Published August 21, 2008

Share payment may come back to bite SGX

By WONG WEI KONG
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IT'S uncommon to come across a situation where market players seem to hold themselves to a higher standard when it comes to conflicts of interests than even the regulator itself.

But that appears to be the case when it comes to the question of whether Catalist sponsors should take shares as payment for sponsoring listings on the junior board of the Singapore Exchange (SGX).

As BT reported last week, the decision by PrimePartners Corporate Finance to take shares in Healthway Medical Group for sponsoring its listing in June - the only Catalist sponsor so far to have done this - has spawned a debate in market circles over a potential conflict of interest.

PrimePartners has defended its move, saying the share payment model is a preferred model for many small, cash-strapped companies, and that it helps to align the interest of the sponsor with the company. It noted that it is practised elsewhere, like in London's Alternative Investment Market (AIM).

But PrimePartners looks to be a lone voice here. Many other investment bankers, Catalist sponsors and corporate lawyers have reservations about taking this path.

PrimePartners is acting within SGX rules, clearly, but it is also putting itself in a position where a potential conflict of interest could arise.

The sponsorship system is, after all, the cornerstone of Catalist, which requires all its firms to have sponsors not just to list them but also to keep watch over them after listing, playing the role of a regulator. The worry is that the objectivity required in the performance of that role may be compromised if the sponsor holds shares in the company it is supervising.

It is this that is holding back other sponsors from doing what PrimePartners did, as attractive as it is as a business proposition. The fact that other sponsors are staying clear of taking shares as payment, even when they are allowed to do so, is surely telling. But the SGX has leapt to the defence of this arrangement. Its response to the BT report was titled 'OK to have shares as payment'. It said allowing smaller companies to use share payment would help them conserve cashflow for funding purposes. It noted that only sponsors with high standards and good track records have been approved. Its 10 per cent shareholding cap also acts as a safeguard. In other words, there is no cause for worry.

This does not fully address the issue. For one, share payment for sponsors is put forward as a way to alleviate cashflow constraints for small companies. However, lawyers, auditors, and other professionals are not allowed to enter into similar arrangements so that their independence can be safeguarded.

In other words, allowing share payment for sponsors is at odds with the position taken for the other professionals, especially given that non-sponsor fees are making up an increasingly significant portion of listing expenses.

Or is the SGX now saying, 'it's OK for them too'? Would companies one day also pay their listing fees to SGX in shares?

It's a fallacy to look at the shareholding cap as a safeguard of independence. The more critical factor is the potential contribution of the share payment to the income of the sponsor. For smaller-sized sponsors, this might be a bigger proportion of their earnings than for larger firms, and this would pose a more serious threat to their objectivity and independence as sponsors.

While there are penalties against sponsors who do not act properly, it is equally important to avoid constructing situations that would put them in a compromised position in the first place.

Expensing the payment?

There are other issues. The implementation of accounting standards requiring the expensing of share-based payment in the profit-loss statement of companies was to deter them from using share payment structures (such as issuing stock options to staff) at the expense of shareholders. But share payment for sponsors also falls into this category, and will have to be expensed too. So while the model may initially align the interests of the sponsor with the company, there is a future cost to be borne by both the company and its shareholders.

To be sure, share payment for sponsors is used elsewhere, but that is not reason enough to justify their use here. Singapore does not always follow practices in other markets. For instance, companies are required by law in several leading markets to disclose the actual pay of their directors. But while many have advocated that as best practice, it was decided that Singapore was not ready to do that. So while share payment is used, for instance, in AIM in London, it may not be best for Singapore.

But the biggest point being missed is this: when it comes to corporate governance, avoiding the appearance of any suggestion of a potential conflict of interest is as important as keeping to the rules. All it takes is just a hint - that the sponsor may be conflicted - to undermine trust in the system. That is why companies are often encouraged to uphold standards of corporate governance beyond the minimal requirements.

Disallowing share payment may cause the SGX to lose a few Catalist listings and mean less business for sponsors. But it would have shielded the system from being questioned.

It has to be said that this does not come as a surprise to those who regard the SGX as a creature of contradiction itself as both a listed company and a regulator. The share payment episode has reinforced that perception. And should share payment lead to problems down the road, the SGX would find itself with plenty to answer for.