On September 25, the Hong Kong Securities and Futures Commission (SFC) announced that following the Securities and Futures Appeals Tribunal's earlier decision to uphold the SFC's disciplinary action against RaffAello Capital Limited (RaffAello), the regulator has issued a reprimand and imposed a HK$4 million fine on the firm for failing to fulfill its sponsor duties during Publicca Holdings Limited's (Publicca) listing application.
The SFC's investigation revealed that RaffAello failed to complete all reasonable due diligence on Publicca before submitting the listing application. The regulator also found that RaffAello did not maintain professional skepticism when reviewing the accuracy and completeness of representations, submissions, or other information provided by Publicca.
Specifically, the SFC determined that RaffAello's due diligence on Publicca's retail sales was inadequate. Publicca marketed and sold handbags and related accessories to retail and wholesale customers. For the two consecutive financial years ending March 31, 2017, retail sales accounted for approximately 90% of Publicca's revenue, with over 80% coming from retail store sales.
RaffAello conducted walk-through tests on a sampling basis for transactions at Publicca's retail stores and discovered that during the period from February 19, 2016, to March 13, 2016, there was a series of consecutive cash transactions across different retail stores, representing 90% of the total cash sales for the relevant stores on the sampled dates. Many handbags were sold within one to ten minutes. Multiple individuals, including three owners of Publicca's wholesalers and suppliers, made successive large purchases of handbags using credit cards at different retail stores. Cash transaction receipts marked "POS test" were included in the sales documents provided by Publicca.
Although RaffAello made further inquiries to Publicca, its wholesalers, and suppliers regarding these transactions, the SFC's investigation found that RaffAello largely accepted information provided by Publicca and the parties involved in these transactions without maintaining professional skepticism to examine the information and documents provided by Publicca. The firm failed to assess the accuracy and completeness of the information provided and did not notice multiple warning signs observable from the relevant retail sales documents, which indicated that Publicca might have fabricated these transactions to inflate its retail sales.
The SFC also determined that RaffAello's due diligence on Publicca's largest wholesaler, Novi eBusiness Limited (Novi), and fifth-largest supplier, API Trading Company Limited (API), was insufficient. During the due diligence process, despite discovering multiple warning signs suggesting that Novi and API might be controlled by Publicca (contrary to Publicca's claims that they were independent third parties), RaffAello failed to conduct reasonable due diligence to verify their independence.
Notably, RaffAello did not adequately investigate the following matters: Novi and API were former subsidiaries of companies controlled by a shareholder holding 15% of Publicca's shares; both Novi and API were purchased from their former owners around the same time at the request and prompting of Mr. Leung Sai Wai, Publicca's founder, chairman, and CEO; Novi's new owner collaborated with two mainland Chinese companies to sell Publicca products purchased by Novi, and an individual who was both the founder of one mainland Chinese company and a supervisor of another company was simultaneously authorized by Mr. Leung to collect payments from multiple suppliers of Publicca goods; the owners of both Novi and API were involved in making successive large purchases of handbags using credit cards at different Publicca retail stores.
RaffAello also failed to conduct reasonable due diligence to determine whether API was a company with substantial business activities. The Appeals Tribunal found that RaffAello did not adequately and proactively address concerns raised by the transaction team regarding API's actual business model based on their findings. Specifically, the transaction team discovered that API obtained product supplies from Publicca's existing supplier (Long Yiu Leather Factory) and then resold the products to Publicca. The products supplied to Publicca increased dramatically from HK$41,000 in the year ending 2016 (when Long Yiu Leather Factory was a direct supplier) to HK$3.18 million in the year ending 2017 (when Long Yiu Leather Factory supplied products to Publicca through API).
Given the severity of RaffAello's deficiencies, the SFC originally proposed a fine of HK$13 million for RaffAello but accepted a reduction to HK$4 million considering the firm's financial difficulties. The Appeals Tribunal agreed that an excessive fine could lead to RaffAello's liquidation, potentially harming its existing clients. The tribunal also ruled that the fine amount determined by the SFC best served the principles of justice in this case.
The Appeals Tribunal further elaborated that when sponsors become aware of any circumstances that might call into question the information provided to them or indicate potential problems or risks, they have a responsibility to conduct additional due diligence. The tribunal stated that if sponsors identify matters of concern, they cannot merely investigate, hastily record relevant facts (if any records are made), and then ignore them. During the due diligence process, if sponsors identify any concerns, they should maintain systematic records of the circumstances discovered and matters resolved.
If RaffAello had concerns about any warning signs and believed that the reporting accountants could help address these concerns, RaffAello had the responsibility to consult on such signs. Regarding these situations, the tribunal stated that without consulting on specific concerns, RaffAello's transaction team had no reasonable basis to comprehensively assume that the reporting accountants would necessarily be able to independently discover and examine the same issues they found and similarly conclude that these issues were not of concern.