The Hong Kong Securities and Futures Commission (SFC) has just announced that it has reprimanded and fined CCB International Capital Limited (CCBIC) $24 million for failing to discharge its duties as the sole sponsor in the listing application of Fujian Dongya Aquatic Products Co., Ltd (Fujian Dongya) in 2013 and 2014.
The disciplinary action followed the SFC’s investigation which found that CCBIC failed to:
- conduct all reasonable due diligence on Fujian Dongya before submitting the listing application;
- conduct proper customer due diligence; and
- keep a proper audit trail or written record of its due diligence work.
Failure to conduct all reasonable due diligence
Around 90% of Fujian Dongya’s turnover during the track record period (i.e. the years ended 31 December 2011, 2012 and 2013) was derived from sales to its overseas customers, and around 90% of such sales was paid by the overseas customers through third party payers (TPP Arrangement).
As part of the verification of the genuineness of Fujian Dongya’s sales, CCBIC instructed its lawyers to devise a due diligence plan on the TPP Arrangement.
The plan required CCBIC to, among other things,
- arrange Fujian Dongya’s overseas customers and their third party payers to sign a letter of confirmation;
- arrange overseas customers which could not terminate the TPP Arrangement to sign an indemnity agreement (Indemnity Agreement); and
- interview the third party payers before submitting Fujian Dongya’s listing application to The Stock Exchange of Hong Kong Limited (SEHK).
CCBIC, however, did not complete the due diligence plan prepared by its lawyers. For instance, it did not obtain from Fujian Dongya a list of customers which could not terminate the TPP Arrangement and select some of these customers for interview. It also did not interview any third party payers.
In the course of conducting the due diligence, CCBIC also discovered a number of red flags concerning the TPP Arrangement but there was no evidence that it had made further enquiries with the relevant customers or third party payers, nor records of its justifications for not doing so. The red flags included that:
- a number of Fujian Dongya’s customers relied on multiple third party payers from different countries to pay Fujian Dongya;
- some customers of Fujian Dongya acted as the third party payers of other Fujian Dongya’s customers when they also relied on third party payers to make payments to Fujian Dongya; and
- Fujian Dongya informed CCBIC that it was impossible or very costly for its customers in Taiwan to make direct payments to Fujian Dongya but SFC’s investigation revealed that various third party payers in Taiwan had made payments to Fujian Dongya on behalf of its customers.
The SFC’s investigation also revealed that one of the members of CCBIC’s transaction team had raised concerns about the genuineness of the signatures on the Indemnity Agreements.
After reviewing the Indemnity Agreements, the SFC found that:
- some of the Indemnity Agreements appeared to have been signed by the same person on behalf of different customers; and
- some of the Indemnity Agreements were apparently signed by the same person in different countries on behalf of different customers on the same day.
Failure to conduct proper customer due diligence
While CCBIC planned to conduct face-to-face interviews with Fujian Dongya’s customers in the absence of Fujian Dongya representatives and had made it clear to Fujian Dongya that telephone interviews would only be conducted with a small number of customers who could provide reasonable explanations as to why they could not attend face-to-face interviews, the SFC’s investigation found that:
- Of the 22 overseas customers interviewed by CCBIC, only 12 of them were interviewed in face-to-face meetings and 11 of these 12 interviews were conducted in the presence of one or two Fujian Dongya representatives;
- 8 of these 12 interviews were not conducted in the customers’ premises; and
- 10 customers were interviewed by telephone but there is no record as to why these customers could not attend face-to-face interviews.
Moreover, there is no evidence to show that CCBIC had taken steps to verify that the interviewees had the appropriate authority and knowledge to attend the interviews.
Failure to keep a proper audit trail or written record
The SFC’s investigation also found that CCBIC did not keep a proper audit trail or written record of its due diligence work. For example, CCBIC did not maintain records that could explain its decision of not completing the above-mentioned due diligence plan.
In deciding the disciplinary sanction, the SFC took into account that:
- the SFC found no evidence that the breaches and deficiencies identified above were deliberate, intentional or reckless;
- CCBIC cooperated with the SFC in accepting the disciplinary action and did not dispute the SFC’s findings and regulatory concerns;
- there is no evidence that suggests that there is a systemic failure in CCBIC’s policies, procedures and practices in respect of its sponsor work;
- CCBIC has on its own initiative enhanced its internal controls and systems in respect of its sponsor work since Fujian Dongya’s listing application and it agreed to engage an independent reviewer to review its enhanced policies, procedures and practices in relation to its sponsor work, particularly, in performing due diligence on listing applicants and preparing listing application documents;
- Fujian Dongya’s listing application had lapsed; and
- CCBIC has an otherwise clean disciplinary record.
The SFC reminded sponsors that before submitting a listing application to the SEHK, they should have performed all reasonable due diligence in order to gain a thorough knowledge and understanding of the listing applicant’s business and satisfy itself that all information concerning the listing applicant in respect of the application was fully, fairly and accurately presented.
A sponsor must also plan and execute its due diligence inquiries on information proposed to be disclosed in the IPO prospectus with professional skepticism and critically assess the information or documents provided by the listing applicant, recognising that it is possible for information or statements proposed to be disclosed in the IPO prospectus to be materially misstated due to error or fraud.