Setting the scene: SFC recalibrating enforcement priorities
With a new head of enforcement came a reinvigorated approach to enforcement for the Securities and Futures Commission (SFC). In his first published speech after he became Executive Director of Enforcement in May 2016, Thomas Atkinson explained the key priorities for the SFC’s Enforcement Division. Listed company-related issues are top of the SFC’s priorities. The SFC has indicated that it is concerned about risks posed by corporate fraud and misfeasance, in addition to intermediary misconduct and market misconduct. We explore below how these concerns have been reflected in enforcement actions.
In the same speech, Mr Atkinson revealed that new, specialist enforcement teams have been established to focus on the identified priority areas, and new cases will be prioritised so that resources will be allocated to “high impact” cases in those areas. This marks a move towards a more focused strategy, and combined with the increasing complexity of cases, has been reflected in a fall in the number of investigations completed within the seven-month target previously set by the SFC. Temporary teams have also been formed to address areas where the SFC believes there are serious risks, for example misconduct by IPO sponsors, anti-money laundering (AML), the Growth Enterprise Market (GEM), and the selling (and mis-selling) of investment products. Mr Atkinson also emphasised that the SFC intends to “vigorously exercise its powers” to hold individual directors and senior executives responsible for their companies’ failings, a message that has since been reinforced through the SFC’s new measures to strengthen senior management accountability in Licensed Corporations, including a new Managers-in-Charge regime, which has generated much discussion within the financial industry.
Individual and senior management responsibility
According to publicly available statistics, the number of SFC enforcement actions against individuals has increased by around 55%, while the number of SFC enforcement actions against financial institutions and companies has dropped by around 24%, when compared with the previous year. Here is a snapshot of the SFC enforcement actions in 2016, as compared with 2015:
No. of press releases
(No. of individuals/firms)
No. of enforcement actions against individuals
No. of enforcement actions against firms
Average amount of fines across individuals and firms
The trend of increasing enforcement focus on individuals is consistent with repeated reminders from Hong Kong regulators over the past few years that management of financial institutions must instil the “right culture” within their organisations and lead with the right “tone from the top”, failing which individual directors and executives would be held personally responsible for any non-compliance by their firms. Focus on individual wrongdoers also addresses the regulators’ concern that some financial institutions may have regarded financial penalties as part of “the cost of doing business”. This point was highlighted by Meena Datwani, head of enforcement and AML of the Hong Kong Monetary Authority (HKMA), at the SFC’s 2016 Regulatory Forum.
The regulatory agenda for individual and senior management responsibility was highlighted in December 2016 when the SFC introduced measures for augmenting the accountability of senior management of Licensed Corporations. Those measures include clearer guidance about who forms “senior management”, senior management’s roles and responsibilities, and new requirements for a Licensed Corporation to appoint “Managers-in-Charge” to be responsible for managing its key functions, and to submit to the SFC detailed information about its management structure and internal reporting lines (Reporting Lines Document). The revised regime, which will come into operation on 18 April 2017, will bring personnel who may not previously have been widely considered to be at risk of SFC disciplinary action (e.g. those who head risk management, compliance, finance and accounting, and information technology) more firmly into focus, even if they do not hold a personal SFC licence. This, and the fact that the SFC can more easily link a failing of a Licensed Corporation to specific Managers-in-Charge, directors and/or Responsible Officers through the Reporting Lines Document, means we can expect more enforcement against individuals and senior management in future.
In 2013, a new listed company inside information disclosure regime came into force. The first three enforcement cases before the Market Misconduct Tribunal (MMT) have now been concluded, and the SFC was successful in all of them. In the first case, concluded in November 2016, the MMT held that AcrossAsia Limited, its CEO and former chairman had failed to disclose promptly an overseas petition which had been filed against AcrossAsia and a related summons, in contravention of Part XIVA of the Securities and Futures Ordinance (SFO). The MMT fined AcrossAsia and the two individuals a total of HK$2 million. The AcrossAsia decision was followed in February 2017 by the MMT’s ruling against Mayer Holdings Limited and nine of its senior executives, including three former independent non-executive directors and one non-executive director. The inside information in that case concerned the resignation of the company’s auditors, and various audit issues that the auditors had repeatedly flagged with the company and its management but which were not appropriately addressed. In the third case, the MMT found that Yorkey Optical International (Cayman) Limited, its CEO and Financial Controller failed to disclose promptly material losses suffered by the company, and the failure had caused investors to suffer a notional loss of approximately HK$1.5 million. The MMT findings from these cases will provide additional guidance for interpreting various Part XIVA provisions in future cases. For example, in AcrossAsia, the MMT considered when disclosure would be regarded as having been made “as soon as reasonably practicable”, and concluded that on the facts of that case, a listed company would be expected to announce the information in question once it has promptly obtained legal advice enabling a rational and comprehensive understanding of the company’s legal position.
