Regulators attending the Institute’s latest Annual Corporate and Regulatory Update, held last month at the Hong Kong Convention and Exhibition Centre, confirmed that listed company governance will remain the top priority for their enforcement and educational work in the years ahead.
What should we expect from our regulators in the years ahead? Hong Kong’s statutory and frontline regulators attending the Institute’s latest Annual Corporate and Regulatory Update (ACRU) gave an unequivocal answer to this question. We can expect tougher enforcement of listed company misconduct and more engagement with the market to improve the governance culture of listed issuers.
‘The SFC’s top enforcement priority is corporate fraud and misconduct,’ said Kenneth Luk, Senior Director, Enforcement, Securities and Futures Commission (SFC). The types of malpractice at the top of the SFC’s enforcement agenda are:
- IPO fraud
- false or misleading financial statements, and
- serious conflict of interest and other fraud.
Lessons to be learned
Mr Luk highlighted the lessons the market can learn from a number of recent fraud cases pursued by the SFC. In the Greencool Technology case, which Mr Luk described as ‘the most complex investigation the SFC has handled to date’, the Market Misconduct Tribunal recently found that the former chairman/CEO and four former senior executives had disclosed false and misleading information about Greencool’s sales, profit, trade receivables and bank deposits in a massive fraud.
This case has a specific interest for professional practitioners in Hong Kong since the financial controller and company secretary of the company was found liable for accepting an arrangement that excluded the company’s Mainland subsidiaries from his supervision – limiting his responsibility to the Hong Kong holding company. He was disqualified for three years and referred to the Hong Kong Institute of Certified Public Accountants for disciplinary proceedings.
In another case – that of Qunxing Paper – the Court of First Instance found that the company’s former chairman and former vice-chairman disclosed false or misleading information in Qunxing’s IPO Prospectus in 2007, as well as its subsequent results announcements, by materially overstating its turnover and understating its bank borrowings.
Mr Luk emphasised that the key lessons to be learned from these cases are that directors and senior executives should not allow themselves to be blindsided by dominant company controllers. Mr Luk pointed out that if directors accept a compromised role they are failing to properly discharge their oversight duties and run the risk of also being held liable for fraud. The perpetrators of the fraud went to extraordinary lengths to disguise their malpractice. This included hiring ‘experts’ to forge bank documents and hiring actors to pose as clients to lend credence to their fictions, but where were the non-executive directors? They are supposed to act as a check on the owners and executive directors, so they need to be sceptical and diligent in performing their oversight duties. He added that the SFC will be holding directors and senior managers accountable for corporate governance failures.
The role of the board
The governance role of directors was also a central focus of the ACRU presentations by Hong Kong Exchanges and Clearing Ltd (the Exchange) speakers. Karen Lee, Vice-President, Enforcement, Listing Department, the Exchange, told ACRU attendees that the most common theme of the Exchange’s enforcement actions remains directors’ duties.
She emphasised that governance professionals need to ensure that directors are aware of their obligations and that the company’s internal controls are effective. ‘Directors need to take an active interest in the issuer’s affairs, they can’t just leave this to management,’ she said. She urged ACRU participants to read the latest SFC’s Enforcement Reporter and the SFC Regulatory Bulletin: Listed Corporations since these publications emphasise the importance of company directors understanding and fulfilling their fiduciary duties.
Failure to cooperate with the Exchange’s investigations is the second most common theme of the Exchange’s enforcement work. Ms Lee reminded ACRU attendees that Rule 2.12A (GEM Rule 17.55A) requires issuers to provide, as soon as possible or in accordance with time limits imposed by the Exchange:
- information the Exchange reasonably considers appropriate to protect investors or ensure smooth operation of the market, and
- any other information or explanation that the Exchange may reasonably require for investigating a suspected listing rule breach or verifying compliance with the listing rules.
She added that directors also need to abide by the terms of their Declaration and Undertaking to the Exchange, which they sign when taking up a directorship. This requires directors to cooperate in any investigation conducted by the listing department and/or the listing committee and to inform the Exchange of any change to their contact details. She warned that a breach of this Declaration would be taken into account by the Exchange when assessing an individual’s suitability to be appointed as a director of a listed issuer in Hong Kong in the future.
The role of governance professionals in cooperating with regulatory investigations was addressed in the Q&A of the SFC’s ACRU session. Gillian Meller FCIS FCS, Institute Vice-President and Chair of the SFC session, asked what advice Mr Luk would give to company secretaries who suspect malpractice in the company they work for. Mr Luk acknowledged the important role company secretaries play in ensuring regulatory compliance and advising directors on their legal and regulatory obligations, but in cases where this advice is ignored, practitioners should report their suspicions to the SFC.
Ms Lee of the Exchange also highlighted the new themes that have been added to its thematic enforcement list. These are:
- failure to comply with procedural requirements in respect of notifiable/connected transactions
- inaccurate, incomplete and/or misleading disclosure in corporate communication, and
- repeated breaches of thelisting rules.
