Due Diligence Guidelines –
Anti-Corruption, Anti-Money Laundering and Sanctions
2. Performance of Anti-Corruption, Anti-Money Laundering and Sanctions Due Diligence
2.1.1 Regarding the preparation of a listing document, a sponsor should perform, without limitation: … [an] assess[ment] of the legality and compliance of the business operations and whether the listing applicant is subject to any material legal proceedings or disputes. [Paragraph 17.6(d)(vii) of the Code of Conduct]
2.1.2 Where material deficiencies are identified in relation to the operations and structure, procedures and systems, or directors and key senior managers of a listing applicant, a sponsor should provide adequate advice and recommendations to assist the listing applicant to remedy these material deficiencies. [Paragraph 17.3(b)(ii) of the Code of Conduct]
2.1.3 Where these material deficiencies cannot be remedied prior to the submission of a listing application, a sponsor should make adequate disclosure as part of its submission of the listing application, including the nature of these deficiencies, reasons for non-rectification and remedial actions taken or to be taken. [Paragraph 17.3(b)(iii) of the Code of Conduct]
2.2.1 When conducting due diligence in relation to anti-corruption, anti-money laundering and sanctions issues, the initial step the sponsor should take is to ascertain which anti-corruption and anti-money laundering laws and regulations apply and which sanctioned targets are relevant to the listing applicant by reference to the location of the place of incorporation, domicile, residence and operations of the listing applicant, its directors, key senior management and controlling/substantial shareholders. This is necessary, as the applicable anti-corruption and AML law(s) and regulation(s) and relevant sanctioned targets will determine the scope, extent, focus and procedure of the due diligence exercise. These questions should naturally form part of the overall business due diligence exercise. For sanctions, it is important to understand the types, design and operation of all relevant sanctions and to be aware of each relevant regime’s extraterritorial application20 (if any), its targets and prohibitions and to whom the prohibitions apply.
2.2.2 The sponsor should exercise particular attention in the due diligence process if the listing applicant, or any of its directors, key senior management and controlling/substantial shareholders operates or conducts business in certain industries which are generally perceived as high-risk industries. Such industries include the casino and gaming sector,21 the securities/banking sector22 and money remittance/currency exchange providers,23 which have been identified as being vulnerable to money laundering activities, as well as the oil and gas sector, where countries/entities subject to sanctions are likely to be involved. Other examples of high risk industries include red-light businesses/adult entertainment, cash intensive businesses such as travel agencies, defence equipment producers/suppliers, gold/previous gem dealers, political/religious associations and charities. Again, these questions should naturally form part of the overall business due diligence exercise. The relevant Anti-Corruption/AML/Sanctions laws and regulations may prescribe more stringent requirements for these industries. Therefore, if the listing applicant is involved in these high-risk industries, the sponsor should ensure the breadth and depth of its Anti-Corruption/AML/Sanctions due diligence is in accordance with the requirements under the relevant rules and regulations.
2.2.3 The sponsor should similarly pay special attention in its due diligence exercise if certain territories/countries/regions are involved. This is because some territories are perceived to render a higher risk of non-compliance in the Anti-Corruption/AML/Sanctions related areas.
2.2.4 It should also be borne in mind that sanctions regimes are often proposed and adopted with little notice and are rapidly implemented. Therefore, it is essential for the sponsor to obtain the most up-to-date information on the relevant laws and regulations when conducting due diligence in these areas. In doing so the sponsor should consult its internal legal/compliance personnel and/or seek external legal advice if needed.
2.2.5 The sponsor should also be alert to certain “red flags” uncovered during the due diligence process. Typical examples of such “red flags” include –
(a) there is an indication that certain information has been deliberately omitted from due diligence or other documents;
(b) expenses and accounting records lack consistency and transparency;
(c) substantial payments are made in cash and/to multiple bank accounts;
(d) it has been suggested that shell companies, holding companies, or blind trusts be used in transactions without any reasonable commercial justification; and
(e) there are insufficient or inadequate mechanisms/procedures in place to prevent certain deficiencies.
The existence of red flags only indicates the possibility or potential risk of non-compliance. They are not evidence of non-compliance taken by themselves. However, where they are discovered, the sponsor will need to consider whether further enquiry/investigation is needed.
2.2.6 In addition to conducting due diligence on the listing applicant’s current business operation, the sponsor should also make enquiries as to the listing applicant’s prior investigations and compliance history. If prior instances of non-compliance have occurred, the sponsor should enquire whether remedial measures have been taken to address such non-compliance and seek to examine whether they have been effective.
2.2.7 If certain deficiencies are identified as a result of the Anti-Corruption/AML/Sanction due diligence exercise, the sponsor should assess the materiality of such deficiency with the assistance of the listing applicant and other third parties, such as the internal control consultant, reporting accountants and lawyers –
(a) If such deficiency is not material, then the sponsor should require the listing applicant to remedy these deficiencies. The sponsor should provide advice to the listing applicant as to the identified deficiencies which need to be remedied, and where the assistance of other third parties is required, the sponsor should point the listing applicant to the appropriate third party to assist the listing applicant to remedy these deficiencies. If such deficiencies cannot be remedied prior to the submission of the listing application, the sponsor should ensure adequate disclosure (including nature of such deficiency, reasons for non-rectification and remedial actions taken or to be taken) is made as part of its submission.
