Introduction
Going public is a key stage in the growth and development of a company. Obtaining a listing on the Hong Kong Stock Exchange enables a company to improve its standing in the business community and gives it greater access to equity and debt capital raising markets, while at the same time providing shareholders with an internationally recognised stock exchange on which they can freely trade their shares.
The Herbert Smith Hong Kong IPO Guide is intended to provide an overview to capital raising in Hong Kong and in particular to the initial public offering (IPO) process for companies listing on the main board of the Exchange from the pre-IPO strategic investor stage through listing. In 2006 year to date the Exchange has raised more capital through IPOs than any exchange in the world. The global nature of the investment community and capital markets has resulted in more and more companies considering dual listings on other international exchanges, like New York or London, or structuring their offerings as exempt offerings so their shares can be offered to US and other investors. This Guide is a summary only of the more significant legal and regulatory issues encountered in the IPO process as at October 2006 and as such should not be relied upon as legal advice. In particular, this Guide does not consider regulatory issues imposed by jurisdictions other than Hong Kong and the United States. Herbert Smith accepts no responsibility for any errors or omissions this Guide may contain. Reference should be made to the Herbert Smith Compliance Guide for HK Exchange Listed Companies for details of the continuing obligations applicable to companies following listing on the Exchange. This Guide may be updated from time to time. However, we are under no obligation to do so or to forward any revised Guide to any previous recipients. We trust you will find the Herbert Smith Hong Kong IPO Guide a useful reference tool and a helpful introduction to the IPO process in Hong Kong. If you have any questions please feel free to contact any of the people named on the following page.
Herbert Smith
Herbert Smith is a leading international legal practice with over 1,100 lawyers based in its offices in Europe and Asia. We are committed to providing high quality and innovative legal services to corporations, governments, financial institutions and all types of commercial organisations. The firm advises its clients on corporate, dispute resolution, banking and finance issues, and energy and projects and offers a full range of specialist services including investment funds, regulatory, construction, insurance, tax and IP/IT. Hong Kong office: 23rd Floor, Gloucester Tower 15 Queens Road Central Hong Kong Beijing office: 1410-1419, China World Tower 1 1 Jianguomenwai Avenue Beijing 100004 Peoples Republic of China Shanghai office: 38th Floor, Bund Center 222 Yan An Road East Shanghai 200002 Peoples Republic of China
Contacts
Corporate Partners Ashley Alder T Tom Chau T Michael Fosh T Gary Lock T Roddy Martin T Tommy Tong T Andrew Tortoishell T Jeremy Xiao T +852 2101 4001 +852 2101 4104 +86 10 6505 6512 +86 21 6335 1144 +852 2101 4183 +852 2101 4151 +852 2101 4012 +86 10 6505 6512 ashley.alder@herbertsmith.com tom.chau@herbertsmith.com michael.fosh@herbertsmith.com gary.lock@herbertsmith.com roddy.martin@herbertsmith.com tommy.tong@herbertsmith.com andrew.tortoishell@herbertsmith.com jeremy.xiao@herbertsmith.com john.moore@herbertsmith.com kevin.roy@herbertsmith.com nicky.cardno@herbertsmith.com tim.wright@herbertsmith.com
US Securities Partners John Moore T +852 2101 4106 Kevin Roy T +852 2101 4102 Practice Support Lawyer Nicky Cardno T +852 2101 4137 Business Development Asia Tim Wright T +852 2101 4665
Defined Terms
CO Exchange INEDs LR or Listing Rules SFC SFO Share Repurchase Code Takeovers Code Companies Ordinance (Cap.32, Laws of Hong Kong) The Stock Exchange of Hong Kong Limited Independent Non-Executive Directors the Main Board Listing Rules of the Exchange Securities and Futures Commission of Hong Kong Securities and Futures Ordinance (Cap.571, Laws of Hong Kong) SFC Code on Share Repurchases SFC Code on Takeovers and Mergers
The information provided in this Guide is general and may not apply in a specific situation. Legal assistance should always be sought before taking any action based on the information provided.
Contents
Regulatory background
1. 2. 3. Offers of securities is a prospectus required? Who can offer securities Main Board and GEM key listing criteria 1 4 5
Pre-IPO preparation
4. 5. Group reorganisations Strategic investors and pre-IPO placings 6 8
IPO process
10. The team 11. Listing methods and criteria 12. Listing timetable and Exchange documents 13. Sponsors responsibilities 14. Prospectus content 15. Approval and registration of prospectus 26 29 31 37 45 48
International Offerings
30. Exempt US offerings 31. Hong Kong and US dual listings 32. Hong Kong and Shanghai dual listings 89 92 102
Legislation
Ordinances The primary legislation in Hong Kong governing the offering of securities and other investment arrangements to the public in Hong Kong is the Companies Ordinance and the Securities and Futures Ordinance (SFO). Companies Ordinance Under the Companies Ordinance it is unlawful for a person to issue or distribute in Hong Kong an offer or invitation to the public to subscribe for shares unless a prospectus is prepared, approved by the Securities and Futures Commission (SFC) and filed with the Registrar of Companies. The Companies Ordinance contains guidelines as to certain exempt offers which do not require a prospectus (such as offers to not more than 50 people) and includes detailed provisions on the content requirements for prospectuses. SFO Under Section 103 of the SFO, a person is prohibited from issuing any advertisement, invitation (including any oral invitation), offering memorandum, or document (together an offer document) which to his knowledge is or contains an invitation to the public to subscribe for securities or acquire an interest in a collective investment scheme (such as a unit trust or mutual fund), unless the offer document: relates to an exempt offer under the Companies Ordinance; or is authorised by the SFC; or is issued to professional investors (discussed below).
Exempt offers
The Companies Ordinance requires a prospectus to be prepared where an offer of securities is made to the public. Very little guidance is given as to whom constitutes the public. However, from 3 December 2004 the Companies Ordinance was amended to specifically identify offers which do not require a prospectus. If an offer does not fall within one of these exemptions, the more important of which are noted below, then generally it will be considered as being made to the public and will require a prospectus: offers to professional investors as defined in the SFO (see definition below); offers to not more than 50 people; offers with a maximum offering value of HK$5 million; offers with a minimum subscription value of HK$500,000; offers made in connection with a genuine invitation to enter into an underwriting agreement; offers made under a takeover or merger made in compliance with the Code on Takeover and Mergers; offers where there is no consideration involved (such as bonus issues) or as an alternative to a dividend or other distribution; offers to qualifying persons (including directors and employees) of the company or of any other member of the same group of companies; offers in connection with a collective investment scheme (mutual fund or unit trust) authorised under s104 of the SFO.
All of the above can be used in combination with each other (other than offers with a maximum offering of HK$5 million and offers with a minimum subscription of HK$500,000) so that it is possible to offer shares to an unlimited number of professional investors and up to 50 other investors. The offer document for any of the exempt offers noted above must state that the offer document has not been reviewed by any regulatory authority. Only offers to Hong Kong residents must be considered, thus an offer could be made to 50 Hong Kong residents and additional persons outside Hong Kong provided the offer complies with the rules of the relevant offshore jurisdictions. For the purposes of the above exemptions professional investors include: any individual, either alone or with his spouse or child, having a portfolio of securities and/or currency deposits of not less than HK$8 million; any corporation or partnership having a portfolio of securities and/or currency deposits of not less than HK$8 million or total assets of not less than HK$40 million; any corporation the sole business of which is to hold investments and which is whollyowned by an individual who falls within 2.3.1; or any trust corporation with total assets of not less than HK$40 million.
Unsolicited calls
A licensed intermediary cannot make unsolicited calls or emails offering to sell securities except: if the call is made to a solicitor, professional accountant, licensed intermediary, authorised financial institution, money lender, professional investor, or an existing client; or if the call is a permissible communication (pursuant to the Securities and Futures (Unsolicited Calls Exclusion) Rules) being any communication other than one made in the course of a visit in person, or by a telephone conversation, or any other interactive dialogue in the course of which statements and responses to them are exchanged immediately.
More details on the Main Board listing criteria are set out in 'Listing Methods and Criteria'.
4. Group reorganisations
At the early stages of an IPO it is essential to ensure that the group of companies to be listed has the correct group structure and that the group holds all rights necessary to carry on its business operations. For large IPOs this reorganisation process may commence more than a year before the IPO process commences. Below are some of the issues which must be considered. Group structure
As a group develops over time it will often end up with a large number of subsidiaries, some of which may have multiple divisions, while others may no longer be needed. The reorganisation process gives the opportunity to reorganise the overall group structure if desired including addressing issues such as: winding up any redundant companies; shifting companies within the group structure to ensure they are within the correct business groups and reporting lines; splitting up large subsidiaries with multiple divisions to place the divisions within separate subsidiaries; ring-fencing any speculative or high risk business ventures in separate subsidiaries (and where possible excluding these companies from general group funding obligations to avoid triggering cross-defaults).
Regard should also be had to potential competition issues where competing businesses may be excluded from the group, and connected transactions issues where part of the groups operations are held by (see page 8) connected persons following the reorganisation (see page 7). The reorganisation process may also present an opportunity to eliminate minority interests in major subsidiaries, particularly where the minority shareholders are connected persons which may render the subsidiary itself a connected person of the company under the Listing Rules.
The consideration paid for any transfer of assets must be carefully considered. Transfers are often simply recorded at book value and where this value is below book value it may trigger deemed distribution and insolvency clawback issues.
Tax
When implementing group reorganisations it is important to liaise with the groups accountants or auditors to ensure that the groups tax position is optimised. Often the use of offshore holding companies may be preferable both for minimising any tax liability and enabling easier distribution of cash from operating subsidiaries up to the parent company. In addition, any inter-group transfers of shares and assets must be reviewed from a tax perspective to consider issues such as the appropriate transfer price, stamp duty and protection of accumulated losses.
Financial assistance
Financial assistance must be considered when transferring shares and assets. The financial assistance provisions of the Companies Ordinance can be quite far reaching.
Nature of investment
Where the investment is made at the same time as the IPO, the investor will invariably take ordinary shares like the other IPO investors. However, where the investment is made prior to the IPO, the investor may wish to subscribe for securities which offer the investor a greater degree of protection than ordinary shares. Convertible notes or preference shares are commonly used for these pre-IPO investments as they can be converted into ordinary shares on the IPO (or later), but can also be redeemed for cash in certain situations thus providing the investor with downside protection without limiting the upside equity potential.
In listing decisions 55-1, 55-2 and 55-3, the Exchange rejected pre-IPO placings on the basis that their terms were contrary to LR 2.03. Terms which the Exchange had difficulty with included: the investment would be completed only after approval in-principle of the listing application by the listing committee, combined with a guaranteed discount and the ability of the investor to put its shares back to the controlling shareholders after listing at a premium; payment was deferred until in-principle listing approval, the investor could sell its shares back to the controlling shareholder if final listing approval was not granted, and the shares may be issued at a discount as the agreed price was the mid-point of the intended offer price range in this situation the Exchange noted that given the listing conditions the investor was taking investment risks no different from those of IPO investors; and shares were subscribed for at a discount well before the IPO (which is of itself generally acceptable), but immediately before the listing the parties modified the terms to provide that the investor could sell the shares back to the controlling shareholder after listing at a minimum sales price.
Accordingly, when a pre-IPO placing is undertaken the terms must be carefully considered as the Exchange may require the placee to give a lock-up undertaking (regardless of whether one is already given to the company and/or the underwriters under the terms of the placing) or may require other changes to the terms of the placing to ensure such terms do not breach the intent of LR 2.03. In these situations the consent of the investor will be required to any such changes and this may delay the listing or result in the investor trying to renegotiate the terms of its investment. Where the Exchange imposes a lock-up on the shares placed to the investor, such shares will not count towards the companys public float.
Size of investment
Often a strategic investor will acquire less than 10% of the shares of the company as once the investor holds 10% or more the investor will be treated as a connected person of the company and as a result, the investor will not constitute part of the public for calculating the minimum public float.
As a result of the potential trigger of the clawback rules and given that a strategic investor usually invests as part of the placing tranche of the IPO, strategic investors sometimes negotiate that, as part of the offering, they will be guaranteed a specific allocation of shares which will not be reduced in the event of a clawback due to an over-subscription for the public tranche of the IPO. This is a commercial decision for the company to make, provided that sufficient shares would otherwise be available for reallocation to the public offer tranche pursuant to any clawback.
In addition, if the investment agreement is likely to be a material contract of the company, it has to be disclosed as such in the prospectus and a copy made available for public inspection.
Publicity restrictions
Upon submission of the Form A1 to the Exchange, the company will be bound by LR 9.08 which provides that all publicity material (including an announcement of a possible pre-IPO investment) must be reviewed and cleared by the Exchange before release. In the event of any leakage of information regarding a proposed investment, the Exchange is likely to require
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written submissions on the reasons for the leak and this could result in the timetable for the listing being delayed.
Other jurisdictions
There may be potential securities law issues relating to offers and sales of securities to investors in other jurisdictions (such as the US). If the pre-IPO investor is in the US, the offer and sale of the securities to such pre-IPO investor will be subject to the requirements of the US securities laws, including but not limited to restrictions on publicity, provision of information, the manner of the offer and sale and the status of the investor, which are necessary to comply with exemptions from US securities registration requirements. If restrictions under applicable securities laws of such jurisdictions are such that the investor has to consider using a Hong Kong affiliate to hold the shares, such Hong Kong affiliate should, for purposes of compliance with US law, generally hold the shares for its own account and not for the account of its US affiliate unless certain requirements under the US securities laws are complied with.
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Regulation S under the Securities Act of 1933, which provides a safe harbour from registration requirements for securities issued outside of the United States.
See International Offerings Exempt US Offerings, for a more detailed discussion of these exemptions from registration. An offering exempt from registration under federal securities laws may still be subject to registration or qualification requirements imposed by state securities laws in the United States. US states are not prevented from imposing filing and fee requirements on issuers. Although the above exemptions provide for exemption from the securities registration requirement of Section 5 of the Securities Act of 1933, they do not provide exemption from the anti-fraud rules of the US securities laws. See Prospectus Liabilities US Securities Law for further information regarding such rules.
Documentation
Where the investment is made prior to the IPO process starting, the documentation may include a subscription agreement, the terms of the securities if the investor wishes to take convertible notes or other quasi-equity securities, and possibly a shareholders agreement. Where the investment is to be made in the IPO shares an investment agreement will generally be entered into and the global coordinator should be a party to this agreement to enjoy the benefit of the subscription undertaking and any lock-up undertakings; at a minimum the investor would give an irrevocable undertaking to subscribe for a certain number, or value, of shares in the IPO.
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6. Prospectus liabilities
At the start of the IPO process it is important that the directors of the company are informed of the potential civil and criminal liabilities they face in connection with the issue of the prospectus, in particular liability for any untrue statements or for the omission of any material information. A number of the regulatory provisions are wide enough to impose liability not only on the company and its directors but also on persons who authorised the issue of the prospectus such as the sponsor. Common law
Misrepresentation A prospectus is a document upon which potential investors rely to assess whether they wish to subscribe for shares in the company. As a general principle, where representations are made by one party to induce another party to enter into a contract, and those representations are false, the other party may be entitled to rights of rescission and/or damages if it suffers loss as a result, regardless of whether the misrepresentation was made deliberately, negligently or innocently. Negligent misstatements Directors may also be liable for negligent misstatements in a prospectus if persons whom the directors intend will rely on those statements suffer financial loss as a result of such reliance and it was reasonable for those persons to have relied on those statements. Deceit Directors may be liable under the tort of deceit if it can be shown that they signed or authorised the issue of a prospectus containing a false statement which they did not honestly believe to be true, with the intention that another person would rely upon such statement, and that other person acted upon the statement and suffered a loss as a result. Verification There is no strict legal requirement to prepare verification notes for a prospectus. Verification is carried out for the protection of the company, the directors, sponsors and all those upon whom liability for misstatements in the prospectus may fall. The object of verification is to ensure, as far as practicable, that statements in the prospectus can be independently verified and are made by the directors and other relevant parties based upon a reasonable belief in the truth of the statements. For a number of offences, it is a valid defence to claim that the person had reasonable grounds to believe the accuracy of the statement.
