Background

Recently, CCB International Capital Limited (“CCBIC”) was found to have failed to satisfy its due diligence requirement as the sole sponsor of initial public offering application of Fujian Dongya Aquatic Products Co., Ltd (“Fujian Dongya”). The Securities and Futures Commission (the “SFC”) concluded that it has failed to (i) conduct all reasonable due diligence on Fujian Dongya; (ii) to conduct proper customer due diligence; and (iii) to keep a proper audit trail or written record of its due diligence work. Consequently, SFC has reprimanded and fined CCBIC for HK$24 million for its failure to discharge its duty.

Due diligence requirement

It has been a long-established principle that in the process of initial public offering, sponsors are required to conduct due diligence over the disclosure to be made in the listing documents and in particular, the prospectus. In gist, such process serves the purpose of ensuring the accuracy of the statement and representation made in the listing documents. During such process, sponsors are expected to exercise their professional scepticism with a questioning mind to continuously carry out critical assessments on the matters to be disclosed in the listing documents.

Background facts and loopholes in CCBIC’s due diligence exercise

The crux of the case goes to CCBIC’s failure in obtaining sufficient evidence in verifying the turnover of Fujian Dongya. In short, during the track record period, about 90% of Fujian Dongya’s turnover was derived from sales to overseas customers through third party payment arrangements (the “TPP Arrangements”). Accordingly, CCBIC instructed its lawyers to come up with a due diligence plan to verify Fujian Dongya’s sales.

In conducting the due diligence exercise, CCBIC did not complete the due diligence plan proposed by its lawyers. For instance, it had made no further enquiries despite discovery of several suspicious issues in the TPP Arrangements. For instance, the customers relied on different multiple third party payers but some of which were at the same time customers of Fujian Dongya who also relied on third party payments. In addition, no further enquiries were made despite concerns voiced by a CCBIC transaction team member regarding the legitimacy of signatures on several indemnity agreements. The investigation by SFC revealed that the same person signed on behalf of different customers on the same indemnity agreement, some of which were even signed on behalf of customers in different countries on the same day.

In respect of the work conducted for customer due diligence, CCBIC failed to obtain Fujian Dongya’s list of customers and did not interview any third party payers. Further, while CCBIC had previously made known to Fujian Dongya that they intended to conduct face-to-face interviews with its customers and they would only entertain a few customers with telephone interviews if they have proper explanations for their incapability of meeting face-to-face, almost half of the interviewees had telephone interviews in the end. For the remaining customers with telephone interview, no record was found for their explanation.

Lastly, no proper audit trail or written record of CCBIC’s due diligence work was kept for further investigations. Manifestly, CCBIC failed to verify the interviewees for their authority for the due diligence interviews.

SFC decision

Having concluded that CCBIC had failed to discharge its due diligence duty as a sponsor, SFC reprimanded and fined CCBIC for HK$24 million. In reaching such decision, SFC has taken into account, among other things, that there is no evidence suggesting deliberate or intentional breach, that CCBIC did not dispute SFC’s findings and that they have a clean disciplinary record. SFC also considered the fact that there is no evident systemic failure in CCBIC’s policies, procedures and practices of sponsor work. Lastly, CCBIC did attempt to enhance its internal control systems and independent reviewers were also engaged to review its enhancements.

Conclusion

This case serves as a good reminder for sponsors in relation to the standard of due diligence required under the Listing Rules. As suggested in relevant SFC’s statement published on 9 July 2018, in order to ensure that the listing applications submitted are fair and accurate, sponsors are obliged to thoroughly understand the listing applicants’ business and satisfy themselves that the information provided in the listing documents is correct.

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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.