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Introduction: With the implementation of the Shanghai Stock Exchange's punishment for irregularities that occurred during the IPO of Hengdazhi, CICC has encountered four penalties in 2024 due to issues in the performance of its duties in the underwriting business. Eight sponsors have been held accountable, and four of them have been criticized.

This article was exclusively published by Koukou Finance (ID: koukouipo)

Author: Zhao Qing@Beijing

Editor: Zhai Rui@Beijing

When Zhengzhou Hengda Intelligent Control Technology Co., Ltd. (hereinafter referred to as "Hengda Intelligent Control"), which had applied for an IPO on the Science and Technology Innovation Board, announced on May 11, 2024 that it would terminate the listing review by voluntarily withdrawing its application, most outsiders attributed the failure of its IPO to the strict supervision of spin-off listings by the regulators at that time.

As a company planning to go public after being spun off from Zhengzhou Coal Mining Machinery Co., Ltd., a listed company on the A-share market, Hengda Intelligent Control is mainly engaged in the research and development, production, sales and service of coal mine comprehensive mining face control technologies and systems.

One month before Hengda Intelligent Control's IPO was officially halted, on April 12, 2024, the State Council had just issued the "Several Opinions on Strengthening Supervision, Preventing Risks and Promoting High-Quality Development of the Capital Market" (hereinafter referred to as the "New Nine National Articles"). Article 2, "Strictly Control Access to Issuance and Listing," clearly stated that it is necessary to "strictly supervise spin-off listings."

Immediately afterwards, on April 26, 2024, Zheng Coal Machinery took the lead in issuing an announcement stating that it planned to terminate the spin-off of its subsidiary Hengda Intelligent Control to be listed on the Shanghai Stock Exchange Science and Technology Innovation Board and withdraw the relevant listing application documents. At this time, it was less than half a month away from the implementation of the new "Nine National Regulations".

On the eve of Zheng Coal Mining Machinery announcing the abandonment of its plan to spin off Hengda Intelligent Control for listing, several companies including Weicai Power have also announced the termination of their plans to spin off and list.

"Based on the current market environment and other factors, and in order to coordinate the business development and capital operation planning of Hengda Intelligent Control, after full communication and careful demonstration with relevant parties, the company decided to terminate the spin-off of Hengda Intelligent Control to be listed on the Shanghai Stock Exchange Science and Technology Innovation Board and withdraw the relevant listing application documents." This was the reason for the termination of Hengda Intelligent Control's IPO given in the relevant announcement of Zheng Coal Machinery at that time.

The regulatory authorities' strong supervision policy on spin-off listings and Zheng Coal Mining Machinery's so-called market environment factors are obviously only part of the reasons for the failure of Hengda Intelligent Control's IPO.

On July 22, 2024, the Shanghai Stock Exchange issued two regulatory warning decisions, revealing the unknown side of why Hengda Intelligent Control’s IPO was suspended.

In a regulatory letter entitled "Decision on Regulatory Warning to Zhengzhou Hengda Intelligent Control Technology Co., Ltd." (hereinafter referred to as the "Warning Decision") issued by the Shanghai Stock Exchange that evening, it was stated that because Hengda Intelligent Control "failed to ensure the authenticity, accuracy and completeness of the application documents and information disclosure for issuance and listing" in the process of applying for an IPO on the Science and Technology Innovation Board. The above behavior violated Article 15, Article 25 and other relevant provisions of the "Shanghai Stock Exchange Stock Issuance and Listing Review Rules" (hereinafter referred to as the "Review Rules"), and it was decided to impose a regulatory warning on it.

