Alert - Directors and Auditors YTL LLP

SFC and AFRC have joined forces to combat companies channelling funds to third parties in dubious circumstances

Introduction

On 13 July 2023, the Securities and Futures Commission (SFC) and the Accounting and Financial Reporting Council (AFRC) issued a joint statement in relation to loans, advances, prepayments and similar arrangements made by listed issuers.

The cooperation between regulators is aimed at promoting market discipline and standards of conduct. The joint statement stipulates the regulators’ observations on (i) listed companies granting dubious loans; (ii) expected conduct standards and practices that listed issuers, their directors, audit committees and auditors; and (iii) potential consequences for failures for listed companies and auditors.

There has been an increase in cases of suspected misconduct involving listed issuers channelling a company’s funds to third parties in dubious circumstances, by way of, among others, advances, prepayments, deposits or by some other label. The recipients of the funds may be related to or associated with the listed issuer, its shareholders or its management.

Some of the hallmarks of dubious loans and related practices identified during investigations:

Lack of commercial rationale
Insufficient risk assessments, due diligence and documentation
Inadequate internal controls

Expected standards

Directors of listed companies

Directors should ensure that loans are subjected to effective vetting, risk assessments and due diligence processes, and proper approval.
Listed companies and their management should:
- Act in good faith, and in the best interest of the company, and exercise due care and diligence when evaluation, proposing and approving loans;
- Establish and maintain appropriate and effective internal controls for assessing and managing credit risks;
- Engage a competent person to carry out credit assessment;
- Maintain proper documentations;
- Establish procedures for identifying and reporting issues to board of directors;
- Particular attention to granting of loans to related parties;
- Disclosure in the financial statements regarding nature of relationship, terms of the collateral or guarantees;
Board of directors should:
- Not rely solely on management’s representation, but to take reasonable steps to ensure that the company’s risk management and internal control systems are effective;
- Invite auditors to attend board meetings at which significant matters arising from the audit.

Audit committees

Should:
- ensure company has appropriate and effective internal controls.
- maintain dialogue with auditors

Auditors

In performing audit procedures on loans of a dubious nature, the auditor is expected to:

consider the need to attribute a higher risk of material misstatement due to fraud or other irregularities;
obtain evidence of company’s internal controls;
design and perform audit procedures responsive to assessed risks of material misstatement due to fraud or other irregularities;
maintain professional skepticism;
evaluate accounting policies adopted;
maintain effective communications with audit committee.

Potential consequences for failures of listed companies:

Criminal liability:
- section 298 of the Securities and Futures Ordinance, provides that it is an offence for a person to disclose or be concerned in the disclosure of false or misleading information which is likely to induce transactions in securities, knowing or being reckless as to whether the information is false or misleading
- section 384 of the SFO, imposes criminal liability on any person who knowingly or recklessly provides any information which is false or misleading to the SFC or the HKEx

Civil liability:
- section 214 of the SFO provides that the SFC may commence civil actions against wrongdoing directors or persons involved in the management of the listed company who are involved in granting or managing the business of the company in relation to dubious loans and seek orders for disqualification and compensation.

Potential consequences for failures of public interest entity (PIE) auditors and registered responsible persons:

Deficiencies in audit procedures performed by a public interest entity auditor and a registered responsible person on dubious loans of a listed company could constitute misconduct under Accounting and Financial Reporting Council Ordinance (AFRCO).
AFRC may impose sanctions in respect of a PIE auditor and a registered person pursuant to the power granted under AFRCO.
AFRC can revoke, suspend or prohibit the auditor from applying for registration or recognition as a PIE auditor; or remove a person’s name from the list of registered responsible persons of the PIE auditor.

Takeaways

In today’s increasingly complex business landscape, the potential for legal claims arising from misleading information can pose significant risks for directors and auditors.

Our team specializes in advising clients on issues related to corporate governance, compliance, and risk management. We offer tailored legal solutions that address the unique challenges faced by directors and auditors in maintaining the integrity of financial and non-financial information provided to stakeholders.

To learn more about our services and how we can assist in mitigating potential exposures, please contact us.

Alfred Leung, Partner (alfredleung@hkytl.com; 852 3468 7202)