An earthquake was one of the reasons given by an investment bank for its failure to conduct due diligence.
Industry experts say a lack of harsh penalty is why some investment banks do not perform their gatekeepers’ role in full.
But the Securities and Futures Commission is taking its role as watchdog seriously, stepping up its vigilance. This month it slapped a record fine of HK$786.7 million (US$100.2 million) on investment banks UBS, Morgan Stanley, Merrill Lynch Far East and Standard Charted for failing in their respective duties as IPO sponsors of China Forestry Holdings, Tianhe Chemicals Group and China Metal Recycling.
“Part of the answer is simply the lack of stiff criminal penalties,” said Steve Vickers, chief executive of risk consultancy firm Steve Vickers and Associates, who assists investment banks in their IPO due diligence. “As long as people don’t get sent to jail for deliberate misrepresentation and false statements then the deterrent value is limited.”
Vickers, a former head of criminal intelligence bureau at Royal Hong Kong Police, said after the financial crisis of 2009 many investment banks started cutting costs and began sending junior staff to get the job done, which led to a predictable deterioration in the quality of listings.
A magnitude 5.7 earthquake in Yunnan in 2009, is what UBS said prevented it from conducting an on-site examination to verify the existence of China Forestry Holdings’ forest assets.
The bank also said that its staff could not conduct interviews with the company’s clients because of the earthquake, according to the SFC’s investigation.
The SFC said that due diligence was essential part of the sponsors’ duties. The other three sponsors involved in the IPOs of China Forestry as well as Tianhe also had not conducted proper interviews during the due diligence process.
SFC last year also started legal action against China Forestry’s former chief executive Li Hanchun and froze his assets worth HK$398 million to prepare for the potential return of these assets to some of the shareholders.
Francis Leung Pak-to, chairman of the Chamber of Hong Kong Listed Companies, said the SFC penalties are not tough enough to discourage misconduct.
“The SFC can only impose heavy fines. But in the US, investment bankers who fail in their duty as gatekeepers of quality of IPOs, can go to jail,” Leung said.
Leung, a former investment banker who brought many “red chips” to list in Hong Kong in the 1990s, said that investment banks must fulfil their due diligence duties.
“We want to see sponsors, not regulators, determine companies that are qualified to list. As such, the duty of the sponsors is very important in maintaining market quality,” Leung said.
He added adding that the SFC’s recent actions will compel investment bankers to lift their due diligence game and improve the quality of companies sSeking listing in Hong Kong.