The Hong Kong Securities and Futures Commission has proposed the enhanced regulation of initial public offerings under a regime containing both civil and criminal penalties. For clarity and to enhance efficiency, the SFC proposes to consolidate all key obligations for sponsors of IPOs into a centralized code. The new code would clarify the liabilities of sponsors, both civil and criminal, for untrue statements, including material omissions, in a prospectus. Under the reform, all key sponsor obligations would reside in the Code of Conduct for Persons Licensed by or Registered with the SFC.
According to SF Chairman Eddy Fong, a major objective of the new regulatory regime is to ensure that sponsors maintain a high standard of due diligence in their work. A sponsor must exercise careful judgment about the nature and extent of due diligence and the manner in which it should be performed, emphasized Chairman Fong, and should not place uncritical reliance on other experts’ reports, including accountants reports, contained in the IPO prospectus.
Sponsors play a lead role in coordinating an IPO, noted SFC CEO Ashley Alder, since they advise and guide directors and are centrally involved in ensuring that prospectuses contain reliable and relevant information for investors. Mr. Alder said that the proposals encourage best practices across all sponsor firms whom investors rely on as key gatekeepers of market quality.
Regarding due diligence, the proposed regulations require sponsors to gain a thorough understanding of a company and adopt an open and questioning approach and not accept statements at face value. Moreover, a sponsor should collaborate and discuss with auditors, lawyers, directors and other experts to assess all information available to it about the company.
When submitting a listing application under the new regime, a sponsor should have already completed the vast majority of due diligence and resolved key issues concerning the operation, governance and structure of the company, as well as issues affecting the suitability for listing. Further, the first draft of the prospectus must be published on the website of Hong Kong Exchanges and Clearing Ltd.
A sponsor should also be reasonably satisfied through due diligence on the company that information in the prospectus is accurate and complete; and be able to demonstrate that it is reasonable to rely on accountants, valuers and other experts’ reports in the prospectus. While proper due diligence does not envision repeating the work done by experts, noted the Commission, it does involve testing the information provided in the reports to ensure that the totality of disclosure in the prospectus is credible and coherent. Sponsors must also be closely involved in the preparation of the MD&A section of a prospectus to ensure that sufficient qualitative information explaining the company’s track record is communicated clearly to potential investors.
A sponsor’s management should ensure that sufficient resources are allocated to an IPO and oversee the progress and the standard of due diligence, as well helping resolve difficult issues. The regulations would restrict the number of independent sponsors for each listing to one only or a limited number.
The role of sponsors is unique, said the Commission. While other experts and advisers are subject to a range of legal, regulatory and professional obligations, only sponsors have a function that begins and ends with the IPO itself and in that capacity are specifically licensed by the SFC.
Among other things they perform a lead role in co-ordinating all of those involved in the IPO process, they advise and guide directors throughout and they are centrally involved in the conduct of intensive due diligence on the company designed to ensure that the listing document contains sufficient information to ensure that investors are in a position to form a valid and justifiable opinion on its business and prospects. Further, investors rely on sponsors to act as key gatekeepers of market quality, emphasized the Commission, and at the heart of this lies the expectation that sponsors have conducted sufficient due diligence to properly understand and assess a company aspiring to join the stock market.
The Commission proposes that a sponsor should not submit a listing application unless it is satisfied that the applicant is ready to be listed, in that any material deficiencies as to its operations structure, and systems and its directors and key senior managers have been remedied and it meets the listing qualifications. Similarly, a sponsor should not submit a listing application unless it is satisfied that the draft listing document submitted with the application is substantially complete and all material information is disclosed in this draft or otherwise brought to the attention of regulators.
According to the SFC, the appointment of multiple sponsors can lead to fragmentation of work, gaps and overlaps. Moreover, there is no benefit for investors in having more than one sponsor. Thus, the Commission proposes that either a sole independent sponsor should be appointed for each listing transaction, or, alternatively, there should be a limit on the number of sponsors that can be appointed for each listing transaction, each of whom should be independent of the listing applicant.