Hong Kong SFC Fines IPO Sponsors for Due Diligence Failures

In October 2021, Hong Kong’s Securities and Futures Commission (SFC) reprimanded and fined two sponsors – Ample Capital Limited (Ample)1 and Yi Shun Da Capital Limited (Yi Shun Da Capital)2 – for their respective breaches of their sponsor due diligence obligations on two separate Hong Kong listing applications. In both cases, the sponsor was found to have failed to conduct adequate due diligence of third-party payments which the SFC alleged raised red flags – in the Ample case of channel stuffing in the context of a distributorship business model, and in the case of Yi Shun Da Capital, of a circular flow of funds potentially indicative of an attempt to disguise the original source of funds and facilitate a deceptive or fraudulent scheme.

The latest disciplinary actions come as a reminder of the SFC’s determination to crack down on substandard sponsor due diligence, even in cases where the listing applicants do not proceed to listing and the sponsor’s failure to conduct adequate due diligence causes no financial loss to investors. The decisions underline the onerous and extensive nature of IPO sponsors’ obligation to carry out all reasonable due diligence on a listing applicant under Paragraph 17 of the SFC Code of Conduct for Persons Licensed by or Registered with the Securities and Futures Commission3 (the SFC Code of Conduct). They provide sponsor principals, in particular, with a timely reminder of the need to be alert to the existence of red flags and to conduct independent due diligence by reference to sources external to the listing applicant to ascertain the facts, rather than accept statements or documents provided by the listing applicant’s representatives at face value. Key takeaways from the cases are:

  • As demonstrated by the Securities and Futures Appeals Tribunal’s (SFAT) confirmation of the SFC’s findings of breach of sponsor duties by Yi Shun Da Capital, the existence of red flags (in that case, the extensive use of third-party payments) requires sponsors to conduct additional independent due diligence to ascertain the rationale for circumstances that are suspicious on their face.
  • The SFAT accepted that had proper due diligence been conducted, the sponsor might have come to the conclusion that the third-party payments were not suspicious (there was no allegation that the payments were fraudulent or fictitious) or were justified in the circumstances. What was not acceptable was for the sponsor to accept at face value representations of the listing applicant’s representatives: the situation required independent due diligence into the reasons for the extensive use of indirect payments which, without proper explanation in the listing document, risked raising concerns among potential investors.
  • To merely verify the existence of the dominant third-party payment method did not constitute the conduct of “all reasonable due diligence” required by the SFC Code of Conduct. And therein lay the sponsor’s breach of its due diligence obligations. The potential red flags obliged the sponsor to look in-depth into the payments and their rationale and this meant that the sponsor should have interviewed relevant customers and third-party payers as to why the listing applicant was paid indirectly.
  • In the Ample case, the sponsor failed to conduct independent enquiries into the relationship between the listing applicant and a distributor accounting for a significant portion of its sales, despite the HKEX specifically questioning the listing applicant’s sales to the distributor.
  • Ample also failed to critically assess the reliability of shipping documents provided by the listing applicant, failing to conduct the necessary independent due diligence despite obvious signs that the documents were not reliable.

The SFC has made no secret of its intention to stamp out substandard sponsor due diligence work. These latest decisions underline the need for sponsors to comply strictly with the requirements of Paragraph 17, even where the circumstances do not in fact, but could potentially, indicate fraud or misconduct on the part of the listing applicant or its directors.

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