In December 2017, the Process Review Panel (PRP), tasked to ensure fairness and consistency in the operation of the Securities and Futures Commission (SFC), published its annual report for 2016-17.1 The PRP’s report provides an interesting insight into the workings of the SFC. We discuss some of the PRP’s findings and highlight those areas where the SFC may change its approach.
Slow Investigation Times: Shift in Approach
The PRP commented on the positive effect of better communication with mainland regulators, other regulatory bodies, the Department of Justice (DoJ), and outside advisers and counsel to improve SFC investigation times. The PRP noted in particular that following the Memorandum of Understanding (MOU) between the SFC and the DoJ on 4 March 2016, there was a significant reduction in turnaround time for advice from the DoJ to the SFC on prosecution cases.
However, the PRP have suggested that the SFC streamline its process and procedure in disciplinary and enforcement cases to better expedite investigations.
The intention is to avoid further examples of long delays: in one case reviewed by the PRP, SFC investigators took a year to collect and examine evidence, another year to review and prepare an evidence matrix for referral to SFC disciplinary officers, and another year for the SFC disciplinary officers to review the evidence matrix and prepare a Notice of Proposed Disciplinary Action (NDPA).
- The SFC reiterated its intention to move from a "try-to-do-everything" approach to a "focused" approach targeting key risk areas. This is exemplified by its creation of four permanent and four temporary specialist enforcement teams in 2016.
- The SFC also intends to adopt a "One SFC" approach, through which it hopes to increase coordination within the SFC and to use its full regulatory toolbox to fulfil its functions.
- As part of the "One SFC" approach, in July 2016 the SFCestablished a cross-divisional working group, "ICE", involving the Intermediaries Division, the Corporate Finance Division, and the Enforcement Division in order to achieve closer collaboration and better efficiency at an operating level.2
Picking the Right Cases: Resource Allocation
The PRP recommended that the SFC streamline its process and allocate resources in an effective manner. The PRP noted in particular that the SFC would investigate alleged misconduct based on information published on "open blogs" that may have information in an unverified or informal form. Bearing in mind limited resources, the PRP asked if the SFC intended to investigate every allegation in such "open blogs" or the media and, if not, how the SFC would select cases for enquiry.
- The SFC has implemented a new process in order to determine work allocation. A new case intake team will review the importance of a case based on a set of agreed criteria aligned with the priorities of the SFC, its divisions, and investigatory and enforcement practicalities. Each case will be allocated a "score" through this process. The case intake team will then recommend to the Enforcement Steering Committee whether or not to investigate a case based on the score allocated.
- The SFC also intends to adopt a "frontloading approach". It will give the market clear messages to encourage market participants to change their behaviour and therefore adopt a preventative approach to regulation. It will try to express its priorities and expectations to the industry regularly and not just in the context of a suspected breach or disciplinary action. For example, the SFC notified the industry in October 2016 that it would conduct a cybersecurity thematic review on brokers’ internet or mobile trading systems, and subsequently set out the common deficiencies and vulnerabilities that the SFC would focus on. The SFC will also instigate more thematic reviews to address specific and more complex risks in the market.
Better Survelliance systems: USe of technology
The PRP recommended that SFC should have access to, and use, better market surveillance systems. It referred to one case where an individual had been conducting voluminous matched trades through a small number of securities firms to create an active trading environment with a view to inducing further trading from market participants. The trading volume of the stock was inflated more than 400% within a month. The extreme change in trading volume should have been an obvious signal of possible market manipulation and yet the SFC’s surveillance system failed to pick it up in a timely manner.
- The SFC has resolved to constantly develop and enhance trade alerts and deploy new technologies in order to better detect irregular trading activity.
- These efforts will be supported by a new "Case Management Dashboard" to facilitate senior management’s monitoring of case progress within the Enforcement Division.
Exemptions under Part XV: Introduction of the Application Lapse Policy
The PRP reviewed an application seeking exemption from the disclosure of interests rules under the Securities and Futures Ordinance (SFO). The application took nearly a year to process, including an 11 month wait for the applicant to confirm the date of listing and submit the required information. The PRP recommended that the Corporate Finance Department of the SFC take proactive steps to reduce delays by introducing a policy by which applications would lapse.
- The SFC launched an application lapse policy effective in October 2017.3 Under this policy, applications seeking an exemption under the SFO that do not contain all relevant information will lapse within six months subject to the discretion of the SFC. Once the application has lapsed, the applicant will need to make a fresh application and pay the application fee again.
Licensing: Risk Based Approach and better monitoring of case progress
The PRP expressed concern that the resources of the SFC were being unduly spent processing licensing applications with missing information. The PRP asked the SFC to elaborate on its criteria on when an application should be returned to the applicant and to provide a comprehensive checklist of the required documents for each type of application. Further, the PRP raised concerns about the monitoring of applications by case officers, supervisors, and senior management, noting that a number of cases had taken longer than the SFC’s performance pledge to complete.
- The SFC noted that it had reviewed its guidelines on the return of applications. The revised guidelines were incorporated into the Licensing Handbook, the latest version of which was published on 21 April 2017. The SFC has also updated the information on its website to provide more guidance on how to apply for a licence.
- The SFC is also reviewing and working on a risk assessment approach with a view to identifying early potential areas of risk in an application. Based on this assessment, the application will be assigned to staff with the appropriate knowledge and experience of handling such an application. Applications that are more complex will be brought to the attention of Licensing Directors for closer monitoring and guidance to ensure that additional resources are allocated to complex cases.
A number of themes identified by the PRP in previous years are reflected in the current publication, particularly those relating to efficiency, speed of processes, and enforcement action.
In particular, a concern over slow investigation times is not new. The apparent focus of the SFC from its former approach to "big ticket" matters such as corporate fraud and misfeasance cases may, however, be having a real impact on the SFC’s existing case load. As noted in the SFC’s quarterly report for July-September 2017, the number of section 182 notices and the number of SFC investigations started were each down by 39% from the previous year.4
That does not mean that the SFC should be considered a regulator with a more benign attitude to its regulatory and enforcement responsibilities than that it has exhibited in the past.
This is underlined by the use of a "frontloading" approach. The adoption of such an approach predates the PRP report; the SFC’s Chief Executive Officer made express reference to it in a speech in July 2017. Examples include a circular issued in September 2017 to licensed corporations engaged in asset management identifying potential regulatory concerns5 and the SFC’s Compliance Bulletin published in December 2017 providing guidance to market practitioners on managing conflicts of interest.6 The SFC Compliance Bulletin in particular is intended to be a regular publication to provide guidance on the SFC’s regulatory and supervisory priorities. Indeed, figures from the quarterly report showing that the number of press releases, consultation papers, industry-related publications, codes and guidelines, and circulars to industry in the six months ending on 30 September 2017 has increased significantly compared to the same period last year.
Similarly, the SFC has previously conducted thematic inspections on issues ranging from selling practices of Chapter 37 bonds to alternative liquidity pools, best execution and client facilitation, anti-money laundering, placing of GEM IPO stocks, and cyber-security. The SFC has also recently announced that it has initiated a thematic review of prime services.
We anticipate that there will be a greater emphasis placed by the SFC on these thematic reviews and advanced notice being provided ahead of conclusions being published.
Keeping abreast of such papers will be essential for those institutions who wish to gain insight into the on-going priorities of the SFC.
Against this background, we expect the SFC to remain very active in its regulation of the securities and futures markets and to continue to extract noteworthy resolutions from institutions that are found to have breached applicable laws, rules, or guidelines