In January this year, Sun Hung Kai International Limited (SHKI) was publicly reprimanded and fined HK$12 million by the Securities and Futures Commission of Hong Kong (SFC) for poor due diligence practices and failing to maintain adequate records in its role as a sponsor in the listing of Sino- Life Group Limited (Sino-Life) on the Growth Enterprise Market of the Stock Exchange of Hong Kong Limited (GEM). In addition, SHKI’s licence to advise on corporate finance was suspended for one year. Amongst others, SHKI had failed to disclose and explain a 45% difference between the respective cash flow figures reported by two accounting firms, a difference which was regarded as material as it impacted on whether Sino-Life satisfied the listing requirement for positive operating cash flow. On appeal to the Securities and Futures Appeal Tribunal (Tribunal), the Tribunal affirmed the SFC’s decision and laid down several principles in relation to the duties of sponsors in initial public offerings (IPOs). Given the substantial overlap between these principles, and the legislation and guidelines governing such duties in Singapore, this decision should be of particular interest to IPO managers in Singapore.
Differing Standards of Due Diligence between Mainboard listing and GEM listing?
The Tribunal unequivocally rejected SHKI’s argument that a GEM listing warranted a different standard of due diligence as compared to a Mainboard listing due to the lower fees charged by GEM listing sponsors. Instead, the Tribunal stated that the same standard of due diligence applies to both. Given that issue managers in a Mainboard listing and sponsors in a Catalist listing (collectively, IPO Managers) are subject, under the SGX-ST Listing Manual, to the same duty to exercise due care and diligence in ensuring the completeness and accuracy of information in a listing application , the SGX-ST will undoubtedly adopt a position similar to that taken by the Tribunal. That must be the correct position.
Reasonable Due Diligence
IPO Managers should be aware that the Securities and Futures Act (SFA) imposes criminal and civil liabilities for any false or misleading statements in or omission of material information from a prospectus. Nonetheless, an IPO Manager has a valid defence if it can show that it has made all inquiries that were reasonable in the circumstances or placed reasonable reliance on information provided by an unconnected third party.
In determining what constitutes reasonable inquiry, the Tribunal in Sino- Life’s case accepted that it was not the role of the sponsor to “chase every rabbit down every hole”. However, sponsors cannot turn a blind eye to known issues and should make a reasonably detailed enquiry to resolve such issues. A similar approach is adopted in the IPO Due Diligence Guidelines (ABS Guidelines) issued by the Association of Banks in Singapore (ABS), which provides that where an issue manager becomes aware of any information which may indicate potential issues and concerns, the scope of due diligence should be varied in order to ensure that they are properly addressed. First issued in 2004 by the Singapore Investment Bankers Association (SIBA) with the endorsement of the Monetary Authority of Singapore and the SGX-ST1 in order to assist IPO Managers in fulfilling their duties, the ABS Guidelines were adopted by ABS when SIBA was subsumed under ABS in 2011.
SHKI had in fact taken steps to approach the new accounting firm for its views on the discrepancy. However, the accounting firm declined to comment on the grounds that it was inconvenient for them to do so and that it had been told by Sino-Life to refrain from approaching the previous accounting firm. It is noteworthy that the Tribunal found that SHKI had failed to conduct reasonable due diligence as it should have at least attempted to obtain the materials that Sino-Life had provided to the two accounting firms in order to determine the basis on which the differing cash flow figures were calculated. We expect Singapore regulators to take a no less stringent position. The necessity of raising queries in the face of red flags is also underscored in the ABS Guidelines, which cites as an example an issue manager who discovers that certain weaknesses in the issuer’s internal controls are not disclosed in the internal control report. The ABS Guidelines states that in such a scenario, the issue manager is expected to discuss the report with the auditors and require them to provide a response on the omission so as to be satisfied with the basis on which the internal control report is prepared.
As only reasonable due diligence will effectively shield IPO Managers from liability under the SFA, such parties should be mindful that passivity in the face of unresolved issues and taking responses at face value are unlikely to suffice. Instead, IPO Managers must take a more proactive approach and make persistent attempts to resolve such issues. They should also refrain from blindly relying on representations made by the issuer, and should take steps to verify such information in the event of any contradictions or not in line with the norm.
Relying on Expert Advice
In determining whether SHKI could rely on the opinion issued by Sino- Life’s Taiwanese counsel as to the extent of encumbrances on certain material properties in Taiwan, the Tribunal noted that SHKI was aware of the fact that the opinion did not adequately address the issues raised but failed to make any further independent queries. As such, it was found to have placed undue reliance on such expert advice. Similarly, the ABS Guidelines also caution against accepting at face value the accuracy and completeness of statements made by the issuer and their advisors and IPO Managers should be aware that while they are entitled to rely on expert advice, they are also expected to review such advice responsibly and actively raise queries where there are indications of inadequacy or unreliability.
Keeping Adequate Records
The Tribunal also made it clear that while flagging issues and actively attempting to resolve them was a crucial element in discharging the due diligence duties of a sponsor, the importance of keeping adequate records of such due diligence work, especially in relation to material or contentious matters, should not be overlooked. In the context of Singapore, such an expectation has been ‘codified’ in the ABS Guidelines where it is provided that the due diligence process should be properly documented and that key correspondences should be kept in order to ensure a proper trail of work. As such, it would be prudent for IPO Managers to be mindful of this aspect as after all, a substantial part of determining whether an IPO Manager has adequately discharged its duties would be conducted through an examination of such records.
In recent years, IPO Managers have come under fire for poor due diligence practices and inadequate disclosures, and it is expected that the securities regulators will only be tightening the reins further. In 2013, China’s largest brokerage, Citic Securities Co., was reprimanded by the China Securities Regulatory Commission (CSRC) for failing to disclose a drop in profits at Soochow Securities Co. when it advised on the latter’s IPO. This was closely followed by CSRC’s reprimand of Everbright Securities Co. Ltd and Guosen Securities Co. Ltd for similar disclosure failures. In 2008, the SGX-ST barred Omega Capital Limited from handling IPOs until it raised its due diligence standards. These are all real-life lessons that IPO Managers should constantly remind themselves of. The key is to be proactive in their due diligence processes and to maintain adequate records in order to avoid being subject to such sanctions.