Introduction

A sponsor firm (the “Sponsor Firm”) was recently reprimanded and fined HK$15 million by the Securities and Futures Commission (the “SFC”) for failing to discharge its duties as a sponsor in the listing application (the “Listing Application”) of a PRC company (the “Company”). This article will summarise the statement published by the SFC in relation to its disciplinary action against the Sponsor Firm.

Background

The Company was established in the People’s Republic of China (the “PRC”). The Sponsor Firm was appointed to act as its sponsor on 8 September 2014. On 10 November 2014, the Sponsor Firm submitted the Listing Application together with the draft Application Proof to The Stock Exchange of Hong Kong Limited (the “Stock Exchange”). The Sponsor Firm had subsequently submitted 5 revised versions of the prospectus of the Company during the Listing Application process. During the track record period, the Company’s connected persons (having the meaning as defined under the Rules Governing the Listing of Securities on the Stock Exchange (the “Listing Rules”) had provided guarantees for short-term loans advanced by the Company’s subsidiary to its customers (the “Connected Guarantees”).

Breaches and Reasons for Action

Failure to conduct all reasonable due diligence
before submitting the Listing Application

Paragraphs 17.4(a)(i) and 17.6(c) of the Code of Conduct for Persons Licensed by or Registered with the SFC (the “Code of Conduct”) require a sponsor (a) to have performed all reasonable due diligence on the listing applicant before submitting an application on its behalf, except in relation to matters that by their nature can only be dealt with at a later date; and (b) to undertake additional due diligence to ascertain the truth and completeness of the matter and information provided by the listing applicant, after the sponsor becomes aware of circumstances that may cast doubt on information provided to it or otherwise indicate a potential problem or risk.

During the track record period, the principal business of the Company was providing short-term loans, which accounted for over 90% of the Company’s operating income, to its customers which were small and medium-sized enterprises and individuals in Jiangsu Province. A majority of the loans were not secured by collateral but guaranteed by individuals or companies. The said loans were a key aspect of the Company’s business.

In the course of conducting due diligence, the Sponsor Firm discovered that a number of the Company’s connected persons, including but not limited to its executive director and chief executive officer, had guaranteed some of the short-term loans to its Connected Guarantees. The Sponsor Firm was also aware that the second largest shareholder of the Company had obtained a number of loans from the Company’s subsidiary as a borrower and such loans were guaranteed by another party. However, the Sponsor Firm did not conduct any due diligence in relation to the Connected Guarantees or the concerned connected persons (the “Connected Guarantors”), before submitting the Listing Application to the Stock Exchange. The Sponsor Firm did not ascertain (a) the percentage of the Connected Guarantees to the total amount of loans granted by the Company during the track record period; (b) the relationship between the borrowers and the Connected Guarantors; (c) whether there was any dealings between the Connected Guarantors, the borrowers and the Company that would require closer scrutiny; (d) the genuineness of the Connected Guarantees; and (e) whether the Connected Guarantees would continue, and if so, how would the Company manage the conflicts of interests between itself and the Connected Guarantors.

The SFC also queried the Sponsor Firm whether certain information had been obtained in relation to the loans obtained by the second largest shareholders of the Company and the Sponsor Firm informed the SFC that it did not consider such information material or that further due diligence was necessary on that matter.

The SFC considered that the above issues are material relating to the Company’s business model, the authenticity of the transactions involving connected persons, the Company’s internal controls for managing conflicts of interests, and whether the Connected Guarantees should be considered as connected transactions under the Listing Rules. Therefore, by failing to conduct reasonable due diligence on the issues abovementioned, the Sponsor Firm breached the Code of Conduct by not having performed all reasonable due diligence on the Company and ascertaining the truth and completeness of certain information provided by the Company.

Failure to ensure that all material information
has been included in the Application Proof

Paragraphs 17.4(a)(ii) and 17.4(b) of the Code of Conduct provide that before submitting an application on behalf of a listing applicant, a sponsor should (a) ensure that all material information as a result of this due diligence has been included in the Application Proof; and (b) come to a reasonable opinion that the information in the Application Proof is substantially complete except in relation to matters that by their nature can only be dealt with at a later date.

The Connected Guarantees were not disclosed in the Application Proof submitted to the Stock Exchange and were only disclosed until the fifth version of the post-Application Proof on 7 September 2015 while the submission of the Application Proof was on 10 November 2014.  In the absence of reasonable due diligence on these issues, the Sponsor Firm was not in a position to assess the materiality of the Connected Guarantees to the operation of the Company and to ensure that all material information in relation to the Company has been included in the Application Proof, which was in breach of the Code of Conduct.

Failure to ensure that all information provided
to the regulators is accurate and not misleading

Paragraph 17.9(a) of the Code of Conduct requires a sponsor to reasonably satisfy itself that all information provided to the Stock Exchange and the SFC during the listing application process is accurate and complete in all material respects and not misleading in any material respect and, if it becomes aware that the information provided does not meet this requirement, the sponsor should inform the Stock Exchange and the SFC (as the case may be) promptly.

During the Listing Application, the Stock Exchange and the SFC asked about the independence of the persons who guaranteed the loan granted by the Company. The Sponsor Firm initially did not disclose the existence of the Connected Guarantees or that parties related to the Company had guaranteed its short-term loans, but only did so until after rounds of queries from the Stock Exchange or the SFC. The SFC found that the Sponsor Firm breached the Code of Conduct by failing to ensure that all information provided to the Stock Exchange and the SFC is accurate and not misleading in any material respect.

Conclusion

The Stock Exchange regarded that the disclosure of information in the Application Proof was not complete in all material, which is in breach of rule 9.03(3) of the Listing Rules, and returned the Listing Application.

This case illustrates the importance for sponsors to ensure that all material due diligence should be completed and adequately disclosed when the Application Proof is submitted. Even though the listing application is rejected, disciplinary action can still be levied as a result of an inadequate Application Proof. Sponsor can no longer expect any tolerance to an inadequately prepared Application Proof.

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Important: The law and procedure on this subject are very specialised and complicated. This article is just a very general outline for reference and cannot be relied upon as legal advice in any individual case. If any advice or assistance is needed, please contact our solicitors.