As the SFC imposes another heavy fine for sponsor failures, authors at Mayer Brown highlight the key lessons sponsors need to learn about the expected standards for sponsor work in Hong Kong.
- sponsors are expected to exercise reasonable judgement and apply professional scepticism
- they should decline to submit a listing application for and on behalf of the issuer if the issuer refuses to address any non compliance with the relevant requirements
- they also need to keep records to be able to demonstrate that proper and sufficient due diligence was carried out
The Securities and Futures Commission (SFC) in Hong Kong has reprimanded and fined Changjiang Corporate Finance (HK) Ltd (CJCF) HK$20 million for serious and extensive sponsorship failures in six listing applications submitted between September 2015 and December 2017. The SFC has also banned CJCF from acting as a sponsor for listing applications on The Stock Exchange of Hong Kong Ltd (SEHK) of any securities for one year from 18 August 2023, or until the SFC is satisfied that CJCF has adequately ensured its compliance with the relevant sponsor-related requirements, whichever is later.
Under paragraph 17 of the Code of Conduct for Persons Licensed by or Registered with the SFC (Code of Conduct), a sponsor is required to conduct reasonable due diligence on a listing applicant so as to ensure that the disclosure in the application proof prospectus and all information provided to the SEHK is true, accurate and complete in all material respects, and does not omit any material information.
The SFC found that, in breach of various sections of the Code of Conduct, CJCF had fallen ‘substantially below the standards expected of it as a sponsor’ and failed to discharge its duties as the sole sponsor in the six listing applications, namely, the listing applications of:
- Pacific Infinity Resources Holdings Ltd (Pacific Infinity)
- Van Chuam International (Cayman) Ltd (Van Chuam), and
- Rising Sun Construction Holdings Ltd (Rising Sun)
to list on the Main Board of SEHK, and the listing application of:
- AsiaPac Net Media Holdings Ltd (AsiaPac)
- Perpetual Power Holdings Ltd (Perpetual Power), and
- Byleasing Holdings Ltd (Byleasing)
- to list on the GEM of the SEHK.
Summary of the sponsor’s breaches of the Code of Conduct
Reasonable due diligence – Code of Conduct paragraphs 17.2(b) and 17.4(a)(i). CJCF did not perform all reasonable due diligence for three of its listing applications.
Advice and guidance – Code of Conduct paragraphs 17.3(b)(i) and (ii). CJCF did not properly advise or guide three of the listing applicants on their compliance with all relevant listing qualifications.
Identifying material issues – Code of Conduct paragraph 17.4(d)(i). CJCF failed to ensure disclosure of all material information in the application proof prospectuses of three of its listing applications.
Proper records – Code of Conduct paragraphs 17.2(e) and 17.10(c)(ii) and (v). There were systemic record- keeping failures in that CJCF failed to maintain proper records of the due diligence works it claimed to have done for all listing applications. It did not retain a substantial portion of verification notes and their supporting materials, and it did not document work done, analyses and conclusions against a substantial number of steps in the due diligence plans.
Professional scepticism – Code of Conduct paragraph 17.6(b). Without proper records of due diligence, CJCF failed to demonstrate it had exercised professional scepticism by querying the reliability of information and verifying statements disclosed in the application proof prospectuses.
Details of the six listing applications
In the listing application for Pacific Infinity (an exporter of unprocessed nickel ore from the Philippines to the Mainland), the SFC found that CJCF fell short of the required standard by failing to conduct any due diligence on a legislative bill in the Philippines which, if enacted, would have the effect of banning the export of all unprocessed minerals, thereby adversely affecting the core business of Pacific Infinity. While CJCF was aware of the bill, it failed to identify this as a red flag and take any follow up action.
The SFC further found that CJCF failed to disclose all material information in the application proof prospectus (including the likelihood of the enactment of the bill and Pacific Infinity’s contingency business plans), which impeded investors from forming a ‘valid and justifiable’ opinion of Pacific Infinity’s shares, financial condition and profitability.
In the listing application for AsiaPac (a digital marketing service provider), the SFC found that CJCF did not discharge its duty as the sponsor because it failed to properly advise and guide AsiaPac to make sufficient material disclosure in its application proof prospectus. AsiaPac, for unjustifiable reasons, was reluctant to disclose certain information in the application proof prospectus relating to its pricing strategy and how it increased profitability, but the SFC found that it was CJCF’s duty to insist that the disclosure made by AsiaPac was sufficient so that investors could understand AsiaPac’s financials.
