Report of the Panel of Inquiry on the Penny Stocks Incident
 
Robert G. Kotewall & Gordon C.K. Kwong
9 September, 2002
 

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Contents
EXECUTIVE SUMMARY

 

INTRODUCTION

 

MAJOR FINDINGS

 

CONCLUSIONS

 

RECOMMENDATIONS

 

Engaging the Market and the Public

 

Assessing Market Reaction

 

Improving the Consultation Process

 

Reviewing the Three-tiered Regulatory Structure

 

Strengthening Investor Education and Protection

 

OTHER RECOMMENDATIONS

 

FINAL REMARKS

 

 

PART ONE

BACKGROUND

CHAPTER 1

INTRODUCTION

 

THE PENNY STOCKS INCIDENT

 

APPOINTMENT OF THE PANEL

 

SCOPE OF THE INQUIRY

 

MODUS OPERANDI

 

STRUCTURE OF THE REPORT

 

 

CHAPTER 2

OVERVIEW OF THE HONG KONG STOCK MARKET

 

INTRODUCTION

 

OVERVIEW OF THE HONG KONG MARKET

 

PENNY STOCKS OR MICRO CAPS

 

KEY STAKEHOLDERS IN THE SECURITIES INDUSTRY

 

Interested Parties

 

Investors

 

Securities Intermediaries

 

Credit Providers

 

OBSERVATION

 

 

CHAPTER 3

THE THREE-TIERED REGULATORY FRAMEWORK FOR THE SECURITIES AND FUTURES INDUSTRY

 

INTRODUCTION

 

THE THREE-TIERED REGULATORY FRAMEWORK

 

Origin of the Three-tiered Structure

 

The First Tier - The Government

 

The Second Tier - The SFC

 

The Third Tier - The HKEx

 

REVIEW AND REFINEMENT

 

 

CHAPTER 4

ORGANIZATION, COMMUNICATION AND CONSULTATION CHANNELS

 

INTRODUCTION

 

RELEVANT PARTIES

 

The First Tier - The Government

 

The Second Tier-The SFC

 

The Third Tier - The HKEx

 

Segregation of HKEx' s Business and Regulatory Functions

 

The Listing Committee

 

CO-ORDINATION WITHIN AND AMONGST DIFFERENT PARTIES

 

Within the First Tier - The Government

 

Within the Second Tier - The SFC

 

Within the Third Tier - The HKEx

 

Between the First and Other Tiers

 

Between the Second and Third Tiers

 

CONSULTATION AND MARKET ASSESSMENT

 

The Government

 

The SFC

 

The HKEx

 

 

CHAPTER 5

PROCEDURES FOR THE PREPARATION AND RELEASE OF LISTING RULES AND AMENDMENT THERETO BY THE HKEx

 

INTRODUCTION

 

LISTING

 

AUTHORITY FOR MAKING OR AMENDING LISTING RULES

 

Transfer of Authority from the SFC to the Exchange and from the HKEx Board to the Listing Committee

 

PROCEDURES FOR AMENDMENT TO THE LISTING RULES

 

Four Stages

 

Initiation

 

Preparation and Release of Consultation Papers

 

Market Consultation

 

Approval

 

OBSERVATIONS

 

No Pre-consultation Sounding Exercise by the HKEx

 

Involvement of the Listing Committee

 

Role of the SFC

 

 

CHAPTER 6

THE ACCOUNTABILITY SYSTEM AND ITS IMPLICATIONS

 

INTRODUCTION

 

ACCOUNTABILITY SYSTEM

 

ROLE OF THE FINANCIAL SECRETARY

 

ROLE OF THE SECRETARY FOR FINANCIAL SERVICES AND THE TREASURY

 

IMPLICATIONS OF THE ACCOUNTABILITY SYSTEM ON THE THREE-TIERED REGULATORY FRAMEWORK

 

Statutory Powers and Functions of the FS and the Secretary

 

