Chinese companies may soon find the back door to a Canadian stock listing slammed shut, as regulators weigh tougher rules on a fast-track approach to going public taken by Sino-Forest and other fallen angels. A growing list of suspect Chinese companies listed in Canada has prompted the country's main securities regulator to initiate a review that could lead to tighter norms for listing a foreign company and stringent accounting rules for those that make the grade.
While the Ontario Securities Commission has not singled out Chinese companies per se, most of the emerging market companies listed in Canada are headquartered in China. Like Sino-Forest, a tree planation operator accused of massive fraud, most of those companies went public via reverse take-overs (RTOs), a process that entails less regulatory scrutiny than initial public stock offerings.
More than 50 percent of the Chinese companies currently on the small-cap TSX Venture Exchange listed via reverse take-overs. In fact, Canadian exchange operator TMX Group encourages reverse takeovers. One type of reverse take-over is a particularly easy path. Under TMX's capital pool company (CPC) program, investors can set up shell companies on the TSX Venture Exchange. These exist solely to acquire fledgling companies that want to raise capital but have no experience in the listing process.
Startup companies can list via CPCs without being vetted by underwriters, as required under an initial public offering. The potential for abuse runs high, some critics say. "I'm willing to bet that the commission looks seriously at doing away with emerging market issues coming to market via shell take-over bids," said Joseph Groia, a Toronto-based securities lawyer and former OSC enforcement director.
Back door listings via CPCs have become more common than traditional reverse take-overs, which usually involve a defunct company that a private entity uses to go public. While in a normal reverse take-over the shareholders of the acquirer get to vote on the proposed take-over, in the case of CPCs the investors typically have no say in the acquisition.
The OSC confirmed in an email that it plans to examine emerging market entities that listed via CPCs and other types of reverse take-overs. "We have not disclosed specific information on the issuers being examined as part of this review," said OSC spokeswoman Carolyn Shaw-Rimmington. "Once the review is completed, the OSC will consider whether the findings have broader policy implications for the regulatory regime."
The OSC has faced criticism in recent weeks for its inaction while shares of Toronto-listed Sino-Forest collapsed in the wake of fraud accusations made by an influential short-seller and analyst. Groia believes the Sino-Forest scandal and other cases will prompt regulators to get tougher.
"What I think the commission is essentially saying is that they're not sure any more that the current rules and regulations are sufficient for protection of investors with emerging market issuers," said Groia. However, Kevan Cowan, group head of equities for the TMX, argues that these companies undergo as rigorous a listing process as any company listing through an IPO.
The TMX imposes the same due-diligence on companies listing on the junior exchange as it does on those listing on the senior Toronto Stock Exchange, he said. However, Jean-Marc Suret, an accounting professor at Laval University, disagrees and has been calling for a reform of the CPC program for years.
Suret's data suggests that it is usually only CPC insiders that stand to make money after the company goes public, as share prices tend to peak when CPCs announce their acquisition, and then fall. "Basically, for the investors, this is a waste of money," said Suret. The CPC program evolved from the erstwhile Alberta Stock Exchange's Junior Capital Pool Program. Its primary aim was to give small Canadian resource companies with early stage assets an avenue to go public and tap equity markets.
Suret compares CPCs to the "blank check" penny stocks that proliferated in the United States in the 1980s. Like blank check companies, CPCs tend to lack liquidity and entice investors before disclosing any details of their business operations, critics say. Blank check companies were severely restricted by the Penny Stock Reform Act of 1990 and SEC's Rule 419, which among other things increased their minimum size. Suret suggests a similar overhaul to the CPC program.
Then again, some believe that making CPCs larger would hurt worthwhile Canadian ventures. While CPCs are not necessarily the best way for Canada to promote emerging market issuers, putting undue restrictions on these companies could harm Canadian interests, Groia says. The country needs to balance regulation with the need to foster growth within the junior resource sector.