Monumental price collapses aren’t unusual: ArtGo Holdings Ltd. and Kasen International Holdings Ltd. each fell more than 90% in a single day in November. A year ago five stocks slumped more than 60% during a single trading session. The phenomenon can afflict groups of firms connected by shareholders or business line, but often there’s no obvious link. A common explanation is the practice of major shareholders pledging shares as collateral for loans, which can result in a lender suddenly dumping stock. The issue for money managers is that there’s no need to disclose such loans, except in limited circumstances, making it hard to assess the risks associated with some stocks and shareholders. Securities and Futures Commission (SFC) Director Brian Ho said in late 2018 that some stocks were manipulated upward to qualify for inclusion in indexes.
• Regulator reaction: The SFC issued new market guidance on Nov. 21 to “remind” listed companies about their disclosure requirements. It noted that some companies failed to sufficiently identify their counterparties or described them in ways that “are not meaningful” for investors to assess risk. Past attempts to widen share pledge disclosure rules failed due to opposition from banks and brokerages.
Local investors have long been aware of notorious “Lo Tsin” stocks, Cantonese slang for “tricksters.” As described by SFC officials, these can include networks of shares tainted by questionable financial managers, money lenders and brokers who conspire to divert public shareholder wealth into private hands, often by selling and buying assets at huge discounts or overvaluations. Another type, this one involving a web of cross shareholdings, is epitomized by the “Enigma Network,” a name coined by activist investor David Webb who identified links between some 50 firms in May 2017. Many of the companies’ shares plunged in the following months as the regulator and anti-corruption police raided premises and made arrests. Court cases showed alleged efforts to steal tens of millions of dollars from some member firms through elaborate lending scams.
• Regulator reaction: Six people connected with Convoy Global Holdings Ltd., which was at the center of the Enigma Network, were charged in 2019 with conspiracy to defraud. A Hong Kong court has frozen up to HK$125 million ($16 million) held by 15 local and overseas entities that allegedly stemmed from stock manipulation. The SFC also ordered brokers to freeze client accounts linked to suspected market manipulation. In its Nov. 21 guidance, the regulator expressed concern that various “means are being used to conceal ownership and as part of wider schemes to engage in illicit activities or market misconduct,” and vowed to intervene “in serious cases ... to protect the investing public,” including suspending trading or delisting.
Hong Kong has the highest concentration of directors in developed markets, hindering efforts to diversify boards and risking lax corporate oversight by overstretched directors. In 2018 the city had at least 113 companies with a director who served on more than six boards, compared with 39 on the New York Stock Exchange and eight in London, a Bloomberg News analysis showed. Some of the most prolific directors often sit on boards at firms caught up in fraud, huge drops in share prices and regulatory investigations, according to research by Charles Dery of risk management firm Lyra Financial Corp.
• Regulator reaction: New rules that took effect in 2019 require a company to say why it determined that any new independent, non-executive director already serving on more than six boards “would be able to devote sufficient time” to another. But Hong Kong Exchanges & Clearing Ltd. stopped short of imposing a cap.
Heavy demand for backdoor listings by Chinese firms gave rise to one of the quirkier sides of Hong Kong’s capital market: Newly listed public companies changing ownership, and even their type of business, within months of an initial public offering. Regulators suspected firms were going public on false pretenses and that the new owners were trying to evade the scrutiny of an IPO. Typically the companies involved were small or mid caps. The practice became so widespread that speculators pumped the shares of suspected backdoor targets leading to some roller-coaster stock movements.
• Regulator reaction: New rules from HKEX to “restrict undesirable backdoor listings and shell activities” took effect in October.
Corporate governance issues aside, Hong Kong’s small and mid cap markets struggle from low volumes and wide spreads. Investors such as Angela Chow, Chief Executive Officer at Cachet Asset Management, worry that even a small stake adjustment can move a stock price, making it easier for bad actors to manipulate the market and discouraging serious investors. Short-selling, which adds scrutiny to companies, is also limited in Hong Kong to firms with a large market capitalization. Officials at HKEX have often spoken about ways to improve trading volumes though most changes require regulatory or government approval.
• Regulator reaction: The SFC and government are waiting for HKEX to submit formal proposals.
6. Small-cap IPO pops and repeat rights issues
Areas that the regulator and exchange appear to have nixed are the phenomena of extraordinary first-day gains in small-cap IPOs (this one rose 1,500 percent) and repeat rights issues (such as the company that planned an eighth in five years after wiping out 99.99 percent of its original value).
• Regulator reaction: Following several rule changes and enforcement action these practices have largely disappeared, the SFC’s Ho said in late 2018.
--With assistance from Fox Hu.
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