Hontex, the Chinese fabrics company at the centre of the case, was among hundreds of mainland companies that have raised money from Hong Kong investors and made the island the biggest market for initial public offerings in each of the past three years.
But many of the stocks have performed poorly and Hong Kong's Securities and Futures Commission found shortcomings in the due diligence work of banks that sponsored listings in a review last year.
The regulator is now threatening banks with a far stricter liability and compliance regime just as the market is witnessing its most dismal start to a year since early 2009 and is losing ground to the Shenzhen exchange on the mainland.
Mega Capital Asia, the Hong Kong arm of Taiwan's Mega Securities, has been banned from advising on future listings and dealing securities in Hong Kong on top of being hit with the record HK$42m (US$5.4m) fine by the SFC.
It was the sole financial adviser to Hontex, which raised HK$1bn when it floated in December 2009. Three months later, the SFC moved to freeze the proceeds of the listing and accused Hontex of using false and misleading information.
Hong Kong's High Court last summer delayed a decision on whether the SFC could return those funds to Hontex's investors pending the outcome of another case testing the reach and powers of the regulator.
The SFC seized the local assets of US-based hedge fund, Tiger Asia, accusing the traders of market manipulation. Tiger Asia has denied their charges and is pursuing appeals against the SFC's action.
Both cases are key tests of the SFC's ability to act against offshore companies and investors that are unlikely to return onshore to face prosecutions or market tribunals. This is important for a market that does much of its business with offshore participants.
Mark Steward, the head of enforcement at the SFC who some in Hong Kong see as a candidate to replace Margaret Cole in the same position at the UK regulator, said on Sunday that Mega Capital's failures echoed those found at a number of sponsors in last year's inspection report into the IPO market.
"Given the important role played by sponsors, these failures must be regarded most grimly," he said. "The sanctions imposed on Mega Capital should make it clear that the SFC condemns such failure in the strongest terms."
The SFC found no evidence that Mega Capital was involved in any fraud and took into account Mega Capital otherwise had a clean record. It added that Mega Capital denied all allegations of wrongdoing.
The company could not be reached for comment.
