Introduction

The SFC reprimanded and fined Citigroup Global Markets Asia Limited (Citi) HK$57 million for failings in performance of its duties as sponsor of the listing application of Real Gold Mining Limited (Real Gold), as set out in the SFC’s Statement of Disciplinary Action published on 17 May 2018.

Background

Real Gold’s listing application was submitted to the Hong Kong Stock Exchange on 26 May 2008 and re-submitted on 31 December 2008, more than six months after its initial application submission. At the company’s request, trading in Real Gold’s shares was suspended from 27 May 2011.

The track record period was the three years ended 31 December 2007 and the ten months ended 31 October 2008 (Track Record Period).

Failure to conduct adequate and reasonable due diligence inquiries

Real Gold’s prospectus dated 10 February 2009 (Prospectus) disclosed that Real Gold owned 97.14% in Shirengou Gold Mine, the Nantaizi Gold Mine and the Luotuochang Gold Mine in Chifeng Municipality in Inner Mongolia, and specialised in gold mining and ore processing into concentrates with gold and other minerals for further sale. It also detailed that:

1. in 2007, only the Shirengou Gold Mine 50 tpd ore processing facility was in operation, while the commercial production at Nantaizi Gold Mine and the Luotuochang Gold Mine started in July and September 2008, respectively;

2. between the year ended 31 December 2007 and the 10 months ended 31 October 2008 (the last full year and the last 10 months of the Track Record Period, respectively), Real Gold’s sales increased by more than twenty times;

3. for the year ended 31 December 2007 and the 10 months ended 31 October 2008, sales to Real Gold’s top five customers represented 100% and 95.4% of total sales, respectively; and

4. Real Gold entered into a memorandum of long-term cooperation (MLC) with each of three customers who contributed to an aggregate of 35.2% of Real Gold’s sales for the 10 months ended 31 October 2008, pursuant to which the customers were obliged to purchase any amount of gold or zinc concentrates Real Gold decided to sell them.

The SFC found that Citi’s due diligence was inadequate. Information provided to Citi during its due diligence enquiries showed that Real Gold’s customers for the two periods were completely different, with one exception. There was no evidence that Citi had independently verified the identities and contact details of the customers’ representatives when it conducted customer interviews by telephone using numbers provided by Real Gold. It is also not clear whether internet background searches were conducted on Real Gold’s customers, and Citi only had a business licence record for one customer. Further, Citi did not request confirmation from customers as to the amounts involved in their transactions with Real Gold.

Confirmations obtained from Real Gold’s top 5 customers only confirmed that the customers had had “a business relationship” with the Company and/or its subsidiaries for more than 7 months, which was expected to continue. One of the three customers who allegedly had an MLC with Real Gold was not interviewed, and another one of the three was not asked about the MLC when interviewed. Citi did not verify the authenticity of the MLCs.

Citi justified its actions by stating that it had put primary emphasis on production-related due diligence based on an assessment of key risks. Production is considered a key risk area for early stage mining companies that produce a commodity with a ready market. Citi also explained that it considered verification of production to be comparable to sales verification. The SFC disagreed with this analysis finding that a company’s ability to sell the concentrates it produces from processing mined ore does not necessarily correlate with the existence of resources or reserves.

The Prospectus stated that “given that most of our revenue is derived from the sale of concentrates to our five largest customers, any adverse effect on their ability to purchase our concentrates will have a material adverse effect on our results of operations”.

The SFC considered that Citi’s approach to customer due diligence did not satisfy the relevant regulatory requirements.

Failure to supervise the transaction team

The most senior banker involved at the mandate and the kick-off and preparation stage was a managing director, rather than a sponsor principal involved in the due diligence on Real Gold’s assets and operations. The sponsor principal was appointed only four months after the kick-off meeting and was a director in another team of Citi’s investment banking division with no responsibility for listing applications. The sponsor principal was not involved in conducting due diligence or in correspondence with the Hong Kong Stock Exchange. She thought that her role was that of “signing responsible officer”, that she would only play a nominal role and that another person would perform the sponsor principal role. The sponsor principal was not aware that any key issues had been raised.

The due diligence on Real Gold’s customers was dealt with by Citi’s junior members without adequate supervision. Hence the due diligence issues raised above, such as no verification of the identity of the interviewees’ phone numbers during phone interviews, were a consequence of junior staff having little supervision from Citi’s senior staff.

The SFC therefore considered that Citi failed to properly supervise its staff as required by the Additional Fit and Proper Guidelines for Corporations and Authorized Financial Institutions applying or continuing to act as Sponsors and Compliance Advisers and failed to conduct reasonable due diligence inquiries.

In disciplining Citi, the SFC took into account that:

• this is the first and only listing application that has raised concerns as to the standard of Citi’s listing sponsor work;

• the breaches and deficiencies occurred only in relation to specific areas of the due diligence Citi conducted on Real Gold’s listing application;

• breaches and deficiencies identified were not found to be deliberate, intentional or reckless;

• Citi’s due diligence approach reasonably weighted production-related concerns over customer-related concerns, although the SFC does not consider this approach to be compliant with the regulatory requirements;

• Citi engaged its senior management and external counsel early on in order to address the SFC’s concerns;

• after Real Gold’s listing, Citi strengthened its internal controls and systems for its sponsor work; and

• Citi co-operated with the SFC fully to resolve its regulatory concerns.