11 March 2020

Enforcing internal controls and pursuing accountability

This article was written by Rachel Yu, Urszula McCormack, Evan Manolios, Kellie Tse and Iris Shaw. 

On 21 February 2020, the Securities and Futures Commission ("SFC") published its latest Quarterly Report, summarising the key developments from October to December 2019.

As reflected in the Quarterly Report, the SFC remained active in its regulatory activities, with a notable enforcement focus on record-keeping, online trading, dealing malpractices and anti-money laundering (“AML”) controls, as well as a 61.2% increase in the number of individuals and corporations subject to civil proceedings, various of which involved breaches of duties by supervisors and directors.  

Overall, the key focus areas of the SFC’s activities fall within the following six categories:


Some particular highlights of the quarter include:

  • 76 on-site inspections of licensed corporations to review their compliance with regulatory requirements;
  • 5 licensed corporations and 5 licensed representatives disciplined, resulting in total fines of over HK$413.3 million;
  • 2,345 requests to intermediaries for trading and account records triggered by untoward price and turnover movements;
  • issuing section 179 directions to gather additional information in 14 cases and writing to detail concerns in 6 transactions;
  • enhancing the investor compensation regime and raising the compensation limit to HK$500,000 per investor per default with effect from 1 January 2020;
  • issuing a position paper that sets out a regulatory framework for licensing virtual assets trading platforms and publishing terms and conditions for licensed corporations managing portfolios which invest in virtual assets;
  • issuing a circular to asset managers on dubious arrangements or transactions (click here for our earlier article summarising the circular);
  • releasing consultation conclusions on margin requirements for non-centrally cleared over-the-counter derivatives which will be phased starting from 1 September 2020;
  • launching a consultation on proposed enhancements to the open-ended fund companies regime to encourage more private funds to set up in Hong Kong*; and
  • launching an investor identification regime for southbound trading under Stock Connect together with the China Securities Regulatory Commission.

On-site inspections and regulatory breaches

The table below, as provided in the Quarterly Report, details the numbers and the types of breaches that were noted during SFC’s on-site inspections.


Regulatory breaches and enforcement priorities

Compared to the third quarter of 2019 (click here for our earlier article summarising the SFC’s report for that quarter), the number of on-site inspections conducted by the SFC has dropped from 106 to 76. However, the number of breaches noted during the on-site inspections in the last quarter remained at a similar level.

Various types of breaches have increased in numbers as compared with the third quarter. They include, but are not limited to, breaches of client money and securities handling, online trading regulations and the Fund Manager Code of Conduct, and internal control weaknesses. Indeed, online trading has become very common nowadays. Heightened monitoring and regulation of online trading can be anticipated.

What has been consistent throughout the year of 2019 though is that internal control weaknesses remain the most prevalent type of breach found among licensed corporations, followed by non-compliance with anti-money laundering guidelines, unauthorised trading and breaches of the Code of Conduct for Persons Licensed by or Registered with the SFC.  In fact, out of the total fines of over HK$413.3 million imposed by the SFC in the final quarter, HK$408.8 million resulted from disciplinary actions concerning internal control weaknesses.

The year-on-year change figures also confirm the SFC’s regulatory focus. Indicated in the Quarterly Report are a year-on-year 100% surge in the number of notices of proposed disciplinary actions issued by the SFC to regulated persons and a year-on-year 61.2% rise in the number of individuals and corporations subject to ongoing civil proceedings. Statistics demonstrated that the SFC has little hesitation in stepping up on their enforcement actions, holding licensed corporations and individuals accountable for non-compliance and misconduct.

As an example of the SFC’s increasing focus on personal accountability and corporate governance, the SFC recently obtained a compensation order from the court against a former chairman and executive director of a listed company for losses due to his misconduct. He was ordered to compensate the group’s wholly-owned subsidiary RMB20.3 million and, together with three other former executive directors, disqualified from being a director or being involved in the management of any listed or unlisted corporation in Hong Kong for up to six years.

In a few other cases, the SFC separately commenced High Court proceedings and obtained disqualification orders against former chairmen and executive directors of listed companies for breach of fiduciary duties and failure to exercise due and reasonable skill, care and diligence. These suggest that the SFC is more prepared to intervene if they have serious concerns over the conduct of the management of listed entities, which echoes the SFC’s recent emphasis on corporate governance. This is also especially significant as Hong Kong has very few cases involving directors’ duties under the general companies legislation, so the ripple effect on regulated entities’ directors is likely to be considerable.

Licensing and regulatory highlights

We also identify a number of key SFC developments over the quarter:

  1. Regulatory data storage: the SFC in October 2019 issued a circular to licensed corporations setting out its expectations and requirements for using external electronic data storage providers (click here for our article on using external electronic data storage providers). This circular has caused significant industry interest given that it affects licensed corporations’ storage policies, methods and controls and also imposes, indirectly, requirements on external service providers who store regulatory records. This continues to be an area of focus for both the SFC and those affected by it.
  1. Landmark virtual asset regulation: The SFC has also in November 2019, published a position paper setting out the SFC’s regulatory approach and framework for virtual asset trading platforms. The position paper describes its licensing and supervisory regime for virtual asset trading platforms, as well as regulatory standards expected of qualified platform operators.

Together with the position paper, the SFC issued a set of pro forma terms and conditions for platform operators.

Key messages – front-loaded regulation requires front-loaded compliance

Notwithstanding the decrease in the number of inspections initiated by the SFC in the final quarter in 2019, the breaches noted, and the fines imposed, by the SFC are no less substantial. These seem to manifest a more targeted intervention and impactful regulation which evidence the “front-loaded” approach of the SFC.

More broadly, the Quarterly Report offers a glimpse into the SFC’s priorities and areas of focus. It is evident from the statistics and developments that internal control weaknesses remain a focus, as do AML controls and practices. The SFC also continues to enhance its regulatory framework in line with market conditions and technological development – a trend that may continue through the course of the year.   

All these point to the need to keep controls up-to-date and relevant. Audits and investigations are especially painful when compliance policies and procedures are outdated or (worse) merely lifted from overseas branches without proper localisation. They can also prove expensive to remediate, particularly when coupled with audit / investigation-related costs and fines.

There is also a strategy in dealing with regulatory notices and self-identified breaches and weaknesses – please speak to us anytime if you need support.

*Any reference to “Hong Kong” shall be construed as a reference to “Hong Kong Special Administrative Region of the People’s Republic of China”.

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