A round up of regulatory enforcement developments for the fourth quarter of 2016.
Trends in Securities and Futures Commission (SFC) enforcement actions
The following broad trends can be seen in the SFC’s latest published quarterly report for July - September 2016:
- Statistics show a 23.5% year-on-year increase in investigations being completed, together with a decrease in percentage for new investigations (-1.6% year-on-year). This reflects the SFC’s recent approach in closing investigations efficiently. Statistics also indicate an increasing trend for investigations to be closed within seven months (11% year-on-year). Although not a significant increase, this is consistent with the SFC’s attempt to conclude or settle investigations which have little prospect of success as early as possible, to focus resources on priority issues with a clear market impact.
- The trend towards the use of disciplinary actions and civil proceedings instead of criminal prosecutions continues. The issuance of Notices of Proposed Disciplinary Action and ongoing civil proceedings have increased by 66.7% and 20.5% year-on-year, respectively, while criminal charges have decreased by 21.1% year-on-year.
Creating a culture of accountability
On 16 December 2016, the SFC published a Circular on its implementation of the new Manager-In-Charge (MIC) regime. This regime is designed to allocate responsibility to individual members of senior management and to ensure they are fully aware of the relevant regulatory obligations and maintain the appropriate standards of conduct within their organisations.
By 18 April 2017, licensed corporations are expected to submit to the SFC their organisation chart which maps out the management and governance structures with key reporting lines. The chart should also identify at least one individual as MIC for each of the following eight core functions:
- overall management oversight
- key business line
- operational control and review
- risk management
- finance and accounting
- information technology
- compliance, and
- anti-money laundering and counter-terrorist financing.
Although the SFC has mentioned to the media that the new regime does not indicate the Commission’s intention to sanction managers, our forecast is that the SFC will rely more heavily on the definition of “regulated person” under sections 194 and 196 of the SFO which includes “a person involved in the management of the business” regardless of whether that person is licensed or not.
Additionally, we do not think this regime changes the existing approach of the SFC to hold senior members of management in a licensed corporation accountable, but it does give the SFC more transparency into who has what responsibilities within licensed corporations, therefore making it easier for the SFC to directly investigate and/or discipline individual managers.
For more details and commentary, see our article.
Anti-money laundering: a booming space
On 13 December 2016, the Hong Kong Monetary Authority (HKMA) introduced the Enhanced Competency Framework (ECF) to provide the compliance profession in Hong Kong, in particular those who are in anti-money laundering and counter-terrorist financing (AML/CFT) roles, with HKMA-endorsed competency standards. This ECF is one of several other modules recently developed by the HKMA (for example, the ECF on cybersecurity) and there is a perception that the HKMA is over-regulating, going beyond banking and financial activities.
The ECF is aimed at raising and maintaining the professional competence of AML/CFT practitioners in the industry, and is in line with the HKMA’s requirement that AML/CFT employees should be sufficiently qualified and trained in what they do (set out in the Supervisory Policy Manual and Guideline on Anti-Money Laundering and Counter-Terrorist Financing). Although participation in the ECF is not mandatory, the HKMA has stated that when it assesses an Authorised Institution (AI) in its effort to enhance staff competence and development (as part of its supervisory process), the HKMA will consider whether or not that AI has implemented the ECF.
The ECF appears to be an attempt by HKMA to train up local practitioners so that Hong Kong does not fall behind Singapore and stays competitive as the financial hub in Asia.
It is also, in our view, a way the HKMA can closely monitor individuals within AIs who are responsible for complying with AML/CFT requirements. With the ECF in place, the HKMA will have greater reach towards those who are certified as professionals and, when necessary, hold them accountable for any failures or falling below standard. In connection with this, we note the recent UK enforcement action by the Financial Conduct Authority against Sonali Bank, in which the FCA held the AML reporting officer personally accountable for the bank’s internal AML control failures. This action demonstrates another possible approach by the regulators to foster a culture of individual accountability.
Grave consequences for irresponsible authorship
On 10 November 2016, the Market Misconduct Tribunal sent a strong message to the public in its decision to ban Andrew Left (head of Citron research and activist short seller based in the US) from dealing in the Hong Kong market for five years. Mr Left was also ordered to disgorge HK$1,596,240 in profits and pay the Government and the SFC a total of HK$5.2m in costs. As we previously reported, Left was found culpable of market misconduct under the SFO for publishing a false and misleading research report on Evergrande Real Estate Group Limited.
The fact that the Tribunal gave a “cold shoulder” order for five years (the maximum period of time permitted by statute) shows the gravity of Mr Left’s wrongdoing and the Tribunal’s intolerance towards irresponsible authorship of research reports intended to mislead the investing public.
Mr Left’s application for leave to appeal has been dismissed as it was made out of time.
This is a landmark case showcasing that the Tribunal will be tough on any form of market misconduct and that the SFC will not shy away from prosecuting offshore parties.
Hefty fines for disclosure failures in research reports
On 20 October 2016, the SFC reprimanded and fined JP Morgan Securities (Asia Pacific) Limited (JPMSAP) HK$3m for failure to disclose its financial interests in respect of certain listed issuers covered in its research reports, in breach of paragraphs 16.5(a) and 16.5(b) of the Code of Conduct.
In its decision, the SFC found that it was insufficient for JPMSAP to simply include a standard disclosure clause referring investors to the Stock Exchange’s website to check if JP Morgan was a liquidity provider or market maker for the securities covered. Instead, the SFC found that JPMSAP should have made a clear, concise and specific disclosure in its research reports where JP Morgan is a market maker. The SFC also criticized JPMSAP’s five-month delay in reporting the incident, in breach of paragraph 12.5 of the Code of Conduct.
