Post-China Forestry and Tianhe era – SFC’s front-loaded regulation and reforms to tackle sponsor failures
Introduction
In
mid-2017, Mr Ashley Alder, Chief Executive Officer of the Securities of Futures
Commission (“SFC”)
announced its relative new “front-loaded, transparent and direct” approach to
market regulation. As it happens, in or around March 2019, the SFC made its
landmark and stern decision in reprimanding
top investment banks, namely UBS, Morgan Stanley, Merrill Lynch and Standard
Chartered and imposing on them record-breaking fines of HK$786.7 million in
total, for failing to carry out their respective responsibilities as IPO
sponsors for listing applications of China Forestry Holdings Company
Limited (“China
Forestry”) and Tianhe Chemicals Group Limited (“Tianhe”)[1].
It has
been four years since the SFC implemented its front-loaded regulation and we
have now entered the post-China
Forestry and Tianhe era, it presents to us the appropriate time to review,
re-visit and even reacquaint with the SFC’s regulatory expectations on the work
of sponsors and related reforms.
Recent SFC’s enforcement actions on
sponsor failures
Let’s start with the enforcement actions recently
taken by the SFC against various sponsors’ deficiency and misconduct in listing
process.
Action
against Ample Capital Limited
On 18 October 2021, the SFC released a statement of
disciplinary action against Ample Capital Limited (“ACL”) in relation
to its failure to discharge its due diligence duties as the sole sponsor for
the listing application of COCCI International Limited (“COCCI”). In
particular, it appeared that COCCI’s major wholesale distributor’s (the “Distributor”) debt
owed to COCCI together with its subsidiaries (“COCCI Group”) in the sum of
RMB9,715,000 was settled by cash, in which third parties nominated by COCCI’s
chairman received cash from the sole shareholder and director of the
Distributor in Hong Kong, converted them into Renminbi and physically carried
the cash to the Mainland and deposited the same into Mainland bank account of
COCCI Group. Payments made in cash, which were then physically carried
cross-border to evade Mainland’s foreign exchange control regulations, were
clearly highly suspicious but ACL plainly turned a blind eye to them. Further,
it was discovered that COCCI Group’s revenue rise was largely attributable to
the Distributor and the ultimate customers through the Distributor, and COCCI
and the Distributor and COCCI’s ultimate owners appeared to be interlinked; but
ACL simply failed to make additional due diligence enquiries. Accordingly,
pursuant to section 194 of the Securities and Futures Ordinance (“SFO”), the SFC
reprimanded and fined ACL HK$5.5 million.
The SFC also suspended the licence of the responsible
officer (“RO”)
and sponsor principal for 17 months for his failure to properly supervise the
execution of the listing application of COCCI.
Action
against Yi Shun Da Capital Limited
On 19 October 2021, the Securities and Futures Appeals
Tribunal (“SFAT”)
upheld the SFC’s enforcement decision to reprimand and fine Yi Shun Da Capital
Limited (“YSD Capital”)
for its deficiencies in fulfilling the sponsor duties in the listing
application of Imperial Sierra Group Holdings Limited (“Imperial Sierra”)
in 2017, in which YSD Capital acted as its sole sponsor, global coordinator,
bookrunner and lead manager to guide Imperial Sierra through the listing
procedures. The SFC found that, as similar to ACL, instead of receiving direct
payments from its customers, Imperial Sierra had been receiving third parties’
payments during the 3-year track record period leading up to the listing
application. It is pertinent to note that these payments were highly
significant and unusual, amounting to over 50% of Imperial Sierra’s total
revenue in the first two years, and came close to 40% of the total revenue in
the third year, with the details, reasons, relationships of the third parties
being unclear. YSD Capital still failed to conduct adequate verification,
interviews and independent enquiries, hence falling short of its sponsor’s
obligations. Further, against the backdrop of these unusual and dominant
third-party payments, there existed “suspicious transactions” where Imperial
Sierra and/or its chairman might have provided “financial support” to some of
the customer’s payments. SFAT condemned YSD Capital for its total failure to
carry out any effective enquiry, if at all. YSD Capital was fined for HK$3
million.
Action
against Fabian Shin Yick
For the sake of completeness, kindly note that SFC
also prohibited Mr Fabian Shin Yick, former RO, CEO of YSD Capital and sponsor
principal for Imperial Sierra from re-entering the industry for 20 months as he
had found to failed to (1) exercise due skill, care and diligence in handling
the listing application; (2) diligently supervise his subordinates to carry out
the sponsor work undertaken by YSD Capital; and (3) ensure the maintenance of
appropriate standards of conduct by YSD Capital[2].
