SFAT affirms SFC decision to reprimand and fine RaffAello Capital Limited for sponsor failures

The Securities and Futures Commission (SFC) has reprimanded and fined RaffAello Capital Limited (RaffAello) $4 million for failing to discharge its duties as the sponsor in the listing application of Paprika Holdings Limited (Paprika) after the Securities and Futures Appeals Tribunal (SFAT) upheld the SFC’s disciplinary action against RaffAello (Notes 1 to 4).

The SFC’s investigation found that RaffAello had failed to perform all reasonable due diligence on Paprika before submitting the listing application. The SFC also found that RaffAello had failed to examine with professional scepticism the accuracy and completeness of statements and representations made, or other information given, to it by Paprika.

Inadequate due diligence on Paprika’s retail sales

Paprika marketed and sold handbags and related accessories to retail and wholesale customers. During the two consecutive financial years ended 31 March 2017, retail sales accounted for around 90% of Paprika’s revenue, of which over 80% were generated by sales from its retail stores.

RaffAello conducted a walkthrough on the transactions conducted at Paprika’s retail stores on a sample basis and found that during the period from 19 February 2016 to 13 March 2016:

• series of consecutive cash transactions were conducted at different retail stores which made up 90% of their total cash sales on the sampled dates when purchases of a significant number of handbags were made within one to 10 minutes (Note 5);

• a number of individuals, including three owners of Paprika’s wholesaler and suppliers, repeatedly purchased handbags in bulk from different retail stores by credit cards (Note 6); and

• cash transaction invoices that were marked “POS Test”, referring to testing of Paprika’s point-of-sale system, were included in the sales documents provided by Paprika.

While RaffAello had made further enquiries with Paprika, its wholesaler and suppliers concerning the above-mentioned transactions, the SFC’s investigation found that RaffAello had:

• accepted to a large extent the information provided by Paprika and parties involved in the transactions, without examining the information and the documents provided by Paprika with professional scepticism in order to assess the accuracy and completeness of the information provided; and

• overlooked a number of red flags discernible from the relevant retail sales documents which indicated a risk that the transactions might have been fabricated by Paprika to inflate its retail sales (Note 7).

Inadequate due diligence on Paprika’s largest wholesaler (Novi eBusiness Limited (Novi)) and fifth largest supplier (API Trading Company Limited (API))

In the course of its due diligence, RaffAello failed to undertake reasonable due diligence to verify the independence of Novi and API even after discovering a number of red flags indicating a risk that they could be controlled by Paprika – contrary to Paprika’s claim that they were independent third parties (Notes 8 and 9).

Notably, RaffAello did not carry out sufficient investigations on the matters below:

• Novi and API were former subsidiaries of a company controlled by a shareholder with a 15% stake in Paprika;

• Novi and API were acquired from the former owner at about the same time, under the request and facilitation of Mr Samuel Leung, Paprika’s founder, Chairman and Chief Executive Officer;

• the new owner of Novi partnered with two Mainland Chinese companies in order to sell Paprika’s products it purchased, while the person who was the founder of one of these Mainland Chinese companies and the supervisor of the other one had also been authorised by Leung to receive payments from a number of suppliers of merchandise to Paprika;

• the owners of both Novi and API were involved in repeatedly purchasing handbags in bulk from different Paprika retail stores by credit card.

RaffAello also failed to conduct reasonable due diligence to determine whether API was a company of commercial substance. The SFAT found that RaffAello did not consider with sufficient vigour and concerns as to API’s true business model raised by the transaction team’s discovery. Specifically, the team discovered that API obtained its supply of products from a pre-existing supplier of Paprika’s (Lung Yiu) and on-sold the products to Paprika, and that there was a rapid increase in the supply to Paprika from $41,000 in the year ended 2016 (when Lung Yiu was the direct supplier) to $3.18 million in the year ended 2017 (when Lung Yiu supplied to Paprika via API).

The SFC originally proposed a $13 million fine against RaffAello in light of the gravity of its failings, but accepted a reduction to $4 million to account for RaffAello’s financial difficulties. The SFAT agreed that too great a financial penalty could drive RaffAello into liquidation, to the prejudice of its existing clients. The Tribunal also determined that the same amount of fine determined by the SFC would best meet the ends of justice in this matter.

The SFAT further made an observation regarding the sponsor’s duty to undertake additional due diligence when it becomes aware of circumstances that may cast doubt on information provided to it or otherwise indicate a potential problem or risk. The Tribunal, chaired by Mr Michael Hartmann, GBS, said that: “[i]f issues of concerns are identified, it is not sufficient for the sponsor simply to investigate the matter, make a bald note of that fact, if making any note at all, and to move on… if a matter of concern is identified by a sponsor in the course of the exercise of due diligence, a coherent note should be made of what has been discovered and what has been resolved” (Note 10).

The Tribunal took the view that if RaffAello had harboured concerns as to any red flag issues, and if it was of the opinion that the reporting accountants could assist in resolving those concerns, the obligation would have been on RaffAello to consult regarding those issues.

In the circumstances, the Tribunal said that: “… absent consultation as to specific matters of concern, it would not have been reasonable for the RaffAello transaction team to adopt a blanket assumption that the reporting accountants must – independently – have spotted and considered the same issues that it had spotted, also concluding that they were not of concern.”

End

Notes:

1. RaffAello is licensed under the Securities and Futures Ordinance to carry on Type 6 (advising on corporate finance) regulated activity.

2. RaffAello submitted Paprika’s listing application on the Growth Enterprise Market to The Stock Exchange of Hong Kong Limited on 14 June 2017. The application was withdrawn on 16 April 2018.

3. Please see the SFAT’s determination for SFAT Application No. 2 of 2023 on its website.

4. The SFC had also prohibited Mr Tsang Kwong Fai, a former responsible officer of RaffAello, from re-entering the industry for two years. Tsang was the sponsor principal in charge of supervising the execution of the listing application of Paprika. Please refer to the SFC’s press release dated 11 July 2023.

5. There were around 230 consecutive cash transactions, involving the sale of 1,431 handbags. These transactions contributed to around 90% of the total cash sales and 42% of the total sales (including cash, credit card and EPS sales) of the relevant retail stores on the dates on which they occurred.

6. There were around 240 credit card purchases, involving the sale of 1,860 handbags. These purchases accounted for around 83% of the total credit card sales and 45% of the total sales of the relevant retail stores on the dates on which they occurred.

7. For details, please see paragraphs 95 to 160 of the SFAT’s determination.

8. Paprika’s wholesale revenue increased by 96% between the year ended 31 March 2016 and the year ended 31 March 2017. Over 90% of the increase was attributable to the increase in sales to Novi.

9. API, along with two other top five suppliers of Paprika for the year ended 31 March 2017, accounted for 53.4% of Paprika’s total purchase costs in that year, even though they only commenced business relationship with Paprika in 2016.

10. Paragraph 17.6(c) of the Code of Conduct for Persons Licensed by or Registered with the Securities and Futures Commission states that where the sponsor becomes aware of circumstance that may cast doubt on information provided to it or otherwise indicate a potential problem or risk, the sponsor should undertake additional due diligence to ascertain the truth and completeness of the matter and the information concerned. Over reliance on management’s representations or confirmations for the purposes of verifying information received form a listing applicant cannot be regarded as reasonable due diligence.