Large, undocumented money transfers to unidentified third parties should raise eyebrows. But it was exactly these red flags that Guangdong Securities Limited (“GSL”) a brokerage, failed to deal with adequately. The result? A HK$3 million fine and a public reprimand from the Securities and Futures Commission (“SFC”).

Our recent SFC enforcement trends alert identified anti-money laundering and counter-terrorist financing (“AML/CTF”) as a focus area for the SFC.

This article describes the key facts, findings and messages of the GSL case.

The exception that became the norm

Between February 2011 and March 2013, GSL, a brokerage, processed approximately 700 payments from client accounts to third parties. This may seem unremarkable – except that GSL, like many other brokerages, prohibited third party transfers.

GSL’s general prohibition did allow third party transfers under “exceptional circumstances”. To make use of this exception, GSL clients were required to complete an application form, attaching proof of the third party’s identity, the client’s relationship with that third party, and the reasons for the transfer.

GSL management was then required to review the form and the attached documentation, and only if satisfied, approve the transfer.

The SFC’s investigation

Following an investigation by the SFC, it was revealed that only 570 application forms for third party transfers could be located. Of these 570, only 67 forms were supported by the required documentation. The remainder displayed varying degrees of non-compliance, from a complete lack of documentation through to incomplete forms. These application forms truly are a treasure trove of AML/CTF red flags, as we highlight below:

1. Inadequate third party verification

Transfers between parties with no apparent business relationship is a common AML/CTF indicator.

Yet a significant number of the application forms stated that the transfer was between “friends” or that it was a “friend transfer”, and lacked any verification of the third party’s identity.

2. Inadequate reasons for transfer

Transfers without an economic rationale is another common AML/CTF indicator.

GSL's application form did request that the client state the reason for the transfer. However, some clients did not bother to state the reason – and others gave vague responses, such as “business dealings”, “loan” or “repayment”.

3. Large amounts through brokerage accounts

It does not generally make economic sense to move large sums through brokerage accounts rather than through bank accounts.

Yet the transfers that GSL processed often involved millions of dollars – and in one case, a transfer of over HK$39 million was approved without any supporting documentation.

4. Coincidental transfers

When multiple apparently unconnected accounts suddenly make a transfer to the same third party on the same day, bells should ring.

Yet GSL’s records show two transfers, from two separate accounts to the same third party, totalling HK$10 million, on the same day – with seemingly no questions asked.

5. No reasons for approval

Any and all departures from policy must be subject to written reasons for approval. This echoes a fundamental principle of AML/CTF regulation of Hong Kong, in that departures from regulatory guidance are permitted, but only with a justified and documented rationale. GSL’s staff and management failed to detail reasons for approval in any form whatsoever.

GSL did claim that its staff made enquiries where insufficient documentation was provided by clients. However, as these enquiries were also not recorded in writing, the SFC simply made this the grounds of another finding against GSL.

6. Deficient application forms

The SFC considered that GSL’s application form itself was deficient. The form lacked detail on key topics, such as the relationship between the client and the third party.

The SFC’s findings

The SFC found that GSL’s failure to adequately control third party payments constituted breaches of:

The transactions clearly show that any internal controls and monitoring that were in place at GSL between February 2011 and March 2013 were inadequate from an AML/CTF perspective – although no finding of actual money laundering or terrorist financing was made.

But no AMLO finding?

Strikingly, the SFC’s findings did not include a breach of the Anti-Money Laundering and Counter-terrorist Financing (Financial Institutions) Ordinance (Cap. 615) (“AMLO”). The SFC only exercised its disciplinary powers under the Securities and Futures Ordinance (Cap. 571). This means that we still do not have a test case from the banking or securities regulator under the AMLO.

Why this case matters

The GSL case is a timely reminder of three key points:

1. The SFC takes a hard line on third party payments

The SFC provided a list of controls for third party payments in its 3 December 2013 circular. These included the following:

Please click here to view the table. 

2. Departures from AML/CTF guidelines must be documented and justified

It is possible to take a different approach on certain aspects of AML/CTF regulation, but they must be documented and justified. The “risk-based approach” does not contemplate ad hoc decisions or (worse) lazy compliance. We are seeing more compliance and financial crime team members take this on board, but this is not universal.

3. Lack of documentation is tantamount to no controls

An ongoing theme in regulatory investigations is documentation generally. Where no records of an action exist, regulators generally assume that it didn’t happen. This is particularly important for individuals with AML/CTF functions, where personal criminal liability and other penalties at stake. The law only protects individual staff members to the extent that they can demonstrate that they followed internal policies and procedures. This means that relevant actions and any departures from policy need to be carefully documented. During AML/CTF investigations, we have seen regulators ask for not only the end result of an action (eg screening), but also the decision-making process along the way.