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Recently, SZSE has completed the review of 2016 annual reports issued by listed companies, sending a total of 990 letters of enquiry or so to over half of the listed companies and raising over 6800 questions. According to the degree of risk involved and the letters of reply received from listed companies, SZSE publicized about 200 enquiry letters and replies.
“The review of annual report has always been a major responsibility of SZSE as a first-line regulator,” expressed an officer from SZSE. To carry out the arrangements of the Party Central Committee and the State Council on prevention of financial risks, SZSE, with the guidance of CSRC, by focusing on the problems and risks, has deepened the review of the annual reports via various effective means in accordance with laws and the spirit of strict regulations.
Six Issues of Concern
“The review of annual report was strengthened this year, with more enquiries raised and more issues taken into consideration,” said the officer from SZSE.
During SZSE’s review of 2016 annual reports, the following issues rank high on SZSE’s list of concerns: authenticity of the annual reports, the accounting and auditing results, fulfillment of profit commitments of underlying assets and depreciation of goodwill, compliance of information disclosure, corporate governance and standard operation, and information disclosure regarding social responsibility.
First, SZSE pay close attention to the authenticity of the financial reports of listed companies.
The companies of concern are those faced with delisting risk, involved in performance commitments after restructuring, implementing equity incentive plans or applying for cancellation of the delisting risk warning.
SZSE mainly focused on such issues as false revenue reporting, understatement of costs and expenses, especially of costs carry-forward, and for profits from unexpected end-of-year transactions, the necessity and commercial nature of such transactions.
For example, SZSE was especially interested in a company trading at a large quantity with new customers in the fourth quarter, sending two letters enquiring about the contents of the transactions and whether the sales satisfy the conditions for revenue under the current accounting standards. Given the contradictory replies from the company on whether the client is a related party, SZSE timely reported the issue to CSRC.
Second, SZSE imposed strict regulation on accounting and auditing.
SZSE mainly focused on whether the accounting treatments are in line with accounting standards, trying to prevent accounting errors from affecting investors’ decisions. At the same time, SZSE also reminded intermediary institutions of their responsibilities and urged them to do their duties.
For instance, SZSE noticed that a company managed to achieve profitability with the addition of investment proceeds from the selling of equities in a subsidiary at the end of year, while the accounting standards provide that the difference between the transaction consideration and the net asset share shall be deemed as capital reserve rather than investment proceeds whilst the seller still has control over the said asset. The Company’s treatment of investment proceeds is not in line with the accounting standards and its intention is apparent to maintain its listing status by achieving profitability.
Therefore, SZSE issued three letters of concern to the Company requesting clarification on the compliance of the accounting treatment from the Company and verification and issuance of a clear opinion from the auditor.
Third, SZSE is concerned about the fulfillment of profit commitments of underlying assets and depreciation of goodwill.
In recent years, M&As and restructuring are featured by overvaluation and high premium, accompanied by the gambling on performance by transaction parties. Failure to deliver profits as promised has become a threat to the development of listed companies.
For companies disclosing profit commitments fulfilled in their annual reports, SZSE, by examining the change of clients before and after the restructuring, the abnormally of gross profit margin, and change of auditors, found that some companies might have delivered a profit commitment by fabricating transactions and circulation of capital and etc.
Furthermore, SZSE, on the basis of operation of underlying companies and the fulfillment of performance commitments, examined the accuracy of the provision for goodwill impairment.
Fourth, SZSE emphasized the compliance of information disclosure.
SZSE paid special attention to whether listed companies have fully disclosed the discussion and analysis of the management team and major events in accordance with the regulations on compilation of annual reports. SZSE watched closely for violation of disclosing obligations such as replacement of current reports with periodic reports before taking responsive regulatory measures. SZSE also paid attention to listed companies’ disclosure of industry information, instructing them to improve the usefulness of information disclosed.
Fifth, SZSE closely tracked the corporate governance and standard operation of listed companies.
