Combating IPO-related irregularities in Hong Kong

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

Over the past year, the HKEX conducted inquiries into the use of IPO proceeds by 16 newly listed companies, while the SFC sought disqualification and compensation orders from the Hong Kong Court against directors of a listed company for IPO-related breaches. The HKEX also initiated disciplinary actions against three listed companies for IPO-related misconduct, resulting in public criticism and censure of the companies and their directors.

The SFC, with its broader statutory investigative powers, can compel subjects of investigation or other parties to produce documents, execute search warrants, and require individuals to attend interviews to give evidence. This is in contrast to the HKEX, which typically invites listed companies to provide written submissions. The collaboration between HKEX and SFC allows for better allocation of investigative resources.

Most IPO-related misconduct cases involve the misuse of proceeds through dubious financial arrangements that lack commercial justification, leading to significant losses for listed companies. Often, these companies fail to properly disclose changes in the use of IPO proceeds when they materially diverge from 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. Additionally, some cases involve suspicious financial arrangements at the IPO stage to artificially meet initial listing requirements and create a false market for the shares.

Ramp-and-dump scams, another key area of focus for the HKEX and the SFC, involve market manipulation by sophisticated cross-border syndicates. These syndicates ramp up a listed company’s share price by spreading favorable news on social media to lure investors, then dump the shares at a high price, causing the share price to collapse and leaving investors with significant losses.

All directors and senior managers of listed companies should maintain good corporate governance and implement effective internal controls to ensure compliance with regulatory requirements. Under Hong Kong’s regulatory framework, directors have a collective and individual responsibility to comply with their fiduciary duties and duties of care, skill, and diligence to the listed company.

Directors must exercise independent judgment, proactively monitor the use of IPO proceeds and other assets, consult with compliance advisers as needed, and oversee commercial transactions and agreements. They are responsible for properly disclosing any material changes in the use of IPO proceeds.

When handling financial arrangements, directors should ensure transactions align with the company’s best interests, and implement adequate vetting procedures, risk assessment, due diligence, and an approval process. Compliance with disclosure obligations is essential, as is maintaining detailed records to demonstrate regulatory compliance. A proper record-keeping system is crucial for demonstrating compliance during regulatory investigations.