Dual Filing System

The dual filing system has been launched since the commencement of SFO in 2003, which represents the mechanism taken by SFC to supervise the due diligence work done by sponsors. It also indirectly helps SFC oversee the listing approval function of SEHK.

Every quarter SFC issues an update on the operation of the dual filing system by illustrating those listing applications with disclosure problems. One of the typical issues is the insufficient disclosure of risk factors, particularly legal risk (e.g. compliance with the PRC's social insurance requirements). Another common issue is the concealment of business models and key business relationships.

In one case illustrated in the latest update of SFC:

• The company's principal supplier is also its principal customer, which on-sells the products to an ultimate customer.
• The sales to this principal supplier/customer are apparently priced above market prices and contributed substantially to the company's impressive increases in historical profits.
• There were unusual settlements and fund transfers between two parties.

It is quite obvious that certain artifical arrangements have been made to window address the company's financial performance disclosed in the prospectus. But the sponsor may have turned a blind eye to this problem, or even advised its client to play these tricks.

I've heard that many sponsor firms rely only on the lawyers or accountants to perform the due diligence work which requires both business sense and regulatory knowledge. Under the new sponsor guidelines, they are required to employ more human resources to discharge their duties. Compliance officers need also to do more jobs to assess the competency of the transaction teams.