Due Diligence Guidelines –
Legal and Regulatory Compliance and Legal Proceedings and Disputes
2. Dealing with Material Non-Compliance
When submitting an application on behalf of a listing applicant to the Stock Exchange, the sponsor should ensure that all material issues known to it which, in its reasonable opinion, are necessary for the consideration of: … whether the listing applicant is suitable for listing … are disclosed in writing to the Stock Exchange. [Paragraph 17.4(d)(i) of the Code of Conduct].
2.2.1 Where material legal or regulatory non-compliance incidents are identified, the sponsor should consider whether such incidents render the listing applicant unsuitable for listing, or whether they can be addressed by way of disclosure in the listing document. The sponsor should refer to Chapter 31 “Due Diligence Guidelines – Dealing with “Material Deficiencies” of the Listing Applicant” and Chapter 4 “Due Diligence Guidelines – Submission Readiness” for further guidance.
2.2.2 Where legal or regulatory non-compliance incidents are of a serious nature (for example, involving fraud or deceit by directors or senior management, systematic failure of a listing applicant’s internal controls and/or matters with a significant financial impact on a listing applicant), this may call into question the suitability of the directors and/or mean that the listing applicant is not suitable for listing. For further guidance on matters which may impact suitability for listing, sponsors should refer to paragraph 3.2.2 of Chapter 4 “Due Diligence Guidelines – Submission Readiness”. Sponsors should also refer to the following chapters for specific guidance on suitability issues: Chapter 7 “Due Diligence Guidelines – Knowing the Listing Applicant and its Management”; Chapter 8 “Due Diligence Guidelines – Business Model”; Chapter 10 “Due Diligence Guidelines – Controlling Shareholders’ Relationship with the Listing Applicant”; Chapter 13 “Due Diligence Guidelines – Internal Controls”; Chapter 15 “Due Diligence Guidelines – Anti-Corruption, Anti-Money Laundering and Sanctions” and Chapter 23 “Due Diligence Guidelines – Mineral Companies”.
2.2.3 Any material non-compliance which could affect the listing applicant’s suitability for listing is required to be disclosed to the Exchange in writing at the time of submission of the listing application.28
2.2.4 Decisions on the resolution of material non-compliance issues may be required to be made by Management or a committee designated by Management for making decisions on critical issues.29
2.3 Recommended Steps
2.3.1 Where decisions on the resolution of material non-compliance incidents are required, the sponsor should follow the guidance on escalating critical matters in Chapter 32 “Due Diligence Guidelines – Escalation of Critical Matters”. It should be noted that where a Transaction Team is able readily and definitively to resolve a matter which appeared on initial encounter to involve material non-compliance, without any residual concern or doubt, then the matter would not require escalation to Management or its designated committee.
2.3.2 The sponsor should refer to section 4 of Chapter 4 “Due Diligence Guidelines – Submission Readiness” for guidance on the requirement to disclose to the Exchange material issues necessary for consideration of whether the listing applicant is suitable for listing under Paragraph 17.4(d)(i) of the Code of Conduct.
2.3.3 The sponsor should consider whether any material non-compliance incident(s) identified renders the listing applicant unsuitable for listing after taking into account:
(a) advice from lawyers in the relevant jurisdiction as to the legal consequences of the non-compliance incident(s);
(b) discussions with the listing applicant’s management as to the likely impact on the business; and
(c) the factors for determining the impact of non-compliance on an applicant’s listing referred to in paragraph 1.2.3 above.
2.3.4 Where appropriate, the sponsor should consider whether any material non-compliance incident(s) identified renders any director(s) unsuitable to act as a director of a listed issuer.30
2.3.5 Where it is considered that any non-compliance incidents identified do not give rise to a suitability issue, the sponsor should consider with the listing applicant and relevant third parties the categorisation of such non-compliance incidents as Material Impact Non-compliances, Systemic Non-compliances or Immaterial Non-compliances in order to determine the Exchange’s expected level of disclosure in the listing document and whether rectification of the non-compliance incidents is required. See paragraphs 1.2.4 to 1.2.8 above.
