Last Friday, the SFC issued supplemental consultation conclusions covering prospectus liability for sponsors. The SFC has concluded that sponsors already have potential civil and criminal liability for prospectuses under the current legislation and therefore no legislative amendments are required.
In its previous consultation conclusions on the regulation of IPO sponsors published in 2012, the SFC had concluded that the Companies Ordinance (now retitled the Companies (Winding Up and Miscellaneous Provisions) Ordinance (CWUMPO)) should be amended to clarify that a person who authorises the issue of a prospectus would include a sponsor. The SFC has reconsidered the position and reached the view that the existing legislation is sufficient to impose liability on sponsors.
The supplemental consultation conclusions published last Friday send a message to the market that the SFC considers sponsors are already caught by the existing regime and it will consider bringing criminal proceedings against sponsors in appropriate circumstances where material untrue statements are made in a prospectus.
However, the consultation conclusions published last week also indicate that certain proposed amendments to address potential shortfalls in the existing regulatory regime identified in the 2012 consultation conclusions will not be further considered. These relate to the liability of individual employees of sponsors and the burden of proof in any enforcement action.
Changes to the regulation of IPO sponsors came into effect in October 2013 following the SFC’s consultation on the regulation of IPO sponsors. The changes were prompted by SFC concerns that there had been a decline in the standards of work by sponsors engaged in IPOs, in particular regarding inadequate due diligence and the quality of draft listing documents. As a result, the Code of Conduct for Persons Licensed by or Registered with the SFC (Code of Conduct) now codifies the sponsor’s key roles in an IPO.
The one key area outstanding from the SFC’s consultation concerned the statutory prospectus liability regime. The SFC was of the view that the prospectus liability regime (both criminal and civil) in the company legislation should be amended to clarify that a person who authorises the issue of a prospectus (and who is therefore liable for its content) would include a sponsor. Opinion on whether this was already the case under the existing legislation was divided at the consultation stage. However, there is no Hong Kong case law on whether sponsors are subject to the existing legislation and so the SFC was looking to put the matter beyond doubt by amending the legislation.
2. Prospectus liability under CWUMPO
The CWUMPO contains statutory provisions dealing with civil and criminal liability for untrue statements in a prospectus. Section 40 of the CWUMPO sets out categories of persons who are liable to pay compensation to investors who rely on a prospectus containing untrue statements and suffer loss. One of the categories is a “person who has authorised the issue of the prospectus”.
Section 40A(1) sets out the criminal liability for misstatements in a prospectus. It provides that where any untrue statement is included in a prospectus, any person who authorised the issue of the prospectus is liable to imprisonment and a fine unless he proves either that the statement was immaterial or that he had reasonable grounds to believe and did believe up to the time of the issue of the prospectus that the statement was true.
The CWUMPO also contains provisions extending these sections to prospectuses issued by companies incorporated outside Hong Kong.
3. Application of the CWUMPO to sponsors
In Friday’s consultation conclusions, the SFC stated that, in its view, sponsors would fall within the category of persons authorising the issue of a prospectus under the existing CWUMPO. This follows a detailed review of the legislation and the role of a sponsor in an IPO. The SFC is, therefore, no longer pursuing legislative changes to specifically provide that sponsor firms are deemed to be persons who authorise a prospectus as it is of the view that this is already the case under the existing legislation.
4. Who is liable under the existing regulations – individual liability?
In the SFC’s original proposals for legislative change, it had proposed imposing specific liability only on sponsor firms, namely the licenced entity appointed as a sponsor under the Listing Rules. This would have clarified that criminal liability would apply only to the sponsor firm, not to individual staff members (absent evidence that an individual had colluded in making a false statement or had consented to the commission of an offence where aiding and abetting offences may be pursued).
Given that the SFC did not deal with this in Friday’s consultation conclusions it has left open the issue of whether individual staff members of the sponsor firm will be considered liable under the CWUMPO. Further clarification from the SFC as to their interpretation and enforcement policy with respect to individual staff members would be welcome.
5. Lost opportunity to amend the burden of proof provisions under the CWUMPO
In its 2012 consultation conclusions on the regulation of IPO sponsors, the SFC acknowledged concerns about the drafting in the current legislation with regards to the burden of proof by the prosecution in criminal proceedings relating to prospectus misstatements. Under the CWUMPO, the prosecution only has to prove that the prospectus contains an untrue statement, leaving the defendant to establish that there were reasonable grounds to believe, and the defendant did believe at the time the prospectus was issued, that the statement was true or immaterial. Following market feedback, the SFC recommended in 2012 changing the legislative provisions to require the prosecution to prove that: (a) a person authorising the issue of the prospectus knew that, or was reckless as to whether, a statement in the prospectus was untrue; and (b) the untrue statement was materially adverse from an investor’s perspective.
Now that the SFC has decided not to pursue legislative changes, this opportunity to revise the burden of proof has been lost, leaving defendants exposed to the shortfalls identified in the 2012 consultation conclusions in any action brought against them.
The supplemental consultation conclusions mark an end to the SFC’s initiative to enhance the regulatory regime for sponsors in an IPO. The amendments to the Code of Conduct emphasised the SFC’s expectations of the sponsor’s as a gatekeeper, in conducting due diligence (and ensuring that all material information revealed is included in the draft listing document) and in advising and providing guidance to the listing applicant and preparing the listing document.
With the SFC’s conclusions on the application of the CWUMPO to sponsors, the SFC is clearly letting sponsors know its view that both statutory civil and criminal liability for prospectus misstatements also apply to them. The SFC has stated that it will pursue cases against sponsors in appropriate cases of material untrue statements in a prospectus.