Hong Kong Watchdog Repeats Call for Banks IPO Liability

Hong Kong’s securities regulator proposed to make banks criminally liable for false statements in initial public offering documents, seeking to strengthen investor protection after a series of accounting scandals.

The Securities and Futures Commission said Hong Kong should change its laws to make an IPO sponsor’s criminal and civil liability unambiguous. The proposal, first raised in May, was repeated today after the regulator considered responses to the plan, according to a statement.

The SFC said a stricter regime is needed to protect investors, after a string of accounting scandals involving publicly traded Chinese companies hurt investor confidence. Critics have said the regulator already has powers to hold underwriters accountable for improper disclosure, and the new requirements will increase the cost of underwriting IPOs.

“Having someone on the hook for the quality of the information that’s provided, at face value, appears to be a positive step,” said Mark Konyn, chief executive officer of Cathay Conning Asset Management Ltd. “Whether or not the market can bear that level of liability is a question for the sponsors.”

Banks should be held criminally liable if they “knowingly or recklessly approved a prospectus containing an untrue statement (including an omission) which was materially adverse from an investor’s perspective,” the regulator said. Starting next October, the SFC will require companies to publish early drafts of IPO prospectuses, to be filed together with a listing application to Hong Kong’s stock exchange.

‘Chilling Effect’

Firms that act as IPO sponsors should be paid regardless of whether the deal gets completed, the SFC said.

Banks expressed concerns that the some of the changes may have a “chilling effect” on Hong Kong as an IPO market, according to a response to the proposals from a group of 23 banks including Goldman Sachs Group Inc., UBS AG and Morgan Stanley.

“An early filing process will have professional cost implications for the listing applicant before there is any deal certainty,” according to the statement, which was posted on the SFC’s website.

“The changes, along with a streamlined regulatory process, will incentivise sponsors to raise standards, pick the right deals and manage them well, which should in turn reduce risks for investors and all those involved in IPOs,” SFC Chief Executive Officer Ashley Alder said in today’s statement.

Falling Fees

At a press conference today, Alder said he hopes that clarification of Hong Kong’s laws will be complete by October. The current criminal fine is HK$700,000 ($90,321) and will be looked at in a separate review, he said.

Some lawyers including Christopher Betts, a Hong Kong partner at New York-based Skadden, Arps, Slate Meagher & Flom LLP, said the new rules won’t change Hong Kong’s position as a natural choice for Chinese companies looking to raise capital.

“The only issuers who should have anything to fear from all this are those that probably shouldn’t be going public in the first place,” Betts said.

The proposal come with Hong Kong on track for its worst year for IPOs since 2003, with proceeds falling 68 percent from last year to $6.6 billion, data compiled by Bloomberg show. It may add to pressure on banks already stung by falling fees.

In 2007, the SFC introduced a system where one or several investment banks arranging an IPO would act as a so-called sponsor and be responsible for due diligence. The sponsors on a deal are typically identified on the front page of the prospectus.

Due Diligence

Regulators started reviewing the sponsor regime after first-time sales raised a record $58 billion in Hong Kong in 2010, making the city the world’s biggest IPO center. Deals that year had inadequate due diligence at times, with some sponsors failing to keep proper records of their checks on listing applicants, according to an SFC report last year.

The 182 companies that began trading on the main board of Hong Kong’s exchange since the start of 2010 have fallen an average 12 percent from their IPO prices, according to data compiled by Bloomberg. The 118 Chinese companies among them are down on average 15 percent, the data show. Over the same period, the benchmark Hang Seng Index has gained 3 percent.

Boshiwa Investigation

Boshiwa International Holding Ltd., a Chinese maker of children’s apparel and licensee of the Harry Potter brand, said in March that Deloitte Touche Tohmatsu resigned as its auditor because of a lack of financial information. The company, which is investigating the matters raised by Deloitte, has been suspended from trading in Hong Kong for nine months.

Boshiwa raised $321 million in an initial public offering in September 2010, data compiled by Bloomberg show. Before they were suspended, Boshiwa’s shares fell 66 percent from the IPO price. UBS, Credit Suisse AG and BOCOM International Securities Ltd. were joint sponsors for the share sale, according to a prospectus published on Sept. 16, 2010.

“The proposals are a much-needed response to the deterioration of sponsor behavior in recent years,” the Asian Corporate Governance Association said in response to the SFC’s proposal, in a July 6 submission which didn’t refer to any specific IPOs.

Officials at UBS and Credit Suisse declined to comment on the Boshiwa IPO. A spokesman for BOCOM couldn’t be reached.

The new rules will require some investment banks to review their internal procedures, which may prove difficult initially due to limitation of resources with the downsizing of teams at banks in recent months, according to Conrad Chan, a partner in the Hong Kong office of law firm King & Wood Mallesons.

Falling Fees

Underwriters have already been stung by by falling fees, earning about $250 million from first-time share sales this year, down from an average of $775 million annually since 2006, according to data compiled by Bloomberg.

The SFC is already able to bring criminal and civil charges under existing laws, according to Shearman & Sterling, a law firm.

“There are existing provisions in the Securities and Futures Ordinance which impose civil and criminal liability,” according to the newsletter from the New York-based firm dated August 2012. “Moreover, the SFC seems to have sufficient powers to reprimand sponsors without relying on statutory provisions.”

The regulator in April fined Mega Capital (Asia) Co. a record HK$42 million for failing to highlight misleading information in the share sale prospectus of Hontex International Holdings Co. Mega Capital, the sole sponsor on the deal, was also stripped of its corporate finance license -- an unprecedented penalty.

Hontex, which raised $141 million in a December 2009 IPO, in June agreed to pay shareholders $133 million to end a lawsuit. The settlement was the first time the SFC negotiated a share repurchase by a listed company to compensate initial public offering investors.

Hontex, which has been suspended since just three months after the IPO, this month said Hong Kong’s stock exchange has decided to cancel its listing.

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