China''s Regulation of Domestic Companies'' Indirect Overseas Listing: A Critical Assessment after the Financial Fraud
liu yi
【全文】
INTRODUCTION
Since the end of 2010, a large sum of China-based companies listed on U.S. stock exchanges have been investigated by the U. S. Securities and Exchange Commission (SEC) for financial fraud, some of which have been suspended trading or revoked the securities registration.[1] Triggered by the SEC investigation, the first huge setback relentlessly struck the China-based companies since they set foot on the international capital market nearly twenty years ago. On March 14, 2011, the U.S. Public Company Accounting Oversight Board (PCAOB) issued a report raising serious concerns about the audits of China-based reverse mergers companies.[2] On June 9, 2011, the SEC issued an investor bulletin to warn investors on investment risks involving reverse merger companies.[3] On July 11, 2011, credit-rating firm Moody’s Investors Service published a red flag report, lifting warnings about accounting and corporate governance risks at dozens of China-based companies.[4] By the end of June 30, 2011, thirty class actions had been filed against China-based companies listed on U.S. exchanges and the companies'' directors and officers.[5] This crisis of deteriorating trust on China-based companies revealed the serious deficiencies of the cross-border listing regulatory mechanism between China and the U.S., which call for immediate remediation. Competent authorities from China and the U.S. held a symposium on audit oversight in July 2011, which represents an important step toward Sino-U.S. cooperation on audit oversight of public companies.[6]
In fact, the Sino-U.S. cross-border listing regulatory mechanism comprises three parts, namely, China’s oversight of domestic firms’ overseas listing, U.S.’s oversight of China-based companies’ listing, and the cross-border regulatory cooperation between the two countries. Under the current regulatory framework, China’s domestic firms can go publicly listed on foreign securities markets in two ways, namely, direct overseas offering and listing of securities (hereinafter direct overseas listing) and indirect overseas offering and listing of securities (hereinafter indirect overseas listing), and the corresponding regulatory framework has been established and developed based on the division of these two forms. More specifically, direct overseas listing refers to the overseas issuance and listing of securities by a joint-stock limited company incorporated in the PRC Mainland, while indirect overseas listing refers to the issuance and listing of securities by a company incorporated outside the PRC Mainland (excl. Hong Kong, Macau and Taiwan) after establishing the red-chip framework, i.e. acquiring the stakes, assets or revenue of one or more domestic enterprises in the PRC Mainland. Based on the nature of domestic firms’ ownership, indirect overseas listing can be further divided into two categories, i.e. grand red-chip listing (mainly suitable for state-owned enterprises (SOEs)) and small red-chip listing (mainly suitable for private companies).[7] Based on the operation mode for issuance, indirect overseas listing can be further divided into IPO, listing by introduction and reverse merger listing.[8] Most of the China-based companies whose honesty is being sternly questioned are small red-chip firms that went publicly listed through reverse mergers.
There have been huge changes in Chinese and overseas capital markets in recent years, especially with China having already become a major source of public-offering companies. However, the above regulatory frameworks and related systems have never accordingly made adjustment to adapt to such changes, and thus became too obsolete to effectively cope with the increasingly complex and broad cross-border listing activities and moreover, can not satisfy China’s pursuit for an internationalized domestic capital market and stronger capital market competitiveness. This article is focused on China’s regulation of domestic companies’ indirect overseas listing, which has arisen much attention after the financial fraud debacle of China-based U.S. listed companies. The following three parts review and introduce the characteristics and key regulatory regimes of the regulatory framework at each of the three stages as defined in light of the regulatory framework’s formation and development history. In Part IV, I first analyze the historical background for the indirect overseas listing regulatory framework, and then make in-depth comments on its defects and deficiencies with reference to this financial fraud crisis of China-based companies. This part also gives a series of advice about the policies aimed at improving the regulation of indirect overseas listing. Finally I briefly look into the prospect of China''s indirect overseas listing regulation and reach the conclusion.
