IPO Sponsors and Prospectus Liability: The Bridge Too Far?
Asian Institute of International Financial Law (AIIFL) Working Paper No. 17
46 Pages Posted: 6 Jul 2016
Date Written: August 31, 2015
Hong Kong’s prospectus law provides for statutory civil and criminal liability in respect of material misstatements for specified categories of persons, including those who “authorized the issue of the prospectus”. Since the introduction of these provisions the mechanisms of control and liability in the securities market have undergone quantum changes, in particular, via the development of an overarching regulatory architecture. The manner in which a prospectus is now produced and issued in connection with an initial public offering (“IPO”) is guided by non-statutory regulations as well as potential statutory liabilities.
The concept of the sponsor, as a person who assists a company seeking a listing, predates relatively recent regulatory developments that affect the undertaking of sponsor work, with notable changes being introduced in 2001 through to the most recent developments in October 2013. There is now a significant regulatory emphasis on the role of the sponsor as an important gateway mechanism intended to ensure the quality of disclosures made in IPO prospectuses.
In tandem with the evolving sponsor concept, an issue that has been extensively debated in the industry, including through a series of public consultation exercises undertaken by the SFC between 2003 and 2014, is the question of whether sponsors undertaking IPO work are or should be subject to statutory prospectus liability, and whether the existing law needs to be amended.
In August 2014 the SFC published its conclusion that IPO sponsors are persons who authorize the issue of a prospectus within the meaning of Hong Kong’s prospectus law. While previous consultation exercises had pointed to the lack of clarity in the existing law and the need to make changes to it, the SFC also stated that no legislative amendments are required. The SFC’s position implies that a court would not need to make any determination of whether a sponsor has in fact “authorized the issue of the prospectus” – if it were so, it would be open to a court to make a determination in the usual manner, possibly finding that some sponsors have engaged in the authorization act whereas others have not.
Appropriate law-based accountability, in addition to a sponsor’s regulatory obligations, may be desirable in a well-developed marketplace. However, as the sponsor is a creature borne out of regulatory requirements and is not specifically referred to in Hong Kong’s prospectus law, or in any other statutory law, it is equally important to clearly establish the basis for any legal liability. Whereas the SFC has referred to the specific duties and acts of an IPO sponsor and its central role in relation to the production and issue of an IPO prospectus, these are essentially driven by non-statutory regulatory requirements - accordingly, the precise source of a sponsor’s statutory liability remains somewhat opaque.
This paper examines the SFC’s position with a view to understanding its basis in law. In some ways, this paper is akin to the due diligence exercise an IPO sponsor itself is required to undertake. As such, it does not seek to address the significant policy considerations surrounding whether sponsors should be liable, or issues in the current legislative drafting, save to the extent directly relevant to the above focus. In the absence of a detailed explication in the SFC’s consultation paper, any case law directly addressing the matter, or any other detailed published assessment of the SFC’s position, this paper pursues three lines of enquiry:
(1) since statutory law does not specifically recognize the sponsor concept per se, is there some other legal mechanism that recognizes the regulatory functionality known as the sponsor; (2) what is the scope of the phrase “authorized the issue of the prospectus” for the purposes of prospectus law and how might sponsor work fall within that scope; and (3) as an IPO is subject to legal, regulatory and commercial requirements, what other matters of practice may be relevant to consider?
The analysis suggests that the acts a sponsor normally undertakes to discharge its regulatory obligations do not appear to give rise to any legal presumption of it having authorized the issue of the prospectus, such that it would no longer be a question for the court to determine, even under a possible wider meaning of the “authorized” term. Nor does the special role of the sponsor in submitting the declaration of compliance required under Appendix 19 of the Listing Rules assist. Non-statutory regulations affecting IPO sponsors operate in a different sphere from that of prospectus laws, and no sound argument is identified that clearly bridges the two - it is noteworthy that over a decade of consultation exercises on the issue has not identified any such bridge. Whether an argument based on ‘considerations of a broader nature’ works to bring sponsors within prospectus law, or whether this might be the basis of the SFC Position, is at present undetermined.
An unexpected finding was that elements underlying the SFC Position could potentially also capture underwriters. To the extent there is a legal basis for the SFC Position, underwriters that are not sponsors may therefore need to reconsider their liability position under Hong Kong’s prospectus law.
The observations made in this paper serve to highlight that prospectus law has not kept pace with the evolution of the regulated marketplace and market expectations. The continuing lack of clarity of the sponsor’s legal position in the face of the SFC’s current view places sponsors at a disadvantage, in particular as the extensively discussed problems inherent in the current legislative drafting, such as absence of mens rea and the reversal of the usual burden of proof, remain.
The paper concludes with a review of the other significant powers the SFC may exercise in relation to sponsors failing to undertake their duties to the required standard. It is noted that these powers may provide meaningful sanctions, and remedies to investors, where sponsors have failed to properly undertake their regulatory duties. The options for resolving the current disjunct between prospectus provisions that have been overtaken by market conditions and expectations are briefly considered.
Keywords: IPO, initial public offering, sponsor, underwriter, hong kong, prospectus, public offer, securities law, financial regulation
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