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Worrying cracks in the crackdown on ‘trash stocks’
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SHARES in Nanjing Textiles Import & Export Corp Ltd, a listed company that deceived investors for years with phony profit statements, rose after China’s securities regulator unveiled stricter delisting rules aimed at getting dodgy companies off the boards.
How can that be? Loopholes in the new regulations seem to suggest Nanjing Textiles will slip through the cracks of the crackdown.
Shares of the state-owned company advanced 1.1 percent on the Shanghai Stock Exchange last Monday, the first trading day after the China Securities Regulatory Commission announced the tighter rules. For the whole week, they rose 0.19 percent.
“The CSRC has been too lenient with wrongdoers,” a disappointed investor wrote in an online investment community on Sina.com, “A delisting system incapable of ousting companies like Nanjing Textiles is nothing more than a paper tiger.”
In a draft proposal released on July 4, the regulator said that a company would be delisted if false documentation, misrepresentation or omissions in its financial statements were deemed “serious violations” by the commission.
‘Sugared up’
Companies found to have “sugared up” application documents in order to meet requirements for initial public offerings or to have inflated offer prices also will be expelled from the market, according to the draft rules.
It’s the first time the securities watchdog has added financial fraud to delisting triggers like negative net assets, inactive trading or poorly performing prices.
“I believe these rules will be effective in preventing this kind of violation because they greatly increase the cost of fraudulent listings and false disclosures,” Hua Sheng, a professor at Southeast University in Nanjing, told China Securities Journal.
Dong Dengxin, the head of the Finance and Securities Institute at Wuhan University of Science and Technology, said that the new rules indicate the regulator is aiming for a law-based delisting system, which is the best protection for investors.
“The new rules will help ensure the authenticity and accuracy of IPO documents, paving the way for the regulator to establish a registration-based listing system,” Dong added.
However, the rules appear a bit toothless in cases like Nanjing Textiles. Between 2006 and 2010, the company fabricated profits to the tune of 344 million yuan (US$55.5 million). The fictitious profits masked company losses for five straight years.
The CSRC issued a warning and imposed a fine of 500,000 yuan on the company. But the words “serious violation” were absent in the penalty notice.
Critics said regulatory use of the term “serious violation” is vague, lacking clarity and quantitative criteria. That leaves a lot of wiggle room.
China’s delisting system has long been criticized as feeble in filtering out “trash stocks.”
Since 2001, only 78 companies had been jettisoned from China’s stock exchanges, according to CSRC data. That represents a meager 3 percent of the more than 2,500 companies listed in Shanghai and Shenzhen.
By comparison, more than 3,000 companies were delisted from the New York Stock Exchange and 8,000 were delisted from the Nasdaq Stock Market between 1995 and 2012.
Last month, Nanjing Tanker Corp, a subsidiary of the state-owned China Changjiang National Shipping (Group) Corp, was the first state company ever delisted from the market. The action came after the company posted losses for four consecutive years.
However, Pi Haizhou, an independent financial commentator, said the delisting was merely a stunt to show the effectiveness of China’s delisting system, rather than the result of a market-oriented mechanism.
Nearly 40 percent of stocks on the verge of delisting received subsidies from local governments in 2013 so they could embellish profits and cling to market status, according to Pi.
“China’s delisting system is flawed because it is so easily manipulated by major stakeholders and governments,” Pi said.
Last year, China COSCO Holdings Co Ltd, the county’s biggest shipping group, sold a key unit to its parent to help itself return to profitability after two consecutive years of losses. A third straight annual loss would have resulted in the company being suspended from trading on the Shanghai Stock Exchange and four consecutive losses would result in delisting.
In 2012, Tsann Kuen (China) Enterprise Co Ltd, a Fujian-based electronics manufacturer listed on China’s B-share market, managed to cut its share base with the support of local government, thus boosting its share price after trading below par for 18 straight days. Stocks can be delisted if their prices fall below their par value for 20 consecutive trading days.
No signs of remedies
In CSRC’s new draft rules, there are no signs of remedies to close these loopholes.
Under the new delisting rules, the regulator is supposed to clarify procedures for companies seeking to voluntarily exit China’s stock exchanges because of restructuring or privatization. The regulator has promulgated seven conditions under which companies can apply for a delisting.
“Voluntary delisting is very common in mature capital markets but has not been given enough attention to in the Chinese market,” said Deng Ge, a spokesman for the CSRC.
Market watchers say voluntary delistings are likely to be unpopular in China, considering the several years’ wait and complicated procedures for IPOs.
Companies headed for delisting become inviting targets as shell companies for quick backdoor listings. Sometimes their share prices surge on market rumors of such a maneuver.
“Only when a market-oriented listing system is established will voluntary delisting become normal,” said Ye Tan, an independent business commentator.
Regulators said earlier that it would unveil detailed plans for a registration-based listing system by the end of the year, aiming to allow the market to play a more decisive role in IPOs.
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