Methodology and Depth of Intellectual Property Verification in Sponsor Due Diligence

The SFC’s December 2024 circular on sponsor due diligence in technology-driven IPOs has sharpened the focus on intellectual property verification, moving it from a peripheral checklist item to a core liability risk for lead sponsors. The circular, which followed the Commission’s review of 15 sponsor-led IPO applications between 2022 and 2024, explicitly cited inadequate IP due diligence as a contributing factor in two enforcement cases where sponsors were sanctioned under the Code of Conduct for Persons Licensed by or Registered with the SFC (the Code), specifically paragraph 17 of Schedule 1. The market context is clear: the HKEX’s Main Board has seen a 32% year-on-year increase in biotech and hard-tech listings in H1 2025, with aggregate proceeds of HKD 48.2 billion, according to exchange data. These issuers typically carry patent portfolios, trade secrets, and licensing arrangements that form the bedrock of their valuation. A sponsor’s failure to verify the legal status, ownership chain, and commercial enforceability of these assets now carries direct disciplinary consequences, including fines of up to HKD 10 million per breach under Section 213 of the Securities and Futures Ordinance (SFO). This article examines the specific methodologies and depth requirements that sponsors must apply to IP verification, drawing on regulatory guidance and market practice as of Q3 2025.

The Regulatory Baseline: From Checklist to Forensic Standard

The SFC’s Explicit Requirements Under the Code of Conduct

The SFC’s 2024 circular did not introduce new rules but instead clarified the existing standard under paragraph 17 of the Code, which requires sponsors to exercise “due diligence to a standard that is reasonable in all the circumstances.” The circular’s annex lists eight specific areas where IP verification has been found deficient, including failure to confirm the legal ownership of patents listed in the prospectus and failure to assess the materiality of pending patent applications. The Commission’s position is that a sponsor must independently verify the legal status of each material patent with the relevant patent office, not rely solely on issuer-provided patent landscape reports. This means direct searches on the PRC National Intellectual Property Administration (CNIPA) database, the US Patent and Trademark Office (USPTO) database, or the Hong Kong Intellectual Property Department’s registry, as applicable. The circular cites a specific case where a sponsor accepted a third-party patent search report without cross-checking the legal status of the patents against the issuing authority’s online register, resulting in a failure to identify that two of the issuer’s five core patents had lapsed due to non-payment of renewal fees. The SFC’s enforcement division subsequently imposed a fine of HKD 4.5 million on the sponsor firm and a 12-month suspension on the responsible principal.

The HKEX’s Listing Decision Framework and IP Disclosure

The HKEX’s Listing Decision LD143-2024, published in November 2024, provides a complementary framework. The decision addressed an issuer in the semiconductor sector whose prospectus claimed ownership of 12 patents, but where the sponsor’s verification only covered the 8 patents granted in the PRC. The remaining 4 patents were filed in the US and Taiwan, and the sponsor had not verified their legal status with the respective patent offices. The HKEX’s Listing Committee, in its decision, required the sponsor to re-verify all 12 patents and to include a specific risk factor in the prospectus stating that the issuer’s patent portfolio was subject to the laws and enforcement practices of multiple jurisdictions. The decision also established a precedent: any patent that accounts for more than 5% of the issuer’s projected revenue, as disclosed in the profit forecast or business model section of the prospectus, must be subject to independent legal verification by a qualified patent attorney in the jurisdiction of filing. This threshold is now widely adopted by sponsors as a materiality benchmark for IP verification scope.