Responsibility over Executive Departments

 

OBSERVATION

 

 

PART TWO PREPARATION AND RELEASE OF THE CONSULTATION PAPER

CHAPTER 7

PREPARATION OF THE CONSULTATION PAPER

 

INTRODUCTION

 

IDENTIFYING PENNY STOCKS AS A PROBLEM

 

FORMULATING THE PROPOSALS

 

The Proposal in its Embryonic Form

 

Subsequent Evolution

 

The Main Communications

 

How The Matter Developed

 

EXCHANGES BETWEEN THE HKEx AND THE SFC

 

Key Exchanges

 

First Draft Paper on Share Consolidation

 

The SFC's Comments on First Draft Paper on Share Consolidation

 

Second Draft Paper on Share Consolidation

 

The SFC's Comments on the Second Draft Paper on Share Consolidation

 

First Draft of the Consultation Paper on Admission Eligibility Criteria and Continuing Eligibility Criteria

 

Second Draft of the Consultation Paper

 

Third Draft of the Consultation Paper and the SFC' s Comments

 

Fourth Draft of the Consultation Paper and the SFC's Comments

 

Fifth Draft of the Consultation Paper and the SFC's Comments

 

Sixth Draft of the Consultation Paper

 

Sixth Draft Circulated to the Listing Committee

 

Listing Committee Deliberation

 

Finalizing the Consultation Paper

 

Observations

 

INVOLVEMENT OF THE GOVERNMENT

 

Chronology of Events Involving the Government

 

From October 2000 to November 2001

 

December 2001 to January 2002

 

Tripartite Meetings and Co-ordination Committee Meetings

 

First Tripartite Meeting on 24 January 2002

 

Coordination Committee Meeting on 1 March 2002

 

Second Tripartite Meeting on 19 March 2002

 

Third Tripartite Meeting on 7 June 2002

 

SFST Assumed Office on 1 July 2002

 

1 July to 24 July 2002

 

Involvement of the Financial Secretary

 

OBSERVATIONS

 

COMMUNICATIONS WITH THE MARKET

 

The HKEx

 

The SFC

 

Consultation Networks

 

Consulting the Shareholders Group on the HKEx's Proposals

 

Observations

 

Shareholders Group Meeting on the 6 March 2002

 

Advisory Committee Meeting on the 13 May 2002

 

Government

 

OVERALL OBSERVATIONS

 

Formulating the Proposals

 

Alternative Trading Platforms

 

 

CHAPTER 8

THE PRESENTATION AND RELEASE OF THE CONSULTATION PAPER

 

PRESENTATION

 

TIMING FOR THE RELEASE OF THE PR PACKAGE

 

TIMING FOR THE RELEASE OF THE CONSULTATION PAPER

 

The HKEx' s Plan

 

Why 25 July 2002?

 

Why a Thursday?

 

PRESS CONFERENCE

 

DISTRIBUTION OF THE CONSULTATION PAPER

 

 

CHAPTER 9

THE SIX EVENTFUL DAYS - 26TH TO 31ST JULY

 

MARKET RESPONSE

 

THE AFTERMATH

 

Overview

 

26 JULY 2002

 

Morning and Early Afternoon

 

The HKEx' s Press Statement

 

The SFC's Press Statement

 

The Secretary's Media Stand-up

 

27 JULY 2002

 

The HKEx' s Clarification and Extension of Consultation Period

 

Discussion between the FS and the Secretary

 

28 JULY 2002

 

Luncheon with Brokers

 

Meeting at the FS'Residence

 

Press Conference at 6:00 p.m.

