New Trading Suspension Rule: A Double-Edged Sword...Oct 17, 2019 · Exemption #1: Going concern...

New Trading Suspension Rule:A Double-Edged Sword

Presentation to INED

17 October 2019 Information Classification: Internal

For internal discussion only© 2019. For information, contact Deloitte China. 2

Part I


What’s new about 13.50A (“new suspension rule”)

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Issuer Regulator Issuer Regulator

Old regime New regime


“This consultation was about improving the quality and reliability of financial information of issuers to safeguard market quality,”

“The new Rule encourages issuers to maintain appropriate and effective risk management and internal control systems, and where necessary, requires them to act promptly to resolve issues with their auditors,”

- David Graham, HKEX’s Head of Listing

Mainboard - 13.50A (GEM Listing Rule 17.48B)

“The Exchange will normally require suspension of trading in an issuer’s

securities if it publishes a preliminary results announcement for a financial year as required under rules 13.49(1) and (2) and the auditor has issued, or has

indicated that it will issue, a disclaimer of opinion or an adverse opinion on

the issuer’s financial statements. The suspension will normally remain in force until the issuer has addressed the issues giving rise to the disclaimer or adverse opinion, provided comfort that a disclaimer or adverse opinion in respect of such issues would no longer be required, and disclosed sufficient information to enable investors to make an informed assessment of its financial positions.”


Audit Opinion

Unmodified opinion

Clean

Clean Opinion with Emphasis of

Matter

Modified Opinion

Qualified Disclaimer Adverse

Audit opinions that will trigger suspension


Example of disclaimer

• Failure to substantiate carrying amounts investment or other fixed assets

• Certain books and records of the issuers being lost or inaccessible

• Fire or natural disaster resulting in loss of primary evidence

• De-consolidation of subsidiaries from the group’s consolidated financial statements as the issues were unable to exercise control over time and have no access to the books and records

Limitation of scope on valuation of assets due to lack of books and

records and/or supporting documents, etc.

Material uncertainties related to issuer’s abilities to continue as a going concern


Example of disclaimer

“… Management was not able to provide us with satisfactory explanations as to the commercial substance of these transactions, and provide us with adequate documentary evidences to support the nature and source of these receipts from and payments to the above company …”

“… we have independently identified significant amounts of payments to and receipts from (including the payments and receipts described in the above sections) a number of companies ... Such payments and receipts were not supported by legitimate documentary evidence. …”

“Given the above, together with our concerns on those transactions described in the sections … we have requested the board of directors of the Company to form an independent committee to commission an independent investigation on the authenticity and commercial substance of these transactions (the “Proposed Investigation”) …”

Disclaimer Opinion (846)


Example of resignation of auditor

Before the deadline for publication of the audited account, the Auditors resigned.

In the auditors’ letter of resignation, it was said: “We continue to have concerns about matters pervasive to the financial statements including (1) … transactions brought to the attention of management and acknowledged by them to be fraudulent; (2) unexplained differences between sales receipt notes …; (3) the explanation provided by management … for removing accounting records which were then not available to us continuously during the audit; (4) the validity and commercial substance of acquisition.”

The HKEx imposed a resumption condition for the Company to conduct a forensic investigation on the audit issues (including the certain potentially fraudulent transactions).

Auditors cease work and resign (1007)


The disclaimer or adverse opinion relates solely to going

concern

Exemption #1: Going concern

material uncertainties about the

company’s ability to continue as a

going concern

Completed an equity fundraising for repayment of debts and working capital, and issued convertible bonds to settle certain amounts due to creditors

Improvement in the company’s operating performance during the year

Year 2Year 1

Material uncertainties about the company’s ability to continue as a going concern

Disclaimer

Clean Opinion with an emphasis of matter

relating to the going concern issue


Exemption #2: Issue resolved

Fire accident

Loss of books and records

Reconstruct accounting records

Publication of financial results for the year

the underlying issue is resolved before the issuer publishes the preliminary results announcement

the audit issues would not have an ongoing effect on the issuer’s financial statements for the succeeding financial years

Disclaimer


Effective Date

• Apply to preliminary annual results announcements for the financial

years commencing on or after 1 September 2019

Longer remedial period

• For issues remains unresolved outside the issuer’s control, HKSE may allow longer remedial period, with the duration of the period being determined on a case by case basis.