(b) If such deficiency is material, the sponsor should check with its internal legal/compliance department and/or seek external legal advice.
(c) In relation to sanctions, when assessing the materiality of risk, the sponsor should bear in mind that the extent of the revenues derived from the listing applicant’s projects/business in the sanctioned countries as a percentage of its total revenue during the track record period may not necessarily be relevant if it is demonstrated that the listing applicant would not be exposed to sanctions risks as a result of these projects/business. However, for projects/businesses that are subject to sanctions risk, the nature and size of these projects/businesses would be relevant in assessing the effectiveness of the measures that the listing applicant has taken or will take to ring-fence/minimise sanctions risk, and the financial and operational impact of these measures on the listing applicant’s business operations and profitability.24
2.2.8 The sponsor should also consider obtaining, in addition to general compliance representations and warranties, specific representations and/or warranties in the underwriting agreement in relation to the relevant “red flags” and/or deficiencies, if any, identified during the due diligence process.
2.3 Recommended Steps
2.3.1 Specific anti-corruption/AML/Sanctions due diligence should generally be carried out after the sponsor has performed the bulk of its business due diligence given that, as referred to in paragraph 2.2.1 to 2.2.3 above, the background understanding needed for the exercise will naturally form part of the overall business due diligence. Accordingly, the sponsor should ensure that the business due diligence includes:
(a) the nature of the business/industry the listing applicant operates in, and whether such business/industry has traditionally been vulnerable to corruption/money laundering/actions that are prohibited under sanctions;
(b) the geographic areas in which the listing applicant, its directors, key senior management and controlling/substantial shareholders operate or reside in and whether there is any “high-risk” location involved. In particular, the sponsor should consider whether any of these geographic areas is (a) on a sanctions list; and (b) is an area that scores below 50 out of 100 in the annual Corruption Perceptions Index published by Transparency International, a non-governmental organization that monitors and publicises corporate and political corruption in international development;25
(c) the types of organisations and/or individuals with whom the listing applicant does business, and whether any of such organisations and/or individuals are involved in “high-risk” business/industry or location mentioned in sub-paragraphs (a) and (b) above;
(d) the likely effects to the listing applicant’s officers, operations, prospects, shareholders, persons providing services and/or facilities to the listing applicant and the market perception of the listing applicant, including any negative impact on the reputation of the listing applicant, if there is or has been any breach of applicable anti-corruption/AML law or dealing in or with any sanctioned country, entity or person; and
(e) the business culture of the listing applicant and the methods which are employed in developing and sustaining business relationships with its counterparties.
2.3.2 The sponsor should review the findings of the due diligence exercise on the listing applicant’s internal controls for any “red flags”, structural risks and compliance weaknesses in the operations of the listing applicant and its affiliated companies that may have been identified.
2.3.3 Once the sponsor has formed a reasonable understanding of the listing applicant’s business and risk profile, the sponsor, with its legal adviser, should tailor questions/checklists which cater to the particular circumstances of the listing applicant, anticipate responses and design follow-up actions.
2.3.4 Throughout the Anti-corruption/AML/Sanctions due diligence process, the sponsor should work closely with the relevant internal control personnel to assess how the listing applicant ensures the effectiveness of its internal control/compliance system. Relevant personnel may include a member of senior management who is directly accountable for the oversight of the relevant internal control/compliance system, and a designated legal/compliance officer or a designated person equipped with the specialised knowledge for risk assessment and compliance monitoring.
2.3.5 If “red flags” are uncovered during the Anti-corruption/AML/Sanctions due diligence process, the sponsor should conduct follow-up work. The sponsor may request the listing applicant to submit additional documents/information that can substantiate, clarify or explain the suspicious situation.
2.3.6 In cases where the red flags arise out of suspicious activities performed by a specific party within the listing applicant (e.g., a director or an employee) or a counterparty, the sponsor should make further due diligence enquiries by conducting an interview with such party involved.
2.3.7 If deficiency is uncovered as a result of the Anti-corruption/AML/Sanctions due diligence, the sponsor should work closely with the listing applicant’s internal control personnel and the internal control consultant to assess the seriousness of such deficiency and provide advice and recommendations to assist the listing applicant to remedy it.
2.3.8 If such deficiency amounts to a material one based on the assessment conducted in paragraph 2.3.7 and cannot be remedied prior to the submission of the listing application, the sponsor should ensure adequate disclosure (including nature of such deficiency, reasons for non-rectification and remedial actions taken or to be taken) is made as part of its submission.26
20. US sanctions tend to have broad application and extraterritorial effect. For example, OFAC defines US persons to include all US citizens and permanent resident aliens regardless of where they are located, all persons and entities within the US, all US incorporated entities and their foreign branches. In the cases of certain sanctions, such as those regarding Cuba and Iran, all foreign subsidiaries owned or controlled by US companies also must comply, unless a general or specific license is available.
