Introduction

In September 2018, the Stock Exchange of Hong Kong Limited (the “Exchange”) published a Consultation Paper on Proposal Relating to Listed Issuers with Disclaimer or Adverse Audit Opinion on Financial Statements (the “Consultation Paper”). The Consultation Paper sought market views on the proposal to introduce a specific suspension requirement applicable to listed issuers with disclaimer or adverse audit opinions on their financial statements.

In the Consultation Paper, the Exchange proposed a new Rule 13.50A (Rule 17.49B for GEM issuers) (“New Rule”) that:

• The Exchange will normally require suspension of trading in an issuer’s securities if the issuer publishes a preliminary results announcement for a financial year and the auditor has issued, or has indicated that it will issue, a disclaimer or adverse opinion on the issuer’s financial statements; and
• 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.The proposal seeks to afford better investors’ protection by safeguarding the quality and reliability of financial information published by listed issuers. It would also encourage issuers to strengthen their risk management and internal control systems, and to resolve audit issues promptly with their auditors. In May 2019, the Exchange published the Consultation Conclusion, in which the Exchange set out the major comments from the respondents and its responses and conclusions on the proposal.
• A disclaimer or adverse opinion on the financial statements indicates that the risk of misstatements could be both material and pervasive, and investors may not have sufficient information to make an informed assessment of the issuer’s financial position.

To add a specific suspension requirement

Modify proposed suspension requirements

The Exchange noted that some of the respondents are concerned that suspension deprives shareholders the ability to trade in the issuer’s securities. In the circumstances, the Exchange added a Note to the New Rule to clarify that suspension of trading may not be required if the underlying issues giving rise to the disclaimer or adverse opinion has been resolved before the issuer published its preliminary results announcement and the issuer has disclosed sufficient information to enable investors to make an informed assessment of its financial positions.

The Exchange however refused to adopt some respondents’ suggestion to provide a one-month trading window before publication of the financial statements (and after publication of the preliminary results announcements), as it would not address the concern about a lack of reliable financial information during that one-month trading period. Further, the short trading window may invite volatile trading and market confusion.

Issuers with going concern modification

A number of respondents also commented that suspension may trigger events of default under bank loans, notes and bonds, and worsen the financial position of the issuers. This may be particularly problematic for financially distressed issuers with going concern issue as suspension would affect their ability to raise funds and attract investors, making it more difficult for these issuers to restructure or self-rescue.

On balance, the Exchange took the view that the going concern issue relates mainly to differences in judgment between the auditors and the management on the basis of preparation of the financial statements, rather than on the accuracy of individual financial figures, and thus can be addressed by issuers making clear disclosures in their annual report. In the circumstances, the Exchange added one note to the New Rule to exclude going concern issuers from the suspension requirement. However, the issuer must disclose in its preliminary results announcement details of the audit modification, the facts and circumstances giving rise to the modification (including the different views of the issuer and its auditor), and the actions taken and/or to be taken by the issuer to address the modification.

Transitional arrangement

To allow time for issuers to review and improve their internal controls and risk management practices, the Exchange proposed a transitional arrangement to allow a longer remedial period of 24 months (for both Main Board and GEM issuers) where the issuer is initially suspended solely due to the New Rule and the continued suspension is solely subject to resolution of these audit issues giving rise to the disclaimer or adverse opinion. The 24 months remedial period will apply for the financial years commencing on or after 1 September 2019 and up to and including 31 August 2021.

Criteria for trading resumption

Under the New Rule, 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.

The Exchange, in the Consultation Conclusions, commented that the examples given in the Consultation Paper on the types of audits that may be performed for the issuers to provide comfort are only examples to provide guidance on the possible actions that the issuers may take having communicated with its auditors, and must be considered cases by case to fit the particular circumstances.

Effective date

The New Rule will apply to issuers’ preliminary annual results announcements for financial years commencing on or after 1 September 2019. Under the New Rule, transitional arrangement described above will apply to issuers suspended solely due to disclaimer or adverse opinions in financial years commencing on or after 1 September 2019 and up to and including 31 August 2021.

In respect of issuers currently with disclaimer or adverse opinions on their financial statements, unless the issuers continue to receive such disclaimer or adverse opinions on their financial statements for the financial years commencing on or after 1 September 2019 and the issues giving rise to the audit modifications remain unresolved, they will not be required to suspend trading under the New Rule.

Conclusion

The New Rule helps incentivising the board and the senior management to communicate within the company and with its auditor to promptly resolve any audit issue. The resumption criteria however seem particularly difficult and it will take a long time to get approval from the Exchange to resume trading.

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Important: The law and procedure on this subject are very specialised and complicated. This article is just a very general outline for reference and cannot be relied upon as legal advice in any individual case. If any advice or assistance is needed, please contact our solicitors.