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07 Nov 2019

Regulatory focus on directors of listed companies – specific issues to be aware of

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Companies act through their directors and all directors of listed companies should be aware that the Stock Exchange and the SFC are increasingly making a priority for regulation and enforcement corporate conduct that does not meet the required standards.

Various publications, including the SFC's guidance note and policy statement on directors’ duties and conduct in the context of acquisitions and disposals, the SFC's bulletins on the regulation of listed companies, as well as the Stock Exchange's periodic enforcement newsletters relating to all aspects of conduct of listed company directors, together with various enforcement actions taken by the SFC and the Stock Exchange, aim to give guidance on the concerns of the regulators and the conduct that is expected of listed company directors.

In this briefing we share some recent developments and observations on the conduct of listed company directors.

General legal duties

The underlying legal principle that applies to directors is the duty to act in the best interests of the company, to exercise due and reasonable care and skill and to exercise independent judgment in the performance of duties.  These duties apply equally to non-executive directors as to executive directors and are codified in the Listing Rules.

Active participation

One key element for directors to demonstrate compliance with this principle is for a director to take an active role in the company to ensure that the affairs of the company are conducted in a manner compliant with relevant laws and regulations.

A director should actively and diligently carry out all the functions and powers of his/her specific role.  A director is expected to challenge and make inquiries of other directors (or other management), particularly when he/she believes that more detailed information is required.  For example, in relation to non-compliant conduct, directors should be aware that they could be subject to enforcement action merely for failing to prevent non-compliant conduct as well as for the misconduct itself. Two examples that highlight this are :-

  • The SFC is seeking to disqualify a former CFO, on the grounds that, despite knowledge that there were issues surrounding certain withdrawals from the funds generated by the company’s IPO, he did not properly inquire into the basis for, or alert the board to, such withdrawals, which were made without the board’s approval and which did not serve any genuine purpose.
  • The SFC is seeking to disqualify the former chairman and chief executive of a listed issuer, where the chairman implemented a scheme which caused the company to pay a substantially higher price for an acquisition than it otherwise should have.  The grounds for the proceedings to disqualify the chief executive are that he failed to make sufficient enquiries about the relationships among the persons involved in the scheme and failed to take steps to prevent the company from making the acquisition at an excessively high price, while he knew or ought to have known that the scheme, if carried out, would result in a loss to the company.

Exercising independent judgement

It is clear that a director should not unquestioningly rely on information provided or statements made to him/her, but should independently assess and form his/her own judgment on its reasonableness.  Directors should challenge and question such information and statements and make inquiries of the relevant persons as appropriate, to ensure that the board takes actions and makes decisions on a fully informed basis.  It is dangerous for a director to unquestioningly agree with or ‘rubber-stamp’ a decision made or statement made or information provided by other directors.

In the last six weeks alone there have been three instructive examples of this, where the SFC has obtained or are trying to obtain disqualification orders against certain directors, on the grounds of breach of duties to the company. In summary, the misconduct complained of was:

  • signing security documents in relation to loans without making inquiries on the transaction, signing documents to grant share options to employees without assessing the subscribers’ ability to pay the subscription price, and signing attendance sheets for board meetings at which a transaction of which she knew nothing about was approved and which turned out to be a sham connected transaction.  This director was disqualified for six years;
  • failing to carry out due diligence prior to the acquisition of certain hotels and failing to negotiate the consideration for the acquisition. In this case the chairman and three of the executive directors were disqualified for three years;
  • entering into a transaction involving disposal of assets, at a time when the chairman derived significant personal benefit from the transaction, but without investigating the terms of the transaction and without considering whether to postpone the transaction to a time when the chairman would not derive such personal benefit.  Additionally, despite his material interest in the transaction, the chairman failed to disclose such interest, to abstain from voting on the approval of the transaction and to avoid being involved in the negotiations. This case is still ongoing.

One other example that is worth looking at occurred in Australia, when the principles are not substantially different from Hong Kong. In this case, the directors of a listed company relied on management’s assessment that the impact of a certain event was minimal and therefore there was no requirement to announce that event.  However, the impact turned out to be much worse than the management had presented to the directors.  The court held that the directors breached their duties by failing to properly test the management information, and if they had done so they would not have relied on it.  Although this is an Australian case, the principles are equally applicable in Hong Kong.

In the context of corporate acquisitions and disposals, the SFC issued a guidance note in May 2017 and a policy statement in July 2019, whereby it stated that  it expects due diligence in such transactions to include, among other things, understanding the nature of the asset or business, carefully considering all information relevant to assessing the merits of the transaction, verifying the accuracy and reasonableness of material information, seeking assistance of professional valuers and other advisers if appropriate and seeking further information from the counterparty and other parties as appropriate.

It is not always easy in practice, especially for non-executive directors, to carry out extensive reviews of all decisions or statements made or provided to them, especially as they may not be privy to some of the underlying information and they may be under pressure in some circumstances to give quick approval to a decision.  It can be tempting, when coming to a decision, to rely solely on information presented by others without testing its accuracy and reasonableness.  However, to comply with his/her legal duties he must make sure he has all relevant information to come to a conclusion and makes his own conclusions. If he can show that he made his own conclusion, had a questioning mind and made queries as appropriate, this would go a long way to demonstrating satisfaction of his duties.

Conclusions

A recurring message is that each director of a listed company should independently and actively be coming to his/her own conclusion to ensure that the board is at all times making decisions on a fully informed basis and to foster a culture of compliance.  It is dangerous for a director to unquestioningly go-along with, ‘rubber-stamp’, or rely on decisions made or statements made by other directors or other persons.

There is no bright line test or a specific list of required actions which a director can rely on to show compliance with requirements.  What would be reasonably expected of directors will differ on a case-by-case basis, depending on the circumstances of each situation.

That said, if a director can show that he/she has taken steps to ensure that information which form the basis of a decision made by the board is accurate, to actively challenge and question other directors’ statements and decisions, and to procure that the interests of the company and all shareholders are protected, this could go a long way to demonstrating satisfaction of his/her duties.

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KEY CONTACT

Paul Westover

Paul Westover
Partner

T:  +852 2533 2755 M:  +852 6907 1885 Email Paul | Vcard Office:  Hong Kong

Michelle Chung

Michelle Chung
Of counsel

T:  +852 3166 6927 M:  Email Michelle | Vcard Office:  Hong Kong