Introduction

A recent disciplinary action taken by the Securities and Futures Commission (SFC) emphasises the importance of adequate internal controls to ensure proper compliance with the HK disclosure of interests regime. It indicates that internal control systems should enable monitoring and reporting of changes of equity positions in HK listed corporations beyond those resulting directly from your own transactions. It also highlights that not only should written policies and procedures be put in place, but more importantly adequate guidance and training should be provided to the relevant staff.

Background facts

In January 2011, Deutsche Bank Aktiengesellschaft (Deutsche Bank) was issued convertible notes convertible into shares of Up Energy Development Group Limited (then known as Tidetime Sun (Group) Limited) (Up Energy), which was listed on the HK Stock Exchange, resulting in Deutsche Bank having a notifiable interest of 50.72% in Up Energy. Deutsche Bank disclosed its notifiable interest to the Stock Exchange.

In the next seven months, there were 27 occasions of changes in Deutsche Bank's notifiable interest crossing a percentage level triggering a duty of disclosure under Part XV of the Securities and Futures Ordinance (SFO) as a result of either Deutsche Bank's acquisitions or disposals of Up Energy shares (on 3 occasions), or increases in Up Energy's issued share capital as a consequence of other convertible note holders exercising their conversion rights (on 24 occasions), but these were not reported.

In January 2013, Deutsche Bank reported that its notifiable interest had ceased as its holdings in Up Energy was significantly reduced to below 3%.

Relevant regulatory requirements

Under Part XV of the Securities and Futures Ordinance (SFO) regulating disclosure of interests, where a person (a) first acquires a notifiable interest (5%) in the shares of a listed corporation, (b) ceases to have a notifiable interest, (c) has a notifiable interest but the percentage level of his interest changes; or (d) has a notifiable interest but the nature of interests changes, he comes under a duty of disclosure.

In respect of (c), it is important to note that there may be changes in the percentage level of a person's interest as a result of transactions conducted by others. For changes due to actions taken by others, the obligation to report runs from the date that the person becomes aware of the facts that lead to the change in the percentage level of his interest.

Cause of breaches - internal control failures

As reported, Deutsche Bank's transactions involving Up Energy were settled through an internal settlement system used in Singapore, which was not configured to automatically feed into its global equity monitoring system. Daily manual adjustments had to be made in order for the global equity monitoring system to capture changes in Deutsche Bank's position, but they were not made due to an oversight.

The SFC identified that although Deutsche Bank was aware of the limitations of its monitoring systems, it failed to actively follow up and check its holdings in Up Energy and failed to provide adequate guidance and training to the relevant business groups regarding the reporting requirements.

Sanctions

The SFC reprimanded and fined Deutsche Bank HK$1.6 million, having taken into account, among other things, the duration of the disclosure failures, Deutsche Bank's immediate report to the SFC upon its discovery of failures and that Deutsche Bank has since enhanced its systems.

The disciplinary action against Deutsche Bank was brought under section 196 of the SFO (not within Part XV of the SFO) as the SFC was of the view that Deutsche Bank's fitness and properness as a registered institution had been called into question.  This level of fine is much higher than the fines imposed on convictions of disclosure of interests offences under Part XV of the SFO. Based on the statistics shown in the SFC's annual/quarterly reports since 2003, the highest fine imposed on convictions under Part XV of the SFO was below HK$100,000.

Lessons to be learned - Importance of effective internal controls

This disciplinary action related to deficiencies in internal control systems which led to disclosure failures.

It is noteworthy that a majority of failures of disclosure (24 out of 27 occasions) involved increases in Up Energy's total issued share capital due to exercise of conversion rights by other note holders. This disciplinary action seems to indicate that internal control systems should enable monitoring and reporting of changes of equity positions in listed corporations not only resulting from own transactions but also those prompted by actions taken by others. It should send a clear and timely message on the importance of effective internal controls for ensuring due compliance with disclosure of interest requirements. The full text of the Statement of Disciplinary Action published on the SFC's website on 22 May 2014 can be accessed via the link below:  http://www.sfc.hk/web/EN/files/ER/PDF/14PR59_s.pdf

Other regulatory development concerning dealing disclosures:

On 30 May 2014, the Securities and Futures Commission launched a new online platform for submission of disclosures of dealings in the offeree company (or the offeror company as well in the case of a securities exchange offer) made by parties to an offer and their respective associates, for themselves or for their discretionary clients, during an offer period under Rule 22 of the Code on Takeovers and Mergers (Rule 22). New electronic versions of the public and private disclosure forms have also been introduced for use with the new system.

Effective from 1 July 2014, all Rule 22 dealing disclosures must be submitted using the online system and the new forms.

The new Rule 22 Dealing Disclosure Online Submission system can be accessed via this link:https://www.sfc.hk/dealdisclosure/gateway/landing?locale=en The current and new forms can be accessed via this link:  http://www.sfc.hk/web/EN/forms/listings-and-takeovers/