28 February 2017

SFC enforcement action – what you can expect in 2017

This article was written by Urszula McCormack and Alice Molan.

On 17 February 2017, the Securities and Futures Commission (“SFC”) released its Quarterly Report for the final quarter of 2016 (“Quarterly Report”).  Criminal action is down, but investigations and disciplinary action have swelled significantly.

In this article, we summarise the key SFC focus areas over that period and examine the potential SFC focus areas you can expect going forward.  These include market conduct, regulated activities, cybersecurity, anti-money laundering and counter-terrorist financing (“AML/CTF”), algorithmic trading, senior managers, suitability and client agreements.  

We also bring together five key messages, including our recommendations for maintaining a strong innovation agenda in this era of compliance and enforcement.

Snapshot of enforcement activities

The Quarterly Report exemplifies the SFC’s broad range of regulatory tools and its willingness to use these.  

Specifically, enforcement activity highlighted in the Quarterly Report shows the SFC focusing on traditional areas of action and monitoring, including bribery, stock market manipulation, and surveillance of regulated and unregulated activities.  

Enforcement activity included:

  • actions in the Market Misconduct Tribunal which have resulted in fines, disgorgement of profits and training orders for activities involving disclosing false or misleading information, failures to disclose information and insider dealing;
  • the application of Restriction Notices in respect of dealing in certain assets;
  • disciplinary action against 5 licensed corporations and 11 representatives, with total fines of $9.8 million and a number of banning orders and licence revocations;
  • court proceedings commenced and proceedings finalised involving breaches of director’s duties and unlicensed activities; and
  • ongoing market surveillance, including requests for information.

ongoing market surveillance

Criminal action down?

Notably, there were no criminal charges laid in Q4 2016.  The number of criminal charges laid year-on-year was also down considerably, by 74%. 

It is tough to speculate whether this trend will continue, but we anticipate this reflects the combination of two key factors - the foundation for the SFC’s concluded actions (regulatory vs statutory) and timing.

A big start to 2017

Already, we are seeing a strong start to enforcement for 2017.   Notable actions in just the past two months include the following:

Directors and employees behaving badly

Embezzlement and false statements

Disqualification and HKD84 million orders against the former chairman and executive director of First Natural Foods Holdings Limited, in connection with a major embezzlement, plus the provision of false bank statements to auditors and the publication of a false market announcement.

Concealment of interests

Proceedings against the former chairman and executive director of Kong Sun Holdings and China Sandi Holdings Limited alleging concealment of interests in those companies’ share placements.

Commission fraud

Industry ban for life for a former HSBC employee, following her criminal conviction in connection with recording product sales that never happened, and receiving sales commissions for them.

Director failures and connected transactions

Proceedings against the former chairman and four current independent non-executive directors of Hanergy Thin Film Power Group Limited.  Allegations include the failure to question the viability of Hanergy’s business model, to properly assess the financial position of connected parties and to take proper steps to recover receivables due from connected transactions.  Linked with the ongoing suspension of Hanergy shares.

Compliance control failures

Employee dealings

Reprimand and HKD70,000 fine imposed on North Sea Securities Limited for failing to implement proper controls to monitor and supervise employee dealings.

Funds compliance

Reprimand and HKD2 million fine in connection with two entities’ failure to manage two SFC-authorised funds in accordance with their constituent documents.

Inadequate staff investment experience

Reprimand and fine of HKD3million for failing to implement adequate policies and procedures in connection with the investment experience of key personnel under the SFC Code on MPF Products and the Fund Manager Code of Conduct.  Findings also included a failure to ensure staff members knew of their designation as key personnel and advise them of the experience required.

Clients at risk

Short selling

Reprimand and HKD50,000 fine for misrepresenting the Hong Kong short selling restrictions to a client, exposing the client to legal and regulatory risk.

These are in addition to the usual actions for employee fraud that continue to occur in both small and large institutions.  

What about AML/CTF?

The elephant in the room remains AML/CTF.  Why aren’t we seeing more action?  The last formal SFC action on the subject was nearly three years ago and resulted in a disciplinary fine under old guidelines that pre-dated the current legislation.

Well, fear not, the SFC has not forgotten.  There are plenty of investigations on the boil at both the SFC and the HKMA.  

The SFC also signalled in its 26 January 2017 circular that it is looking at AML/CTF very carefully, articulating four key areas of concern covering:

  • risk assessments;
  • staff guidance and control monitoring;
  • customer due diligence and ongoing monitoring; and
  • suspicious transactions,

together with some useful guidance on addressing perceived weaknesses.

