The Securities and Futures Commission (SFC), a Hong Kong regulator, announced today that it will be fining Citigroup Global Markets Asia HK$57 Million ($7.26 million). Citigroup will have to pay the fine as a result of due diligence failures surrounding its sponsorship of a Stock Exchange listing application for Real Gold Mining Limited, a Chinese gold mining company.

Real Gold was listed on the Main Board of the Stock Exchange of Hong Kong Limited (SEHK) in February 2009 with Citi as its sole sponsor. In 2011, Real Gold requested that trading of its shares be suspended.

The SFC suspended the company’s shares in June 2016. The investigation into Citigroup’s sponsorship of the company’s listing application appears to have proceeded from this point onward.

In its investigation, the company found that Citigroup’s sponsorship was based largely on Real Gold’s prospectus from the year 2007 and the first ten months of 2008.

The Hong Kong regulator found that Real Gold’s sales increased twenty-fold in the first ten months of 2008 when compared to sales in 2007. This seems to have been attributable to a suspicious memorandum of long-term cooperation (MLC) that the firm made with three of its largest buyers.

The MLC stated that these three buyers would be obliged to purchase whatever amount of gold and zinc concentrates Real Gold decided to sell them. The SFC’s announcement today partly stems from these MLCs. They noted that Citigroup had failed to verify the authenticity of these MLCs and had not even spoken to any of the three companies that Real Gold was alleged to have made the deals with.

Identity verification failures

Beyond this, the SFC stated that Citigroup had conducted all of its customer interviews over the phone, with numbers provided by Real Gold. No effort was made to verify the identity of these customers or validate the veracity of the claims Real Gold was making regarding transaction volumes with those customers.

The lackadaisical approach taken by Citigroup seems to have stemmed from their risk assessment methodology. Citigroup focused its due diligence efforts on verifying the production capabilities of Real Gold. The SFC seems to have fundamentally disagreed with this approach, arguing that Citigroup should have focused more of their efforts on sales verification - something Citigroup argued it was done by assessing Real Gold’s production.

The SFC also objected to Citigroup having assigned certain managing directors to the sponsorship effort. These individuals appear to have signed necessary documents without having done any work on the necessary due diligence or having had any involvement in the sponsorship of the listing application.

Despite the fine levied on Citigroup, the regulator did note that Citigroup had taken some steps to perform due diligence, just not all of those required by Regulation . It added that this was the first time they had been concerned by a sponsorship application signed by Citigroup and that the company had put in place mechanisms to prevent such incidents occurring again in the future.