Following our scoop that Vincent Lo's Shui On Group had an undisclosed interest in Panda-Recruit, the company put out an announcement which defined "independent" in a piece of legal dissection not seen since Bill Clinton's definition of "is". This affair highlights a much wider loophole in the Stock Exchange's definition of connected parties, as we explain.

The Independent Panda
11 August 2000

In our exclusive article on 19-Jul-00, we disclosed that Shui On Group, run by Vincent Lo Hong Sui (Vincent Lo), had a 22.22% stake in a company called Century Faith Investments Ltd (Century Faith), which in turn owns 23.54% of Panda-Recruit Ltd (Panda Recruit) after its recent IPO. Shui On Group's stake was held through a wholly-owned subsidiary called Salespost Ltd (Salespost).

Vincent Lo is a director of both Century Faith and Panda-Recruit. He is a brother of Lo Ka Shui, who is Chairman of Panda-Recruit, Chairman of the GEM Listing Committee and a director of Century Faith. 66.67% of Century Faith is owned by Great Eagle Holdings Ltd, founded and chaired by their father.

While the prospectus disclosed Great Eagle's interest, the document claimed (p138):

"the remaining 33.33% [is] held by independent third parties"

The prospectus also states that Lo Ka Shui represents Century Faith on the board of Panda-Recruit, and (p139):

"Apart from the representative nominated, the Directors [of Panda-Recruit] and their respective associates as defined in the GEM listing rules are independent from Century Faith".

The Meaning of Independent

In response to our article and the ensuing press coverage, Panda-Recruit put out an announcement (PDF format) on 23-Jul-00 addressing the two statements we highlighted. The announcement states that:

"the Company's legal adviser has reconfirmed to the Company that the statements were not misleading"

Well that's a relief! By the way, the legal advisers to the company on the IPO were Messrs Sit, Fung, Kwong & Shum. Senior Partner Peter Sit Kien Ping is a non-executive director of Panda-Recruit. He is also an independent non-executive director of Chinese Estates Holdings Ltd, The Kwong Sang Hong International Ltd and Asia Commercial Holdings Ltd.

In relation to the first statement, that the remaining 33.33% of Century Faith is held by independent third parties, the legal adviser confirmed that the statement was "legally correct" because:

"the ultimate owner of [Salespost] is a discretionary trust managed by the third party Trustee who is legally independent from [Vincent Lo] notwithstanding the fact that the Trustee, under the GEM Listing Rules, is an associate of [Vincent Lo]".

The trustee may be legally independent, but the reasonable reader would assume that "independent" did not include persons who are associates of directors under the Listing Rules, since such persons are also "connected parties" under the Listing Rules.

What this means is that the Stock Exchange and all of us, from now on, should be extra suspicious of any unqualified claim by a listed company that a person is an "independent third party". Unless there is an additional statement that the person is not a connected party (which includes directors and their associates) then the statement is worthless.

What's a Trust?

For those who don't have billions to protect from estate duty (or death tax) we should explain that a discretionary trust is a legal method which the rich use to avoid death tax on their HK assets.

The person with the assets (known as the "settlor") establishes a trust by appointing a trustee under the terms of a trust deed, and nominating his family as beneficiaries. He then passes all his assets to the Trustee, and can die penniless in the eyes of the HK tax man, provide he lives for 3 more years. (Note: if you are a tycoon reading this, get your own tax advice - we are not responsible).

The trustee in theory acts independently of the settlor and controls the assets, but in practice most trustees will follow the wishes of the settlor, since their business and reputation depends on it. You won't find them voting against the settlor's wishes in shareholders' meetings!

Leading trustees of Hong Kong's tycoons include subsidiaries of Bank of Bermuda, HSBC, Citibank and Barclays. It's a huge but seldom-mentioned industry. There is an International Trust Companies Association and there is even a Hong Kong Trustees Association.

If you took the legal advice offered to Panda-Recruit, then you would believe that the controlling shareholder of Sun Hung Kai Properties is "independent" of the Kwok brothers, and so on.

Some tycoons prefer not to trust banks and instead set up complicated unit trust arrangements whereby the trustee of the unit trust owns the shares, and the units are held by another trust, and both trustees are owned by the tycoon, and so on. We are in for a few entertaining court cases when these arrangements get tested by the Inland Revenue as the current generation of tycoons passes on.

The Meaning of Associate

The second statement in the prospectus (p139) was more explicit:

"Apart from the representative nominated, the Directors [of Panda-Recruit] and their respective associates as defined in the GEM listing rules are independent from Century Faith".

Now "respective associates" includes the Trustee, and Panda-Recruit's response accepted this, but then dodged around the point by saying:

"The Trustee is independent of Century Faith notwithstanding its passive indirect minority interest in Century Faith".

Of course, one might regard the Trustee as passive - it is unlikely to go around telling Vincent Lo how to run the Shui On Group, even if technically the Trustee owns and controls it. But it is a bit of a stretch to call a 22.2% beneficial shareholder of Century Faith "independent".

The Associates Loophole

OK, now wake up and pay attention at the Stock Exchange - we will show you a loophole big enough to pass a camel through.

Notice that the response from Panda-Recruit did not discuss whether Salespost and Shui On Group are "associates" of Vincent Lo under the GEM Listing Rules, and hence did not discuss whether they are "independent" of Century Faith.

In fact, this spotlights a loophole which may well have been exploited by other listed companies in the past.

An "associate" as defined in Rule 1.01 in relation to any director, chief executive, substantial shareholder or management shareholder (being an individual) includes:

"(a)(ii)    the trustees, acting in their capacity as such trustees, of any trust which he or any of his family interests is a beneficiary or, in the case of a discretionary trust, is a discretionary object"

Unfortunately, the definition stops there. It does not go on to include any company which is controlled by such a trustee. So strictly speaking (and clearly, that is how lawyers work), Salespost and Shui On Group are not associates of Vincent Lo, even though the Trustee is. That makes the inclusion of trustees in the definition of "associates" almost useless.

It makes us wonder how many transactions by listed companies are done with companies controlled by trustees of trusts set up by the directors. Such transactions could fall into two categories - those which are not disclosed, and those which are disclosed but the parties are claimed to be "independent" and "not connected" as they pass through the loophole.

In the case of Panda-Recruit, the failure to disclose Shui On Group's interest in the company was not disastrous, but in other cases, it could seriously damage your wealth.

The incredible shrinking Panda

In case you were wondering, the Panda-Recruit share price is now $0.173, down 38% from its $0.28 IPO price since the 20-Jul-00 debut.

©, 2000

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