During the review, SZSE focused on the operation of the meetings of shareholders, the supervisory committee and the board, and the performance of duties by directors, supervisors and senior executives. SZSE examined the compliance of the profit distribution plans, raised enquires at the discovery of any violation and requested explanation from the companies within a designated period. SZSE also checked whether the connected transactions have undergone necessary approving procedures and whether they fell within the authorized quota. SZSE watched for the fulfillment of commitments by shareholders, directors, supervisors, senior executives and other related parties, and publicized unfulfilled commitments of resolving horizontal competitions and reducing related-party transactions.
For companies caught in the internal fighting over control of the company, SZSE paid attention to whether shareholders’ interests are jeopardized or their rights restricted.
Sixth, SZSE attached emphasis to the disclosure of information relating to social responsibility.
In the review of the 2016 annual reports, SZSE focused on the work on energy-saving and environment protection as carried out by listed companies. For major pollutant dischargers under monitoring and supervision of the environmental department who failed to disclose environmental information in accordance with relevant rules and regulations, SZSE would issue a letter to the companies requesting supplements to the information. SZSE also made a summary of listed companies’ performance of the social responsibilities to alleviate poverty.
Pushing through the upgrading of review methods
SZSE adopted multiple effective methods to review the 2016 annual reports in a way that improve the efficiency and quality of their work.
“SZSE is much concerned with the review of 2016 annual reports and had made full preparation and arrangements for it,” expressed the officer. SZSE made adjustments to the implementation of classified regulation, furthered the work on risk prediction, formulated the reviewing plan, and optimized the reviewing system. To ensure the disclosure and review of annual reports, SZSE also met with some companies and auditors of concern.
By making use of the classified regulation and appraisal system and over 40 indicators including operation capacity, profitability, liquidity, corporate governance and standard operation, SZSE was able to predict and classify the risks of the companies during the review.
Based on that, SZSE went on to optimize the reviewing plan which would enable them to carry out the work with a clear view in mind. SZSE divided its regulators into groups responsible for different industries. They would double-review, cross-review or verify reports of high-risk companies. SZSE also set up professional teams of accounting, restructuring and corporate governance to make the final check and ensure the efficiency of the review work.
“SZSE also relied on technology to help them with the regulation and review of 2016 annual reports, and that actually improved the efficiency and quality of the work,” said the officer.
By drawing on the regulation and review work of previous years, SZSE has established a system to assist them with the review. The system would be able to break down the review procedure and the issues of concern, and mark the review along the way. SZSE also built a smart review system to compare the financial indicators of the companies with historic data and industry data thus providing clues for financial violations.
Furthermore, SZSE built a database of accounting and auditing regulatory cases which enables them to summarize and archive typical regulatory cases. In this way, the regulatory experience would be passed on and the regulatory measures would be consistent.
The officer stated that SZSE would initiate the disciplinary procedure immediately at the discovery of any important clue to violations during their review of the annual reports. Their focus are centering on change of performance, correction of major accounting errors, substitution of current reports with periodic reports, related parties’ failures to fulfill commitments as prescribed and omission of approving procedure for related-party transactions.
Statistics show that SZSE has initiated disciplinary procedures against 46 companies, issued regulatory letters to about 100 companies, and requested over 340 companies to issue supplementary or correction notices according to regulation.
During the review, SZSE reported relevant problems and clues to CSRC or solicited the help of local agencies of CSRC to conduct investigations depending on the facts and degree of the violations. Besides, based on the review, SZSE had fully investigated companies under unstable control, with false revenue reporting or violations in information disclosure, reported the issues to CSRC and informed the local agencies, in which way, regulation on high-risk companies would be better coordinated.
The officer expressed that SZSE shall, in accordance with laws and the spirit of strict regulation, perform its duties as a first-line regulator and promote the sound and sustainable development of a multi-layer capital market of Shenzhen.
