Shift of focus from listed companies and directors to financial institutions
Based on publicly available information, whilst there was a decrease in both the total number of enforcement actions as well as the number of enforcement actions against individuals (of around 48.6%), the number of enforcement actions against firms increased by over 57%. 2015 saw a shift of focus from listed companies and directors to financial institutions, with the Securities and Futures Commission (SFC) highlighting a number of internal control failings in financial institutions.
Larger fines compared to 2014
In 2015, the SFC imposed either a fine or license suspension in all disciplinary actions; there were no examples of a public censure being the only form of punishment meted out.
The amount of fines imposed by the SFC and the courts totalled approximately HK$71 million, representing an increase of almost 13% from 2014. Hefty fines were imposed on a number of financial institutions:
- a fine of HK$11 million was imposed on a financial institution for failing to report cross trades to the Stock Exchange;
- a fine of HK$15 million was imposed on a financial institution for dark liquidity pool-related failures (see below for further details); and
- a combined fine of HK$30 million was imposed on a financial institution for various regulatory breaches and/or internal control failings.
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Responsible officers / Senior Management
Mr James Shipton, the SFC’s Executive Director of Intermediaries, continued to express the SFC’s views on integrity in financial markets and the SFC’s enhanced supervisory approach, suggesting that the SFC will put more emphasis on senior management responsibility. In James Shipton’s words: “It is no longer enough that firms merely provide the existence of a control system, but need to proactively demonstrate that it is effective and working in practice. Accordingly, we expect firms to move away from a “tick-box” approach to compliance and controls.”
During 2015, the SFC announced enforcement action against the former Chief Executive Officer (CEO) of Ping An of China Securities (Hong Kong) Company Limited (Ping An) for contributing to Ping An’s serious internal control deficiencies, including acting as a nominee in a number of suspicious transactions and failing to ensure that sufficient anti-money laundering procedures and training were in place.The SFC also highlighted an attempt by the CEO to abdicate responsibility and offload blame to subordinates when the deficiencies were uncovered.
We expect senior management responsibility to continue to feature in global enforcement trends, with the new Senior Managers and Certification Regime coming into operation in the UK for the banking sector on 7 March 2016, with a proposed extension to cover all UK authorised financial institutions in 2018. Key features of the new regime include the requirement to submit documentation on the scope of responsibilities of senior managers to regulators, and the imposition of a statutory duty on senior managers to take reasonable steps to prevent regulatory breaches in their areas of responsibility. In addition, the regime will require banks to establish an internal approval framework for non-senior management individuals who perform a function that may cause significant harm to the bank or its customers.
Similarly, in the US, there was a clear sentiment in favour of an increased focus on the prosecution of individuals in 2015. The Department of Justice issued a policy statement in November 2015 which called for a greater focus on individual accountability for corporate wrongdoing. In particular, the policy statement made clear that a company must provide all relevant facts relating to individuals responsible for misconduct to receive credit for cooperation.
In 2015, we saw the first case taken by the SFC against a listed company and its directors for breach of the statutory disclosure regime introduced on 1 January 2013. In July 2015, the SFC commenced proceedings in the Market Misconduct Tribunal (MMT) against AcrossAsia Limited (AcrossAsia), a company listed on the Growth Enterprise Market Board, as well as its Chairman and CEO for failing to disclose highly sensitive inside information as soon as reasonably practicable. At issue was allegedly late disclosure of insolvency-related proceedings in Indonesia against AcrossAsia for failure to pay money to its subsidiary. The substantive MMT hearing is scheduled to be held in late 2016.
The long awaited trial of the MMT case against CITIC Limited and its former directors also began in November 2015. The SFC alleges that the company and its former directors violated section 277 of the Securities and Futures Ordinance (SFO) by disclosing false or misleading information on CITIC’s financial position at a time when the company was suffering from significant potential losses over its investment in leveraged foreign exchange contracts. The hearing was adjourned to the middle of 2016 and the judgment is expected to be handed down towards the end of this year.
In January 2016, the Court of First Instance handed down a landmark ruling on the offence of using fraudulent or deceptive schemes in securities transactions under section 300 of the SFO. The judgment has extended the territorial reach of Hong Kong securities law beyond insider dealing of Hong Kong listed securities. Insider dealing of overseas listed securities in Hong Kong may now be pursued through section 300 so long as the fraudulent or deceptive conduct took place in Hong Kong.
Electronic platforms / dark pools
Alternative liquidity pools (ALPs) (also known as “dark pools”) were kept under close scrutiny in 2015. In 2015, the SFC fined two financial institutions for a total HK$18 million for failures in relation to its dark pool trading services. We have also seen enforcement action taken in other jurisdictions in relation to dark pools, with financial institutions paying hefty fines for settlements with the US federal and state regulators for charges that they misled investors in their dark pool.
