the ACRU formula this year – the ‘Practitioner Practical Sharing’ session. Following the SFC session, ACRU attendees were given the practitioner perspective on how to build an effective inside information disclosure regime. The presenters were Edith Shih, International President, ICSA, and Institute Past President, and Mark Hughes, Partner, Slaughter and May, Hong Kong. The session was moderated by Gillian Meller, Institute Vice-President. 

Ms Shih further elaborated on a point raised by Mr Cheuk – the need to have an effective system to capture relevant information. Ms Shih shared with ACRU attendees the system devised by CK Hutchison Holdings to ensure effective inside information disclosure. Given the size of CK Hutchison Holdings, this system is highly elaborate and complex, involving many layers by which information is escalated to the board. Ms Shih emphasised that some elements of the system may not be relevant to other organisations, it should nevertheless be useful as a model from which organisations can devise their own systems.

She also discussed the company secretary role in building and maintaining internal control systems. ‘My job,’ she pointed out, ‘is not to enable all colleagues to identify specific inside information, but to create a system whereby those who come across something suspicious can escalate the information to the relevant parties.’

Gillian Meller asked the two ‘Practitioner Practical Sharing’ speakers about how company secretaries can persuade directors to give inside information disclosure the attention it needs. Ms Shih emphasised that it may be a good idea to highlight specific cases where things have gone wrong – ‘scare tactics work’, she quipped. Ms Meller agreed, pointing out that the threat of personal liability can be a very persuasive argument for any undecided directors.

Mr Hughes also backed this point up. He highlighted the fact that inside information is an enforcement priority for the SFC and that officers, including company secretaries, have been fined for inside information disclosure breaches.

The 20th Annual Corporate and Regulatory Update (ACRU) of The Hong Kong Institute of Chartered Secretaries was held on 5 June 2019 at the Hong Kong Convention and Exhibition Centre.