The Securities and Futures Commission (“SFC”) has highlighted its concerns on certain aspects of recent corporate acquisitions and disposals by listed companies. The SFC issued a guidance note on directors’ conduct and duties in May 2017 and subsequently issued a “Statement on the Conduct and Duties of Directors when Considering Corporate Acquisitions or Disposals” on 4 July 2019 (“Statement”).
In 2017 and 2018 the regulator issued letters of concern to more than 46 listed issuers, and more than half of these cases involved proposed corporate acquisitions or disposals. Where there are serious concerns that an acquisition or disposal constitutes a breach under the Securities and Futures Ordinance and/or other applicable laws, the SFC will consider utilising its powers under the Securities and Futures Ordinance to hold the directors accountable for the breach and/or misconduct.
The Statement listed eight examples of recurring misconduct that listed companies’ directors should avoid when evaluating or approving the acquisition or disposal of a company or business. They are:
1. lack of independent professional valuation;
2. absence of independent judgement and accountability;
3. unjustifiable selection of comparable companies;
4. questionable sources of earnings/earnings manipulation;
5. suspicious connected parties;
6. proper investigation and due diligence;
7. post-transaction financial impact on listed issuers not ascertained; and
8. no verification of the vendor’s ability to compensate.
In considering a corporate transaction, directors, together with their financial advisors and/or their legal advisors, should consider the following five steps:
Investigation and due diligence
At the planning stage, directors should consider their duties under the Listing rules and specific duties in corporate transactions such as:
• understand the nature of the target’s business and assets and ask the seller for supporting information;
• carefully consider all relevant information; and
• verify the accuracy and reasonableness of material information, and if required, engage a professional advisor to assist.
Pay attention to red flags
Directors should look into the following factors and identify any risks and red flags:
• the historical financial performance of the target company (such as whether it is loss-making);
• assumptions used in a forecast (whether they are consistent with historical trends, industry developments and market conditions);
• sales projections are not substantiated with supporting documents (eg non-binding contracts, unsupported growth and sales from the new business); and
• the shares of the target company were recently transferred at a price lower than that offered by the listed company.
Consider the need to engage a valuer
Although there is no statutory requirement for a listed company’s director to obtain an independent professional valuation for a planned acquisition, the Statement states that the majority of cases where an independent professional valuation was not obtained, there was insufficient information available to determine the basis of the consideration. As a consequence “by not obtaining a professional valuation, the directors would have failed to exercise the degree of care, skill and diligence that may be reasonably expected of them.”
Be aware of the limitations of the valuation engagements and reasonable reliance on valuation work
Where an independent professional valuation is obtained, directors are advised to consider the limitations for example:
• limited scope (eg valuers rely on forecasts provided by directors without conducting any due diligence);
• the valuation may not have covered synergies and other commercial considerations that could have material impacts on the valuation conclusions; and
• the valuation does not provide an opinion on the reasonableness and achievability of the financial forecasts and underlying assumptions.
As such, when relying on an independent valuation report, a director should consider:
• whether the information relied upon, assumptions and limitations stated are appropriate; and
• analyse the valuation report and enquire with the valuer if the report is unclear.
The Statement reiterates that “obtaining an independent professional valuation in relation to a planned acquisition or disposal would not reduce or modify the statutory duties of care, skill and diligence, or fiduciary duties, owed by directors of listed issues”. Each valuation is case specific and there is no one-size-fits-all approach. Consult your financial and/or legal advisors if in doubt.