Better take SGX queries seriously

Source: The Straits Times

Author: Goh Eng Yeow 28/3/2011

THOSE looking for tough action to stamp out problems in the S-chip sector - China businesses listed in Singapore - may well be applauding the latest efforts of the Singapore Exchange (SGX).

But on closer inspection, moves to rein in wayward S-chips are set to cause headaches for decent and well-run firms, while the warning signs on dodgy S-chips were there for all to see, if only they had taken heed of the red flags.

In recent weeks, SGX has rushed to put in place even more safeguards aimed at the problematic sector, after it had been rocked by fresh accounting scandals. These include getting companies to make it clear in their books that they have the right to hire and fire the legal representatives in their China subsidiaries. These are the people recognised by Chinese law as having the authority to execute agreements, transfer assets and negotiate bank loans on the company's behalf.

And because of the irregularities that have repeatedly surfaced over cash balances at scandal-hit S-chips, the SGX is also 'encouraging' listed firms to get auditors to perform additional procedures such as 'cash validation on an ongoing and regular basis' at their China units.

No doubt, the SGX's latest actions will find favour among those who believe that tougher action is needed to stamp out the corporate malfeasance festering in the maligned S-chip sector.

But it also begs the question as to whether the SGX is overreacting to the latest spate of accounting scandals.

In tightening the screws for all S-chips because of the misconduct of a few black sheep, the SGX runs the risk of unfairly punishing the rest of the sector for wrongs that are not of their doing.

That is unfortunate. As the experience of the past two years shows, those S-chips with excellent businesses, like Sihuan Pharmaceutical and Man Wah, will simply uproot and move to a friendlier listing destination. Both Sihuan and Man Wah chose Hong Kong.

Take a closer look at the latest moves and one pertinent question is whether it is worthwhile giving the board the power to hire and fire the legal representative at the China unit, even though China's regulatory framework allows him to stay on, unless he resigns of his own accord.

For many S-chips, the legal representative is also the founder and major shareholder of the company. Clearly, other investors have no business investing in his firm if his interests are not aligned with those of the company.

Getting companies to engage auditors to perform additional checks on an ongoing basis to confirm the cash balances of their China units is fine, if this serves to pacify jittery shareholders that the money is indeed there.

But it will just be another costly distraction for management whose brief should be to notch up the maximum level of profits for their shareholders.

So what should be done?

It is time to take a more measured and proactive approach to repair the tarnished image of the S-chip sector.

For a start, let's recognise that investor education plays a very important role in our 'caveat emptor' regime where investors are supposed to make informed decisions on their investment choices.

Having a well-educated investing public is the best defence against any unscrupulous businessmen taking advantage of investors because of their investment naivete.

Take the latest accounting scandal to hit the scene - China Gaoxian.

For the last few months, the investing public has been besotted with its plan to launch a dual listing in South Korea.

And without digging deeply into the company's financials, some analysts had taken to making 'buy' calls on the stock, based on this stunt.

The implicit assumption is that the Korean securities houses would have made thorough background checks on China Gaoxian before shepherding it into Seoul.

But China Gaoxian is a recent listing here. It is possible the Koreans gave it the thumbs up in the belief that since the firm had vaulted past regulatory hurdles here, it should be good enough for their market - without further investigations.

China Gaoxian's accounting irregularities might have continued to escape notice, if the SGX had not flagged its concern by asking why the company had drawn down on its bank credit lines and did much of its business on cash terms, even though it was sitting on a huge cash hoard.

In hindsight, the company's explanation that the increased borrowings were made to support Chinese banks in meeting their loans quota seemed ludicrous, given the nationwide efforts to clamp down on credit to stamp out inflation.

Aggrieved investors, stuck with suspended China Gaoxian shares, could have spared themselves the agony if they had paid closer attention to the type of disclosures made by the company in response to SGX's queries.

In future, when the SGX queries a company on its financials, investors should make the extra effort to sit up and study the reply carefully - if only to avoid further grief.

Querying a listed company on its financials or unusual price movements is the SGX's modus operandi in raising a red flag - and sounding the alert to the investing public to trade prudently.

Otherwise, investors will have only themselves to blame for any ensuing losses.

engyeow@sph.com.sg