Having explained “takeover defenses,” today is the turn of “prohibited trading activities” when acquiring a listed company. This entry completes the series about takeovers of listed companies.
In bringing about a takeover of a listed company, a party cannot engage in “prohibited trading activities” as defined in the Securities Law 2006 (http://www.csrc.gov.cn/pub/csrc_en/laws/rfdm/statelaws/200904/t20090429_102757.htm).
Section IV of the Securities Law. Article 73 in particular states that: Any insider who has access to any insider information of securities trading or who has unlawfully obtained any insider information is prohibited from taking advantage of the insider information as held thereby to engage in any securities trading.
Generally speaking, these “prohibited trading activities” are essentially the equivalents of insider dealing (this expression means dealing with “insider information” which is information concerning the company to be acquired which has not been disclosed and which may have a major effect on the market price of the company’s shares, the Securities Law sets out various examples of information that could be considered to be “insider information,” see Article 75, Securities Law.) and market manipulation activities. (The Securities Law prohibits various types of activities that have the effect of manipulating the Securities market. and imposes civil, administrative and even criminal liabilities on the perpetrator, see Article 77, 203, and 231 of the Securities Law).
Certain persons are considered to be “informed person with insider information on securities trading” (see Articles 74 and 76, Securities Law), they include: (i) directors, supervisors, and senior officers; (ii) companies in which the company has a controlling interest and their directors, supervisors, and senior officers; (iii) persons who have access to insider information of a company by virtue of the positions they hold; and (iv) a de facto controlling shareholder and its directors, supervisors, and senior officers. (Also included are shareholders who hold at least 5% of the shares of the company and their directors, supervisors, and senior officers even though a 5% shareholder may not necessarily in fact have access to insider information).
The basic prohibition is that “informed persons” with insider information, on securities trading and persons who have unlawfully obtained insider information are prohibited from: (i) using such information to trade in securities; (ii) disclosing such information; or (iii) making recommendations to third parties to buy or sell securities. One important ambiguity here is whether the focus should be on the possession of such information itself (knowing) or the informed persons should also act due to such information (using). Article 76 and Article 73 seem conflicting in this point, the first of which suggests a tougher stance against the insiders without carving out any exception for the dealings out of other reasons.
Certain trading restrictions are imposed on a director, supervisor, senior officer and shareholder that hold 5% of the shares of a listed company, for what known as the short swing profit in the US. If such a person sells shares of the company within six months of acquiring such shares, or acquires shares of the company within six months of selling shares in the listed company, any gains made from such transactions shall belong to the company and the person is also liable to a fine. The directors of the company are charged with the responsibility of enforcing it and recovering the gains, and if they fail to do so, the shareholders are entitled to institute proceedings to seek recovery in their own names and the relevant directors can be held jointly and severally responsible with the shareholders.
It is noteworthy the State Council on Thursday, November 18, 2010 ordered further measures in its crackdown on stock market insider trading. The measures include ensuring confidentiality of non-public information about listed companies and regulating government officials who have access to such information, according to a statement posted on the State Council. The move involves the collaboration of multiple government agencies including the CSRC, the SASAC and the Ministry of Public Security. The State Council also called for registration of people who have privileged market-moving information and improvement of disclosure requirements for listed companies as well as rules concerning suspension and stock trading.
Since 2008, the securities regulator has investigated 295 insider trading cases, accounting for 45% of the total cases filed during the period, according to its figures. One of the most prominent cases of insider trading concerns Chinese retailing tycoon Huang Guangyu who was sentenced to 14 years for insider trading and market manipulation. It seems in this case the Court delivered a strong warning to people involved in trading, but the current punishment are largely symbolic, levying fines that are just a fraction of the amount made by illegal trading.
The launch of trading in stock index futures in the end of 2010 is a major step taken by the regulator to make the Chinese stock markets more like bourses of developed countries which provide investor sophisticated tool to hedge risks, but analysts warned that the new trading tools can also lead to more irregularities that potentially undermine the market if it is not well regulated.
As for the stock market manipulation, Article 77 of the Securities Law prohibits any person from engaging in the following activities: (i) carrying out combined or successive sales or purchases by building up an advantage in terms of funds or shareholdings or by using one’s advantage in terms of information, thereby manipulating the price or volume of securities traded, whether independently or in collusion; (ii) collaborating with another person to mutually trade securities at a prearranged time, price and method, thereby affecting the price or volume of securities traded; (iii) carrying out securities transactions between the accounts actually controlled by oneself, thereby affecting the price or volume of securities traded; (iv) manipulating the securities market by other methods. While such a provision is not unique to this law an acquirer that builds up a position in a listed company through successive purchases should take note of these prohibited activities. In particular, the first scenario is somehow circularly defined for the term “manipulation,” and a practical guide or a safe harbor might be necessary to draw the clear line between the lawful takeover and the illegal manipulation.
Furthermore, Article 98 of the Securities Law requires that in an acquisition of a listed company, the stocks of the target company as held by a purchaser may not be transferred within 12 months after the acquisition is concluded. The said ban period was extended from six months one under the previous version of Securities Law, with a hope to further deter either hostile takeovers at the expense of small shareholders or viciously manipulating the stock price by the disguise of takeover.
Finally on this topic, it is interesting to note that if an investor acquires 5% or more of the issued shares of a listed company it will, pursuant to the listing rules of the Shanghai and Shenzhen stock Exchanges, become a “connected person” of the company. Transactions between a company and a “connected person” may need to be disclosed or approved by independent shareholders.
This entry completes the theme about takeovers of listed companies in China.
Cristiano Rizzi
(Some of my entries are extracted from my work titled M&A and Takeovers in China, so if you are interested in this topic, please visit: http://www.kluwerlaw.com/Catalogue/titleinfo.htm?ProdID=9041140484).