Summary

2014 was another busy year for the Securities and Futures Commission (SFC).  It remained active in bringing disciplinary, civil and criminal actions against market wrongdoers, and using its statutory powers to protect investors’ interests.   

We expect the SFC’s level of activity to further increase in 2015, particularly with the implementation of the Shanghai-Hong Kong Connect program and other cross border activities. 

Numbers at a glance

Based on publically available information, in 2014, the SFC referred to 128 enforcement actions, representing around a 56.1% increase from 2013.

Similar to 2013, the SFC continued to impose either a fine or license suspension in almost all disciplinary actions.  Of the 53 disciplinary actions concluded by the SFC in 2014, all but one led to either a revocation, suspension or a fine.

The amount of fines imposed by the SFC and by the courts totalled approximately HK$62.8 million, representing an increase of over 52% from 2013.

The SFC continued to seek compensation/restoration orders from the courts.  A total of nine compensation/restoration orders were sought by the SFC or granted by the courts in 2014, involving over HK$2.16 billion, subject to the courts’ final determination on the amount of compensation to be awarded in some cases.

Click here to view table

Corporate governance

Sponsors in the spotlight

The SFC continued to be active in monitoring the work conducted by sponsors in listing applications.  However, the SFC’s emphasis on this area does not appear to have been fully reflected in the number of public enforcement actions it undertook during 2014, possibly due to a time lag in concluding these investigations in light of the significant volume of materials involved.  In 2014, we saw the SFC take enforcement action in two sponsor related cases, both in relation to listings which took place in 2009. 

We expect the SFC to continue to be vigorous in combatting any sponsors’ failures to help ensure the integrity of the Hong Kong’s initial public offering market.  In this regard, the SFC has issued its Supplemental Consultation Conclusions on the Regulation of IPO Sponsors – Prospectus Liability Sponsors in August 2014, where the SFC confirmed that it considered that sponsors were among the persons who have potential civil and criminal liability under the Companies (Winding Up and Miscellaneous Provisions Ordinance) (CWUMPO) for untrue statements (including material omissions) in a prospectus.   The SFC has also made it clear that it will have “no hesitation in relying on the existing criminal liability provisions in the CWUMPO in appropriate cases”.

Disclosure by listed companies

We have not yet seen the first case taken by the SFC against listed companies and/or their directors for breaches of the statutory disclosure regime that took effect in January 2013.  However, the SFC has commenced proceedings in the Market Misconduct Tribunal (MMT) against CITIC Limited and its former directors, alleging that they  violated section 277 of the SFO for disclosure of false or misleading information on CITIC’s financial position arising from losses incurred by CITIC over its investment in leveraged foreign exchange contracts. The SFC has also completed its seven-year investigation into Greencool Technology Holdings Limited, which resulted in the company’s former chairman and senior executives facing proceedings in the MMT for alleged overstatements of Greencool’s sales, profit, trade receivables, bank deposits and net asset value and understatement of its bank loans in annual reports and results announcements released between 2001 and 2005.  In both the CITIC and Greencool cases, the SFC also concurrently sought remedial orders from the court under section 213 of the SFO for compensation of relevant shareholders of those companies.  

Directors’ conduct

The SFC continued to seek disqualification orders against listed company directors for breaches of directors’ duties.  The relevant directors were also asked to repay the companies for loss or damage caused or profits made by their alleged misconduct. In March 2014, the former chairman of GOME Electrical Appliances Holdings Limited and his wife agreed to compensate GOME in the amount of HK$420 million to rectify their breaches of duties as GOME’s directors.  They also agreed to take a number of other remedial steps for full and final resolution of the SFC’s proceedings against them under section 213 of the SFO. 

We expect directors’ conduct to remain a key focus area on the SFC’s enforcement agenda, with the SFC being ready and willing to utilise its powers under section 213 and/or section 214 of the SFO where appropriate.  The SFC has made clear that it will be examining the ethics, integrity and professionalism of organisations and their managers – they will be looking for greater integrity and accountability and want to ensure senior managers are setting an appropriate “tone at the top”.