In May 2015, the SFC released its consultation conclusions on proposals to enhance and unify the regulatory regime for ALPs. The enhanced regulatory regime, aimed at providing a level playing field for all ALP operators in Hong Kong, came into effect on 1 December 2015, with the introduction of a new paragraph 19 and Schedule 8 of the Code of Conduct for Persons Licensed or Registered with the Securities and Futures Commission. In summary, features of the enhanced regime include: (a) no individual investors are allowed to use ALPs; (b) client facilitation orders are treated as proprietary orders and therefore will have a lower execution priority in ALPs than agency orders; and (c) no mandatory “opt-in” requirement before client orders are routed to ALPs, but ALP operators should permit clients to opt-out.
In November 2015, the SFC also released a consultation paper on proposals to update the regulatory regime for automated trading services (ATS). The existing ATS Guidelines have not been amended since they were first introduced in 2003. A review is therefore needed in light of regulatory and other developments over the last 12 years, and to take into account the SFC’s experience of regulating ATS and to bring the Guidelines in line with major changes in the international regulatory standards and best practices.
Private banking and selling practices
In its circular dated 6 January 2015, the Hong Kong Monetary Authority (HKMA) stressed that its 2015 work plan was to place supervisory focus on institutions’ compliance with required standards on the selling of investment products. In line with its work plan, the HKMA conducted onsite inspections at various private banks, with a focus on areas such as product due diligence, assignment of product risk rating, training to sales staff , suitability assessment, the sale process and internal controls and monitoring. We expect the HKMA to continue its scrutiny over private banks’ selling of investment products.
In March 2015, the Court of Final Appeal made a ruling in favour of Pacific Sun Advisors Limited and its director who had been prosecuted with the offence of issuing unauthorised advertisements containing an invitation to the public to acquire securities or interests in collective investment schemes under section 103 of the SFO. The case hinged on the interpretation of the exemption from authorisation which applies if the securities are intended to be disposed of only to professional investors. The Court of Final Appeal held that the exemption may apply even though it is not expressly stated in the advertisement that the offer was only intended for professional investors, so long as there are mechanisms in place to ensure that the products were sold to professional investors only. As a result of this ruling, the SFC is exploring the possibility of proposing amendments to section 103.
In 2016, the private banking sector will be faced with important regulatory changes, with the new Professional Investors Regime coming into force in March 2016 and the review and revision of client agreements by financial intermediaries to ensure compliance with new SFC requirements to be implemented in 2017.
In July 2015, the HKMA instituted its first ever disciplinary action under the Anti-Money Laundering and Counter-Terrorist Financing (Financial Institutions) Ordinance (AMLO). The enforcement action was taken against the State Bank of India’s Hong Kong branch for insufficient internal controls to ensure compliance with the AMLO, including failures to:
- carry out customer due diligence requirements before establishing business relationships;
- continuously monitor its business relationships with customers;
- establish and maintain effective procedures for identifying whether its customers or their beneficial owners were politically exposed persons; and
- establish effective compliance procedures for its obligations under the AMLO.
On the back of these internal control failings, the State Bank of India’s Hong Kong branch was issued with a formal reprimand, fined HK$7.5 million and required to submit a report on the sufficiency and effectiveness of its remedial plan to address the contraventions of the AMLO.
Looking ahead, the HKMA has declared that there are currently several ongoing AML investigations and it is actively hiring to grow its AML investigation and enforcement teams.
New competition law regime in Hong Kong
The Competition Ordinance entered into full force on 14 December 2015 and is the first economy-wide Hong Kong competition law. The Competition Ordinance has the potential to change some of the ways business is carried out in Hong Kong; in particular, financial institutions are not exempt from compliance with the Competition Ordinance on the basis that they may be subject to other regulatory regimes.
Of particular note for financial institutions is the uncertainty surrounding the status of the leniency (whistle-blowing) regime in Hong Kong which may operate as a “one and done” regime. In other words, the first leniency applicant is offered immunity while subsequent applicants receive no guarantee of any fine reduction or other lenient treatment in exchange for cooperation with an investigation. In that context, when applying for leniency for anti-competitive conduct in relation to products marketed on a cross-border basis (including Hong Kong), applying for leniency early in Hong Kong will be critical.
The landscape going forward
In 2016, we expect to see:
- continued focus on corporate disclosures, with new investigations into, and enforcement actions against, listed companies as well as work conducted by sponsors of initial public offerings;
- anti-money laundering related investigations;
- implementation of proposed amendments to the Professional Investors Regime and review and revision of client agreements;
- results of the CITIC Limited MMT proceedings;
- how the introduction of the Competition regime will affect the SFC’s approach to regulating conduct;
- more focus on senior management responsibility and increased enforcement against individuals; and
- a potential change in direction/focus with the appointment of a new Head of Enforcement at the SFC.