Listing Rules
The Listing Rules require the inclusion in the prospectus of a statement that the directors of the company collectively and individually accept full responsibility for the accuracy of the information contained in the prospectus and confirm, having made all reasonable enquires, that to the best of their knowledge and belief there are no other facts the omission of which would make any statement in the prospectus misleading. This statement can be relied upon by investors.
Companies Ordinance
Sections 38 and 342 These sections, in conjunction with the Third Schedule to the Companies Ordinance, set out the minimum level of information which should be contained in
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a prospectus. If a prospectus does not comply with or contravenes such requirements, any person who is knowingly responsible for the issue, circulation or distribution of the prospectus is liable to a fine. Section 40(1) This section provides that where a prospectus invites persons to subscribe for shares of the company, the following persons will be liable to pay compensation to all persons who subscribe for any shares on the faith of the prospectus for the loss or damage they may have sustained by reason of any untrue statement (which includes the omission of material information) included in such prospectus: directors of the company at the time of the issue of the prospectus; any person who has authorised himself to be named and is named in the prospectus as a director or as having agreed to become a director; every promoter of the company; and every person who has authorised the issue of the prospectus (which we believe includes the sponsor).
A person will not be liable under section 40(1) if he proves that: having consented to become a director, he withdrew his consent before the issue of the prospectus, and that it was issued without his authority or consent; or the prospectus was issued without his knowledge or consent and that on becoming aware of its issue he forthwith gave reasonable public notice that it was issued without his knowledge or consent; or after its issue, but before allotment of the shares, he became aware of an untrue statement in the prospectus, withdrew his consent and gave reasonable public notice of the withdrawal of his consent and the reason for it; or if the untrue statement was not purported to have been made on the authority of an expert or a public official document or statement, he had reasonable grounds to believe, and did until the time of allotment of shares believe, it was true; or if the untrue statement was purported to have been made by an expert or copied or extracted from an experts report and it fairly represented the statement or was a correct and fair copy of or extract from such a report, he had reasonable grounds to believe and did up to the time of the issue of the prospectus believe that the person making the statement was competent to make it and that the person had given his consent to the inclusion of the statement and had not withdrawn the consent prior to delivery of a copy of the prospectus for registration or (to the knowledge of the director) had not withdrawn his consent prior to allotment of the shares pursuant to the prospectus; or if the untrue statement was purported to have been made by an official person or contained what purported to be a copy or extract from a public official document, it was a correct and fair representation of the statement or extract.
Section 40A In addition to the civil liability under section 40(1), section 40A provides that any person who authorised the issue of a prospectus containing any untrue statement (or omits any material information) shall be liable to imprisonment and a fine, unless he proves either that the statement was immaterial or that he had reasonable grounds to believe and did up to the time of issue of the prospectus believe that the statement was true.
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The Hong Kong prospectus legislation is under review and it is expected that proposed legislative amendments, reflecting the September 2006 Consultation Conclusions on the Consultative Paper on Possible Reforms to the Prospectus Regime in the Companies Ordinance (published by the SFC), will be issued. It is presently not possible to predict when any of the reforms will be effected.
Besides criminal liability, a person guilty of the acts described above may also incur civil liability under section 108 to compensate persons who have suffered pecuniary loss as a result of having relied on the misrepresentation. Negligent misrepresentation Section 108 also imposes civil liability for negligent misrepresentations inducing another person to enter into or offer to enter into an agreement to acquire, dispose of, or subscribe for securities a negligent misrepresentation being a statement, promise or forecast which is false, misleading or deceptive and was made without reasonable care. However, if a remedy is available under section 40 of the Companies Ordinance, no right of action arises under section 108 of the SFO.
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Misrepresentation Ordinance
Section 3(1) of the Misrepresentation Ordinance provides that a party to a contract who is induced to enter into that contract by a misrepresentation made by the other party, and who suffers loss as a result of the misrepresentation can rescind the contract, or recover damages in lieu of rescission, from the party who made the misrepresentation. The only exception to this is where the misrepresenting party proves that he had reasonable grounds to believe, and did believe up to the time the contract was made, that the facts represented were true.
Theft Ordinance
In addition to any civil liability for making misrepresentations, directors should also be aware of criminal liability under the Theft Ordinance. The Theft Ordinance contains a number of offences relevant to directors and officers of companies regarding the publication of various documents and announcements, such as the prospectus and other information disclosed to the public. In particular, if a director of the company intends to deceive members or creditors about the companys affairs, publish or concur in publishing a written statement or account which he knows is or may be misleading, false or deceptive in a material way, he may be held criminally liable and punishable by a maximum of 10 years imprisonment.
US securities law
Several key provisions under the US securities laws create liability in connection with offering documents. Liability provisions applicable to Rule 144A and other exempt offerings Two liability provisions apply to Rule 144A and other exempt offerings: Section 12(a)(1) Pursuant to Section 12(a)(1) of the Securities Act of 1933, purchasers of any security offered in violation of the registration requirements of the US securities laws may recover the consideration paid for such securities. Strict liability exists thereunder for the seller of the securities. In order to prevail, plaintiffs need show only that the defendant was a seller or broker, the defendant failed to comply with the Section 5 registration requirements, there was use of the means and instrumentalities of interstate commerce, the applicable statute of limitations has not elapsed (ie, the suit was filed within one year of the violation); and adequate tender of the securities is made by a plaintiff seeking rescission. The only practical defence available to a defendant is that the security or the transaction was exempt from the registration requirements of Section 5. Rule 10b-5 Pursuant to Rule 10b-5 under the Securities Exchange Act of 1934, purchasers of a security have a cause of action against any person who makes an untrue statement of a material fact, or omits to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, in connection with the purchase or sale of any security. If successful, private litigants in Rule 10b-5 claims may be awarded damages, or may seek to rescind the transaction and obtain a refund of the original purchase price.
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In addition to establishing materiality, a plaintiff must demonstrate each of the following elements: Reliance The plaintiff must prove that it relied on the misstatement or omission. Under the fraud on the market theory, US courts will presume reliance on a material misstatement or omission if the securities are traded on an established trading market. Under the fraud on the market theory, a material misstatement or omission will be deemed to have affected the market price of the stock, and courts will presume that the plaintiff traded in reliance on the integrity of the price set by the market. Causation A plaintiff also must prove that reliance on the misstatement or omission caused the plaintiffs loss. Scienter The plaintiff must prove that the defendant made the material misstatement or omission with some intent to defraud or manipulate. US courts have held that recklessness may constitute scienter, but mere negligence will not. This is in contrast to claims under Sections 11 or 12(a)(2) of the Securities Act, which principally apply to SECregistered offerings, for which only a failure to show reasonable care is required. Loss US courts have required claimants under Rule 10b-5 to prove that they relied on and suffered loss as a result of the misstatement or omission.
The exercise of reasonable care, in the form of a carefully conducted due diligence investigation, tends to negate the existence of an intent to deceive. As a consequence, underwriter due diligence has become a critical component of a defence to liability in Rule 144A and other exempt transactions.
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US securities background
Generally, liability will arise under US securities laws in the case of either materially misleading misstatements or an omission of material information that would have been necessary to make statements in the offering document not misleading. Explicitly or implicitly, a due diligence type defence generally exists for underwriters, which provides that liability can be avoided if a defendant can prove it was duly diligent in investigating the business and financial condition of the issuer to ensure that the disclosure in the offering document is adequate. In an SEC registered offering, due diligence allows underwriters, directors and officers to establish that a reasonable investigation of the contents of the registration statement was made, thereby meeting the requirements of the due diligence defence against Section 11 and Section 12 liability available under the Securities Act. In a Rule 144A or other exempt offering, due diligence allows underwriters, directors and officers to refute the scienter element of a Rule 10b-5 claim.
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Underwriters counsel normally prepares a set of due diligence questions (generally comprising legal, financial and business sections and prepared before the prospectus is drafted) to which the company will provide responses. A typical due diligence request list is comprehensive, although tailored to the type of transaction being conducted and the type of business in which the issuer is engaged. The issuer will also make available its corporate books and records, material contracts and other documents, pertaining to the matters identified in the due diligence question list. The primary goal of the attorney in reviewing the documents provided by the issuer is to identify potential issues that may expose those working on the transaction to liability under US securities laws. Generally, the risk of 10b-5 liability can be reduced if any risks or potential problems involving the issuer or the securities being offered are disclosed to potential investors in the offering documentation. Accordingly, the attorney conducting documentary due diligence review should look for any information that could affect the value of the securities to ensure that potential problems identified are rectified prior to the offering and/or disclosed to potential investors in the offering documentation. The review undertaken forms a basis for further questions to be asked of the issuer and its management at face-to-face meetings. The documentary due diligence process also allows the reviewing attorney to identify any obstacles that might prevent the consummation of the transaction (eg debt covenants which may require lender consents, changes in capital structure, such as could be triggered by an IPO).
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Legal counsel generally will begin the drafting process by utilising precedent documentation used in similar offerings by issuers in the same business or industry as the subject issuer. US counsel should ensure that the offering document discloses any material information discovered in the documentary due diligence review and through discussions with management and the accountants. It also is important in the process of drafting to obtain confirmation from the issuers management that the disclosure accurately reflects the reality of the issuers business. This is most important for three key sections of the disclosure document: the description of business, managements discussion and analysis of financial condition and results of operations and risk factors.
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with respect to the unaudited interim financial statements and specified financial statement line items during the stub period. Negative assurance refers to the auditors confirmation that, after having carried out the specified procedures, including certain review procedures described below on the unaudited interim financial statements: Nothing has come to their attention that would cause them to believe that any material modifications should be made to the unaudited interim financial information for it to be in conformity with the applicable generally accepted accounting principles (GAAP) and that it complies as to form in all material respects with the applicable GAAP, and Nothing has come to their attention that would cause them to believe that there have been material changes in certain financial statement line items since the date of the latest financial statements included in the offering circular.
The types of financial statement line items included in the negative assurance are subject to negotiation between the underwriters and the accountants but they are usually items which are considered to be important indicators of the issuers financial condition or that directly affect pricing sensitive attributes of the issuer or are good predictors of the issuers future performance. Another important source of auditor comfort letter procedures is SAS 100, which was adopted in October 2002. This standard governs the review of interim financial information and the comfort that is permissible on such information by limiting the situations where auditors are permitted to perform reviews of interim financial statements. SAS 100 provides that auditors may conduct a review of interim financial information of an issuer in preparation for a public offering or listing, if its latest annual financial statements have been or are being audited. The goal of a SAS 100 review is to provide the auditors with a basis for reporting whether material modifications should be made to conform the interim financial statements to the applicable GAAP. Without a SAS 100 review, a comfort letter cannot contain negative assurance comfort as to the interim unaudited financial statements. As a practical matter, comfort letters delivered in connection with Hong Kong IPOs which have Rule 144A/ Regulation S tranches rely on SAS 700, a Hong Kong accounting standard that is similar to SAS 100. Auditors may not give negative assurance on interim financial statements if 135 days or more have passed between the date of the most recent financial statements that have been audited or reviewed and the date of the comfort letter. On negative assurance comfort letters, the auditors also deliver a circle draft as an attachment to their comfort letter, whereby financial information in the offering document is circled and comfort provided by the auditors to the extent of certain procedures identified in the comfort letter, with each specific piece of circled financial information being ticked and tied to a specific procedure identified in the comfort letter.
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diligence representation or interim financials are issued 135 days or more after the most recent audit or SAS 100 or SAS 700 review.
US legal opinions
A variety of US legal opinions may be requested in connection with an IPO being offered into the United States pursuant to an exemption. Some commonly requested US legal opinions are the following: The no registration opinion An opinion that the sale of the securities to the initial purchasers, and from the initial purchasers to subscribers, does not require registration under the Securities Act. The 1940 Act opinion An opinion that the issuer is not required to register as an investment company under the Investment Company Act of 1940. The 10b-5 disclosure letter A letter from US counsel which states that nothing has come to such counsels attention that leads it to believe that the offering circular contains material misstatements or omissions.
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Liability insurance
A company may purchase liability insurance for any officer which can cover: any liability to any party in respect of any negligence, default, breach of duty or breach of trust (save for fraud) of which he may be guilty in relation to the company or a related company; and any liability incurred by him in defending any proceedings taken against him for any negligence, default, breach of duty or breach of trust (including fraud) of which he may be guilty in relation to the company or a related company.
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Global coordinator, bookrunner and lead manager (which is usually also a Sponsor) Other underwriters Legal adviser to the company (as to Hong Kong law)
Legal adviser(s) to the company for any other jurisdiction(s) where the company may have material business interests or otherwise where the company is incorporated, eg, the PRC
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Legal adviser to the sponsors and the underwriters (as to Hong Kong law) Legal adviser to the sponsors and the underwriters (as to US law)
Providing legal advice to the sponsors and the underwriters in relation to Hong Kong legal and regulatory requirements pertaining to various matters arising in the course of the IPO Providing legal advice to sponsors and the other underwriters in relation to US legal and regulatory requirements pertaining to various matters arising in the course of the IPO, including providing a Rule 10b-5 letter and no-registration legal opinion if required Providing legal advice to the sponsors and other underwriters in respect of legal and regulatory issues relevant to that jurisdiction, assisting with local due diligence and providing any legal opinions which may be required Acting as the reporting accountants of the company to prepare, among other things (a) an accountants report; (b) a report on unaudited pro forma financial information; (c) an opinion on profit forecast and (d) appropriate comfort letters Preparing an independent valuation on the property interests held by the group for inclusion in the prospectus Receiving and processing applications under the Hong Kong public offering tranche of the global offering Processing and balloting public offer applications, liaising with the sponsors, Hong Kong Securities Clearing Co. Ltd., and the company for the preparation and dispatch of share certificates to successful applicants; processing of share transfers of the company after listing Providing strategic advice on communications, media relations and event support to the IPO, including developing content of speeches and media materials
Legal adviser(s) to the sponsors and the underwriters for any other relevant jurisdiction(s) Reporting accountants
Independent property valuer Receiving banks Share registrar and transfer office
The following persons and committee must also be appointed for the purposes of the companys listing. However, they will not necessarily have an active role in the listing process. Compliance adviser The compliance adviser must be acceptable to the Exchange (and may be the sponsor or someone who has acted as a sponsor). The adviser is appointed until the publication of the issuers accounts for its first full financial year commencing after the date of listing. Under the Listing Rules, the company must seek advice from the compliance adviser if it wishes to undertake certain specific matters such as issuing a regulatory announcement or entering into a notifiable or connected transaction.