In respect of Perpetual Power (an infrastructure company dealing with hydropower plants in the Mainland), the listing application was submitted by CJCF despite the fact that Perpetual Power was in fact ineligible for listing because it was non-compliant with a GEM Listing Rule (which required the issuer to have land title certificates and building ownership certificates for all properties in the Mainland used in infrastructure projects; Perpetual Power lacked certificates for two out of three of its hydropower plants). The SFC found that CJCF had failed to properly advise and guide Perpetual Power on its compliance with all relevant listing qualifications.
In respect of the listing application for Van Chuam (a property developer in the Mainland), the SFC found that CJCF did not discharge its duty as the sponsor because it failed to conduct proper due diligence on two core aspects of Van Chuam’s debt restructuring arrangements. The SFC found that CJCF, among other things, did not obtain and review all relevant loan agreements for the purpose of verifying their existence, or perform any appropriate verification to assure itself that the underlying loans were in fact distressed and hence eligible for restructuring by the asset management company.
Further, the SFC found that CJCF had failed to disclose all material information in the application proof prospectus, including the salient terms of the various agreements under the debt restructuring arrangement, the basis for qualifying the underlying loans as distressed assets, and the fund flows and total financing costs of the debt restructuring arrangements.
In the listing application for Rising Sun (a property construction company in the Mainland), the SFC found that CJCF fell short of its required standard by failing to conduct reasonable due diligence on the risk that Rising Sun might not be able to meet its working capital requirements due to its negative operating cash flows. In particular, the SFC found that CJCF had simply accepted Rising Sun’s financial condition at face value, without performing any appropriate verification in respect of the fact that the turnover period of Rising Sun’s trade receivables was significantly longer than the credit period granted to its customers.
The SFC found that CJCF failed to properly advise and guide Byleasing on the selection of the track record period and the timing of submission of the listing application in accordance with the GEM Listing Rules and SEHK guidance, resulting in the SEHK’s return of the application.
It appears that some sponsor firms in the Hong Kong financial markets continue to ignore the SFC’s Code of Conduct and published guidance on the expected standards of sponsor work.
In a circular dated 26 March 2018, the SFC set out a summary of its findings following a thematic review of sponsor work. We note that a number of problems with sponsor performance identified by the SFC in the thematic review have been repeated in the present case:
- failure to exercise reasonable judgement and apply professional scepticism (all six listing applications)
- failure to conduct reasonable due diligence (for example, Van Chuam and Rising Sun)
- failure to identify and follow up on red flags (for example, Pacific Infinity), and
- failure to maintain proper records (for example, Rising Sun).
On 14 March 2019, the SFC imposed its largest fines for inadequate sponsor work against four major international financial institutions totalling around HK$786 million. These enforcement actions were intended by the SFC to send a strong deterrent message to the industry that sponsor failures would not be tolerated. Nevertheless, since March 2019, there have been eight more enforcement actions (including this one) in which shortcomings previously publicised appear to have been repeated.
Bearing in mind these cases, our key takeaways for sponsors are highlighted below.
Ignore red flags at your peril. Not paying attention to red flags or failing to fully investigate and conduct reasonable due diligence on them may result in a rejection of the listing application by the SEHK and potentially an enforcement action by the SFC.
Sponsors must stand up to issuers if necessary. As demonstrated in this case, it is ultimately the sponsor’s responsibility to insist on advising the issuer regarding its compliance with the relevant requirements before a listing application is submitted and to decline to submit the listing application for and on behalf of the issuer if the issuer refuses to address any non-compliance with the relevant requirements.
Implement a robust and customised due diligence plan. This should be done for each sponsor engagement, instead of relying on a generic due diligence checklist.
Ensure that sufficient records are maintained. The records need to demonstrate that proper and sufficient due diligence was carried out and that any red flags or contentious issues were adequately investigated and how they were resolved.
Alan H Linning, Thomas Kollar, Billy KM Au, Wei Na Sim and Sara Troughton
“some sponsor firms in the Hong Kong financial markets continue to ignore the SFC's Code of Conduct and published guidance on the expected standards of sponsor work”