Joint statement of the Securities and Futures Commission (SFC) and the Accounting and Financial Reporting Council (AFRC) in relation to loans, advances, prepayments and similar arrangements made by listed issuers

In view of recent observations regarding dubious lending practices or loan arrangements of issuers involving financial assets of the issuer firm, the Securities and Futures Commission (SFC) and the Accounting and Financial Reporting Council (AFRC) have jointly published a statement in this context. Specifically, the regulators have noticed an increase in activities, where issuers seem to channel funds to third parties under the pretext of loans with highly suspicious lending terms. Such „lending“ activities, so the regulators, often lack commercial rationale which leads them to believe of cases of fund misappropriations. Furthermore, issuers often fail to perform proper risk assessments and apply sufficient due diligence in such loan arrangements which has caused significant losses in the past on part of the issuers.
Against this background and also in light of the fact that such lending activities may be performed for „window dressing“ purposes, the SFC and the AFRC have now drawn up this statement. In it, they describe (mal)practices they have observed in this context and summarize conduct standards and practices that „listed issuers, their directors, audit committees and auditors should adhere to“ in relation to loans granted to third parties or other lending arrangements. The key expectations are briefly outlined below; for more detailed comprehensive information, please refer to the enclosed statement.
#### Overall expectations as regards company loans and loan arrangements
– Firms shall have policies and procedures in place to ensure the safeguarding of company assets.
– Firms shall have adequate monitoring systems to ensure that these policies and procedures are complied with.
– Audit committees of issuers must ensure to adequately and independently supervise management and compliance with beforementioned policies and procedures and local rules and regulations.
#### Expectations of company directors
– Company directors need to actively monitor the situation of a company, including its loan arrangements.
– Any material loan must be vetted on before the Board and must be adequately disclosed to the public.
– The Board of Directors must act in the best interest of a company’s investors which implicates that Directors must ensure to have adequate internal procedures in place to monitor credit risks and loan arrangements (including risk assessment, documentation, follow-up on loans).
– There must be an adequate communication channel between the Board and management to keep the Board informed of any issues arising in the context of loan arrangements (e.g. the default of material borrowers).
– Boards are also recommended to have auditors attend Board meetings, especially those where relevant, material loan arrangements are discussed and vetted on.
#### Expectations of audit committees and individual auditors
– The audit committee is responsible for overseeing the company’s internal controls related to loans, ensuring proper accounting and disclosure in financial statements.
– The audit committee should closely monitor that the company has set approval procedures for loans exceeding a certain threshold.
– The committee should also maintain communication with auditors to address significant loan-related matters identified during an audit.
– In relation to loan arrangements, auditors should always monitor the rationale behind loans, the documentation of such, the documentation of any risk assessments performed in the context of a loan, and perform follow-ups, e.g. via look-through of bank statements to ensure the adequacy of a loan arrangement. It is also necessary to critically look at any assumptions behind a loan, the accounting principles applied, and the proper entry of the loan in the company’s journal.
– In case of doubt or where the rationale behind a loan cannot be identified, auditors are expected to information from third parties and to communicate with those that are responsible for governance and the audit committee.
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The statement concludes by noting the potential consequences for issuers and auditors, if above noted expectations aren’t met which may include significant fines of up to $10 million and to imprisonment for 10 years, or – in case of auditors – $10 million or up to „three times the amount of profit gained or loss avoided by the person as a result“ of any associated misconduct.