SEC Steps Up Cooperation with the Hong Kong SFC; Hong Kong Increasingly in the Sights of U.S. Short-Selling Funds
By Neil Pinchuk, Co-Regional Managing Partner, Marcum Bernstein & Pinchuk LLP
Back in January of 2017, the Securities & Exchange Commission (SEC) announced a significant expansion of its cooperation framework with Hong Kong’s Securities and Futures Commission (SFC), as the SEC seeks to effectively protect U.S. investors from fraud and trading abuses in increasingly globalized capital markets.
The new framework expands on the agencies’ 1995 Enforcement Cooperation MOU and 2002 IOSCO Multilateral MOU. It provides for significant information-sharing and enforcement cooperation including, but not limited to, investment advisers, broker-dealers, securities exchanges, market infrastructure providers, and credit rating agencies. With this expanded cooperation framework, the SEC is signaling that market players cannot evade the reach of U.S. law simply by operating from an offshore location.
Under the new cooperation framework, the two regulators will be able to facilitate reciprocal access to data and on-site inspections so as to monitor risks and evaluate the compliance practices and culture of a Cross-Border Regulated Entity (entities with global operations in Hong Kong). Hong Kong is a major capital markets platform for all of Asia and a gateway for many Chinese companies and investment entities in particular.
Implementation of the new framework was followed swiftly by an SEC enforcement action in February 2017, which resulted in a court order freezing more than $29 million in profits maintained in U.S. accounts of Summitview Capital Management Limited1, a Hong Kong-based private equity firm. The SEC alleged that partner Michael Yin bought $56 million of Dreamworks Animation stock ahead of the announcement of its acquisition by Comcast, using inside information. Yin allegedly used U.S. brokerage accounts in the names of five Chinese nationals, including his elderly parents, to amass $56 million of shares in a few weeks before the deal was announced, leading to a 47% pop in the share price.
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Taken together, the new cooperation framework and enforcement action send a clear message that entities operating out of Hong Kong will be subject to greater transparency in their trading activities, and onsite examinations and sweeps if there are grounds to believe they are flouting U.S. securities laws, while U.S.-based entities that trade in Hong Kong-listed securities will be subject to monitoring and inspections by the Hong Kong authorities.
The Hong Kong market has become an increasingly active playground for U.S. short-selling funds, with the Hang Seng Index up 18%2 in the first six months of 2017 and allegations of improprieties similar to those that plagued many U.S.-listed Chinese companies several years ago. On June 7, 2017, Carson Block of Muddy Waters issued a short report on Man Wah Holdings, causing it to drop by 15% before trading was suspended. After the company issued a detailed rebuttal, the stock reopened and more than made up the lost ground. Other targets have not been so lucky. China Huishan Dairy Holdings Co. has lost 85% of its value since Carson Block attacked it, while LED lighting manufacturer Tech Pro Technology Development Ltd. has dropped 95% since Glaucus Research and GeoInvesting issued negative reports.
As is often the case in the capital markets, short-sellers may be acting as the advance guard for enforcement actions by regulatory authorities, who take a much more deliberate approach. Short-sellers also would be advised to be very certain of their claims before publishing research, given a market regulatory environment in Hong Kong that is less absolute on free speech claims, as Andrew Left, the founder of Citron Research, learned in October 2016 when he was ordered to pay HK$5.6 million and barred from trading in Hong Kong for five years by the Hong Kong Tribunal (he is now appealing).
With 18 Hong Kong-listed companies3 targeted by shortsellers in the past 12 months, the city has become the focus of the contentious debate around alleged fraud by companies and the responsibility of shortsellers to make sure that their claims are well substantiated before going public. As the window to China’s massive economy, Hong Kong is highly attractive, given the restrictions on both foreign investment and short selling that exist in China’s various domestic stock markets, where trading can be suspended indefinitely and foreign shortsellers are often demonized by the government during market downturns.
The new cooperation framework between the SEC and SFC is a sign that the U.S. is taking a more global approach to risk monitoring, but it also highlights the conspicuous lack of progress between the SEC and mainland China’s Securities Regulatory Commission (CSRC) on any meaningful level of cooperation in investigating. The SEC can bring charges against China residents who have been involved in alleged securities fraud but has no ability to enforce judgments on China residents who remain in China or get access to books and records in China. At present, the reach of the SEC appears to end at Hong Kong’s border.
1. Summitview Capital Management Limited is not a defendant and nor are they listed as a “Relevant Entity” in the SEC complaint. A partner of Summitview Capital Management Limited, Michael Yin, is the defendant and there are five China residents that are Relief Defendants.
2. Bloomberg Market Date as of June 26, 2017. https://www.bloomberg.com/quote/HSI:IND
3. Bloomberg News, (May 22, 2017) “Hong Kong’s Short-Seller Invasion Spurs Unusual Defense Plan”