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Hong Kong regulators intensify collaboration on IPO-related misconduct crackdown

HKEX conducted IPO inquiries on 16 newly listed firms last year.

The Stock Exchange of Hong Kong Limited (HKEX) and the Securities and Futures Commission (SFC) are intensifying collaboration to target IPO-related misconduct, suspicious financial arrangements, and ramp-and-dump scams plaguing the city’s financial markets.

True to their commitment to combat IPO-related misconduct, the HKEX conducted inquiries into 16 newly listed companies’ use of IPO proceeds over the past year, whilst the SFC sought disqualification and compensation orders from the Hong Kong Court against directors of a listed company for IPO-related breaches.

The HKEX commenced disciplinary actions against three listed companies over the past year for their IPO-related misconduct, sanctioning them and their directors with public criticism and public censure.

Stephanie Chan, partner at Sidley Austin Hong Kong, noted that increased cooperation between the regulators will help them achieve their regulatory objectives in a “more cost-effective manner.”

“Compared to the HKEX, which usually invites listed companies to provide written submissions, the SFC has much wider statutory investigative powers, such as powers to compel subjects of investigation or other parties to produce documents, to execute search warrants to search premises and to obtain documents, and they can also require a person to attend an interview to give evidence. Through collaboration, the regulators can better allocate their investigative resources,” Chan told Hong Kong Business.

In a recent case, the HKEX identified some questionable transactions involving a listed company during their routine monitoring of the company’s announcements. Recognising the potential issues, the HKEX referred the case to the SFC for further investigation.

“The SFC is better placed to obtain evidence that may not otherwise be available to the HKEX. In that case, the SFC shared the evidence with the HKEX to facilitate its investigation. This is a good example showing the benefits of strategic collaboration between the regulators,” Chan said.

IPO-related misconduct

Chan said most IPO-related misconduct cases involve the misuse of proceeds through dubious financial arrangements that lack commercial justification and can cause significant losses for listed companies.

She said many listed companies involved in these cases do not properly disclose their change in use of IPO proceeds when it materially diverges from their initial business plans disclosed in the prospectus.

Newly listed companies may misuse IPO proceeds by paying unusually high, undisclosed expenses to parties related to directors or shareholders, disguised as listing expenses like IPO consultancy fees and underwriting commissions.

They may also make disproportionately high upfront payments to consultants and promoters not aligned with their purported purposes.

“There are also other cases involving suspicious financial arrangements at the IPO stage to artificially satisfy the initial listing requirements and create a false market of the shares,” Chan said.

She further noted that ramp-and-dump scams, another key area of focus for the HKEX and the SFC, may involve market manipulative activities conducted by sophisticated cross-border syndicates through taking steps to“ramp” up a listed company’s share price by spreading favourable news on social media to lure investors.

“They will then  “dump” the shares at a very high price and cause the share price to collapse and leave the investors with significant losses,” Chan said.

A warning

With the increased scrutiny over IPO-related misconduct, Chan advised directors and senior managers of listed companies to “maintain good corporate governance and implement effective internal controls to ensure compliance with the regulatory requirements.”

Chan warned that the SFC and the HKEX have a broad range of sanctions for enforcement actions targeting IPO-related misconduct and suspicious financial arrangements.

For instance, the SFC can pursue civil cases before the Market Misconduct Tribunal or initiate criminal or civil proceedings in the Hong Kong Courts against parties responsible for misconduct. The SFC can also seek appropriate remedies, including disqualification and compensation orders, against directors and other relevant parties.

On the other hand, the HKEX can initiate disciplinary proceedings and impose appropriate sanctions if it finds a breach of the Listing Rules, including private reprimands, public statements involving criticism, public censures, prejudice interests of investors statements , and director unsuitability statements.

Chan reminded directors of listed companies that under the city’s regulatory requirements, they have the responsibility, collectively and individually, to ensure compliance with their “fiduciary duties and duties of care, skill and diligence to the listed company and ensuring the company’s regulatory compliance.”

Directors must exercise independent judgment, proactively make inquiries and monitor the use of IPO proceeds and other assets, consult with the compliance adviser as needed, and oversee commercial transactions and agreements entered into by the listed company.

Directors and the listed company have the responsibility to properly disclose any material changes in how IPO proceeds are used.

When handling financial arrangements, directors should ensure transactions align with the company’s best interests.

“There should also be adequate and effective vetting procedures, risk assessment, due diligence and approval process, and full compliance with the disclosure obligations,” Chan said.

She concluded by stating that directors should keep detailed records to demonstrate to regulators that they have properly discharged their duties to ensure regulatory compliance.

“Maintaining a proper record-keeping system is also essential for demonstrating compliance with regulatory requirements in the event of a regulatory investigation,” she added.

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