The Securities and Futures Commission (“SFC”) has become increasingly concerned that some listed companies either do not obtain a valuation when circumstances suggest it would be appropriate or they rely on a valuation to justify a transaction when reliance on the valuation is imprudent. This sometimes results in the listed companies acquiring assets at unreasonably high prices or selling assets which are substantially undervalued, thereby causing loss to the listed companies and their shareholders.
On 15 May 2017, the SFC issued the following guidance to listed companies’ directors, financial advisers and valuers on their duties, obligations and liabilities in relation to valuations in corporate transactions:
- Guidance note on directors' duties in the context of valuations in corporate transactions;
- Circular to Financial Advisers in relation to their Advisory Work on Valuations in Corporate Transactions; and
- Statement on the liability of valuers for disclosure of false or misleading information.
Guidance note on directors' duties in the context of valuations in corporate transactions
The guidance note reminds listed companies’ directors that they are the guardians of a listed company’s assets and therefore, when considering, proposing or approving corporate transactions, they are expected to, among other things:
- carry out independent due diligence regarding the asset/ target company, instead of accepting blindly and unquestioningly financial forecasts, assumptions or business plans provided to them;
- take all reasonable steps to verify the accuracy and reasonableness of material information that is likely to affect the valuation of the asset/ target company, including financial forecasts, business plans and assumptions;
- consider the need for a valuation by a professional valuer of the asset/ target company;
- consider the scope of the valuer’s mandate to ensure that the valuation report will be relevant and useful in aiding the directors to determine the fair and reasonable offer price for the asset/ target company and the directors can reasonably rely on the valuation;
- provide a valuer with all relevant information that is likely to affect the valuation;
- rely on valuation only if this is reasonable in all the circumstances; and
- where a listed company appoints a financial adviser to assist in a transaction, ensure the scope of review and mandate of the financial adviser (in consultation with the financial adviser) are drafted appropriately for the matter at hand. For example, the mandate should provide that the financial adviser should review the reasonableness of any relevant assumptions to be made in the valuation and comply with the relevant requirements set out in the SFC’s Corporate Finance Adviser Code of Conduct.
The SFC will take into account whether the directors have adhered to this guidance note in assessing a breach of directors’ duties. The SFC is more likely to investigate and seek orders against directors who do not act in accordance with this guidance note. The SFC may seek disqualification, compensation and other orders against them as a result.
Circular to Financial Advisers in relation to their Advisory Work on Valuations in Corporate Transactions
The SFC noted that the prevailing industry practice is for the scope of the financial advisers’ work in their mandates being confined only to provide the required confirmation under the Listing Rules that the financial adviser is satisfied that a profit forecast involving valuation of assets or businesses acquired by a listed company based on discounted cash flows or projections of profits, earnings or cash flows has been made by the directors after due and careful enquiry. Financial advisers typically do not provide an opinion on the reasonableness of the valuation methods or the bases and assumptions adopted, stating explicitly that the directors and the valuers (if appointed) are solely responsible for these aspects.
This circular urges that when assisting in listed companies’ transactions, financial advisers should:
- comply with all applicable requirements under the SFC’s Corporate Finance Adviser Code of Conduct;
- not rely solely on representations made by the directors, their delegates or any third party, but should conduct their own assessment and undertake reasonableness checks on the forecasts, assumptions, qualifications and methodologies of any valuation and the directors’ decision on whether or not to appoint a professional valuer;
- if a financial forecast appear unduly optimistic, bring this to the attention of the directors for consideration and appropriate action; and
- if they cannot be satisfied that the valuation methodology is reasonable and that the valuation has been made by the directors after due and careful enquiry, use all reasonable efforts to ensure that the directors understand the relevant regulatory requirements and their implications and provide advice, and depending on the circumstances, might also need to consider the need to cease to act for the directors concerned.
Statement on the liability of valuers for disclosure of false or misleading information
This statement reminds valuers that they may have civil and criminal liabilities if they have authorised or were concerned in a listing applicant’s or listed company’s disclosure of false or misleading information and the valuers know that, or are reckless or negligent as to whether the information is false or misleading. They may be liable to compensate investors who subscribe for, sell or buy listed company shares at an undervalue or overvalue if the valuation contributed to the information in the corporate disclosure document being false or misleading.
The SFC is more likely to investigate the involvement of a valuer in the disclosure of false or misleading information by a listed company if it appears to the SFC that:
- the valuer knew or should have known that the valuation and/or any of the underlying assumptions is not reasonable and fair;
- the valuer has made an obvious mistake in the valuation;
- the valuer has not exercised the degree of skill and care which is ordinarily exercised by reasonably competent members of the profession; and
- the valuer has lost independence or impartiality in performing the valuation. For example, if a valuer, who the listed company instructed to produce the valuation, advised the vendor of the target company to amend key terms of sales agreements, e.g. the unit price and transaction volume of the sales agreements, which were the basis for the revenue projection used in the valuation of the target company.
The SFC makes it clear that it will take appropriate action against those companies, directors, advisers or valuers who fail to comply with their requirements under the Securities and Futures Ordinance, and that in assessing a potential breach of duties, it will take into account whether the guidance note, the circular and the statement have been adhered to, and is more likely to investigate and take action against those who have chosen to disregard them. Listed companies’ directors and any financial advisers and valuers involved in listed companies’ corporate transactions are reminded to take note of and adhere to the SFC’s requirements and expectations as set out in these guidance materials.