Hong Kong: The Stock Exchange issued a new guidance letter emphasizing its

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On November 26, 2024, the Stock Exchange of Hong Kong Limited (SEHK) issued a new guidance letter (GL120-24)¹) (“Guidance letter“) to inform the market of expectations regarding investigations into suspended issuers and the role of directors and the Independent Investigation Committee (IIC). According to the latest monthly long-term suspension status report published by the Exchange, as of November 29, 2024, there were 57 Main Board and eight GEM issuers have been suspended from trading for three months or more.

About six years ago, the Exchange established a delisting framework that stipulates that issuers that fail to resume trading within a specified period (18 months for Main Board issuers and 12 months for GEM issuers) must be delisted. Therefore, issuers should act quickly to address all resumption conditions. Conditions for resumption typically include an independent investigation into irregularities identified in an audit of the issuer’s financial performance. We have been regularly advising issuers and IICs on how best to handle these investigations.

The forensic investigation is not a new step in seeking to restore the deal. Given the common deficiencies identified in recent investigations, the Exchange appears to believe it is necessary to issue this guidance letter now.

Expected standards for independent investigations

• evidence preservation: Upon becoming aware of a material breach, directors (whether part of an IIC or not) should immediately identify the problem and potentially relevant evidence (including data on electronic devices). Directors should prevent such potentially relevant evidence from being tampered with or lost. Electronic devices should not be used further or reformatted.
• independence of investigation: The IIC should exclude directors who may have been involved in or aware of irregularities at material times. Written confirmation of independence from IIC members should be obtained. In connection with matters related to the investigation, the IIC should not engage or seek advice from advisers who represent the issuer or its connected persons or who have been involved in transactions related to the breach.
• Investigator involvement: The IIC shall select and retain an independent investigator with the necessary expertise, capabilities, resources, and time to conduct the investigation. If potentially fraudulent activity is suspected, a forensic investigator should be hired. Changes of investigators are not expected without valid reasons.
• Survey plan and regular updates: The IIC should discuss and agree with the investigator the investigation plan (i.e., the objectives, scope, methods, and time frame of the investigation). If accounting irregularities are involved, the IIC should also discuss it with the issuer’s auditors before developing an investigation plan. The IIC should ensure that researchers provide regular updates in a timely manner.
• IIC’s evaluation of findings: The IIC should be skeptical when evaluating its findings. It is not advisable to rely excessively or unquestioningly on the findings of the researcher.
• Investigation reports and announcements: The issuer should make a timely announcement after the investigation report is released. In addition to the report summary, the announcement should describe the following: (i) the IIC’s assessment and opinion (e.g., whether this is an isolated/recurring incident or a systemic failure), (ii) the recommended remedial actions, (iii) the investigators All key limitations and issues encountered. Issuers should also provide a copy of the investigation report to the Exchange as soon as possible.

Investigate defect example

The guidance letter also provides several examples of investigation deficiencies:

• The scope of the investigation is not adequately defined: In some past cases, despite the discovery of internal control deficiencies, investigators failed to identify those who circumvented those internal controls to conduct related unauthorized transactions. Findings should cover root causes.
• Selection criteria unclear: When conducting sample testing (e.g. based on minimum capital flow), researchers should explain the basis and rationality of the selected sample size in the report.
• There are no alternative procedures to address the limitations of the survey: Limitations such as loss of records, reformatting of computer operating systems, and/or lack of cooperation by the parties shall be adequately addressed through alternative procedures. The IIC should discuss with the investigator and reviewer (if applicable) to implement alternative procedures.

We participate in investigations and work with many investigators, all of whom vary in style, quality and responsiveness. Choosing the right researcher is important. We know that investigation costs are often a concern. However, hiring the wrong investigators will mean that the issuer must put in the hard work and incur additional costs to correct an inadequate investigation. More importantly, the purpose of the investigation would be defeated as it would only raise more questions. The return to work schedule will undoubtedly be affected. Going forward, investigations that do not meet these expected standards may be challenged by the Exchange. Therefore, it is important to hire the right researcher first.

To avoid delays in the resumption timetable, issuers, directors and IICs should keep the following points in mind:

• Seek prompt legal advice and be aware of the need to maintain legal professional privilege.
• Carefully design the scope and methodology of your investigation.
• Maintain regular communication with investigators to discuss investigation progress and possible issues/limitations.
• Consider expanding the scope of the investigation to cover additional violations discovered during the investigation, if any.
• Critically review draft investigative reports and be prepared to question methodology and/or findings.
• When challenged, all parties involved should be prepared to explain and justify the steps taken by investigators and the basis for their findings.

1 “Guidelines for investigating long-suspended issuers“