I. THE ORIGIN OF THE REGULATORY FRAMEWORK
China began to implement the economic policies known as "Reforms and Opening-up" in late 1970s, and the promotion of the SOEs reform constitutes an important aspect of these policies. By the early 1990’s, the fundamental direction of the SOEs reform was clarified, i.e. to establish a modern enterprise system catering for the requirements of market economy, characterized by clearly established ownership, well defined rights and responsibilities, separation of enterprises from governmental administration, and scientific management. [9] After the birth of the Shanghai Stock Exchange (SHSE) and the Shenzhen Stock Exchange (SZSE) in late 1990, the market for domestically listed foreign capital shares (B shares) was also created.[10] Subsequently, a program aiming at supporting the overseas listing of joint-stock enterprises was enforced under the direct leadership of the PRC State Council (i.e. China’s highest organ of state administration). At that time, there are three main objectives that were pursued by the program: (i) to learn from the experience of mature securities markets; (ii) to promote the reform of SOEs and establish corporate governance for them; and (iii) to attract foreign funds which were scarce at that time. In the meantime, some industrial regulatory authorities under the PRC State Council and some local governments began to help SOEs explore the access to international capital market through overseas backdoor listing and overseas business restructuring. For example, in 1987, former Guangdong Enterprises (Holdings) Limited (current GDH Limited) acquired a controlling interest in a listed company on the Hong Kong Stock Exchange (HKEX), former Union World Development Company Limited (current Guangdong Investment Limited, HK: 0270); former China International Trust and Investment Corporation (current CITIC Group) bought a HKEX listed holding company, former Tylfull Company Limited (current CITIC Pacific Limited, HK: 0267) in early 1990; China State Construction Engineering Corporation (CSCEC) reorganized its overseas business and launched a subsidiary China Shipping Development Company Limited (HK: 0688) which was listed on the HKEX in August 1992. Brilliance China Automotive Holdings Limited (hereinafter Brilliance Automotive), a company incorporated in Bermuda, was successfully listed on the New York Stock Exchange (NYSE) on October 9, 1992. Brilliance Automotive is the first China-based company that was indirectly listed abroad after the accomplishment of an initial public issue of shares. The company underwent a complicated reorganization in preparation for the listing of its shares on the NYSE. As a result, a red-chip architecture was formed under which the China Foundation for the Development of Financial Education (established in the PRC Mainland) and Shenyang Jinbei Automotive Company Limited (SH: 600609) jointly held all the shares of Brilliance Automotive, and Brilliance Automotive held 51% of the equity interest of Shenyang Jinbei Bus Manufacturing Company Limited (incorporated in the PRC Mainland).[11] Hereinafter, almost all China enterprises seeking to be indirectly listed on a foreign securities exchange adopted this operation mode of building the red-chip architecture before launching IPO.
At that time, China had no nationwide securities regulatory rules in place, and the PRC State Council had not established a securities regulatory authority yet. As a result, companies like Brilliance Automotive needed not obtain an approval from any domestic authority for their indirect overseas listing. After the establishment of the former State Council Securities Committee (SCSC) and the China Securities Regulatory Commission (CSRC) on October 12, 1992[12], the PRC State Council and relevant competent authorities including the former SCSC or the CSRC severally or jointly promulgated several regulatory documents, including: (i) Tentative Regulations on the Administration of Share
Issuance and Trading (hereinafter the Share Issuance and Trading Regulation)[13]; (ii) Circular of the PRC State Council on Further Enhancing the Macro-control of the Securities Market (GUOFA [1992] No. 68, hereinafter the Macro-control Circular)[14]; (iii) Circular on the Approval and Circulation of China Securities Regulatory Commission’s “Report on Issues Relating to the Overseas Public Offer of Shares and Listing of Domestic Enterprises” (ZHENGWEIFA [1993] No.18, hereinafter the SCSC Circular)[15]; (iv) Letter from the China Securities Regulatory Commission to the Hong Kong Securities and Futures Commission Concerning the Approval Procedure for Domestic Companies’ Overseas Issuance and Listing of Shares (hereinafter the CSRC’s Letter)[16]. These documents set for the first time the regulatory rules concerning domestic enterprises’ overseas listing. First, there may be two models for overseas listing, i.e. direct overseas listing and indirect overseas listing. The former means domestic companies’ direct overseas issuance and listing of shares (or the derivations of shares) on a foreign stock exchange, while the latter means the issuance and listing of shares on a foreign stock exchange by the overseas holding entity of domestic companies.