Disclosure of inside information – an update
One of the toughest challenges facing companies seeking to comply with Hong Kong’s statutory regime for the disclosure of inside information, as set out in Part XIVA of the Securities and Futures Ordinance, has been identifying what is and what is not inside information. In April this year, the Securities and Futures Commission issued new guidance on this topic.
T he revised Securities and Futures Ordinance (SFO), implemented in January 2013, requires listed companies to disclose to the public, as soon as reasonably practicable, any inside information that has come to its knowledge. That requirement may seem very clear, but identifying what information needs to be disclosed under Hong Kong’s statutory inside information regime is not always straightforward. There are many factors to consider, for example: is the information specific to the company? Is the information already known to the market? Will the disclosure of the information have a material effect on the company’s share price? Is the disclosure exempted by one of the safe harbours in the SFO?
In general, listed companies have opted to disclose all information which might be deemed to be inside information rather than risk breaching the provisions of Part XIVA of the SFO. In addition to its Guidelines on Disclosure of Inside Information, the SFC has published specific guidance on inside information disclosure. Last year the SFC issued a new ‘frequently asked questions’ section on its website to help listed companies improve their inside information disclosure practices. In April this year, the SFC issued more guidance on this topic in the second edition of its Corporate Regulation Newsletter.
Some of the issues raised by the newsletter are highlighted below.
The Corporate Regulation Newsletter reminds listed companies that inside information announcements are rarely necessary where the information has already been disclosed to the market, and companies making such repeat disclosures may be regarded as misleading the market. For example, if a company announces that its profits for a six-month period increased due to a gain arising from the sale of a building, repeating the announcement may cause investors to believe that there were two separate transactions resulting in gains.
There may be cases, however, where updates are required to information previously disclosed. The SFC advises companies who feel that they need to make an announcement about matters previously disclosed to clarify the extent to which the information in the announcement differs from previously disclosed information.
Moreover, the above does not apply to general disclosures previously made. If, for example, a company has warned the market in its prospectus that potential work stoppages are a risk factor, an inside information announcement may still be required when an actual stoppage occurs. In this case, the company would have to consider whether the disclosure of the information would have a material effect on its share price and hence whether an inside information announcement under the SFO is required.
‘The company could not rely on its previous disclosures in the prospectus as vague references to possible future events do not fulfil a company’s disclosure obligations if any of those events come to pass,’ the SFC states.
Disclosure of one-off events
The SFC also warns listed companies that a repeat disclosure of a one-off event can be problematic. For example, the absence of a one-off gain which was included in the prior year is sometimes cited as a reason for a decline in profits in the current year.
‘By definition, one-off, extraordinary, discontinued or other similarly described items are not expected to reoccur, and therefore the fact that they did not reoccur would not normally be considered inside information,’ the SFC states.
The SFC adds that, where a reference to the absence of a one-off gain is designed to mask the impact of other factors in a company’s financial performance, the company may be regarded as having made a misleading statement. For example, if a company announces that its profits for 2015 will be substantially reduced from 2014’s $500 million due to the absence of the previous year’s gain of $300 million arising on the sale of a subsidiary, and the company then issues the 2015 accounts showing a loss of $50 million, adjusting for the one-off gain in 2014, there was a shift from a profit of $200 million in 2014 to a loss of $50 million in 2015. ‘Such a significant change in trading performance is likely to have been evident quite early on and needs to be considered independently from the previous year’s one-off gain,’ the SFC states.
Disclosure of information generated by internal developments
The SFC also addresses the difficult issue of when information generated by a company’s internal developments, such as trading performance, needs to be disclosed. The SFC recognises that the determination of when trading performance is inside information that needs to be disclosed can be a difficult judgement, and the newsletter highlights a number of factors, many of which are likely to be company-specific, which should be taken into account.
Although it is impossible to provide an exhaustive list, companies would need to consider at least the factors set out below.
Companies are rightly cautious about providing the market with precise figures for expected long-term earnings. However, that does not mean that the company needs to know the level of profit for a period to the nearest dollar before deciding that its trading performance amounts to inside information. Some care needs to be taken in assessing whether an apparent change in results is merely a short-term effect or indicative of a longer-term trend. But increased profits arising from strong customer orders should not be ignored solely because there is no absolute certainty that the customers will place orders at the same rate in the future.
Companies should consider how results match market expectations. Under normal circumstances, if trading profits for the period were substantially lower than the previous period, this would very likely be inside information. But if the company has already warned investors that such an outcome is expected due to the loss of a significant contract, then it is much less likely to be inside information.
Likewise, a property investment company may believe that because property prices in the relevant market had dropped 10%, the expectation would be that their portfolio had dropped a similar amount. However, if the company had a track record of consistently beating the market or the consensus of analyst comments were more favourable, then it should still consider making an announcement.
Also, if the local press does not closely follow the relevant market (for example, an overseas property market), the company should still consider making an announcement, even if its performance is in line with analyst expectations, as the public may not be equally well informed about the property market concerned.
Just because one month’s trading results are higher than expected, this might not be sufficient to justify an announcement. But if that month’s sales figures are of particular importance (for example, December sales in the run up to Christmas) then the performance in that month can be the difference between a good year and a bad year. A single-month figure can be of such significance that a trading update would be appropriate.
Disclosure of investment portfolio performance
The newsletter adds that the same three aspects – certainty, expectations and materiality – may be just as relevant when considering making disclosures in connection with investment gains or losses on investment portfolios.
Gains or losses arising from disposals of listed investments do not need to be confirmed by an auditor before they can be announced, nor do fair value adjustments of listed investments which can easily be marked to market. If the gains or losses are sufficiently material to be considered as inside information, the company should consider whether an announcement is appropriate.
If the investment portfolio of listed shares held by a company has been previously disclosed – such details often form part of the interim and annual accounts – then, if there have been no significant changes to the portfolio, investors can gauge the changes in value of such a portfolio and the significance to the finances of the company. However, if the portfolio has changed and now has a very different valuation from an unchanged portfolio, the company should consider whether an announcement is necessary.
If part of a company’s business is trading in shares, then there is no requirement to inform the market of normal fluctuations in portfolio valuation on a daily basis. However, if in early January such a company disposes of an investment at a significant gain over the previous book valuation, or the market valuation of a listed investment held, but not previously disclosed, increases enough to materially affect projected profits for the period, it is unlikely to be reasonable to only disclose that fact in the interim results announcement for the period to June.
Where an investment portfolio may significantly affect a company’s finances, it is worth considering disclosing the portfolio’s details at least on a half-yearly basis.
The SFC’s ‘Corporate Regulation Newsletter’ together with its ‘Guidelines on Disclosure of Inside Information’, is available on the SFC website (www.sfc.hk)
SIDEBAR: The role of the corporate secretary
Since the implementation of the revised Securities and Futures Ordinance in January 2013, many companies have revised their internal control processes to ensure that potential inside information is identified and escalated to the board to determine whether it triggers a disclosure obligation. Corporate secretaries are typically closely involved in these internal control processes. Their duties relating to the disclosure of inside information may include:
• establishing procedures for monitoring and escalating potential inside information to the board
• advising the board on the obligations for disclosure
• ensuring that undisclosed inside information is kept confidential
• reviewing publicly available information and information disclosed to analysts, the media or in conference calls to determine whether confidentiality has been breached
• maintaining channels of communication with outside advisers and regulatory bodies, and
• reviewing all relevant D&O policies in light of the new inside information disclosure regime.