Hong Kong Stock Watchdog Slaps 4 Major Banks for Shoddy Work
Hong Kong's securities regulator has fined Morgan Stanley, Merrill Lynch, UBS and Standard Chartered for lack of fact checking and due diligence in preparing stock offerings for now-liquidated China Forestry and still-suspended Tianhe Chemicals.
By ALEX FREW MCMILLAN
Mar 15, 2019 | 11:30 AM EDT
Stocks quotes in this article: UBS, MS, BAC, SCBFF
Hong Kong's securities watchdog has punished four of the world's largest investment banks for not doing their jobs properly when arranging stock offerings in the city.
The Hong Kong Securities and Futures Commission (SFC) has fined and punished UBS (UBS) , Morgan Stanley (MS) , Bank of America's (BAC) Merrill Lynch unit and Standard Chartered (SCBFF) for their roles as sponsors underwriting new listings on the Hong Kong Stock Exchange.
Specifically, it outlined a litany of faults concerning a lack of fact checking and due diligence in preparing the stock offerings of the logging company China Forestry Holdings in 2009 and chemicals manufacturer Tianhe Chemicals Group in 2014. One company collapsed; the other's stock has been suspended for a few years.
While it's great that the SFC is taking such action, it remains an excellent question why such dubious companies were allowed to list in Hong Kong in the first place. And it's an even better question why the for-profit company that runs the stock exchange and futures exchange in Hong Kong has successfully pushed for changes in Hong Kong's listing rules that allow even dodgier companies to go public here.
But back to these fines.
China Forestry's shares were suspended 14 months after its 2009 public offering, which raised US$216 million. The move came after its auditor, KPMG, uncovered "irregularities," which led the Hong Kong regulators to charge its then-chairman, Li Kwok Cheong, and CEO, Li Han Chun, with fraud and running a secret second set of books. The company was delisted in 2017 and liquidated.
Tianhe Chemicals shares have been suspended from trading since 2015, first by the company and then in 2017 by the regulator. Soon after listing in 2014, it found itself under attack by short sellers from the hacking collective Anonymous, which claimed Tianhe had overstated profits and disguised companies that were related to it as its customers. Tianhe denied those allegations.
The Hong Kong regulators levied the heaviest punishment on UBS and its Hong Kong arm, fining them HK$375 million (US$48 million) for failing their duties in the listing applications of China Forestry Holdings, Tianhe Chemicals Group and another company it did not identify because it's part of an ongoing investigation.
The third company is China Metal Recycling, a now-defunct scrap merchant, according to Reuters.
The regulator also partially suspended the license of UBS Securities Hong Kong for one year, barring it from advising on corporate finance, meaning it can't participate in the offerings of any securities. That's the first time a major bank has been barred from offering securities in the city.
The SFC also fined Morgan Stanley Asia HK$224 million (US$29 million) and Merrill Lynch Far East HK$128 million (US$16 million) for their part in the Tianhe Chemicals listing. They and UBS ran the books for that initial public offering (IPO) together.
The SFC fined the Hong Kong arm of Standard Chartered Securities HK$60 million (US$8 million) for its part in the China Forestry listing. UBS and Standard Chartered organized that together.
Sad but comical reading
The SFC's explanations behind the fines are worth a read. They're quite comical, as long as you weren't involved as an investor in any of the companies. And if you were, maybe all you can do is laugh anyway.
With Tianhe Chemicals, UBS, Morgan Stanley and Merrill Lynch talked to 10 of Tianhe's "customers," although they only met four of those customers at their company premises. The banks took Tianhe's word for it when the company said some of the customers could only talk over the phone or had refused to talk at their own company.
UBS, Morgan Stanley and Merrill asked to interview Tianhe's largest customer at its office. But the investment banks swallowed Tianhe's line that since there was a big anti-corruption crackdown in China, this customer at a massive state-owned enterprise would turn down any visit to its premises from a third party.
The mysterious 'Customer X'
So the investment banks interviewed "Customer X" at Tianhe's office. At the end of the chat, "Customer X" refused to hand over a business card -- the first thing everyone does in any meeting in Asia -- and then refused to produce any proof of identity before storming out of the room. He claimed he wouldn't have agreed to an interview under his own company's internal procedures and only came as a favor to the family of Tianhe's CEO.
Anyway, the investment banks never checked out who "Customer X" actually was. They weren't too clear about the other customers they spoke to, either.
In the rest of their interviews, the investment banks were trying to check on the business that customers had with the Tianhe subsidiary Jinzhou DPF-TH Chemicals. But when these customers were asked which part of the Tianhe Group they did business with, only three confirmed they had any dealings with Jinzhou DPF-TH Chemicals.
One customer said he was dealing with another company that actually belonged to the CEO of the Tianhe Group but was a private company that wasn't part of the group at all.
Not seeing the forest for the trees
As for China Forestry, it claimed to own 171,800 hectares of forests in Yunnan and Sichuan provinces in China. But neither UBS nor Standard Chartered did a proper job of checking whether that was true.
UBS never visited any of the forests after it came on board as a sponsor for the listing in 2009. It said it had visited some of the forests in 2008 when it was acting as a bookrunner for the potential listing, but it couldn't produce any inspection records for the SFC or say exactly where in the woods it went.
Standard Chartered did at least go and visit China Forestry's holdings in both Sichuan and Yunnan in both 2007 and 2008. But it didn't check out whether the locations matched what China Forestry was claiming.
UBS and Standard Chartered both said lawyers and forestry experts had done site inspections. But it turned out none of those experts had been told to check out whether the forests belonged to China Forestry or were as big as it claimed.
The investment banks also relied on paperwork supplied by China Forestry itself to "prove" that it had legal rights to the forests, that the relevant Chinese government bureaus had approved its logging, and that it had the proper insurance.
The banks didn't detect anomalies such as a mismatch between what China Forestry was calling one forest in its prospectus yet gave a different name for that forest on the certificate.
No post-quake inspection
China Forestry claimed it had bought 150,000 hectares, more than 90% of its forests, in Yunnan Province in 2008. There was a huge earthquake in Yunnan in July 2009, but neither UBS nor Standard Chartered ever went there after the quake or asked for any assessment of the impact of the earthquake on the company's holdings.
The two banks had planned to go and check out some of China Forestry's biggest customers in Yunnan, but they cancelled those visits after the earthquake. So they only did interviews on the phone -- and only called numbers provided by China Forestry itself without checking out who those "customers" actually were.
I'd say job well done with the SFC for rooting out all these problems -- were it not for the sneaking suspicion that this goes on all the time, with all kinds of listings.
These two companies simply ran into problems that blew up publically and were too big for the stock watchdog to ignore.
At the time of publication, McMlillan had no positions in the stocks mentioned.
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