1. What are the backgrounds and main considerations for launching the Implementation Rules?
The share sales mechanism for shareholders of listed companies is a key basic mechanism of the capital market and also a big concern in securities trading on the secondary market. In order to regulate share sales activities on the secondary market, in January 2016, China Securities Regulatory Commission (hereinafter, CSRC) released the Several Regulations on Reduction of Shareholdings by Controlling Shareholders, Directors, Supervisors and Senior Executives of Listed Companies and as a supporting policy, SZSE formulated the Circular on Relevant Issues on the Implementation of the Several Regulations on Reduction of Shareholdingsby Substantial Shareholders, Directors, Supervisors and Senior Executives of Listed Companies. The implementation of such regulations and circular has played a positive role in guiding proper share sales, clarifying market expectations and promoting the stable and sound development of the market. Despite all this, over the past year, new situations and problems have arisen in the market. For example, after substantial shareholders reduced shares through block trading, the transferees immediately sold out such shares in large quantities on the secondary market; also, some shareholders conducted “liquidation-like” share sales, and some directors, supervisors and senior executives sold shares by resigning before the expiration of their terms, etc. These activities have aroused market attention.
To address the prominent problems that arose in practice, on May 27, the CSRC released its revised Several Regulations on Reduction of Shareholdings by Shareholders, Directors, Supervisors and Senior Executives of Listed Companies (hereinafter, Regulations). The Regulations supplemented and refined the former share sales mechanism and also imposed requirements on stock exchanges for intensifying supervision of share reduction activities. Reduction of shareholdings is closely related to securities transactions and has direct impact on the orderly trading and steady development of the market. As front-line regulator of the securities market, stock exchanges assume the basic duties of organizing and managing securities transactions. In addition, it is their unshirkable responsibility to formulate supporting rules pursuant to the relevant regulations of the CSRC so as to guide orderly and proper share sales activities and prevent and control unusual share sales activities. Because of this, based on the above-mentioned circular released last year, SZSE formulated the Detailed Implementation Rules of Shenzhen Stock Exchange on Share Sales by Shareholders, Directors, Supervisors and Senior Executives of Listed Companies (hereinafter, Implementation Rules).
2. What major adjustment has been made in the Implementation Rules compared to the former regulations?
Major improvement in the Implementation Rules focuses on the following four aspects:
Firstly, the scope of application is expanded. Apart from regulation of share sales activities of substantial shareholders (namely controlling shareholders and shareholders holding at least 5 percent of the shares of a listed company), the Implementation Rules also bring under supervision the reduction of pre-IPO shares and private placement shares of listed companies (hereinafter collectively, specific shares) by other shareholders.
Secondly, restriction on share sales become more detailed. New provisions include: the number of private placement shares reduced by a shareholder within the 12 months after the expiration of the lock-up period shall not exceed 50 percent of the shares it holds; the number of shares reduced through block trading during a period of 90 consecutive calendar days shall not exceed 2 percent of the total shares of the listed company and the transferee shall not transfer such shares within 6 months after the transfer; where a shareholder loses its status as a substantial shareholder as a result of share reduction through negotiated transfer, the transferor and transferee shall continue to observe share-reduction proportion and information disclosure requirements within 6 months; and where directors, supervisors and Senior Executives resign, they shall still observe share-reduction restrictive provisions according to their original terms of office, etc.
Thirdly, share reduction disclosure is strengthened. Substantial shareholders, directors, supervisors and senior executives shall disclose their share reduction plans before the reduction, the progress of share reduction during the reduction, and the share reduction results after the reduction by submitting reports to the SZSE and publishing announcements.
Fourthly, stern punishment is imposed on non-compliant share sales activities. SZSE may take regulatory measures or exert disciplinary punishment, such as written warnings, notices of criticism, public censures and trading restrictions, on share reduction activities that violate the Implementation Rules, evade share reduction restrictions or constitute abnormal transactions.
3. Which market players’ share reduction activities are the main targets of the Implementation Rules? Is there any impact on the transactions of small and medium investors?
The Implementation Rules are question-oriented and focused, which target “key minority” and mainly address share sales behaviors of three types of market players: first, share sales conducted by substantial shareholders of listed companies, i.e., controlling shareholders and shareholders holding at least 5 percent of the total shares of a listed company (hereinafter, 5 percent shareholders), except for the reduction of shares which have been purchased by substantial shareholders through collective auction; second, share sales conducted by specific shareholders of listed companies, i.e., shareholders holding specific shares (pre-IPO shares and private placement shares); and third, share reduction activities conducted by directors, supervisors and senior executives of listed companies.
