New Share Offerings in the PRC

LEAD UNDERWRITERS

Obligations are also imposed on lead underwriters. This ensures that offerings or initial offerings are more reliable where shareholders are concerned. Under Article 11, lead underwriters are expected to pay attention to the following issues and give adequate explanations in their respective investigative reports where:

(a) connected transactions exist that may affect the operational ability and income levels of the company;

(b) there are major risks with respect to its major financial indices or accounts receivable as compared with others in the same industry;

(c) the company has a negative cash flow and may have difficulties with its accounts payable;

(d) there were discrepancies between its stated funding schedule and original offering documents, and frequent changes in investment strategy resulting in the use of funds differing from that stated in the company's disclosure statements;

(e) its fund-raising strategy is not compatible with the needs of its investment projects and timing, and its investment projects lack sufficient evidence;

(f) the revenue of the listed company has decreased since the previous offering or its profit figure is less than 80% of its predicted profits;

(g) no reasonable explanation is provided by the company directors as to why no dividends have been paid in the past three years;

(h) the company lacks a stable accounting policy;

(i) the company has large amounts of idle capital, and effective control of the capital is entrusted to a third party;

(j) the company has a low debt gearing ratio and an unreasonable financial structure may result by raising funds through the issuance of shares as the company lacks a clear investment direction, the result of which could be excessive capital;

(k) the company may have many debts and may have created high risks;

(l) the company has major arbitration or litigation suits;

(m) there are serious systemic faults with the internal control system of the company;

(n) the company lacks the ability to continue development or its operation seriously lacks stability;

(o) the company has received public criticism or reprimand from the CSRC or the stock exchange in the past year due to non-compliance with disclosure regulations or reporting requirements;

(p) directors of the company have not fulfilled their obligations to the shareholders;

(q) the company has not completed rectification within the period set out in the notice issued by CSRC or its designated delegates.

Further, Article 14 stipulates that listed companies shall, upon the occurrence of any one of the above events, notify their lead underwriters who are required to provide explanations within two working days thereafter to the CSRC and the stock exchange. All affected application forms shall be amended accordingly. Where the approval of shareholders is needed, the board of directors shall also hold shareholder meetings in a timely fashion.

Under Chapter 3, directors of a listed company must employ their lead underwriters by unanimous directors' resolutions. Lead underwriters shall conduct investigative reports into the proposal for the issue of new shares and prepare recommendations to the CSRC with respect to the companies' new offerings.

Accountability to the shareholders in all possible circumstances is emphasized in the Procedures. Directors are required under Article 13 to pass resolutions on issues concerning whether the offering proposal conforms to the legality of this law, details and feasibility of application of the funds raised, report on funds raised in previous exercises, and submit the same for approval to the shareholders. Likewise, shareholders are required to pass resolutions concerning the volume of current offering, method of pricing or price (including price spread), targeted investors, application of funds, period of validity of the resolutions, and authorization to the board of directors for the current funding exercise.

In order to create a stable investment environment, Article 16 stipulates that where registered accountants have issued standard audit reports with no reserved opinions for listed companies in the past three years, such audited financial statements are to be included with the application documents to the CSRC. Where necessary, the mid-term financial report should also be included. Further, where no standard audit reports without reserved notes were issued in the past three years, and although there had been no major impact or the impact had been reduced, all illegal, extraordinary or unusual matters must be rectified. In this regard, the company must submit a supplementary opinion. This rule also applies to listed companies that have been listed for less than three years and have undergone a major reorganization within an accounting year from this current issue.

Upon CSRC's approval, the listed company shall discuss matters with the stock exchange such as the time period for issue and registration. In order to prevent multiple submissions, Article 20 prohibits a listed company from attempting a new issue application within six months of the previous non-approval by the CSRC.

Since a well-regulated market is vital to the development of the market, insider trading and financial assistance is addressed in Article 21, which requires listed companies and lead underwriters to undertake confidentiality of the news of the offering of additional shares until the actual offering date, and that no subsidy or assistance shall be rendered to participating institutions.

DISCLOSURE OF INFORMATION

Previous regulations placed a limited emphasis on disclosure requirements. Given the general concern with secrecy and commercial secrets, it is necessary to detail provisions to ensure consistency of information and easy access for shareholders at the appropriate times. Due to the complexity of business activities and the increased information needs of the user for financial statements, disclosure requirements to protect shareholders have now been strengthened in these Procedures.

Article 22 basically provides a schedule within which directors and accountants must comply with disclosure requirements with respect to shareholders and to the CSRC. This important disclosure provision brings into play transparency of the transaction to shareholders, directors' accountability and fiduciary duties towards shareholders and the company. Another important requirement is increased accountability. The use of the funds must be reported in the company's annual report for the three years following the fund-raising.

Article 22 provides that within two working days of the directors having passed a resolution approving the current share placement proposal, directors of a listed company shall report the same to the stock exchange and issue a public notice to hold a shareholders meeting. The notice shall include details of the directors' resolution, the share placement proposal, the use of the funds being raised in this placement, a special report by a chartered accountant on the use of funds raised in the previous share placement which shall carry the words: "upon being approved at the shareholders meeting, this resolution shall be submitted to the CSRC for verification."