While the Shanghai Stock Exchange made a regulatory warning decision to Hengda Intelligent Control, it also pointed the sword of punishment at CICC, the sponsor of Hengda Intelligent Control's IPO, and related sponsor representatives, believing that CICC, as the sponsor of Hengda Intelligent Control, failed to perform its duties properly in the sponsorship work, resulting in inaccurate disclosure of relevant information. As the sponsor representatives of the project, Yan Yan and Lv Yingxia bear the main responsibility for this. In this regard, the Shanghai Stock Exchange also issued regulatory warnings to CICC and Yan Yan and Lv Yingxia, and required CICC to take warning, "take practical measures to rectify, conduct internal accountability in accordance with relevant issues", and submit a written rectification report to the Shanghai Stock Exchange within 20 trading days.

As stated in the above-mentioned regulatory decision issued by the Shanghai Stock Exchange to Hengda Intelligent Control, CICC and related sponsors, the information disclosure issues of Hengda Intelligent Control's IPO were revealed during the on-site inspection initiated by the China Securities Regulatory Commission.

On January 4, 2024, as per convention, the first batch of on-site inspection lists for A-share IPOs in 2024 were released. Unfortunately, two companies planning to go public were selected. One was Beijing Urban Construction Design and Development Group Co., Ltd. (hereinafter referred to as "Beijing Urban Construction"), an IPO project applying for listing on the main board of the Shanghai Stock Exchange, and the other was the protagonist of this article, Hengda Intelligent Control.

On May 11, 2024, four months after the on-site inspection, Hengda Intelligent Control took the lead in choosing to terminate the promotion of its IPO.

More than a month later, at the end of June 2024, Beijing Urban Construction finally followed the example of Hengda Intelligent Control and voluntarily withdrew its application materials for listing on the main board.

So far, all the companies that were selected by lottery for the first time in 2024 to undergo on-site inspection by regulators have returned empty-handed.

According to the two latest "Warning Decisions" issued by the Shanghai Stock Exchange, through on-site inspections by the regulatory authorities, the main problem with Hengda Intelligent Control's IPO is concentrated on the collection of its research and development expenses. It is believed that Hengda Intelligent Control's identification of R&D personnel and the collection of R&D expenses are both unreasonable.

"For companies planning to list on the Science and Technology Innovation Board, R&D expenses are an important indicator of whether they meet the positioning attributes of the Science and Technology Innovation Board, and are also an important basis for regulators to make judgments on whether companies meet listing requirements. Regulators have also repeatedly conveyed the importance of correctly aggregating relevant indicators to companies and intermediary institutions through various public channels." A head of an investment bank from a large brokerage firm in Shanghai told Kekou Finance that judging from the amount of non-compliant R&D expenses involved in Hengda Intelligent Control, after deduction, although there is no situation that causes it to fail to meet the positioning attribute conditions of the Science and Technology Innovation Board, from the principle of authenticity of information disclosure, it did violate the Shanghai Stock Exchange's "Stock Issuance and Listing Review Rules."

However, in the opinion of the person in charge of the above-mentioned investment bank, even without the "deterrence" of on-site inspections by regulators and the strict supervision of spin-off listings in the new "Nine National Regulations", Hengda Intelligent Control's IPO will be difficult to achieve.

"There is another fatal obstacle for Hengda Intelligent Control to go public, and that is its 'surprise liquidation' dividends during the IPO reporting period. This is a very sensitive audit point for regulators in recent IPO reviews," the head of the above-mentioned investment bank admitted.

According to the IPO filing materials of Hengda Intelligent Control, in the three years from 2020 to 2022, its cash dividends were 350 million, 300 million and 750 million respectively, while the corresponding non-net profit of Hengda Intelligent Control in these three years was 369 million, 479 million and 710 million respectively.

That is to say, from 2020 to mid-2022, Hengda Intelligent Control's cash dividends accounted for as much as 89.9% of its non-GAAP net profit in the same period.

As early as mid-April 2024, the Shanghai Stock Exchange proposed in the "Opinions on Strictly Controlling Access to Issuance and Listing and Improving the Quality of Listed Companies from the Source (Trial)" that it is necessary to strictly investigate and prevent sudden "clearance-style" dividends by companies planning to go public.

