New listings on the Growth Enterprise Market (GEM) have been repeatedly in the headlines in recent years for dramatic share price increases on their listing debuts and high share price volatility in post-listing periods. This has led to regulatory concerns. The Securities and Futures Commission (SFC) has been working with the Stock Exchange to review listing policy, including a holistic review of GEM, interlinked with a review of backdoor listings, listed shells and companies with prolonged suspensions.

On 20 January 2017, the SFC and Stock Exchange released a joint statement regarding the price volatility of GEM stocks (Joint Statement). On the same day, the SFC issued guidelines to sponsors, underwriters and placing agents involved in the listing and placing of GEM stocks (Guidelines). These seek to clarify the expectations on those involved in GEM listings and placings pending further regulatory reform.

In this bulletin, we highlight the key points in the Joint Statement and Guidelines and the impact for those involved in GEM listings.

JOINT STATEMENT ADDRESSES CONCERNS ON ORDERLY FUNCTIONING OF GEM IPOS

The Joint Statement discusses certain market practices which are giving rise to regulatory concerns as to the orderly, informed and efficient operation of the GEM market (particularly with respect to the public float and open market requirements) and notes a number of factors contributing to the price volatility of GEM stocks.

Based on its review of GEM IPOs in 2015 and the first half of 2016, the SFC has noted that almost all GEM IPOs were conducted by way of placing only, with many GEM stocks having a small shareholder base and highly concentrated shareholdings. In certain GEM IPO placings, whilst the total number of placees exceeded the minimum requirement of 100, the substantial majority of shares were placed to a small number of “top placees” with the remaining placees only receiving a small allocation. In addition, in otherwise unconnected GEM IPOs, certain “top placees” have repeatedly benefited from allocations.

The Joint Statement focuses on the areas below, concluding that the SFC or the Stock Exchange will take action against new applicants, sponsors, underwriters or placing agents where they fail to adopt appropriate policies and procedures to ensure a GEM IPO placing is conducted in a fair and orderly manner.

Adequate spread of shareholders

The Joint Statement reiterates that the requirement in the GEM Listing Rules for a minimum of 100 public shareholders is just a guideline. Nominees holding shares for the same ultimate beneficial owner must not be treated as distinct placees. Even where there are 100 public shareholders, concerns may still arise where securities in the hands of the public are overly concentrated.

Shares in “public hands”

The GEM Listing Rules exclude shareholdings by certain persons, such as directors and substantial shareholders of the listing applicant and their close associates (non-public shareholders), from counting towards the public float. The Joint Statement confirms that where a placee receives any direct or indirect benefit (financial or otherwise) for taking up placing shares from any such non-public shareholder, that placee will not count as the public for the purposes of determining whether the minimum number of shares are held in public hands. The SFC and Stock Exchange will take appropriate action to combat arrangements where shares are held on behalf of non-public shareholders in an attempt to avoid the minimum public float requirements in the GEM Listing Rules.

Preferential treatment

Any preferential treatment offered by either the listing applicant or other persons (including underwriters and placing agents), such as a guaranteed allocation, waiver or rebate of brokerage commission or other non-arm’s length arrangement connected with taking up an allocation under the placing, may be rejected by the Stock Exchange. Where permitted, such arrangements must be adequately disclosed in the listing document.

Role of new applicant, sponsors and underwriters/placing agents

In order to ensure there is an open market for the securities to be listed, the Joint Statement sets out steps the new applicant should take in conjunction with the sponsor and underwriter and placing agents which dovetails with the guidance in the Guidelines discussed below. The new applicant should consult with the sponsor to decide on the most appropriate listing method, target investor type and placee mix, the overall strategy and allocation basis and whether any placees should be afforded preferential treatment. Records should be kept on these matters. The new applicant should look to the underwriters or placing agents for guidance on the allocation basis and strategy for achieving an open market in the shares. To facilitate investor access to information about available distribution channels, the prospectus should list all underwriters and placing agents.