This enforcement action, together with the decision on Andrew Left (above), clearly indicates the SFC’s firm stance to maintain the integrity of market publications.
Another entity of JP Morgan, JP Morgan Chase Bank, was reprimanded by the SFC at the same time for offering offshore listed index options without the required licence over the course of 12 years, and was fined HK$2.6m. This is another example of the SFC’s recent approach, since Tom Atkinson’s arrival, of grouping smaller control flaws under one investigation which we previously reported on.
Say no to nepotism
In November 2016, JP Morgan paid US$264m to the Securities and Exchange Commission (SEC), Department of Justice (DOJ) and Federal Reserve Board of Governors to settle charges under the Foreign Corrupt Practices Act (FCPA) for allegedly offering prestigious internships to the children of Chinese government officials in exchange for lucrative business deals. Details are set out in the SEC order.
JP Morgan had a referral hiring program (internally known as the “Sons & Daughters Program”) and over the course of seven years, hired nearly 100 candidates referred by Chinese government officials of different PRC state-owned enterprises in exchange for deals resulting in approximately US$100m revenue to the firm. Employees within JP Morgan’s legal and compliance functions did identify the risk of the firm being charged with bribery and corruption under the FCPA and set up systems designed to prevent violations. However, the referral hiring program persisted due to weak internal controls, for example, front office staff giving misleading information to legal and compliance that they knew would pass scrutiny.
Although settlement has been reached in the US, unfortunately, this may not be the end for JP Morgan in Hong Kong. Since the Sons & Daughters Program was created and primarily executed by JP Morgan Securities (Asia Pacific) Limited, a corporation licensed by the SFC, the SFC has the power to start a fresh investigation against the Hong Kong entity in respect of the same subject matter. Additionally, FI’s should also be reminded of the extraterritorial impact of the Prevention of Bribery Ordinance (PBO). So long as the advantage is received in or offered from Hong Kong, the provisions under the PBO will bite.
Another notable anti-bribery case is the Independent Commission Against Corruption's (ICAC’s) arrest of 29 current and former staff of five financial firms (including four banks) in December 2016 on suspicion of them accepting bribes as rewards for disclosing confidential customer data. The confidential data has allegedly been provided to call centers in the PRC so that the victim customers can be contacted and offered high interest loans. It is suspected that the commission received has been split between the employees who initiated the improper disclosures and the employees who provided the data. According to media sources, the HKMA has expressed its concerns following media reports of the arrest and said it would follow up with the relevant banks.
Although recent enforcement trends have indicated that the SFC is leaning towards the use of civil proceedings and disciplinary actions, it is important to bear in mind the collaboration efforts and criminal prosecutions that other relevant authorities (such as the ICAC) may take.
Continued enforcement on conflicts of interest
In October 2016, the SFC reprimanded and fined FXCM Asia Limited (FXCM, now known as Rakuten Securities Hong Kong Limited) HK$4m for not acting in the best interests of their clients in their Forex practice. This follows similar enforcement actions taken against State Street Global Advisors and BNP Paribas which we reported on during 2016. The level of fine in both those cases was also HK$4m.
FXCM had a “no-dealing desk” for clients, displaying prices from the interbank market where Forex is traded. Clients could place an order and FXCM would execute that order directly with providers in the market. Three possible outcomes could occur:
- FXCM achieved a price equal to client’s request (No Slippage)
- FXCM achieved a higher price than client’s request and kept the difference (Positive Slippage), or
- FXCM achieved a lower price than client’s request and the client bore the difference (Negative Slippage).
Over a period of four years between 2006 and 2010, FXCM retained a total of US$1.45m from Positive Slippage. The SFC found that the asymmetric treatment of the Positive Slippage and Negative Slippage was unfair to FXCM’s clients. In particular, the SFC concluded that by engaging in such asymmetric treatment and not giving the best available prices to clients, FXCM was in breach of General Principal 1 (honesty and fairness), General Principle 2 (diligence), paragraph 3.2 (best execution) and paragraph 3.10 (best interests of clients) under the Code of Conduct.
The SFC also found that FXCM made inaccurate representations to its clients (informing them that FXCM would execute at the order at the “best price available”) and lacked proper internal controls to ensure its Forex practice was in compliance with regulations.
Clarity on enforcement approach under the OTC Derivatives Regime
In September 2016, the HKMA published a Guideline explaining how it intends to exercise its powers in respect of ordering a pecuniary penalty under the Over-the-Counter Derivatives Regime (commenced in April 2014) for breaches of mandatory reporting, clearing, trading and record keeping obligations.
Although the maximum level of fine that can be ordered by the HKMA is three times the amount of the profit gained or loss avoided, the HKMA explained that it will not automatically connect the pecuniary penalty with the amount of profit gained or loss avoided. Instead, the HKMA will take into account various other factors, such as:
- the financial resources of the person subject to disciplinary action (the penalty is not intended to put the person in financial jeopardy)
- nature, seriousness and impact of the contravention (unsurprisingly, the more serious or frequent the contravention, the larger the penalty)
- whether the contravention reveals systemic weakness of management systems or internal controls
- whether the contravention was intentional, reckless or negligent
- whether the contravention caused loss to any other person or benefited the person subject to disciplinary action, and
- whether any remedial steps were taken since the contravention.
Enforcement activities (Reproduced from the SFC quarterly report July - September 2016)
(I) Enforcement activities
(II) HKMA complaints volume tracker (September to December 2016)*
|Cases received relating to conduct issues
|Cases received relating to service quality issues or commercial dispute
|Total complaint cases received
* Obtained from the HKMA’s press releases
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