Like shops, IPO sponsors must be held liable for what they sell

Issue prospectuses have long played fast and loose with the truth - we should applaud the SFC for holding HK's investment bankers to account

PUBLISHED : Thursday, 13 December, 2012, 12:00am
UPDATED : Thursday, 13 December, 2012, 3:34am

If you splashed out on a new 55-inch television, got the thing home, unpacked it and found out that - contrary to what it said on the outside - the box contained only a 47-inch screen, you'd naturally feel you'd been ripped off.

But you wouldn't call the manufacturer's head office in Korea or Japan or wherever to complain. You'd storm back into the shop where you bought it, and either demand your money back or insist that the salesman replace the television with the model he'd promised you.

And you'd be fully within your rights. Under the Trade Descriptions Ordinance the retailer has a legal duty to make sure the goods he sells are what he says they are, and do what they are meant to do. False description is a criminal offence. Shopkeepers found guilty can go to prison for up to five years.

But investors who buy shares in a Hong Kong initial public offering enjoy no such protection. The issue prospectus can turn out to be a complete pack of lies, but the investment banks selling the shares face no criminal liability.

It's the equivalent of our dodgy TV salesman telling the aggrieved customer: "Nothing to do with me, complain to the factory."

So three cheers for the Securities and Futures Commission, which yesterday called for a change in Hong Kong law to make IPO sponsors criminally liable for prospectuses that contain misleading information or leave out key details.

The change is long overdue. A prospectus is meant to be a legal document containing all the information an investor needs to decide whether to buy shares or not. Its accuracy should be beyond doubt.

Yet with no criminal liability, investment banks have taken a distinctly slapdash approach to their duties as IPO sponsors, neglecting basic due diligence, and, in many cases, approving prospectuses that are little more than works of imaginative fiction.

In the 12 months to March of this year, the SFC received applications from 191 companies for listings on the main board of the Hong Kong stock exchange. Of these, it queried 168, while deferring comment on another nine because of "serious deficiencies" in their draft listing documents.

In other words, an astonishing 93 per cent of IPO prospectuses failed to pass muster at the first attempt.

The SFC complains that draft prospectuses failed to disclose risks, lied about companies' past performance, and often based their financial forecasts on assumptions "at odds with observable facts".

Prospectuses for property developers were among the worst offenders. One claimed the company's business was viable because of strong cash flow forecasts based on expected sales prices some 30 per cent higher than its historical average.

At the time the developer was actually busy slashing its prices in a desperate attempt to drum up sales in a stalled market.

In another developer's prospectus, its track record of profits hinged on a doubling in the estimated value of its investment properties, even though many of them had failed to find tenants because of severe oversupply.

Although it should be the IPO sponsor's duty to verify the claims in a company's listing documents, Hong Kong's investment bankers have bitterly opposed calls for them to be made liable for the information in deal prospectuses.

Typically, they complain that the extra due diligence involved will drive up costs and deter eligible companies from listing on the Hong Kong market.

This is doubtful. A greater degree of confidence in their prospectuses will allow companies to command a premium, making Hong Kong more, not less, attractive as a place to list shares.

In any case, it is ludicrous for investment bankers to expect to be held to a lower standard of consumer care than TV retailers.

Well done to SFC chief executive Ashley Alder for standing up to them.