Methodology: A Three-Tier Verification Architecture

Tier 1 – Legal Status and Chain of Title Verification

The first tier of IP verification requires the sponsor to obtain a direct electronic search result from the relevant patent or trademark office for each material IP asset. For PRC patents, this means a CNIPA patent register search that shows the current legal status (granted, pending, lapsed, or invalidated), the applicant, the inventor, the priority date, and any recorded assignments or licenses. The search must be conducted within 30 business days of the date of the prospectus, as the SFC’s circular notes that patent status can change rapidly, particularly in jurisdictions with expedited examination procedures. For patents filed in Hong Kong, the search must be conducted on the Intellectual Property Department’s e-Search system, which provides a certified extract for HKD 150 per patent. The sponsor must also verify the chain of title from the inventor to the issuer. This requires reviewing assignment agreements, employment contracts with IP assignment clauses, and any joint development agreements that may create co-ownership rights. The SFC’s enforcement case from 2023, where a sponsor failed to identify that a key patent was co-owned with a PRC university, resulted in a public reprimand and a fine of HKD 2.8 million under Section 194 of the SFO. The sponsor’s verification must confirm that the issuer has the exclusive right to exploit the patent in all material commercial territories, not just the jurisdiction of grant.

Tier 2 – Freedom-to-Operate and Infringement Risk Assessment

The second tier addresses the issuer’s freedom to operate (FTO) in its target markets. The SFC’s circular specifically requires sponsors to assess whether the issuer’s products or processes infringe third-party IP rights that are not owned by the issuer. This is not a general market risk statement but a specific, document-based analysis. The sponsor must commission an FTO search from a qualified IP search firm covering the issuer’s core products, as defined by the revenue contribution in the prospectus. The search must cover patents and published patent applications in the PRC, the US, and the European Patent Office (EPO) for the relevant technology fields. The circular cites a case where an issuer in the medical device sector had not conducted an FTO search and subsequently faced a patent infringement lawsuit in the US District Court for the District of Delaware within six months of listing. The sponsor was found to have failed in its due diligence because it had not identified that the issuer’s core product fell within the scope of a competitor’s patent that had been granted in the US three years earlier. The FTO report must include a legal opinion from a qualified patent attorney in each jurisdiction where the issuer has material operations or sales, addressing the likelihood of infringement and the potential damages exposure. The sponsor must also assess whether the issuer holds any indemnity or insurance policies that cover IP infringement claims, and whether those policies remain in force post-listing.

Tier 3 – Valuation and Commercial Dependency Analysis

The third tier requires the sponsor to link the IP portfolio to the issuer’s financial projections and valuation. This is the most demanding layer, as it moves beyond legal verification into commercial assessment. The sponsor must identify which specific patents or patent families are directly linked to the products or services that generate the revenue figures disclosed in the prospectus. For each such patent, the sponsor must assess the patent’s remaining term, the jurisdictions where it is in force, and the availability of substitute technology. The HKEX’s Guidance Letter GL94-18, as updated in January 2025, requires that any patent that accounts for more than 10% of the issuer’s projected revenue must be the subject of a separate valuation report prepared by an independent valuer. The sponsor must review this valuation report and assess whether the assumptions regarding the patent’s remaining economic life, the market size for the patented technology, and the royalty rates used are reasonable. The SFC’s 2024 circular adds that the sponsor must also assess the issuer’s dependency on in-licensed technology. If the issuer licenses a material patent from a third party, the sponsor must review the license agreement, confirm that the license is exclusive or non-exclusive as stated, and assess the risk of termination or non-renewal. The circular notes that in one case, an issuer’s entire revenue stream was dependent on a license agreement that could be terminated by the licensor on 90 days’ notice, a risk that the sponsor had not disclosed in the prospectus.

Practical Challenges and Common Deficiencies in IP Verification

Cross-Jurisdictional Verification and Language Barriers

A recurring deficiency in sponsor due diligence is the failure to verify IP assets across multiple jurisdictions with consistent methodology. The SFC’s review found that sponsors often apply a higher standard of verification to PRC patents than to US or European patents, or vice versa, depending on the sponsor’s own jurisdictional expertise. The circular requires that the same standard of independent verification be applied to all material patents, regardless of jurisdiction. This creates practical challenges. For example, the CNIPA database provides search results in Chinese only, and the sponsor must engage a translator or a PRC-qualified patent agent to interpret the results. The cost of a full CNIPA patent status search for a portfolio of 20 patents, including certified copies, is approximately HKD 15,000 to HKD 25,000 per search, depending on the complexity of the chain of title. For US patents, the USPTO’s Patent Center provides free search but requires the sponsor to understand the US patent numbering system and the distinction between granted patents and published applications. The sponsor must also verify the maintenance fee payment status for US patents, as failure to pay maintenance fees can result in the patent lapsing, a fact that is not always immediately visible on the USPTO’s public search interface. The sponsor’s internal compliance manual should specify the exact search procedures for each jurisdiction and require the search results to be saved as PDF files with a timestamp.