The SFC also continued to target another focus area in corporate disclosure: false or misleading disclosure inducing transactions (sections 277 and 298 of the SFO). In December 2016, the MMT found that Greencool Technology Holdings Limited and its senior executives were involved in grossly overstating the company’s net asset value in its annual reports and results announcements, with some of the executives found to have perpetrated a complex and systemic accounting fraud.
Separately, the MMT proceedings in the high profile CITIC Limited case – which commenced in September 2014 and in which the SFC alleges that the company and several of its then directors misled investors regarding the significant investment losses that CITIC had suffered – have completed, with the MMT’s decision expected soon.
Over the past year, the SFC has expressed its concerns about other areas of corporate misconduct (e.g. rights issues and open offers that result in substantial dilution of the interests of non-subscribing minority shareholders), and about significant price volatility in newly listed GEM shares and highly concentrated shareholdings. In January 2017, a joint SFC and Hong Kong Stock Exchange statement expressed “grave concerns” about the latter matters, and was accompanied by a new SFC guideline setting out the standards of conduct expected of sponsors, underwriters and placing agents involved in the listing and placing of GEM stocks. Further developments relating to GEM are expected, as David Graham, Chief Regulatory Officer and Head of Listing at Hong Kong Exchanges and Clearing Limited, noted that the joint statement represents “an initial step to address some of the current concerns with GEM IPO placings”, while regulators “continue to work on a broader GEM reform”.
The SFC has continued to rely on its powers under section 214 of the SFO to seek disqualification orders against listed company directors over allegations of breaches of directors’ duties. In December 2016, the Court of First Instance clarified the SFC’s obligations to respondents with respect to the disclosure of evidence in such proceedings. In SFC v Wong Yuen Yee & others (HCMP 241/2015), the Court held that in section 214 proceedings, the SFC is under a “generous” duty to disclose to respondents materials that it has obtained during the course of its investigation, where such materials are relevant to any matter in question in the proceedings (rather than the narrower test of relevance to issues already pleaded). The court had particular regard to the nature and effect of a disqualification order, in that it materially affects an individual’s freedom. It concluded that in proceedings where the respondents face a regulator that controls the investigatory process and has coercive powers to obtain information, the regulator is obliged to be “a fair minded regulator willing if not anxious to make all materials available for potential use in the trial to ensure a just outcome”. Accordingly, this approach can be expected from the SFC irrespective of whether its proceedings are civil or criminal in nature.
In the latest issue of the SFC’s revived Enforcement Reporter, the SFC highlighted its “holistic approach” to tackling misconduct that may have systemic implications. This is particularly relevant to market participants who conduct their businesses through a network of group entities. The SFC explained that where it identifies multiple failings within a company or corporate group, it will consider such failings together to assess whether they are attributable to systemic weaknesses. This approach was evident in:
- an enforcement action in October 2016 against a global financial services provider, where two of its entities were reprimanded and fined a total of HK$5.6 million for multiple regulatory breaches, including unlicensed activities and failure to disclose interests in research reports. Three entities of the same group were reprimanded and fined a total of HK$30 million in December 2015 for systems and control failures in relation to their short selling activities, client facilitation and principal trading business, and dark pool trading services; and
- an enforcement action in August 2016 against a securities unit of a global investment bank, where the institution was reprimanded and fined HK$18.5 million over a range of internal control failures in relation to conflicts of interest, documentation within its electronic trading systems, short selling disclosure, position limits and reporting, and execution of client instructions.
The SFC has indicated that focusing on systemic issues within financial institutions is an effective way to promote a good compliance culture. It is likely that the engagement of independent reviewers will continue to feature in future disciplinary settlements with the SFC, where such reviewers might help in identifying and addressing any remaining systemic deficiencies.
A number of particular hotspots can be identified with respect to intermediary misconduct-related enforcement.
Inherently linked to the SFC’s drive to improve the quality of Hong Kong’s market through improving the standards of conduct of listed companies and listed company directors is the issue of IPO sponsor conduct. The SFC’s August 2016 disciplinary action against Quam Capital Limited for failing to act with due skill, care and diligence when preparing a listing prospectus will likely be followed by other actions, not least given that the SFC has dedicated a temporary enforcement team to addressing this area.
