Overseas Firms Listing in Taiwan: A look at the legal dimensions

Taiwan’s government has been working hard recently to spell out its program for economic recovery. The capital markets naturally cannot be left out, and the main issue presenting itself has been how to get Taiwanese-owned companies abroad to “come home” for market listings.

Supervision of Taiwan’s capital market has gone through a number of phases, and its structure has been perfected steadily. Investor protections have become more effective as well, especially since the Investor Protection Center was established, even as investigation of insider trading continues.

That said, a basic limitation of Taiwan’s capital market is its small scale compared to major markets such as New York, London or Tokyo, which means that it is easier in Taiwan for eggs to get concentrated in relatively few baskets. Foreign investors can have a considerable influence on market trends, making the latter far from independent. If capital market participation can be expanded by encouraging overseas firms to return for market listings, it would of course be good for the long-run health of Taiwan’s capital market.

In terms of corporate listings, the legal system for securities regulation in Taiwan has tended to emphasize the “gatekeeper” role played by underwriters and CPAs. Underwriters and CPAs, for their part, tend to be concerned mostly with the financial aspects of market listing applicants, and in the application process they are bound to seek assurance that financial information is of sound quality and follows full disclosure principles. Admittedly,  many of the risks companies applying for listings face have their origins in inaccurate financial statement disclosures, but when you get to the bottom of it you see that failures of corporate governance in such cases stem, at a fundamental level, from insufficient disclosure of “soft information”, and from trading arrangements that constitute violations of applicable laws and regulations (e.g., violations of non-competition restrictions, conflict of interest regulations, duties of loyalty and due care, arm’s length transaction requirements, intellectual property right protections, labor and fair trade laws, or simply laws against engaging in false transactions).  Violations such as these are difficult to detect, much less make thoroughly known, as long as CPAs perform audits following ordinary audit principles. In fact, a reasonable degree of clarity can be achieved, but only if audits are also performed on the legal aspects of operations and transactions.

In the case of overseas enterprises listing in Taiwan, there are even more striking legal variables relating to the thoroughness of disclosures:

• In most cases, the management teams of firms coming to list in Taiwan will not have established a formal presence here, so the potential for moral hazard may be greater;
• Since such firms will not have established substantive operations in Taiwan either,  they will be at a greater remove from the local regulator;
• Even if such firms have their principal operations in developed countries, dealing with them may involve different time zones, languages, cultures, systems and laws, which can make understanding and oversight difficult and raise regulatory costs;
• The risks may be greater still if such firms operate primarily in mainland China, even if there are no time or language differences, basically because the local legal system is not that well developed;
• Finally, many firms coming to list shares in Taiwan will do so via places like the Cayman Islands, which has a so-called common law system clearly different from Taiwan’s, and this introduces yet more variables into the legal compliance equation.

Given the foregoing, it is encouraging to learn that the Taiwan Stock Exchange (TWSE) is planning a change in its regulatory direction and will strengthen the rigor of legal audits, basically departing from what, up to now, have been pro forma examinations of a very short list of legal matters, and will clear the way for legal audits that are essentially open-ended. Lawyers will be called upon to carry out general and wide-ranging audits of overseas firms applying to list shares. To assure full disclosure of legal aspects, moreover, they will even be required to produce legal opinions on matters specific to laws of the applying firms’ places of registration and operation.

The direction being taken by the TWSE to reform the auditing of overseas listing applicants is indeed praiseworthy. Nonetheless, one must note that risk management cannot be separated from cost considerations. While it is true that strengthening legal audits can raise the quality of disclosures, it will also necessarily increase the cost to overseas companies of applying to list shares in Taiwan, thereby affecting decisions on whether or not to pursue that option; and consequently, the challenge for Taiwan’s regulators will be to take into account its knowledge of past and present practices in order to avoid overkill even as it continues, step by step, to align the local capital market with international norms.

[This article appeared in the Economic Daily on April 6, 2009.]

Eric Tsai is a partner at PricewaterhouseCoopers Taiwan. Please send your comments and questions to:  eric.tsai@tw.pwc.com.