23 July 2019
Thirteen stocks plunged more than 50 percent on Tuesday and five of them even tumbled more than 80 percent. Photo: AFP
Thirteen stocks plunged more than 50 percent on Tuesday and five of them even tumbled more than 80 percent. Photo: AFP

Hong Kong small-cap meltdown: What does it tell us?

A number of small-cap stocks in Hong Kong suffered a price crash Tuesday. Thirteen stocks plunged more than 50 percent and five of them even tumbled more than 80 percent. There are numerous speculations about the trigger behind the meltdown.

Some of these speculations are not well-grounded such as one that links the selloff to the visit of Chinese President Xi Jinping, which makes no sense at all.

Another report had it that the Hong Kong stock exchange has submitted a proposal to force delisting of so-called zombie stocks, which have a share price of below HK$1 with thin trading. However, the exchange has quickly dismissed that.

In my opinion, the following factors might have a more direct relationship with the small-cap share collapse.

For starters, David Webb, a former director of the Hong Kong stock exchange, issued a report titled “The Enigma Network: 50 stocks not to own” six weeks ago. Some brokerages might have tightened financing for these stocks, forcing some investors to dump these shares.

Second, it was reported that the Hong Kong Securities and Futures Commission is in the middle of revoking the license of a certain brokerage firm.

Third, the Hong Kong stock exchange unveiled consultation papers to overhaul the Growth Enterprise Market early this month. Some investors may decide to abandon some “shell stocks” in light of the potential rise in the cost of keeping them.

Fourth, some investors might be struggling with a liquidity crunch after China tightened capital outflow.

While market attention has been focused on the crash of small caps, it so happened that another related event took place this week and went largely unnoticed.

The Market Misconduct Tribunal (MMT) on Monday ordered the former chairman and chief executive of Greencool Technology Holdings Ltd. (Greencool), Gu Chujun, to give up HK$482 million of profit from his market misconduct.

Gu, a mainland business tycoon, controlled at one point up to seven public companies more than a decade ago, including Greencool, Kelon, Hefei Meiling, Xiangyang Automobile Bearing and Yangzhou Yaxing Motor Coach..

Nearly half of the plummeting small-cap shares in the latest selloff are listed on GEM. Greencool was one of the first stocks listed on GEM.

Gu raised US$70 million from the Greencool IPO. He then issued more shares and used the proceeds to acquire and control six other listed firms, growing the empire to a market value in excess of HK$30 billion and making huge profits on the way.

Famed analyst Zhang Huaqiao questioned Gu’s manipulation in a critical e-mail and newsletter to the brokerage’s clients. Zhang was sued by Gu in 2002, and the matter was eventually settled out of court.

Yet, Gu was finally nailed by the China Securities Regulatory Commission three years later. He was accused of fund embezzlement and arrested by the police in August 2005

Greencool was delisted from the Hong Kong stock market in May 2007 and Gu received a 10-year sentence in the mainland in 2008. (His sentence was reduced and he got out in September 2012)

So Hong Kong’s MMT, which accused Gu of grossly overstating Greencool’s sales, profit, trade receivables, bank deposits and the company’s net asset value between 2000 and 2004, took 10 years to deliver the penalty since the delisting. It is somewhat too little too late.

Meanwhile, there are many others like Gu, who have been manipulating small caps and gaining handsomely from such activities. And that should also be part of the background behind the latest small cap tumble.

This article appeared in the Hong Kong Economic Journal on June 28

Translation by Julie Zhu

[Chinese version 中文版]

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Hong Kong Economic Journal columnist

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