Thirdly, a prominent feature of these three types of shareholders is that they either have shareholding advantage, for example, substantial shareholders hold at least 5 percent of the shares of a listed company and may have considerable impact on the operation, management and decision-making of the company; or they have information dominance, for example, directors, supervisors and senior executives directly participate in the operation and management; or they have shareholding-cost advantage, for example, they hold specific shares, such as pre-IPO shares and private placement shares, at a lower price. As all these shareholders are well-positioned, a lack of necessary and effective limitation on their reduction of shares will easily affect the sound operation of listed companies, undermine the fairness of the market and damage the interests of small and medium investors. As such, they should be put under special supervision.
Except the restrictions on share reduction activities of the foregoing shareholders, the Implementation Rules do not involve limitation on stock trading activities of other investors. Thus normal trading activities of small and medium-sized investors will not be affected. As a matter of fact, what the Implementation Rules seek to precisely guide orderly share reduction so as to maintain an orderly market, promote sound operation of the market and protect the interests of investors, in particular those of small and medium investors.
4. What requirements are imposed on share reduction by substantial shareholders in the Implementation Rules?
Share reduction by controlling shareholders and 5 percent shareholders has always been a regulatory focus. The Implementation Rules contain the following provisions on share reduction by substantial shareholders:
Firstly, rationally dividing the types of share sales to be restricted. In order to encourage substantial shareholders to increase their shareholdings, the Implementation Rules do not limit their reduction of the shares purchased through collective auction. Except the shares purchased through collective auction, reduction of all other types of shares by substantial shareholders, including pre-IPO shares, private placement shares, rights shares, and shares obtained through block transactions, negotiated transfer, judicial transfer of ownership and inheritance, shall be subject to the Implementing Rule.
Secondly, restricting the number of shares to be reduced. Concentrated share reduction by substantial shareholders is likely to impact the prices of the secondary market. For this reason, a substantial shareholder is required to reduce not more than 1 percent of the total shares of the listed company through auction trading and not more than 2 percent of the total shares of the listed company through block trading, i.e., a total of not more than 3 percent, during any period of 90 consecutive calendar days.
Thirdly, preventing Evasion. In the case of “bridge reduction” through block trading, the Implementation Rules add a new provision that prohibits the transferee from transfering the shares obtained within 6 months after completion of the transfer; in the case that substantial shareholders reduce shares through the persons acting in concert, the Implementation Rules clarify that the shares held by substantial shareholders and the persons acting in concert shall be aggregated and that both substantial shareholders and the persons acting in concert shall observe share reduction volume restrictions and they shall share relevant reduction quota.
Fourthly, disclosure requirements are refined. Substantial shareholders, directors, supervisors or senior executives, as the case may be, are required to disclose relevant information before, during and after the share reduction. More specifically, they shall announce their share reduction plans 15 days in advance, including the quantity, source of the shares to be reduced, the reason for the reduction, timeframe and price range; they are also required to disclose the progress of share reduction when they are more than halfway through the reduction or when they unload more than half of the shares to be reduced; upon the completion of reduction, they shall publicize reduction results.
5. Share-reduction following the lock-up period has long been a market concern, how do the Implementation Rules address this issue?
In recent years, reduction of restricted shares, including pre-IPO shares and private placement shares of listed companies, following the lock-up period has become a prominent issue. The Implementation Rules include two new provisions concerning the two types of shares:
Firstly, reduction of specific shares shall be subject to reduction volume restrictions. Shareholders holding specific shares shall not reduce more than 1 percent of the total shares of the listed company through auction trading and more than 2 percent of the total shares of the listed company through block transactions, or totaling not more than 3 percent, during any period of 90 consecutive calendar days, regardless of the percentages of their stakes in the company.
Secondly, reduction of private placement shares of listed companies shall be further subject to special restrictions. In response to “liquidation-like” reduction of private placement shares of listed companies, the Implementation Rules include a new restrictive provision, i.e., in addition to the above share reduction restriction, during auction trading within the 12 months after the expiration of the lock-up period, shareholders shall not reduce more than 50 percent of the total private placement shares it holds from the same placement. In other words, relevant shareholders shall be subject to the above restriction or the 50 percent restriction, whichever is lower.
