The Securities and Futures Commission (SFC) clarifies its approach to backdoor listings and shell activities, using its statutory powers under the Securities and Futures (Stock Market Listing) Rules and the Securities and Futures Ordinance.
In recent years, problems associated with backdoor listings and shell activities have attracted wide attention. These activities can undermine the integrity and quality of our market, and may affect investor confidence and our market’s reputation.
Backdoor listings involve transactions or arrangements that are structured to achieve a listing of assets while circumventing the requirements that apply to a new listing applicant, including:
- initial listing criteria under the listing rules, such as suitability for listing, financial eligibility criteria and sufficiency of public interest in the business of the company, and
- obligations such as disclosure and due diligence requirements.
- Backdoor listings are often associated with assets of lower quality or with suitability issues.
Issues relating to backdoor listings and shell activities
How backdoor listings are achieved
The means by which backdoor listings are achieved have evolved in ways that make them harder to detect or regulate. Some examples of backdoor listings are highlighted below.
- Instead of one single substantial acquisition, a backdoor listing may involve a series of smaller acquisitions of a new business (sometimes this could also involve organic development of the new business), which has no connection with the listed company’s original business, financed by the proceeds from an issue of new shares to a new major shareholder.
- An incoming major shareholder may acquire a significant interest in the listed company, which is less than 30% but circumstances suggest that the shareholder is able to exercise de facto control over the company.
- Transactions may be arranged in a sequence designed to circumvent the related rules. For example, when a disposal of the original business to the outgoing controlling shareholder is deferred to a later stage instead of before or at the time of the change in control.
In most cases, the end result would be a fundamental change in the nature of the listed company’s business and substantial changes in its major shareholders, directors and management.
The role of shell companies
Closely related to backdoor listings are various activities involving shell companies. These are listed companies that are maintained with a low level of business operations as vehicles for backdoor listings. These shell activities include:
- listing businesses in order to monetise the premium attached to the listing status rather than to genuinely develop an underlying business
- disposing of all or substantially all of the listed company’s original business in preparation for a subsequent change in control and injection of assets by the new controlling shareholder, and
- pursuing new businesses with low entry barriers and little commercial substance (for example, a moneylending business with only a few customers) in an attempt to maintain the shell company’s listing status.
To enhance our listing regime and maintain market quality, the SFC and The Stock Exchange of Hong Kong Ltd (the Exchange) have conducted a thematic review of the regulation of listed companies. The Exchange has since introduced a series of amendments to the listing rules to address issues
relating to GEM, highly dilutive capital raising activities and the prolonged suspension of trading in some companies’ listed securities. The Exchange has published a consultation conclusions paper on backdoor listings and continuing listing criteria together with related amendments to the listing rules (see ‘New reverse takeover rules’, CSj August 2019).
In addition to the Exchange’s regulation of listed companies based on the listing rules, the SFC will not hesitate to use its statutory powers, including its investigation powers, and take action against the parties involved, including companies, directors, major shareholders and intermediaries, where appropriate. In particular, under the Securities and Futures (Stock Market Listing) Rules (SMLR), the SFC may object to a listing application based on one or more of the grounds set out in Section 6(2), and it may also direct the Exchange to suspend trading in a listed corporation’s shares under Section 8(1) of the SMLR (see ‘Key provisions of the SMLR’).
Factors SFC considers in exercising its statutory powers
In deciding whether to exercise its powers of investigation under the Securities and Futures Ordinance or its powers under the SMLR in cases involving backdoor listings and shell activities, the SFC will have regard to the facts and circumstances of each case including whether there are any red flags:
- indicating a possible scheme designed to mislead regulators and/or the investing public or to circumvent applicable rules, or
- suggesting that other forms of serious misconduct have been or will be committed.
Set out below are some non-exhaustive factors that the SFC considers are likely to be relevant.
- Whether there are any red flags indicating concealed arrangements or understandings (such as one involving a change in control or a change in de facto control) between the parties involved, including the directors, shareholders, intermediaries and advisers.
- Whether the listed company or the listing applicant has disclosed the true nature or extent of its business, affairs and plans.
- Whether there are any fundamental issues relating to the new assets or businesses being or to be injected that would lead to concerns as to whether these assets or businesses should be allowed to be listed and have access to public investors’ capital.
- Whether there are any concerns that the directors might not have fulfilled their fiduciary duties and acted in the interests of the shareholders as a whole.
- Whether sufficient due diligence has been conducted on the assets or businesses acquired, and whether the scope of due diligence is appropriate.
Cooperation between the SFC and the Exchange
The SFC and the Exchange will continue to work closely and exchange information to tackle backdoor listings and shell activities.
Source: Statement on the SFC’s approach to backdoor listings and shell activities (26 July 2019).
Further information is available in the review the 20th Annual Corporate and Regulatory Update (ACRU) of The Hong Kong Institute of Chartered Secretaries (CSj July 2019), the article ‘New reverse takeover rules’ (CSj August 2019), and on the websites of the Securities and Futures Commission: www.sfc.hk, and Hong Kong Exchanges and Clearing Ltd: www.hkex.com.hk.
SIDEBAR: Key provisions of the SMLR
Under Section 6(2) of the Securities and Futures (Stock Market Listing) Rules (SMLR), the SFC is empowered to object to a listing application if it appears to the SFC that:
- the application does not comply with a requirement under Section 3 of the SMLR
- the application is false or misleading as to a material fact or is false or misleading through the omission of a material fact
- the applicant (i) has failed to comply with the SFC’s request for information under Section 6(1) of the SMLR, or (ii) in purported compliance with such request, has furnished the SFC with information which is false or misleading in any material particular, or
- it would not be in the interest of the investing public or in the public interest for the securities to be listed.
Section 8(1) of the SMLR provides that the SFC may direct The Stock Exchange of Hong Kong Ltd to suspend all dealings in a listed corporation’s shares if it appears to the SFC that:
any materially false, incomplete or misleading information has been disclosed by the corporation in any document (such as a prospectus or circular) issued in connection with the listing of its shares, or in any announcement, statement, circular or other document made or issued by or on behalf of the listed corporation in connection with its affairs
- it is necessary or expedient in the interest of maintaining an orderly and fair market in securities traded on the stock market
- it is in the interest of the investing public or in the public interest, or it is appropriate for the protection of investors generally or for the protection of investors in any listed securities, or
- there has been a failure to comply with conditions imposed by the SFC in the context of a resumption of dealings under Section 9 of the SMLR following a previous suspension.