GUIDELINES SET EXPECTATIONS ON SPONSORS, UNDERWRITERS AND PLACING AGENTS

Against the above background, the Guidelines set out the standard of conduct expected of sponsors, underwriters and placing agents engaged on GEM IPOs to ensure compliance with their regulatory requirements and to tie in with the obligations in the Joint Statement. Failure to comply with the Guidelines may result in disciplinary action or affect the fitness and properness assessment of a sponsor or placing agent.

Best endeavours

Sponsors and placing agents are expected to use their best efforts to assist new applicants to comply with the GEM Listing Rules, as supplemented by the Joint Statement. This extends to compliance with obligations set out in the listing document, for instance where the prospectus specifies the method of allocation of placing shares based on particular factors.

Sponsor specific guidance

Under the Guidelines, sponsors must advise the new applicant on a number of aspects linked to the Joint Statement. These include advising on the regulatory requirements (including those set out in the Joint Statement) and consequences of non-compliance, as well as matters discussed above on which the applicant is required to consult the sponsor (including advice on the new applicant’s record keeping obligations). The sponsor must also retain its own records to show it has used all reasonable efforts to comply with this requirement.

Placing agent specific guidance

The guidance stresses the need for placing agents to have robust marketing and placing strategies and allocation bases to ensure that an open market is achieved in the securities being placed. These must address the need for an adequate spread of shareholders (and to avoid undue concentration of shareholders) and the public float requirement.

Marketing programmes

Marketing programmes should be directed at a wide range of clients. Placing agents should notify their active clients of each placing opportunity when they have been appointed as a placing agent. Notifying only selected clients (for instance to take account of the risk profile and investment preferences of clients) is permitted only where senior management has reached a view that the opportunity is offered to a sufficient number of clients and there is a reasonably low risk of undue concentration of shareholdings.

Certain clients should not be offered the placing opportunity to the exclusion of others and no clients should receive preferential treatment, unless this has been properly disclosed in the listing document. Placing agents should endeavour to respond to enquiries from potential clients interested in the placing in good time to enable account opening procedures to be completed in time for such investors to take up the opportunity.

Information to clients

When notifying clients of the placing opportunity, placing agents should give information on their appointment with a brief description of the new applicant. Information provided should be factual, fair and balanced. No recommendation is required to be given. A cautionary statement regarding the increased risk profile of GEM companies must also be included.

Suitability obligations

In placing shares to clients, placing agents must take into account the suitability obligations under paragraph 5.2 of the SFC’s Code of Conduct for Persons Licensed by or Registered with the Securities and Futures Commission. This is supplemented by two sets of circulars attaching frequently asked questions (on compliance with suitability obligations and triggering of suitability obligations respectively) issued by the SFC on 23 December 2016. Our e-bulletin on these circulars and frequently asked questions can be accessed here.

Staffing

Sufficient senior management oversight of placings is required. A reasonable number of account executives must be allocated to each placing transaction.

KYC procedures

Placing agents must take reasonable steps to identify their clients, including their beneficial ownership and independence from the listing applicant, its controlling shareholders and directors. Additional enquiries should be made where there is any doubt as to the accuracy of any client declaration of independence. Particular care should also be taken in “red flag” situations, such as where:

  • clients are introduced by the new applicant, its controlling shareholders or directors;

  • clients have a known relationship with such persons;

  • clients have familial relationships or share the same address with other placees; or

  • client accounts are operated by the same person.

Other KYC procedures must also be properly conducted. Funding sources, which should be commensurate with the client’s financial position, should be established prior to accepting a subscription from a client. Where there is any suspicion that the client is acting as a nominee for an unascertained person, the subscription should be rejected.

Record keeping

Proper records should also be kept to cover compliance with the above.

Sub-placing agents

The guidance also extends to sub-placing agents appointed by the listing applicant or underwriter.

CONCLUSION

The SFC and Stock Exchange have indicated that they will take action against listing applicants, sponsors, underwriters or placing agents who fail to have appropriate policies and procedures to ensure GEM placings are conducted in a fair and orderly manner. Those involved in GEM listings should ensure that they update their policies and procedures to take into account the Joint Statement and Guidelines to ensure compliance. We would be happy to assist in any policy review or with any queries on the implication of these to existing practices.