Published March 9, 2009

Time to disclose pledged shares?

By LYNETTE KHOO

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MARGIN calls and forced selling of pledged shares have been sweeping the market of late, causing some drastic declines in share prices.

While this is to be expected in a depressed market, what is worrying is when a forced sale results in a management overhaul or change of group control, or affects a company's ability to continue as a going concern.

This raises the question of whether there should be rules to govern the disclosure of pledged shares. There is currently no such rule and shareholders only know about the pledging of shares after an announcement is made on the change in substantial shareholding, usually days after a forced sale has already taken place.

By then it may be too late for shareholders to react.

It gets more unsettling when the shares are mortgaged for personal loans or trading/margin accounts by key management personnel or board members.

In the cases of Beauty China and Sino-Environment, their single-largest shareholders pledged all their shares for personal loans. Beauty China chairman and founder Wong Hon Wai and Sino-Environment chairman and chief executive Sun Jiangrong have defaulted on repayment of the secured debts and face the risk of losing their controlling stake, and potentially management control.

The problem appears particularly acute at Sino-Environment, where a change of control can trigger early redemptions on its $149 million convertible bonds and material losses on its equity swaps. The group has warned that it may not be able to repay the full redemptions if called to do so and this would affect its ability to continue as a going concern.

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What's happening here bears uncanny similarities with the Guangzhao Industrial Forest Bio-Technology Group, where its majority shareholders are no longer the collective single-largest holder after some forced sales late last year. This triggered early redemptions of its convertible bonds. Since then, trading of its shares has been suspended until a solution can be worked out.

No doubt, shareholders have the legal right to pledge their own shares for personal reasons, just like mortgaging a house or other assets. But in the event of default on the secured loans, shareholders - and sometimes the companies of the affected shares - are left treading on thin ice.

If the controlling shareholder who has his shares forced-sold is pivotal to the company's growth, his departure creates even more uncertainties for the group.

Of course, some dealers are concerned that disclosure of pledged shares may put some investors off the market. They argue that if a company is driven by one single shareholder, this alone should have set investors thinking about the risks that could arise if this person loses his stake, quits or encounters something untoward.

There is also the tricky issue of how to define an event as foreseeable. Could we foresee the impact of pledged shares on the control of the group, a default on the group's financial instruments, or its ability to continue as a going concern?

Necessary move

But as memories of Jade Technologies - where a forced sale of pledged shares sabotaged a takeover attempt - remain fresh, most agree that a disclosure of pledged shares is necessary if a share transaction is underway.

While it is probably not feasible or wise to ban the pledging of shares, as that would choke market liquidity, disclosure of pledged shares under certain circumstances may be in the right order.

Perhaps, Singapore can take a leaf from the Securities and Exchange Board of India, which has, since January, enforced mandatory disclosure of any pledged shares held by promoters (persons who are directly or indirectly in control of the company or persons named as 'promoters' in the offer document or in the shareholding pattern) in their own listed companies.

On India's stock exchange, such disclosures will be made as and when the shares are pledged as well as on a quarterly basis. The capital markets regulator will also prescribe limits for such pledging of shares.

It would add transparency to the Singapore market if there are rules that require the disclosure of pledged shares that exceed a certain limit. Shareholders that directly or indirectly own controlling stakes, and control the board or the management, should disclose whether they have pledged their shares.

For the sake of privacy, these disclosures can be made without revealing the purpose of pledging the shares or the amount borrowed.

Whichever way the lines are drawn, the current opacity surrounding pledged shares needs to be addressed. This is so crucial in a caveat emptor market, where investors' only protection is better disclosure.