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Company secretary
The company secretary must be an individual ordinarily resident in Hong Kong, have the requisite knowledge and experience to discharge the functions of a company secretary and be either (i) a member of the Hong Kong Institute of Chartered Secretaries, (ii) a solicitor, barrister or professional accountant, or (iii) an individual with academic or professional qualifications or relevant experience acceptable to the Exchange. The company must employ a full time individual to oversee financial reporting procedures and internal controls. The individual must be a member of senior management (preferably an executive director) and be a qualified accountant and a member of the Hong Kong Society of Accountants or similar body of accountants recognised by that Society. The qualified accountant can also act as the company secretary provided he satisfies the criteria. The company must appoint two authorised representatives to act as the companys principal channel of communication with the Exchange, being two directors or a director and the company secretary The audit committee must comprise non-executive directors only, have a minimum of three members, the majority of the members and the chairman must be independent nonexecutive directors and they must include at least one independent non-executive director with appropriate professional qualifications or related financial management expertise as set out in LR 3.10
Qualified accountant
Authorised representatives
Audit committee
In addition, the Exchange Corporate Governance Code sets out requirements in relation to the establishment of the following committees. Remuneration committee Under the Corporate Governance Code the company must appoint a remuneration committee to determine, among other things, directors remuneration policy. A majority of the members must be independent non-executive directors. If no such committee is appointed, the company must disclose and explain the reasons for such fact Under the Corporate Governance Code it is a recommended best practice that a nomination committee is established for determining the policy for the appointment of directors, again a majority of the members must be independent non-executive directors
Nomination committee
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Listing criteria
The qualifications for a primary listing on the main board of the Exchange are detailed in Chapter 8 of the Listing Rules. The principal qualifications are set out below. Currently, the Exchange only accepts listing applications from companies incorporated in Hong Kong, the PRC, Bermuda and the Cayman Islands. For other jurisdictions the applicant must show that the relevant country offers equivalent standards of shareholder protection as are provided in Hong Kong. Suitability for listing (LR 8.04) the company and its business must, in the opinion of the Exchange, be suitable for listing. Sufficient trading record (LR 8.05) the company must have (i) a trading record of not less than three financial years, (ii) management continuity for the last three financial years, and (iii) ownership continuity for at least the most recent audited financial year (although limited exemptions are available for companies relying on the market capitalisation/ revenue/cash flow test or the market capitalisation/revenue test described below and for mineral and project companies), and either: profit test a profit in the most recent year of not less than HK$20 million, and in respect of the previous two years, an aggregate profit of not less than HK$30 million (such profits to exclude any income or loss generated by activities outside the ordinary and usual course of the business or by associated companies or entities whose results are recorded in the companys accounts using the equity method of accounting), although some limited exemptions are available; or
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market capitalisation/revenue/cash flow test a market capitalisation of at least HK$2 billion, revenue of at least HK$500 million in the most recent financial year, and positive cash flow of at least HK$100 million in aggregate in the last three years; or market capitalisation/revenue test a market capitalisation of at least HK$4 billion and revenue of at least HK$500 million in the most recent financial year, and at least 1,000 shareholders at the time of listing.
Latest financial accounts (LR 8.06) the most recent financial period reported on in the prospectus must not have ended more than six months before the date of the prospectus. Sufficient public interest (LR 8.07) the Exchange must be satisfied that there will be sufficient public interest in the company. Minimum public shareholding (LR 8.08) the shares held by the public must constitute at least 25% of the issued shares, although if the market capitalisation of the company is over HK$10 billion, the Exchange may accept a percentage of between 15% and 25%. In addition, there must be a minimum of 300 public shareholders and not more than 50% of the shares in public hands at the time of listing can be beneficially owned by the three largest public shareholders. Minimum market capitalisation (LR 8.09) the expected initial market capitalisation of the company must be at least HK$200 million, with at least HK$50 million held by members of the public. Competing businesses of controlling shareholder (LR 8.10) if the controlling shareholder (being a person, or group of persons, who exercise or control the exercise of 30% or more of the voting power of the company or who is in a position to control the composition of a majority of the board), or any director of the company has an interest in a business which competes or is likely to compete, either directly or indirectly, with the companys business, various disclosures must be made in the listing document. See page 62. Voting power of shares (LR 8.11) the share capital of the company must not include shares which have a voting power which does not bear a reasonable relationship to the equity interest of such shares. Local management presence (LR 8.12) the company must have a sufficient management presence in Hong Kong. This will usually require at least two of the executive directors to be ordinarily resident in Hong Kong. Shares freely transferable (LR 8.13) the shares for which listing is sought must be freely transferable. Director qualifications (LR 8.15) each director must satisfy the requirements of Chapter 3 of the Listing Rules including (i) satisfying the Exchange that he has the necessary character, experience and integrity, and (ii) the board must include at least three independent non-executive directors and at least one of these independent non-executive directors must have appropriate professional qualifications or accounting or related financial management experience.
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Listing flowchart
Advance booking of an application for listing (Form A1) (at least 25 clear business days before hearing) Further documentary submissions (at least 20/15/10 clear business days before hearing) Formal Application for Listing (Form C1) (at least four business days before hearing) Recommendation/rejection by Listing Division (if rejected can appeal to Listing Committee) Formal hearing by Listing Committee to approve listing application (if rejected may appeal to Listing (Review) Committee) Issue of pre-deal research and commence pre-marketing Issue of red-herring prospectus and road-show HK underwriting documents signed and prospectus registered and issued Public Offer opens and closes IPO price fixed and international underwriting documents signed and final offering circular issued Announcement of results of public offer share applications Dealing in shares commences on the Exchange
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commence preparation of all listing documents this is an indicative date only and depending on the circumstances the commencement date may need to be significantly earlier Main documents to be submitted when making advance booking of a new listing application at least 25 clear business days before the expected hearing date include: Form A1 Advance Booking Form Listing application fee Draft prospectus (must generally include draft accountants report for three full financial years) Audited accounts for each of the companies comprising the group for at least the first two years of three year track record Waiver applications (eg continuing connected transactions and management presence (if applicable)) Various checklists (eg listing qualifications, prospectus content, accountants report, offering mechanism, property valuation report) Submission on qualification of company secretary (if required) Various prescribed additional information (eg information on top five suppliers and customers, comparison of the groups performance with peer group companies, details of reorganisation and corporate structure) Confirmation from the independent non-executive directors on their understanding of the obligations and duties of an independent nonexecutive director For companies with operations in the PRC, PRC legal opinion on issues including corporate matters and property interests (if applicable) For companies with operations in the PRC, tax confirmation from relevant PRC tax bureaux (if applicable) Sponsors confirmation that a copy of the Standing Request has been passed to each director who has confirmed to the Sponsor that he/she understands his/her obligations under the Standing Request Sponsors undertaking to use reasonable endeavours to ensure all information provided to the Exchange is true and does not omit material information Sponsors statement of independence Specified matters to be brought to the attention of the Exchange which include confirmation on various aspects of the companys operations (eg compliance with relevant laws, litigation or other investigations) Draft share option scheme (if any)
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Documents to be submitted at least 20 clear business days before the expected hearing date include: Advanced draft accounts for each of the companies comprising the group for latest financial year (if not provided previously) Draft statement of adjustments relating to accountants report Memorandum and articles of association, related checklists and confirmation from the companys Hong Kong counsel that the articles of association comply with Listing Rules For PRC issuers, draft service contracts with directors, supervisors and senior management Draft compliance adviser's agreement
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Documents to be submitted at least 15 clear business days before the expected hearing date: Formal declaration by the directors and proposed directors on various matters including any other business activities (Form B or H) Independence confirmation from each of the independent nonexecutive directors Boards draft profit forecast memorandum if the prospectus will include a profit forecast If no profit forecast will be included in the prospectus then an undertaking is required from the sponsor and the underwriters undertaking that no profit forecast or other forward looking statements or financial information of a similar nature will be included in the pre-IPO research reports Sponsors confirmation in relation to the sufficiency of the issuers working capital (usually in draft form) Cash flow forecast for the period ending at least 12 months from the expected prospectus date Summary of new listing particulars Summary of key financial ratios during the track record period
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Documents to be submitted at least 10 clear business days before the expected hearing date include: Copies of material contracts Draft formal notice Draft application forms Draft definitive documents of title For PRC issuers, draft legal opinion from companys Hong Kong legal advisers attaching legal opinion from PRC lawyers on due incorporation and legal person status of the company
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Documents to be submitted at least 4 clear business days before the expected hearing date include: Form C1 Formal application for listing Hearing proof of prospectus Final form of formal notice and application forms Certified copy of various corporate documents (eg certificate of incorporation, articles of association, board and shareholders resolutions, notice of general meetings (if any)) Specimen share certificates Letter from sponsor or auditors as to sufficiency of working capital (usually in draft form) Declaration by corporate shareholder holding over 5% Statutory declaration of promoter which is a company as to identity of those who control it (if applicable) For PRC issuers, certified copy of the approval from the China Securities Regulatory Commission For PRC issuers, confirmation from the companys Hong Kong counsel confirming the accuracy of the summary of material differences between Hong Kong law and PRC law
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Exchange hearing date Documents to be submitted before bulk-printing of the prospectus include: Undertaking from the issuers controlling shareholder as required by LR 10.07 Undertaking from connected persons that they will provide information to auditors for the purpose of reviewing connected transactions Undertaking from directors to exercise share repurchase powers in accordance with Listing Rules (if applicable) Adoption of Standard Transfer Form (STF) Consent to include website hyperlinks(s) on the Exchanges website e-Submission system registration (if applicable) Authorised representatives form
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Documents to be submitted as soon as practicable after Listing Committee hearing but before 11 am on the intended date of registration of the prospectus: Application for authorisation to register the prospectus Signed prospectus Translators certificate certifying accuracy of Chinese translation Sponsors certificate relating to competency of translator Certified copy of each power of attorney pursuant to which prospectus is signed Submission of soft copies of the prospectus and application forms and related confirmations for publication on the Exchange website
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Prospectus registered Documents to be submitted as soon as practicable after Listing Committee hearing but before the date of issue of the prospectus: Formal notice and application forms Certified copies of all documents included or referred to in the prospectus (eg accountants report, property valuation report, board and shareholders resolutions, material contracts) Experts consent letters Notification issued by HKSCC that shares will be eligible securities Sponsors confirmation in relation to publication of the prospectus on the Exchange website together with a copy of the letter from the Companies Registry confirming the registration of the prospectus Sponsors declaration under LR 3A.13 Undertaking from the Company and other persons to the Exchange not previously provided Other signed undertakings, confirmation letters and documents
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Prospectus issued Documents to be submitted after issue of prospectus but before dealing in the securities commence include: Certified copies of board and shareholders resolutions unless previously provided Copy of formal notice, notice of allotment results and final offer price extracted from relevant newspapers List of successful applicants showing the names and addresses Form D Marketing statement and placee lists Form E Sponsors declaration Form F Declaration by issuer Letter from registrar confirming despatch of share certificates Letter from receiving bank confirming receipt of cleared funds Compliance advisers undertaking
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If a Rule 144A and/or Reg S tranche is included alongside the Hong Kong listing, an international wrap will be prepared by US counsel containing certain summary terms, risk factors and other disclosures that are specific to US or other international investors and wrapped around the Hong Kong prospectus approximately 7-10 days prior to bulk printing the Hong Kong prospectus to create the preliminary offering circular or red herring. The preliminary offering circular, which generally does not contain pricing information, is primarily used to market the shares to US and other international investors on the international roadshow. Following the finalisation of the share price and just prior to listing, the offering circular will be finalised and circulated to investors who have committed to purchase shares together, where relevant, with a pricing term sheet.
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the company has established procedures, systems and controls (including accounting and management systems) which are adequate having regard to the obligations of the company and its directors to comply with the Listing Rules and other relevant legal and regulatory requirements (in particular Rules 13.09, 13.10, 13.46, 13.48 and 13.49, Chapters 14 and 14A and Appendix 16) and which are sufficient to enable the companys directors to make a proper assessment of the financial position and prospects of the company and its subsidiaries, both before and after listing; the directors of the company collectively have the experience, qualifications and competence to manage the companys business and comply with the Listing Rules, and individually have the experience, qualifications and competence to perform their individual roles, including an understanding of the nature of their obligations and those of the company as an issuer under the Listing Rules and other legal or regulatory requirements relevant to their role; in relation to each expert section in the prospectus, having made reasonable due diligence inquiries the sponsor reasonably believes (to the standard reasonably expected of a sponsor which is not itself expert in the matters dealt with in the relevant expert section) that: where the expert does not conduct its own verification of any material factual information on which the expert is relying for the purposes of any part of the expert section, such factual information is true in all material respects and does not omit any material information, where factual information includes: factual information that the expert states the expert is relying on; factual information the sponsor believes the expert is relying on; and any supporting or supplementary information given by the expert of the company to the Exchange relating to an expert section;
all bases and assumptions on which the expert sections of the prospectus are founded are fair, reasonable and complete; the expert is appropriately qualified, experienced and sufficiently resourced to give the relevant opinion; the experts scope of work is appropriate to the opinion given and the opinion required to be given in the circumstances (where the scope of work is not set by a relevant professional body); the expert is independent from the company and its directors and controlling shareholder(s); and the prospectus fairly represents the views of the expert and contains a fair copy of or extract from the experts report.
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In addition, it should be noted that the Exchange expects the sponsor to remain primarily responsible for being satisfied itself as to the overall due diligence conducted and therefore it may not be appropriate to appoint third party professionals to undertake all due diligence inquiries and the sponsor should participate in certain core aspects of due diligence (eg business and financial due diligence).
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Directors typical due diligence inquiries in relation to the collective and individual experience, qualifications and competence and integrity of the directors (including nonexecutive directors) include: reviewing written records that demonstrate each directors past performance as a director of the company including participation in board meetings and decision making relating to the management of the company and its business; assessing individually and collectively the financial literacy, corporate governance experience and competence generally of the directors with a view to determining the extent to which the board of the company as a whole has the depth and breadth of financial literacy and understanding of good corporate governance required; and reviewing the financial and regulatory track record of each publicly listed company (including those listed on other exchanges) of which any of the directors is or was an executive or non-executive director, for example, by reference to company disclosures, media articles and information about these companies on the website of the relevant stock exchange.
Qualifications for listing typical due diligence inquiries in relation to the qualifications for listing and suitability of the company for listing include: searching the company registry in the companys place of incorporation to confirm that the company is duly established in that place and that the company is in compliance with its memorandum and articles of association or equivalent constitutive documents; reviewing material financial information, including: financial statements of the company; financial statements of all subsidiaries of the company and other companies that are material to the groups financial statements; and the internal financial records, tax certificates and supporting documents to the tax certificates for the track record period.
The Exchange expects that in conducting such review, the sponsor should in most cases interview the companys accounting staff and internal and external auditors and reporting accountants and, where relevant, obtain comfort from the companys external auditors or reporting accountants based upon agreed procedures; and assessing the accuracy and completeness of the information submitted by the company in demonstrating that it satisfies the trading record requirement.
Preparation of listing document and supporting information typical due diligence in respect of the preparation of the listing document and supporting information includes: assessing the financial information to be published in the listing document including: obtaining written confirmation from the company and its directors that the financial information (other than that already reported upon by a reporting accountant) has been properly extracted from the relevant underlying accounting records; and being satisfied that the confirmation referred to above has been given after due and careful inquiry by the company and its directors;
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assessing the companys performance and finances, business plan and any profit forecast or estimate, including an assessment of the reasonableness of budgets, projections and assumptions made when compared with past performance, including historical sales, revenue and investment returns, payment terms with suppliers, costs of financing, long-term liabilities and working capital requirements. The Exchange expects that this would normally include interviewing the companys senior management and would often involve interviewing the companys major suppliers and customers, creditors and bankers;
assessing whether there has been any change since the date of the last audited balance sheet included in the listing document that would require disclosure to ensure the listing document is complete and not misleading; assessing whether it is reasonable to conclude that the proceeds of the issue will be used as proposed by the company, taking into account the outcome of the sponsors assessment of, in particular, the companys existing cash and liquid reserves, projected liabilities, working capital requirements and expenditure controls; undertaking a physical inspection of material assets, whether owned or leased, including property, plant, equipment, inventory and biological assets (for example, livestock or crops) used or to be used in connection with the companys business; The Exchange expects the sponsor to visit the site of the asset in order to view the asset and to assess its extent, quality and quantity and the purpose for which it is used. Nevertheless, the Exchange understands that where, in the reasonable opinion of the sponsor, assessment of an asset, including as to its extent, quality, quantity and use, genuinely cannot be achieved without the use of an expert (for example, in undertaking the physical inspection the sponsor becomes suspicious that the asset does not exist as to the extent represented or exists but is not used for the purpose claimed) the company may instruct an appropriately qualified independent expert to conduct all or part of the inspection. In such cases the sponsor should ensure the expert is required to provide a written report in respect of the inspection.
reaching an understanding of the companys production methods; reaching an understanding of the manner in which the company manages its business, including as relevant actual or proposed marketing plans, including distribution channels, pricing policies, after-sales service, maintenance and warranties; reviewing the business (ie non-legal) aspects of all contracts material to the companys business; reviewing legal proceedings and other material disputes that are current or recently resolved (for example, resolved in the previous 12 months) and in which the company is involved, and all proceedings or material disputes the company knows to be contemplated and which may involve the company or one of its subsidiaries; analysing the business aspects of economic, political or legal conditions that may materially affect the companys business;
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considering the industry and target markets in which the companys business has principally operated and is intended to principally operate, including geographical area, market segment and competition within that area and/or segment (including existing and potential principal competitors and their relative size, aggregate market share and profitability); assessing whether there is appropriate documentation in place to confirm that the material assets, whether owned or leased, including property, plant, equipment, inventory and biological assets used or to be used, in connection with the companys business, are appropriately held by the company (for example, reviewing the relevant certificates of title and rights of land use); assessing the existence, validity and business aspects of proprietary interests, intellectual property rights, licensing arrangements and other intangible rights of the company; reaching an understanding of the technical feasibility of each new product, service or technology developed, being developed or proposed to be developed pursuant to the companys business plan that may materially affect the companys business; and assessing the stage of development of the companys business and assessing the companys business plan and any forecasts or estimates, including reaching an understanding of the commercial viability of its product(s), service(s) or technology, including an assessment of the risk of obsolescence as well as market controls, regulation and seasonal variation.
