The revised Securities Law was promulgated on 28 December 2019, and will enter into force on 1 March 2020. This revision to the Securities Law, as the underlying law for the domestic capital market, is an update of the previous rules and sets the legislative logic for future supervision and review of capital market.
According to article 9(2) of the revised Securities Law, among the three identified circumstances of a “public offering of securities”, the “offering of securities to more than 200 specified investors accumulatively” is subject to a newly added proviso, which reads: “excluding the employees covered by the employee stock ownership plan implemented in accordance with the law.” That is, an exception of “employee stock ownership plan” is attached to the original clause where offering to more than 200 investors is identified as a public offering.
According to relevant regulations issued by the China Securities Regulatory Commission (CSRC), the employee stock ownership plan implemented by enterprises includes arrangements for indirect employee shareholdings through such platforms as corporation business, partnerships and asset management plans created by enterprises.
Cause and effects of clause changes
The supervision of securities issuance begins with the regulation of a “public offering of securities”. Pursuant to regulations on the “200 investors” threshold, one of the criteria for public offering of securities under the Securities Law, once the threshold is exceeded the issuance shall be deemed a public offering that must be registered with the securities regulatory department of the State Council or an agency authorized by the State Council.
The origin of the “200 investors” criterion is untraceable, but the principal reason for setting a limit on the number of investors lies in the necessity of establishing a regulatory threshold. The issuance of securities that does not exceed a certain scope may be exempt from administrative licensing due to its insignificant influence and low awareness.
However, offering securities to too many investors will have an impact on the social, economic and administrative orders, and thus should be included under administrative regulation. Therefore, a limit on the number of investors should be considered in a public offering, which results in the establishment of the “200 investors” criterion for a public offering.
Based on the above reasoning, once the offering activity of an issuer is deemed a public offering, yet not permitted by the regulatory authority, the issuer will be punished for violation of law. A pre-IPO issuer that offers securities publicly or in a disguised public manner without the statutory authority’s approval will be disqualified from applying for an IPO for 36 months following such offering and its rectification, which is a serious punishment.
Therefore, whether the number of shareholders of the pre-IPO issuer exceeds 200 or not becomes a matter that regulators pay close attention to, and shall conduct a “look-through check” to count shareholders.
This special calculation process means looking through to the ultimate shareholders, who should be natural persons, listed companies or state-run entities. If the number of shareholders is more than 200 after checking, then it should be rectified and subject to a special review by the securities regulator.
Significance of clause changes
In light of the analysis on the above public offering circumstances, an issuer should pay particular attention to whether the number of its shareholders exceeds 200. The calculation criteria should be that the final number must be the number of equity holders confirmed after a look-through calculation of all tiers of shareholding.
Except for registered private equity funds, listed companies and state-owned investors that are exempt from the look-through calculation of the shareholder number, all the other types of shareholders, especially the employee stock ownership platforms, must be included in shareholder number calculations via this process.
Given the review requirements imposed by regulators, only high-quality enterprises will have access to the capital market. Well-developed high-quality enterprises need to attract the best talent to support their development, and stock ownership incentives are a practical and effective approach to introducing talent and retaining it.
Pursuant to the above-mentioned requirements on review and regulation of 200 shareholders, however, an enterprise implementing the employee stock ownership plan shall be restricted by the limit on the number of participants of the plan; otherwise, it will become a substantial barrier to the enterprise’s IPO.
Therefore, the new Securities Law has adjusted the criterion so that to offer securities to more than 200 investors is deemed a public offering by excluding participants in the employee stock ownership plan from the target investors to whom securities are offered. This adjustment lifts the restriction on pre-IPO employee stock ownership, which meets the reasonable development needs of the issuer and also protects the interests of participants in its employee stock ownership plan.
Analysis of clause changes
The author believes that the revision of the above-mentioned clause of the Securities Law is based on the consideration that the employee stock ownership plan is a matter of a company’s internal management, with a controllable size and limited impact, so excessive administrative intervention is unnecessary and inadvisable.
Furthermore, the Star market has embraced a registration-based IPO system in which the rule that employee stock ownership shall be exempt from the look-through calculation of the shareholder number under the “closed loop principle” is an early practice of the current revision.
Although the current revision is good news, consideration should be given to how to deal with the situation when the shareholder number already exceeds 200 due to any employee stock ownership plan implemented prior to the current revision.
Will such historical activity still be illegal under the “principle of non-retroactivity of law” established by the Legislation Law, or is it legal under the new law applied pursuant to the principle of “beneficence first”? Or will the legislative body issue a special interpretation regarding the application of such clauses?
To sum up, the introduction of new rules is just the first step. The specific application and interpretation of such rules needs to be fine-tuned in practice, so now we wait to see what happens.
Zhao Zeming is a salaried partner at Grandway Law Offices.