Regarding the last of these, Ms Lee pointed out that often each breach is not particularly egregious and taken in isolation may not warrant disciplinary action, but the fact that these breaches are repeated suggests a failure of directors’ oversight and a failure of internal controls to prevent listing rule breaches. The Exchange will therefore be taking a tougher line on repeated breaches of the rules.
Hong Kong, like many other jurisdictions around the world, complements its statutory and listing rule requirements with a principles-based Code of Corporate Governance. The code, Appendix 14 of the listing rules, sets out best practice recommendations and comply-or-explain provisions designed to uphold governance standards among listed issuers in Hong Kong. The Exchange reviewed the code in 2017 and subsequently made a number of proposals to enhance its effectiveness. It will be issuing its consultation conclusions on these proposals in the next few months. Katherine Ng, Senior Vice-President and Head of Policy, Listing Department, the Exchange, focused her presentation on the findings of the code review.
The role of INEDs
The oversight role of independent non-executive directors (INEDs) is key to effective governance in Hong Kong, and many of the Exchange’s proposed amendments to the code are designed to enhance the effectiveness of their role. For example, among other things, the Exchange proposes to:
- introduce a Code Provision to require the disclosure of the process used for identifying and selecting proposed INEDs, as well as the reasons for their nomination
- introduce a new note to the relevant listing rule to encourage inclusion of an INED’s immediate family members in the assessment of the director’s independence
- introduce a new Recommended Best Practice to encourage disclosure of INEDs’ cross-directorships or significant links with other directors, and
- revise the relevant Code Provision to recommend INEDs meet with the chairman in the absence of other directors at least annually.
Ms Ng confirmed that the Exchange has also been looking at the time commitment of INEDs. Having a good understanding of all aspects of the business of a company is a prerequisite for directors to be able to contribute to board discussions in a constructive manner. INEDs therefore need to ensure they give adequate time to understand the issuers’ affairs.
A related question raised in the Q&A of the Exchange’s session asked for guidance on how many directorships individuals can reasonably hold and whether the Exchange is considering imposing a cap on the total number of directorships an individual can hold.
‘There is no magic number of directorships which any individual can hold. You would need to look at the specific circumstances of each case to know whether an individual is capable of investing enough time in his or her directorship,’ Ms Ng said. Moreover, the factors that might be relevant to this question are very varied. Is the director a CEO or full-time executive director of another company? How many board committees does he or she serve on? What kind of other organisations are involved? Even the financial year-end date of these organisations would be relevant, since, if the year-end dates coincide, the individual in question would be extremely busy at that time of year.
The Corporate Governance Code requires issuers to explain why they consider proposed INEDs holding seven or more directorships will be able to devote sufficient time to their new appointment. This was based on the fact that Institutional Shareholder Services has suggested that, for most directors, the maximum number of public company boards that a director can sit on before being considered ‘overboarded’ is six.
The Exchange also proposes to upgrade the current Code Provision on issuers’ board diversity policies to a listing rule requiring the issuer to have a board diversity policy, to disclose the policy or provide a summary and to issue guidance on the factors included in the policy.
Ms Ng pointed out that having a diversity of perspectives on the board reduces the risk of groupthink. She added that the Exchange does not want issuers to take a box-ticking approach to the proposed board diversity requirements. Diversity policies need to show that issuers are genuinely seeking to enhance diversity in all aspects (gender, age, cultural and educational background, professional experience, etc). Empty blandishments about the importance of diversity will not be of use to the company or its investors. A genuinely engaged diversity policy should set measurable objectives and show how recruitment and selection practices have been revised to ensure the company benefits from a wider pool of talent. She added that the Exchange recommends an annual assessment of the company’s diversity profile.
In addition to reviewing the Corporate Governance Code, the Exchange also reviews compliance with its ESG Reporting Guide. Ms Ng pointed out that, in its latest review, the Exchange wanted to get a sense of the level of compliance with the upgraded ‘General Disclosure’ requirements of the Guide – these were upgraded to comply or explain, effective for financial years beginning in January 2016. The review (published in May 2018) looked at 400 sample issuers’ ESG reports and found that overall the level of compliance was high. There were, however, a number of areas of weakness. For example, Ms Ng pointed out that many issuers’ materiality assessments lacked detail. She confirmed that the Exchange will be focusing on ESG reporting, along with diversity policy, in the years ahead and encouraged ACRU attendees to get their boards involved with these issues.
The SFC’s ‘Enforcement Reporter’ and the ‘SFC Regulatory Bulletin: Listed Corporations’ are available from the SFC website: www.sfc.hk. The Exchange has produced a wide variety of training materials relating to the issues discussed at the ACRU forum. These are available on its website: www.hkex.com.