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TWO weeks ago, a sudden plunge in a string of penny stocks on the Hong Kong stock exchange wiped out US$6.1 billion in market value in two days and left some companies down 90 per cent.
Forty of those companies turned out to be part of a web of 50 firms linked by cross-holdings, overlapping directorships and questionable corporate transactions that former HKEX director-turned-independent investor and stock commentator David Webb had called out in a May report titled The Enigma Network: 50 stocks not to own.
Research from corporate intelligence portal Handshakes, an artificial intelligence platform run by Singapore startup DC Frontiers, now indicates that key individuals from the Enigma network are linked to a wider web of Hong Kong small caps.
Most of these companies share characteristics of the Enigma firms, such as overlapping directorships and similar histories of regulatory, enforcement or disciplinary reprimands from authorities, and could potentially trigger another rout, say analysts.
"With increasing evidence pointing to the existence of a network that runs far deeper than initially revealed, it is difficult to dismiss these cross-connections as mere coincidences," read the Handshakes research report obtained by The Business Times.
Singapore Press Holdings, BT's parent company, owns a 20 per cent stake in DC Frontiers, which provides curated data from publicly available information on listed firms.
Handshakes identified 195 directors in Mr Webb's original blacklist as "notable connected individuals" (NCIs) with common links to other directors in the Enigma web across a further 145 listed companies.
Many of these NCIs hold multiple independent director positions, which "should be 'red flags' in any investment process", said Mr Webb, who runs a site which compiles and publishes information on Hong Kong listed companies and measures the total returns during the period of a person's directorship.
"The data show that some individuals who hold multiple INED (independent non-executive director) positions are associated with strongly negative returns, either absolutely or relative to the market," Mr Webb told BT.
"They are either extremely unfortunate or are hired for their ability to endorse bad behaviour."
Mr Webb added that some companies linked to Handshakes' most notable connected individuals are part of a group that he has found "do very little but trade with each other and in each other's stocks, sucking in cash from the markets and creating occasional bubbles".
"Investors should avoid all of these," he said.
Cross-holding of companies and overlapping directorships "are not entirely healthy" and raise "obvious corporate governance issues", said Kevin Leung, director of investment strategy at Haitong International Securities Company Limited.
The companies linked to individuals involved in the latest small caps crash could potentially see similar losses "since it's evident there is a cashing out process going on for this series of companies", he added.
But Mr Leung expects the next sell-off to "be slower and less blatant" because the last collapse "caught the eyes of regulators".
A Securities and Futures Commission (SFC) statement published by Reuters after the "bloodbath" involving the Enigma companies said that the stocks involved "occupy a market segment characterised by thin turnover, small public floats, high shareholding concentrations, and multiple relationships between different companies and listed brokerage firms".
"These characteristics can be especially conducive to extreme volatility and also to market misconduct," the SFC statement added.
Misconduct could refer to "things ranging from manipulation and the ways in which that might be assisted through, to shareholders who may not be fully independent when voting", SFC chief executive Ashley Alder told the Financial Times right after the two-day crash. Mr Alder added that the regulator is increasing its focus on corporate issues, but did not provide details.
In response to BT's query, SFC said it "is not in a position at this stage to confirm whether it has been or will be pursuing investigations into specific individuals or companies operating in this market segment".
More has to be done to address "major weaknesses in the Listing Rules governing the behaviour of listed companies", said Mr Webb, including moving regulation out of the for-profit HKEX and into the SFC.
He added: "The defective regulatory framework will continue to undermine corporate governance and facilitate fraudulent behaviour by listed companies."