Regarding the recognition standards for sudden "clearance-style" dividends, the Shanghai Stock Exchange also clearly stated that if the cumulative dividend amount in the three years of the reporting period accounts for more than 80% of the net profit in the same period; or the cumulative dividend amount in the three years of the reporting period accounts for more than 50% of the net profit in the same period and the cumulative dividend amount exceeds 300 million yuan, and the total proportion of cash flow replenishment and loan repayment in the raised funds is higher than 20%, their issuance and listing will not be allowed.

It is worth mentioning that with the implementation of the Shanghai Stock Exchange's punishment for irregularities that occurred during the IPO of Hengdazhi, CICC has encountered four penalties in 2024 due to issues in the performance of its duties in the underwriting business. Eight sponsors have been held accountable, and four of them have been criticized.

1) Project managers are recognized as full-time R&D personnel

As mentioned above, through on-site inspection, the Shanghai Stock Exchange's determination of Hengda Intelligent Control's violations mainly focused on inaccurate allocation of R&D expenses.

The IPO filing documents submitted by Hengda Intelligent Control to the Shanghai Stock Exchange earlier showed that two middle-level managers among its R&D personnel were in charge of both the technical debugging department and the project operation and maintenance department, and their salaries were included in R&D expenses on a full-time basis.

The Project Operation and Maintenance Department of Hengda Intelligent Control mainly undertakes non-R&D functions and is formed by the merger of the Automation Project Department and other departments.

Before the merger, the Hengda Intelligent Control Automation Project Department had 25 and 18 people recognized as full-time R&D personnel in 2020 and 2021 respectively. After the merger, the Project Operation and Maintenance Department had 11 and 15 people recognized as full-time R&D personnel in 2022 and 2023 respectively.

According to the "Warning Decision" issued by the Shanghai Stock Exchange to Hengda Intelligent Control, an on-site inspection revealed that in 2023, Hengda Intelligent Control identified 15 full-time R&D personnel in the project operation and maintenance department as project managers. Their main job content was only project after-sales maintenance such as collecting customer needs, and they were responsible for the process approval of department business such as leave and business trips.

In 2023, the salaries and remuneration of 15 project managers and 2 middle-level managers in charge of the Project Operation and Maintenance Department will be fully included in R&D expenses, involving salaries of RMB 3.5569 million, accounting for 3.87% of R&D expenses.

The Shanghai Stock Exchange believes that Hengda Intelligent Control’s inclusion of the above-mentioned employees’ salaries and wages as full-time R&D expenses is not reasonable enough and the aggregation is inaccurate.

Judging from the amount alone, the "adjustment" of more than 3.5 million in R&D expenses will not substantially affect the determination of Hengda Intelligent Control's attributes on the Science and Technology Innovation Board.

According to the financial data released by Hengda Intelligent Control, in the three years from 2020 to 2022 during its IPO reporting period, its research and development expenses reached 52.603 million yuan, 74.054 million yuan and 99.3259 million yuan respectively.

Based on the calculation that the R&D expenses of 3.5569 million yuan that have collection issues in mid-2023 account for 3.87% of its current R&D expenses, Hengda Intelligent Control's R&D expenses in 2023 will be approximately 91.9095 million yuan. Excluding the unreasonable amount of more than 3.5 million yuan in 2023, its R&D expenses in 2023 will still be as high as 88.3526 million yuan.

According to the latest requirements for the Science and Technology Innovation Board's attribute determination indicators, companies applying for Science and Technology Innovation Board IPOs must meet the following requirements: "R&D investment accounts for more than 5% of operating income in the past three years, or the cumulative amount of R&D investment in the past three years is more than 80 million yuan."

Obviously, after Hengda Intelligent Control's R&D expenses are "compliant", it also meets the positioning conditions of the Science and Technology Innovation Board.

However, according to Kekou Finance, although the proportion of R&D expenses that Hengda Intelligent Control has "problems" is not large, under the premise that Hengda Intelligent Control's R&D investment has been questioned and criticized compared with comparable companies in the same industry, its negative impact on Hengda Intelligent Control's IPO is magnified exponentially.