Verification of Trade Secrets and Know-How

Trade secrets and know-how present a unique verification challenge because they have no public register. The SFC’s circular acknowledges this and requires sponsors to adopt a different methodology for trade secrets. The sponsor must review the issuer’s internal policies for protecting trade secrets, including confidentiality agreements with employees and contractors, physical and digital access controls, and the issuer’s procedures for identifying and documenting trade secrets. The sponsor must also assess whether the issuer has taken reasonable steps to maintain the secrecy of the information, as a trade secret that is not protected by reasonable measures may lose its legal status as a trade secret under PRC law, specifically Article 9 of the Anti-Unfair Competition Law. The circular cites a case where an issuer claimed that its manufacturing process was a trade secret, but the sponsor’s due diligence revealed that the process was described in detail in a publicly available academic paper co-authored by the issuer’s founder. The sponsor was required to disclose this fact in the prospectus and to reassess the issuer’s valuation, as the trade secret was no longer secret. For trade secrets, the sponsor’s verification is necessarily more qualitative than quantitative, but the circular requires the sponsor to document its assessment in a written memorandum that addresses each of the criteria for trade secret protection under the relevant law.

The Role of Independent Experts and Their Limitations

The SFC’s circular encourages sponsors to engage independent IP experts, particularly for complex technology fields such as biotechnology, pharmaceuticals, and semiconductor design. However, the circular also makes clear that engaging an expert does not relieve the sponsor of its own due diligence obligations. The sponsor must review the expert’s qualifications, assess the scope of the expert’s work, and verify the expert’s independence from the issuer. The circular cites a case where a sponsor engaged an IP expert who had previously provided patent prosecution services to the issuer, creating a conflict of interest that the sponsor had not identified. The SFC held that the sponsor had failed in its duty to ensure the expert’s independence, as required by paragraph 17.3 of the Code. The sponsor must also ensure that the expert’s report covers all material IP assets and that the expert’s conclusions are consistent with the sponsor’s own independent verification. If the expert’s report identifies a material risk, such as a pending patent opposition or a potential infringement claim, the sponsor must assess that risk and disclose it in the prospectus. The cost of engaging a qualified IP expert for a full portfolio review, including FTO analysis and valuation, typically ranges from HKD 200,000 to HKD 500,000 for a mid-size technology issuer, depending on the number of patents and the number of jurisdictions involved.

Actionable Takeaways for Sponsors

• Establish a written IP verification policy that specifies the materiality threshold for independent patent office searches, the required search procedures for each jurisdiction, and the documentation standards for trade secret verification, and ensure this policy is reviewed by the sponsor’s compliance officer at least annually.
• For each IPO mandate, commission a legal status search from the relevant patent office for every patent that accounts for more than 5% of the issuer’s projected revenue, and obtain a certified extract or a timestamped PDF of the search result within 30 business days of the prospectus date.
• Engage an independent IP expert to conduct a freedom-to-operate analysis for the issuer’s core products in the PRC, the US, and the EPO, and require the expert to provide a legal opinion on infringement risk and damages exposure in each jurisdiction.
• Review all in-license agreements for material patents and assess the risk of termination, non-renewal, or renegotiation, and require the issuer to disclose any license agreement that can be terminated on less than 12 months’ notice in the prospectus risk factors.
• Document all IP verification steps in a due diligence memorandum that includes the search results, the expert reports, the sponsor’s own assessment of each material IP asset, and the rationale for any decisions not to disclose a particular risk, as this memorandum will be the primary evidence in any subsequent SFC investigation.