HKEX Censures Goldman For Breaching Listing Agreement
GS (as Issuer of structured products listed and traded on the Exchange) and The Goldman Sachs Group, Inc. (as Guarantor) signed the Listing Agreement with the Exchange dated 25 October 2005. The Listing Agreement set out the obligations to which GS was and is subject as an issuer of structured products. Under Paragraph 2(5) of the Listing Agreement, GS also agreed to comply with the Listing Rules in force from time to time.
GS was the issuer of four European style cash-settled derivative warrants over the Nikkei 225 Stock Average Index (the “Warrants”).
On 11 February 2011, GS published two launch announcements (the “LA”), one for Warrants 10073 and 10074, and another for Warrants 10075 and 10076.
On 17 February 2011, GS published two supplemental listing documents (“SLD”), the first for Warrants 10073 and 10074, and the second for Warrants 10075 and 10076.
The LA and SLD were prepared by external legal advisers on instructions of GS. They were reviewed and approved internally by GS.
In both the LA and SLD for the call Warrants:
“Cash Settlement Amount per Board Lot” was defined as: “(Closing Level – Strike Level) x Index Currency Amount x Exchange Rate” (emphasis added),
where “Exchange Rate” was defined as:
“the rate of Exchange between JPY and HKD (expressed as the number of units of JPY per 1 unit of HKD) on the expiry date at or about 4:00 p.m. Hong Kong time as determined by us by reference to (a) divided by (b), where:
(a) The mid quote as per the rate “USD/JPY” on Reuters page ASFH; and
(b) The mid quote as per the rate “USD/HKD” on Reuters page ASFI.”
(2) “Cash Settlement Amount” in the SLDs is defined as “the excess of the Closing Level on the Valuation Date over the Strike Level, multiplied by the Index Currency Amount, converted from the Reference Currency into the Settlement Currency by multiplying by the Exchange Rate…” (emphasis added)
The equivalent definitions in the LA and SLD for the put Warrants contained the same definition of Exchange Rate and applied it as a multiplier.
Trading of the Warrants commenced on 18 February 2011.
Errors in the LA and SLD and trading suspension on 31 March 2011
On 29 and 30 March 2011, GS noted an increase in the trading volume of some of the Warrants. GS attributed the increase to increased interest in the Warrants since the Japan earthquake. GS staff checked the term sheets of the Warrants (which were correct).
During the night of 30 March 2011, a member of the GS warrants team was informed by an acquaintance of a market rumour that there was a difference in the formula used in documentation prepared and published by GS in relation to the Warrants and the documentation for a similar Nikkei warrant issued by another institution.
Around 8:30am on 31 March 2011, GS staff identified the error arising from the combination of the definition of “Exchange Rate” and the definition of “Cash Settlement Amount per Board Lot” and “Cash Settlement Amount” in the LA and SLD. The Cash Settlement definitions incorrectly provided for the conversion from the Reference Currency to the Settlement Currency to be achieved by “multiplying” the JPY pay out by the Exchange Rate (the “Errors”), rather than “dividing” for the purpose of calculating the HKD pay out.
At approximately 9:00am, GS instructed its external legal advisers to (a) prepare Amendment Notices to correct the Errors; and (b) inform the Exchange of the Errors and that GS as the Liquidity Provider would not provide “ask” quotes for the Warrants until the Amendment Notices had been published. GS’s external legal advisers contacted the Exchange at around 9:10am, and there was subsequently frequent dialogue throughout the morning between GS and/or its legal advisors and the Exchange.
The market opened at 9:30am. The price of the Warrants started to increase sharply at around 9:50am. There was substantial trading of the Warrants in an unusually high price range deviating substantially from the pattern observed since 18 February 2011 although such trading activity did not involve GS as liquidity provider or in any other capacity. A significant portion of this trading was conducted by licensed institutions or individuals, driving up the turnover and price of the Warrants and leading to the unusual price surge.
The Exchange suggested that GS consider suspension of trading of the Warrants. GS promptly emailed the Exchange requesting trading suspension at 10:48am. Trading of the Warrants was suspended at 10:52am.
In the afternoon on 31 March 2011 (after trade suspension), GS published two Amendment Notices to:
correct the formula for “Cash Settlement Amount per Board Lot” in both the LA and the SLD for the call Warrants to:
(Closing Level – Strike Level) x Index Currency Amount
(2) correct the “Cash Settlement Amount” to “the excess of the Closing Level on the Valuation Date over the Strike Level, multiplied by the Index Currency Amount, converted from the Reference Currency into the Settlement Currency by dividing the Exchange Rate…”.
The Amendment Notices corrected the equivalent definitions in the LA and SLD for the put Warrants accordingly.
Trading of the Warrants has not resumed. However, GS offered compensation to all affected investors through a buyback programme which valued the Warrants at the higher of 110 per cent of their acquisition cost or the highest value they might have reached during the period of suspension. The Warrants expired in September and December 2011 respectively. GS voluntarily withdrew from issuing new warrants between April and November 2011.
THE LISTING DIVISION’S ALLEGATIONS OF BREACH BY GS OF THE LISTING AGREEMENT
The Listing Agreement required GS to comply with the Listing Rules in force from time to time. Listing Rule 2.13(2) required that the LA and the SLD be accurate in all material respects. However, the LA and the SLD contained the Errors described above.
The information presented to the Division suggests that the cause of the Errors originated from the draft LA and SLD prepared by GS’ external legal advisers. However GS staff reviewed and approved the documents. GS was the issuer of those documents. Thus, GS is ultimately responsible for the accuracy of the documents. Further each of the LA and SLD stated (as also required by the rules) that the responsibility for the accuracy of the documents rests with the issuer.
