Chapter 9

Due Diligence Guidelines –

Interviews of Major Business Stakeholders

4. Arranging and Conducting Interviews

4.1 Standard

In conducting interviews, the sponsor should: … (ii) carry out the interview directly with the person or entity selected for interview with minimal involvement of the listing applicant; [Paragraph 17.6(f)(ii) of the Code of Conduct]

4.2 Guidance

4.2.1 The manner in which due diligence interviews are conducted can directly affect the quality and reliability of information obtained and, to the extent that such information is relied on when preparing the listing document, undermine the ability of the sponsor (and in turn, the investors) to properly assess the listing applicant’s financial condition.

4.2.2 It is likely that the sponsor will need the assistance of the listing applicant to identify appropriate interviewees and to arrange interviews. It is also possible that the listing applicant or the interviewee will require that the listing applicant is represented at the interview. However, the listing applicant should not seek to “condition” the interviewee or influence the results of the interview process. The sponsor should conduct interviews in a manner that enables it to make an independent assessment of the matters in respect of which such interviews are conducted and, if the listing applicant is represented at the interview, its role should be passive.

4.3 Recommended Steps

4.3.1 The sponsor may conduct interviews face-to-face in a physical meeting, via telephone or video-conference, or by means of a written interview questionnaire.

4.3.2 Where the sponsor has requested interviews with business stakeholders, it should not accept without further enquiries assertions by a listing applicant that business stakeholders selected for interviews have refused interviews with the sponsor or interviews of the type requested by the sponsor.6

4.3.3 The sponsor should seek to understand the cause and nature of any apparent resistance on the part of the interviewee to participate or cooperate in the interview. For example, explaining the scope, process and purpose of the interview may help to allay concerns. However, it is acknowledged that third party interviewees are under no compulsion to cooperate with the interview process and the refusal of a third party to participate in an interview does not mean that the sponsor has failed to perform adequate due diligence although the sponsor should assess the materiality of not conducting that interview to the veracity of the due diligence process as a whole. The sponsor should be particularly sceptical if the resistance originates or appears to originate from the listing applicant itself or the listing applicant’s financial or other professional advisers.

4.3.4 Presence of Listing Applicant’s Representatives

(a) Listing applicants should understand that their representatives are not normally expected to be present at third party interviews. However, third party interviews may be attended by one or more representatives of the listing applicant provided that they attend in the capacity of passive observers. Where representatives of the listing applicant are present at the interview, the sponsor should ask interviewees to give true and frank answers without being influenced by the presence of the listing applicant’s representative(s).

(b) The sponsor may explain the scope, process and purpose of the interview to help allay concerns the interviewee may have regarding the confidential or commercially sensitive nature of the information to be requested.

Note

If the proposed listing is mentioned to the interviewee, the listing applicant should emphasise to the interviewee that this is confidential information.

(c) As far as practical, questions should be posed by the sponsor or its representative and answered directly by the interviewee without reference to the listing applicant’s representative(s) (except where this is necessary to clarify particular information).

4.3.5 Presence of Legal, Financial and/or other Advisers

(a) Legal, financial or other advisers are permitted to be present at third party interviews (and in the case of legal advisers may be expected to be present). However, this does not change or exonerate the sponsor’s obligation to conduct interviews in accordance with the Code of Conduct’s requirements.

(b) The listing applicant should ensure that any of its financial or other advisers who attend the interview do so in the capacity of passive spectators and do not engage in any conduct that would affect the way in which the sponsor wishes to conduct the interview.

4.3.6 Use of Interview Questionnaires

(a) The sponsor may use an interview questionnaire to obtain information from third parties.

(b) Where practical, the sponsor should send questionnaires directly to, and should receive the completed questionnaires directly from, the interviewees in order to prevent the listing applicant intercepting or otherwise tainting the results of the due diligence enquiries. Ideally and if practicable, questionnaires returned by PRC entities should be stamped with a company chop.

(c) The sponsor should take steps (for instance in the cover letter and/or in a follow-up call to the interviewee) to ensure that the interviewee knows that the completed questionnaire should be returned directly to the sponsor. The sponsor may also consider providing pre-paid envelopes or arranging for collection of the completed questionnaire (e.g., by courier) to facilitate direct return to the sponsor or, alternatively, requesting that responses should be emailed directly to the sponsor (in which case, it would be permissible for the listing applicant also to be copied on the response).

(d) If the sponsor receives completed questionnaires through the listing applicant, it should:

(i) insofar as is practical, follow up with the interviewee to clarify why the questionnaire was not returned directly to the sponsor and ask for confirmation that the questionnaire was completed by the interviewee; and

(ii) perform additional due diligence to satisfy itself in relation to the independence of the responses.

