Investors in a Chinese textile company accused by Hong Kong regulators of exaggerating its earnings have the chance to get most of their money back under a landmark court settlement reached in the territory on Wednesday.
The case marks a breakthrough in the ability of Hong Kong’s market watchdog, the Securities and Futures Commission (SFC), to act against offshore companies or investors who are unlikely to return to the city to face prosecution or a market tribunal.
“It’s of considerable significance for the SFC as they’ve shown they can obtain shareholder relief in a reasonably effective way,” said Martin Rogers, head of litigation at Clifford Chance law firm in Hong Kong.
Hontex International Holdings Co, based in China’s Fujian province, listed on the Hong Kong Stock Exchange in December 2009. Its shares were suspended three months later when the SFC accused the company of materially overstating its earnings in its initial public offering (IPO) prospectus.
The regulator then got an injunction to freeze up to HK$997.4 million ($128.54 million) – the bulk of the IPO proceeds – held by Hontex and its subsidiaries, but investors were left hanging while the SFC battled to win the right to have their money returned.
Hontex admitted, according to the SFC, that it was reckless in allowing false and misleading information to be included in its prospectus.
The case is one in a string of accounting scandals involving Chinese companies listed on exchanges outside the mainland, particularly in North America, leaving regulators struggling to bring executives to book or gain compensation for investors.
In a high-profile example, short seller Carson Block and his firm Muddy Waters last year accused Sino-Forest Corp of exaggerating its timber assets. The company, which denies the allegations, has since been delisted in Canada and been charged with fraud.
The SFC faced a setback in the Hontex case when a court ruled last year that a criminal or civil court first had to find a company or its executives culpable before it could seek independent remedial action in alleged cases of market abuse.
A later ruling by the city’s Court of Appeal in a separate case against US hedge fund Tiger Asia Management, which was accused of insider dealing in Hong Kong stocks, overturned that decision and said the SFC could ask a court for investor refunds or other remedies.
Now, under an agreement reached between the SFC and Hontex at Hong Kong’s High Court, Hontex will buy back shares held by minority stockholders at HK$2.06 a share, the last price traded before the stock was suspended in late-March 2010.
Under the deal, which needs to be approved by Hontex shareholders, the company will buy back a total of HK$1.03 billion ($132.7 million) worth of shares from minority shareholders.
“The SFC will feel vindicated they were able to freeze the money in the first place, as that will form the lion’s share of the money to repurchase the shares,” said Nicholas Huntsworth, a litigation lawyer at Mayer Brown in Hong Kong, though he cautioned the SFC’s ability to help investors hinged on the IPO proceeds being in Hong Kong bank accounts.
“An unscrupulous company may now look to move its listing proceeds as quickly as possible out of the city,” he said.
Lawyers expect the SFC to make more use of the section in the city’s securities law, Section 213, that it used as the basis in this case to take remedial action against other offshore companies or investors it believes have breached their rules. Around 75 percent of the market capital listed on Hong Kong’s exchange is domiciled outside the city, meaning the SFC has a particular challenge trying to enforce the law.
The SFC is also looking to bring in tougher rules for investment banks and corporate finance houses that sponsor IPOs, to try and make them act as better gatekeepers when they bring companies on to the Hong Kong market.
Mega Capital (Asia), the corporate finance house that sponsored Hontex’s listing, was hit with a record HK$42 million ($5.4 million) fine in April and stripped of its corporate finance licence.
Category: Hong Kong