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24 May, 2017
The Securities and Futures Commission (SFC) has issued a circular to financial advisers to provide guidance on its expectations as to their role when advising listed companies on corporate transactions (FA circular). The FA circular reminds financial advisers of their obligations under the Corporate Finance Adviser Code of Conduct (CFA Code) and provides specific guidance as to steps financial advisers should take to discharge their obligations. At the same time, the SFC issued a statement to valuers (liability statement) highlighting their potential liability for valuation reports and related information in disclosure documents published by listed issuers. The SFC warns that those who fail to follow the FA circular and liability statement are at greater risk of investigation and regulatory action.
These developments come amidst concerns expressed by the SFC over certain transactions by listed companies pricing acquisitions at unreasonably high levels or selling assets at an undervalue, which have resulted in losses for shareholders. Coupled with the FA circular and liability statement, the SFC has also issued a guidance note to directors of listed companies as to their duties in respect of corporate transactions.
In this bulletin we highlight the key implications of the FA circular and liability statement for financial advisers and valuers respectively. Please refer to our bulletin here for the key aspects of the guidance note for directors.
Financial advisers
The FA circular applies to financial advisers appointed to advise on valuations in corporate transactions. It is important to note that it covers a broad range of engagements where financial advisers advise listed companies and goes beyond engagements where the financial adviser is required to report on business or asset valuations based on discounted cash flows or projected profits, earnings or cash flows (under Rule 14.62(3) of the Listing Rules).
Mandate/engagement terms
The FA circular clarifies that the scope of any mandate for financial advisers should be sufficiently wide to enable a financial adviser to comply with the CFA Code. In the past, the SFC has observed that market practice has been to scope mandates narrowly. Now, mandates will need to be drafted to ensure compliance with all relevant aspects of the CFA Code.
Specifically, where the listed company is appointing a valuer, the mandate should specify that the financial adviser will undertake reasonableness tests on the experience and expertise of the experts to ensure that it is fair to rely on their work. In addition, save where certain categories of professionals (such as property valuers and legal advisers) are appointed, the mandate scope should require the financial adviser to review and discuss with their clients and the relevant expert, the qualifications, bases and assumptions that the expert has adopted.
Guidance where a valuer is appointed
Where the listed company appoints a valuer to produce a valuation report, the FA circular sets out a list of areas that financial advisers should check and be satisfied with.
Valuer's appointment – Financial advisers must be satisfied that the directors have properly considered the valuer's independence, qualifications, experience and available resources before making the appointment and that the scope of the mandate is appropriate. In practical terms, this will require financial advisers to conduct due diligence on the valuer and review the scope of the mandate in the context of the opinion to be given. Financial advisers will need to critically assess the mandate scope, and any qualifications, to ensure its coverage is sufficient and it that it will be reasonable for the directors to rely upon the report.
Reasonableness of forecasts – Financial advisers must ensure that the directors have critically reviewed the reasonableness of the financial forecasts, both in respect of those prepared internally and any provided by third parties (such as a vendor of an acquisition target). This will, in practice, require the financial adviser to discuss with the board the valuation methodologies, assumptions and qualifications upon which valuation report has been produced to ensure these are reasonable and that the directors are aware of any limitations to the report. Where any valuation methodologies, financial forecasts assumptions or qualifications do appear unreasonable, financial advisers must ensure that the directors have addressed these by making further due diligence enquiries to resolve the issues.
Guidance where no valuer is appointed
Where the directors of a listed company have decided not to appoint a valuer, the FA circular obliges financial advisers to advise the directors as to whether that decision is appropriate.
Financial advisers will need to assess and be satisfied that the decision not to appoint a valuer is reasonable. In reaching that conclusion, the financial advisers must have regard to:
(i) the directors' experience and expertise, both in respect of the asset or business being acquired or sold, and in forecasting profits and valuations;
(ii) whether the merits of the transaction can be assessed properly without professional advice or scrutiny; and
(iii) how material the transaction is relative to the listed company, the nature of the transaction and the risks and complexity involved.
If the directors have made their own financial forecast or valuation, financial advisers will need to test with them whether they can reasonably explain the assumptions, methodology, source and reliability of the financial forecast or valuation.
Where the directors are relying on a valuation or financial forecast prepared by a non-valuer, a similar due diligence exercise to that set out above for valuers will be required in respect of the person preparing the valuation or financial forecast.
Ceasing to act where appropriate
The FA circular provides guidance to financial advisers in situations where they are not satisfied that the valuation methodology adopted by listed company directors is reasonable or that the directors have made due and careful enquiry in arriving at their valuation. Financial advisers are required to use all reasonable endeavours to ensure that directors understand the regulatory requirements and the implications for non-compliance. This will include providing advice to the directors on the requirements under the SFC's new guidance note for directors referred to above and highlighting the risks of potential regulatory enforcement actions. In certain cases, financial advisers may need to cease to act where issues cannot be resolved.
Our practical tips for compliance
We encourage financial advisers to carefully review the FA circular and to assess its impact on their existing business practices. In particular, financial advisers should:
- review their engagement terms to ensure that they comply with the FA circular, particularly in respect of the scope of work;
- review their business processes and compliance procedures to ensure that each of the requirements in the guidance is addressed during an engagement. For instance, financial advisers should ensure they have protocols on the due diligence required on valuers and the steps to be taken when advising on a corporate finance transaction either with or without a separate valuer being engaged. This may including assessing existing policies and record keeping requirements; and
- ensure that all financial advisers are aware of these developments and provide training as necessary.
Valuers
The liability statement provides guidance to valuers on their potential liability for false or misleading information related to their valuation reports which may be contained in listed company publications. Listed companies often rely on, or include information from, valuation reports in shareholder publications, such as prospectuses, circulars or announcements and in financial statements. Where information in, or derived from, a valuation report is false or misleading, the valuer may face both criminal and civil liability for instance:
- civil or criminal liability for disclosure of false or misleading information inducing transactions under section 277 or 298 of the Securities and Futures Ordinance (SFO) (plus potential liability in connection with remedial or other orders under section 213 SFO proceedings); or
- civil liability to compensate investors for any untrue or misleading statements where a valuation is included in a prospectus with the consent of the valuer, under sections 40 and 243E of the Companies (Winding Up and Miscellaneous Provisions) Ordinance.
The liability statement sets out situations where the SFC is more likely to investigate the role of a valuer where there has been false or misleading disclosure. If it appears to the SFC that the valuer: (i) knew of ought to have known that the valuation or any underlying assumption was not reasonable and fair; (ii) made an obvious mistake; (iii) had not exercised the expected degree of skill and care, namely that ordinarily exercised by reasonably qualified members of the profession; or (iv) had lost independence or impartiality, the SFC is more likely to investigate a valuer's involvement.
The liability statement serves a warning to valuers that they may face regulatory investigation or civil suit if they fail to exercise the required skill and care or knowingly or recklessly accept assumptions that are not fair and reasonable.
Conclusions
The FA circular and the liability statement provide important reminders to financial advisers and valuers respectively to act diligently in their roles when advising on corporate transactions.
There has recently been heightened regulatory scrutiny over the accuracy of disclosures made by listed companies concerning their acquisition targets. In this latest set of SFC guidance, it is clear that the SFC will not hesitate to take disciplinary action when future issues arise in circumstances where the FA circular or liability statement have not been adhered to.
For further information, please contact:
Matt Emsley, Partner, Herbert Smith Freehills
matt.emsley@hsf.com