Most major players in the market have completed, or at least are well advanced on, their AML/CTF reviews and remediation work.  However, one thing to bear in mind is that the goal posts are forever shifting.  Keeping abreast of both regulatory and peer developments is crucial.  Regulators are learning more about “best practice” in a range of key areas including source of wealth/funds, screening, monitoring, politically exposed persons and specialist areas like trade.  Risks and typologies are also changing.  

The most forward-thinking financial institutions are also harnessing technology solutions, including distributed ledger technology (like blockchain) – more on that in our December 2016 alert.

Focus areas going forward

Undoubtedly, the SFC will continue to enforce its mandate to monitor the market to ensure compliance with licensing obligations, identify market misconduct and ensure licensees are meeting the standards expected of them. 

Besides these areas and AML/CTF, we anticipate that the SFC’s focus will expand to ensure compliance with its newly introduced regulatory requirements.  

Key examples include:

  • senior manager regime - the new Manager-In-Charge initiative, which must be implemented from 18 April 2017;
  • algorithmic trading – further guidance on algorithmic trading issued by the SFC on 13 December 2016, following its thematic review of certain licensed corporations.  The guidance focuses on controls, due diligence, contingencies and everyone’s favourite: policy and procedure;  
  • cybersecurity – an alert on 26 January 2017 regarding distributed denial of service (DDoS) attacks on securities brokers, with a concomitant reminder to implement the measures circulated in the SFC’s circular of 23 March 2016;
  • listing and placement of GEM stocks - a new guideline for sponsors, underwriters and placing agents on the standards of conduct applicable to  the listing and placing of GEM initial public offering (IPO) stocks; 
  • client agreements – the new SFC requirements for client agreements (including the controversial suitability undertaking), which must be implemented by 9 June 2017 (see our separate alert on this subject for further information); and
  • suitability - we also expect that the SFC will continue to examine compliance with suitability obligations, including in light its recent circular and FAQs.

In addition, the SFC signed a memorandum of understanding with the United States Securities and Exchange Commission with effect from 18 January 2017.  This is relevant to many institutions with both a Hong Kong and US footprint.

Is there a silver lining?

The SFC’s activities are not all about enforcement action.  For example, the SFC has been proactive in engaging with the market and taking steps to educate players in the financial technology (“fintech”) space in respect of the interaction between fintech services and Hong Kong regulatory obligations.  

Aside from the launch of its Fintech Contact Point, key initiatives in the last few months included its “Regtech and Fintech Contact Day” in November, plus the publication of further guidance on compliance with client identity requirements in the context of fintech services in October.

Innovation is therefore clearly on the agenda, alongside the ongoing focus on compliance and controls.

Key messages for Legal, Compliance and Senior Management

There are five key messages from this:

  1. Be on the front foot – it might not be an exact science, but it isn’t rocket science either to predict the likely focus areas for the SFC for this year.  Think about your compliance suite, audit program and what needs attention.  Read the updates on what’s happening next.  Make sure senior management knows the key points.
  2. Report – delays in reporting are always considered with the benefit of hindsight and viewed negatively.  From an industry perspective, we are seeing an uptick in the level of day-to-day engagement between compliance officers and their SFC/HKMA case officers - and a move away from an overly narrow interpretation of what is “material”.
  3.  Cooperate with investigations – this always bodes favourably, although make sure you consider whether appropriate limits need to be drawn.  Take particular care with privileged information and “over-sharing”.  Think carefully about how you frame the delivery of information and documents – the message accompanying bad news can make all the difference.
  4. Consider the broader impact – entities regulated in multiple jurisdictions must take into account the local impacts of particular regulatory actions.  The SFC/SEC MoU is only the latest in a string of cooperation agreements and certainly will not be the last.  
  5. Work out how this merges with your innovation agenda – compliance controls don’t necessarily mean that new products won’t work.  Start-ups may have been perceived as an existential threat to established market participants a year ago, but we are now seeing them face the same (and even greater) hurdles.  Clients who think about innovation and compliance hand-in-hand tend to develop better results.  For Legal and Compliance teams, avoid the temptation to say “no” just because it hasn’t been done before – work through the issues.

See also our alert on “Bank shutdown – the new frontier of AML/CTF regulation”, which provides additional tips on dealing with regulatory enquiries.

A Guide to Doing Business in China

We explore the key issues being considered by clients looking to unlock investment opportunities in the People’s Republic of China.

Doing Business in China
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