HKEx Imposed Severe Sanctions against Directors for Failures to Comply with Connected Transaction Rules

In a recent Statement of Disciplinary Action, the Hong Kong Stock Exchange (HKEx) censured Xinyuan Property Management Service (Cayman) Ltd for having conducted 11 separate connected transactions with its majority parent shareholder and/or subsidiaries in breach of the Listing Rules. 

Four directors were also censured, and two of them were further imposed a Prejudice to Investors’ Interest (PII) Statement – indicating that in the Exchange’s opinion, their retention on the board of directors would be prejudicial to investor interests.

The controversial Transactions took place over about eleven months shortly after the Xinyuan’s listing, involving a total outflow of approximately RMB570 million. The majority were without written agreement and paid out as loans, deposits and prepayments.

From reading the company's announcements, the transactions apparently caused audit concern, leading to delayed publication of the financial statements and eventual suspension of trading.

During a prescribed 18-month remedial period, Xinyuan engaged independent professional advisers to conduct an independent transaction review and internal control review; issued various announcements in relation to the transactions admitting non-compliance of the Listing Rules; and terminated certain existing and new connected transactions.

The four relevant directors all resigned and no longer held any executive management position in the company and its subsidiaries. 

The Listing Committee, in wrapping up the case, found that the transactions were mainly for the benefit of the parent shareholder and some appeared to lack business substance. On top, none of the transactions were escalated to the board for discussion/consideration.

Two directors (on whom PII statement was imposed) were found to have been involved in the internal approval process of all transactions – and their failures to discharge their Rule responsibilities were "wilful and/or persistent".

The other two directors, also shareholders of the parent, were found to have failed to avoid their conflict of interest in relation to the transactions. They respectively undertook to HKEx that they would not use their shareholding in the company and parent to influence selection of the company's director, or any company decision to enter into any transaction with, or make any payment to, the parent and/or its subsidiaries.

Key Take-away:

1. Breach of the connected transaction requirements may have material adverse effect on the audit process of the financial statements of issuers, and may result in trading suspension, as in this case.
2. Issuers may be required to unwind/terminate connected transactions that did not comply with the Listing Rule requirements in the first place.
3. Severe sanction such as PII Statement may be imposed on directors who repeatedly fail to take steps to procure compliance of the connected transactions requirements by the issuer.