The Securities and Futures Commission (“SFC”) recently reported two disciplinary actions, i.e. Securities And Futures Commission v DFRF Enterprises LLC and Others  HKCU 2092 (the “DFRF Case”) and Securities and Futures Commission v Maxim Capital Ltd and Another  HKCU 2621 (the “Maxim Case”), both of which show how the SFC tackled securities fraud.
The two cases share a lot in common in that both operate deceitful, if not false, investment traps. The DFRF Case is one of the typical global “Pyramid and Ponzi Scheme” in which the fraudster purports to operate a business or an investment which promises high returns to victims with little or no risk at a later pay date and victims are persuaded to recruit other people to participate in the business or the investment. Whereas, the Maxim Case can be categorized as the “Boiler Room Fraud” where a bogus stockbroker cold-calls investors and forces or persuades them into buying worthless shares.
No matter what these securities frauds are called, it can be observed that they are swiftly dealt with by the SFC, primarilyresorting to legal weaponry available under sections 109, 114 and 213 of the Securities and Futures Ordinance (Cap 571 of the Laws of Hong Kong) (the “SFO”).
In the DFRF Case, from about October 2014, DFRF Enterprises LLC and DFRF Enterprises, LLC (“DFRF”), and its founder and associates, represented to the outside world that DFRF operated gold mines and reserves in Mali, Brazil and the USA. They invited individuals around the world to invest in DFRF by acquiring “membership units”. Existing DFRF members would extend memberships to prospective investors – the referring member would receive a 10% commission of the initial subscription fee of the newly-joined member and there would be a further 10% to be paid on any re-investment of the returns by the newly-joined member. From about late March 2015, DFRF claimed that it was registered with the US Securities and Exchange Commission, its stocks were about to become publicly traded and current investors may convert their membership units into stock options at US$15.06 per share. Receipts from investors soared to more than US$4.3 million and the high rate of investment continued in April and May 2015. Subsequently, it was discovered that: (1) there were no gold mines, gold reserves or gold operations as alleged; (2) all monies received from the members were dissipated to DFRF’s founders and associates; and (3) most members did not receive any return – whilst some of them did receive a small amount, it was apparently coming from investments paid by other members.
In the other Maxim Case, Maxim Capital Limited (“Maxim Capital”) and some unknown person(s) purporting to carry on the related securities dealing or asset management business known as Maxim Trader (“Maxim Trader”) were sued. Prospective investors were solicited to become investors of a fund called “Maxim Fund”, which was purportedly operated and managed by the Maxim fraudsters. They were also encouraged to open a Maxim Trader account. After investors deposited funds, whether through the Maxim Trader accounts or not, the funds would be deposited into the Maxim Fund and investors would sign up for investment packages typically for 18 months. The alleged investment returns ranged from 3 to 8% of the investment principals. Investors who successfully referred new investors were awarded referral bonus of 6 to 10%. Since about early 2015, the investors could no longer receive their monthly return or credit balance from their Maxim Trader accounts as usual. Suddenly, it was announced online that all the investors’ fund would be converted into shares of a shell company at US$0.8 per share, and the fraudsters claimed that the shell company would be listed on the New York Stock Exchange in the first quarter of 2016. The listing never happened, which meant investors were left with some worthless shares.
DFRF and Maxim’s respective liability
Both DFRF and Maxim Capital were found to have contravened sections 109 and 114 of the SFO. By way of background:
1. Section 109(1) of the SFO provides that a person commits an offence by knowingly issuing an advertisement in which they held themselves out as being prepared to carry on the regulated activity whilst unlicensed and unregistered.
2. Section 114(1) of the SFO provides that a person commits an offence by either actually carrying on a business in a regulated activity (section 114(1)(a) of the SFO) or holding out as carrying on businesses in regulated activities (section 114(1)(b) of the SFO) in Hong Kong whilst unlicensed and unregistered and without reasonable excuse.
Section 114 of the SFO
In Hong Kong, “advising on securities” is a Type 4 regulated activity and a license should be obtained from the SFC to conduct the same:
In the DFRF Case, the breadth of the meaning and definition of “advising” and “securities” allows the SFC to easily capture the misconduct of fraudsters. The solicitation of subscribing into the membership units of DFRF does not by itself constitute “advising on securities”. But persuading the members on the option of converting their membership units into shares of DFRF to be listed in the USA and explaining the benefits in exercising their options do. The emails sent to the members inviting them to ask questions about exercising the options indicated DFRF’s inclination to give further advice. Promoting and publicising the purported options and shares conversion, which induce current as well as prospective members to invest in securities was counted towards “advice”.
Similarly, Maxim Capital and Maxim Trader have never been licensed by the SFC to carry on any regulated activities. Again, on top of what had been stated above, section 114 of the SFO holds two limbs which make it wide enough to cover potential misconduct. Maxim Capital and Maxim Trader had “held themselves out by representation” to purportedly offer asset manager services, i.e. Type 9 regulated activities. Further, the management and handling of investors’ funds, or their Maxim Trader’s account, or at least holding out that it would manage these funds by conducting currency exchange, buy, sell or hold securities and etc, constituted “advising on securities”, i.e. Type 4 regulated activities.
Section 109 of the SFO
With the wide definition and interpretation of “advertisement”, both DFRF and Maxim were found to have contravened section 109(1) of the SFO. “Advertisements” do not bear the traditional and narrow meaning (as if in traditional newspaper generally available to public), it shall suffice if it bears the “promotional” element made to a group of persons, i.e. the investors in these cases. In both DFRF and Maxim’s Case, all the investment opportunities were made through representations in websites, social medial, seminars and meetings. The fact that they all served to promote financial services, i.e. the regulated activities, the fraudsters purported to provide, made it possible to constitute as “issuance of advertisement”.
Remedies granted under section 213 of the SFO
A list of remedies under section 213 of the SFO will be available once the Court rules that there is a breach of any provisions in the SFO. In these two cases the Court ruled that the fraudsters had breached sections 109 and 114 and therefore made the following orders:
1. Prohibitory injunction: For the fullest protection of the investing public, in both DFRF’s Case and Maxim Case, traditional injunctions are granted against the fraudster to restrain them from contravening or continuing to contravene sections 109 and 114 of the SFO.
2. Restitutionary order: In both disciplinary actions, interim injunctions were sought and granted at an earlier stage to freeze all the relevant bank accounts. The monies seized from these accounts will be used to compensate the victims.
3. Appointment of administrators: Professional administrators were appointed as an attempt to recover as much money as possible, so as to give effect to the restitutionary order, i.e. the distribution.
The two cases above illustrated how the SFC uses different provisions within the SFO to compensate victims of fraudulent investment schemes, especially when the fraudsters are nowhere to be found. At this juncture, it would be interesting to observe whether the proposed amendments to the SFO (in particular section 213 of the SFO), once implemented, would be able to further enhance its protection to the investors in Hong Kong.