The Boundaries of Sponsor Legal Liability During Prospectus Drafting: A Practical Guide

The Boundaries of Sponsor Legal Liability During Prospectus Drafting: A Practical Guide

The SFC’s December 2024 consultation on proposed amendments to the Code of Conduct for Persons Licensed by or Registered with the SFC (the “Code of Conduct”) has placed sponsor liability during the prospectus drafting phase under unprecedented scrutiny. The consultation paper, which closed for public comment on 28 February 2025, proposes to codify the principle that a sponsor’s duty of care extends beyond the final prospectus to encompass all material written communications with the Listing Division of HKEX during the vetting process. This shift, if enacted, would align Hong Kong’s sponsor regime more closely with the UK’s Prospectus Regulation Rules and the US SEC’s Rule 10b-5 liability framework, where draft documents carry legal weight. For sponsors holding SFC Type 6 (advising on corporate finance) and Type 6A (sponsor) licences, the practical implications are immediate: internal compliance procedures must now treat every draft submitted to HKEX as a potentially discoverable document in enforcement proceedings. The SFC’s 2023 enforcement record, which saw 14 sponsor-related disciplinary actions with aggregate fines of HKD 87.3 million, underscores the regulator’s willingness to pursue liability through the entire listing process, not merely the final offering document.

The Legal Framework: Where Drafting Meets Liability

The statutory foundation for sponsor liability during prospectus drafting is not a single rule but a layered structure of primary legislation, subsidiary legislation, and regulatory codes. The Securities and Futures Ordinance (Cap. 571) (“SFO”) provides the overarching framework through section 213, which empowers the Court of First Instance to grant injunctions and other remedial orders for market misconduct, including misstatements in prospectuses. Section 277 of the SFO creates criminal liability for any person who makes a false or misleading statement in a prospectus, with penalties of up to HKD 10 million and imprisonment for 10 years. However, the more relevant provision for sponsors is section 108 of the SFO, which imposes civil liability on every person who authorises the issue of a prospectus containing an untrue statement. The SFC has consistently interpreted “authorises the issue” to include the sponsor’s role in preparing and submitting draft prospectuses to HKEX.

The HKEX Listing Rules, specifically Rule 3A.02 and Rule 3A.03, impose the primary obligation on sponsors to conduct reasonable due diligence and to ensure that the information in the listing document is accurate and complete. The Guidance Letter HKEX-GL85-16, issued in August 2016 and updated in December 2023, explicitly states that the sponsor’s due diligence obligations apply “from the commencement of the listing application process through to the listing of the applicant’s securities.” This temporal scope is critical: it means that draft prospectuses submitted to HKEX at the A1 filing stage are subject to the same standard of care as the final document.

The SFC’s Code of Conduct, particularly paragraph 17.1 and the Sponsor Provisions in Schedule 9, sets out the specific due diligence standards. Paragraph 17.1(b) requires a sponsor to “exercise reasonable care and skill in the performance of its duties” and to “take all reasonable steps to ensure that the listing document is accurate and complete in all material respects.” The SFC’s December 2024 consultation proposes to add a new paragraph 17.1A, which would explicitly state that this duty extends to “all material written communications with the Exchange during the vetting process, including draft listing documents, responses to comments, and supplementary information.”

The Role of the “Due Diligence Defence”

The primary legal defence available to sponsors facing liability for prospectus misstatements is the “due diligence defence” under section 108(2) of the SFO. This defence requires the sponsor to prove that it had reasonable grounds to believe, and did believe up to the time of the prospectus’s issue, that the statement was true and not misleading. The burden of proof is on the sponsor, not the regulator. In practice, this means that a sponsor must maintain a complete and contemporaneous record of its due diligence work, including all drafts, comments, and responses.

The SFC’s enforcement actions against sponsors in 2022-2024 reveal a pattern: the regulator examines not just the final prospectus but the entire drafting history to assess whether the sponsor exercised reasonable care. In the SFC’s disciplinary action against ABCI Securities Company Limited in March 2023, the SFC cited the sponsor’s failure to properly document its due diligence on the applicant’s revenue recognition policies, even though the final prospectus contained accurate disclosures. The SFC’s reasoning was that the sponsor’s internal emails and draft comments showed a lack of understanding of the applicant’s business model, which the SFC characterised as a failure to exercise reasonable care during the drafting phase.