Public data shows that in the three-year period from 2020 to January-March 2023, the average R&D expense rates of comparable peers of Hengda Intelligent Control were as high as 8.09%, 8.98%, 9.67% and 9.33% respectively. In contrast, Hengda Intelligent Control's R&D expense rates in the same period were only 3.62%, 4%, 4.09% and 4.68%.

In the IPO filing materials, Hengda Intelligent Control also admitted that its R&D expenses were significantly lower than the industry average. However, it said that this was mainly due to the company's adherence to the principle of R&D service sales, that is, the company invested R&D resources in a targeted and focused manner based on market demand, and its R&D efficiency was relatively high.

However, the indicator that best reflects R&D efficiency - the number of patent projects - does not seem to support the above explanation of Hengda Intelligent Control.

In the IPO prospectus (draft filing), Hengda Intelligent Control identified Tianma Intelligent Control, Hengli Hydraulics, Zhongkong Technology and VEICHI Electric as comparable companies in the same industry. Both the number of authorized patents and the number of invention patents of these companies are far higher than that of Hengda Intelligent Control.

As of March 31, 2023, Hengda Intelligent Control has a total of 63 authorized patents, including 15 invention patents.

However, among the above-mentioned four comparable companies, even WeiChuang Electric, which has the least number of authorized patents, already had 149 authorized patents by the end of 2022, including 36 invention patents. Zhongkong Technology, which has the largest number of patents, had as many as 708 patents in 2022, including 425 invention patents.

Previously, in order to standardize the information disclosure of R&D personnel and R&D investment and the verification work of intermediary institutions, and to improve the transparency of the review work, on November 24, 2023, the China Securities Regulatory Commission drafted and issued the "Guidelines for the Application of Regulatory Rules-Issuance No. 9: R&D Personnel and R&D Investment" (hereinafter referred to as the "No. 9 Guidelines").

The Guidelines No. 9 require that companies planning to go public should formulate and strictly implement internal control systems related to R&D, and reasonably identify R&D personnel and R&D investment. At the same time, it also clarifies the verification requirements and focus of intermediary institutions in more than ten aspects such as R&D activities, R&D personnel, and R&D investment.

"Guideline No. 9" clearly stipulates that R&D personnel should be professionals who are directly engaged in R&D projects in the R&D department and related functional departments.

By identifying after-sales maintenance personnel responsible for projects such as collecting customer needs as full-time R&D personnel, Hengda Intelligent Control is not the most outrageous among the companies that have planned to list on the Science and Technology Innovation Board in recent years in terms of identifying R&D personnel.

For example, Fujian Fotec Optoelectronics Co., Ltd. (hereinafter referred to as "Fotec"), which had passed the review of the Science and Technology Innovation Board Listing Committee as early as the end of 2021, was found after the regulatory authorities initiated an on-site inspection that it had actually identified the company's front desk staff as full-time R&D personnel, and there were even Western cooking professionals engaged in the production department to collect materials, etc. (See the relevant report of Kekou Finance for details: "Ten years of reincarnation, Fotec's second attempt at IPO in A-shares is tracked again: the registration barrier was indeed a failure! Several "crimes" of internal control were revealed, and the "front desk" turned out to be full-time R&D personnel").

In early June 2024, in the "Shanghai Stock Exchange's Issuance and Listing Review Dynamics" 2024 No. 3 (hereinafter referred to as the "Latest Review Dynamics") published by the Shanghai Stock Exchange, it announced an even more "unbelievable" identification of R&D personnel for a company that is engaged in the design, manufacture and sales of power semiconductor chips and power devices and plans to be listed on the Science and Technology Innovation Board (see the relevant report of Kekou Finance for details "Unbelievable! Nurses, tour guides, and customer service staff have become R&D personnel of high-tech enterprises. Who is the latest regulatory case of the Shanghai Stock Exchange targeting: More than a year after the review, the mystery of Anxin Electronics' IPO withdrawal of materials and termination of listing will be revealed?").

