Lately, a listed company in the Shanghai market planed to purchase assets of its controlling shareholder at the cost of nearly RMB2.7 billion cash. The release of this scheme immediately attracted widespread market attention. The market generally queried the abnormally high valuation for the underlying asset, and the major shareholder's motive of short-term cash extraction was obvious. With regard to this, the Shanghai Stock Exchange (SSE) carried out an inquisitive enquiry at once and made site inspection together with the securities regulatory bureau. And the company finally terminated the trading on its own initiative due to the great pressure imposed by the regulatory inquiry. It represents a typical case of the SSE to strengthen the regulation on behaviors of controlling shareholders and actual controllers recently.
Recently, the credit risks of controlling shareholders and actual controllers of some listed companies have been aggravated, and such improper conducts as overt or covert capital occupation and illegal guarantees have occurred from time to time, which have affected the operation of listed companies, led to great slumps in stock prices and severely damaged the interests of small and medium-sized investors. And the market has responded strongly towards these behaviors. In this context, the SSE has made study and research in advance, taken targeted regulatory measures, and carried out continuous rectifications against these behaviors, especially the concentrated behaviors like high-ratio share pledge, asset trading at a high premium, capital occupation and illegal guarantee, so as to regulate the behaviors of relevant controlling shareholders and actual controllers, build up a solid fire wall of corporate management and earnestly guarantee the order of the securities market and the interests of small and medium-sized investors.
Preventing the high-ratio pledge risks of controlling shareholders
Central authorities and relevant financial regulatory departments have stressed for many times the strict regulation over financial chaos like leverage financing, capital nesting and rigid payment to earnestly prevent systematic risks since last year and the strict financial regulation has formed on the whole. As a result, the market capital has gradually returned to the normal status, and market participants that had relied on credit expansion to maintain operation have encountered some difficulties. Among the companies in the Shanghai market, some have shown the problem of controlling shareholders making high-ratio pledge and being unable to pay debts during fluctuations of stock price, which has led to the position-closing risk. Previously, the SSE has handled a group of ventures with controlling shareholders making high-ratio pledge, such as Geo-Jade Petroleum, *ST China Security & Fire, *ST Inter-Telecom, *ST Protruly and *ST Tianye. After overall analysis, it can be noted that these companies were of serious problems. For example, as they had poor business performance, most of their controlling shareholders and actual controllers were careless in operation but enthusiastic in capital speculation, resulting in the relatively tight capital chain. To some extent, these controlling shareholders and actual controllers were closely related to the dilemma these companies have got into.
The position-closing risks caused by the high-ratio pledge of controlling shareholders are highly possible to affect the listed companies, directly influencing their operation and the stability of their controlling rights, resulting in the slumps of their stock prices and severely damaging the rights of small and medium-sized investors. Therefore, prediction and rapid disposal are necessary to avoid risk spillover and that has been the risk factor affecting the stable operation of the market. With regard to this situation, the SSE has made overall study and research and disposed cautiously in two aspects – information disclosure and risk release. In terms of information disclosure, the SSE has required relevant controlling shareholders to reveal their detailed credit position and take positive measures to resolve the credit risks and urged the companies to ensure stable operation and investigate whether there is potential risk exposure, thus avoiding secondary crisis. As for risk release, it has required the long trading-suspended companies to examine the situation and resume the trading in time, thus gradually releasing risks through trading and avoiding the continuous risk accumulation. Judging from actual results, even though the pledged shares of controlling shareholders were closed out, they had to abide by the new shareholding reduction rules and fulfill their beforehand disclosure duty, thus not excessively impacting the secondary market; no risk spillover occurred in disposing relevant cases and, though a few companies have presented continuous drop in their share prices, it has not affected the trading order of the whole market.