(e) The sponsor should review completed interview questionnaires.

(f) If any material information is missing from a completed questionnaire, the sponsor should follow up on the missing information with the interviewee.

(g) The sponsor should check that questionnaires appear to be signed by the interviewee in his or her capacity as a representative of the relevant entity rather than in a personal capacity. For example, the name and office or position within the relevant entity held by the signatory(ies) should be stated beneath the signature(s).

(h) If an interview is conducted following the completion of a questionnaire, the sponsor should not be limited by the contents of the questionnaire.

Endnotes

6. The SFC’s press release “SFC fines and revokes the licence of Mega Capital (Asia) Company Limited” of 22 April 2012 included among its criticisms of Mega Capital (Asia) Company Limited (“Mega Capital”) that important aspects of its due diligence on the listing applicant’s suppliers, customers and franchisees were sourced from the listing applicant without independent scrutiny, displaying inappropriate reliance on the listing applicant. The SFC cited as one of its examples of Mega Capital’s failure to act independently, its acceptance of the listing applicant’s representation, without any enquiries, that some of its suppliers/customers refused to have face-to-face interviews with Mega Capital.

Other findings of the SFC set out in this press release included:

(a) Mega Capital’s due diligence work with regard to the listing applicant’s customers, suppliers and franchisees was inadequate and sub-standard. It noted that: material information (like transaction figures with the listing applicant’s group), was missing from questionnaires that Mega Capital completed with suppliers and customers; Mega Capital failed to follow-up on the missing information; a number of interviews with suppliers and customers were conducted over the phone in haste on the very day that the listing application was filed; and franchisees’ information provided by the listing applicant (name, address and turnover of each franchisee) was not properly verified and transaction records between franchisees and the group were not obtained; and

(b) Other examples of Mega Capital’s failure to act independently of the listing applicant were that: it acceded to the listing applicant’s request that it should not approach the group’s suppliers, customers and franchisees directly. Accordingly, all interviews were arranged by the listing applicant and conducted in the presence of its representatives. In addition, Mega Capital accepted the arrangement to have telephone interviews with such suppliers/customers arranged by the listing applicant. Finally written confirmations from franchisees confirming that they were independent from the listing applicant were obtained through the listing applicant.

In addition, the SFC Report on Sponsor Theme Inspection Findings of March 2011 was critical of inadequate due diligence on major business stakeholders by certain sponsors. The report notes inter alia that:

(a) Since each case is unique, Practice Note 21 to the Listing Rules does not prescribe the scope of the due diligence exercise on suppliers/customers, nor the manner in which the exercise should be conducted. It is the sponsor’s duty to exercise its professional judgement as to what is necessary and appropriate in the given context;

(b) The manner in which due diligence interviews are conducted can directly affect the quality and reliability of information obtained and, to the extent that such information is relied on when preparing the listing document, undermine the ability of the sponsor (and in turn, the investors) to properly assess the listing applicant’s financial conditions;

(c) The due diligence on the listing applicant’s suppliers/customers should not in any circumstances be confused with and limited by the minimum content requirements of listing documents;

(d) In a case reviewed by the SFC where the interview practices adopted could not effectively verify the identities of the interviewees and incomplete/unsatisfactory responses were not followed up by the sponsor, the information obtained, which formed a considerable part of the sponsor’s due diligence for verifying the existence of major customers and genuineness of sales as disclosed in the prospectus might not have been reliable. The consequences can be far-reaching as listing applicants, after their successful listings, may subsequently be found to be deceptive, to have acted fraudulently or provided false information in the IPO application process. Specific criticisms made by the SFC included that:

(i) information on the interviewee was scanty and insufficient to demonstrate that he/she was the appropriate person to be interviewed;

(ii) some of the questionnaires were substantially incomplete;

(iii) some of the questionnaires returned were only signed by an individual (purportedly on behalf of his/her company) though one would generally expect to see a company chop affixed on to the questionnaire given the local market practice; and

(iv) the sponsor did not follow up on the missing information or seek to confirm the identity of the interviewee.

(e) If sponsors do not arrange to receive the interview questionnaires or confirmations directly from interviewees, the results of due diligence inquiries might be subject to interception by the listing applicant or be otherwise tainted. In such circumstances, sponsors should perform additional due diligence to satisfy themselves in relation to the results. The SFC considered that it would be more effective if the sponsor was the one sending out and receiving these questionnaires, with minimal involvement of the listing applicant.

(f) In order to achieve the purpose of such due diligence interviews and be assured that the information obtained is reliable, it is important that the sponsor properly plans, manages and carries out the interviews.