5 February, 2013
On 12 December 2012, the Securities and Futures Commission (“SFC”) published the conclusions of its “Consultation Paper on the regulation of sponsors”. Other than the proposal to have a limit on the number of sponsors appointed for each IPO and the requirement for all sponsors to be independent of the listing applicant, the SFC has decided to proceed with most of its proposals.
The new rules on sponsor responsibilities, to be included in the Code of Conduct for Persons Licensed by or Registered with the Securities and Futures Commission (“Code of Conduct”), will apply to listing applications submitted on or after 1 October 2013. The proposed clarification of sponsor liability under the Companies Ordinance, as discussed below, will be subject to a separate legislative process and timetable.
Statutory Reform – Prospectus Liability under the Companies Ordinance
One of the most controversial proposals of the SFC is to remove any ambiguity in the case law by clearly identifying sponsors as being liable, along with directors and others who authorize the issue of a prospectus, under section 40 (civil liability for misstatements in prospectus) and section 40A (criminal liability for misstatements in prospectus) of the Companies Ordinance. Any person who commits an offence under section 40A is liable to a fine of HK$700,000 and imprisonment for three years.
In deciding to proceed with its proposal, the SFC acknowledges that the current standard of liability under section 40A may be too onerous. The SFC therefore proposes that criminal liability should only apply if the prosecution can prove that:
- the person knew that, or was reckless as to whether, a statement in the prospectus was untrue; and
- the untrue statement was materially adverse from an investor’s perspective.
The SFC also proposes that only sponsor firms, and not individuals, will be subject to the civil and criminal liability under the Companies Ordinance. However, as stated in the Consultation Conclusions, there could be situations where individuals would be held liable under general criminal law, e.g., “aiding and abetting” under the Criminal Procedure Ordinance.
Publication of Application Proof on HKEx’s website
With effect from 1 October 2013, the first draft of the listing document submitted to the Hong Kong Stock Exchange (“Application Proof”) will be required to be posted on the website of Hong Kong Exchanges and Clearing Limited (“HKEx”). The Hong Kong Stock Exchange will also increase its practice of rejecting poor quality draft documents and will consider imposing a “cooling-off” period during which the submission of a revised draft will not be allowed.In response to market concerns that applicants already listed on an overseas stock exchange might face practical difficulties given that any public disclosure in Hong Kong might trigger a corresponding disclosure obligation overseas, the SFC stated in the Consultation Conclusions that it may consider confidential filings for overseas listed companies.
Streamlined Regulatory Commenting Process
Some market participants have commented that disclosures in listing documents are sometimes driven by the rounds of regulators’ comments rather than their relevance or materiality, and the paternalistic approach of the regulatory commenting process has been a contributing factor of sub-standard listing documents. While stressing the regulators are not responsible for the adequacy or accuracy of disclosures, the SFC stated that it will work with the Hong Kong Stock Exchange on measures to streamline and shorten the regulatory commenting process.
Sponsors’ Role – Minimum Appointment Period and Fees
The SFC has also adopted some of the proposals by market participants to enhance the role and authority of sponsors, e.g.:
- a sponsor will be required to be formally appointed for a minimum period of two months before submission of the listing application. Where there is more than one sponsor, each of them will be required to comply with the minimum appointment period; and
- sponsor fees will be required to be specified in terms of engagement and should be based solely on a sponsor’s role. Any “no deal, no fee” arrangement should be avoided.
The Revised Code of Conduct
The SFC has consolidated all existing rules and new obligations and standards governing sponsor conduct in a new paragraph 17 of the Code of Conduct. A key theme of the new rules, as reflected in some of the provisions summarized below, is early completion of comprehensive due diligence:
Work required before submission of listing application. Under the revised Code of Conduct, a sponsor is required to complete all reasonable due diligence on the listing applicant before submitting a listing application, except in relation to matters that by their nature can only be dealt with at a later stage. In addition, before submitting a listing application, a sponsor should come to a reasonable opinion that:
- the information in the Application Proof is substantially complete;
- the applicant has complied with all relevant listing qualifications under the Listing Rules (except to the extent that waivers from compliance have been applied for);
- the applicant has established procedures, systems and controls to ensure compliance with the Listing Rules and other relevant regulatory requirements; and
- the directors individually and collectively have the necessary experience, qualifications and competence.
