The Securities and Futures Commission answers questions relating to corporate announcements, profit warnings and the SFC’s review and investigation process raised by attendees at this year’s Annual Corporate and Regulatory Update seminar.
1. Announcements and profit warnings
Q: Are companies obliged to disclose quantitative details in profit warnings?
A: This is entirely dependent on the circumstances and the context for the issue of the profit alert/warning. Such alerts/warnings are driven by the obligation to disclose inside information (information that is likely to have a material effect on the price of the company’s securities when the information is made public). If the inside information relates to specific figures then those figures may need to be included. Some profit alerts/warnings include such things as vague references to ‘market conditions’ which suggest that either an announcement should have been made earlier because the effect of market conditions on trading performance would have been identified during the year, or this is an excuse to explain other factors.
Q: The number of corporate announcements has surged since the inside information regime was implemented, but only 14% of these announcements have actually resulted in material market movement. Does this indicate that the majority of announcements are not actually important, but have been issued to avoid SFC queries?
A: Profit alerts/warnings should only be issued when the company believes that knowledge of the change to the company’s profits is information that is likely to have a material effect on the price of the company’s securities when made public. It is possible that some companies are issuing profit alerts/ warnings in the belief that this will avoid SFC queries. In fact, if the profit alerts/ warnings provide insufficient information to allow an investor to assess its importance, or give a false or misleading impression regarding the profits of the company, then such an announcement is more likely to generate interest from the SFC. It is also worth noting that no investors have made complaints to the SFC that too many announcements are being made to the market leading to them being unable to identify the important announcements against the background chatter.
Q: Does the SFC inform the Stock Exchange when an announcement has been found to be misleading?
A: If a company has made an announcement that appears to be misleading then it would be referred to the Enforcement Division within the SFC. Following more detailed investigation, the SFC may determine that the company had made a false or misleading statement. The appropriate response in such circumstances depends heavily on the particular facts of the case, the seriousness of the apparent breach, the impact of the announcement, etc. There are lines of communication between the SFC and the Exchange which ensure that, where action by the Exchange is merited, it has the information it needs to address the issue appropriately.
Q: If a company’s profit has increased drastically solely because of valuation gains (which is in line with the market, and so the directors expect that the gain is known by the market/investors) and no profit alert announcement is made, will it be deemed as failing to make due disclosure should the share price go up?
A: It is not possible to give a definitive answer to this question as it will depend so much on the specific facts. Paragraph 89 of the Guidelines on Disclosure of Inside Information makes it clear that general external developments would not normally be expected to lead to a disclosure by a listed company. However, if the information has a particular impact on the company then this might be inside information requiring disclosure.
The question implies that the market would already know that the profits will have increased drastically because of valuation gains. This will depend significantly on the level of previous disclosure regarding the assets held by the company.
If there has been detailed disclosure of the assets held by the company and the increase in value of such assets is widely known, then it would be possible to argue that investors have sufficient information to be able to anticipate the increase in the company’s profits. However, this ignores the impact of the other activities of the company and any other issue that might impact on the increase in valuation of the company’s assets.
Although that asset class may have increased during the period, has that general level of increase been replicated by the specific assets held by the company? What has the company said previously about the assets held? What proportion of the company’s financial health is determined by the value of the assets held? Are the assets fungible and liquid or bespoke and illiquid? These are just some of the questions that would have to be considered before deciding that the increase in valuation is effectively already public knowledge.
Q: Would it be a problem if the purchase consideration of a VSA transaction in an announcement is based on a desktop valuation report; it is stated in the desktop valuation report that the value may be changed upon a detailed inspection and/ or verification of the value; but subsequently the formal valuation report included in the relevant circular reflects a value much lower than the one in the desktop report?
A: Announcements regarding proposed transactions will often be made on the basis of information that is to some extent dependent on events. When an announcement is made about the proposed terms of a transaction and the purchase price, for example, is determined on the basis of a calculated value, then the details of, and rationale for, that calculated value should be made clear. If there are any uncertainties inherent in that calculation, or the calculation may change after receipt of further information, there should be full disclosure of those possibilities.
If the previously announced anticipated value of the transaction is changed in the light of new information, there should be full disclosure of the change in expected value and how that affects the purchase price that will be paid. The fact that a valuation has changed as a result of new information being obtained does not mean that the original announcement must by definition be regarded as being false or misleading.
But the existence of other factors may call into question the reasons for the disparity or the nature of the announcements. For example, a situation where a company announced that a valuable asset was going to be obtained for a discounted price and following an increase in the company’s share price there was a placing of shares, which was then followed by another announcement which revised the valuation of the asset being purchased substantially downwards. The decision to do a share placement following the share price increase generated by the first announcement based on a much higher asset valuation, might call into question the basis for the first valuation and the motives behind making the announcement.
Q: When we are preparing a profit alert/warning, should we consider/ compare ‘profit for the period’ or ‘profit attributable to the owner of the group’? If ‘profit for the period’ and ‘profit attributable to the owner of the group’ move in different directions (for example, the former increases and the latter decreases), how should this be considered?
A: This question seems to relate to the situation where a holding company has an interest in one or more subsidiaries that are not necessarily wholly owned. So, not all of the profit made by the subsidiary would relate to the holding company. On the assumption that a listed company wholly owns a subsidiary, then the test of whether the information about a subsidiary is inside information depends on the materiality of the subsidiary to the listed group. For example, if one subsidiary doubled its profits, but these profits still only amounted to an increase of contribution to group profits from 1% to 2% then it is unlikely that this information would be inside information for the listed holding company.
