The Securities and Futures Commission (SFC) has reprimanded and fined CCB International Capital Limited (CCBIC) $24 million for failing to discharge its duties as the sole sponsor in the listing application of Fujian Dongya Aquatic Products Co., Ltd (Fujian Dongya) in 2013 and 2014 (Notes 1 & 2).
The disciplinary action followed the SFC’s investigation which found that CCBIC failed to:
- conduct all reasonable due diligence on Fujian Dongya before submitting the listing application;
- conduct proper customer due diligence; and
- keep a proper audit trail or written record of its due diligence work.
Failure to conduct all reasonable due diligence
Around 90% of Fujian Dongya’s turnover during the track record period (i.e. the years ended 31 December 2011, 2012 and 2013) was derived from sales to its overseas customers, and around 90% of such sales was paid by the overseas customers through third party payers (TPP Arrangement).
As part of the verification of the genuineness of Fujian Dongya’s sales, CCBIC instructed its lawyers to devise a due diligence plan on the TPP Arrangement.
The plan required CCBIC to, among other things, (i) arrange Fujian Dongya’s overseas customers and their third party payers to sign a letter of confirmation; (ii) arrange overseas customers which could not terminate the TPP Arrangement to sign an indemnity agreement (Indemnity Agreement); and (iii) interview the third party payers before submitting Fujian Dongya’s listing application to The Stock Exchange of Hong Kong Limited (SEHK) (Notes 3, 4 & 5).
CCBIC, however, did not complete the due diligence plan prepared by its lawyers. For instance, it did not obtain from Fujian Dongya a list of customers which could not terminate the TPP Arrangement and select some of these customers for interview. It also did not interview any third party payers (Note 6).
In the course of conducting the due diligence, CCBIC also discovered a number of red flags concerning the TPP Arrangement but there was no evidence that it had made further enquiries with the relevant customers or third party payers, nor records of its justifications for not doing so. The red flags included that:
- a number of Fujian Dongya’s customers relied on multiple third party payers from different countries to pay Fujian Dongya;
- some customers of Fujian Dongya acted as the third party payers of other Fujian Dongya’s customers when they also relied on third party payers to make payments to Fujian Dongya; and
- Fujian Dongya informed CCBIC that it was impossible or very costly for its customers in Taiwan to make direct payments to Fujian Dongya but our investigation revealed that various third party payers in Taiwan had made payments to Fujian Dongya on behalf of its customers.
The SFC’s investigation also revealed that one of the members of CCBIC’s transaction team had raised concerns about the genuineness of the signatures on the Indemnity Agreements.
After reviewing the Indemnity Agreements, the SFC found that:
- some of the Indemnity Agreements appeared to have been signed by the same person on behalf of different customers; and
- some of the Indemnity Agreements were apparently signed by the same person in different countries on behalf of different customers on the same day.
Failure to conduct proper customer due diligence
While CCBIC planned to conduct face-to-face interviews with Fujian Dongya’s customers in the absence of Fujian Dongya representatives and had made it clear to Fujian Dongya that telephone interviews would only be conducted with a small number of customers who could provide reasonable explanations as to why they could not attend face-to-face interviews, the SFC’s investigation found that:
- Of the 22 overseas customers interviewed by CCBIC, only 12 of them were interviewed in face-to-face meetings and 11 of these 12 interviews were conducted in the presence of one or two Fujian Dongya representatives;
- 8 of these 12 interviews were not conducted in the customers’ premises; and
- 10 customers were interviewed by telephone but there is no record as to why these customers could not attend face-to-face interviews.
Moreover, there is no evidence to show that CCBIC had taken steps to verify that the interviewees had the appropriate authority and knowledge to attend the interviews.
Failure to keep a proper audit trail or written record
The SFC’s investigation also found that CCBIC did not keep a proper audit trail or written record of its due diligence work. For example, CCBIC did not maintain records that could explain its decision of not completing the above-mentioned due diligence plan (Note 7).
In deciding the disciplinary sanction, the SFC took into account that:
- the SFC found no evidence that the breaches and deficiencies identified above were deliberate, intentional or reckless;
- CCBIC cooperated with the SFC in accepting the disciplinary action and did not dispute the SFC’s findings and regulatory concerns;
- there is no evidence that suggests that there is a systemic failure in CCBIC’s policies, procedures and practices in respect of its sponsor work;
- CCBIC has on its own initiative enhanced its internal controls and systems in respect of its sponsor work since Fujian Dongya’s listing application and it agreed to engage an independent reviewer to review its enhanced policies, procedures and practices in relation to its sponsor work, particularly, in performing due diligence on listing applicants and preparing listing application documents;
- Fujian Dongya’s listing application had lapsed; and
- CCBIC has an otherwise clean disciplinary record.
The SFC would like to remind sponsors that before submitting a listing application to the SEHK, they should have performed all reasonable due diligence in order to gain a thorough knowledge and understanding of the listing applicant’s business and satisfy itself that all information concerning the listing applicant in respect of the application was fully, fairly and accurately presented.
A sponsor must also plan and execute its due diligence inquiries on information proposed to be disclosed in the IPO prospectus with professional skepticism and critically assess the information or documents provided by the listing applicant, recognising that it is possible for information or statements proposed to be disclosed in the IPO prospectus to be materially misstated due to error or fraud.
The SFC will continue to take action against sponsors who fail to fulfil these requirements.
- CCBIC is licensed to carry on Type 1 (dealing in securities), Type 4 (advising on securities) and Type 6 (advising on corporate finance) regulated activities under the Securities and Futures Ordinance.
- Fujian Dongya applied for listing on the Main Board of the SEHK on 21 March 2014 with CCBIC as its sole sponsor. The company’s listing application lapsed on 22 September 2014, i.e. six months after its submission of the application.
- According to the draft letter of confirmation prepared by CCBIC’s lawyers, the customers were asked to confirm, among other things, that: (i) they were independent from Fujian Dongya and its directors, senior executives or major shareholders etc.; (ii) the names of the third party payers that made payment to Fujian Dongya; and (iii) the amounts of such payments.
- According to the draft letter of confirmation prepared by CCBIC’s lawyers, the third party payers were asked to confirm, among other things, that: (i) they were independent from Fujian Dongya and its directors, senior executives, shareholders and staff etc.; (ii) the names of the customers whom they made payment to Fujian Dongya for; (iii) the amounts of such payments; and (iv) the reasons for making such payments on behalf of the relevant customers.
- The customers represented and warranted in the indemnity agreement, among other things, that: (i) the payments made by the third party payers were for purchase of products from Fujian Dongya; (ii) neither they nor their third party payers had engaged in money laundering activities, nor did the TPP Arrangement involve any money laundering activities; and (iii) their third party payers had no right to request for a refund of the amounts paid to Fujian Dongya.
- Paragraph 17.4(a) of the Code of Conduct for Persons Licensed by or Registered with the Securities and Futures Commission (Code of Conduct) provides that before submitting an application on behalf of a listing applicant to the SEHK, a sponsor should have performed all reasonable due diligence on the listing applicant except in relation to matters that by their nature can only be dealt with at a later date.
- Paragraph 17.10(c)(ii) of the Code of Conduct provides that in respect of each listing assignment, a sponsor should keep records and relevant supporting documents and correspondence relating to, among other things, its due diligence, changes to the due diligence plan and reasons.