The SSE has carried out screening towards the relatively concentrated pledge risks of controlling shareholders for a long time and has got a clear picture of the high-ratio share pledge of high risk companies in advance. On the whole, the pledge of most controlling shareholders of companies in the Shanghai market is safe. There are about 150 companies whose controlling shareholders' pledge ratio reaches 80% and above and no more than 50 of them present great risks. The SSE has issued a Letter of Regulation to the controlling shareholders of these companies and had a conversation with them if necessary, thus urging them to well arrange the capital in advance and earnestly preventing pledge risks. On that basis, the SSE has further inspected whether these controlling shareholders had hidden capital occupation, illegal guarantee and other behaviors and made sure to claim responsibility in time. Recently, the SSE has initiated the disciplinary proceedings towards the illegal conducts of a group of relevant subjects. Besides, the SSE has started to revise the guidelines on the formats of relevant notices, which will focus on strengthening and detailing the information disclosure of high-ratio pledge of controlling shareholders, requiring them to fully release their credit position and carefully evaluating the influence of high-ratio pledge on listed companies.
Strictly regulating shareholders' improper trading with obvious motive of cash extraction
Another situation also emerged in regulation practice. Controlling shareholders and actual controllers realized high-amount cash extraction from listed companies through improper asset trading. For example, recently a company specialized in textile dyestuff production and sales have purchased the assets of its controlling shareholders in cash at nearly eightfold appreciation rate, but the target's asset business was far away from the main business of this listed company and showed no synergistic effect. As another example, a listed company purchased in cash the assets of an actual controller who was in investigation at about 33 times of appreciation rate. But the underlying asset had not been established for a long time, its quality and performance were in query and its business commitments cannot fully cover the transfer price. And the example of a company purchasing the assets of its controlling shareholder at the cash of RMB2.7 billion mentioned above is also another example of this situation.
Generally, the asset trading of this kind is of distinctive features and will exert great influence on listed companies. The asset trading usually uses large amount of cash to pay consideration, and the trading counterparty is the controlling shareholder of a listed company or the potential interested party of the controlling shareholder who is financially strained or in dilemma and has obvious motive of cash extraction. Besides, relevant underlying asset is of general quality and is far away from the main business of the listed company, but the price is abnormally high. Even if the trading counterparty makes a performance commitment, the indemnifying measures can hardly cover the trading consideration. In this sense, it is a "no-lose" deal for the controlling shareholder. But such trading is obviously detrimental. On the one hand, the listed company makes a large amount of cash payment and is likely to bear huge amounts of debt, which will severely affect its business performance and further influence its share price and damage the interests of small and medium-sized shareholders. In addition, the poor-quality assets might become a heavy burden of the listed company. On the other hand, as the cash extraction of controlling shareholders is very covert, the internal control institution of the company or the external intermediary that is in charge of checking are very likely to regard it as an ordinary trading and even "turn a blind eye" to it under the pressure of the controlling shareholder.
The SSE has maintained high vigilance against this kind of trading, intensified the identification of its motive, and strengthened the "inquisitive" enquiry. The regulation focus is on the quality of the underlying assets and the motive of controlling shareholder's cash exaction, and the SSE has required the intermediary to further examine the case and remind the company to be cautious in trading before clarifying the doubts. For those with strong suspicion, it will submit to the securities regulatory bureau for inspection and will carry out a site inspection together with the securities regulatory bureau if necessary. These regulatory measures have given full play to the deterrent force of regulation. Some companies have adjusted their asset valuation and some have terminated the asset trading out of their own initiative. Later, the SSE will continue to pay attention to the asset trading of controlling shareholders that is suspected of high-amount cash extraction and maintain the tough stance of strict regulation. Besides, it has also been noted in the regulation that this kind of trading also reflects the problem of insufficient market constraint. For example, the general meeting of shareholders that deliberates on relevant trading has presented low participation degree, the opinions of independent directors have become a mere formality, and intermediaries have chimed with others. With regard to these, the SSE will speed up optimizing relevant mechanisms and take multiple measures to enhance the participation degree of the general meeting, increase the right of speech of small and medium-sized shareholders, intensify the sense of fulfillment and the accountability of independent directors, and urge intermediaries to earnestly display their duty as a "gatekeeper".
