Due Diligence Guidelines –
Dealing with “Material Deficiencies” of the Listing Applicant
2. Disclosure of Material Deficiencies
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 Where the deficiencies cannot be remedied prior to the filing of the listing application, the sponsor should include adequate disclosure in the listing application, including the nature of the deficiencies, reasons for non-rectification and remedial actions taken or to be taken. The sponsor should explain why it believes that the listing applicant is still suitable for listing despite any material deficiencies that cannot be remedied prior to listing and, where appropriate, seek guidance from the regulators.10
2.3 Recommended Steps
2.3.1 Where it is not practicable to remedy material deficiencies prior to the submission of the listing application, the sponsor should disclose details of the relevant material deficiencies as part of the listing application submission, including:
(a) details of the nature of the deficiencies;11
(b) reasons for the non-rectification of the deficiencies identified prior to the submission of the listing application; and
(c) the remedial actions to be taken by the listing applicant to address the material deficiencies.
2.3.2 The sponsor may also consider including, where relevant, disclosure of the potential financial and operational impact of the material deficiencies on the listing applicant.
2.3.3 The sponsor should also explain why it believes that the listing applicant is still suitable for listing despite any material deficiencies that cannot be remedied prior to listing.12
2.3.4 Where there have been non-compliance incidents, the Stock Exchange expects different disclosure in the listing document depending on the categorisation of the non-compliances. No disclosure is required for Immaterial Non-compliance.13
2.3.5 For Material Non-compliances, the Stock Exchange expects the following to be disclosed in the listing document:14
(a) reasons for, nature and extent of the non-compliance incidents, corresponding risk factors, and the identity and position of the directors and senior management involved in the non-compliance incidents (if any);15
(b) whether the listing applicant has been penalised for the non-compliance incidents during the trading record period and up to the latest practicable date or is likely to be penalised in the future, with confirmation from the competent authorities.16 A legal opinion should be obtained to confirm the competence of the relevant authorities. Where there are penalties, the actual or maximum penalty (including the amounts) should be disclosed and whether the listing applicant has made provision for this, or if not, the reasons for not making provision. The disclosure should also include the potential operational and financial impact on the listing applicant (if any);
(c) details of the enhanced internal control measures implemented to prevent their recurrence, including when they were implemented and the identity, position, qualifications and experience of the personnel who are responsible for ensuring compliance, the directors’ and sponsor’s view on the adequacy and effectiveness of the enhanced internal control measures and the basis thereof. If an independent internal control expert has been separately engaged to review the internal controls,i the listing document should include the identity and scope of the review of the internal control expert, its major findings and recommendations, and the listing applicant’s timing of implementation of such recommendation of the internal control expert (and the internal control expert’s follow-up review, if material);
(d) what and when the rectification actions were or will be taken (see paragraph 2.3.6 below);
(e) why the directors and the sponsor believe the directors are suitable to act as the listing applicant’s directors under Listing Rules 3.08 and 3.09 and why the listing applicant is suitability for listing under Listing Rule 8.04; and
(f) a brief summary of the non-compliance incidents in the “Summary and Highlights” section of the listing document with appropriate cross reference.17
2.3.6 As noted in paragraph 1.3.10 above, the Stock Exchange normally expects all the Material Non-compliances to be fully rectified before listing unless the rectification is not applicable or possible. Where applicable, the listing document should include (1) detailed explanations on why rectification is not applicable or possible; (2) where a listing applicant is able to demonstrate that Material Non-compliance incidents can only be rectified shortly after listing, a legal adviser’s confirmation that there is no impediment to the rectification of the Material Non-compliances and a statement that the listing applicant will disclose progress of the rectification in the interim/annual reports and detailed explanation for any delay in rectification; or (3) what and when the rectification actions were taken/will be taken.
2.3.7 For Material Non-compliances that involve bill financing from banks and interest rate/loan arbitrage that are not criminal in nature and can be addressed by disclosure, the listing document should include, as well as the information set out in paragraph 2.3.5 above, (i) the amount of gains from the non-compliant bill financing; (ii) an unqualified audited financial results covering at least one complete 12-month period after the cessation of the non-compliant bill financing, and (iii) the independent internal control expert’s review and conclusions at the end of a 12-month audited period on the listing applicant’s enhanced internal control measures indicating that there are no other negative findings on the listing applicant’s internal control system during such 12-month audited period.18
2.3.8 For Systemic Non-compliances, the Stock Exchange expects the listing applicant to include the same information as for Material Non-compliances, save that no rectification is required.19
2.3.9 Where appropriate, the sponsor should seek guidance from the regulators.20
2.3.10 Sponsors should also refer to Chapter 17 “Due Diligence Guidelines – Legal and Regulatory Compliance and Legal Proceedings and Disputes”.
11. Sponsors should note paragraph 22(iii) of . In this decision relating to a company with non-compliance incidents, one of the factors taken into account by the Stock Exchange in returning the listing application was the failure of the listing applicant to include sufficient disclosure in the listing document of rectification measures and internal controls which were aligned to the non-compliance incidents.
17. There have been instances where the Stock Exchange has cited a failure to include the views of the directors and sponsor in the listing document where there have been material non-compliance incidents among the reasons for rejecting a listing application (for instance Company A referred to in ).
i If the internal control expert is the reporting accountant or another accounting firm, the relevant guidelines and practices of the accounting profession position an internal controls review as private advice to the directors of the applicant (and if they are party to the engagement, the sponsors). Accordingly, in such circumstances the name of the reporting accountant or other accounting firm and details of their work and findings may be prevented from being quoted or referenced in the listing document. One circumstance in which internal controls work may be referenced in the listing document is where it is practicable for the applicant and the sponsor to additionally and separately engage the reporting accountant or other accounting firm to also perform an assurance engagement in relation to internal controls. (Footnote 2 to Exchange Guidance Letter GL63-13)
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.