Attacks on listed companies

In recent years, overseas research companies have been monitoring PRC based listed companies, publishing negative research reports claiming to be based on their own due diligence findings.  Share prices of listed companies subject to these reports typically fall significantly after publication. 

In December 2014, the SFC instituted proceedings in the MMT against the head of Citron Research (a US-based publisher of research reports on listed companies) for allegedly publishing a report on a Hong Kong listed company that contained false and misleading information, while short-selling the company’s shares in advance of the publication for profit. 

Ongoing monitoring by the SFC of the circulation of information on listed companies that creates market volatility will likely continue and there is now clear precedent for taking action against those believed to be involved in creating a false market in the relevant securities.  

Cross border issues

In May 2014, the CFI ordered Ernst & Young (EY) to produce to the SFC specific accounting records relating to its work as the reporting accountant and auditor for a listing applicant in Hong Kong. The production of such records had been resisted by EY on grounds that such records were not in its possession (but in the possession of its PRC agent), and that such records contained state secrets restricting production under PRC law.  

With the implementation of the Shanghai-Hong Kong Stock Connect pilot programme and increased cross border activities between Hong Kong and the PRC, we expect issues arising from the differences in legal and regulatory regimes as well as the investigative approach of the SFC and CSRC to be further tested in 2015.  

During 2014, we also saw the conclusion of the HKMA’s investigations in relation to the setting of HIBOR and foreign exchange trading operations in Hong Kong.  While these investigations have not resulted in the imposition of significant fines (unlike other jurisdictions including the UK and the US), the HKMA recommended that relevant financial institutions take  certain remedial action, including taking appropriate disciplinary action against individuals who may have engaged in misconduct, enhancing internal controls and conducting independent reviews of certain business operations.

Innovation

The evolution and continuous growth of electronic trading platforms for securities and other financial products has posed new regulatory challenges for regulators. 

The SFC has responded by introducing new requirements under the SFC’s Code of Conduct on algorithmic trading, which came into effect on 1 January 2014.  In February 2014, the SFC issued a consultation paper on the regulation of alternative liquidity pools (ALP) (also known as “dark pools”). The SFC proposes to refine and standardize the regulatory obligations imposed on all ALP operators licensed in Hong Kong by introducing a uniform set of requirements under the SFC’s Code of Conduct. 

It is expected that algorithmic trading and dark pools will continue to be kept under close scrutiny, and that the SFC will continue to develop and refine its regulatory rules to cater for new innovative trading methods and platforms. 

Selling of investment products

Since the outbreak of the financial crisis in September 2008, the SFC has been focusing on increasing investor protection, particularly for individual professional investors.  In September 2014, the SFC issued its consultation conclusions on the proposed amendments to the professional investor regime.  One key change under the new regime (which will come into effect in March 2016) is that intermediaries can no longer waive suitability and other requirements targeted at investor protection under the SFC’s Code of Conduct when dealing with individual professional investors.  Corporate professional investors will also need to have performed a principles-based assessment before those requirements can be waived.

The SFC has also concluded that a new provision should be added to its Code of Conduct that precludes intermediaries from including in client agreements terms which are inconsistent with the Code of Conduct obligations, or misdescribe the active service to be provided to clients.  The implementation date of this new requirement is yet to be fixed, pending further consultation by the SFC in relation to other proposed amendments to client agreements.  These other amendments include the addition of a term in all client agreements whereby intermediaries will confirm that if they solicit the sale of or recommend any financial product, that product must be reasonably suitable for the client, having regard to the client’s financial situation, investment experience and investment objectives.  These proposed amendments, when implemented, will likely affect the manner in which the court will consider mis-selling claims going forward.  

The landscape going forward

In 2015, we expect that the SFC will continue to utilize powers available to it under the SFO to combat any infractions.  We expect to see:

  • disciplinary actions against sponsors, and possible civil or criminal actions against sponsors under the Companies Ordinance;
  • the first MMT decision concerning the timely, accurate and/or even disclosure of inside information by listed companies;
  • enforcement action addressing research firms’ attacks on listed companies; and
  • a continued focus on organisational culture, senior management’s responsibility and “tone at the top”.