After on-site supervision by the Shanghai Stock Exchange, it was found that many of the full-time R&D personnel identified by this semiconductor chip manufacturing company were transferred from other positions, and there was no significant difference in the content of their work before and after the transfer. After the regulatory authorities interviewed these relevant full-time R&D personnel, they learned that these so-called full-time R&D personnel did not even understand the specific situation of the R&D projects. In addition, the academic qualifications and professional backgrounds of some R&D personnel did not match the R&D activities. Not only did some R&D personnel have no relevant work experience, but they even worked as nurses, tour guides, customer service, etc. before joining the company.

2) CITIC Construction Investment was fined four times in a row in 2024

It was revealed that Hengda Intelligent Control’s IPO had “flaws” in the identification of key indicators of its scientific and technological innovation attributes. Naturally, its IPO sponsor CICC and related sponsor representatives cannot escape blame.

The Shanghai Stock Exchange has determined the accountability of CITIC Construction Investment and related sponsors for the Hengda Intelligent Control listing project. In addition to the identification of R&D personnel and the concentration of R&D expenses, CITIC Construction Investment and its related responsible persons failed to increase their duty of care in light of relevant circumstances, and did not conduct a prudent review of the rationality and relevant basis for including the above-mentioned employees' salaries and remuneration in the issuer's R&D expenses. The relevant review records in the sponsorship working papers were insufficient. The Shanghai Stock Exchange also pointed out that CITIC Construction Investment and the sponsor responsible for the project did not properly implement the confirmation procedures.

The Shanghai Stock Exchange stated that after an on-site inspection of Hengda Intelligent Control's IPO, it was also found that in the sponsor's confirmation procedures for some of Hengda Intelligent Control's customers, there were cases where the sending address and the reply address were inconsistent, and there were cases where the recipient and the reply were the same person but the contact information was two different mobile phone numbers. The sponsor's working papers did not indicate the reason why the confirmation reply address was inconsistent with the sending address. In addition, the sponsor did not fully verify the independence-related matters such as Hengda Intelligent Control's procurement through the controlling shareholder's bidding platform and the joint application for invention patents with the controlling shareholder, and there were omissions in the verification papers for Hengda Intelligent Control's capital increase.

More than a month ago, Koukou Finance wrote an article pointing out that at a time when the competition with CITIC Securities for the title of "Investment Bank King" in the A-share market is becoming increasingly fierce, CITIC Construction Investment's investment banking business has once again faced an awkward moment of mixed joy and sorrow (see the relevant report from Koukou Finance for details: "With two large IPO underwriting orders in hand, CITIC Construction Investment's investment banking business has "restarted" the A-share listing application door, and faced a mixed moment of joy and sorrow: it has been continuously punished by regulators for more than a month, and 4 underwriters have been criticized in a notice!").

On the evening of June 20, 2024, the A-share IPO application list, which had been suspended for half a year, finally saw an update. The proposed IPO applications of two companies were officially accepted by the Shanghai Stock Exchange and the Shenzhen Stock Exchange respectively. The Science and Technology Innovation Board listing application of Xi'an Taijin New Energy Technology Co., Ltd. (hereinafter referred to as "Taijin New Energy") was successfully accepted by the Shanghai Stock Exchange on the same day. At the same time, China Uranium Corporation (hereinafter referred to as "China Uranium") also obtained the qualification to launch a listing sprint on the Shenzhen Stock Exchange's main board.

These are also the only two companies planning IPOs in Shanghai and Shenzhen that have been approved to apply since 2024.

Coincidentally, these two high-quality investment banking projects that "reopened" the A-share IPO application door were "taken down" by CICC, and both were sponsored and underwritten by CICC.

This will undoubtedly add another highlight to CICC's investment banking business resume.