Experts typical due diligence inquiries in relation to the expert sections of the listing document include: interviewing the expert, reviewing the terms of engagement (having particular regard to the scope of work, whether the scope of work is appropriate to the opinion required to be given and any limitations on the scope of work which might adversely impact on the degree of assurance given by the experts report, opinion or statement) and reviewing publicly available information about the expert to assess: the experts qualifications, experience and resources; and whether the expert is competent to undertake the required work;
reviewing the expert sections of the draft listing document in order to form an opinion as to whether the following are disclosed and commented on appropriately: the factual information on which the expert relies; the assumptions on which the expert opinion is based; and the scope of work performed by the expert in arriving at his/her opinion;
verifying factual information where the expert does not conduct its own verification of any material factual information on which the expert is relying for the purposes of any part of the expert section, and ensuring that such factual information is true in all material respects and does not omit any material information;
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where the sponsor is aware that the company has made formal or informal representations to an expert in respect of an expert section or in respect of a report made in connection with the listing application, assessing whether the representations are consistent with the sponsors knowledge of the company, its business and its business plans; by reference to the sponsors knowledge of the company, its business and its business plans assessing whether the assumptions disclosed by the expert as those on which the experts opinion is based, are fair, reasonable and complete; if the experts opinion is qualified, assessing whether the qualification is adequately disclosed in the listing document; and where the standard of independence is not set by a relevant professional body, obtaining written confirmation from the expert that it is independent from the company and its directors and controlling shareholder(s), and being satisfied that there is no cause to inquire further about the truth of such confirmation. This would include confirming that the expert does not have a direct or indirect material interest in the securities or assets of the company, its connected persons, or any associate of the company beyond those allowed by Rule 3A.07 of the Listing Rules.
Accounting and management systems typical due diligence inquiries in relation to the companys accounting and management systems and in relation to the directors appreciation of their and the companys obligations include: assessing the companys accounting and management systems that are relevant: to the obligations of the company and its directors to comply with the Listing Rules and other legal and regulatory requirements, in particular the financial reporting, disclosure of price sensitive information and notifiable and connected transaction requirements; and to the directors ability to make a proper assessment of the financial position and prospects of the company and its subsidiaries, both before and after listing. Such assessment should cover a review of the companys compliance manuals, policies and procedures including corporate governance policies and any letters given by the reporting accountants to the company that commented on the companys accounting and management systems or other internal controls. interviewing all directors and senior managers with key responsibilities for ensuring compliance with the Listing Rules and other legal and regulatory requirements (including the chief financial officer, company secretary, qualified accountant and any compliance officers) to assess: their individual and collective experience, qualifications and competence; and whether they appear to understand relevant obligations under the Listing Rules and other relevant legal and regulatory requirements and the companys policies and procedures in respect of those obligations.
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To the extent that the sponsor finds that the companys procedures or its directors and/or key senior managers are inadequate in any material respect in relation to the issues referred to above, the sponsor should typically discuss the inadequacies with the companys board of directors and make recommendations to the board regarding appropriate remedial steps. The Exchange also expects the sponsor to take such steps prior to listing, which could include training tailored to the needs of individual directors and senior managers.
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under which they were made, not misleading, in connection with the purchase or sale of any security. As a result, all material information must be provided, and no material information may be omitted or misstated. Offering documents written to US disclosure standards for Hong Kong-listed IPOs will generally include significant disclosure in a so-called international wrap preceding the Hong Kong prospectus, the purpose of which is to provide additional disclosure regarding the issuer and the offering relevant to US and other international investors: Risk factors (specific to international investors); Exchange rate information; Capitalisation and indebtedness; Dilution; Summary of significant differences between the GAAP under which the audited financial statements were prepared and US GAAP; Description of the Exchange; Description of shares; US federal tax considerations; and Plan of distribution
Of the sections in the Hong Kong prospectus, those sections of particular importance to US counsel are the following: Risk factors: The risk factor section in both the international wrap and the Hong Kong prospectus contains a discussion of the principal factors that make an investment in the issuer speculative or of high risk. Business: The business section is a description of the principal business, products and services of the issuer, frequently addressing total sales and revenue by categories of activity and geographic market. Financial information: In a Hong Kong prospectus, the financial information section is the functional equivalent of the management discussion and analysis (MD&A) commonly found in Rule 144A offering circulars. As discussed further below, this section of the offering circular presents a discussion of the historical performance and current financial condition of the issuer and calls for disclosure of information as to trends, uncertainties and other circumstances that may have a material impact in the future on the issuers financial performance.
MD&A
As noted above, the MD&A section is frequently referred to in Hong Kong prospectuses as the Financial Information section. In a Rule 144A offering, the MD&A includes information with respect to results of operations, liquidity, capital resources, and other information necessary to an understanding of a companys financial condition, changes in financial condition and operating results. The purpose of the MD&A is to improve overall financial disclosure and provide the context within
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which financial statements should be analysed, to provide information about the quality of, and potential variability of, a companys earnings and cash flow, and to provide a narrative explanation of the issuers financial statements to enable the investor to see the company through the eyes of management. This is achieved by presenting in the MD&A, on a periodon-period basis, the issuers financial condition, changes in financial condition and results of operations for each year and interim period for which financial statements are included in the offering circular, and explaining causes of material period-to-period changes in key financial statement line items, focusing on the issuers profit and loss statement and statement of cash flows. The MD&A also typically includes a summary of the issuers critical accounting policies (estimates and assumptions involved in the application of GAAP which have a material impact on the issuers reported financial condition and operating performance), principal factors affecting financial performance and a narrative summary of the components of key line items. An issuer must also provide a description of any known trends or uncertainties that have had or that the issuer reasonably expects will have a material impact on the issuers net revenues or income. Where, in the issuers judgement, a discussion of segment information would be appropriate to an understanding of the issuers business, segment discussion and analyses of the issuers financial condition and results of operation should also be included in the MD&A. Segment information would be commonly included in a MD&A if a segment contributes in a materially disproportionate way to revenues, profitability or cash needs, or if failure to discuss a segment would present an incomplete and misleading picture of the enterprise. In the past, extensive US-style MD&A sections were not typical in Exchange listings, but such sections have become increasingly common and expected by the Exchange. SEC-registered offerings must include an MD&A section, and hence it is market practice to include them in Rule 144A offering circulars as well. US-style MD&As are also being included in some Regulation S offerings, as investors and the Exchange have become accustomed to such disclosure.
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Registration process
Once the listing application and the prospectus has been approved, the final step before issuing the prospectus to the public is registration of the prospectus with the Registrar of Companies. Registration of the prospectus with the Registrar of Companies is a two stage process involving an application to the Exchange for authorisation of registration followed by an application to the Registrar of Companies for registration. The Exchange must be given at least 14 days advance notice of the intended date of registration of the prospectus (LR 11A.09). Application for authorisation of registration The following documents must be submitted to the Exchange at the time of applying for authorisation of registration: an application for authorisation of registration; the prospectus duly signed by the directors; the application forms; any power of attorney pursuant to which the prospectus is signed; a translation certificate in respect of the Chinese translation of the prospectus and a certificate issued by the sponsor confirming that the translator is competent to give the certificate;
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the consent of any expert named in the prospectus; any statement of adjustments; and certified copies of the material contracts referred to in the prospectus.
Registration of the prospectus At registration various documents will be filed including: a cover letter requesting registration of the prospectus; the prospectus duly signed by the directors; any power of attorney pursuant to which the prospectus was signed; a translation certificate in respect of the Chinese translation of the prospectus and a certificate issued by the sponsor confirming that the translator is competent to give the certificate; the consent of any expert named in the prospectus; any statement of adjustments; certified copies of the material contracts referred to in the prospectus; and a certificate of authorisation of registration from the Exchange.
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H share listing
Chapter 19A of the Listing Rules Chapter 19A of the Listing Rules deals specifically with the listing on the Exchange of companies incorporated in China setting out additional requirements, modifications and exceptions to the other relevant chapters of the Listing Rules to take account of: The PRC legal system is not a common law legal system; Restrictions on use of foreign exchange in the PRC and its remittance out of the PRC; and Only PRC citizens and legal persons are permitted to own domestic shares and only foreign investors and investors from Hong Kong, Taiwan and Macau may own overseas listed foreign shares the two types of shares therefore operate in separate markets.
Among such requirements: PRC issuers are expected to present their accounts in accordance with Hong Kong or international financial reporting standards; The articles of association of PRC issuers must contain provisions reflecting the different nature of domestic shares and H shares and the different rights of their respective holders; and Disputes involving holders of H shares arising from a PRC issuers articles or from any rights or obligations under the PRC Company Law or other relevant PRC laws and regulations are to be settled by arbitration in Hong Kong or the PRC at the election of the claimant
Additional requirements, modifications and exceptions to the Listing Rules under Chapter 19A Basic Requirements The Exchange will consider an application for listing by a PRC issuer only if (i) the issuer is duly incorporated in the PRC as a joint stock limited company (ii) there are adequate communication and cooperation arrangements in place between the Exchange
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and relevant securities regulatory authorities in the PRC and, where relevant, any other stock exchange on which the PRC issuer is listed and (iii) the Exchange is satisfied that applicable PRC law and the articles of association of the PRC issuer provide a sufficient level of shareholder protection to holders of H shares. Sponsors Sponsors for a listing application by a PRC issuer have a particular responsibility to satisfy themselves that: The PRC issuer is suitable to be listed; and The PRC issuers directors and supervisors appreciate the nature of their responsibilities and can be expected to honour their obligations, and understand what is required of them, under the Listing Rules and applicable PRC laws and regulations.
If the PRC issuer also is or is to be listed on another stock exchange, the sponsor must make a written submission to the Exchange stating whether, in its opinion, the PRC issuers directors appreciate the differences and similarities between H shares and the shares listed on other exchange(s) and between the rights and obligations of holders of such shares and the basis for such opinion. Compliance advisers The PRC issuer should ensure that there are adequate and efficient means of communication between itself, its authorised representatives, directors and officers and the compliance adviser and should keep the compliance adviser fully informed of all communications with the Exchange. The compliance adviser must inform the PRC issuer on a timely basis of any amendment or supplement to the Listing Rules and any applicable new or amended law, regulation or code in Hong Kong. Where the authorised representatives of the PRC issuer are expected to be frequently outside Hong Kong, the compliance adviser must act as the principal channel of communication with the Exchange. Accountants reports Accountants reports must have been audited to a standard comparable to that required in Hong Kong. Reports will normally be required to conform with the requirements of the Hong Kong Financial Reporting Standards or International Financial Reporting Standards. PRC issuers may, in addition, present in a separate part of the report, financial information conforming with applicable PRC accounting rules and regulations provided that the report contains a statement of the financial effect of the material differences with HKFRS or IFRS as appropriate. Qualifications for listing The following modifications and additional requirements apply: Public interest The Exchange has absolute discretion to refuse a listing of securities of a PRC issuer if it believes that it is not in the public interest to list them Agent for service The PRC issuer must appoint and maintain while its shares are listed on the Exchange a person authorised to accept service of process and notices on its behalf in Hong Kong Hong Kong register For registered securities, the PRC issuer must maintain a register of holders in Hong Kong for local registration/transfers of shares. Unless the Exchange otherwise agrees, only securities registered on the Hong Kong register may be traded on the Exchange
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Competing business LR8.10 requires disclosure of any competing business in which a controlling shareholder or directors of the company have any interests. For these purposes, the Exchange will normally not consider a PRC governmental body (including central, provincial or local level governments, but excluding entities under the PRC government carrying out commercial business or operating a commercial entity) as a controlling shareholder of a PRC issuer Management presence the requirement in LR8.12 for sufficient management presence in Hong Kong, ie at least two executive directors to be ordinarily resident in Hong Kong, shall apply except as otherwise permitted by the Exchange. PRC issuers will commonly seek a waiver from the Exchange from the requirements of LR8.12. In considering any such waiver application, the Exchange will have regard to, among others, the PRC issuers arrangements for maintaining regular communication with the Exchange Company secretary the secretary of a PRC issuer need not be ordinarily resident in Hong Kong, provided that they can meet the other requirements of LR 8.17. If the secretary does not meet the qualification requirements of LR8.17(2) (ordinary member of The Hong Kong Institute of Chartered Secretaries, solicitor, barrister or professional accountant) the PRC issuer will have to satisfy the Exchange that the secretary has the relevant experience to be capable of discharging the functions of a company secretary. In assessing relevant experience, the Exchange will have regard to, among others, the period of the persons employment with the PRC issuer, and his familiarity with the Listing Rules. A submission must be made to the Exchange setting out details of the training provided to the person for these purposes. A waiver is commonly sought from LR8.17 providing for the appointment of joint company secretaries for a period of at least three years following listing, one of whom meets the qualification requirements under LR8.17(2) (listing decision 35-1) Independent non-executive directors in addition to the requirements under Chapter 3 of the Listing Rules, the INEDs of a PRC issuer must demonstrate an acceptable standard of competence and adequate commercial or professional experience to ensure that the interests of shareholders will be adequately represented. At least one INED must be ordinarily resident in Hong Kong Supervisors supervisors of a PRC issuer must have the character, experience and integrity and demonstrate a standard of competence commensurate with their position Connected persons connected persons of PRC issuers include its promoters, directors, supervisors, chief executive and substantial shareholders. The Exchange will normally not consider a PRC governmental body (as defined above) as a controlling shareholder of a PRC issuer for these purposes
Application procedures Chapter 19A contains certain modifications to the application procedures, including the documents to be filed with the Exchange. These include the requirement to file a legal opinion from the PRC issuers Hong Kong legal advisers attaching a legal opinion from the PRC issuers PRC lawyers concerning due incorporation and legal person status of the PRC issuer as a joint stock limited company under PRC law. In addition, the PRC issuer will be required to submit a copy of the approval of the China Securities Regulatory Commission approving the PRC issuers listing on the Exchange and the issue of equity securities which, in practice, is required prior to the Listing Committee hearing. A PRC
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issuer will also be required to submit to the Exchange a PRC legal opinion covering a range of PRC legal issues including the obtaining of all requisite PRC approvals for the listing, approvals and permits required by the PRC issuer for the conduct of its business, compliance with applicable legal requirements, and title to properties. Listing Documents Chapter 19A contains modifications to the content requirements for listing documents for PRC issuers, including in particular: Constitutive documents a summary of provisions of its constitutive documents affecting shareholders rights and protection and directors powers Summary of PRC law a summary of relevant PRC law including taxation, taxation of dividends, foreign exchange controls, company law, securities regulations and relevant PRC regulations affecting its industry and major businesses Warning statements and risk factors specified warning statements and risk factors Company law a description of applicable company law including material differences between PRC and Hong Kong laws
Language All documents submitted to the Exchange in a language other than English must be accompanied by a certified English translation. Documents for inspection which are not in English must, unless otherwise provided by the Companies Ordinance, be accompanied by a certified English translation. Offering structure National Social Security Fund Pursuant to applicable PRC regulations, shareholders who hold State-owned shares are required to reduce their shareholdings in an amount of 10% of the entire offering (ie including any additional shares offered upon the exercise of an over-allotment option) in any overseas public offering by remitting the sales proceeds of such shares to the National Social Security Fund (NSSF), transferring such shares to the NSSF for retention or pursuant to other methods that are approved by the competent PRC authorities. Such shares will be converted from domestic shares to H shares upon listing.
