Chapter 10

Due Diligence Guidelines –

Controlling Shareholders’ Relationship with the Listing Applicant

1. Understanding Controlling Shareholder(s)

1.1 Standards

1.1.1 Based on reasonable due diligence, a sponsor should have a sound understanding of: … the personal and business backgrounds of the directors, key senior managers and (where applicable) controlling shareholders of the listing applicant. [Paragraph 17.3(a)(ii) of the Code of Conduct]

1.1.2 A sponsor should conduct the following independent due diligence steps: … inquire directly of knowledgeable persons within or outside the listing applicant e.g. directors, key management staff, consultants and controlling shareholder(s). [Paragraph 17.6(e)(i) of the Code of Conduct]

1.2 Guidance

1.2.1 A controlling shareholder is defined under the Listing Rules as a person or group of persons who is entitled to control the exercise of 30% or more of the voting power at general meetings of the listing applicant or in a position to control the composition of the majority of its board of directors.1 Therefore, a listing applicant may have more than one controlling shareholder.

1.2.2 The purposes of conducting due diligence and understanding the background of the controlling shareholder(s) of a listing applicant are:

(a) to gain a better understanding of the listing applicant and supplement the sponsor’s other due diligence findings on the listing applicant, particularly in cases where a controlling shareholder is not part of the management of the listing applicant;

(b) to ascertain the relationship between a controlling shareholder and the listing applicant to assess whether it may have an impact on the listing applicant’s suitability for listing; and

(c) to ensure that particulars relating to a controlling shareholder and its relationship with the listing applicant are properly disclosed in the listing document (for further guidance on due diligence for connected transactions, please refer to Chapter 11 “Due Diligence Guidelines – Connected Persons and Connected Transactions”).

1.2.3 In identifying the controlling shareholder(s), a sponsor should take note of the following:

(a) there may be a group of shareholders that are “acting in concert” in their exercise of 30% or more of the listing applicant’s voting power, and as a result, they should be considered collectively as a group of controlling shareholders;2 and

(b) where there is no shareholder holding 30% or more of the voting power of the listing applicant, the sponsor should consider conducting due diligence on the single largest shareholder, especially where the holding of such shareholder is close to 30%.

1.2.4 If there is more than one controlling shareholder, the sponsor should also gain an understanding of the relationship between the controlling shareholders.

1.2.5 The extent of due diligence to be conducted would also depend on the nature of the controlling shareholder(s) and the listing applicant. For example:

(a) extensive due diligence on a controlling shareholder may not be required where the listing applicant is a PRC state-owned enterprise, and the controlling shareholder is a government body that is not engaged in the management of the listing applicant or other commercial activities. The sponsor may have difficulties obtaining answers from sovereign entities, and should therefore consider how it would perform due diligence on these entities; and

(b) more due diligence should be conducted for a controlling shareholder that supplies goods or provides services to the listing applicant.

1.2.6 The Exchange is likely to regard a controlling shareholder as a person who is likely to exert substantial influence on the operation and management of the listing applicant after listing. Accordingly, where an individual controlling shareholder has a past record of criminal conviction or regulatory non-compliance which raises serious concern as to the individual’s integrity, there may be concern as to the listing applicant’s suitability for listing which may not be solved by the individual refraining from acting as the listing applicant’s director.3

1.3 Recommended Steps

1.3.1 Identifying the Controlling Shareholder(s)

(a) The sponsor should check the register of members of the listing applicant and make enquiries with the listing applicant to identify any controlling shareholder or group of controlling shareholders (or single largest shareholder).

(b) The sponsor should request information from the listing applicant or the controlling shareholder(s) (or where applicable, the single largest shareholder) directly on the personal/family and business background of the controlling shareholder(s) and determine the extent of due diligence required, including:

(i) any equity interests transferred to family members or other persons, the basis of consideration and whether there are any disputes in relation to the equity interests; and

(ii) any previous or current entrustment arrangements between a controlling shareholder and other parties.