Guidelines
for Sponsors
Despite
the record high fines imposed to the sponsors during China Forestry and Tianhe
era, sponsor and its sponsor principal failures remain commonplace. Whilst the
legal principles and expected role of sponsors in the IPO process can be found
in ample case law, SFC has time and again published updated guidelines and
circulars for sponsors, adapting to the ever-changing business and listing
environment, which are definitely worth a read.
In the SFC’s Report on the Thematic Review of Licensed
Corporations Engaged in Sponsor Business (“Thematic Report 2018”), SFC conducted
thematic inspection covering licensed corporations engaged in sponsor business
and identify common serious deficiencies and instances of non-compliances,
giving practical guidelines to market participants of what the SFC expects and
what qualifies as compliance. For example, indirect payment through third
parties and the inter-linkage between different business stakeholders (e.g.
supplier, distributor, customer, ultimate controller of the listed applicant
and etc.) are expressly categorised as red flags (both red flags appeared in
both cases mentioned above), calling for heightened scrutiny. Facing with these
obvious red flags, sponsors should execute their due diligence exercise with
utmost care, which would include conducting independent, comprehensive
interviews and enquiries, maintaining updated search and database and etc,
standards and requirements of which are set out in the Thematic Report 2018.
As an active response to the SFC’s front-loaded
regulatory approach, the SFC Regulatory Bulletin Issue No. 4 (February
2020) (“Regulatory
Bulletin Feb 2020”) was issued. Usefully, one of its aim
was to address “recurrent problems in sponsor work include failing to apply
professional scepticism and turning a blind eye to obvious red flags uncovered
by due diligence”. Apart from sponsor’s response to red flags,
the Regulatory Bulletin Feb 2020 touched upon the internal management
within the sponsor and ultimately the role of sponsor principals. SFC reminded
that for each sponsor engagement and/or task, senior management, who has the
requisite experience and skills should effectively and sufficiently co-operate
and supervise junior staff for the proper function of a sponsor, whereas
sponsor principal are reminded that they are not rubber stamps for signing
documents only.[3]
SFC’s proposed reform- sponsor coupling
Back in July 2017, when Mr Alder made his speech, he
pinpointed that “…of
course, tackling misconduct through traditional enforcement is always vital to
send strong deterrent messages to companies, initial public offering (IPO)
sponsors and other intermediaries. But we have convinced there was still a gap
in regulation…”. This hits the nail on the head. The current
commercial and market landscape exists where in an IPO process, the overall
coordinator as the head of underwriting syndicate (“OC”) enjoys higher
fees than sponsors, though sponsors generally incur more substantial costs and
bear the risks of consequences in the event of regulatory breach. This lures
sponsors to compromise their due diligence work to win the OC role amongst the
fierce competition with the non-sponsors.
Apart from rounds and rounds of enforcement and
disciplinary battles against sponsors, aligning with its strong emphasis on
“earlier, more targeted intervention”, SFC provides another alternative through
its “sponsor coupling” proposal, the consultation of which was issued in
February 2021 and then completed and concluded in October 2021. In short, SFC
proposes that the listing applicant must appoint at least one sponsor who will
also be appointed as an OC for the IPO process. This appointment has to be made
two months before filing the listing application. This aims to allow at least
one sponsor to be free of potential incentives to limit its due diligence work
as the OC role has been secured and this sponsor should be able to give
comprehensive advice to the listing applicant.
In the consultation conclusion, after considering
feedback from the market stakeholders, SFC has decided to implement the
“sponsor coupling” requirement to IPOs on the Main Board of the Hong Kong Stock
Exchange within nine months after gazettal.
Conclusion
It goes without saying that sponsors play a unique
role in ensuring market quality: they coordinate the IPO process, give advice
to directors and are centrally involved in and execute the due diligence
exercise on the listing applicant. Hence, the SFC emerges to take a two-pronged
approach to maintaining and upholding their standards: the traditional
enforcement actions giving deterrent warning; together with the forward-looking
and impactful “sponsor coupling” reform. While the reform is underway and the
real and practical effects towards the overall market remain to be seen, market
practitioners should keep abreast of the latest market and regulatory
development to ensure that they can discharge their duties effectively,
professionally and up-to-standard.
[1] For details, please refer to our previous newsletter titled “The SFC’s most severe disciplinary actions taken against sponsors” (April 2019 Issue)
[2] A more detailed discussion can be found in our previous newsletter “Latest regulatory action on sponsor failure“ (September 2020 Issue)
[3] For details on sponsor principals, you may visit our previous newsletter “Industry ban against a sponsor principal, but who is he?“ (July 2021 Issue)
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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. |
Published by ONC Lawyers © 2021 |