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Legal opinion the company must submit to the Exchange a PRC legal opinion covering a range of PRC legal issues including the obtaining of all requisite PRC approvals for the listing or a confirmation that no such approvals are required, obtaining of all requisite approvals and permits required for the conduct of its business, compliance with applicable legal requirements, and title to properties Disclosure disclosure of specific risks relating the conduct of business in the PRC.
Where the red chip listing applicant is State-owned, the State-owned shareholder may be subject to a requirement to sell part of its shareholding and remit the sales proceeds to the NSSF or to transfer such shares to the NSSF for retention etc.
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comprising the group to be listed have been recently organised into a group. Paragraph 4 of PN3 sets out the factors the Exchange will take into account where the company has acquired new businesses during the track record period: whether the new business forms a material part of the companys business at the time of listing; whether the new business is forecast to make a material contribution to the companys profit forecast; whether the new business is in a similar line to that of the companys previous business activities and is part of the logical growth trend of the business; whether the company has retained the management of the new business and whether it can be demonstrated to the Exchange that necessary continuity and synergy of the management is provided; the period of time which has elapsed since completion of the acquisition; and whether the new group has been formed solely for the purpose of satisfying the listing requirements or to enhance the apparent attractiveness of the group as a new applicant for listing.
The issue of materiality and compliance generally with the requirements of LR 8.05 will be determined by the Exchange, in its sole discretion.
Listing decisions/guidelines
The Exchange has issued a number of rulings on management and ownership continuity, each addressing slightly different factual situations. Management continuity An Exchange Consultation issued in July 2002 states that the Exchange has interpreted the management continuity requirement to mean that applicants must demonstrate that there has been no change in the majority of the applicants board of directors and senior management of its principal operating subsidiaries during the three financial year track record period. In listing decision 45-1 the Exchange noted that management continuity was a question of fact and clarified that it would focus on the substance of management of the business when examining management continuity particularly considering whether: (a) an identifiable group of individuals most relevant and responsible for the track record results of a listing applicant remained in positions of responsibility with the enterprise under review throughout the relevant track record period; and (b) such group of individuals would form the core management of the applicant at the time of listing and thereafter. When assessing the relevance of individual members of a management team to the track record results of Company A and its predecessor, the Exchange followed the practice of ordinarily attributing proportionately greater responsibility to officers with more senior positions and those with responsibility at the group level. Provided that the company demonstrates management continuity within the core management group responsible for the track record results of the company, the management continuity requirement may be satisfied
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notwithstanding that such core management may constitute a minority in number on the board of directors. Ownership continuity The Exchange defines ownership continuity and control as the continuous ownership and control of the voting rights attaching to the shares by a controlling shareholder, or where there is no controlling shareholder, the single largest shareholder (Exchange Frequently Asked Questions). In listing decision 44-4, the Exchange confirmed that the requirement for ownership continuity and control under Rule 8.05(1)(c) could be satisfied by aggregating the shareholding interests and control of a group of individual shareholders, where such shareholders could, on the facts, be regarded as a controlling group for the purposes of the Listing Rules.
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18. Accounts
A prospectus must contain an accountants report which reports on the last three audited financial years results and, if the latest financial year ended more than six months before the date of the prospectus, then an audited interim (or stub) set of accounts is required for part of the current financial year. Relevant Listing Rules
The main Listing Rules dealing with the accountants reports to be included in a prospectus are: LR 4.01 (1) a listing document must contain an accountants report. The accountants report must be prepared by independent, qualified professional accountants. LR 4.04 and 4.05 these set out the content requirements for an accountants report, which includes income statements, balance sheets and cashflow statements for the last three year financial years or such shorter period as may be acceptable to the Exchange. LR 4.05(A) if the company has acquired any material subsidiary or business during the three year trading record period then certain pre-acquisition financial information must be included. LR 4.09 The reporting accountants must report on the consolidated or combined results and balance sheet of the company and its subsidiaries. LR 4.11 Such results and balance sheet must normally be drawn up in conformity with Hong Kong Financial Reporting Standards or International Financial Reporting Standards. LR 4.14 Where adjustments are made by the reporting accountants in preparing the accountants report, a statement of adjustments must be prepared, which is made available for public inspection. LR 4.18 Where the reporting accountants qualify or modify their report, they must refer to all material matters about which they have reservations, and give all reasons for the modification or qualification and its effect qualified if relevant and practical. A qualified or modified accountants report may not be acceptable where the modification or qualification relates to a matter of significance to investors. LR 4.28 Where the company has acquired or proposed to acquire a major subsidiary since the date to which its latest audited accounts have been made up, it must include specified pro forma financial information in respect of the enlarged group in the prospectus. LR 4.29 Where pro forma financial information is included in the prospectus, such information must comply with the requirements of Rule 4.29 and must be reported on by the reporting accountants. LR 8.06 the latest financial period reported on by the reporting accountants must not be more than six months before the date of the prospectus and must include a comparison with the corresponding interim period for the previous financial year. Thus where the prospectus will be dated more than six months after the end of the latest financial year a set of interim (or
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stub) accounts must be prepared (with the financial information for the previous financial period being subject to a review).
Listing decision 46-4 applied the same approach to the filing of accounts for any stub period. These decisions enable the Exchange to start reviewing the prospectus earlier without having to wait for the interim accounts to be finalised.
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Listing decisions/guidelines
The Exchange has issued a number of rulings on the requirement for independence, each addressing different aspects of the independence requirement. In listing decision 42-1 the Exchange stated that when considering independence issues, it will generally require the company to take into account the following: financial independence; independent access to sources of supplies/raw materials for production; independence of production/operation capability; independence of access to customers and independent management.
Where the degree of dependence on the controlling or substantial shareholders is excessive, this may give rise to concern as to the suitability of the company for listing under Rule 8.04. When reviewing the reliance issue, the Exchange ordinarily would consider the particular facts and circumstances of the applicant. In listing decision 46-1 the Exchange noted that the issue of reliance on controlling shareholders can usually be dealt with by disclosure in the prospectus but where the degree of reliance could not be addressed by disclosure alone the company must take concrete steps to address the reliance rather than simply demonstrate that it has the ability to operate independently. Financial independence In listing decision 42-1, the Exchange referred to its established practice that prior to listing, a listing applicant will ordinarily be required, barring exceptional circumstances, to repay all outstanding loans due to, and release all guarantees provided by, the controlling/substantial shareholders (even though such loans may constitute exempt financial assistance allowed under the connected transactions requirements of the Listing Rules).
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Operational independence In listing decision 46-1, the Exchange noted that reliance which the listing applicant placed on its controlling shareholder for provision of sales and procurement functions gave rise to concerns including conflicts of interests, substantial reliance on the protection mechanisms offered by the connected transaction requirements under the Listing Rules and how performance of the listed company may be independently evaluated. Reliance on a controlling shareholder for supply of raw materials may, in certain circumstances, be dealt with by disclosure including a description of the associated risks provided that adequate mechanisms are put in place to protect minority shareholders (listing decision 46-2).
Independence of management In assessing the level of independence of management of the company, the Exchange will consider the level of overlap between the management of the company and its controlling shareholder. In listing decision 52-2, the Exchange considered factors including the number of common directors between the company and its controlling shareholder, the role of the common directors in the management of the companys business and daily operation, the extent of delineation of the business of the company and its controlling shareholder and the amount of connected transactions between the company and its controlling shareholder.
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Non-competition undertakings
Although not specifically required under the Listing Rules, it is common market practice for the controlling shareholder of a new listing applicant to enter into a non-competition agreement with the listing applicant to delineate their businesses following listing and to eliminate future competition. Such undertakings may include provisions for referral of future business opportunities to the listing applicant, approval procedures prior to the controlling shareholder entering into future competing businesses and rights of first refusal for the listing applicant to acquire any excluded business retained by the controlling shareholder.
Listing decisions/guidelines
The Exchange has issued a number of rulings on this issue of competing interests, each addressing slightly different factual situations. In listing decisions 51-2 and 51-3 the Exchange stated that it normally requires the company to take into account factors relating to the conduct of the applicants business independently from its controlling shareholder, in areas including financial independence, operational independence and management independence. An applicant may be dependent on its controlling shareholders in one or more of these areas. Where the degree of independence is excessive, this may translate into a concern about the suitability of an applicant for listing.
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Competition is normally regarded by the Exchange as a disclosure issue. However, in extreme cases where in the view of the Exchange, there are inadequate arrangements to manage conflicts of interest and delineation of businesses between the applicant and other businesses under common control, the Exchange would consider the impact on the applicants suitability for listing. A review of whether the applicant is or is not capable of carrying on its business independently of its controlling shareholder in the light of competing businesses operated by the controlling shareholder therefore involves careful balancing of all the relevant factors in the applicants case. The giving of non-competition undertakings by the controlling shareholder on a voluntary basis is a relevant factor but is not decisive. Non-competition undertakings may or may not effectively contain competition within acceptable boundaries. Enforceability of noncompetition undertakings, in turn, is often dependent on a number of other factors, including but not limited to (a) the effect of exemption clauses on non-competition undertakings, (b) how independently a listing applicant can exercise its right to enforce the non-competition undertakings in light of its own corporate governance and (c) the degree to which the management of the listing applicant and its controlling shareholders are closely connected. If there are indications that a non-competition agreement may not function effectively in light of the facts and circumstances of an individual case, the Exchange may disregard the agreement when determining whether the requirements of the Listing Rules have been satisfied.
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The company must enter into written agreements with relevant parties in respect of its connected transactions not falling under the final three exemptions as set out above. The period for the agreement must be fixed and not exceed three years.
Waiver submission
If shareholder approval would usually be required for any of the continuing connected transactions then a waiver must be sought from the Exchange. Waivers will also generally be sought for transactions subject to the announcement requirements. The waiver will normally be sought subject to certain conditions, including: the agreements must be in the ordinary course of business, on normal commercial terms and in the interests of the company and its shareholders as a whole; details of the transactions shall be disclosed in each annual report; the aggregate value of each transaction will be made subject to an annual cap; and the independent non-executive directors and the auditors shall review the transactions annually to ensure they comply with the waiver conditions.
The sponsor is required to opine in the prospectus whether the continuing connected transactions for which waivers are sought are in the ordinary and usual course of business of the company, on normal commercial terms, are fair and reasonable and in the interests of the shareholders as a whole.
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23. Forecasts
Profit forecasts are not required to be included in a prospectus. However, where a forecast is included, or any language is used which implies a forecast (eg the companys profit should increase next year) then various rules must be followed, assumptions must be prepared, the accounting policies and calculations must be checked by the reporting accountant and the sponsor must be satisfied that the directors have made due and careful enquiries in making their forecast. The inclusion of a profit forecast in the prospectus will also determine whether profit forecasts or other forward looking financial information may be included in analysts research reports. Relevant Listing Rules
Listing Rules 11.16 to 11.19 set out the rules relating to profit forecasts, these include: LR 11.16 the prospectus must not contain any general or particular reference to future profits or contain dividend forecasts based on an assumed level of profits unless supported by a formal profit forecast. The term profit forecast is defined very widely in LR 11.17 to include any profit or loss forecast however worded and includes any estimate for a period which has already past but for which results have not yet been audited or published. In addition any valuations (other than for land and buildings) for assets or businesses purchased by the company based on discounted cashflows, or projections of profits, earnings or cashflows will be treated as profit forecasts. LR 11.17 the company may elect to include a profit forecast if it wishes to, however if one is included it must be clear and unambiguous, the principal assumptions must be stated, consistent accounting policies must be used, the reporting accountants must report on the accounting policies and calculations, and the financial adviser or sponsor must report that they have satisfied themselves that the forecast has been made by the directors after due and careful enquiry. LR 11.18 a profit forecast should normally cover a period which ends on the financial year-end. If it is only prepared to the half year-end then the relevant interim accounts will need to be audited in due course. A profit forecast cannot cover a period not ending on the financial year end or the half year-end. LR 11.19 the assumptions must provide useful information to investors to help them form a view of the reasonableness and reliability of the forecast, be quantified where possible, and be specific and definite rather than vague and general. It will not normally be acceptable for assumptions to relate to matters which the directors are best able to take a view on or are able to exercise control over since such matters should be directly reflected in the profit forecast.
Profit forecast
Where the company intends to include a profit forecast in its prospectus, it must prepare a profit forecast memorandum, which is submitted to the Exchange for review together with the 15 day documents. Such memorandum will be reviewed by and discussed with the reporting
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accountants and sponsor prior to submission, to ensure that such forecast is prepared in accordance with the accounting policies used in the preparation of the companys audited accounts contained in the prospectus and to check the calculations and by the sponsor to ensure that the forecast has been prepared by the directors after due and careful enquiry. Reports from the reporting accountants and the sponsor are then included in the prospectus. A listed issuer must consult with and seek advice from its compliance adviser if its results deviate from any profit forecast or estimate contained in its prospectus. In such circumstances, the company will be required to issue an announcement and include an explanation of the difference in its annual report.
Listing decisions
In listing decisions 35-2 and 50-4, the Exchange determined that it was inappropriate to include a risk factor or disclaimer in respect of the profit forecast in the prospectus.
US considerations
The inclusion of forecasts and projections in offering documents is generally disfavored in the context of offerings to be sold in the United States. Even where forecasts and projections are qualified, the risk of liability in the United States may exist with regard to such forecasts and projections. In general, projections, forecasts and other forward-looking statements are considered inherently unreliable, involving known and unknown uncertainties which may cause actual results to be materially different from any projected or forecasted results. The international wrap prepared by US counsel in connection with Hong Kong-listed IPOs typically contains one or more risk factors stating that forecasts and projections provided in the base prospectus pursuant to local legal requirements should be disregarded as unreliable. Many offering circulars set forth detailed assumptions made in providing forecasts and projections, the incorrectness of any of which may cause the forecast or projection to be inaccurate.
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The US Private Securities Litigation Reform Act, as amended, contains a safe harbour from anti-fraud liability in private securities litigation for certain forward-looking information under certain conditions. As a result, market practice on Rule 144A transactions is to comply with the requirements of the safe harbour. These include accompanying the forward-looking information with meaningful cautionary language identifying important factors that could cause results to differ. It is common to exclude from the international offering circular copies of the letters from the reporting accountants and the sponsor in respect of the profit forecast.
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The Exchange also issued a directive to all listed companies in 2005 clarifying the application of LR 17.03(13) which deals with adjustments to option exercise prices on the issue of new shares by the company. While this clarification did not expressly amend the Listing Rules (and is arguably inconsistent with the Listing Rules) regard to this ruling should be had when preparing the option scheme and when issuing new shares while there are options outstanding.
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Clawback arrangements
Practice Note 18 provides for a reallocation of shares from the placing tranche to the public offer tranche where the public offer tranche is significantly over-subscribed, as follows: a clawback mechanism that increases the number of shares under the public offer to 30% of the shares initially available under the IPO when total demand in the public offer tranche is 15 times, but less than 50 times, the initial allocation; a clawback mechanism that increases the number of shares under the public offer to 40% when total demand in the public offer tranche is 50 times, but less than 100 times, the initial allocation; and a clawback mechanism that increases the number of shares under the public offer to 50% when total demand in the public offer tranche is 100 times or more the initial allocation.
