IPO Sponsor Duties and the SFC’s Recent Disciplinary Actions

In March and May 2019 the Securities and Futures Commission (“SFC”) took disciplinary action against five investment banks in relation to shortcomings in the standards of sponsor work on three initial public offerings (“IPOs”) in 2009 and 2014. While the recent actions are part of a current thematic enforcement trend of the SFC - in October 2018 the SFC’s head of enforcement stated 28 sponsor firms in relation to 39 IPOs were under investigation – they bring to 14 the number of disciplinary cases against IPO sponsors since 2006.

The actions, which included fines totaling HK$813.7 million, put into sharp focus the special nature of the sponsor’s gatekeeper role in the listing process and the importance of the assurance it provides to the regulators (HKEX and SFC) and the market as regards the quality of disclosures in an IPO prospectus.

The cases were concerned with shortcomings in three key areas. The veracity of the listing applicants’ core assets and customers was not subjected to adequate due diligence. Reliance on experts and other third parties suffered from, inter alia, deficiencies in both the instructions given to them and the follow-up on important matters requiring verification. Record-keeping sufficient to establish an audit trail of what the sponsor had considered and done was inadequate. Further details can be found on the SFC’s website.

Although the question of what standards should apply to a sponsor’s undertaking has been subject to discussion since at least the time of the Hay Davison Report in 1988, the shortcomings observed in the recent disciplinary cases are familiar ones to the sponsor community.

For example, that sponsors should not place unsubstantiated reliance on experts was a concern of a consultation paper issued by the Exchange in 2000. The introduction of the SFC’s Corporate Finance Adviser Code in 2001 led some sponsors to complain the standards were too high and unachievable. Around this time, the recognition of an “expectation gap” and continuing concerns about the quality of sponsor due diligence led to a further codification of sponsor duties in 2005. The SFC’s 2011 thematic review, based on sponsors’ self-assessments circa late 2007 to late 2009, indicated deficiencies in customer due diligence, undue reliance on experts and other third parties, and inadequate record-keeping practices. This led to further changes to the regulations being introduced in October 2013.

Over the course of these developments, whether the underlying expectations for sponsor standards have been subject to escalation remains subject to debate. While some sponsors consider that to be the case, others appear to hold the view that the recent disciplinary actions reflect a continuing expectation gap and, possibly, the exercise by the SFC of hindsight. However, such views sometimes arise out of a misunderstanding of the relationship between the exercise of “professional judgment”, the role of experts and other third parties, and the exercise of reasonable due diligence (which is to be distinguished from forensic examination and the detection of fraud).

Sponsors and their legal advisers would do well to examine Escott v BarChris Construction Corp (283 F.Supp. 643 SDNY 1968), a leading case on what constitutes adequate underwriter due diligence in the context of a securities offering in the United States (there is no sponsor concept per se in the United States). Although Escott is around a half-century old, it is remarkable how many of the failures enumerated in that case continue to be reflected in the recent sponsor cases. Escott (and the cases that follow it) can also assist a deeper appreciation of the overarching objectives of Practice Note 21 - too many sponsors rely on a “PN21” checklist that leads to a box-tick mentality having insufficient bearing on what undertaking reasonable due diligence and exercising professional scepticism should involve in practice.

Where a prospectus does contain materially false or misleading information, or omits material information, aside from the exercise of the SFC’s disciplinary powers against sponsors, the logical next step to safeguarding the integrity of our market for primary equity offerings may be to look to the market abuse provisions of the Securities and Futures Ordinance, which are capable of applying not only to sponsors but also to the originators of misleading disclosure in a prospectus, in particular, the directors of the companies being listed. Regrettably, Hong Kong’s prospectus law remains out-of-date and of secondary relevance.

Editorial Note: Syren Johnstone, a former principal supervisor for IPO sponsor work, was appointed by the SFC as an independent expert in relation to IPO sponsor duties and is sharing his personal views on the SFC’s recent disciplinary actions.


Syren Johnstone is the Executive Director of the LLM (Compliance & Regulation) Programme at the University of Hong Kong and a Director of Keel Consulting. He has undertaken senior management roles regulated by the SFC and The Stock Exchange of Hong Kong, been engaged for expert work by Hong Kong’s statutory regulators, and has been an influential voice in shaping high profile regulatory matters that have been referenced in LegCo and the Court of Appeal. He is a member of the SFC’s Fintech Advisory Group since its 2016 formation.