Cracking down on such behaviors as capital occupation and illegal guarantee
When the liquidity crisis occurs, a controlling shareholder will covet the subordinated listed company and occupy its resources through capital occupation and illegal guarantee. Such a behavior is nothing new and has been the focus of the special rectification of the securities regulatory system in previous years. And good results have been achieved after years of treatment. However, under the circumstance of the increasingly tight market capital and the strict financial regulation, the above-mentioned chaoses seem to have risen again. For example, upon a credit crisis, the former actual controller of *ST Protruly guided the listed company to invest and form large amounts of prepayment or receivables and then transferred the capital out for his/her own use. Taking another example, the controlling shareholder of *ST Tianye, which has been of great market concern recently, has been insolvent and involved in huge debts and lawsuit, but the accountant found during the annual audit that the company had illegally guaranteed for this controlling shareholder with the amount of about RMB1.167 billion and the factoring capital of about RMB2.6 billion was missing and suspected of being occupied by the controlling shareholder. In addition, some controlling shareholders have cashed out from the company via mercantile bills, hollowed out the listed company through such complicated capital operations as inflated debts in bankruptcy reorganization, and continued to sell the company's assets, thus leading to the hollowing of the company's main business. Such malignant violations are of great detriment to listed companies and also reflect the ineffectiveness of their internal control, the disorder of their governance and the potential risks in their production and operation. Once relevant risks break out, the company's share price will suffer "a cliff-like drop", which will lead to the great losses of the investors and also exert negative influence on the continuously improving market ecology.
The SSE has adhered to the rapid disposal and strict strike towards this kind of behaviors. For example, in the *ST Protruly case, the SSE required the company to investigate the whereabouts of its capital and fully sort out and disclose the illegal items and risk exposure like external guarantee and undisclosed lawsuit, and urged it to formulate the compensation scheme for investors as soon as possible despite the non-compliance of its re-organization performance commitments and the pledge and freezing of all the shares held by the reorganizing party. In the case of *ST Tianye, the SSE has rapidly examined its annual report and issued the inquiry letter in two days, requiring it to fully investigate and disclose the information on the capital occupation and illegal guarantee of its controlling shareholders. Besides, it required the company to fully disclose the risks of the issues concerned by investors, such as the corporate control transfer, the secret selling of investment shares of 360 Security Technology Inc. and the termination and buy-back of the equity incentive shares in advance, formulate improvement actions, and come up with targeted remedial measures for the interests of investors. Under the regulation of the SSE, the company has made full explanation on relevant issues and promised to buy back the investment shares of 360 Security Technology Inc. and suspend the buy-back of equity incentive shares from directors, supervisors and senior executives.
It needs to be emphasized that capital occupation and illegal guarantee are the "high-tension cable" that controlling shareholders and actual controllers of listed companies should never touch. The SSE will continue to implement the requirement of comprehensive and strict regulation by law, crack down on illegal behaviors that damage the interests of listed companies, and make sure to dispose of every case resolutely.
Controlling shareholders and actual controllers are an important part of the governance of a listed company, which will fundamentally decide its operation quality and standard operation level. The improper behaviors of the controlling shareholders will internally damage the operation and lead to international management disorder and externally damage investors' interests and break the healthy order of the capital market. The problems and risks of the controlling shareholders exposed recently are mainly related to relevant subject's lack of integrity, ignorance of laws and rules and idea of seeking personal gain through the listed companies. Under the background that the financial regulation is becoming increasingly strict and the capital increasingly tight, the controlling shareholders and actual controllers of some companies can hardly transfer risks through credit expansion and thus stretch their hands towards the listed companies, which is extremely harmful. Therefore, the SSE has included the regulation on the behaviors of controlling shareholders and actual controllers in one of the key tasks of self-regulation, so as to improve the quality of listed companies and create a good external governance environment for their operation and development. Next, the SSE will carry out relevant work from two aspects. In daily regulation, it will continue to keep a close eye on the high-ratio pledge risk of controlling shareholders, as well as their behaviors damaging the interests of listed companies such as improper trading, capital occupation and external guarantee, and make sure to discover, inquire, investigate and dispose in time, thus earnestly completing the task of preventing systematic risks. In institutional improvement, it will summarize the regulatory practice and typical cases, revise relevant business rules by focusing on intensifying the sense of integrity and responsibility of controlling shareholders and actual controllers, and make necessary and proper regulation on their behaviors, thus creating a good external governance environment for the high-quality development of listed companies.