Today, it is not uncommon for the trading of shares in companies listed in Hong Kong or the United States to be suspended. Although such suspensions can stem from positive inside information pending to be released (eg about mergers or acquisitions), this article focuses on suspensions resulting from negative factors. In particular, reports published by active short sellers and orders from the regulators due to allegations against listed companies have led to many trading suspensions in recent years.
Short sellers' reports
There has been an increase in the number of specialised stocks research firms, or 'short sellers', participating in the equities and capital markets. Their targets span the globe and are listed on a variety of stock exchanges. US-listed Chinese companies were once popular targets, and there seems to have been a recent resurgence of this phenomenon, with allegations of fraud and misconduct being made against a number of US-listed Chinese companies in the beverage, education and media-streaming industries. At the same time, short sellers have accused Hong Kong-listed issuers of unreasonable or connected-party transactions.
Accusations and negative reports published by short sellers should not be taken lightly. Preparation and timely reactions are essential. If a company does not have quick and adequate measures for responding to short sellers' reports, these reports can trigger actions by the regulators, who may suspend trading of the company's shares with immediate effect. Indeed, in some cases, listed companies facing accusations by short sellers have eventually been delisted or have gone into restructuring or liquidation.
Once a company becomes the subject of a short seller's report, it should respond swiftly. The report should be studied in detail. Substantiated and factual explanations should be disclosed and announced to clarify any issues highlighted in the report, regardless of whether the allegations are unfounded. The company should also be ready to make further clarifications if the short seller releases additional accusations or reports to counter or rebut the company's explanations. When a company takes appropriate and responsive action to deal with this, the regulators may not need to order a trading suspension. In some previous incidents, when companies made credible and justifiable clarifications, their stock prices even soared to levels exceeding the previous prices before the publication of the short sellers' reports.
Apart from short sellers' reports, in recent years there have been more cases in which the auditors of listed companies have raised concerns about the financials being reviewed. Typically, if the auditors encounter any issues while auditing the prepared financial statements and corresponding records provided by the company managers, they will flag these up to the audit committee of the listed issuers. If the auditors have not received satisfactory explanations or additional supporting documents after liaising with the company management and the audit committee, they will often send a letter to the audit committee to set out their concerns and the additional procedures they wish to undertake. In many circumstances, they will demand that the audit committee engages an independent forensic accounting services provider to investigate the matters concerned. The auditors will resume their audit procedures after they have been provided with satisfactory findings and recommendations by the independent forensic accountant.
Most companies dealing with such incidents form an independent investigation or special committee, which usually consists of all the independent non-executive directors, to commission, direct and supervise an independent review of the questionable areas raised by the auditors. The independent or special committee usually immediately enlists assistance from professionals (including independent financial advisers, solicitors, independent internal controls reviewers and forensic accountants) to address the auditors' queries. The independent forensic accountants propose and agree with the committee a specific scope of work for the investigation. Assistance and cooperation procured by the listed company in terms of providing the relevant documents and information and arranging access to the relevant personnel and premises for the forensic accountants to perform their work are crucial for ensuring that the investigations are completed as quickly as practicable. The independent forensic accountants report their investigation findings directly to the committee. The committee then forms an independent view on the matters raised by the auditors. Usually a series of remedial actions, such as reinforcing control procedures and strengthening management oversight, are then implemented by the company. Such information will usually be formally disclosed by means of announcements made by the company.
The auditors then assess whether the observations of the investigation and remedial measures can address their concerns. Trading will not be suspended if a company can satisfy the auditors' concerns, the auditors can complete their audit to form an opinion on the company's financial statements, and such information is released before the deadlines for announcing results and publishing annual reports as stipulated in the listing rules. Otherwise, as seen in plenty of cases, the suspension begins and the countdown to HKEx's stipulated deadline for resuming trading will start. Reviewing matters to address the auditors' queries takes time, and the regulators may raise additional queries about a company's audited financials or whether it is appropriate for the existing executive directors or senior managers to continue in their roles. As such, it may be difficult to deal with these time-consuming matters before the company's shares can be traded again.
Lawsuits and whistle-blowers
Litigation against a listed company can also raise concerns for the regulators about whether a company is still viable for listing on the stock market. Criminal litigation against executive directors may give rise to doubts about the integrity of the company's management and whether the managers are fit and proper for continuing their duties. Civil claims for large damages against a company may result in going concern and solvency problems if such claims are crystallised and court judgements turn out to be unfavourable for the company. In such cases, the regulators would not be slow to compel the company to suspend trading of its shares.
The regulators may also intervene before a company's initial public offering. It is not surprising to see a listing candidate abort its IPO because it cannot address concerns arising from anonymous whistle-blowers who have reported an alleged misdemeanour by the company to the regulators.
Responsiveness and transparency are key to avoiding suspensions
Companies facing the risk of trading suspensions often need to address and resolve allegations from short-sellers, whistle-blowers or informants, auditors' concerns, adverse litigation and also queries posed by the regulators. The importance of directors responding appropriately to such matters cannot be emphasised enough. It is critical to respond to short sellers by providing prompt feedback and clarifications that are supported by valid facts. It is also crucial to form independent committees and teams of specialised professionals to address the auditors' concerns. Putting contingency plans in place ahead of a crisis resulting from losing a significant court case is essential. Needless to say, communicating with the regulators in a responsive fashion and being proactive in providing credible and justifiable clarifications are of paramount importance. Last but not least, being transparent and keeping investors, creditors, customers, employees and other stakeholders and the market informed in a timely manner are key to a company's continued listing and its ongoing prosperity.