Transitional Arrangement

• Extend the remedial period to 24 months for the financial years

commencing between 1 September 2019 and 31 August 2021

Other highlights


New Trading Suspension Rule

Proactive• Identify and resolve the issues giving

rise to disclaimer and or adverse

opinions before publication of the

preliminary results announcement.

Reactive• Identify and resolve the issues giving

rise to disclaimer and or adverse

opinions within 18 months (or 12

months for GEM issuers)

Main

BoardGEM

Suspension18 months 12 months

Delist

(Prescribed remedial period)

Current Listing RulesHow to prevent suspension

and delisting?

The proactive and reactive approaches


Part II - Seeking a resumption


New delisting regime

New delisting regime with an aim to delist prolonged suspended companies became effective on 1 August 2018:


Recent regulatory updates

The objective of the new delisting rules (Para. 8 of GL95-18)


What is the new delisting regime?

Old Regime New Regime

Delist a company immediately without suspension (LR 6.10)

Delist a company after a specified remedial period (with a specific 3-stage delisting procedures for PN 17 companies (being companies unable to comply with LR13.24)) (LR 6.10)

Delist a company immediately (LR 6.10)

Delist a company after a Specified Remedial Period (LR 6..10)

Delist a company for failure to remedy the issues causing its suspension of trading, to re-comply with the rules and resume trading before the end of the prescribed remedial period of 18 months (the “Prescribed Remedial Period”). (LR 6.01A and 6.10A)


Other highlights of the new delisting regime

Effective date: 1 August 2018.

Transition period:

Companies suspended for more than 12 months before August 2018: 31 July 2019.

Companies suspended for less than 12 months before 1 August 2018: 31 January 2020.

According to the monthly prolonged suspension status report of the HKEx (as at 30 September 2019)

18 suspended companies with PRP expired on 31 July 2019.

At least 9 of them were delisted by the HKEx in August and September 2019 under the new LR6.01A for failure to resume trading by the end of the PRP.

11 suspended companies with PRP expiring on 31 January 2020.


Regulatory landscape



Listed companies governance is one of the top enforcement priorities for regulators in Hong Kong:



It was rare for the SFC to exercise its power to suspend, but this has changed in recent years:

Year Companies suspended by the SFC2010 - 30/03/ 2010: Hontex (0946)

2011 - Nil.

2012 - 22/08/2012: China High Precision (591)

2013 - 20/12/2013: Qunxing Paper (3868)

2014 - 14/02/2013: China Longevity Group Company Limited (1863)- 04/12/2014: Sijia Group (1863)

2015 - 15/07/2015: Hanergy (566)- 15/12/2015: Superb Summit (1228)

2016 - 20/01/2016: Changgang Dunxin Enterprise Company Limited (2229)- 16/04/2016: Sound Global (967)- 28/06/2016: Real Gold Mining (246)- 05/08/2016: National United Resources Holding (254)- 27/09/2016: Hua Han Health Industry Holdings (587)- 13/10/2016: China Fiber Optic Network (3777)

2017 - 22/02/2017: GME (8188)- 04/07/2017: Nationa Agricultural Holdings Limited (1236)- 08/05/2017: Huishan Dairy (6863)- 17/05/2017: CG Dunxin (2229)- 25/05/2017: Tianhe Chemicals (1619)- 06/06/2017: Lerado Financial Group Company Limited (1225)- 17/07/2017: China Household Holdings Limited (692)- 06/10/2017: New Ray Medicine International Holdings Limited (6108)- 09/11/2017: Tech Pro Technology Development Limited (3823)- 24/11/2017: First Credit Finance Group Limited (8215)- 27/11/2017: China Wah Yan Healthcare Limited (648)- 27/11/2017: Town Health International Medical Group Limited (3886)

2018 - 04/07/2018: Real Nutriceutical Group Limited (2010)- 20/11/2018: Hua Han Health Industry Holdings Limited (587)

2019 - 08/03/2019: China Ding Yi Feng Holdings Limited (612)- 29/05/2019: Combest Holdings Limited (8190)



Many listed companies were suspended from trading as a result of certain issues or regulatory concerns:



HKEx continued to focus on the four Enforcement Themes:


