Hong Kong’s Securities And Futures Commission Reprimands And Fines Standard Chartered Securities $59.7 Million For Sponsor Failures

The Securities and Futures Commission (SFC) has reprimanded and fined Standard Chartered Securities (Hong Kong) Limited (Standard Chartered Securities) $59.7 million for failing to discharge its obligations as one of the joint sponsors in relation to the listing application of China Forestry Holdings Company Limited (China Forestry) in 2009 (Notes 1, 2, 3).

The SFC’s investigations revealed that Standard Chartered Securities had failed to make reasonable due diligence enquiries in relation to several core aspects of China Forestry’s business.

Failure to verify the existence of China Forestry’s forestry assets 

According to China Forestry’s 2009 prospectus, the company and its subsidiaries (Group),  a plantation forest operator whose main businesses were the management and sustainable development of forests and the harvesting and sale of logs, owned approximately 171,780 hectares of forests in Yunnan and Sichuan Provinces of Mainland China.   

In December 2007, Standard Chartered Securities conducted site inspections of the Group’s forests in Sichuan and Yunnan in its then capacity as the sole sponsor for China Forestry’s listing application. It made the same endeavour in February and May 2008.  The SFC’s investigations, however, revealed that on such site visits Standard Chartered Securities did not verify the location visited with the location of the Group’s forests as stated in the prospectus (Note 4).

Standard Chartered Securities claimed that other professional parties, including lawyers and forestry experts, were involved in some of the site inspections.  However, none of them had been instructed to verify the existence of the Group’s forests as disclosed in the prospectus.

Further, despite the fact that the Group acquired 150,000 hectares of forests in Yunnan in 2008 which accounted for over 90% of its forestry assets, there is no evidence to suggest that Standard Chartered Securities visited the Group’s forests in Yunnan after the acquisition or commissioned an assessment of the impact of the earthquake of magnitude 6.0 on the Richter scale that hit Yunnan on 9 July 2009 on the Group’s forestry assets. 

Failure to verify the Group’s forestry rights

According to the prospectus, the Group’s legal rights over its forests were evidenced by the relevant forestry right certificates. While Standard Chartered Securities claimed to have inspected the original certificates, it did not identify certain apparent anomalies (for example, a mismatch between the name of the location of a forest as disclosed in the prospectus and as stated in the corresponding certificates) that should have called for further inquiries. 

Standard Chartered Securities also claimed that their Mainland Chinese lawyers had verified and checked the certificates.  However, this was not reflected in the relevant legal opinions. In fact, the legal opinions contained express assumptions as to the genuineness and accuracy of documents China Forestry provided to the lawyers.

Failure to verify China Forestry’s compliance with relevant laws and regulations

Standard Chartered Securities relied on written confirmations purportedly issued by the relevant forestry bureaus that China Forestry had provided for them to confirm that the business and logging activities of China Forestry were in compliance with the relevant Mainland Chinese forestry and environmental laws. There is, however, no evidence that Standard Chartered Securities had verified whether the written confirmations were issued by the relevant forestry bureaus and that the information recorded therein was accurate.

Inadequate due diligence on insurance coverage for the Group’s forestry assets

Having sufficient insurance coverage for the Group’s forestry assets, which were pivotal to its business operation, was of fundamental importance.  Standard Chartered Securities relied on insurance documents provided by China Forestry as evidence of such insurance coverage without independently verifying the authenticity of the insurance documents. 

Although Standard Chartered Securities claimed that its deal team members and Mainland Chinese lawyers had reviewed the insurance documents, it did not identify a number of issues (for example, an inconsistency between the location of a forest as stated in the insurance document and as stated in the forestry right certificate) that should have called for further inquiries. 

Inadequate due diligence on China Forestry’s customers

Over 70% of China Forestry’s customers by revenue for the last 18 months during the track record period were located in Yunnan (Note 5).  Standard Chartered Securities had planned to conduct face-to-face interviews with some of China Forestry’s customers in Yunnan, but subsequently decided to postpone the face-to-face interviews because of the earthquake in Yunnan. Standard Chartered Securities only conducted telephone interviews with these customers in the end.

The SFC found that Standard Chartered Securities called the customers on telephone numbers provided by China Forestry without conducting any background searches on the customers to verify their telephone numbers and/or the identities of the individuals interviewed.  The SFC also found that the records of the interviews were seriously inadequate.

In deciding on the sanctions, the SFC took into account that:

• the deficiencies in the due diligence conducted by Standard Chartered Securities are significant, i.e. it has failed to properly examine and verify crucial aspects of China Forestry’s business - namely, its forestry assets, logging activities, insurance coverage and customers;

• substandard due diligence work of sponsors could facilitate the listing of companies that are, in fact, not suitable for listing. When companies listed in such circumstances fail, their failure may cause significant loss to public investors and jeopardise their confidence in Hong Kong financial markets.  As such, deterrent penalties  for  sponsor failures are warranted; and

• Standard Chartered Securities cooperated with the SFC in accepting the disciplinary actions and the SFC’s findings and regulatory concerns.

Notes:

1. Standard Chartered Securities formerly known as Cazenove Asia Limited (Cazenove), is licensed under the Securities and Futures Ordinance to carry on Type 1 (dealing in securities), Type 2 (dealing in Futures Contracts), Type 4 (advising on securities), Type 5 (advising on futures contracts) and Type 6 (advising on corporate finance) regulated activities. Cazenove changed its name to Standard Chartered Securities on 14 December 2009. With effect from 5 February 2016, for Type 6 regulated activity, Standard Chartered Securities’ licence is subject to a condition that it shall not act as sponsor in respect of an application for the listing on the Stock Exchange of Hong Kong.
2. China Forestry was listed on the Main Board of the Stock Exchange of Hong Kong on 3 December 2009. Standard Chartered Securities was one of its Joint Global Coordinators, Joint Sponsors, Joint Bookrunners and Joint Lead Managers. Trading in the shares of China Forestry was suspended since 26 January 2011. Subsequently, the company was wound up and the listing of its shares was cancelled on 24 February 2017.
3. The SFC has also banned Mr Joseph Hsu Kar Hing, a sponsor principal in charge of the supervision of the execution of China Forestry’s listing application for Standard Chartered Securities, from re-entering the industry for three years. See the SFC’s press release on Hsu dated 17 July 2018.
4. Standard Chartered Securities commenced its due diligence on China Forestry since late 2007 and in its capacity as a sole sponsor, it submitted the first and second listing applications of China Forestry to the Stock Exchange of Hong Kong in April 2008 and November 2008, respectively.
5. According to the prospectus, for the year ended 31 December 2008 and the 6 months ended 30 June 2009, approximately 70.5% and 81.4% respectively of China Forestry’s customers by revenue were located in Yunnan.