Vocational Training Council 20 th Anniversary Distinguished Lecture Series “Post-Enron impact on regulation of financial markets” by Andrew Sheng Chairman Securities and Futures Commission 23 September 2002
Post-Enron Impact Corporate governance failure is global issue Total market cap loss for Enron and WorldCom was US$80 billion (HK$624 billion), roughly equivalent to the drop in the whole Hong Kong market capitalization 2
Summary of Lecture An overview of what went wrong and what the major markets are doing to fix it The current structure of regulation of listed companies in Hong Kong The role of the SFC in tackling corporate misconduct Views are totally personal, and not necessarily the views of the Commission, including non- Executive Directors 3
What went wrong and what are major markets doing to fix it?
Major Market Changes in Regulatory Framework Post-tech bubble, US and European regulators realized that the bubble may have been partly fuelled by bad accounting and corporate misconduct Corporate governance has failed because the various checks and balances within the system have been weakened by the conflicts of interest that exist at different levels Corporate governance is steeped in each jurisdiction’s financial, legal and market history 5
US Regulatory Structure 1929 Wall Street crash, led to the 1933 and 1934 securities legislation that founded the SEC US system premised on statutory disclosure, with companies seeking public funding being required to file statutory information with the SEC, now under the famous EDGAR[1] system. Rules-based system is based on “caveat emptor”, or buyer beware, with a set of rules that specify the disclosure that issuers must make to investors and the public, and which is presumptively material [1] Electronic Data Gathering, Analysis, and Retrieval system. 6
Lines of Defence in Corporate Misconduct US system has four lines of defence First, the management or Board of Directors itself, including the independent non-executive directors, who should represent the public interest Failure of fiduciary duty: “The Enron Board of Directors failed to safeguard Enron shareholders and contributed to the collapse of the seventh largest public company in the United States, by allowing Enron to engage in high risk accounting, inappropriate conflict of interest transactions, extensive undisclosed off-the-books activities, and excessive executive compensation” (Senate Report) Can underpaid non-executive directors stop important corporate misconduct? Still being debated 7
Second Line of Defence Second line of defence lies with the corporate advisers, (auditors, lawyers, professional valuers, sponsors, investment bankers, bankers and rating agencies) who provide independent and professional advice on corporate performance, including compliance with the relevant codes of conduct, rules and laws Question of independence of opinion calls for regulatory oversight US and some parts of Europe, auditing profession has public oversight UK, other parts of Europe and Hong Kong, professions by and large are still self-regulatory 8
Third Line of Defence NYSE and NASDAQ assess eligibility according to their rules and quantitative criteria, but all the issuers must file statutory information with the SEC SEC sanctions range from fines to jail sentences, on the provision of false or misleading information. Willful violation of securities regulations is a criminal offence Delist companies that do not perform. e.g. NASDAQ delisted 770 companies last year, of which 390 were delisted for non-compliance with listing requirement US state and federal prosecutors’ offices can take severe action against corporate theft or fraud 9
Fourth Line of Defence Class action-contingency fee system, whereby shareholders can jointly undertake direct legal action against management or majority shareholders where they feel that they have been disadvantaged Such a powerful weapon in the hands of minority shareholders ensures that directors, controlling shareholders and their advisers are more careful to act without provoking costly class action suits Such system is not available in the UK, Australian and Hong Kong legal systems, because of different legal tradition and risks of a litigious society. Despite these checks and balances, Enron and WorldCom happened 10
US Sarbanes-Oxley Act Strengthen corporate governance and auditing oversight: Independent Public Company Accounting Oversight Board to enforce professional standards, ethics and competence for the accounting profession Prohibit the provision of consulting services to audit clients, when these services create conflicts of interest CEOs and CFOs to vouch for the veracity of their financial statements and much stiffer penalties for fraud Strengthen disclosure requirements for public companies, notably off-balance sheet transactions and insider trading Review rules to protect independence and objectivity of securities analysts; Reviews of corporate governance, the separation of audit and non-audit work, and the role of rating agencies Increasing the resources available to the SEC 11
European & UK Reforms EU has issued various directives on disclosure & listings: Prospectus Directive, the Transparency Obligations Directive, the Investment Services Directive, the Market Abuse Directive and the amendment of the Admissions to Listing Directive UK has upgraded company law and securities regulatory framework: Competent Authority for Listing transferred from LSE to FSA in May 2000. Authority makes and ensures compliance with Listing Rules, and admits securities to the UK’s Official List White Paper issued in July this year indicating that companies law would be simplified and modernised On 31 July, FSA issued consultation paper on the review of the listing regime 12
Reforms in Australia and China In Australia, the Corporate Law Economic Reform Program (CLERP) Act came into force in March 2000: Introduced statutory derivative action against corporate wrongdoing, which modified the common law action and circumstances under which shareholders can enforce their rights Clarified directors’ duties of care and diligence Established new institutional arrangements for the Australian accounting standard setting process CSRC made impressive corporate governance reforms Appointment of independent non-executive directors Quarterly reporting Delisting of poorly performing companies Strengthening enforcement by closer cooperation with 13 the police
Hong Kong’s Initiatives HKEx consultation paper on Listing Rules relating to corporate governance, completed in May, but awaiting results. SCCLR review of corporate governance in 2000, widespread support for its proposals issued in July 2001. Phase II of SCCLR’s review due by end 2002. New SFO will enhance transparency, establish MMT, augment SFC investigatory powers, and provide investors with private cause of action for false/misleading public communication Subsidiary legislation on dual filing to make SFC statutory regulator of information disclosure, closer to US SEC model SFC co-chairs IOSCO Task Force on Transparency and Disclosure with CONSOB to develop a set of International Ongoing Disclosure Standards (IODS) 14
The Current Structure of Regulation of Listed Companies in Hong Kong
Regulation of Listed Companies Recent spate of minority shareholder activism is healthy sign Suspicious transactions less obvious during bull market, because all investors hope that asset prices would rise In a bear market, minority investors concerned majority shareholders may enter into transactions that may dilute their interests or be prejudicial to their rights. Need to regulate listed companies as they have a duty to the public to be honest and fair in their dealings. Listed companies are normally regulated through entry requirements, their conduct in transactions and the enforcement of applicable legislation, such as the Companies Ordinance and the SFO 16
Fig. 1 – Corporate Governance: Entry, Conduct & Exit ENTRY CONDUCT & TRANSACTIONS EXIT Code, Listing Listing Takeovers Securities Companies Criminal Anti- Delisting Rules Rules & Mergers and Futures Law Law Corruption - Listing Rules Ordinance Laws - Corporate Code - Special - Stealing and Law Rules - - Corruption Disclosure - Regulation Investigation - Fraud - Insolvency Investigation - Director & of - Prospectus - Insider Board acquisitions law dealing Practices & mergers - Market - manipulation Protection - Protection of of share- share- holders’ holders’ rights rights Legal Non- Non- Non- Statutory Statutory Statutory Statutory LR – Non- statutory statutory statutory statutory Status Companies Ordinance – statutory Regulator HKEx HKEx SFC SFC FS CCB, ICAC HKEX Police Registrar of Official Companies Receiver 17
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