Regulatory environment

SFC HKEx

Investigation Restructuring

Delisting

Liquidation

Company Sponsors

Company/INEDs

Company

PL/JL

Regulators

Whistle-blowers

Auditors

Creditors

Shareholders

Company/INEDs

Regulators

Regulators to approve

Trading

resumed

Creditors

White knight

Auditors

Suspension

Auditors

Forensic accountants

Controlling / majorshareholders


Seeking a resumption



• Reasons for suspension

− Material breaches of the LR

− Fails to publish financial statements within time limit

− Fails to maintain sufficient operation or assets

− Fails to maintain sufficient public float

− Receives disclaimer or adverse opinion (new suspension rule)

• Depending on the underlying issues, the regulators will impose different resumption conditions on the company

• The principle, however, remains the same: no resumption will be allowed unless and until all issues leading to the suspension have been properly resolved



• 3 key categories of suspension cases

PN 17 companies/ companies with insufficient

operation or assets or in financial difficulties

Companies with material irregularities (accounting/

corporate irregularities)

Companies with insufficient public float

• Demonstrate that it has a business that has substance and is viable and sustainable in the longer term.

• If due to insufficient operation/ assets, acquisition – Note: a suspended issuer that ceased to carry on the original principal business or to retain any material assets is a listed shell and any acquisition by it will be a RTO and be treated as a new listing application.

• If due to financial difficulties, undertake corporate action to resolve the financial difficulties, such as capital reorganization, equity fundraising and a scheme of arrangement.

• Accounting irregularities: discrepancy between group account records and information obtained by auditors; concerns over authenticity of the documents; concerns over the commercial substance of certain material transactions

• Corporate irregularities: fraud; misappropriation of assets; other fraudulent activities

• Address the irregularities: (1) form a IBC; (2) forensic investigation; (3) address audit concerns; (4) audit qualification; (5) internal control review; (6) remedial measures; (7) no concern about management integrity; (8) disclose all material information and publish all financial statements.

• Devise a plan to restore the required the minimum public float.

• Placing of existing shares by the controlling or substantial shareholders; or placing of new shares by the issuer.


Key criteria for resumption

Forensic investigation

Disclose information to

the market

Take appropriate

remedial action

Demonstrate the integrity

and competence of directors

Demonstrate adequate

internal control system

Address auditor’s concern


Old PN 17 company: case study – Grande (186)

Date Chronology of events

30/05/2011 - Suspended upon the presentation of creditors’ winding up

31/05/2011 - Provisional liquidation

08/09/2011 - Grande was placed in the 1st stage of delisting procedure

31/05/2012 - A resumption proposal was submitted but was rejected by the HKEx

05/07/2012 - Grande was placed in the 2nd stage of delisting procedure

25/09/2012 - Grande requested a review of the Listing Division’s decision to place it in the 2nd stage of delisting procedure. Review not successful.

21/06/2013 - A resumption proposal was submitted but was rejected by the HKEx

11/07/2013 - Grande was placed in the 3rd stage of delisting procedure

12/09/2013 - A winding up order made against Grande

12/02/2014 - Grande submitted a resumption proposal to the HKEx

29/05/2015 - HKEx approved the resumption proposal, and made (among others) the completion of all transactions contemplated under the resumption proposal as one of the resumption conditions

30/05/2016 - Fulfilled all resumption conditions and resumed trading

Case study


Case study: PN 17 company

Publication of material information: outstanding financial

information

Internal control review: internal control review, remedial measures, new CFO and Company Secretary

Strengthening existing business: No acquisition, steps taken to strengthen its business

Group Reorganization: liquidating certain

subsidiaries: to improve financial position, and to address audit issues regarding certain subsidiaries.

Scheme of arrangement: Bermuda and Hong Kong

schemes: discharging of all claims (excluding intercompany debts), by cash and creditors shares

Open offer: 5 offer shares for every 2 shares: raising

proceeds of around HKD100 million for the Scheme

Capital Reorganization: capital cancellation

(unissued), capital reduction (reduce par value), increase authorized share capital: remove 1/3 accumulative losses, and enabling Open Offer and Scheme.

Resumption

Suspension

Grande (186) Total current liabilities

over HKD 3.9 billion Total assets around

HKD1.3 billion Issues regarding

amounts due to related companies

Disclaimer Internal control issues


Companies with material issues: case study – Kaisa (1638)

Date Chronology of events

Late 2014/ early 2015

- The Company had liquidity issues. Loans defaulted. Many litigations were commenced against the Company. CEO resigned.