Last year saw two high-profile enforcement actions concerning information disseminated by market commentators.
In April 2016, the SFC reprimanded Moody’s Investors Service Hong Kong Limited and fined it HK$11 million over failings relating to a “red flags” report that it published. This is the first time the SFC has taken action against a credit rating agency since the provision of credit rating services became a regulated activity in 2011. Moody’s report focused on Mainland Chinese companies and identified various companies that were “negative outliers” because of the greatest number of “red flags” which, in Moody’s view, might present governance or accounting risks warranting closer scrutiny. However, the SFC found that Moody’s failed to implement procedural safeguards to ensure the integrity of the report, and that the report itself was materially misleading, confusing and inaccurate in a number of respects. In particular, the SFC found that Moody’s had chosen to highlight the “negative outliers” to make the report “actionable”, although there was no significant correlation between the number of red flags and the companies’ credit risk.
Moody’s challenged the SFC’s findings and proposed penalties before the Securities and Futures Appeals Tribunal (SFAT). The SFAT upheld the SFC’s findings but imposed a lower fine. Interestingly, Moody’s challenged the SFC’s jurisdiction: it argued that the preparation and publication of the report was not part of Moody’s credit rating services and did not amount to a regulated activity, so was not subject to the SFC’s regulation. The SFAT did not agree, and found that the red flag framework constituted a defined mechanism for judging levels of credit risk and, as such, constituted a credit rating and, accordingly, the preparation and publication of the report was a regulated activity. Moody’s has since appealed the SFAT’s decision to the Court of Appeal. That hearing began in January 2017, and its outcome is keenly anticipated.
The other case concerns false and misleading information disseminated by research analyst and short seller Andrew Left, which we discuss further below.
Hong Kong regulators have continued their focus on financial institutions’ conduct in distributing investment products. In December 2016, the SFC issued two Circulars and FAQs to provide further guidance on intermediaries’ suitability obligations, ahead of the new client agreement requirements – including the new contractual “suitability clause” – becoming effective in June 2017. Financial institutions should assess their internal processes governing client onboarding and product sales, and update relevant client documentation, taking into account relevant regulatory guidance.
Fair treatment of clients
Various SFC actions focused on improper treatment of clients and client assets. Examples include the following:
- a securities company was reprimanded and fined HK$4 million for failing to disclose the actual execution price and its financial gains from handling bond transactions for clients;
- another securities company was reprimanded and fined HK$3 million, while its former Responsible Officer was fined HK$200,000 and suspended for 15 months, for mishandling clients’ share dividend entitlements;
- a global financial services provider was reprimanded and fined HK$4 million for failing to put in place adequate internal procedures for the management of interest for a tracker fund’s cash balances and conflicts of interest between its clients and its affiliates;
- the wealth management arm of a global bank was reprimanded and fined HK$4 million for taking monetary benefits in excess of the levels stated in its client documentation; and
- a forex intermediary was reprimanded and fined HK$4 million for keeping profits from favourable price movements in forex trading, while passing unfavourable price movements to its clients.
In the latest issue of the Enforcement Reporter, the SFC stated that its AML specialist team has been investigating a number of cases, and that tough penalties will be imposed for breaches. The SFC took the opportunity to remind licensees and their senior management of their obligation to implement effective AML internal controls to ensure appropriate customer due diligence (CDD) is undertaken. Banks should refer to the HKMA’s September 2016 CDD FAQs, as well as the HKMA’s guidance on de-risking.
The importance of ascertaining the identity of clients (including ultimate clients) was highlighted in a recent enforcement action against the Hong Kong arm of a PRC securities company, where the SFC reprimanded and fined the entity HK$1.3 million for breaching the Client Identity Rule Policy. The SFC found that the entity was unable to obtain information about its ultimate clients from its direct client (an intermediary) and to provide that information to the SFC at the SFC’s request, but continued to deal with the direct client. The SFC made clear that even though the entity’s failure to obtain the requested information was due to its client’s failure to comply with its own obligations under the client agreement, the entity was obliged to refuse business with its client after it became clear that that client was not prepared to provide ultimate client information.
A number of cross-border cases have been the focus of the SFC’s attention. In January 2016, the Court of First Instance ruled against a number of individuals in an important case involving cross-border insider dealing of overseas-listed shares. In November 2016, the SFC banned a former trader at a global bank from re-entering the industry for ten years, following regulatory action by Korean authorities in respect of a market manipulation scheme in which that former trader was found to have been involved.