Practical Scenarios: Where Liability Attaches in the Drafting Process

Sponsors face heightened liability risk at three distinct stages of the prospectus drafting process: the initial A1 filing, the response to HKEX comments, and the finalisation of the prospectus for the hearing. Each stage presents different factual scenarios where a sponsor’s conduct can give rise to liability.

The A1 Filing: Scope of Representations

When a sponsor submits the A1 application to HKEX, it must include a draft prospectus that is “substantially complete” under HKEX Listing Rule 9.10A(1). The Guidance Letter HKEX-GL82-15 states that a substantially complete prospectus must contain all material information that a reasonable investor would require to make an informed investment decision. The sponsor’s certification under Rule 3A.02 that it has conducted reasonable due diligence attaches to this draft. If the A1 draft contains material misstatements or omissions, the sponsor cannot later argue that these were “preliminary” or “subject to revision.” The SFC’s position, as articulated in its 2023 enforcement report, is that the A1 draft represents the sponsor’s best assessment of the applicant’s business and financial condition at that time.

The practical implication is that sponsors must apply the same due diligence standard to the A1 draft as to the final prospectus. This means completing financial due diligence, legal due diligence, and business due diligence before the A1 filing, not after. In the SFC’s disciplinary action against Guotai Junan Securities (Hong Kong) Limited in September 2023, the SFC found that the sponsor had failed to verify key financial data in the A1 draft, including revenue recognition for a major customer contract that was later found to be non-existent. The SFC imposed a fine of HKD 12.8 million and suspended the sponsor’s licence for six months.

Responding to HKEX Comments: The Duty of Candour

The HKEX vetting process typically involves multiple rounds of comments and responses. The sponsor’s responses to HKEX comments are material written communications that fall within the proposed scope of paragraph 17.1A of the Code of Conduct. The duty of candour requires the sponsor to disclose all material information that is relevant to the HKEX’s review, even if that information is adverse to the applicant’s listing application. In the SFC’s enforcement action against Haitong International Securities Company Limited in June 2022, the SFC found that the sponsor had failed to disclose to HKEX that the applicant had engaged in related party transactions that were not properly disclosed in the draft prospectus. The SFC characterised this as a breach of the sponsor’s duty to “act in an honest and fair manner” under paragraph 17.1 of the Code of Conduct.

The sponsor’s internal compliance procedures must therefore ensure that all responses to HKEX comments are reviewed by a qualified compliance officer before submission. The responses should be accurate, complete, and consistent with the sponsor’s due diligence workpapers. Any material change in the applicant’s business or financial condition between the A1 filing and the hearing must be promptly disclosed to HKEX.

Finalisation for Hearing: The Last Mile

The period between the submission of the final prospectus and the listing hearing is the most critical for sponsor liability. The sponsor must certify under Rule 3A.02 that the prospectus contains all material information and that the sponsor has conducted reasonable due diligence. This certification is a statement of fact, not a statement of opinion. If the sponsor later discovers that the prospectus contains a material misstatement, it must immediately inform HKEX and the SFC. Failure to do so can result in liability for market misconduct under section 277 of the SFO.

In the SFC’s enforcement action against UBS AG and UBS Securities Hong Kong Limited in March 2024, the SFC found that the sponsors had failed to disclose to HKEX that the applicant had misrepresented its revenue from a key customer. The SFC imposed a record fine of HKD 375 million and suspended the sponsors’ licences for 12 months. The SFC’s decision emphasised that the sponsors had multiple opportunities to correct the misstatement during the drafting process but failed to do so.

Regulatory Developments: The 2024-2025 Consultation and Beyond

The SFC’s December 2024 consultation on the Code of Conduct represents the most significant regulatory development for sponsor liability since the introduction of the Sponsor Provisions in October 2013. The consultation proposes three key changes that directly affect sponsor liability during prospectus drafting.

Codification of Draft Document Liability

The proposed new paragraph 17.1A of the Code of Conduct would explicitly extend the sponsor’s duty of care to “all material written communications with the Exchange during the vetting process.” This codification would eliminate any ambiguity about whether draft prospectuses and responses to HKEX comments are subject to the same standard of care as the final prospectus. The SFC’s consultation paper states that this change is intended to “clarify the existing legal position” and to “ensure consistency with international standards.”

The practical effect is that sponsors can no longer argue that draft documents are “preliminary” or “subject to revision.” Every draft submitted to HKEX must be treated as a final document for the purposes of due diligence. This means that sponsors must implement internal procedures to ensure that all drafts are reviewed by a qualified compliance officer before submission.