08/03/2015 - Announced restructuring proposal.

31/03/2015 - Trading suspended as a result of its failure to publish the 2014 annual results.

29/04/2015 - Announced that auditors need additional audit evidence on certain matter for its 2014 audit.

23/07/2015 - HKEx imposed resumption conditions on the Company, which included, among others, demonstrating sufficient working capital and investigation of matters raised by the Company’s auditors in the course of the audit.

18/09/2015 - Auditors identified various audit issues. Auditors ceased work. The Company formed an independent committee to investigate matters.

10/06/2016 - Schemes for restructuring of offshore debts were sanctioned by HK and Cayman court

12/07/2016 - Offshore debts restructuring became effective.

15/07/2016 - Auditor resigned and new auditors appointed.

19/12/2016 - Forensic accountants published its findings. Recommended action against wrongdoers and remedial steps to be taken.

24/03/2017 - Internal control review completed.

26/03/2017 - Published the outstanding annual results for 2014 to 2016

27/03/2017 - All resumption conditions fulfilled. - Trading resumed.

Case study


Case study: material issues

Publication of the outstanding financial information: New auditors appointed,

and published outstanding financial information.

Internal control review: internal control

review, various weaknesses identified and remedial measures implemented.

Forensic investigation of audit issues: Engage a forensic accountant to investigate audit issues:

findings (a) certain former employees were involved in a scheme using fictitious agreements, substantial improper and unauthorized payments, incorrect accounting and collusion with third parties, to obscure the existence of certain borrowing agreements; (b) certain payment transactions were without clear business purposes or had no identifiable business purposes; (c) certain acquisitions were not properly authorized and approved. Recommended the Company to report the wrongdoing to the authorities and to implement remedial measures.

Debt restructuring: Restructuring onshore debts by refinancing,

restructuring offshore debts by scheme of arrangement: to improve the Company’s financial position

Resumption

Kaisa (1638) Serious liquidity issues Onshore debts

(RMB49.6 billion) Offshore debts (USD2.9

billion) Loan default; material

litigation Material audit issues

Suspension


Seeking a resumption (Cont.)

Example of a company no longer suitable for listing- False and misleading IPO prospectus: Hontex (946)

Hontex (946)

- 24/12/2009: Hontex was listed on the HKEx

- 30/03/2010: SFC sought injunction to freeze IPO proceeds , alleging that Hontex materially overstated its turnovers and cash in the IPO prospectus.

- 20/06/2012: SFC obtained a repurchase order, requiring Hontex to repurchase shares from 7,700 public shareholders.

- 29/10/2012: Repurchase completed – 0.42% public float

- 22/11/2012: LC decided to delist, on the basis of disclosure of false and misleading information in the IPO prospectus and lack of public float.

- 23/09/2013: Delisted.


Seeking a resumption of trading (Cont.)

Initial listing obtained by fraud: China Metal Recycling (773)

Facts SFC v. China Metal Recycling (HCCW 210/2013)

- 22/06/2009: China Metal was listed on the HKEx.

- 28/01/2013: Trading suspended.

- 26/07/2013: SFC petitioned to wind up the Company on public interest basis under section 212 of the SFO. SFC alleged that China Metal involved in a highly complex, sophisticated and dishonest scheme which inflated its performance, revenue (over HKD 8 billion) and profit (over HKD 1 billion) dating back to the time of its IPO prospectus in 2009.

- 26/02/2015: Winding up order made.

- 04/02/2016: Delisted, on the basis that it obtained its initial listing by fraud.