Shares may be transferred from the public offer tranche to the placing tranche where there is insufficient demand in the public offer tranche to take up the initial allocation. In addition, underwriting agreements may provide an additional discretion to the underwriters to reallocate shares from the placing tranche to the public offer tranche to satisfy excess applications in the public offer tranche, to cater for the position where the level of over-subscription in the public offer is insufficient to trigger the clawback provisions of PN18. Waivers from the requirements of Practice Note 18 In respect of large offerings where the number of shares available to the public in Hong Kong would be very large if the requirements of PN18 were applied in full, the Exchange may be willing to grant waivers from the above allocation ratios to reduce the percentage of the offering allocated initially and upon triggering of the clawback arrangements to the public offer. In practice, such waivers are only available where the total offer size exceeds HK$10 billion. Over-allotment option It is common for companies and selling shareholders to grant an option to the underwriters to require the company to issue and the selling shareholder to sell additional shares representing up to 15% of the number of shares initially available under the IPO for the purpose of covering over-allocations in the placing tranche. Such additional shares will generally be allocated to the placing tranche. Please refer to Chapter 29.
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Allocation of shares within the public offer tranche The total number of shares available for subscription in the public offer tranche is to be divided equally into two pools, Pool A and Pool B. Shares in Pool A should be allocated to investors who have applied for shares with an aggregate price (representing the price initially payable on application rather than the price as finally determined, and excluding brokerage of 1%, Exchange trading fee of 0.005% and SFC transaction levy of 0.005% of the offer price) of HK$5 million or less. Shares allocated to Pool B should be allocated to investors who have applied for shares with an aggregate price of more than HK$5 million and up to the total value of Pool B. Where one of the pools is under-subscribed, surplus shares should first be reallocated to the other pool to satisfy excess applications. Multiple applications The company, its directors, the sponsor and the underwriters should take reasonable steps to ensure that multiple or suspected multiple applications are identified and rejected. For these purposes multiple applications means circumstances where (i) more than one application is made under the public offer by the same person; (ii) an application under the public offer is made for more than 100% of the total number of shares originally allocated to each pool; or (iii) an application is made under the public offer by an investor who has also applied for or been placed shares in the placing tranche. Pricing of the IPO shares Although shares may be offered under the IPO at a fixed price, it is more common that shares will be offered under the public offering at a price range, with applicants under the public offer required to pay the maximum offer price on application together with relevant brokerage, fees and levies, subject to refund. Where the offer price is expressed as a range, the prospectus will generally provide for a reduction in the price range and/or the number of shares offered under the IPO, at any time up to the morning of the last day for filing applications under the public offer. The company is required to issue an announcement in the event of a reduction in the offer price range and/or number of IPO shares with such announcement to be issued no later than the morning of the last day for filing applications under the public offer. Such announcement is required to include updates of any financial information set out in the prospectus which is impacted. In the event of an announcement, the final offer price range, if agreed, must be set within the reduced range. Applications filed prior to any such announcement may not be withdrawn. Where no such announcement is made the final offer price may not be set outside the range stated in the prospectus. The offer price will generally be determined through a book-building process based on the orders placed by professional and institutional investors in the placing tranche. The final offer price will be fixed by agreement between the global coordinator of the IPO and the company. Where no such agreement is reached the IPO will lapse. The offer price will generally be determined on the day following the close of the placing tranche and in any event, not later than the day on which the results announcement is published, and, in practice by 5:00pm on the preceding day, to allow clearance of the relevant announcement by the Exchange. The offer price as finally determined will be the same in both the public offer and placing tranches.
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26 Underwriting arrangements
Pursuant to LR7.02, the public offer tranche of an IPO must be fully underwritten. In practice, the placing tranche is also underwritten. The company and any selling shareholder will enter into underwriting agreements with the underwriters of the public offer and placing tranches setting out their respective rights and obligations. Hong Kong underwriting arrangements
LR7.02 requires that the public offer tranche of an IPO is fully underwritten. In this regard, the company and potentially other parties including major shareholders and executive directors of the company, will enter into an underwriting agreement with the underwriters setting out the underwriting arrangements for the public offer. The Hong Kong underwriting agreement is generally signed on the morning of the day of registration of the prospectus and is a material contract which will be registered with the prospectus and made available for public inspection. Pursuant to the Hong Kong underwriting agreement, the Hong Kong underwriters will agree to procure subscribers for, or failing which to subscribe for, the shares offered under the public offer tranche in return for the payment of an underwriting commission. The obligations of the underwriters under the Hong Kong underwriting agreement are several, with each Hong Kong underwriter agreeing to take up a fixed proportion of the shares available under the public offer. The Hong Kong underwriting agreement will also set out the mechanics of the public offer including the determination of the allotment of the offer shares available under the public offer, clawback and reallocation provisions and arrangements for the delivery of shares and payment of the proceeds of the public offer to the company, subject to the deduction of fees incurred in connection with the IPO. In addition to setting out the underwriters underwriting obligations, the underwriting agreement sets out other provisions in respect of the public offer, including the following: Conditions precedent the conditions precedent to the Hong Kong underwriting agreement will generally include the registration of the prospectus, the agreement of the final offer price, the signing of the international purchase agreement and that agreement becoming unconditional, the Exchange granting admission for listing of the companys shares and the delivery of specified documents to the underwriters; Representations and warranties the company and other warrantors under the underwriting agreement will give extensive representations, warranties and undertakings to the Hong Kong underwriters covering the accuracy and completeness of prospectus disclosure, the financial information, due incorporation, title to assets, legal compliance, approvals required for the offering and other matters. The undertakings will generally cover issues including maintenance of listing status, using the proceeds of the offering in accordance with the prospectus and the issue of announcements; Indemnity the company and other warrantors will also provide the Hong Kong underwriters with an indemnity from liabilities arising from misstatements or omissions in the prospectus, breaches of laws and breaches of the terms of the underwriting agreements, including the representations and warranties;
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Termination provisions the Hong Kong underwriting agreement will also set out comprehensive events of termination, including force majeure events, material restrictions on trading on major securities markets, adverse changes in the business of the company, breaches of warranties, litigation being brought or threatened against the company and material omissions or misstatements in the prospectus, on the occurrence of which prior to a specified time (generally 8:00am on the morning of listing) the underwriters have the right to terminate their obligations under the underwriting agreement; and Lock-up provisions the company and controlling shareholders will give undertakings not to issue shares (in the case of the company) or dispose of their interests in the shares of the company for a specified period of time following the listing of the company's shares on the Exchange.
Agreement among Hong Kong underwriters At the same time as entering into the Hong Kong underwriting agreement with the company, the underwriters of the public offer tranche will enter into an agreement among Hong Kong underwriters, setting out their respective rights and obligations in respect of the public offer. The agreement will include provisions in respect of any default by any Hong Kong underwriter of its underwriting obligation, allocation of the underwriting commissions among the underwriters and authorising the global coordinator to exercise the underwriters discretions under the Hong Kong underwriting agreement on their behalf. Price determination agreement As the offer price will generally be expressed in terms of a range at the time the Hong Kong underwriting agreement is entered into, upon agreement of the final offer price between the global coordinator (on behalf of the underwriters) and the company, the global coordinator and company will enter into a simple price determination agreement setting out the offer price as finally agreed. Receiving bankers agreement In connection with the public offering, the company and the global coordinator will enter into a receiving bankers agreement with a commercial bank, in respect of the distribution of prospectuses and application forms and collection and processing of applications and application monies. The agreement will also provide for the payment of interest on application monies, which on major and popular IPOs can be a significant amount.
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These include, in the case of Regulation S offerings, that no directed selling efforts have been made in the United States by the issuer, a distributor, any of their respective affiliates or any person acting on behalf of the foregoing, that applicable offering restrictions have been complied with and that there is no substantial US market interest in the securities offered. Where Rule 144A is relied upon, typical representations, warranties and covenants include that no general solicitation or general advertising has been made in the United States by the issuer, a distributor, any of their respective affiliates or any person acting on behalf of the foregoing, and that no securities of the same class are listed in the United States. Agreement Among Managers A separate agreement, referred to as an Agreement Among Managers, will specify the underwriters obligations to each other in relation to an international offering. This agreement will generally establish a several commitment of the underwriters and is similar in effect to the Agreement among Hong Kong underwriters. The global coordinator will be authorised but not obliged to arrange for subscription by others of any defaulting underwriters's shares. It will also provide terms as to commissions and expenses. The Agreement Among Managers will also establish the authority of the global coordinator to exercise, on behalf of all underwriters, rights under the underwriting agreement on their behalf, such as extending deadlines and waiving conditions precedent to closing under the underwriting agreement, terminating the underwriting agreement, reallocation among the public offer and the international offering, determining pricing, exercising any over-allotment option, making payment to the issuer in accordance with the underwriting agreement and engaging in stabilising activities. Intersyndicate Agreement A separate agreement, referred to as the Intersyndicate Agreement, is an agreement among the underwriters of the Hong Kong offering and the underwriters of the international offering, and will govern reallocation between the offerings, commissions and expenses and agreed selling restrictions.
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27 Publicity restrictions
There are a number of regulations governing the release of information by the company or any of its advisers in connection with an IPO. It is important that appropriate guidelines are put in place to ensure that any releases of information do not breach the regulations as this may result in potential liability, delays to the timetable and possibly prevent the IPO from being marketed in certain jurisdictions. We have dealt with the rules relating to the release of research reports in Chapter 28. Principal regulations
The regulations governing the release of information in connection with an IPO are contained in the Companies Ordinance, the SFO, guidelines issued by the SFC, and the Listing Rules. The regulations are complex, very restrictive and arguably inconsistent with each other which makes their interpretation very difficult. In this chapter we have endeavoured to simplify these regulations and outline what we consider to be accepted market practice. In broad terms, the regulations provide that before registration of the prospectus the company (and its advisers) cannot issue any press announcements or make any public statements which contain any reference to the IPO or the offer of the shares or the current or future trading prospects of the company, other than a very limited offer awareness statement made not earlier than 14 days before registration of the prospectus and which is approved by the Exchange. Under LR9.08, any publicity material issued by the company relating to the IPO must be approved by the Exchange before release and must not be released until the Exchange has confirmed that it has no further comments thereon. For these purposes, publicity material does not relate to an issue of securities if its purpose is the promotion of the company or its products and not the securities to be issued. Where any material relating to the proposed IPO is released before the Listing Committee hearing without prior review by the Exchange, the Exchange may delay the timetable for the Listing Committee hearing by up to one month. In practice it is rare for authorised publicity material to be issued. If the company and its advisers hold meetings with financial advisers and major investors before registration of the prospectus this may involve a breach of the regulations and thus any information released at these meetings should be limited to that contained in the draft prospectus and the attendees should agree not to publicly release this information until the prospectus is registered.
Publicity guidelines
Guidelines It is recommended that a set of publicity guidelines is prepared and distributed to directors, senior management and all other parties involved in the IPO. Approval by Authorised Person An internal Authorised Person should be appointed by the company to approve all written publicity material (including any oral presentations) relating to the IPO, current or future trading prospects, or the operations of the group other than material issued in the ordinary course of business. Where the Authorised Person is in doubt as to whether the information may breach the regulations he should consult with the companys legal advisers. All approved information should be copied to the legal advisers.
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Enquiries by press or public Before registration of the prospectus, if the company is asked to respond to any enquiry from the press or any member of the public relating to the IPO, or to the current or future trading prospects of the group, then the company should decline to comment. If the enquiry relates only to the general business of the group (excluding trading prospects) or relates to publicly available information then the company can respond to the enquiry, but caution is required. After registration of the prospectus the directors or employees can respond to enquiries provided that they do not provide more information than is contained in the prospectus. Press releases and other materials Prior to registration of the prospectus the company should not issue any press releases or other written material relating to the IPO, except for the very limited statement as permitted by the SFC Offer Awareness Guidelines discussed below. After registration of the prospectus all press releases and other written material relating to the IPO or the operations of the group must be approved by the Authorised Person and, if such release refers to the IPO, it must comply with the SFC Offer Awareness Guidelines and be approved by the Exchange. SFC offer awareness guidelines The SFC guidelines permit offer awareness materials to be issued not earlier than 14 days before registration of the prospectus provided this contains only very limited information (as specified in the guidelines) of the fact of the forthcoming IPO and does not contain any information promoting the company or the offer of shares under the IPO. Such materials need not be approved by the SFC or the Exchange. Such materials should not be used after the close of the offer period. After registration of the prospectus the guidelines also permit the company to issue summary disclosure materials which are materials that do not contain any substantive information that is not contained in the prospectus and also contain certain warning statements as prescribed in the guidelines. Summary disclosure materials must be approved by the Exchange, but are rare in practice. Unsolicited communications No director, officer or employee of the group should make any unsolicited communications to any analyst, potential investor or other person regarding the IPO or the business of the group. Company website The companys website should not refer to the IPO or include any material which is not usually placed on its website, as this information may be viewed as conditioning the market to the IPO. In addition, prior to submission of the Form A1, the companys website should be screened for any information which is inconsistent with the draft prospectus. Press conferences No press conferences regarding the IPO should be held until the prospectus is registered. Once registered, a press conference is often called the same day at which the prospectus can be made available and the company can respond to questions provided that no material should be released which goes beyond that contained in the prospectus. If a press conference is held prior to registration of the prospectus on matters not related to the IPO, the company should decline to answer any questions concerning the IPO or its trading prospects. Underwriter marketing and roadshow Before the Listing Committee hearing, the sponsor and underwriters should not discuss the IPO with the press or any potential investors other than any strategic or anchor investor(s) who should be required to provide a confidentiality undertaking.
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Following the Listing Committee hearing, the sponsor and underwriters will commence the pre-marketing process. Roadshow meetings with potential investors will generally commence after the Listing Committee hearing and pre-marketing process but before the prospectus is registered. At these meetings the practice is to release the red-herring draft of the prospectus to institutional investors and give presentations supported with slides and answer questions. The presentation and any answers should not include any substantive material which goes beyond that included in the prospectus. Those attending these meetings should be required to keep the information confidential until the prospectus is registered.
Examples of marketing activities or publicity that could be deemed to be directed selling efforts, general solicitation or general advertising include: the promotion of feature articles about the issuer or management interviews in US publications by representatives of the issuer; advertisements for the offering in any US publication; and meetings between representatives of the issuer and research analysts or brokers in which the offering is discussed, if such analysts or brokers then distribute such information in the United States.
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Any distribution of publicity by any offering participant in the United States that was found to be directed selling efforts or a general solicitation or general advertising could (i) result in a loss of the exemption from the registration requirements of the Securities Act for either the US or the non-US portions of the offering, (ii) create a risk that the SEC could prevent or delay the US portion of any such offering and (iii) subject offering participants to liability to US investors under US laws for statements made in such publicity.
Protective measures
As a result of these considerations, in general, underwriters should ensure that no press conferences are held in the United States and no press releases or other announcements relating to the IPO are issued or disseminated in the United States by any person involved with the IPO or the company. Press conferences may be held outside the United States in accordance with local market practices and US journalists may be invited provided that access to the conference is provided to both US and non-US journalists. One-on-one interviews may be held with US journalists provided similar opportunities are given to non-US journalists. The issuer should not solicit media coverage in US media or non-US media commonly disseminated in the United States (such as The Financial Times or the Economist). Any written press-related materials must contain an appropriate legend. The legend should state that the written press-related materials are not an offer of securities for sale in the United States, that securities may not be offered or sold in the United States absent registration or an exemption from registration, that any public offering of securities to be made in the United States will be made by means of a prospectus that may be obtained from the issuer or the selling security holder and that will contain detailed information about the company and management, as well as financial statements. Since materials posted on a website are generally available to persons located in the United States, any offering materials posted on the issuers websites could be construed as an offer of securities into the United States, as directed selling efforts in violation of the Regulation S safe harbour and/or as a general solicitation or general advertising, rendering Rule 144A unavailable. Other restrictions on publicity on offerings sold into the United States are similar to those referred to above in relation to offerings generally.
