By Rachel Armstrong and Michael Flaherty
HONG KONG (Reuters) - Hong Kong's securities regulator has set up a task force to detect fraud by listed companies, extending its increasingly muscular approach into an area traditionally overseen by the city's stock exchange.
The power shift marks the latest step by the Securities and Futures Commission (SFC) to try to tackle fraud in the Hong Kong stock market, which is particularly tough to police given the majority of its companies are based overseas.
The move suggests the watchdog is set to take a tougher line against company management and majority shareholders, stepping in after a series of accounting scandals threatened to damage the city's reputation as a leading international financial centre.
"Corporate governance is now firmly on the commission's radar screen," said Gareth Hughes, a partner at Ashurst law firm.
The independent SFC established the corporate regulation group last month to comb through stock market announcements, research notes and press articles looking for possible red flags, mirroring the approach taken by the Securities and Exchange Commission (SEC) in the United States.
The move underlines the SFC's more hands-on role in monitoring corporate governance, a task previously taken by the publicly-traded Hong Kong Exchanges and Clearing Ltd <0388.HK>, the frontline regulator and operator of the city's stock market.
"The SFC is assuming direct regulatory oversight that was historically undertaken by the exchange, resulting in increased listed company surveillance and enforcement by them," said James Wadham, a partner at Davis Polk and Wardwell in Hong Kong.
The SFC has already beefed up its role this year as the stock market's gatekeeper by bringing in tough new rules for investment banks and finance firms that sponsor initial public offerings (IPOs), making them liable for the contents of listing prospectuses.
This latest move was first flagged by SFC chairman Carlson Tong in a speech last week and confirmed by lawyers.
The group is in a soft launch phase and the SFC declined to provide further comment.
"A major priority for the SFC is to take on broader, more proactive oversight of listed companies as a corporate regulator," Tong said.
"By actively detecting misconduct and following up on suspicious activity, we hope to identify red flags and enhance the SFC's role in maintaining quality markets and high corporate governance standards, as well as protecting investors."
Tong added the SFC is working with Hong Kong Exchange to ensure they don't duplicate work.
The team sits in the SFC's corporate finance division and has half a dozen people right now but could grow if its approach proves effective, according to people familiar with the matter.
It will be focusing on issues such as related party transactions and other forms of financial engineering that see value transferred out of a company, trying to provide greater protection to minority shareholders.
If the group spots anything amiss, it will take it up with the company. It will refer cases to the SFC's enforcement division if it suspects serious wrongdoing.
OUT OF REACH
More than half of Hong Kong-listed companies are based in mainland China, with several involved in accounting scandals in recent years.
There is no extradition treaty between Hong Kong and the mainland making it hard to take criminal action for fraud.
Allegations of fraud have been levelled at several companies including China Metal Recycling Holdings Ltd <0733.HK> and Chaoda Modern Agriculture <0682.HK> by short-sellers who often target stocks that have carried out suspicious looking transactions. That has raised questions about why short-sellers, who stand to profit from a falling share price, are raising these concerns rather than the regulators.
Hong Kong Exchange has primary responsibility for ensuring companies follow listing rules and shares are suspended from trading if regulations are not being complied with or if a company is in a precarious financial position.
A report by the exchange shows that on November 30, there were 42 companies whose shares had been suspended for more than three months. Of those, 17 are under formal investigation for potential irregularities.
The SFC's new team is likely to raise questions about whether it is assuming more of the exchange's surveillance role.
How the exchange handles the conflict of interest between earning money from listing and trading fees on one hand and regulating the market on the other has come under scrutiny as a result of Alibaba's possible Hong Kong listing. Alibaba wanted to use a structure not allowed under the exchange's listing rules, and the bourse is under scrutiny to see if it will try to change its rules to accommodate a company worth an estimated $80 billion.
The SFC's move should help counter any suspicion that companies can get an easy ride in the Hong Kong market.
"This should definitely serve as a wake up call to companies to ensure they have their house in order," said Ashurst's Hughes.
(Reporting by Rachel Armstrong and Michael Flaherty; Editing by Jeremy Laurence)