It should be noted that, apart from pre-IPO shares and private placement shares obtained directly by shareholders from the company, the aforesaid specific shares also include the shares obtained by shareholders through non-trade transfer before the above-mentioned shares are released from the lock-up period. However, after shares are released from the lock-up period, such shares obtained by shareholders in any way will no longer be regarded as specific shares and the reduction of such shares by shareholders is not subject to the above restrictions.
6. Are there any measures in the Implementation Rules to address “bridge reduction” through block transactions?
The share reduction mechanism introduced in January 2016 was mainly designed to address reduction activities through collective auction and had no restriction on substantial shareholders’ share reduction through block trading. In practice, some substantial shareholders conducted “bridge reduction” through block trading, evading reduction proportion restrictions imposed on collective auction trading. In response to the new situation, the Implementation Rules include corresponding provisions to ensure the implementation results of the share reduction mechanism and prevent regulatory arbitrage.
Firstly, requiring the transferor to observe share reduction volume restrictions. Substantial shareholders, shareholders holding specific shares, shall not reduce more than 2 percent of the total shares of the listed company through block trading during any period of 90 consecutive calendar days.
Secondly, requiring the transferee to observe the 6-month no-transfer restriction. In the case that the transferee receives shares through block trading which had been previously purchased by substantial shareholders in any way other than through collective auction, or the transferee receives specific shares from other shareholders, the transferee shall not transfer such shares within 6 months after the completion of the share transfer. In the case that the transferee receives shares other than the aforesaid shares through block trading, such 6-month no-transfer restriction does not apply.
Given that it will take some time to complete upgrading of the trading system, within the 6 months following the promulgation of the Implementation Rules, if substantial shareholders apply to reduce, through block transactions, the shares they had purchased in any way other than through auction trading, or other shareholders apply to reduce, through block transactions, the specific shares they hold, the SZSE will process the application manually. After completion of the upgrading, SZSE will separately announce the specific method for processing block transactions.
7. Are there any provisions in the Implementation Rules that apply to share-reduction by shareholders through negotiated transfer?
The circular issued by the SZSE in January 2016 prescribed the minimum transfer proportion, lowest transfer price and continuing obligations in respect of negotiated transfer. Based on the existing provisions, the Implementation Rules contain supplementary provisions regarding new issues such as share-reduction by specific shareholders.
Firstly, further clarifying that the stake to be received by a single transferee from negotiated transfer shall be no less than 5 percent of its share capital and that the lowest transfer price shall be governed by block trading rules.
Secondly, adding new provisions on the continuing obligations of specific shareholders who receive specific shares in a negotiated transfer deal. Such shareholders must observe share-reduction proportion requirements set forth in the Implementation Rules together with the transferor within 6 months after completion of share transfer. After the 6 months, the share-reduction proportion requirements no longer apply. If the transferee constitutes a 5 percent shareholder or reduces specific shares, it shall still comply with the relevant provisions of the Implementation Rules.
Thirdly, further clarifying the continuing obligations of specific shareholders whose stake falls below 5 percent as a result of the share transfer. The transferor shall continue to observe share-reduction proportion requirements set forth in the Implementation Rules together with the transferee within the subsequent 6 months and perform information disclosure obligations pursuant to relevant regulations.
In order to heighten shareholders’ sense of compliance, SZSE will require the transferor and transferee to make a written undertaking when conducting negotiated transfer that they will continue to observe share-reduction proportion requirements set forth in the Implementation Rules and information disclosure obligations within 6 months after completion of share transfer.
8. How do the Implementation Rules address share reduction by a single shareholder through multiple securities accounts, or by multiple shareholders who constitute persons acting in concert?
After the introduction of the mechanism of one person with multiple accounts, investors can open more than one securities account and hold the shares of the same company through multiple accounts. Besides, substantial shareholders are also likely to hold the shares of the same company with the persons acting in concert. In response to these situations, the Implementation Rules introduce the calculation principle of “aggregation”.
