Naming and shaming

With angry taxpayers baying for blood and politicians eager to pass the buck, ritualistic humiliation of banking executives by legislative committees has become a common sight on both sides of the Atlantic. These public dressing-downs have left US and UK bankers, used to a system that discussed and settled regulatory issues behind closed doors, looking rather shell-shocked. Yet such displays might be a precursor to what is coming as government officials and regulators create tough new rules limiting the risk-taking capacity of financial institutions and listed companies.

Stock markets and regulators in the US and Europe typically prefer secretly punishing companies that break the rules, arguing this ‘light-touch’ approach would win the cooperation of the errant issuer. With Adair Turner, the new chairman of the UK’s Financial Services Authority (FSA), insisting that light-touch regulation is dead, there is a growing expectation that the naming and shaming of companies will become more commonplace.

Regulators of the less-developed markets of Asia are more willing to publicly censure companies that have breached listing rules, and several exchanges also publish watch lists of stocks with bad financial records or poor corporate governance. Many companies on these blacklists claim such action is counter-productive, however, as the intense reputational damage caused makes it very difficult for even well-meaning directors to turn the situation around. There is also evidence that naming and shaming can have other undesirable outcomes, such as a spike in highly speculative trading as investors gamble on the chances of recovery at blacklisted firms.

Varied approaches
Most regulatory authorities have the power to publicly censure miscreants, but no clear consensus exists on how frequently such action should be taken. Although the US regulatory system is considered tougher than those of other western markets, the NYSE and NASDAQ have issued just a handful of public censures in recent years. Likewise, in London, both the FSA, regulator of the London Stock Exchange (LSE), and the LSE itself, regulator of the Alternative Investment Market, rarely name companies that break the rules.

The LSE maintains it is not always appropriate to out errant companies, believing it can act more nimbly when it avoids the legal complications inherent in naming rule breakers. But in Asia, where breaches of the listing rules appear to be much more frequent, it is a different picture. The Singapore Exchange (SGX) and Hong Kong Exchange (HKEx) often issue public censures against companies for offenses ranging from failure to disclose information in a timely manner to concealing details of related-party transactions. While disciplinary action in US and UK exchanges can take years, justice is more swift in Asia: in March, the SGX took just days to publicly reprimand shipping group Neptune Orient Lines for failing to address market rumors of a possible rights issue in a timely fashion.

In addition, SGX, like the Shanghai Stock Exchange (SSE) and the Hochiminh Stock Exchange (HOSE), publishes a watch list alerting investors to companies that under-perform (three consecutive years of losses and market capitalization below a set limit). Issuers are then required to take active steps to improve their financial position and have two years to sort out their problems before their shares are forcibly de-listed.
HOSE employs a similar system, while under-performing SSE companies are put under ‘special treatment’, with the prefix ST added to their stock ticker and a 5 percent daily price-band trading limit.

Unhelpful attention
Although many investors appreciate this transparent approach to market discipline, some of the affected issuers argue that naming and shaming is unhelpful for all concerned. ‘We are only a small company, and being put on the watch list has done a lot of harm to our reputation with investors and customers,’ says an executive from one Singapore-listed company, who asked not to be named. ‘Evidently we need to improve our financial performance, but we knew that. Being put on this list only makes it harder to turn things around.’

In Vietnam, where capital markets are new and rule breaches frequent, there is a backlash against HOSE’s policy of putting companies that report losses on a watch list. Critics believe it unfairly penalizes companies in an undeveloped market and will put off new firms from listing at a time when there is already a distinct lack of IPOs. Do Van Trac, general director of Saigon’s Cables and Telecommunication Materials Corp, is one of several Vietnamese executives who spoke out publicly after their firms were added to the HOSE watch list.

The State Securities Commission of Vietnam appears to be listening, working on proposals to make it easier for companies to get off the watch list. The regulator also insists its main priority in 2009 is improving disclosure quality to boost investor confidence, badly bruised by the stock market bubble of 2007-08.

The special treatment system also has opponents in China. They argue the approach actually makes for a less orderly and fair market since ST-prefixed stocks often attract highly speculative and poorly informed investors, and trading can become extremely volatile.

Full and fair disclosure
‘Some people believe all regulatory action and censures should be disclosed to the public so investors are fully aware, but I’m not sure exchanges need to disclose everything,’ says David Smith, co-head of Asia-Pacific corporate governance research at proxy advisory group RiskMetrics. ‘They must strike a balance between the need to inform the public and the need not to focus too much attention on what they’re doing.’

Public censures may seem unfair to individual companies that have slipped up, but a wider benefit can be gained from naming those that breach the rules: it can deter more negligent issuers while educating the whole market about regulatory issues.

When Wolfson Microelectronics, a London-listed microchip manufacturer, was fined $219,008 by the FSA in early 2009 for not disclosing price-sensitive information in a timely fashion, the regulator gave investors insight into how markets work. The FSA noted that Wolfson had been wrongly advised by its IR consultants, Makinson Cowell, choosing not to seek counsel from its corporate brokers, Citi and JPMorgan, out of concern they would leak information into the market given the ‘inherent conflicts that exist in such businesses.’

‘The financial crisis came about, in part, because of the cozy consensus that has built up between issuers, investors and brokers,’ comments one former FSA official, now working for a large financial institution. ‘Naming those who break the rules helps investors to sort the wheat from the chaff and get a better understanding of what is really happening out there.’