 

29 JULY 2002

 

Preparing a Chronology of Events for the Secretary

 

The FS'Remarks

 

30 JULY 2002

 

Discussion between the Bureau and the Secretary

 

31 JULY 2002

 

Clarification

 

Preparation

 

Special Meeting of the LegCo Panel on Financial Affairs on 31 July 2002

 

The Secretary

 

The SFC Chairman

 

Chief Executive of the HKEx

 

 

CHAPTER 10

WHAT HAPPENED ON THE 26 JULY 2002 AND WHY

 

INTRODUCTION

 

GENERAL COMMENTS

 

ECONOMIC OVERVIEW

 

PRESS COVERAGE PRIOR TO THE ANNOUNCEMENT

 

THE MARKET IN THE PERIOD FROM THE 26 JUNE 2002 TO THE 25 JULY 2002

 

THE BEHAVIOUR OF THE MARKET ON THE 25 JULY AND THE 26 JULY 2002

 

The 25 July 2002

 

The 26 July 2002-Immediately after opening

 

After 11:00 a.m. on the 26 July 2002

 

LOSS IN MARKET CAPITALIZATION ON 26 JULY 2002

 

CHURN RATE

 

BEHAVIOUR OF DECLINING STOCKS PRIOR TO THE 26 JULY 2002

 

THE MARKET SINCE THE 26 JULY 2002

 

PRELIMINARY FINDINGS

 

THE SAC's CONCLUSIONS

 

THE PANEL'S VIEWS

 

 

CHAPTER 11

A CRITICAL REVIEW

 

INTRODUCTION

 

COMMENTS ON THE INCIDENT

 

Underlying Spirit of the Consultation Paper

 

Yardstick

 

Number of Criteria

 

Minimum Price Threshold and Scope of the Consultation Paper

 

Confusing Message

 

Alternative Trading Platform

 

Consolidation

 

Under-estimating the Market Reaction

 

Lack of Market Experience

 

Bad Timing

 

The HKEx' s Consultation Practices

 

Consultation Not Genuine

 

Lack of Communication between the HKEx and Market Players

 

Neglecting the Interests of Small Investors and Companies

 

No Contingency Plans and Wavering Attitude

 

Authorities Shirking Responsibilities

 

Lack of Coordination among the Authorities

 

Comments on the HKEx

 

Comments on the SFC

 

Role of the FS

 

Role of the Secretary (SFST)

 

Comments on the Three-tiered Structure

 

EVALUATING THE COMMENTS

 

MINIMUM TRADING PRICE THRESHOLD

 

The HKEx's Response

 

The SFC's Views

 

The Panel' s Views

 

ALTERNATIVE TRADING PLATFORM

 

The HKEx' s Response

 

The SFC's Response

 

The Panel's Views

 

UNDER-ESTIMATING MARKET REACTION

 

The HKEx' s Comments

 

The SFC's Comments

 

The Panel' s Views

 

LACK OF MARKET SENSE

 

The HKEx' s Comments

 

The Panel' s Views

 

NO CONSULTATION WITHIN THE HKEx NETWORK

 

The HKEx' s Comments

 

The Panel' s Views

 

Listing Committee

 

LACK OF COMMUNICATIONS WITH THE MARKET

 

The HKEx' s Comments

 

The Panel' s Views

 

BAD TIMING

 

The HKEx' s Comments

 

The SFC's Comments

 

The Panel' s Views

 

CONSULTATION NOT GENUINE

 

The HKEx' s Comments

 

The Panel's Views

 

 

CHAPTER 12

ROLES OF INDIVIDUALS

 

INTRODUCTION

 

FINANCIAL SECRETARY

 

His Involvement

 

Division of Responsibility between the FS and the Secretary under the New Accountability System

 

Political Responsibility under the Accountability Systems

 

Remarks on the 29 July 2002

 

Observations

 

SECRETARY FOR FINANCIAL SERVICES AND THE TREASURY

 

His Involvement

 

His Responsibilities

 

THE SFC CHAIRMAN

 

His Involvement

 

Remarks on the 28 July

 

His Responsibilities

 

CHIEF EXECUTIVE OF THE HKEx

 

His Involvement

 

His Responsibilities

 

FINANCIAL SERVICES AND THE TREASURY BUREAU

 