Enhanced Due Diligence Requirements

The consultation also proposes to amend paragraph 17.1(c) of the Code of Conduct to require sponsors to “conduct reasonable due diligence on all material aspects of the listing applicant’s business, including its business model, financial condition, and management.” This change is intended to address the SFC’s concern that some sponsors have been conducting “tick-box” due diligence that does not adequately assess the applicant’s business risks.

The proposed amendment would require sponsors to go beyond the applicant’s financial statements and to verify the applicant’s revenue recognition policies, customer contracts, and supply chain relationships. In the SFC’s enforcement actions against sponsors in 2022-2024, the SFC identified a pattern of sponsors relying on management representations without independent verification. The proposed amendment would make it clear that such reliance is not sufficient to satisfy the sponsor’s due diligence obligations.

Increased Disclosure Obligations

The consultation proposes to amend the Sponsor Provisions in Schedule 9 of the Code of Conduct to require sponsors to disclose in the prospectus any material issues that arose during the due diligence process, including any disagreements with the applicant’s management. This change is intended to increase transparency and to allow investors to assess the quality of the sponsor’s due diligence.

The practical implication is that sponsors must document all material issues that arise during the drafting process, including any concerns about the applicant’s business model, financial condition, or management. If the sponsor identifies a material issue that is not resolved to its satisfaction, it must either withdraw from the engagement or disclose the issue in the prospectus.

Practical Compliance Measures for Sponsors

Given the current regulatory environment, sponsors must implement robust compliance measures to protect themselves from liability during the prospectus drafting process. These measures should address the three stages of the drafting process and the specific liability risks at each stage.

Pre-A1 Filing Due Diligence

Before submitting the A1 application, the sponsor must complete a comprehensive due diligence process that covers all material aspects of the applicant’s business. This due diligence should be documented in a detailed due diligence plan that is approved by the sponsor’s compliance officer. The due diligence workpapers should include:

• A business model analysis that identifies the applicant’s key revenue drivers, customer concentration, and supply chain risks.
• Financial due diligence that verifies the applicant’s revenue recognition policies, accounts receivable, and inventory.
• Legal due diligence that reviews the applicant’s corporate structure, contracts, and regulatory compliance.
• Management due diligence that assesses the integrity and competence of the applicant’s senior management.

The sponsor should also conduct a “red flag” review that identifies any material issues that could affect the applicant’s listing application. If the sponsor identifies a red flag, it must either resolve the issue before the A1 filing or disclose it to HKEX.

Draft Review and Approval Process

The sponsor must implement a formal draft review and approval process that ensures that all drafts submitted to HKEX are accurate and complete. This process should include:

• A review by a qualified compliance officer who is independent of the transaction team.
• A verification of all material facts and figures in the draft.
• A comparison of the draft with the sponsor’s due diligence workpapers.
• A sign-off by the sponsor’s senior management before the draft is submitted to HKEX.

The sponsor should also maintain a complete record of all drafts and comments, including the rationale for any changes made to the draft. This record will be critical if the SFC later investigates the sponsor’s conduct.

Post-Filing Monitoring and Disclosure

After the A1 filing, the sponsor must continue to monitor the applicant’s business and financial condition for any material changes. If the sponsor becomes aware of a material change, it must immediately inform HKEX and the SFC. The sponsor should also review all responses to HKEX comments to ensure that they are accurate and complete.

The sponsor’s compliance officer should be involved in all material communications with HKEX, including the preparation of responses to comments. The sponsor should also maintain a log of all communications with HKEX, including the date, time, and content of each communication.

Actionable Takeaways

• Treat every draft as a final document: The SFC’s proposed codification of draft document liability means that sponsors must apply the same due diligence standard to A1 drafts and responses to HKEX comments as to the final prospectus, with no margin for “preliminary” representations.
• Implement a pre-filing due diligence checklist: Before any A1 submission, complete financial, legal, and business due diligence that is documented in a compliance-approved plan, and resolve all material “red flags” before filing.
• Establish a formal draft review process: Require that every draft submitted to HKEX be reviewed by an independent compliance officer, with all material facts verified against workpapers and senior management sign-off obtained.
• Maintain a complete communications log: Record all material written communications with HKEX, including the rationale for changes to drafts, to create a contemporaneous record that supports the due diligence defence under section 108(2) of the SFO.
• Monitor post-filing changes continuously: After the A1 filing, actively monitor the applicant’s business for material changes and promptly disclose any adverse developments to HKEX and the SFC, as failure to do so can trigger liability under section 277 of the SFO.