19 February 2020

Update on SFC’s front-loaded regulatory approach

This article was written by Rachel Yu and Iris Shaw.

The Securities and Futures Commission ("SFC") has in the last two years adopted a front-loaded regulatory approach in identifying risks and minimising harm to the investing public from market misconduct and irregularities. This approach places a strong emphasis on “earlier, more targeted intervention”, which translates into faster, more responsive, forward-looking and impactful regulation, focusing on greater threats or the more significant or systemic risks.

On 7 February 2020, the SFC published a SFC Regulatory Bulletin (“Bulletin”) to provide an update on its front-loaded approach and by drawing on multiple case studies, illustrate its key areas of concern and recent regulatory interventions in initial public offering (“IPO”) applications and corporate transactions.

IPO applications

In conducting their reviews of IPO applications, the SFC has identified various deficiencies in the IPO sponsors’ practices and internal systems and controls which can be broadly categorised under the following themes:

  1. Due diligence – failure to apply professional scepticism and turning a blind eye to obvious red flags uncovered by due diligence;
  2. Third parties’ work – over-reliance on and lack of supervision of third-party professionals such as lawyers and accountants; and
  3. Oversight of junior staff – ineffective or insufficient senior management oversight of junior staff.

Such deficiencies exhibited by sponsors are often followed by SFC disciplinary actions such as suspension of licence, ban of practice, reprimands and fines. In fact, since the launch of the new sponsor regime in October 2013, the SFC have taken disciplinary actions against 11 sponsor firms resulting in fines totalling HK$922.5 million.

The Bulletin serves as a helpful reminder to sponsors about their responsibilities and offers practical tips to ensure compliance with their expected standards. In gist, sponsors should have a proper understanding of a listing applicant’s business model, industry environment and associated risks so they can then design and adhere to a customised due diligence plan. Sponsors should then review all information collected during the due diligence process with professional scepticism and thoroughly follow up on any red flag. It is also important that sponsors do not blindly rely on the work of third parties and junior staff and maintain an active role in supervising and assessing their work.  Proper record keeping is also key.

Finally, sponsors should be reminded that those with a history of returned or rejected listing applications or serious deficiencies and instances of non-compliance may be subject to closer scrutiny when making future listing applications and should expect more frequent inspection visits and supervisory actions.

Corporate transactions

Aside from IPO applications, the SFC is also keen on adopting its front-loaded regulatory approach in combating dubious corporate transactions involving:

  1. Concealed share ownership and control – concealment often done by way of nominee accounts, margin financing, third-party financing arrangements and alternate forms of investment vehicles such as private funds;
  2. Suspicious valuations – unregulated valuation reports involving serious misconduct or lapses by directors or valuers;
  3. Warehousing of shares and nominee arrangements – arrangement commonly used for improper purposes, vote rigging and market manipulation; and
  4. Highly dilutive rights issues – open offers structured or conducted in a manner which appeared to be against the interests of minority shareholders.

As set out in the Bulletin, there were instances where seemingly overvalued acquisitions, dubious acquisitions and dubious fundraising proposals were terminated following the SFC’s expressed concerns and queries over their legitimacy.

As an example, a company proposed to acquire a stake in a target which recorded losses for two consecutive years and had net liabilities. The price was however determined in accordance with a valuation based on the company directors’ assumptions that the target’s estimated revenue growth rates would exceed 40% and its profit margin would turn positive. The aggressive assumptions of the target’s tremendous growth rates provoked the SFC to query whether the company directors had discharged their fiduciary duties in concluding such assumptions and the proposed acquisition was subsequently terminated.

In another case, a company proposed to acquire a target from its controlling shareholder by issuing new shares. The target’s principal asset was a Mainland property to be developed into a commercial complex. However, the Mainland government had in fact prohibited the target from developing real estate. The SFC issued a letter of concern to the company about the acquisition announcement accordingly and the proposed acquisition was subsequently terminated.

With respect to dubious fundraising, a company proposed a placing of new shares to raise money to develop its food and beverage business. However, the placing price was at steep discounts to the company’s net asset value and cash value so the amount to be raised would be small. Besides, the company did not appear to have an imminent need for funds whilst the dilution effect on its shareholders would be significant. As a result, the SFC expressed its concern that the company’s business might have be conducted in a manner which is oppressive or unfairly prejudicial to its shareholders and the proposed transaction was subsequently terminated.

As evident in the case studies above, directors’ breach of fiduciary duties or failure to avoid conflict of interest played a central role in the dubious corporate transactions under the SFC’s radar. To tackle this, the SFC has not hesitated in holding individual accountable for their actions and taking tough enforcement actions against directors who contribute to such misconduct.

In a recent enforcement case, the SFC also worked jointly with the Independent Commission Against Corruption (ICAC) to crack down on a highly suspicious and sophisticated scheme, allegedly designed to defraud shareholders of a listed company. Consequent to the joint operation, four former executive directors of the listed company was charged with conspiracy to defraud.


It is likely that the SFC will continue with its “front-loaded” approach in combating market misconduct and irregularities. Therefore, to ensure compliance and avoid investigations and subsequent disciplinary actions, IPO sponsors should refrain from cutting corners and be particularly diligent and vigilant when conducting due diligence and should exercise professional scepticism when assessing IPO applicants. On the other hand, directors of issuers should be mindful of their obligations to guard shareholders’ interests and remain professional and vigilant when performing their duties.

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