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End of Global Blackout Period Start of US Blackout Period End of US Blackout Period
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Own research Each research report should be the syndicate members own research. Internal compliance procedures All research reports should be reviewed by the syndicate members research compliance officer (or internal legal compliance officer) before publication to ensure that the report is in accordance with internal guidelines. In addition, research reports should also be cleared with the syndicate members corporate finance director in charge of the client relationship with the company before publication. This is to enable the director to check that there are no factual errors in the research report, and no material inconsistencies with the draft prospectus. Compliance with regulatory requirements Each syndicate member issuing a research report is responsible for ensuring that all applicable regulatory requirements and standards of professional conduct in relation to the preparation, publication and distribution of the research report are complied with in all relevant jurisdictions. Chinese Walls Appropriate information barriers should be maintained between the analyst(s) preparing the research and those other divisions of the financial organisation advising the company or involved in the IPO. Such analysts should not attend due diligence meetings in relation to the offering or have other contact with the company, save that they will often attend formal analysts presentations; their reports should be prepared by reference only to draft offering materials provided by bankers advising on the IPO on the other side of the Chinese Wall. Date and disclaimer All research reports should be dated and must include a disclaimer of liability and an indication statement in the form recommended by the underwriters legal advisers. The disclaimer should appear prominently at the front of the research report and the indication should appear on each page. The disclaimer is of assistance in avoiding liability but is not conclusive. To the extent disclosure of an underwriters participation in the Offer is required in its research report due to regulatory or liability considerations, such disclosure must not be given greater prominence than any other disclaimers, legends and qualifying statements in the research report. Basis of preparation Each research report must be produced using a high standard of care. This requires that: the research report should be, and present itself as, an outsiders view of the company which has been independently produced; qualifications, explanations and caveats should be clearly stated; it should be clear what information is a matter of fact and what is a matter of the authors judgement; to the extent that information is based on published or historic information, and particularly if this has not been updated, this should be made clear; the facts should where possible be checked against authoritative sources (and the relevant source should be stated in the research report); where this is not possible, this should be made clear and appropriate qualifications should be included; the research report makes clear that the research report does not, and does not attempt to, contain everything material about the company;
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research reports must be accurate and not misleading by omission; and where there is a reference to the authors belief, there must be a reasonable basis for that belief.
No reference to the IPO The research report should not contain any reference to the IPO or suggest in any way that it is being issued in connection with or because of the IPO. Forecasts, projections and valuations Subject to the restrictions set forth below, research reports may include forecasts, projections and valuations prepared independently of the company. Inclusion of forecasts, projections or valuations in the research report may lead to increased liability with respect to such research report and great care should be taken. If forecasts, projections or valuations are to be included, in order to minimise the potential risk: they must comply with the requirements of local law; they must be fairly based; there must be no price target or fair value per share. Comments on valuation should be restricted to general remarks about the methods that the market generally uses to value comparable companies. It should be made clear that any suggested valuation framework is based upon long-term analysis and is not linked to a short-term assessment of the likely performance of the securities; it must be made clear that they represent the opinion of the authors alone and not of anyone responsible for the preparation of the prospectus or in possession of confidential information regarding the company or any of the subsidiaries and must be accompanied by appropriate cautionary language indicating that such forecasts, projections or valuations may or may not occur, as well as any other applicable risk factors; and detailed assumptions on which they are based must be clearly stated, the sources used must be identified and the sensitivity of the projections to any exogenous factors must be estimated.
The Listing Rules provide that pre-deal research issued by the sponsor, each of the underwriters or their associates must not incorporate any profit forecast or other forward looking statements unless such statements are included, in substantially the same form, in the applicants listing document. Where a profit forecast is included in the prospectus, a practice has developed to request a confirmation from the Exchange that it would not have any comment on the inclusion of independently prepared profit forecasts covering a limited period (of an additional one to two years) beyond that covered in the prospectus. Where relevant contents of a research report prepared by a syndicate member are published in the press (possibly following a leak), the Exchange may withdraw any such confirmation given. Where no profit forecast is included in the prospectus, the sponsor is required to provide an undertaking to the Exchange that it will not include profit forecasts or other forward looking statements or financial information of a similar nature in any analysts report or other report or document of a similar nature. No recommendations The research report must not include any investment recommendation or any wording that implies such a recommendation.
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Independent production Except as referred to in the disclaimer, nothing in the research report should suggest that the report is definitive or authoritative or that any part of the research report is based on information provided by, represents the views of, or has been written, verified or approved by, the company, the sponsor or any other syndicate member or any of their directors. Submission of final draft for review At least three days prior to the publication of the research report and after review by the syndicate members legal and research compliance departments, a final draft of the research report must be provided to the sponsor and the sponsors lawyers. Any drafts submitted to the company should have any sections covering forecasts or projections, the research summary and assumptions removed. Basis of review The sponsor may review the research reports for factual accuracy and consistency with the prospectus. The sponsors legal advisers will review the research reports for compliance with the research report guidelines. Global Blackout Period No research report may be published or distributed anywhere in the world during the Global Blackout Period. US Blackout Period No research report may be published or distributed in, or transmitted to, the United States or to US persons during the US Blackout Period which commences immediately upon preparation of the offering and which is expected to end 40 days after the closing date of the offering or the completion of the distribution of the securities if later (the US Blackout Period). During the US Blackout Period, syndicate members should: screen potential recipients of research reports to ensure that only persons who are outside the US and institutional investors on the relevant analysts current research mailing list with addresses outside the United States receive research reports. A list should be kept of all recipients; adopt procedures to ensure that all personnel responsible for the preparation, storage or distribution of research reports and the recipients of the research reports understand that the research reports are not to be distributed in the United States; and if any reasonable doubt exists regarding a persons US status, the syndicate member should refrain from sending research reports to such person.
Distribution of research reports in Hong Kong Research reports may not be issued, circulated, or distributed in Hong Kong other than to persons whose ordinary business is to buy or sell shares or debentures, whether as principal or agent (except in circumstances which do not constitute an offer to the public within the meaning of the Companies Ordinance), and either (i) such persons fall within the meaning of professional investors as defined in the Securities and Futures Ordinance and the Securities and Futures (Professional Investor) Rules or (ii) the issue of this document to such persons is exempt from the Securities and Futures Ordinance. No research reports should be distributed before the formal hearing by the Listing Committee of the Exchange. Distribution of research reports outside Hong Kong Reports should only be distributed to potential investors in jurisdictions outside Hong Kong in compliance with local laws. The distribution of research reports in certain jurisdictions including Canada, Japan and the PRC is prohibited.
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Hard copy distribution only Research reports must be delivered in physical form in one mail shot only and must not be published on the internet, sent by email or other electronic form or put on an electronic retrieval system. Each individual research report should be numbered and records kept of the recipient to whom such report was sent. Any such records are subject to review at any time by the sponsor. No distribution at roadshows, to press or public Research reports must not be distributed, discussed or reviewed at large meetings, such as roadshow presentations, or given to the press (including information vendors and wire services) or any other media organisation, private investors or members of the public anywhere in the world. Distribution consistent with past practice All syndicate members who distribute research reports should issue only such number of research reports as is consistent with their past practice on similar transactions and should maintain records of the names and addresses of all recipients of research reports. Distribution of final reports only Research reports should not be sent to clients until they are in final form. If a draft research report is circulated internally, it should be stamped or marked for internal use only. The company should in any event be provided with a final copy of each research report as soon as it is disseminated to clients. Distribution of prospectus Each syndicate member should ensure that any person to whom a research report has been sent also receives a copy of the preliminary prospectus and, to the extent such recipient is an investor in the offering, any final prospectus when published.
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Even if there is no over-allocation in relation to the share offer, under the PS Rules, the stabilising manager may still engage in market purchases of the shares in order to stabilise the market price of the shares so as to create a net long position in the shares.
Other restrictions under the PS Rules The stabilising manager is prohibited from taking any stabilising action in relation to the Relevant Securities where the market price of the Relevant Securities was or could reasonably be expected to be an artificial price and the stabilising manager knew or ought reasonably to have known that the artificiality in the market price was attributable in whole or in part to any conduct which constitutes market misconduct or an offence under Part XIV of the SFO. No restrictions on the size of any net long position created as a result of primary stabilising actions The PS Rules do not impose any limit on the size of any net long position which may be created as a result of primary stabilising actions. The number of shares which may be purchased pursuant to primary stabilising actions can thus exceed the number of shares under the over-allotment option. However, in practice, other regulatory requirements, such as the public float requirement under the Listing Rules and the disclosure of interests requirements under the SFO, would limit the size of the net long position.
Disclosure obligations
The PS Rules impose prior, interim and post-stabilisation disclosure obligations. Prior disclosure requirement The stabilising manager may not take any stabilisation actions in relation to the Relevant Securities unless, from the date of the first announcement indicating that a public offer of the Relevant Securities is intended to be made, adequate disclosure is made in relevant documents, including any announcement, invitation or prospectus, that stabilising action may take place in relation to the offer. Interim disclosure requirement As soon as reasonably practicable after any exercise or partial exercise of an over-allotment option, the stabilising manager is required to ensure that a public announcement is made by or on behalf of the issuer or the stabilising manager stating (i) the number of the Relevant Securities subscribed for on such exercise or partial exercise; and (ii) the number of Relevant Securities remaining available thereafter under any unexercised portion of the option. Other than in relation to an exercise of the over-allotment option, the PS Rules do not impose any other obligation on a stabilising manager to flag any stabilisation bid in the market in the course of its stabilising actions by way of simultaneous public announcement. Post stabilisation disclosure Within seven days after the end of the stabilising period the stabilising manager is obliged to ensure that a public announcement is made (whether by or on behalf of the offeror company or the stabilising manager) setting out the following: the date of the end of the stabilising period; whether or not stabilisation was undertaken; the price range between which stabilising purchases were undertaken; the date and price of the last stabilising purchase; and where applicable, the extent to which any over-allotment option was exercised.
There is no obligation under the PS Rules to disclose the volume of stabilising purchases undertaken.
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details of the allocation of the Relevant Securities (name of offeree and amount allotted); details (so far as is known to the stabilising manager) of transactions other than those which are effected by or in accordance with the instructions of the stabilising manager at a price above the current stabilising price for the purposes of determining the maximum stabilising price (referred to as Price C in the section Pricing restrictions above).
In addition details of any agents appointed by the stabilising manager must be included in such register. The SFC expects the stabilising manager to properly separate its activities as stabilising manager and its other trading activities, including proprietary trading, to avoid committing market misconduct not covered by the safe harbour under the PS Rules. All stabilising actions should be recorded in the register in order to be eligible for the safe harbour under the PS Rules.
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In connection with a Regulation D private placement, general solicitation and general advertising may not be undertaken. General solicitation and general advertising include, with respect to the offering: publishing any advertisement, article or notice in any US newspaper, magazine or similar media in the United States or broadcasting such over US television or radio; or any seminar or meeting whose attendees have been invited by any general solicitation or general advertising.
An issuer offering securities under Regulation D must file with the SEC five copies of a notice on Form D no later than 15 days after the first sale of securities in the Regulation D offering (typically considered to be the receipt of the first subscription agreement or acceptance of subscription funds). The Form D, a fairly short form requiring only general information about the issuer and the offering, is a notice filing only; it does not subject the offering to review by the SEC. In practice, however, most issuers do not file the Form D in connection with their private placements on the theory that compliance with all other requirements of Regulation D would suffice to ensure that the exemption under Section 4(2) would be available. However, a Form D may nonetheless need to be filed in certain states to meet state exemption requirements. Rule 144A offerings In Rule 144A offerings, the securities offered must be sold only to QIBs, or those whom the seller reasonably believes are QIBs. Generally, QIBs are entities that in the aggregate own and invest on a discretionary basis at least $100 million in securities of non-affiliated issuers. Rule 144A securities are considered restricted securities and cannot be sold to non-QIBs (unless resold outside of the US under Reg S). In connection with a Rule 144A offering, similar to a Regulation D private placement, general solicitation and general advertising may not be undertaken. Regulation S offerings In a Regulation S offering, two general conditions must be satisfied: (i) any offer/sale must have occurred in an offshore transaction, and (ii) there must have been no directed selling efforts into the United States by the issuer, any distributor or any of their respective affiliates. Directed Selling Efforts are activities undertaken to, or that reasonably could be expected to, condition the US market for the securities. Additional restrictions apply if US holdings (for debt securities) or trading volumes (for equity securities) indicate the presence of substantial US market interest, or SUSMI. In such cases, additional restrictions are required: sales may not be made to US persons, as defined for purposes of Regulation S; offering restrictions must be complied with (ie, distributors must agree that offers and sales during a distribution compliance period will be made under Regulation S); and notice requirements applicable to inter-dealer sales will apply during a 40-day distribution compliance period.
State law (Blue Sky) requirements An offering exempt from registration under federal securities laws may still be subject to registration or qualification requirements imposed by state securities laws in the United States. US states are not prevented from imposing filing and fee requirements on issuers.
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Liability on disclosure Although the above exemptions provide for exemption from the securities registration requirement of Section 5 of the Securities Act of 1933, they do not provide exemption from anti-fraud rules.
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Financial statements Disclosure documents for SEC registered offers require the issuer to provide five years of selected financial data, three years of audited income statements and two years of audited balance sheets. Furthermore, issuers making an initial public offering generally must use audited financial statements (which may cover a period of less than a full year) not older than 12 months at the time the registration statement is filed. If the registration statement is dated more than nine months after the end of the last audited financial year, it should contain consolidated interim financial statements (which may be unaudited) covering at least the first six months of the financial year and comparative statements for the same period in the prior financial year. Moreover, if at the date of the registration statement the issuer has published interim financial information that is more current than required under this standard, the more current information must be included in the document. An additional consideration that may influence the parties decision regarding the financial statements to be included is the unavailability of negative assurance comfort from the auditors with respect to subsequent changes in financial statement items as of a date more than 135 days after the most recent period for which the accountants have performed an audit or interim review. Generally financial statements of non-US private issuers must contain reconciliations of key items to US GAAP and a discussion of material variations between home country and US GAAP. First time non-US registrants are permitted to reconcile financial statements and selected financial data for only the two most recently completed fiscal years. In subsequent reports and registration statements, an additional year is required until eventually the reconciliation covers five years. Audit reports for the financials must provide that the audit was conducted according to US generally accepted auditing standards.
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that, taken as a whole, the document gives, so far as possible, a true and fair impression of the history, business and prospects of the issuer (as part of this exercise the offering memorandum must clearly cover the risks as well as the attractions of the investment); and, that nothing has been omitted so as to make the document misleading.
Pre filing period In connection with an IPO by a foreign private issuer, during the period before the registration statement is filed no one may offer, either orally or in writing, to sell the securities to be registered in the US. In this context, the term offer is broadly construed to include acts that may stimulate market interest in the issuer even if the securities are not mentioned. Rule 135 under the Securities Act allows the publication of very limited information about the offering before the registration statement is filed (provided it does not contain any of the underwriters names). Improper communications during this period are called gun-jumping violations. The penalty for such violations is a SEC imposed cooling off period which is meant to reduce the effect on the market of the improper communication. The cooling off period may last anywhere from a few weeks to several months. The SEC may also require the issuer to include the information that was improperly communicated in its prospectus, thus increasing the potential liability of all parties to the offering. Gun-jumping is also considered to be a violation of Section 5s registration requirement which allows the purchaser to rescind his purchase for up to one year following the sale. Filing the registration statement Filing fees must be paid to the SEC in connection with filing a registration statement. As of November 2002, non-US issuers are required to file registration statements electronically with the SEC by means of its EDGAR (Electronic Data Gathering and Retrieval System) system. A non-US issuer may request a confidentiality review of its registration statement prior to making a formal public filing. This confidential treatment is only available for first-time filers. A formal public filing is usually made after responding to the SECs comments on the confidential filing. The comment (waiting) period The initial public filing with the SEC marks the beginning of a waiting period, during which time the SEC staff may issue comments on the registration statement, and the issuer and the managing underwriter conduct preliminary marketing efforts in order to ascertain the level of interest in the transaction within the investment community. Review by the SEC staff for legal and accounting compliance during this period may take from 30 to 60 days (or longer if novel issues are present or staff workload is intense), although a shorter period is possible if the issuer has submitted a draft registration statement for confidential review and the issues raised by the SEC staff have been substantially resolved prior to the public filing. The managing underwriter should receive some word from the National Association of Securities Dealers (the NASD) and the Blue Sky administrators within four to five weeks following the filing. The SEC will contact the issuer with comments, orally or in writing, and may then schedule meetings to discuss necessary revisions. The SEC may require an interim amendment to the registration statement prior to declaring it effective. During this period oral selling efforts, such as a road show, are permitted.