Firstly, aggregating the shares held by one person through multiple accounts. If a single shareholder holds shares through multiple securities accounts, such shares shall be aggregated if the securities accounts have the same name and the numbers of the relevant certificates are also the same; the shares held by the shareholder in its credit securities account shall be aggregated with that held in the ordinary securities account. The numbers of shares that can be reduced from the various accounts will be allocated pro rata based on the numbers of shares subject to reduction restrictions and held in the various securities accounts and through various depository units.
Secondly, aggregating the shares held by persons acting in concert. Under the Administrative Measures on the Take-over of Listed Companies, shares held by multiple shareholders that constitute persons acting in concert shall be aggregated and they shall observe share reduction proportion restrictions and information disclosure requirements, etc. as a whole.
9. In recent years, some directors, supervisors and senior executives resign for the purpose of unloading their shares. Are there any provisions in the Implementation Rules to address this issue?
Directors, supervisors and senior executives of a listed company are senior management members of the company. They assume fiduciary and due diligence duties to the company and have a bearing on the internal governance and operation stability of the company. The Company Law provides that directors, supervisors and senior executives shall not reduce more than 25 percent of their stakes in the company each year within their terms of office and shall not reduce shares in the company within the half year following their resignation. The main consideration for this provision is to bind the interests of directors, supervisors and senior executives to that of the company in an appropriate way to prevent their early reduction of all their stakes in the company. In practice, some directors, supervisors and senior executives resign from their posts before the expiration of their terms in order to sell their stakes in the company as quickly as possible, betraying their basic duties to the company and violatingthe trust placed on them by all the shareholders of the company.
In response to this problem, the Implementation Rules include a pertinent restrictive arrangement, i.e., if a director, supervisor or senior executive resigns before the expiration of his term, he is still subject to the share reduction proportion requirements in the Company Law during his original term of office. That is to say, if a director, supervisor or senior executive resigns in the first year of his term, he is not only prohibited from reducing shares within the half year following his resignation, but he shall also be subject to the 25 percent share reduction restriction each year within the rest of his term and the subsequent half year.
For example, a director of a listed company took office on March 1, 2016 for a term of 3 years, but he resigned on September 1, 2016 before the expiration of his term. Under the Implementation Rules, within the 6 months following his departure, i.e., from September 1, 2016 to March 1, 2017, he shall not transfer his shares; from March 1, 2016 to September 1, 2019, i.e., within his original term and the subsequent 6 months, he shall not reduce more than 25 percent of his stake in the company each year.
10. Could you elaborate on the pre-disclosure mechanism specified in the Implementation Rules for share reduction by substantial shareholders, directors, supervisors and Senior Executives?
Compared with small and medium shareholders, substantial shareholders, directors, supervisors and senior executives of listed companies have advantages in shareholding and information and their share reduction activities have considerable impact on market expectations. Therefore, it is necessary to establish a pre-reduction disclosure system for them to satisfy the right to know of small and medium investors. Based on the need of practice, the Implementation Rules include substantial shareholders, directors, supervisors and senior executives in the scope of application of the pre-disclosure mechanism and optimize information disclosure requirements in the following three aspects.
Concerning ex-ante disclosure, substantial shareholders, directors, supervisors and senior executives are required to report and announce its share-reduction plan, the number and source of the shares to be reduced, the reason for the reduction, the timeframe and price range 15 trading days in advance if they intend to reduce shares in the next 6 months through collective auction.
Concerning in-the-event disclosure, substantial shareholders, directors, supervisors and senior executives are required to disclose the progress of share reduction when they unload more than half of the shares to be reduced or when they are more than halfway through the reduction. Meanwhile, substantial shareholders, directors, supervisors and senior executives are also required to disclose the progress of share reduction if, during the reduction period, the listed company discloses a high-ratio stock dividend distribution or high-ratio transfer of public reserve into share capital or the listed company plans M&A and restructuring.
Concerning ex-post disclosure, substantial shareholders, directors, supervisors and senior executives are required to announce again the details of share reduction after the completion of the reduction or within 2 trading days after the expiration of the reduction period.
11. How do you determine the nature of the shares reduced if a shareholder holds both the shares that are subject to reduction restrictions in the Implementation Rules and the shares that are not subject to reduction restrictions in the Implementation Rules?