Five working days prior to holding shareholders' meetings, the board of directors of a listed company shall also notify shareholders by public announcement of the following: where the funds raised are to be used for acquisition of assets (including rights), the board of directors shall include the relevant asset appraisal report; whereupon acquisition, the listed company has an actual controlling interest in the acquired enterprise or where it is required to be represented on the balance sheet of the acquired enterprise, the board of directors shall also publicize the latest annual accounts and the audited accounts of the latest financial report as well as undertake that the above acquisition shall not compromise the independence of the company.

In the case of connected transactions relevant to this share placement, the Board of Directors shall also guarantee in the public announcement that they have acted in the best interests of the company and shall not cause losses to the interests of other shareholders not affected by the connected transactions, and that they shall not create competition within the same industry.

Within two working days after the shareholders' meeting passed the current proposal for share placement proposal, the company shall announce the shareholders' resolution. Such announcement shall carry the words, "the proposal concerned shall be submitted to the China Securities Regulatory Commission for verification and approval". Where the shareholders made any changes to the proposal proposed by the Board of directors, the changes shall also be announced.

The CSRC will announce the approval or non-approval of the share placement scheme within two working days of its receipt by the listed company. This will ensure that rumour mills are at least barred from manipulating news that affects market behaviour. Notes for placement shall be announced at least five working days prior to the registration of the share option. After the announcement of the notes for placement, and before the deadline for payment for the shares placed, a reminder notice regarding the venues where the notes for placement may be obtained and the websites designed by the CSRC shall be taken out by the listed company concerned. Likewise, an announcement for the placement of additional shares shall be taken out once the issue price of the shares has been determined, which shall also declare the venues and websites where investors may obtain information thereon. Any amendments to the notes on placement or letters of intent shall be done only with the approval of the CSRC.

Listed companies are now mandated to hire chartered accountants experienced in securities work to prudently disclose trends in company earnings. Where indeterminate factors affect the prediction of earnings, such factors should be provided for with analysis and explanations. Where appropriate, warning signs for particular risks should be placed prominently in letters of intent on offerings, announcements of issue and placement notes.

Despite the existence of these provisions, one cannot yet conclude that disclosure practices in China will now improve dramatically. Nonetheless, upon their implementation, they will be steps in the right direction towards full, fair and accurate disclosure of information. To let China's market economy succeed, investors should also take a stronger role in deciding what sort of information they may need to make better investment decisions.

LEGAL CONSEQUENCES

Under the Procedures, the CSRC keeps its watchdog functions and maintains a stern public face by dishing out criticism to errant market players. Under this section, intermediaries are warned against treading grey areas or flouting regulations, or they will be subject to public criticism. Securities companies are required to set up internal controls as per the CSRC guidelines. Accordingly, the CSRC may exercise their supervisory powers to reform offending intermediary companies and securities companies for an indeterminate period of time and during such reform period, documents submitted by the intermediary or securities company shall not be accepted by the CSRC. For all intermediaries and securities companies, any incommunicado period would mean a substantial loss of business.

Under Article 30, the CSRC shall publicly criticize information disclosures by listed companies and/or their underwriters and the listed company shall be required thereafter to issue a relevant public announcement. Similarly, the CSRC will also issue public censure and order immediate rectification for listed companies and/or their sponsors who provide financial assistance or subsidies to institutional investors participating in additional offerings.

Articles 32 and 33 are worthy of note and will hopefully do a great deal to help combat the inflated claims of those touting speedy and risky returns from the market. These articles also strengthen the concept of fiduciary duties owed by company officers towards the company. That is, that they must act in the best interests of the company and not exceed the authority conferred upon them.

Article 32 stipulates that where there is a shortfall between the actual profit gained and the projected profit due to foreseeable reasons and therefore within control, directors of a listed company, the company's chartered accountant, the legal representative of the underwriter, the persons in-charge-of the project and the persons in-charge-of the business shall provide reasons and explanations to the shareholders and to the public in a designated newspaper for the shortfall. A public apology is required from the abovementioned persons in the case where actual profits do not reasonably reach 80% of the estimated profits. Companies whose actual profits do not reach 50% of the estimated profits shall, in addition to public criticism from the CSRC, be denied the opportunity for new offerings within two years from the date of public criticism. Under Article 33, CSRC also metes out criticism to the abovementioned persons for failure of a reasonable explanation in the event that during the same year as when share placements are completed, the rate of revenue of the weighted average of net assets is not equal to the rate of bank savings in the same period of time. Where loss is incurred during the year of the share placements, the company concerned shall be denied the opportunity for new placements within two years from the date of public criticism.

Last but not least, the CSRC also doles out criticisms to non-financial companies that channel or invest funds obtained from the public offering of shares into financial institutions such as banks or securities companies.

The Procedures clarify the reporting requirements that all listed companies and especially their lead underwriters are expected to follow. These strict requirements are a pre-requisite for more transparency and better accountability, and should be a real benefit to the many small retail investors who dominate China's stock markets.