2.3.6 With a view to disclosing the matters which the Exchange expects to be disclosed referred to in paragraphs 1.2.5 and 1.2.6 above, the sponsor should, where appropriate:
(a) discuss with the listing applicant’s management:
(i) the reasons for the non-compliance incidents;
(ii) the potential operational and financial impact on the listing applicant;
(iii) the identity and position of the directors and/or senior management involved in the non-compliance incidents;
(iv) whether provision has been made in the listing applicant’s financial statements for any potential financial penalty and if not, the reasons for not making provision; and
(v) the latest status;
(b) seek advice or an opinion from local lawyers as to the potential legal consequences of the non-compliance incidents including, where appropriate:
(i) potential maximum penalties;
(ii) potential revocation or suspension of business licences or other Approvals material to the listing applicant’s business;
(iii) inability to use any properties or rights that have in the past contributed materially to the Group’s results;
(iv) potential civil liability to pay compensation or take other remedial actions; and
(v) potential litigation, investigations and other proceedings;
(c) obtain a legal opinion to confirm the competence of any authority which has given or will give any confirmation as to whether the listing applicant has been or will be charged or penalised in relation to the non-compliance incidents;31
(d) discuss with the listing applicant’s management (together with relevant third parties where appropriate) any rectification actions taken or to be taken. Where the Exchange accepts that certain Material Impact Non-compliances can only be rectified within a short period after listing, legal advice should be sought as to whether there is any impediment to rectifying such Material Non-compliances;32 and
(e) consult with the listing applicant and the internal controls consultant as to the enhanced internal controls which could be put in place to prevent the non-compliance incidents recurring.
2.3.7 The sponsor should also consider whether the material non-compliance incidents affect its ability to confirm that: (a) the listing applicant has established procedures, systems and controls which enable the listing applicant and its directors to comply with the Listing Rules and other relevant legal and regulatory requirements on an ongoing basis;33 and (b) the directors of the listing applicant collectively have the experience, qualifications and competence to manage the listing applicant’s business and comply with the Listing Rules.34
27. See Listing Rule 18.05 which requires a Mineral Company’s listing document to include, if relevant and material to the Mineral Company’s business operations, information on compliance with host country laws, regulations and permits.
28. Paragraph 17.4(d)(i) of the Code of Conduct.
29. See Paragraphs 17.11(d)(iii) and 17.11(e)(vi) of the Code of Conduct.
30. According to paragraph 3.2(1) of Exchange Guidance Letter GL63-13, having a past non-compliance or conviction record does not necessarily mean that a person cannot be accepted as a director of a listed company. However, where the non-compliance or conviction raises serious concern as to the individual’s integrity, and the individual is likely to exert substantial influence on the applicant after listing (e.g. where a person is a controlling shareholder and a director), there may be concern as to the applicant’s suitability for listing and the suitability of the individual to act as a director under Main Board Rules 3.08., 3.09 and 8.15. Where a person is both a director and controlling shareholder, the issue of the applicant’s suitability for listing may not be resolved by that person refraining from acting as the applicant’s director. This is because a controlling shareholder’s majority vote is likely to be decisive in the appointment of the listing applicant’s directors and thus it is highly likely that a controlling shareholder will be able to exert substantial influence over the operation and management of the listing applicant even if he is not a director. In Exchange Listing Decision LD96-1, the Exchange considered the following factors in considering the suitability of a person with a past non-compliance record to act as a director of a listed issuer: (i) whether the non-compliance incidents raise serious concern as to an individual’s integrity; (ii) whether the listing applicant can demonstrate and the sponsor can confirm that the proposed director has carried out rectification measures to avoid recurrence; (iii) whether the listing applicant’s internal controls are sufficient to ensure due compliance with all laws and regulations going forward and are not susceptible to undue influence of any one director; and (iv) whether adequate disclosure has been made to enable investors to appreciate that person’s character.
31. See paragraph 3.4(b) of Exchange Guidance Letter GL63-13.
32. See paragraph 3.6 of Exchange Guidance Letter GL63-13.
33. Paragraph (b)(v) of the sponsor’s declaration set out in Appendix 19 to the Listing Rules requires the sponsor to confirm that having made reasonable due diligence enquiries, it has reasonable grounds to believe and does believe that the listing applicant has established procedures, systems and controls (including accounting and management systems) which are adequate having regard to the obligations of the listing applicant and its directors under the Listing Rules and other relevant legal and regulatory requirements (in particular Listing Rules 13.09, 13.10, 13.46, 13.48 and 13.49, Chapters 14 and 14A and Appendix 16 to the Listing Rules, and Part XIVA of the Securities and Futures Ordinance) and which provide a reasonable basis to enable the listing applicant’s directors to make a proper assessment of the financial position and prospects of the listing applicant and its subsidiaries, both immediately before and after listing. Paragraph 17.4(c)(ii) of the Code of Conduct requires that before submitting a listing application, the sponsor should come to a reasonable opinion that the listing applicant has, inter alia, established procedures, systems and controls (including accounting and management systems) which enable the listing applicant and its directors to comply with the Listing Rules and other relevant legal and regulatory requirements on an on-going basis.
34. This confirmation is required in the Sponsor’s Declaration. See paragraph (b)(vi) of Appendix 19 to the Listing Rules. Paragraph 17.4(c)(iv) of the Code of Conduct also requires the sponsor to come to a reasonable opinion that this is the case prior to submitting the listing application.
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.