The report by the
Government-appointed Panel of Inquiry into the recent "Penny
Stocks Incident" was released on Tuesday. Webb-site.com looks
beyond the blame game and into the recommendations for structural reform
of the regulatory system. |
PIPSI Report
15th September 2002
The two-man Panel of Inquiry on Penny Stocks
Incident (PIPSI), appointed
on 31-Jul-02 by the Financial Secretary, released its report on Tuesday.
There is no link to the report on the Government's news
index, and it took us some time to find it deep in the Government web
site. Click
here to read it but be warned, it runs to 189 pages plus 97 pages of
appendices.
If you are new to this subject, you
can read our article PIPSI Submission including the
download of our actual submission.
The Blame Game
To us, the apportionment of blame
is the least important part of the Panel's work, so we will deal with it
briefly before moving on to the weightier conclusions. On the subject of
Fred Ma, Secretary for Financial Services and the Treasury, the panel wrote
(12.27):
"[Mr Ma] joined the Government
on 1 July 2002 and...he had a great deal of catching up to do...We have seen
his engagement diary. [Mr Ma] clearly had a very full plate".
That's an interesting choice of
words in relation to a keen diner who told the press on 16-Jul-02, just a
week before the penny stocks incident and in relation to market hours:
"To have a nice lunch is not
important for Westerners but it is very important for the Chinese. I think
we need to respect this cultural difference."
He was dishing up baloney, perhaps
after a particularly good dish of abalone. Maybe his lunch diary impeded his
ability to digest his in-tray. In relation to a summary table of the HKEx
delisting proposals from the SFC, which was placed in his in-tray on
17-Jul-02 by an assistant, he told LegCo on 31-Jul-02:
"since the papers and files in
my office were piling up like a mountain...I could not possibly have read
every document"
We give him credit for admitting
this even though it shows disorganisation and does not excuse ignorance.
Whatever the height of his paper mountain, he should have informed himself
of the HKEx proposals, and then he would probably have recognised their
likely consequences and intervened. The Panel, by contrast, seems to think
that honesty was not a good quality in front of LegCo, calling it a "sub-par
performance". The panel wrote of his session (9.21):
"It would have required
the skills and experience of a much more seasoned bureaucrat to have come
out of that barrage relatively unscathed."
The Panel implies that a
"par" performance would be to obfuscate to Legislators and not to
admit any errors. This may be politically desirable from the Government's
point of view, but it surely is not the objective of accountability.
"Performance" should not be measured by the degree to which a
politician deflects criticism or avoids blame.
Incomplete record
The Government held a press
conference on Tuesday afternoon, in which Chief Executive Tung Chee Hwa,
Financial Secretary Antony Leung and Mr Ma came out for sequential
stand-alone sessions like ducks in a fairground shooting gallery. Mr Leung's
statement
(but not his Q&A) and Mr Ma's statement
and English portion of his Q&A
are online. The written record does not include Mr Tung's statement, and
only the English portion of his Q&A.
You can watch the whole conference
with simultaneous translation in streaming
video. This in fact is the only way to get the full version of what was
said, because the Government does not produce English transcripts of
Cantonese Q&A or vice versa. So much for transparency in "Asia's
World City". The sporadic production of written statements also raises
the broader question of whether the Government is being selective in
publishing the statements of its officials for the record. Historians and
academics will not find it easy to research this in years to come.
In Tuesday's statement, Mr Ma
pointed to the Panel's conclusion that he had not "failed in the
discharge of his responsibilities" (12.27), but finally on Wednesday
afternoon, with a typhoon causing the cancellation of a LegCo Financial
Affairs Panel, and the political storm continuing, he came out to a hastily
convened selection of media and apologised with a Japanese-style bow. Better
late than never. HKEx apologises to
shareholders for the reaction of shareholders
Kwong Ki-chi, the Chief Executive of
Hong Kong Exchanges and Clearing Ltd (HKEx), in a statement
to LegCo on 31-Jul-02 said:
"I send my heartfelt
apologies to shareholders who have suffered as a result of the market's
response to some of the proposals in our consultation paper" (emphasis
added).
