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INTRINSIC FLAW OF THE SPONSOR SYSTEM: IMBALANCE BETWEEN PROFIT AND RISK

An analysis of the 56 punishments issued by the CSRC and typical cases shows that China's fundamental flaw of the sponsor system is an imbalance between the benefit and risk of sponsors. Specifically, the system has a number of problems, as detailed in the following section.

Incompetence of Sponsors

A sponsor should have a good credit record; deep understanding of the backgrounds and aims of various laws, regulations, and rules; good connections in the industry; as well as project coordination capability and management experience. However, with the current system, a sponsor's ability can be assessed only through exams, which has given rise to a large number of sponsors who are only good at taking exams, not practice. Therefore, many professional sponsor duties such as tutoring, sponsoring, review and verification, communication, continuous supervision, and reviewing and reporting on information disclosure are not actually performed.

Unreasonable Sources of Income for Sponsors

With the current system, the economic interest of the sponsor relies on the successful listing of the issuing company. After successfully sponsoring the listing of the company and extracting sponsor fees and underwriting fees from the funds raised, the right to collect issuing fees comes to an end. The obligation between the sponsor and the issuing company to pay such fees also comes to an end. However, the sponsor's duty does not stop there. The sponsor is still responsible for continuous supervision for the remaining time in the year the company is listed, plus two full fiscal years. Such arrangements have some drawbacks, as follows:

- Sponsor overlooking listing verification and continuous supervision: It is the sponsor's duty to conduct prudent verification and continuous supervision. A shortage of sponsor representatives, large business demand, and bountiful benefits have led some sponsors to focus on the development and listing of new issuing companies. They have been overly obsessed with the number of companies getting listed while conducting the listing verification in a perfunctory way. As a result, many enterprises were found to lack core competitive strength after being listed. The absence of material incentives for the sponsor representative and the sponsor institution to conduct continuous supervision in the continuous supervision period has allowed the sponsor to profit as long as the listing was successful. As a result, the sponsor would spend little time and energy on continuous supervision. Relevant laws also indicate that the term of a sponsor is relatively short. From the point of view of the third person in securities investment, this is not a favorable situation for the settlement of civil disputes. A responsible party is difficult to identify in the end, leaving the third person in securities investment uncompensated.

- Fraudulent listing: The realization of the sponsor's economic benefit mainly depends on the successful listing of the issuing company. This makes an interest group of the sponsor representative, the sponsor institution, and the issuer. Such an interest group could easily collude in a listing fraud. A prevalent covert practice for the issuer and the sponsor is to exchange favors in an arrangement in which the sponsor holds shares in the sponsored company or engages in "direct investment plus sponsoring." This practice has been driven by interests, giving rise to the three highs phenomenon and PE corruption problems.

 
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