The Division acknowledges that this was an isolated incident and that the Errors were inadvertent and appear to have resulted from human error. However, in the Division’s view, the Errors were material because the economics of the Warrants (with the Errors) were significantly different from that intended.
The Division is also of the view that, in a broader sense, the Errors were material by reference to their impact on the market. There was substantial and unusual movement in the price of the Warrants on 31 March 2011 which was not consistent with the intended underlying economics of the Warrants.
It is acknowledged that such trading activity did not involve GS as liquidity provider or in any other capacity and that a significant proportion of this trading was conducted by licensed institutions or individuals. However, by 8:30am on 31 March 2011, GS was aware of the Errors. The Exchange was notified of the Errors at approximately 9:10am, and there was frequent dialogue between GS and the Exchange thereafter. There was unusual trading in the Warrants from 9:50am. At 10:02am, GS mentioned the unusual trading to the Exchange. GS agreed to suspension request at 10:48am after suggestion by the Exchange to GS.
The Division acknowledges that: (a) there was a frequent dialogue between GS and the Exchange from prior to the commencement of trading on 31 March 2011 until (and following) suspension of trading in the Warrants, and the Amendment Notices were published in the afternoon; (b) the situation that GS faced was unprecedented and no warrants have ever been suspended in these circumstances; (c) the Warrants had traded for approximately six weeks since their issuance in accordance with the intended economics with no unusual price movement; and (d) Hong Kong has a disclosure based securities market in which trading suspensions are not automatically required when errors are discovered in listing documents but should only be sought where necessary.
However, the Division is of the view that suspension was needed and GS did not request suspension sufficiently quickly once a disorderly market arose.
In all of the above circumstances, the Division is of the view that GS acted in breach of the Listing Agreement.
For the purposes of settlement, GS:
does not admit or contest the Division’s assertion of its breach of the Listing Agreement; and
(2) accepts the sanctions imposed upon it by the Listing Committee which are set out below.
FINDINGS OF BREACH BY THE COMMITTEE
On the basis of the facts and circumstances and GS not contesting the Division’s assertion of breaches referred to above, the Committee finds that GS has breached the Listing Agreement.
In the Listing Committee’s view, compliance with the Listing Agreement and therefore with the Listing Rules has implications for those trading in the Warrants and the wider derivative warrants market.
Listing Rule 2.13 requires information contained in any announcement or corporate communication published under the Listing Rules must be “accurate and complete in all material respects”. The LA and SLD were published by GS as required by Listing Rules 15A.56 and 15A.58. GS is responsible for the accuracy of these documents.
(2) GS should have requested suspension of trading of the Warrants earlier than it in fact did on 31 March 2011.
This contributed to a disorderly market in the trading of the Warrants from 9:50am to 10:52am on 31 March 2011.
The Listing Committee has taken into account the following matters in considering the overall sanction to be imposed on GS:
This was an isolated incident, there being no record of an earlier failure of this nature by GS despite it having issued approximately 1,700 warrants and CBBCs in Hong Kong since 2005.
(2) The Errors appeared to result from human error rather than systemic failure.
(3) The Warrants had, despite the Errors, traded in accordance with their intended economics for a period of approximately six weeks from their issuance prior to 31 March 2011 with no unusual price movements.
(4) GS notified the Exchange of the Errors promptly and prior to the opening of the market on 31 March 2011, and thereafter maintained a frequent and candid dialogue with the Exchange.
(5) GS fully cooperated with the Exchange, including by promptly agreeing to the suspension when the suggestion was made by the Exchange on 31 March 2011.
(6) There was no precedent for requesting suspension from trading of Hong Kong listed warrants in these circumstances.
(7) The trading activity that resulted in unusual price movement on 31 March 2011 did not involve GS as liquidity provider or in any other capacity.
(8) GS offered compensation to all affected investors through a buyback programme which valued the Warrants at the higher of 110 per cent of their acquisition cost or 110 per cent of GS’ offer price which was calculated by reference to the highest value that the Warrants might have reached during the period of suspension. Eighty-eight per cent of holders of the Warrants accepted the buyback proposal.
(9) GS had internal controls in place for document review at the relevant time albeit there was room for improvement. It has since implemented remedial measures satisfactorily addressing the Exchange’s regulatory concerns.
GS has been a very active participant in the warrants industry working group formed to consider issues, including the standardisation of documentation, so as to ensure the continuing success and high standards of the Hong Kong warrants market.
(11) GS voluntarily withdrew from issuing new warrants from April to November 2011 and focused on resolving this incident.
(12) GS has fully cooperated with the Division throughout its investigation and has a clean disciplinary record.
Taking all of the above into account, the Committee censures GS for its breaches of the Listing Agreement and therefore of Listing Rule 2.13 which resulted in the potential for damage to the reputation of the Hong Kong derivative warrants market and the confidence of investors.
The Committee would also have considered making a direction that GS be denied market facilities for a period of time under Rule 2A.09. However, noting that GS voluntarily withdrew from issuing new warrants from April to November 2011, and has resumed its ability to issue structured products with the permission of the Exchange on 1 December 2011 (having demonstrated to the Exchange that the regulatory concerns arising in this incident have been satisfactorily addressed), the Committee considers it unnecessary to make that direction.
For the avoidance of doubt, the Exchange confirms that this public censure applies only to GS and not any former or current directors or staff members of GS.