News & Insights

SFC disciplined sponsors for inadequate due diligence and disclosure

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Authored by: Peter So and Mandy Pang

In October 2021, the Securities and Futures Commission (SFC) reprimanded Yi Shun Da Capital Limited (YSD) and Ample Capital Limited (ACL) and fined them HK$3 million and HK$5.5 million respectively, for failing to discharge their duties as sponsors in listing applications in 2016 and 2017. Those disciplinary actions underscore the importance for sponsors to carry out adequate due diligence and make adequate disclosure in listing applications.


Role of Sponsors 

Sponsors play a pivotal role in initial public offering activities. Their responsibilities include:

  • Advising and guiding a listing applicant as to the Listing Rules and other relevant regulatory requirements.
  • Conducting reasonable due diligence.
  • Ensuring the listing document provides sufficient particulars and information for investors to form a valid and justifiable opinion of the listing applicant’s shares, financial condition and profitability.
  • Ensuring that the information in the listing application submitted on behalf of a listing applicant to The Stock Exchange of Hong Kong Limited (HKEX) is substantially complete.

Sponsors under SFC’s Scrutiny

Given the critical role of sponsors in initial public offering activities, in recent years, the SFC has closely scrutinised sponsors’ work and taken disciplinary actions against a number of sponsors for different failures, including inadequate due diligence and neglecting red flags.

YSD and ACL’s failures

In October 2021, the SFC reprimanded and fined both YSD and ACL for failing to carry out adequate due diligence and make adequate disclosure in listing applications.

YSD’s failures

YSD was the sole sponsor in the listing application of Imperial Sierra Group Holdings Limited (Imperial Sierra) in 2017.

HKEX identified in the listing application that there was a possible circular flow of funds which gave the appearance that Imperial Sierra was in a strong financial position. The listing application lapsed six months after submission.

The SFC later found that before submitting the listing application, YSD had failed to perform all reasonable due diligence on Imperial Sierra in respect of:

  • Third party payments representing 67.5%, 67.8% and 39.7% of Imperial Sierra’s revenue in the three-year period before the listing application, which the SFC believed was for disguising the original source of funds and facilitated a deceptive or fraudulent scheme. YSD had failed to obtain and review the underlying documents in relation to the arrangements and to make appropriate follow-up enquiries to address a number of red flags concerning the third party payments when conducting due diligence.
  • Suspicious transactions, which raised concern whether Imperial Sierra and/or its chairman had provided financial support to some of the customers’ payments and pointed to a possible circular flow of funds.
  • Withdrawals made by Imperial Sierra’s chairman / controlling shareholder for facilitating various loan and investment arrangements between himself and various individuals who may have connections with the third-party payors. YSD did not obtain or review the underlying documents in relation to the finance arrangements before submitting the listing application.

The SFC found that YSD had failed to ensure disclosure of all material information in the prospectus, including, details and particulars of the relationships between Imperial Sierra’s customers and their third party payors, the reasons for the third party payments, and the explanations for the suspicious transactions.

The SFC found that YSD was culpable of misconduct in its conduct of the listing application of Imperial Sierra and that it was not a fit and proper person to remain licensed. YSD was reprimanded and fined HK$4.5 million. The SFC also prohibited its former responsible officer and chief executive officer from re-entering the industry for 20 months.

Subsequently, YSD sought a review of the SFC decision. The Securities and Futures Appeals Tribunal (SFAT) reviewed and upheld the SFC’s decision but varied the fine imposed on YSD from HK$4.5 million to HK$3 million. The SFAT opined that:

  • A sponsor’s obligation is two-fold. On one hand, a sponsor has an obligation to the listing applicant. On the other hand, a sponsor has an obligation to the HKEX in relation to the listing application and to investors generally in respect of the prospectus.
  • A sponsor must act with independent professionalism in ensuring that all information placed before the HKEX and investors generally is fully, fairly and accurately presented.
  • A sponsor should examine the accuracy and completeness of representations made to it by the representatives of the listing applicant and do so with the necessary degree of professional scepticism. A sponsor fails to discharge reasonable due diligence by simply relying on bland management representations without sufficient details, when seeking to verify information that on its face may be problematic.
  • A sponsor is required to conduct additional due diligence where it becomes aware of circumstances that may cast doubt on the information provided to it.

ACL’s failures

ACL was the sole sponsor in the listing application of COCCI International Limited (COCCI) between 2016 and 2017.  After COCCI submitted its listing application (1st Application), the SFC and HKEX made various comments on COCCI’s wholesale business. 

COCCI thereafter re-submitted another listing application (2nd Application) and the SFC and HKEX made further comments following the 2nd Application. The SFC and HKEX took the view that the revised prospectus submitted by COCCI still failed to explain and provide sufficient information on COCCI’s wholesale business. ACL did not respond to the SFC and HKEX’s comments. The listing application later lapsed. 

SFC found that:

  • ACL failed to conduct adequate due diligence on suspicious cash settlements received by COCCI and keep proper records of its due diligence work. In particular, ACL failed to assess the reasons behind the suspicious cash settlements and failed to conduct independent due diligence to ascertain the truth and completeness of COCCI’s representations.
  • ACL failed to ascertain the background and independence of a major wholesale distributor of COCCI and its associates, and to assess the reasonableness of COCCI’s sales to the distributor. ACL did not seek to obtain any objective data to verify the information provided. ACL only performed further due diligence after COCCI submitted the 1st Application and received comments from the HKEX and SFC.
  • ACL failed to critically assess the reliability of the shipping documents provided to it by COCCI before relying on them as part of its due diligence. ACL also failed to identify red flags which cast doubt on the reliability of the shipping documents.

ACL was reprimanded and fined HK$5.5 million, and the responsible officer and sponsor principal of ACL in charge of supervising the execution of the listing application had his license suspended for 17 months. 

Takeaways

  • Sponsors not only have obligations to the listing applicants, but also to the HKEX in respect of the listing applications and to investors generally in respect of the prospectuses.
  • Before listing applications are submitted, sponsors should perform reasonable due diligence. When sponsors come across information which is dubious or shows a potential problem in the due diligence process, sponsors cannot simply take the representations of the representatives of the listing applicants at face value, but should, in the words of the SFAT, examine the accuracy and completeness of management representations “with the necessary degree of professional scepticism” and conduct additional due diligence.
  • Sponsors should ensure disclosure of all material information in the prospectuses and disclosure of all material issues to the HKEX for their consideration as to whether the listing applicant is suitable for listing.
  • Sponsors will not be absolved from liability and will still, potentially, be held liable for inadequate due diligence and disclosure in the listing applications even though the listing applications lapsed or were rejected and no harm was caused to the investing public.

Key Contacts

Peter So

Partner | Litigation and Dispute Resolution

Email or call +852 2825 9247

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