If the level of holding in the subsidiary changed during the year then this might result in the unusual situation described where the profit for the period and the profit attributable to the owner of the group moved in different directions. So, if a subsidiary’s profits were on track to increase from HK$100m to HK$150m, but the holding company had sold 49% of the company, then the level of profit attributable to the owner would have gone down despite the level of profits increasing (at the subsidiary company level). To some extent the answer to the question will then depend on what had previously been announced. If nothing had previously been announced then the disclosure of the sale of 49% could be inside information and the disclosure of profit figures might form part of that announcement. If the disposal had already been announced, then the market’s expectation may be that profits attributable to the owner would be HK$51m assuming profit figures were flat. The question to be asked then would be whether the expected increase to HK$76.5m as a result of increased profits would be inside information for the holding company.
Q: Do you agree, that, because of differences in the PRC and Hong Kong accounting standards, it is unwise for a PRC company listed in Hong Kong to make a profit/loss alert until the Hong Kong auditor has examined the accounts audited by the PRC auditor?
A: If a company has been keeping the market updated sufficiently regularly, then it will only be infrequently that the final accounts would be inside information. Our understanding of the differences between PRC and Hong Kong accounting standards is that the differences are relatively small and so will only have a significant impact in rare cases. We would also expect that any PRC company for which such a difference in standards would have a material effect would already be aware that this difference in standards could have such an effect and would have made plans to deal with effects accordingly.
Q: In what circumstances does the SFC require listed issuers to provide agreements, or supporting documents, for their review after listed issuers have published an inside information announcement?
A: The SFC will only require supporting or other documents to be supplied when it has some concerns about the nature of the information, the transaction, the announcement or some other circumstances surrounding the matter which is the subject of the announcement.
2. The review and investigation process
Q: How does the SFC manage to review every inside information announcement every day?
A: Each member of the Corporate Regulation team has a portfolio of companies and all announcements made by companies in their portfolio are reviewed, usually on the same day, and any issues of concern are discussed to agree what issues need to be considered in more depth. Letters seeking further information or clarifications are usually written to the company within 24 hours of any announcement.
Q: What is the interaction between the Corporate Regulation team and the Enforcement Division?
A: The Corporate Regulation team conducts preliminary reviews. They will often be the first point of contact between the SFC and the listed company. Where the information available suggests that there may have been a breach of the provisions of the Securities and Futures Ordinance, the Corporate Regulation team will refer the case to the Enforcement Division for consideration. This internal referral process allows a wider consideration of the merits of the case and provides a degree of independent challenge. Once a case has been accepted for in-depth investigation by the Enforcement Division, there will be an ongoing dialogue between the investigation team in the Enforcement Division and the Corporate Regulation team.
As well as the processes relating to the passage of cases to the Enforcement Division, there are many discussions concerning specific aspects of other cases. The Corporate Regulation team takes advantage of the Enforcement Division’s knowledge of how best to conduct enquiries and obtain the right evidence in the most efficient manner. Likewise, the Enforcement Division will seek the Corporate Regulation team’s advice on market issues and opinions on corporate disclosure issues.
Q: How long do SFC investigations generally take?
A: The length of an investigation is dependent on a variety of factors, including the location of witnesses, the availability of documents, including whether there are extra-territoriality issues, the degree of cooperation from all relevant parties and the complexity of the matters to be investigated. For these reasons, the SFC, like other law enforcement agencies, does not impose any deadline on completion. At the same time, most investigations are completed within seven months of commencement.
Q: Will the SFC formally notify the company of the closure of an investigation?
A: The SFC conducts a range of engagements with listed companies including preliminary reviews, factfinding exercises and full investigations using statutory powers. Where statutory information gathering powers have been exercised the company will be informed that the SFC has no further questions if the decision has been taken to close the case. This may take the form of a guidance letter which sets out how the actions of the company officers, the company or the company’s procedures could be improved to provide investors with appropriate information going forward.
Q: How long will the review usually take after a listed issuer provides documents to the Corporate Regulation team and will there be feedback to the listed issuer?
A: When the Corporate Regulation team conducts a preliminary review of the circumstances surrounding an announcement or other action taken by a company it is not possible to predict the length of time such a review will take. It will depend heavily on the nature of the circumstances and the surrounding facts. The length of time taken by the company to respond to SFC enquiries is a major component in the duration of such reviews. However, most reviews are completed within three months of the initial contact from the SFC.
Q: Is the SFC going to promote the role of whistleblowing?
A: While there is no specific whistleblowing regime in the Securities and Futures Ordinance, the SFC is able to provide whistleblowers with a gateway to provide information on a confidential basis, which will also give the whistleblower legal protection for providing the information to us. In those circumstances, whistleblowers should contact the SFC for more details.
Many thanks to Michael Duignan, Senior Director, Corporate Finance, SFC, for his help in preparing this Q&A. Further information can be found in the SFC’s new ‘Corporate Regulation Newsletter’ available from the link on the HKICS homepage (www.hkics.org.hk)
SIDEBAR: Further guidance
The SFC’s Guidelines on Disclosure of Inside Information are available on the SFC website (www.sfc.hk – Regulatory Functions/Listings and Takeovers/Corporate Disclosure). The SFC also provides a consultation service to the market with a view to assist listed corporations in understanding and complying with statutory disclosure provisions. Consultations generally take the form of verbal discussions. The views expressed by the SFC are preliminary and non-binding in nature.
The contact details are: Tel: (852) 2231 1009; Fax: (852) 2810 5385; Email: firstname.lastname@example.org; Address: Corporate Disclosure Team, Corporate Finance Division, Securities and Futures Commission, 35/F, Cheung Kong Center, 2 Queen’s Road Central, Hong Kong