- First public interest winding up

- Justice Harris: “Although the economic interests of creditors and minority shareholders are relevant in determining a petition such as the present, as the authorities to which I have referred make clear, the overarching consideration is the broader interest of market participants as a whole. That interest requires that serious misconduct is subject to unequivocal censure. The appropriate order in a case where a listing has been obtained by wholly dishonest fabrication of accounts would, in my view, almost invariably be a winding-up order”


Preparing for investigations

• A resumption of trading is unlikely to be the end of the matter

• It usually marks the beginning of investigation by the regulators into the problematic companies and/or their officers for past breaches of rules and regulations

• One of the enforcement objectives: to punish wrongdoers

• It is important to bear in mind the likelihood of investigations and enforcement actions by the regulators, and to manage the relevant risks as appropriate


Investigations carried out by HKEx

Sources: HKEX website

0

20

40

60

80

100

120

2015 2016 2017 2018 1H2019

No. of Investigations

Main Board GEM

Issues under Investigations in 1H2019

Director's duties

Failure to cooperate with an Exchange investigation

Inaccurate, incomplete and/or misleading disclosure incorporate communication

Failure to comply with procedural requirements in respect ofnotifiable/connected transactions

Repeated breaches of the Listing Rules

Financial reporting - delays, or internal controls and corporategovernance issues

Multiple themes

Others

0

20

40

60

80

100

120

2015 2016 2017 2018 1H2019

No. of Directors subject to

Disciplinary Sanctions

ED NED INED


Investigations carried out by SFC

0

50

100

150

200

250

13/14 14/15 15/16 16/17 17/18Corporate disclosure Corporate misgovernance Insider dealing

Intermediary misconduct Market manipulation Unlicensed activities

Sources: SFC Annual Report 2017-18

0

50

100

150

13/14 14/15 15/16 16/17 17/18Prosecutions Civil proceedings Disciplinary proceedings Maket Misconduct Tribunal proceedings


More key takeaways …

“No Mistake.”

“No do-overs.”

“Whatever it takes!”

“Alright, we have a plan. Six Stones. Three teams. One Shot. Five years ago we lost. All of us. We lost friends. We lost family. We lost a

part of ourselves. Today we have a chance to take it all back. You know your teams. You know your mission. Get the stones. Get them back. One round trip each. No mistakes. No Do-overs. Most of us are going somewhere we know, but that doesn’t mean we should know

what to expect. Be careful. Look out for each other. This is the fight of our lives. We are going to win. Whatever it takes. Good Luck.”

Steve Rogers, Avengers: Endgame

https://youtu.be/nLRnHaf3t54

https://youtu.be/nLRnHaf3t54



Juvenia Ho

Partner, Hong Kong

Tel: +852 2852 1018

Email: [email protected]

Joseph is a partner in the Dispute Resolution Group. Headvises and represents clients in arbitration, banking,general commercial, tax and trust disputes andinvestigations, with a particular focus on internationalarbitration, regulatory investigations and cross-borderlitigation.

Joseph joined Simmons & Simmons as a partner in October2013. He was admitted in Hong Kong in 2003, England in2008 and qualified as a lawyer in the PRC in 2012. He is oneof the authors of Sweet & Maxwell’s Arbitration in HongKong: A Practical Guide, 2nd Edition, and was a contributingeditor of Hong Kong Civil Procedure (the “White Book”).

Joseph has been recognized as “up and coming” inInternational Arbitration by Chambers Global in 2016. Hehas been described as “best known for his expertiserepresenting Mainland China-based businesses on cross-border arbitrations” and “knowing the Mainland Chinamarket more than most” by Chambers Global. Joseph wasalso identified by the Asian Legal Business in 2016 as one ofthe “Top 15 Rising Lawyers” in the PRC.

Juvenia Ho is a Partner in Deloitte Forensic practice in HongKong. She has over 20 years of experience specializing inforensic accounting, financial/management fraudinvestigations, litigation support and fraud risk compliancereview throughout Greater China .

Juvenia’s extensive forensic accounting experiences includesinvestigation into white collar crime, corruption particularlyin the context of Foreign Corrupt Practices Act and moneylaundering, asset tracing inquiries, bribery & corruption riskassessments.

Juvenia’s investigative experiences cover a wide range ofindustries but in particular she has worked extensively in thePharmaceutical, medical device, media & entertainment,gaming, real estate, retail and manufacturing sectors.

Juvenia is also experienced in preparing accounting expertreports and exhibits for court hearing, in both civil andcriminal cases for family/estate disputes, share placementsand insider dealing.

Joseph Chu

Partner, Hong Kong/ Beijing

Tel: + 852 3919 0505/ +86 10 8588

4505

Email: Joseph.Chu@simmons-

simmons.com

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New Trading Suspension Rule: A Double-Edged Sword...Oct 17, 2019 · Exemption #1: Going concern...

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