In practice, substantial shareholders and shareholders of specific shares may hold both the shares subject to reduction restrictions and that not subject to reduction restrictions. The restrictive provisions in articles 4 and 5 of the Implementation Rules on the reduction of relevant shares by shareholders do not apply to the shares that are not subject to reduction restrictions. In practice, the nature of shares reduced will be determined based on the following principles:
Firstly, if the shares reduced are within the specified reduction proportions, it will be deemed that reduction priority has been given to the shares that are subject to reduction restrictions. For example, if a substantial shareholder reduces not more than 1 percent of the total shares of the listed company through collective auction during any period of 90 consecutive calendar days, the shares reduced shall be deemed as the shares subject to reduction restrictions.
Secondly, if the shares reduced are beyond the specified reduction proportions, it will be deemed that reduction priority has been given to the shares that are not subject to reduction restrictions. For example, if a substantial shareholder reduces more than 1 percent of the total shares of the listed company during any period of 90 consecutive calendar days, the excess portion of the shares shall be deemed as the shares not subject to reduction restrictions.
Thirdly, it is deemed that IPO-shares have priority in share reduction over private placement shares of listed companies. That is to say, if a shareholder holds both IPO-shares and private placement shares of listed companies, when calculating the relevant share reduction proportions, the IPO-share will first be included in the calculation.
For example, if a shareholder holds a 5 percent pre-IPO stake and a 4 percent stake purchased through auction trading, according to the aforesaid principles, if the shareholder sells a total of 4 percent stake during any period of 90 consecutive calendar days, it will deemed that the shareholder cut a 1 percent pre-IPO stake and a 3 percent stake purchased through auction trading. That is to say, it still holds a 4 percent pre-IPO stake and a 1 percent stake purchased through auction trading.
12. Are the specific shares that had been released from the lock-up period before the implementation of the Implementation Rules but have yet to be sold out governed by the Implementation Rules?
In order to unify regulatory standards, provide a clear market expectation, promote sound operation of the market and prevent complicated application of rules, the Implementation Rules are implemented as of the date of promulgation and all market players that conform to the relevant provisions of the Implementation Rules, i.e., 5 percent shareholders and controlling shareholders, shareholders holding specific shares, and the directors, supervisors and senior executives of listed companies, shall comply with share-reduction provisions in the Implementation Rules.
Therefore, specific shares that had been released from the lock-up period before the implementation of the Implementation Rules but have yet to be sold out are also subject to the share-reduction requirements set forth in the Implementation Rules.
13. Do the Implementation Rules have any restrictions on shareholders who are involved in illegal or irregular activities?
In order to strengthen market supervision and deter illegal and irregular activities, the Implementation Rules prohibit share-reduction by substantial shareholders, directors, supervisors and senior executives who are involved in illegal or non-compliant activities. More specifically, there are four types of prohibitions:
First, if a listed company or a substantial shareholder is under investigation for suspected illicit or criminal acts in securities and futures markets, the substantial shareholder is prohibited from reducing shares during the investigation period and within the 6 months following the issuance of criminal judgments or imposition of administrative penalties.
Second, if directors, supervisors and senior executives are under investigation for suspected illicit or criminal acts in securities and futures markets, they are prohibited from reducing shares during the aforesaid investigation period and the six-month period.
Third, substantial shareholders, directors, supervisors and Senior Executives are prohibited from reducing shares within the 3 months after they receive a public censure from the SZSE.
Fourth, if a listed company commits a major violation of law, thus triggering the delisting risk alert standards, its controlling shareholder, actual controller, directors, supervisors, senior executives, and their persons acting in concert are prohibited from reducing shares during the period after the issuance of the relevant decision on administrative penalties or on handing over to the public security organ and before the delisting of the company or resumption of listing.
14. Regarding self-regulation, are there any measures in the Implementation Rules against non-compliant share sales behaviors by shareholders?
Following the promulgation of the Implementation Rules, SZSE will combine ex-ante, in-the-event and ex-post means to intensify supervision of share sales activities and severely punish various non-compliant share sales activities.
SZSE will take the following measures against non-compliant share sales activities as appropriate:
First, imposing regulatory measures or disciplinary actions on the relevant shareholders, directors, supervisors, or senior executives by issuing written warnings, circulating a notice of criticism, issuing public censures and imposing trading restrictions.
Second, imposing severe and speedy disciplinary actions against the non-compliant share sales activities that lead to unusual movement in stock prices, seriously affect the trading order of the market or impair the interests of investors.
Third, reporting suspected illicit or non-compliant share sales activities to the CSRC for investigation and punishment
