By Mak Yuen Teen

In light of the proposal by SGX to scrap the MTP rule, I am re-posting an earlier article on it, which includes a small correction. I had in the earlier version stated that the MTP requirement came into effect two years ago . The original MTP rule was implemented in March 2015, with the first review of companies having taken place in March 2016.  The market capitalisation criterion was added in December 2016 and the first review of companies under the current criteria was made in June 2017.

My view is that we may be delaying the inevitable for many companies trading at extremely low prices and which have been unable to improve their share prices after several years.  

However, having read SGX’s consultation paper, I can see that it is strengthening the financial watchlist regime, through stronger vigilance over companies “gaming” the criteria, and by considering whether a company has an adverse or disclaimed audit opinion or a material uncertainty relating to going concern. This is in line with the suggestion in my original article. I am more supportive of scrapping the MTP rule if the financial watchlist regime is strengthened.



____________________________________

According to the Business Times report “SGX to propose scrapping rule on
minimum trading price: sources” (July 19), SGX Regco is about to embark on a
consultation which may lead to the reversal of the decision taken three years
ago to introduce the Minimum Trading Price (MTP) requirement for Mainboard
companies. In December 2016, the market capitalisation criterion was added, and
the first review of companies under the current criteria was made in June 2017. 
It seems that, faced with the prospect of delisting as many as 54 Mainboard
companies by June 2020, SGX is having second thoughts about the rule. Certain
market practitioners have quickly jumped in to support the removal of the MTP
requirement.

Let’s remember why the MTP requirement was introduced in the first place. It
was based on concerns that low-priced stocks (penny stocks) are more
susceptible to market manipulation. Arguably the biggest scandal that has
occurred in our market is the “penny stock scandal”. Is SGX Regco now satisfied
that the reason for introducing the rule no longer exist or was never valid in
the first place? Or that it and/or other regulators have more effective tools
for dealing with this risk, such as better monitoring and enforcement? One of
the market practitioners quoted in the report indeed cited “new technology and
resources now available to improve market surveillance and analysis” as a
reason to do away with the “blunt tool” of MTP. Not so fast, I say, because I
am not convinced we have got a handle on market manipulation and enforcement
for penny stocks, or for other stocks for that matter.

Removing the rule just because there will be a wave of delistings may not be
the right thing to do – or worse, it may be construed as self-serving as such
delistings will affect SGX’s revenues. In fact, if the rule is intended to
improve market quality and the market is filled with poor quality firms, then
we  would expect such delistings to occur.

Another problem with having many low-priced stocks here is that the market
has attracted the label of a “penny stock market”. If we remove the MTP
requirement, that label will continue to stick.

Low-priced stocks are also unlikely to attract reputable asset managers and
institutional investors, who may have internal guidelines about minimum price
of stocks they invest in. It is doubtful that these investors will be investing
in stocks trading at a few cents. This means that most public investors in
penny stocks are retail investors. Penny stocks are also much less likely
to be covered by analysts. Therefore, market-based checks and balances are
likely to be far less developed for such stocks.

Regulators in the US have long raised concerns about the risks of
manipulation of low-priced stocks, including stocks trading on its
over-the-counter market, which may include stocks which have been delisted from
the public exchanges because of failure to meet their minimum price
requirement. Reading the discussions about “penny stocks” in the US shows how
“penny” our penny stocks here are. In the US, stocks trading at below US$5 have
been referred to as penny stocks by some regulators and practitioners.
Certainly, anything below US$1 seems to considered a “penny stock” even by the
most conservative commentators in the US.

Some companies here have sidestepped the MTP requirement by transferring to
Catalist, which does not have such “watchlist” requirements. A report earlier
this year by Mark Lai and me raised concerns about such transfers and how they
affect the quality of Catalist and potentially harm minority investors.

I empathise with the view of the executive chairman of one company facing
the threat of delisting due to the MTP requirement that transferring to
Catalist is not the answer – because the company which has a good compliance
record will not really benefit from having to appoint a sponsor, which will be
a further drain on the company’s resources. However, rather than totally
discarding the MTP requirement, perhaps SGX Regco should review the whole
“watchlist” scheme and consider modifying certain criteria and introducing
other criteria that better capture the risks to investors.

Minimum trading price

Both NYSE and NASDAQ have a minimum price requirement of US$1. Stocks that
fall below US$1 face the possibility of delisting. However, both exchanges have
a minimum initial listing price of US$4. Therefore, stocks which have fallen by
75% or more face the risk of delisting.

On SGX, the minimum initial listing price for Mainboard companies is 50
cents. It used to be 25 cents. Perhaps an MTP of 20 cents is too high if the
minimum initial listing price is just 50 cents. One possibility is to revise
the MTP to 10 cents.

Market capitalisation

In August 2016, when SGX proposed sparing companies from the MTP watchlist
if they have an average market capitalisation of at least $40 million over the
past six months, it said:

“We noted from the review that among companies with a six-month
volume-weighted average price (VWAP) of shares of less than S$0.20, those with
market capitalisation of S$40 million or more showed better liquidity
characteristics and lower volatility compared with companies with market
capitalisation of less than S$40 million.” SGX said that this suggests that the
market capitalisation test as an MTP entry criterion will complement the
existing requirement to more precisely achieve the goal of reducing excessive
speculation and potential manipulation.

The $40 million market capitalisation criterion already applied to the
Financial Entry watchlist.

An astute market observer pointed out to me how this can be gamed. A company
can issue 40 billion shares and since the minimum trading price is $0.001, the
market capitalisation for the company will always be at least $40 million. So,
this is like insurance against ever getting onto the watchlist. He pointed out
to me that at least one company seems to have figured this out and used it.

Whether it is MTP watchlist or Financial Entry watchlist, SGX needs to be
alert to companies gaming the parameters that are used to determine whether a
company enters or stays out of it. I would argue that the minimum trading
price, which is based on the six-month volume-weighted average price, is harder
to game than the average market capitalisation criterion and the financial
criterion of pre-tax losses for the three most recently completed consecutive
financial years using the latest announced consolidated accounts.

A new criterion?

SGX Regco may wish to consider introducing an additional criterion for
placing companies on the watchlist, based on the external auditors’ opinion on
the issuer’s audited financial statements. For example, companies that have
received either an adverse or disclaimer opinion, or where the auditors have
highlighted a material uncertainty relating to going concern or expressed a
qualification about the issuer’s ability to continue as a going concern, for
two consecutive financial years should be placed on the watchlist. If they fail
to resolve these issues within a reasonable period of one to two years, they
should also be considered for delisting.

This will also provide more teeth to the external auditor’s report and make
issuers take the audit more seriously. There are some “zombie” companies listed
on the Mainboard that have received disclaimers or other serious audit
qualifications for five or more years, but yet have been able to remain listed.
This criterion should also be considered for a watchlist for Catalist
companies.

To me, these companies are arguably worse than companies which have a low
share price or reporting losses but have clean auditor’s opinions. This is
because for the latter, at least we have better assurance about the numbers
that the companies are reporting and whether they are likely to be able to
survive. For the former – especially companies with adverse and disclaimer opinions
– we may not even know if what they report in their financial statements
represent the true state of affairs of the company.

Perhaps SGX can waive the watchlist for companies that have clean audit
opinions, and start putting those with serious shortcomings in their audit onto
the watchlist instead – for both Mainboard and Catalist companies.