Case study of ‘important clients + shareholders’ in IPOs

To prevent interest transfer and forgery in business performance, the regulatory authorities and intermediaries are generally cautious about share purchasing of proposed public companies by clients and suppliers that are parties of interest to the companies.

Since 2018, there have been several cases where important clients were introduced to the board of directors as “important clients + shareholders” prior to when the companies went public, which was subsequently commented on as “hugely profitable” by some securities publications. In order to have a more objective understanding of this, it is necessary to review the cases mentioned in the relevant reports.

The IPO of Wuhan Bester Group Telecom (the company’s name was changed to China Bester Group Telecom in March 2019). Through careful study of the audit results of Bester Telecom as announced by the China Securities Regulatory Commission (CSRC) and the company’s prospectus published after the share release, the author found that China Mobile Innovation Industry Fund (China Mobile Fund), the shareholder associated with China Mobile and the No. 1 client of Bester Telecom, assigned its shares held in Bester Telecom during the audit of the company.

In the audit results announced by the Issuance Examination Committee (IEC), it confirmed that “China Mobile Fund transferred its shares to Li Liubing et al”. Therefore, Bester Telecom cannot be set as an example of where the regulatory authorities have approved of the model of “important clients + shareholders”.

The IPO of Hangzhou DP Technologies (DPtech). As another listed company with shares held by China Mobile Fund, DPtech has two major differences from Bester Telecom. First, the proportion of DPtech’s shares held by China Mobile Fund is less than 5%. Second, the sales revenue DPtech has made from China Mobile accounted for a small amount of its main business income, which was lower than 30% throughout the reporting period, and showed a downward trend year by year.

In addition, although DPtech listed China Mobile Fund as its related party after entering the issuance stage, it did not disclose China Mobile and China Mobile Fund as its related parties in its earlier prospectus.

Judging from the feedback from DPtech and the audit results of DPtech announced by the CSRC, the regulatory authorities have paid special attention to the model of “important clients + shareholders”.

The IPO of Jiangxi JL MAG Rare Earth (JL MAG). JL MAG is quite special in the cases of “important clients + shareholders”. Its shareholder, Xinjiang Goldwind Science & Technology (Goldwind), not only purchases directly from JL MAG, but also designates its suppliers to make purchases from JL MAG. The case is special because:

1. the affiliate transaction between JL MAG and Goldwind/its affiliated companies is not much, with the most being 6% during the reporting period;

2. although the proportion of transactions between JL MAG and the suppliers designated by Goldwind is considerable, the transactions were disclosed in comparison with affiliate transactions based on the principle of prudence;
3. Goldwind has held shares in JL MAG since its inception, not a sudden purchase of shares; and
4. the regulatory authorities have paid special attention to the de-purchase model to see if it is a customary practice within the industry, and whether JL MAG has relied heavily on Goldwind.