But at the same time, what makes CICC quite worried is that since 2024, CICC and its related sponsors have been severely punished by regulators for violations in the performance of sponsored projects. Being held accountable for due diligence issues in sponsoring Hengda Intelligent Control's IPO is only the latest example. Before Hengda Intelligent Control, in the first half of 2024, CICC had been issued regulatory penalties by regulators for professional defects in three consecutive sponsored projects.

Only Haitong Securities can match this record of violations.

On January 3, 2024, the Shenzhen Stock Exchange issued a "Supervisory Letter to CITIC Construction Investment Securities Co., Ltd., Wang Haoji, and Fang Yingjian". This is also the first case in 2024 where CITIC Construction Investment was held accountable for its investment banking underwriting business.

At that time, the reason why CICC was punished was that in the process of sponsoring the GEM IPO of Xintianxia Technology Co., Ltd., it "did not pay sufficient attention to the market situation of the issuer and the situation of comparable companies in the same industry, did not fully verify the issuer's sales to end customers, did not prudently express professional opinions on the issuer's performance forecasts and urge the issuer to improve the quality of information disclosure."

On May 14, 2024, CITIC Construction Investment was given a regulatory warning by the Shanghai Stock Exchange due to its obviously inadequate verification of the issuer's R&D expenses in the underwriting of the IPO listing of Shenzhen ZTE New Materials Technology Co., Ltd. (hereinafter referred to as "ZTE New Materials") on the Science and Technology Innovation Board, as well as its "obvious inadequate verification of the issuer's internal control defects related to waste film management and the operation of the rectification", in which it was underwritten by the Shanghai Stock Exchange.

At the same time, Li Hao and Liu Jianliang, two sponsors from ZTE Construction Investment who were responsible for ZTE New Materials' IPO, were criticized by the Shanghai Stock Exchange for "failure to perform their sponsorship duties."

On June 20, 2024, while the two major exchanges announced the acceptance of two major projects sponsored by CICC to kick off a new round of IPO applications, on the other hand, the Shanghai Stock Exchange also officially issued another decision to give CICC a regulatory warning later that evening, and at the same time made a disciplinary decision to criticize and issue a notice to two other sponsors from CICC.

What led to the Shanghai Stock Exchange's decision was a fixed-increase refinancing project with a financing scale of more than 3 billion yuan. On March 29, 2023, under the sponsorship of CICC, the refinancing project of A-share main board listed company Dasanlin was officially accepted by the Shanghai Stock Exchange.

The initial review stage of Dasanlin's fixed-increase refinancing project went smoothly.

After two rounds of inquiries and feedback from the Shanghai Stock Exchange, on July 20, 2023, less than four months after its application, Dasanlin's private placement was approved by the Shanghai Stock Exchange, which believed that its application to issue shares to specific objects met the issuance conditions, listing conditions and information disclosure requirements.

After passing the review of the Shanghai Stock Exchange, Dasanlin has been slow to submit the registration application for the refinancing to the China Securities Regulatory Commission. Instead, on January 31, 2024, it suddenly terminated its long-planned refinancing plan by voluntarily withdrawing the application documents for issuing shares to specific objects.

During the application and review process of Dasanlin's private placement project, the Shanghai Stock Exchange determined that as the sponsor of Dasanlin's refinancing, CITIC Construction Investment and its relevant sponsor representatives failed to report to the Shanghai Stock Exchange and apply for suspension of review in a timely manner as required when Ke Jinlong, one of the actual controllers of Dasanlin, was prosecuted for suspected corporate bribery. Therefore, it was determined that CITIC Construction Investment and its sponsor representatives failed to perform their duties diligently during the project sponsorship period.

Finally, by the way, CITIC Securities, which has long competed with CITIC Construction Investment for the title of "King of Investment Banks" in the A-share market, not only often surpasses CITIC Construction Investment in the number of sponsored projects, but also clearly has a superior skill in terms of professional quality. Since 2024, CITIC Securities has only received one written warning regulatory measure from the exchange due to professional quality issues in its sponsorship business.

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