No doubt that statement was carefully drafted
to avoid admission of any legal liability, by inclusion of the words "the
market's response to" - after all, "the market" is in fact the
collective body of investors, so he is blaming the suffering of shareholders on
shareholders themselves, not directly on the HKEx proposals. The "market
reaction" was again included in an apology in Tuesday's statement
by HKEx. Incidentally, in material
supplied to the Panel, HKEx included a collection of "over 100 media
reports on penny stocks and delisting mechanism from 11 January 2001 to 25 July
2002". This was included as Annex
7.2. The Panel describes this as "an extremely useful document"
(7.69(a)) - but it is useless to us, since it is in Chinese only -
even the quotes from The Standard, which is an English-language paper,
are produced in Chinese. Only one quote appears in English.
Bad governance, not bad
shareholders
In several places, the Panel
appears to confuse the quality of the market with the performance of
companies. In their conclusions, they write (13.2):
"There is overwhelming market
and public support for the enhancement of the quality of the securities
market in Hong Kong. There is a clear consensus that the authorities should
work together...to minimize market misconduct and to weed out
under-performing companies which damage the reputation of the Hong Kong
market"
It is not clear what is meant by
"under-performance" in this context. If they mean it in a
regulatory sense of "companies which break the rules and laws"
then it should be recognised that companies are just legal entities run by
directors, who make the decisions. We need a system to penalise and deter
the directors from rule-breaking behaviour, not to penalise the minority
shareholders by delisting the company. Put simply, it is the weak regulatory
and legal structure that "damages the reputation of the market" by
facilitating and failing to deter bad governance.
Alternatively, if the Panel mean
"under-performance" in a financial sense, then they seem to forget
that this is a market economy with winners and losers. Shareholders of a
company which have lost money should not be penalised by delisting their
stock, so long as the company is solvent. If a company is already in
liquidation, then this is not a penalty. We already have a delisting
mechanism for such cases, and it can be improved. Financial
under-performance does not in itself "damage the reputation"
of a market, and since under-performance is a relative term, by definition,
there will always be companies which "under-perform" others.
Relationship between HKEx and SFC
The report offers the public some
insight into the strained relationship between the HKEx and SFC. As we noted
in our submission, the SFC cannot direct that changes be made to the Listing
Rules and can only approve or reject changes proposed by HKEx, which gives
the HKEx the upper hand in any negotiations. Indeed, although the original
discussion on Penny stocks between HKEx and SFC centred on proposals to
require them to consolidate, and what price level would be appropriate,
somewhere along the line, it morphed into a proposal to use the most
draconian penalty (delisting) for those companies who failed to comply -
rather than the usual procedure for breaches of Listing Rules (which focuses
on a system of reprimands). So consolidation was combined with delisting.
The proposal was clear:
"We will amend the Main Board
Rules to introduce a minimum share price of HK$0.50 as a continuing listing
eligibility criterion"
The SFC does not have the power to stop
the HKEx from consulting the market on any proposals, so this gives them
somewhat limited influence in the drafting, which is driven by HKEx.
In our PIPSI submission, we
explained how in 2001, on draft proposals for corporate governance aspects
of the listing rules, the SFC Shareholders Group gave views to the SFC,
which were then communicated to HKEx. The report reveals (7.72) that Karen
Lee, Head of the HKEx Listing Division, wrote to the SFC on 12-Dec-01:
"I am very surprised indeed,
and rather concerned, to note that our draft paper was discussed at the
Shareholders Group meeting, and comments on the papers have been officially
passed to us"
In other words, "how dare you
consult your Shareholders Group on matters affecting shareholders". To
which Ashley Alder, Head of Corporate Finance for the SFC replied (7.73):
"I am convinced that had we
not consulted the Group at this stage we would have been subject to
justifiable criticism, including by members of the Group. Exercises like
this are what the Group is for."
The comments of the Shareholders
Group were largely ignored in this matter. The report notes (7.74) that:
"The SFC has since this
incident not discussed any Listing Rules changes with its Shareholders
Group"
In relation to the delisting proposals,
the report notes (7.76) that:
"the SFC felt inhibited from
consulting its Shareholders Group on the HKEx's actual proposals. The previous
attitude of the HKEx... had the effect of preventing the SFC from fully
engaging its network in gauging market feedback which would have benefited the
HKEx."
