Crackdown on due diligence overdue
The securities watchdog has sent a clear message of intent to stamp out shoddy work by listing sponsors. The HK$42 million fine the Securities and Futures Commission levied Monday on the sponsor of Hontex International was a record, and withdrawal of its corporate advisory licence a first. The Fujian-based sports fabric maker was suspended after just 64 days' trading for having overstated its profits. The SFC said sponsor Mega Capital (Asia)'s failure to discharge its duty of due diligence had prejudiced assessment of the listing application and jeopardised the interests of the investing public. Court action will determine whether Hontex has to return the HK$1 billion listing proceeds.
The watchdog is to be applauded for sticking to its new, more aggressive stance on investor protection, which has put insider traders in jail under laws that make their wrongdoing a criminal offence. Given the huge proceeds at stake in IPOs, the fees to be earned, the sheer volume hitting the Hong Kong market and the competition for a piece of the action, there has to be a question of whether big fines are an effective deterrent to inadequate due diligence. The previous record fine of HK$30 million in the Euro-Asia Agricultural scandal apparently did not seem to have that effect.
Such cases are the tip of the iceberg, stemming largely from poor corporate governance standards on the mainland. Profit warnings, audit problems, trading suspensions and de-listings have undermined investor confidence. Evidence of this is to be found in the underwhelming performances of recently listed mainland firms that trade well below their offer price in Hong Kong and New York. Reports by the SFC on IPO submissions have revealed a pattern of unsubstantiated profit claims, overstated asset prices and unexplained revenues higher than those of industry peers. The Hontex case shows how this can happen. According to the SFC, the sponsor delegated most due diligence to inexperienced staff and agreed not to approach related parties directly, effectively putting the applicant in control of the investor-protection process. News of a move to consult the market on proposals for a tougher due-diligence regime for IPO sponsors is, therefore, overdue.
They are expected to propose criminal liability for failure to check misleading information in prospectuses, which could result in executives of sponsoring banks or brokerages facing jail or heavy fines. Lawmakers and investors have welcomed the proposals, though some investment banks and brokers can be expected to resist them strongly. But bankers who do their job properly will not have much to worry about. The consultation is a chance for investors to push for the effective enforcement of the diligence often lacking in the process that is supposed to protect them and safeguard the market's reputation.