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In connection with an IPO by a foreign private issuer, preliminary prospectuses are the only permitted written offering materials during this period and no sales may be made or confirmed during this period. The road show In order to market the securities to be sold, the issuer and bankers will visit potential investors during the SEC comment period, making presentations to them about the issuer and the securities, as part of a so-called road show. The road show typically covers several cities over a relatively short time frame (one three weeks). The presentation is prepared in advance with information drawn from the offering memorandum and is often followed by a question and answer section. For public offerings, no written materials may be distributed at a road show other than the preliminary or red herring prospectus. Interim amendment Depending on the extent to which SEC staff concerns can be resolved in any confidential review process, an issuer making its initial filing may be required to file amendments to its registration statement with the SEC before the registration statement becomes effective. If an amendment reflects material changes that ought to be known by public investors before they receive their sale confirmations after the effective date, a full re-circulation of the revised preliminary prospectus must be made to all persons to whom the underwriters expect to send confirmation not less than 48 hours prior to the mailing of such confirmations. If the changes are not of the type that would require re-circulation, but the SEC staff still wishes to review the revised language, the staff may accept a printers proof of the final pricing amendment, or a letter containing the proposed language. On some occasions, insignificant changes can be discussed over the telephone with the examiner, and included in the pricing amendment without formal review by the SEC staff. Pricing On the day prior to the effective date of the registration statement, the issuer and the managing underwriter will conduct a pricing meeting to determine the IPO price, based on demand for the securities. Once the price is decided upon, the final underwriting agreement is signed. Effective date Once the SEC receives the amended registration statement and approves the disclosure, the staff will declare the registration statement effective, and public trading may commence. Closing Within three days of commencement of public trading, the closing will generally take place. This is the point at which the underwriters receive the securities and required documents, comfort letters, and opinions set forth in the underwriting agreement in exchange for remitting the proceeds of the offering to the issuer and any selling shareholders. DTC trading The Depository Trust Company (DTC) is a clearing agency which holds securities for its participants and facilitates the clearance and settlement of securities transactions between participants through electronic book-entry changes in the accounts of its participants, thereby eliminating the physical movement of certificates. Securities which are registered with the SEC are eligible to clear through the facilities of DTC. Investors hold the beneficial interests in securities directly through DTC if they are participants, or through their accounts with participants such as securities firms, banks and other institutions. The European clearing agencies Euroclear and Clearstream also participate in DTC through their nominees.
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Consequences of registration
As a result of registering securities in the United States, issuers will become subject to a number of requirements under US law. Sarbanes-Oxley Act of 2002 The Sarbanes-Oxley Act of 2002 imposes significant requirements on US-listed issuers relating to corporate governance, composition of board and audit committees, internal financial control reviews and financial statement certification requirements. The Act also creates specific ethics-based requirements for issuers, including a prohibition on personal loans from the issuer to executives. Under the Sarbanes-Oxley Act, an issuer that has a class of securities registered under Section 12 of the Exchange Act must maintain controls and procedures that are designed to ensure that information required to be disclosed by the issuer under the Exchange Act is recorded, processed, summarised and reported within the time periods specified in the SECs rules and forms. The required controls and procedures include procedures designed to ensure that such information is accumulated and communicated to the issuers management as appropriate to allow timely decisions regarding required disclosure. The SEC encourages creation of a disclosure committee to ensure that methods of gathering, analysing and disclosing all information about the issuer are as comprehensive as the methods used for disclosing financial information. Pursuant to Section 404 of the Sarbanes-Oxley Act, the principal executive officer and principal financial officer of an issuer are required to publish information in their annual periodic reports to the SEC concerning the scope and adequacy of the internal financial control structure and procedures for financial reporting. This management report is also required to assess the effectiveness of such internal financial controls and procedures. Section 404 further requires a registered accounting firm provide an auditors attestation to and report on the assessment on the effectiveness of the internal financial control structure and procedures for financial reporting of the company. This financial controls auditor attestation requirement has imposed significant compliance costs upon issuers listing on US securities exchanges. The SEC recognised non-US issuers resistance to these compliance costs by announcing on August 9, 2006 that it had approved extending the Sarbanes-Oxley Section 404 auditor attestation compliance deadline for certain foreign private issuers by one year, and that it proposed extending the Section 404 management report and auditor attestation for certain other foreign private issuers, in terms of the fiscal years to which they first relate. The Section 404 auditor attestation and management report compliance deadlines for foreign private issuers that are large accelerated filers (ie, seasoned issuers with a public float of at least US$700 million) was proposed to remain unchanged (first applying to fiscal years ending on or after July 15, 2006). However, the SEC approved extending the Section 404 auditor attestation compliance deadline for foreign private issuer accelerated filers that are not large accelerated filers from fiscal years ending on or after July 15, 2006 to fiscal years ending on or after July 15, 2007. The SEC also proposed extending (subject to public comment) the Section 404 auditor attestation compliance deadline for foreign private issuers that are not accelerated filers from fiscal years ending on or after July 15, 2007 to fiscal years ending on or after July 15, 2008 and the Section 404 management report deadline for such filers from July 15, 2007 to December 15, 2007.
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Periodic Reporting under the Securities Exchange Act of 1934 Section 12 of the Securities Exchange Act of 1934 (the Exchange Act) requires any non-US private issuer with more than $10 million in assets worldwide and more than 500 global securities holders (of which 300 or more are US residents) to register as a reporting company under the Exchange Act, or seek an exemption from registration. Registration under the Exchange Act is also required before a class of debt or equity security can be listed on any US stock exchange. Registration under the Exchange Act invokes its periodic reporting requirements, which for foreign issuers include the filing of an annual report with the SEC, known as a Form 20-F, which is roughly similar to the initial registration statement in content. The Exchange Acts periodic reporting requirements apply to all non-US private issuers that have either registered securities under the Exchange Act or registered a public offering under the Securities Act. A non-US private issuer subject to these requirements must submit an annual report on Form 20-F and interim reports on Form 6-K. Form 20-F Form 20-F must be filed annually, within six months of the end of the reporting companys fiscal year. The information required to be disclosed is similar to that provided in the registration statement and is intended to provide the SEC and the public with annual updates of the information that was provided during the initial offering. The Sarbanes-Oxley Act requires that Form 20-F be accompanied by two written statements, each signed by the chief executive officer and the chief financial officer certifying that the CEO or CFO has reviewed the disclosure, and that in the view of the officer the information is not misleading, that it fairly presents the condition of the issuer in all material respects, and that the report complies with the Exchange Act. The certification must also include statements with respect to the quality and the effectiveness of an issuers disclosure controls and procedures. A CEO or CFO who knowingly or wilfully certifies a report that does not meet the requirements of the Exchange Act faces fines and/or imprisonment. Form 6-K Form 6-K requires information to be filed with the SEC and any stock exchange on which the issuers securities are listed if such information is (i) required to be made public pursuant to the law of the issuers country of domicile or incorporation, (ii) filed with a non-US stock exchange and made public by such exchange, or (iii) distributed to the security holders of the issuer. Information meeting one of the above tests is only required to be disclosed on Form 6-K if it is material to the issuers business. Ownership reporting requirements under the Securities Exchange Act of 1934 Sections 13(d) and 13(g) require persons acquiring more than 5% of any class of voting securities registered under Section 12 of the Exchange Act to file reports with the SEC. Schedule 13D, if applicable, must be filed within 10 days of a person crossing the 5% threshold. The acquirer must disclose, among other things, its identity, the source of the funds used to acquire the securities and the purpose of the acquisition (including any plans for future purchases). A prompt amendment of the schedule must be filed if there is a material change to the information disclosed on the form. Persons that acquired their securities prior to the issuer becoming a reporting company and certain institutional investors that acquire securities in the ordinary course of business and do not change or influence control of the issuer may qualify to file a short form report on Schedule
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13G. Schedule 13G must be filed within 45 days of the end of the calendar year in which the acquisition occurred. If the acquirers level of ownership falls below 5% prior to the deadline, no filing is necessary. In addition to the more favourable filing deadlines of Schedule 13G, less information is required to be disclosed. National Exchanges and Automated Quotation Services Rules US National Exchanges, such as the NYSE and the American Stock Exchange (the Amex) and NASDAQ (to date the only automated quotation service in the US) impose certain notice and reporting obligations as well as certain listing standards which are discussed in greater detail below. NASD Rules The rules of the NASD will apply to the underwriters involved in a registered offering. Primarily, the rules focus on the fairness of the underwriting compensation. The SEC will not declare a registration statement effective until it receives from the NASD a letter which states that it does not object to the compensation arrangements. Offerings of investment grade debt securities are exempt from the NASD fair compensation rules. The Foreign Corrupt Practices Act The Foreign Corrupt Practices Act contains two important requirements for issuers that have registered securities under the Exchange Act or the Securities Act. The first prohibits the bribery of foreign officials. Issuers may not use means or instrumentality of interstate commerce corruptly in furtherance of improper payments to foreign political parties or officials for the purpose of influencing any act or decision in order to obtain business. The second requirement is that issuers maintain their accounts in a way that will deter bribery. Issuers must (i) keep books, records, and accounts that accurately reflect the transactions and assets of the issuer and (ii) maintain an adequate system of internal accounting controls. Violations of either requirement of the Foreign Corrupt Practices Act can result in criminal fines and/or imprisonment. Also, the SEC may bring civil suit against issuers or individuals that can result in additional fines. If civil or criminal fines are imposed on individuals, they may not be paid by the issuer directly or indirectly. Regulation M: anti-manipulation rules With regards to US-listed securities, the rules under Regulation M generally prohibit participants in the offering from purchasing, or attempting to induce any person to purchase, the securities offered in the market for a certain period. There are exceptions to these rules for ordinary course transactions, actively traded securities and certain stabilisation activities by the underwriters. NYSE and NASDAQ requirements The ongoing requirements of NASDAQ and NYSE are similar to those of the Exchange Act but are in some ways more demanding. In addition, new SEC rules formulated under the Sarbanes-Oxley Act reforms direct national securities exchanges and associations such as NASDAQ to prohibit the listing of any security of an issuer that does not have an audit committee composed entirely of independent directors. Moreover, issuers with an audit committee must disclose whether or not their audit committee has at least one member who fits the SECs criteria of a financial expert and, if not, why. The audit committee is responsible for the appointment, compensation, and oversight of the auditor, for establishing complaint procedures, and for resolving disagreements between the auditor and management.
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NYSE requirements The NYSE requires issuers to provide security holders annual reports within three months of the close of their fiscal year and at least 15 days in advance of their annual meeting. Quarterly reports must be provided as soon as they become available. Non-US issuers may be able to obtain waivers of these requirements. Issuers are also required to promptly release information that could materially affect the market for their securities. Material negotiations do not need to be disclosed so long as discussions are limited to members of top management and their confidential advisors. Once it becomes necessary to involve outsiders, however, public disclosure must be made. Issuers must provide prompt written notice to the NYSE upon the occurrence of certain events. These events include changes to the charter or by-laws, a change of auditors, changes in directors or officers, increases in the outstanding amount of securities and other changes affecting the issuers securities. NASDAQ requirements The disclosure requirements are similar to those of NYSE. Issuers must (i) file annual reports, (ii) provide NASDAQ with any information filed with the SEC on Form 6-K, and (iii) disclose any information that could materially affect the value of their securities.
Liability issues
Various potential legal liabilities exist for issuers failing to comply with the registration requirement under the US securities laws. Section 12(a)(1) In terms of the consequences of a failure to register, Section 12(a)(1) of the Securities Act creates a private cause of action for purchasers of securities that were required to be registered under the registration requirement of Section 5 of the Securities Act but were not registered by the seller. Purchasers may bring civil suits against the seller to have the sale rescinded. Recovery is limited to the purchase price plus interest (less any income received on the security) but this may be a significant amount for purchasers if the share value has fallen from its initial offering price. Section 20 Section 20 of the Securities Act empowers the SEC to bring an action in a United States district court when it discovers a violation of the registration requirements. The SEC may seek the disgorgement of any profits resulting from the prohibited acts and the imposition of a fine. If the violation was wilful, criminal proceedings may be instituted. Section 10(b) and Rule 10(b)(5) The antifraud provisions of the Exchange Act are contained in Section 10(b) and its accompanying Rule 10b-5, both for the SEC and for private litigants. Section 10(b) and Rule 10b-5 are broadly written: Section 10(b) proscribes the use of any manipulative or deceptive device or contrivance in connection with the purchase or sale of any security, and Rule 10b-5 specifies three categories of conduct that qualify as violations. These are (i) employing any device, scheme, or artifice to defraud, (ii) making any untrue statement of material fact or failing to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, and (iii) engaging in any act, practice, or course of business which operates as a fraud or deceit. US courts have
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long held that buyers or sellers of securities have an implied right to recover damages based on violations of Section 10(b) and Rule 10b-5. Information is deemed material for these purposes if there is a substantial likelihood that a reasonable investor would consider it important in deciding whether to purchase or sell securities. In a private right of action the plaintiff must show that the defendant acted with scienter, that is, some intent to defraud or manipulate. Courts have ruled that recklessness also constitutes scienter, but mere negligence will not suffice. The remedies for violations of Rule 10b-5 differ depending on whether the action was initiated by the SEC or by a private litigant (or group of private litigants). The SEC has a number of remedies under Section 10(b) and Rule 10b-5, including: injunctive relief, prohibiting (permanently or temporarily) any person who has violated these provisions from acting as an officer or director of any public company, civil penalties and referral to the Department of Justice, which may seek criminal sanctions for wilful violations of the anti-fraud provisions of the Exchange Act. A private person can recover their out-of-pocket loss, which is generally the difference between the price paid for the security and the true value of the securities, which will normally be deemed to be the market price of the security at the time of the suit. The plaintiff may also seek to rescind the transaction and return the securities to the defendant in exchange for the money originally paid by the plaintiff. Section 11 Section 11 of the Securities Act applies when a registration statement contains a material misstatement or omission. Purchasers, whether they bought the security in the initial offering or the secondary market, may bring civil suits to recover monetary damages. The issuer, underwriters, signers of the registration statement, directors, accountants and others are all potential defendants. Section 12(a)(2) Under the civil liability provisions of Section 12(a)(2) of the Securities Act, liability attaches to any person who offers or sells a security, by the use of any means or instruments of transportation or communications in [US] interstate commerce or of the [US] mails, by means of a prospectus or oral communication, which includes an untrue statement of a material fact or omits to state a material fact necessary in order to make the statements, in the light of the circumstances under which they were made, not misleading...and who shall not sustain the burden of proof that he did not know and in the exercise of reasonable care could not have known, of such untruth or omission. Section 15 Under Section 15 of the Securities Act, liability may be extended to any person who controls any person liable under Sections 11 or 12, as described above. Under the Securities Act control is defined in terms of the power to, directly or indirectly, direct or cause the direction of the management and policies of a person, whether through the ownership of voting securities, by contract, or otherwise. There is an exception for controlling persons if the person had no knowledge of or reasonable ground to believe in the existence of the facts by reason of which the liability of the controlled person is alleged to exist. Section 20(a) of the Exchange
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Act imposes similar liability on persons who directly or indirectly control any person who has violated any provision of the Exchange Act. An exception is available to a controlling person who can demonstrate good faith and a lack of positive action to encourage the violation. Section 18 Under Section 18 of the Exchange Act, filers of Exchange Act reports (such as Form 20-F) are potentially liable for material misstatements and omissions contained in their filings. A purchaser or seller of securities who acted in reliance on the misstatement or omission may bring suit against any person responsible for the misleading statements. Plaintiffs must demonstrate that they actually relied on the misleading information. The defendant can avoid liability by showing that he acted in good faith and had no knowledge of the misstatement or omission.
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