D-graded PERL of the Orient

The Government has announced its decision on Proposals to Enhance the Regulation of Listing. This represents only glacial progress. While they leave the door open for more meaningful reform in future phases, that is about as likely and imminent as universal suffrage, and not unrelated to that problem. We also look at the way investors have been relegated to a footnote in the report.

D-graded PERL of the Orient
28th March 2004

Friday 26-Mar-04 was a busy day. Amid the noise of the decision by the National People's Congress to rewrite - sorry, interpret - the Basic Law's provisions for electoral reform (or non-reform as the case may be), and the kick-off of the Rugby Sevens, the Government on Friday night also announced its decision on the Consultation on Proposals to Enhance the Regulation of Listing (PERL).

To read the Government's conclusions paper, click here. The Government has its own problems with disclosure, failing to publish the submissions received. However, it did publish a list of respondents, excluding those who did not even have the transparency to reveal their names. The list reveals that your editor was not the only Director of Hong Kong Exchanges and Clearing Ltd (HKEx, 0388) to make a personal submission. See our separate article for John Strickland's submission.

The framework

The Government has decided to allow the SFC to exercise existing powers to make Listing Rules under Section 36 of the Securities and Futures Ordinance (SFO). Wait a minute, we hear you say - if they had these powers anyway, then why didn't they use them before?

Well that's politics - the SFO requires the SFC to first consult the Financial Secretary and HKEx, and in practice that means that the SFC cannot go any further than the Government allows. So what the Government has said is that the SFC can now use these powers, but only for three narrow areas of the Listing Rules:

...and that's all. It's a far cry from the original recommendation of the Expert Group that the entire regulatory function be transferred to a new Listing Authority under the SFC. It also is far less than the SFC had proposed in the latest consultation, which in itself was a compromise. The SFC had proposed taking over all disclosure-related listing regulation, dealing with it directly as the US SEC does, and leaving HKEx to make rules on corporate governance. But under the Government's plan, HKEx keeps control of all the disclosure rules, including the disclosure rules on notifiable transactions (such as acquisitions and disposals), other than the 3 areas mentioned above, and retains its front-line role.

Sanctions

The Government proposes to give two sanctioning powers to the SFC, subject to a right of appeal. If you break the new statutory Listing Rules, then you could be reprimanded by the SFC - but as virtually everyone (including HKEx) has accepted, reprimands are an ineffective toothless sanction. The other proposed sanction is that the SFC could disqualify you from being a director - this may have some marginal deterrent effect, but we can think of one or two crooks who successfully control their companies from the shadows without being directors. Indeed, being off the board avoids pesky things like the rules on directors' dealings and undertakings to abide by the Listing Rules. So ironically, the use of this sanction for breaking the statutory Listing Rules could put the individual beyond the reach of the statutory Listing Rules in future, since these rules apply to companies, directors and officers, not shareholders.

However, the paper also makes progress by proposing two further options. In a civil route, the SFC can refer the case to the Financial Secretary who may then refer it to the Market Misconduct Tribunal (MMT), which may then require you to pay up the profit you have made or the loss you avoided from the rule breach, although that money would go to the Government rather than the minority shareholders. Well at least the Financial Secretary would have a better chance of balancing the fiscal budget, so that should incentivise referral!

Alternatively, in a criminal route, if the SFC can show that the breach was intentional and not inadvertent (as people usually claim when their connected transactions are uncovered), then it can refer the case to the Secretary for Justice who may prosecute you, provided you don't run a newspaper company on whose board the Hong Kong Chief Executive used to sit. Such prosecution could lead to 10 years in jail and/or fines.

Don't just disgorge

Notably, the Government stops short of treating listed company directors the same way it treats licensed stockbrokers and asset managers. Such licensed intermediaries are subject to fining powers of the SFC, up to 3 times the amount of profit made or loss avoided from misconduct, subject to appeal. The 3 times multiplier means that if you get caught, it isn't enough just to pay the Government what you've made. Such punitive fines are needed to balance the equation of risk and reward from malfeasance.

We believe there is no reason why listed company directors should not be subject to the same level of sanctions as other financial intermediaries - both are entrusted with your money. If this means treating directors as licensed persons to bring them within the scope of this regime, then so be it.

D-Graded PERL

So while the Government has established the principle of statutory backing for a few listing rules, which will be made under existing powers of the SFC, what we are looking at is just the nucleus of the pearl, with just one layer of nacre.

The reforms are so tentative as to be of little use to investors. Nothing has been done to reform the composition of the Listing Committee or to remove its ability to veto reforms to the (non-statutory) Listing Rules, or to address the fundamental conflicts of being a regulator and for-profit at the same time. The Government again dismisses this with a masterpiece of semantic noodles:

Hang on a minute - if "it appears" that market users have a "point of view", then they are, by definition, perceiving something, and if they perceive a conflict of interest, then how does that make it unreal? Are we all just looking at a mirage? And besides, 98% of investor submissions (see below) endorsed our perception that the conflict was real, and several organisations said the same thing.