[17] Second, the fundamental regulatory principle is clarified that a domestic enterprise must obtain approval from the former SCSC before it directly or indirectly issue shares abroad or has its shares to be traded abroad.[18] Third, the complexity of indirect overseas listing is accepted, and it is stipulated that the domestic firms planning to offer shares abroad and their overseas associates should report to the CSRC beforehand, and the CSRC is responsible for determining whether their cases need to obtain approval.[19] Fourth, the legal responsibilities of domestic lawyers are defined. Specifically, domestic lawyers should include in their legal opinion letter for a domestic firm planning to offer shares abroad the judgment from the CSRC regarding whether the case needs to obtain approval; legal opinion letters without such information should be considered having material omissions and the lawyers should at least take the charge of failing to fulfill their due diligence responsibilities; legal opinion claiming no need to obtain the domestic approval shall be considered to include false statement, the lawyers should at least take the charge of securities-related fraud.[20]
After the introduction of above policies, about thirty Chinese-based companies indirectly offered shares (incl. IPO and backdoor listing) on foreign securities exchanges, such as China Yuchai International Limited (NYSE: CYD), Shanghai Industrial Holdings Limited (HK: 0363), and Beijing Enterprises Holdings Limited (HK: 0392).[21] The birth of Hang Seng China-Affiliated Corporations Index given by Hang Seng Indexes Company Limited in April 1997 marked the formation of a red-chip sector on the HKEX. Although the indirect overseas listing of above domestic firms gained support from the PRC State Council, related competent authorities under the PRC State Council or the local governments, there were some cases that domestic assets were transferred abroad without approval from the former SCSC or the CSRC. Moreover, just before the return of Hong Kong to the PRC, some Hong Kong investors’ wishful expectation of asset injection by the red-chip companies led to the overvaluation of some of the red-chip stocks, creating an adverse image for the red-chip sector. As such, the PRC State Council enacted the Circular of the State Council Concerning Further Strengthening the Administration of Share Issuance and Listing Overseas (GUOFA [1997] No. 21, hereinafter the Grand Red-chip Circular)[22] which laid down some further requirements for overseas indirect listing.
Under the Grand Red-chip Circular, whether an overseas Chinese-invested company (either an overseas Chinese invested non-listed company or an overseas Chinese-holding listed company) should apply to the former SCSC for approval or for record keeping before the issuance and listing of shares abroad depends on the history of assets formation and the period of actual possession of such assets. With regard to the following two circumstances, a report shall be submitted to the CSRC for verification and then subject to the approval of the former SCSC, after obtaining consent in advance from the provincial government or the competent ministry under the PRC State Council based on its subordination thereto: (i) an overseas Chinese-invested company applies abroad for issuance and listing of shares with its domestic assets which are formed from its overseas assets invested in the PRC Mainland and have been in its actual possession for no more than three years; (ii) assets or equity interests of an domestic enterprise are to be transferred to an overseas Chinese-invested company by any means.[23] With regard to the following two circumstances, the consent shall be obtained in advance from the provincial government or the competent ministry under the PRC State Council based on its subordination thereto, and an application shall be submitted to the CSRC for record afterwards: (i) an overseas Chinese-invested company applies abroad for issuance and listing of shares with its overseas assets; (ii) an overseas Chinese-invested company applies abroad for issuance and listing of shares with its domestic assets which are formed from its overseas assets invested in the PRC Mainland and have been in its actual possession for more than three years. Furthermore, the Grand Red-chip Circular stipulates that an application shall also be submitted to the CSRC for record afterwards when an overseas Chinese-holding listed company engages in activities such as capital-dividing for shares or increase in issuance of shares;[24] and back-door listing of domestic companies is prohibited.[25] The CSRC subsequently enacted the Circular on Certain Issues Concerning the Implementation of the “Circular of the State Council Concerning Further Strengthening the Administration of Share Issuance and Listing Overseas” (ZHENGJIAN [1998] No. 5) on February 27, 1998, to emphasize the above-mentioned regulatory policies and set out some specific requirements for the forms and contents of record application.[26] Since then, the CSRC have ratified nearly sixty applications of indirect overseas listing put forward by Chinese companies.[27]