1.3.2 Background Checks

(a) The sponsor should perform background checks to identify the business of the controlling shareholder(s) (or where applicable, the single largest shareholder) and whether there are any issues as to independence, delineation, competition or other issues that may impact on the listing applicant’s suitability for listing or disclosure in the listing document. Background checks may include:

(i) for a company:

(A) searches for the corporate information of a controlling shareholder including the registered name, date and place of incorporation, company number and registration status; and

(B) searches on the website of a controlling shareholder to obtain information regarding its business operations and corporate profile;

(ii) searches for any litigation proceedings or judgments against a controlling shareholder (and its directors) in their place of incorporation/residence and business;

(iii) searches for any bankruptcy proceedings or judgments against a controlling shareholder (and its directors) in their place of incorporation/residence and business;

(iv) searches for any regulatory disclosures of a controlling shareholder. For a company, this may include any financial statements which contain information on the controlling shareholder’s other businesses;

(v) searches for any regulatory, compliance and sanction records against a controlling shareholder (or its directors), particularly for a controlling shareholder operating in a regulated industry (such as the banking, insurance and securities industries) or a controlling shareholder that is a listed company; and

(vi) news checks and searches on local and global media and the Internet for publications that relate to a controlling shareholder (and its directors).

(b) The sponsor should request and review documents from the controlling shareholder(s) (or where applicable, the single largest shareholder) including:

(i) for an individual, the individual’s identification documents;

Note:

If the sponsor intends to keep a copy of any identification document, it should follow procedures designed to ensure compliance with relevant provisions of the Personal Data (Privacy) Ordinance (Cap. 486 of the laws of Hong Kong).

(ii) for a company:

(A) its constitutional documents;

(B) where there is a significant ongoing business relationship with a controlling shareholder or there are other contractual protections provided by the controlling shareholder (for example, a guarantee or other financial support), its financial statements or otherwise obtain a good understanding of its financial position; and

(C) minutes of any board meetings at which business relating to the listing applicant was discussed;

(iii) any material agreements entered into with the Group; and

(iv) any shareholders’ agreement, joint venture agreement or voting agreement relating to the listing applicant or members of the Group.

1.3.3 Interview

(a) The sponsor should have an in-depth discussion with the controlling shareholder(s) (or where applicable, the single largest shareholder) in order to obtain an understanding of it, the listing applicant, and their relationship. Issues to be covered should include:

(i) information on the Group, including its establishment and reasons for establishment, how the founders financed the business when it was first established, and material developments since establishment;

(ii) information on the businesses of the controlling shareholder(s) and business relationships between the controlling shareholder and the Group; and

(iii) the relationship with other shareholders of the Group including the terms of any shareholders’ agreements, any disputes or disagreements among shareholders, and any financial support provided to the Group.

(b) The sponsor should note the following when conducting an interview with a controlling shareholder (or where applicable, the single largest shareholder):

(i) the sponsor should conduct the interview after having the opportunity to review results from background checks;

(ii) the sponsor may consider whether to conduct the interview in the absence of representatives of the listing applicant so that the controlling shareholder(s) may give answers without being influenced by the listing applicant. However, if the interviews are attended by representatives of the listing applicant, they should attend in the capacity of passive observers. Where representatives of the listing applicant are present at the interview, the sponsor should ask the controlling shareholder(s) to give true and frank answers without being influenced by the presence of the representatives of the listing applicant;

(iii) the sponsor should seek to verify the identity and position of the interviewee, for example through information in public records (such as regulatory filings), an email from a company address, obtaining a business card, or on the basis of customary identification documentation such as an identity card or passport;

(iv) legal, financial and other advisers may be present at the interview, however, they should attend in the capacity of passive spectators and not engage in any conduct that would affect in any way the sponsor’s conduct of the interview;

(v) as far as practical, questions should be posed by the sponsor and answered directly by the controlling shareholder(s) without reference to the listing applicant’s representatives and advisers;

(vi) the sponsor should be alert for information that is inconsistent in a material respect with other information (particularly financial information) regarding the listing applicant that has been provided to the sponsor, which may indicate that the information previously provided is unreliable;

(vii) information obtained in the interview should, where practical, be cross-checked for consistency with information provided by the listing applicant or obtained from other sources and for consistency with information included in the listing document; and

(viii) the sponsor should seek to identify issues arising from the due diligence interviews that may require further information, and promptly follow up with the controlling shareholder(s) on any missing information after the interview.

Endnotes

1. Listing Rules 1.01 and 19A.14.

2. In SFC Dual Filing Update of June 2009, the SFC noted an instance where an initial draft listing document disclosed that the listing applicant had no controlling shareholders, but following enquiries by the regulators, the sponsors submitted that two shareholders, including one previously described as a passive investor, were at all material times acting in concert and should have been disclosed as the controlling shareholders throughout the track record period. The SFC commented that the deficient disclosure in the draft listing document suggested that the sponsor might not have exercised due care in advising on the preparation of the initial listing application.

3. Exchange Guidance Letter GL68-13 (at paragraph 3.2(1)).