Next thing you know, the Government will be talking about a "perceived rather than real" need for democracy - the public doesn't really need the right to vote for their leader, they just think that they do.

Glacial and orderly progress?

The only glimmer of hope for further progress is that the Government has chosen to give statutory backing by way of subsidiary legislation under the SFO rather than primary legislation. This allows the possibility of further statutory rules to be made by the SFC (subject to negative vetting by LegCo) in what the government calls a "phased approach". But this can only happen after consultation with the Government and HKEx, and no timetable is offered.

Don't hold your breath. This has many parallels with the much wider debate on constitutional reform in Hong Kong, where it was decided in the Basic Law, published in 1990, that there would be "gradual and orderly progress" towards the "ultimate aim" of "universal suffrage". Ironically, the same day as the HK Government announced the PERL conclusions, the PRC Government announced that it would make an interpretation of the Basic Law, and will almost certainly decide that 2007 is too soon for democracy.

These two issues are not unrelated. If there were investor pressure at the ballot box, then the competing candidates and elected Chief Executive would be much more inclined to listen to the calls for stronger and more effective regulation, class action rights, a competition law and many other pro-consumer measures. Corporate governance and investor protection have been an election issue in many democracies in recent times. But in plutocratic Hong Kong, where the Chief Executive is elected by an 800-member committee dominated by tycoons, this will not be an election issue.

It starts at the top

Let us not forget that Hong Kong Chief Executive Tung Chee-hwa's own listed company, then known as Orient Overseas (Holdings) Ltd (OOHL), was steered to the brink of bankruptcy in the mid-1980s principally because of a mass of connected transactions between OOHL and his private family companies. He's an old master of bad governance. As Mr Tung himself wrote in a restructuring circular on 10-Nov-86:

OOHL wrote off US$156m of debts due from the Tung Private Group, which comprised over 200 trading companies, and was only bailed out as a result of a US$120m equity injection "signed by" tycoon Henry Fok Ying-tung on behalf of a Liberian company called Treelane Co Ltd, the owners and financiers of which were never disclosed. During his selection campaign in 1996, Mr Tung did admit that he had received unspecified help from the mainland government during the rescue.

Government transparency, please

Speaking of disclosure, and turning back to the PERL conclusions paper, the Government said there had been 48 submissions. In Annex A of the paper, 35 respondents are named, but the other 13 requested not to be identified. We wonder whether any of the other 11 directors of HKEx, besides Mr Strickland and your editor, made personal submissions.

The public interest would be better served if the Government practiced transparency and published all submissions, as HKEx did on sponsor regulation and as telecom regulator OFTA does. Those who decline to be named or published often have a vested interest to protect or are simply trying to pad the numbers.

Speaking of which, of the 35 PERL respondents who were named, 4 of them fall under the same control; Melco International Development Ltd (Melco, 200) is 50.8% owned by Lawrence Ho Yau-lung and his father, casino tycoon Stanley Ho Hung-sun. Melco owns 67.6% of Value Convergence Holdings Ltd (VC, 8101), which in turn owns 100% of both VC CEF Brokerage Ltd and VC CEF Capital Ltd. Melco and its three subsidiaries each made PERL submissions. Not only that, but Lawrence Ho is Vice Chairman of The Chamber of Hong Kong Listed Companies, which also made a submission. Could any of these 5 submissions be the same, by any chance? And how many of the unnamed submissions also are members of that chamber?

History may provide a guide - thanks to transparency, we can tell you that of the 98 submissions to the HKEx/SFC consultation on sponsor regulation, 36 of them were identical photocopies, coming from the Chamber of Hong Kong Listed Companies, 34 listed companies and one law firm, Arculli & Associates.

Meanwhile, back to the Government conclusions on Listing, where in the appendix the public were dealt the final insult - 52 people who sent e-mails supporting our submission, some including their own comments, and one who disagreed, were listed only as a footnote and not counted as submissions in their own right.

Now we know full well that this is not a referendum, and that the number of investors in Hong Kong far outweighs the number of listed companies, but it is nevertheless insulting to the public to stuff them all into a footnote and leave only one investor (your editor) on the list of submissions. Instead, the Government should have listed them out, numbered 1 to 53, and summarised investors' views on a separate basis. Only 5 of the 53 people asked to remain anonymous.

This brings back memories of the way HKEx handled the last consultation on the Listing Rules. When it published it's conclusions in Jan-03, HKEx decided that there were 167 submissions - including 110 from listed companies, and one from your editor. They chose to ignore 337 e-mails from the public supporting our submission, some including their own additional comments. We would be amazed if the 110 listed companies were all unrelated to each other and astounded if many of those submissions were not identical, but the public will never know, because the submissions were not published.

PERLs online

Some organisations have published their PERL submissions online. The ones we have found online or published on our server can be found in our index at this link.

We call on the Government to publish all the submissions, but in the meantime, if you or your organisation made a submission which has not been published, and you believe in transparency, then please just let us know and we will publish it for you on our server and add it to the list.

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