Involvement

 

Responsibilities

 

 

PART THREE CONCLUSIONS AND RECOMMENDATIONS

CHAPTER 13

CONCLUSIONS

 

INTRODUCTION

 

CONCLUSIONS

 

Conclusion No. 1

 

Conclusion No. 2

 

Conclusion No. 3

 

Conclusion No. 4

 

Conclusion No. 5

 

Conclusion No. 6

 

Conclusion No. 7

 

Conclusion No. 8

 

Conclusion No. 9

 

 

CHAPTER 14

RECOMMENDATIONS

 

SUMMARY OF RECOMMENDATIONS

 

GENERAL RECOMMENDATIONS

 

PREPARATION AND RELEASE OF CONSULTATION DOCUMENT

 

Engaging the Market and the Public

 

Making the Best Use of the Existing Network

 

Expanding the network

 

Ensuring a Broadly Representative Network

 

Engaging the Market at an Early Stage

 

Proposals by the Executive of the HKEx

 

Assessing Market Reaction

 

Improving the Consultation Process

 

Reviewing the Three-tiered Regulatory Structure

 

Strengthening Investor Education and Protection

 

OTHER RECOMMENDATIONS

 

 

CHAPTER 15

FINAL REMARKS

 

 

 

List of Annexes

Annex

Documents

Annex 1.1

Representations Received

Annex 4.1

Government Officers Involved in Securities-related Policies

Annex 4.2

Organisation Chart of the Securities and Futures Commission (SFC)

Annex 4.3

Organisation Chart of the SFC Corporate Finance Division

Annex 4.4

Hong Kong Exchanges and Clearing Limited: Membership of the HKEx Board and Committees

Annex 4.5

Terms of Reference and Membership of the HKEx Consultative Panels

Annex 4.6

Organisation Chart of the HKEx

Annex 4.7

The HKEx's Listing, Regulation & Risk Management Unit

Annex 4.8

Board of Directors of the Stock Exchange of Hong Kong Limited

Annex 4.9

Membership List of the Listing Committee

Annex 4.10

Securities and Futures Liaison Meeting

Annex 4.11

Tripartite Meeting

Annex 4.12

Coordination Committee

Annex 4.13

SEHK-SFC (Listing) Liaison Committee Meetings

Annex 4.14

SFC Advisory Committee

Annex 4.15

SFC Shareholders Group

Annex 6.1 Examples of Statutory Provisions Conferring Powers and Responsibilities upon the Financial Secretary

Annex 7.1

Chronology of Events

Annex 7.2

Newspaper Summaries Put Together by The HKEx

Annex 11.1

Media Coverage in the Morning of the 26 July 2002

Annex 12.1

Job Description of the Secretary for Financial Services and the Treasury

 

Legend of Abbreviations

AMS

Automatic Order Matching and Execution System

Bureau

The Financial Services Bureau (before 1.7.2002)
The Financial Services and the Treasury Bureau (since 1.7.2002)

CE

Chief Executive of the Hong Kong Special Administrative Region

FS

Financial Secretary

FSA

Financial Services Authority

FSB

Financial Services Bureau

FSTB

Financial Services and the Treasury Bureau

GEM

Growth Enterprise Market

HKEx

Hong Kong Exchanges and Clearing Limited

MOU

Memorandum of Understanding

LegCo

Legislature Council

MSCI

Morgan Stanley Capital Investment

OTC

Over-the-counter

PRP

Process Review Panel

PSFS

Permanent Secretary for Financial Services and the Treasury (Financial Services)

SAM

Semi-automatic Matching System

Secretary

The Secretary for Financial Services and the Treasury

SEHK

Stock Exchange of Hong Kong Limited

SFAP

Securities and Futures Appeals Panel

SFC

Hong Kong Securities and Futures Commission

SRC

Securities Review Committee

UK

United Kingdom

US

United States


ChineseGovernment Information Centre Last updated: October 17, 2002