Hong Kongs Securities and Futures Commission fined UBS, Morgan Stanley and Merrill Lynch this month for inadequate due diligence in the 2014 initial public offering of Tianhe Chemicals Group Ltd.
UBSs penalties are also based on its handling of IPOs for two other companies on the Hong Kong Stock Exchange. In addition to its fine of HK$375 million (U.S. $48 million), UBS was suspended for one year from sponsoring listing applications in Hong Kong. Morgan Stanley and Merrill Lynch were fined HK$224 million and HK$128 million, respectively, just for work on the Tianhe offering.
The SFC chided all three institutions for sloppiness in validating information that underlay Tianhes stock offering, which raised approximately U.S. $654 million in its offering.
Sponsors have considerable control over the listing process, the commission said in its March 14 announcement of the penalties against UBS.When sponsors perform substandard due diligence work and companies unsuitable for listing are nevertheless listed and eventually fail, their failure may cause enormous loss to public investors and jeopardize their confidence in Hong Kongs financial markets.
Tianhe and one of the other companies for which UBS was penalized, China Forestry Holdings Co., are still in business. SFC did not identify the third company, stating that it is involved in an investigation that continues. The Hong Kong exchange has halted trading of shares of both Tianhe and China Forestry.
UBS, which is based in Switzerland, issued a statement emphasizing that all of the IPOs were conducted some time ago.
UBS takes note of the findings of the Hong Kong Securities and Futures Commissions investigations, it said. We are pleased to have resolved these legacy issues relating to our Hong Kong IPO sponsorship license. We look forward to continuing to service our clients in Hong Kong.
Merrill Lynch parent company Bank of America declined to comment, and Morgan Stanley did not respond to requests for comment. Tianhe also did not respond to a request for comment.
The SFC said all three institutions failed to follow guidelines on due diligence interviews. For one thing, they relied on Tianhe to arrange interviews with its customers instead of contacting customers directly. Ten individuals identified as Tianhe customers were interviewed but only four at the customers offices, as called for by the commissions code of conduct.
The other six were either interviewed at Tianhes offices in Jinzhou, China, or over the telephone.
The commission specifically cited an interview with one individual said to be Tianhes largest customer. (The commission did not identify the company or say if it was a customer of Tianhe Chemicals lubricant additive or fluorochemicals businesses.) The institutions asked to interview the customer at its office, but was told that an anti-corruption campaign in China prevented the large state-owned enterprise from accepting third-party requests to visit its premises.
The interview was conducted at Tianhes office. At the end of the interview, when the institutions asked to see his identity and business cards, the customer refused and stormed out of the meeting room, saying he only attended the interview to help the family of Tianhes CEO, the commission said. The institutions never followed up to confirm that the individual was the appropriate contact at the customer company.
The institutions allowed Tianhe to control the due diligence process and failed to take appropriate steps to address the red flags raised in the customer interviews, the SFC stated. According to the commission, the institutions asked interviewees questions related to the Tianhe Group instead of Jinzhou DPF-TH, the subsidiary through which Tianhe said it interacted with those customers. The institutions did ask interviewees if they did business with Jinzhou DPF-TH, but only three confirmed that they did, and the institutions did not follow up with the other seven. One of those companies later told the SFC that its responses referred to dealings with Lianoning Tianhe Fine Chemicals, which is wholly owned by the family of Tianhes CEO, but was not part of the business to be listed.
As both the listed and unlisted chemical businesses of the family of the CEO of Tianhe were named Tianhe, the SFC considers that it was insufficient for UBS to merely refer to the Tianhe Group during customer interviews and/or not to request the interviewees to identify the exact Tianhe entity with which their organizations had dealings, said the SFC.
Tianhe was listed on the Stock Exchange of Hong Kong on June 20, 2014. In September of that year, Anonymous Analytics, a shadowy watchdog organization, published a report alleging that the IPO was fraudulent in several respects. Tianhe refuted all of the allegations, but trading of its stock was suspended twice over the next seven months. Trading has not resumed since the second suspension, which was put in place because the company failed to file earnings reports due to questions raised by regulators, some of which related to Anonymous Analytics accusations.
Tianhe has repeatedly stated that it is working to resolve those issues so that trading of its stock may resume, but it stands to be delisted from the stock exchange if trading does not resume by the end of July.