One has to wonder who is in charge of
whom here, which brings us neatly on to:
Structural reform
In its description of the so-called
"three-tier regulatory structure", the Panel notes:
"the HKEx...is only a regulator
in a limited sense since it possesses no statutory powers of investigation and
its powers, such as they are, are conferred by the Listing Agreement entered
into by issuers... There are those who would consider it a straining of
language to describe a party with the right to enforce a contract as a
regulator."
In other words, the Listing Rules have
no teeth. As far as we know, the HKEx (or more accurately, the SEHK) has never
sued a company for breach of the Listing Agreement. It would not be appropriate
to give statutory powers to a commercial entity such as HKEx, which is one of
the reasons that listing regulation should be moved to the SFC, so that these
powers can be granted to the SFC, to fine directors for breaking the rules.
The most important part of the
report is the recommendations section, and here we see encouraging signals.
The Panel wrote (14.21):
"The handling of regulatory
issues by both the HKEx and the SFC and the splitting of roles and functions
between them not only lead to inefficiencies but also to confusion...We
consider it timely for the present arrangement to be reviewed...in
particular, most [commentators] have suggested that if a Listing Committee
is to be retained, as most believe it ought to be, it cannot be housed under
the HKEx. Within the current structure, the only entity under which it can
be accommodated is the SFC. We see the sense of all these comments and
commend them to the authorities for further consideration."
(emphasis added).
Is a commendation a recommendation?
It certainly looks like one. Webb-site.com has been calling
since Mar-99, when the creation of HKEx was first announced, for the HKEx to
get out of regulation, and it looks like this ball is now rolling. It can be
assumed that by moving the Listing Committee to the SFC, the Listing
Division goes with it, lock, stock and barrel. The
Government has said it "accepts" all the recommendations in the
report. This hopefully removes the roadblock which Mr Ma imposed the day before
the delisting proposals were announced, when he announced that the HKEx would
remain the frontline regulator pending a review which would not happen for at
least another 2 years. We covered this in our article "Listing
Chaos".
Listening to Investors
The Panel appears to have accepted
our submission that unlike the SFC, which has a Shareholders Group of which
your Editor is a member, the HKEx has no sounding board to gauge investor
opinion. By implication, they also accept that the HKEx Listing Committee
does not reflect investor opinion, which is hardly surprising given that
only 4 out of its 25 members can be fund managers. The Panel writes (14.11):
"We note that the HKEx does
not have within its structure any group specifically reflecting the views of
consumers or shareholders...We recommend that the HKEx consider setting up
its own consumer panel or shareholders group."
We agree, but we also suggest that
the HKEx should use the existing Shareholders Group which was formed by the
SFC rather than duplicate the effort with a second group. There is no
conflict in having the same Shareholders Group advise both the SFC and HKEx.
Whether or not Listing regulation is moved to the SFC, the HKEx still needs
to hear the views of investors on matters such as new products, the clearing
system, trading spreads, price dissemination and scripless registration.
The government should also
reconsider enabling the HAMS proposal
which contained a democratic mechanism for investors to elect their own
representatives as a board of governors. If HAMS existed, then its Policy
Division would have engaged the authorities on matters such as the delisting
proposals, and then the Penny Stock fiasco need never have happened.
Empowering investors
The Panel also touches on the fact
that minority shareholders are relatively powerless to protect their
interests. The Panel writes (14.23):
"We recommend that further and
continuous consideration be given to how minority shareholders' rights can
be better protected."
One of the keys to this is
empowering investors to help themselves, and create their own deterrent to
bad governance. There is no class action system in Hong Kong law, and no
contingent legal fees. The lack of class actions fragments the value of
claims that investors would have against offending parties, making legal
action unaffordable. HAMS was designed to create a quasi-class action
system, with an Enforcement Division producing joint actions on behalf of
thousands of investor-members.
However, in the absence of enabling
HAMS, we believe the Government must instead introduce a statutory right of
class action, where a lead plaintiff can represent an entire class of
minority shareholders (other than those who opt out). Lawyers should also be
permitted to conduct work on a contingent fee basis, working for free in
return for a negotiated success fee. They would then accept cases that had a
reasonable chance of success, and large awards for the whole class would
begin to create a deterrent effect.
Until shareholders have effective
legal remedies, all of the burden of deterrence will fall on the Government's
regulatory and law enforcement agencies.
© Webb-site.com, 2002
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