Standards and responsibility of due diligence. The revised Code of Conduct codifies due diligence obligations and sets out typical due diligence steps and interview practices to be followed. In particular, it provides that a sponsor cannot abrogate its due diligence responsibility. Where a sponsor engages a third party (e.g., lawyer or consultant) to assist in the due diligence exercise, the third party’s work, in itself, would not be sufficient evidence that the sponsor has discharged its obligation.
In relation to expert reports to be included in a listing document, the revised Code of Conduct introduces a “negative” test: a sponsor (i) should have no reasonable ground to believe; and (ii) should not believe that the information in the expert reports is untrue, misleading or contains any material omissions. A sponsor should carry out due diligence on expert reports covering the following aspects:
- the expert’s qualification, experience and competence;
- the expert’s scope of work;
- the bases and assumptions underlying the report; and
- the expert’s opinion together with the rest of the information in the report.
Provision of information to regulators. A sponsor should reasonably satisfy itself that all information provided to the regulators is accurate and complete in all material respects and not misleading in any material respect. Where a sponsor becomes aware of any change in information provided or any material information which concerns non-compliance with the Listing Rules or other regulations, it should report the matter to the Hong Kong Stock Exchange in a timely manner.
Where a sponsor ceases to act for a listing applicant, the sponsor should inform the Hong Kong Stock Exchange in a timely manner of the reasons for ceasing to act.
Resources, systems and controls. A sponsor should maintain sufficient resources and effective systems and controls to ensure that it is able to meet its obligations. In respect of each assignment, a sponsor should ensure that it has sufficient staff with appropriate levels of knowledge, skills and experience to devote to the assignment. The management of a sponsor must be ultimately responsible for supervision of the sponsor work and there must be clear and effective reporting lines so that decisions on critical matters are made not by the transaction team but by the management.
Record keeping. A complete set of sponsor’s records should be retained in Hong Kong for at least seven years after completion or termination of a listing assignment. A sponsor should keep a record of all sponsor work and maintain adequate records to demonstrate that it has complied with the Code of Conduct.
Impact of the Reform
As shown in the Hontex case where the SFC imposed a HK$42 million fine and revoked the license of Mega Capital for failure to discharge its sponsor’s obligations, the SFC will not hesitate to take action against sponsors and exercise its disciplinary power to the full extent. With the revised Code of Conduct and the potential civil and criminal liability, the SFC will be vested with further powers. It is therefore important for sponsors to get prepared for the new regime.
The new rules will have significant impact on the ways IPOs are conducted in Hong Kong. Sponsors will be concerned about potential criminal liability and will look for additional safeguards and comforts during the listing exercise to ensure that they will not be tainted with any allegation of “recklessness”. The tightened regulations under the revised Code of Conduct will front load many tasks and sponsors and all professional parties involved will be working on a much longer and intensive pre-A1 timetable. To offset the increased workload under the new regime, it is important that the SFC and the Hong Kong Stock Exchange streamline the regulatory commenting process, as promised in the Consultation Conclusions. We look forward to the announcement of the new measures and hope that the streamlined procedure will mean not only fewer rounds of regulators’ comments, but also a change in the overall vetting approach.
The Consultation Paper and the Consultation Conclusions are available at:
http://www.sfc.hk/edistributionWeb/gateway/EN/consultation/openFile?refNo=12CP1
http://www.sfc.hk/edistributionWeb/gateway/EN/consultation/conclusion?refNo=12CP1
Matthew Bersani, Partner, Shearman & Sterling
Shearman & Sterling Capital Markets Practice Profile in Hong Kong