SFC and HKEx Joint Statement on IPO-related misconduct
Introduction
On 20 May 2021, The Stock Exchange of Hong Kong Limited (the “Stock Exchange”) and the Securities and Futures Commission (the “SFC”) (collectively, the “Regulators”) published a Joint statement on IPO-related misconduct (the “Joint Statement”), setting out the approach taken in response to various regulatory issues observed in recent new listings and how the Regulators may use their respective powers to address these issues in the future to safeguard the integrity of the capital market and reputation of Hong Kong as an international financial centre.
Observations and regulatory concerns
The Regulators underlined the following regulatory issues associated with initial public offerings (“IPOs”) in recent years, including suspected arrangements (a) to artificially satisfy the initial listing requirements; or (b) to facilitate market manipulation of shares at a later date. These arrangements would undermine the development of an open, orderly and fair market, and call into question the existence of genuine investor interest in IPOs.
Ramp-and-dump schemes
The Regulators noted an increasing number of suspected “ramp-and-dump” schemes, in which fraudsters first used different means, usually through social media platforms, to “ramp” up the share price of a listed company shortly after the listing of the shares and to induce investors to purchase the shares. Subsequently, the shares were dumped at a high price and the investors would suffer a loss.
The Regulators suspected that the schemes were orchestrated at the outset of the IPO process with the purpose of manipulating the share price at a later stage. Shares were allocated in the placing tranche to controlled accounts that appeared to be financed by funds from unusually high underwriting commissions or other listing expenses. Following an initial rise after listing, the share price often plummeted and the turnover also shrank to a minimal level.
Lack of robust and transparent share placement and price discovery process
The Regulators observed that, in some IPO cases, there had been a lack of robust and transparent share placement and price discovery process. It was unclear as to how the placees were identified, how shares were allotted in the placing tranche and how the IPO price was determined, giving raise to suspected market manipulation.
Unusually high underwriting commissions
The Regulators were concerned that there were peculiarly high underwriting commissions in some IPO cases. The average underwriting commission rate for IPOs with market capitalisations under HK$600 million surged from around 4% in 2017 to 12% in 2020.
The Regulators associated the disproportionately high underwriting commissions with arrangements to (i) artificially satisfy the listing requirements regarding sufficiency of investor base or the minimum threshold of market capitalisation; or (ii) perpetrate ramp-and-dump schemes.
Red flags that call for Regulators’ scrutiny
For ensuring an open, fair and orderly market, in the Joint Statement, the Regulators set out a non-exhaustive list of red flags in which the Regulators will call the genuineness of the investors’ interest of those listing applications into question. Those red flags include:
1. the applicant’s market capitalisation at listing barely meets the minimum listing;
2. very high price-to-earnings (P/E) ratios in view of the applicant’s financials (including its profit forecast) and as compared to the valuation of other listed peers;
3. unusually high underwriting commissions or listing expenses; and
4. high concentration in shareholding upon listing, especially the limited shareholders’ spread which barely meets the listing requirement.
Where a listing application entails one or more of the above red flags, the Regulators may raise enquiry as to the genuineness of investors’ demand and the reasonableness of the expected valuation. Listing applicants should also prepare themselves for demonstrating that the price determination process is robust and transparent. In cases where there are unusually high underwriting commissions or listing expenses, or there are discretionary expenses, the Regulators will examine the relevant details and such information should also be disclosed in the listing documents. The use of proceeds after listing would be subject to the Stock Exchange’s continuing scrutiny.
The Regulators’ Powers
Objection to a new listing
In the Joint Statement, the Regulators reiterated their powers to reject a listing application, if in the opinion of the Regulators that the basic conditions for listing under the Listing Rules are not met or questions raised regarding the share placement and price discovery process are not satisfactorily addressed. The conditions for listing under the Listing Rules include having sufficient public interest, an open market in the shares and an adequate spread of shareholders.
The Joint Statement reminded the market that the SFC can exercise the powers conferred upon section 6(2) of the Securities and Futures (Stock Market Listing) Rules (Chapter 571V of the Laws of Hong Kong) to object to a listing application if it considers that the listing application fails to comply with the Listing Rules or that that the listing would not be in the interest of the investing public or in the public interest.
Investigation and suspension of dealings
The Regulators indicated in the Joint Statement that they may initiate an investigation and take appropriate action against listed issuers and other relevant parties if:
1. there are any unusual movements in the share price or trading volume;
2. there is a high concentration of shareholdings after listing;
3. it appears that a listing document may have included false, incomplete or misleading information; or
4. there is evidence of other misconduct.
In addition to the powers under the Listing Rules exercisable by the Stock Exchange on regulating listed issuers, the SFC stated in the Joint Statement that it will not hesitate to exercise its statutory powers, including investigation powers, on listed issuers, their directors, shareholders as well as intermediaries in case of suspected misconduct.
Conclusion
The Joint Statement emphasised the Regulators’ front-loaded approach to combat IPO-related misconduct. It is anticipated that listing applications which encompass any of the red flags may now be subject to additional scrutiny by the Regulators.
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