As Hong Kong IPOs start to make a timid comeback after a long summer lull, I unearthed an interesting working paper entitled “IPO sponsors and prospectus liability: the bridge too far?”, published in August by the Asian Institute of International Financial Law (AIIFL) of the University of Hong Kong.
Its authors, Syren Johnstone (in the interest of full disclosure, co-author with me of the study manual for IPO sponsor examinations published by the Hong Kong Securities and Investment Institute), Antonio da Roza and Nigel Davis (who runs a course at HKU where I teach as a honorary lecturer), are all members of the university’s faculty of law.
They argue at some length that, contrary to the conclusions reached by the Securities and Futures Commission (SFC) in August 2014, there appear to be no clear legal grounds supporting the SFC’s view that sponsors are subject to statutory civil and criminal liabilities in respect of material mis-statements made in Hong Kong IPO prospectuses.
"Criminal liability is as serious as it gets, but the SFC's two-page conclusion falls well short of explaining to sponsors on what basis they should fear criminal penalties" said the authors, in an interview with Clawback.
Their findings could prove to be ground-breaking, and help to topple the SFC’s position. In such a case, it would then be up to the courts to determine the responsibility of sponsors on a case by case basis, a much more palatable outcome for brokers and investment banks accused of having been involved in sponsoring work of sub-standard quality.
Square peg, round hole
The SFC’s conclusions on such an important issue, which has been widely debated since at least 2000, stated that no legislative amendments were needed for sponsors to be caught within the scope of prospectus law. The crux of the regulator’s argument was that sponsors are deemed to have authorised the issue of a prospectus, an analysis supported by the fact that they are required to file, after the listing hearing of an IPO, a “declaration of compliance” signed by the principal(s) supervising the offer, pursuant to Appendix 19 of the Listing Rules.
"It’s a square peg for a round hole problem — prospectus law was designed when the market was largely unregulated, and the sponsor role is hugely different in today's highly regulated environment", said the trio of academics, who have thoroughly deconstructed the SFC’s conclusions.
To start with, in Hong Kong, the status of sponsor is not specifically recognised in the prospectus provisions of the old Companies Ordinance (CO), which is the item of legislation that provides for potential civil and criminal liabilities for parties having authorised the issue of a listing document. The concept of sponsor also does not feature in any Hong Kong statutes or subsidiary legislation. The Securities and Futures Ordinance (SFO) does not even contemplate the duties of sponsors in connection with listing work.
In addition, sponsors do not make statements in prospectuses, unlike those parties considered as “experts” for regulatory purposes, or under prospectus law in the CO. And, unlike experts, a sponsor’s consent is not statutorily required prior to the registration of a prospectus.
Prospectus law specifically identifies persons subject to liability under its civil provisions, such as the directors, promoters, and those who have engaged in the authorisation of publication of the prospectus. The latter category is also subject to criminal liability. Since sponsors are not specifically mentioned, central is the question of whether they could be construed as having authorised the publication of a prospectus.
Consultations by the SFC, in 2003, 2005/2006 and 2012 pointed to a lack of clarity on this issue, while legislation in other countries (with the notable exception of Singapore) shows that providing advice on the contents of a prospectus does not actually make an adviser responsible for its issue.
Finding safe territory
In practice, boards of directors pass resolutions authorising sponsors to liaise with the stock exchange (and the SFC, given the dual regulatory regime for IPOs in Hong Kong) on their behalf, although they typically retain the authority to approve the final form of a prospectus, an authority that is usually carved out of the delegation given to the banks. It is also market practice for sponsors to seek back-to-back confirmation to file with the exchange the form that sets out the information to be submitted with the draft prospectus for review by the regulators.
Moreover, the authors of the working paper found nothing in case law, statutory analogues, or academic material to back the SFC’s position. Further, public offers in Hong Kong (which require the publication of a prospectus) can, in theory, readily be undertaken without the involvement of a sponsor provided there is no listing application.
Rather surprisingly, the authors of the AIIFL paper found that, taken to its logical conclusion, elements of the SFC’s position could potentially also capture underwriters because the SFC’s position implicitly assumes certain commercial considerations. Underwriters do not always act in a sponsor capacity, and vice versa. This was, for example, the case for most of the 29 bookrunners in the first iteration of the WH Group IPO syndicate. Such firms effectively have a significant commercial stake in the quality of prospectus disclosure, to support the marketing of an offer. Unlike sponsor firms, nowadays, global co-ordinators and bookrunners are usually paid on a “no deal, no fee” basis.
In conclusion, while the role and obligations of sponsors to the regulators and issuers in connection with IPOs are clear, there would appear to be no definitive argument under law that sponsors effectively authorise the publication of prospectuses.
As things stand now, there are clear penalties for sponsors submitting a false declaration of compliance to the exchange after the listing hearing. The SFC also has the power to substantially fine sponsors for regulatory breaches, with a number of well-established precedents. Certain market misconduct provisions of the SFO can also apply to sponsors. However, the regulator’s position, as far as civil and criminal liabilities for sponsors under prospectus law are concerned, would appear to be on rather shaky ground.
I understand that the SFC has yet to respond to the AIIFL paper, but no doubt the legal and compliance departments of firms licensed to act as sponsors will be carefully perusing its authors’ conclusions, perhaps with a view to pursuing some vigorous lobbying.
Ultimately, a change in prospectus law may well be needed for the SFC to have the last word. Experts, however, suggest that this could be both difficult and time consuming. The saga continues.