21. FATF published a report on vulnerabilities of casinos and gaming sector in March 2009 (Vulnerabilities of Casinos and Gaming Sector). The report points out that there is significant global casino activity that is cash intensive, competitive in its growth and vulnerable to criminal exploitation. It also identifies significant gaps in global coverage of anti-money laundering and combating of terrorist financing over the casino and gaming sector. This sector should also include online gaming/casino business. The report also points out on p58 that “it is clear that there are a number of related risks and vulnerabilities from online casinos. A number of jurisdictions license physical casinos and online casinos under a similar process.” Therefore, although a number of jurisdictions lack awareness of money laundering and terrorist financing risks in online gaming/casino business, the sponsor should consider performing the same level of Anti-Corruption/AML/Sanctions due diligence to assess the legality and compliance of the business operations. A significant number of jurisdictions have implemented regulatory controls over this sector, including imposing the ‘fit and proper’ test for casino owners, managers and staff, and requiring comprehensive internal control mechanism and system be set up.
22. See “Money laundering and terrorist financing in the securities sector” published by FATF in October 2009: http://www.fatf-gafi.org/media/fatf/documents/reports/ML and TF in the Securities Sector.pdf. This report describes (i) how criminals might be able to use securities firms to launder money and finance terrorism and (ii) how illicit funds can be generated through fraudulent activities.
23. See “Money Laundering through Money Remittance and Currency Exchange Providers” published by FATF in April 2012. This report sets out identified money laundering and terrorist financing methods and techniques involving money remittance and currency exchange providers, as well as identifies a number of vulnerabilities to money laundering across the sector.
24. Exchange Listing Decision LD76-2013 and Listing Committee Report 2013 .
25. Transparency International publishes an annual Corruption Perception Index measuring the perceived levels of public sector corruption in countries worldwide. Some countries score well but two-thirds of the 168 countries ranked in the 2015 Index score below 50 (out of a full score of 100). The 2015 Corruption Perception Index can be accessed at http://www.transparency.org/cpi2015.
26. In Exchange Listing Decision LD48-2013, for Company F, there were several deficiencies identified in disclosure made in the application proof of prospectus. One of such deficiencies was about non-compliance incidents. The Stock Exchange found the disclosures on non-compliance incidents were unclear and insufficient. The rectification measures and internal controls were not specific and could not be aligned to the non-compliances. There was also limited disclosure on the maximum penalties and liabilities.
In Exchange Listing Decision LD76-2013, the Stock Exchange also set out specific requirements as to prospectus disclosure where the listing applicants had entered into contracts with companies in the sanctioned countries. To enhance investors’ understanding of the listing applicants’ exposure to sanctions risk, the listing applicants should disclose prominently in the listing document, including the “Summary”, “Risk Factors” and “Business” sections –
(a) details of the listing applicants’ projects/businesses in the sanctioned countries;
(b) the legal adviser’s views on whether there was any risk of sanctions violations as a result of the listing applicants’ projects/business in the sanctioned countries and if so, the relevant impact and sanctions risk on the listing applicants, their investors and shareholders and other relevant persons who might be involved in permitting the listing, trading and clearing of the listing applicants’ shares (including the Stock Exchange);
(c) the facts that the listing applicants would terminate or transfer the existing projects/businesses in the sanctioned countries before listing and the resulting financial and operational impact on the listing applicants;
(d) details of legal consequences and maximum penalties (if any) for such termination and transfer;
(e) If the listing applicants after listing intended to undertake any new businesses in the sanctioned countries which would not expose them to any sanctions risk, details of such intention and the parameters or criteria the listing applicants would consider when determining whether to undertake such businesses;
(f) the listing applicants’ undertakings to the Stock Exchange that (i) the IPO proceeds and other funds raised through the Stock Exchange would not be applied, directly or indirectly, to finance or facilitate any projects or businesses in the sanctioned countries or pay any damages for terminating or transferring the contracts in the sanctioned countries; (ii) the listing applicants would not, directly or indirectly, perform any of the obligations under the relevant contracts under any circumstances, and details of the measures that the listing applicants would put in place to ensure compliance with these undertakings; and (iii) the listing applicants would disclose on the Stock Exchange’s and their own websites if they believed that the transactions they entered into in the sanctioned countries would put themselves or their investors and shareholders at risk of being sanctioned, and in the annual reports/interim reports their efforts on monitoring their business exposure to sanctions risk, the status of future business, if any, in the sanctioned countries and their business intention relating to the sanctioned countries;
(g) the risk of possible delisting of the listing applicants’ shares should the listing applicants be in break of their undertakings to the Stock Exchange; and
(h) details of internal control measures to control and monitor the listing applicants’ exposure to sanctions risk, and the views of sponsor(s) and directors on the adequacy and effectiveness of these measures to protect the interests of the listing applicants, their investors and shareholders, and the relevant persons referred to in (b) above.
HKCFEF Limited and the contributing law firms, accountants and sponsors are not offering these due diligence guidelines as legal, financial or professional advice or services and they should not be relied upon as such. These due diligence guidelines should not be used as a sole basis for any decision, action or inaction and are not meant to serve as a substitute for the advice of qualified professionals. See here for the full terms and conditions.