(Yicai) Oct. 22 -- China will tighten restrictions on share sell-downs by major shareholders and impose harsher penalties on those who circumvent the rules, Wu Qing, chairman of the China Securities Regulatory Commission, said on Oct. 19.

“The new rules, which take effect Dec. 1, establish standards for identifying illegal securities transfers and determining administrative penalties,” Huang Qingfeng, a partner at Lifeng Law Firm, told Yicai. “Those who bypass rules to sell shares by any means will be punished severely. This marks a new phase in China's regulation of unlawful securities transfers, characterized by greater standardization, precision and transparency.”

In the past, many violations appeared compliant with the rules in form but breached them in substance, he said. Examples include transferring shares through divorce settlements, closing positions by pledge as well as gifts. Although these transactions did not formally constitute share sell-downs, they effectively allowed shareholders to dispose of their holdings and cash out.

For example, some actual controllers of listed companies would transfer their stocks to their former spouses following a divorce and thus reduce their holdings indirectly. Under the new rules, however, when major shareholders, actual controllers, directors, supervisors and senior executives divide shares as part of a divorce settlement, all parties involved in the transfer must abide by the original reduction limits.

“Some practices that were relatively common in the past will become much more difficult under the new rules,” Huang said.

For example, some major shareholders, based on non-public information, buy shares in advance using the accounts of their family or friends during restricted periods, when the shareholders themselves are prohibited from trading. These parties may then use these accounts for trading, without disclosing that they are effectively conducting transactions on behalf of the major shareholder.

There are numerous methods used by major shareholders to cash out in violation of the rules, from large-scale share disposals and selling shares after resigning from corporate positions to indirect and intermediary-based transactions designed to bypass restrictions. Such violations can have a particularly pronounced impact during periods of weak stock market performance, undermining market fairness.

“The share reduction system is a fundamental component of the capital market framework and is essential for maintaining the stable operation and healthy development of the market,” the head of the CSRC's listing department told Yicai earlier.

The policy is designed to maintain strict controls on share disposals by major shareholders and actual controllers, while applying differentiated policies to share disposals by private equity and venture capital funds. Compared with overseas markets, China imposes more stringent restrictions on share sell-downs, the official said.

Some companies believe the restrictions should not be too tight and that investors should be free to enter and exit the market, otherwise overly restrictive rules could discourage entrepreneurship and hinder business growth, Huang said.

“However, channels for selling shares already exist. The key point is that major shareholders should not be allowed to reduce their holdings at the expense of minority shareholders. Market fairness must remain the overriding principle at all times,” Huang said.

The latest announcement comes amid significant volatility in the Chinese mainland market. In his Oct. 19 remarks, Wu reiterated the CSRC's commitment to safeguarding the security and stability of the capital market.

Measures include consolidating and improving mechanisms for market stabilization and strengthening the resources available to support market stability. The regulator will also encourage eligible listed companies to increase share buybacks and share purchases with the aim of delivering better returns to investors.

Editor: Kim Taylor