The SFC also took its first enforcement action against a research analyst and short seller, when it commenced MMT proceedings against head of Citron Research, Andrew Left. The SFC alleged that Mr Left had published a report on Citron Research’s website that contained false or misleading information about Evergrande Real Estate Group Limited, a Hong Kong-listed company with extensive interests in Mainland China. The report alleged that Evergrande was insolvent and had engaged in accounting fraud. In August 2016, the MMT found that the allegations in the report were “sensationalist” in nature, and that Mr Left had made these allegations recklessly or negligently without understanding the applicable accounting standards and without seeking expert advice or approaching Evergrande for clarification. The MMT imposed a cold shoulder order against Mr Left, under which he has been banned from trading securities in Hong Kong for five years, and a “cease and desist” order. Mr Left was also ordered to disgorge his personal profit of over HK$1.5 million from shorting Evergrande shares. The Court of Appeal recently dismissed Mr Left’s application for leave to appeal the MMT’s decision on questions of fact, but his appeal on points of law will be heard at a later date.
The SFC also entered into further agreements with other regulators and authorities which provide for mutual cooperation in supervision, investigation and enforcement. These include agreements with the US Financial Industry Regulatory Authority and Securities and Exchange Commission, as well as with the Bank of England. The SFC also signed an agreement with the Hong Kong Department of Justice with a view to formalising and further strengthening cooperation in the handling of criminal cases under the SFO. There is also likely to be increased cooperation between the Hong Kong and Mainland Chinese regulators, as well as increasing emphasis on cross-border market misconduct, given enhanced connectivity between Hong Kong and the Mainland through the two stock connect programmes.
On the horizon
The following areas may well be on the horizon for the coming year:
- More investigations and enforcement actions against individuals and senior managers can be expected (including those involving unlicensed managers), following the introduction of the Managers-in-Charge regime for Licensed Corporations.
- Continued focus on corporate governance, and IPO sponsor conduct. The SFC may assume a greater role as a gatekeeper as well as enforcer in the regulation of listed companies, should the proposals in the June 2016 joint consultation on listing regulation reform be adopted.
- Greater regulatory and enforcement cooperation between Hong Kong and Mainland regulators, given that a large proportion of Hong Kong listed companies continue to have their centre of gravity in Mainland China, and the two stock connect programmes. As the SFC’s CEO, Ashley Alder, indicated, the traditional “one-way street of cross-border information requests” to Mainland regulators will evolve into a “two-way street of reciprocal assistance”.
- Continued focus on market misconduct, particularly cross-border market misconduct and disclosure-related market misconduct.
- AML will remain high on the regulatory agenda, ahead of the next round of Financial Action Task Force mutual evaluation of Hong Kong which is currently scheduled for October/November 2018.
- Investigations relating to the revised professional investor regime, enhanced suitability requirements, and new client agreement requirements.
- Technology and cybersecurity are likely to be key focus areas. The SFC intends to consult in the first quarter of 2017 on proposed guidelines for online distribution and advisory platforms (which aim to provide tailored guidance on complying with regulatory requirements, including suitability obligations). Further guidance/requirements focusing on suitability and related requirements applicable to robo-advice and automated fund platforms can be expected. Regulators will continue to focus on cybersecurity preparedness and resilience of financial institutions. In late 2016, the SFC commenced a cybersecurity review of Licensed Corporations. The SFC and the HKMA will likely assess financial institutions’ compliance with recent guidance, including SFC guidance for brokers to ensure protection of online trading accounts, and HKMA guidance for Authorised Institutions to strengthen security controls over online services, and to implement various pillars of the Cybersecurity Fortification Initiative.
- Treating clients fairly: in late 2016, the SFC commenced a thematic review of best execution and client facilitation, which aims to enable the SFC to better understand Licensed Corporations’ operations, controls and compliance, as well as market developments and challenges in this area. The SFC has indicated that Codes of Conduct may be revised as a result of findings from that review and a benchmarking exercise against regulatory requirements in overseas markets.
- The SFC will take further steps to enhance the regulation of the fund management industry, following its proposals in the November 2016 consultation, which, if implemented, would mean changes to the SFC Code of Conduct and Fund Manager Code of Conduct. The SFC has also indicated its intention to seek more direct access to overseas markets for Hong Kong funds, following the Mutual Recognition of Funds (MRF) with Switzerland announced in December 2016, as well as the MRF with Mainland China launched earlier.