Hong Kong regulatory enforcement update: July - December 2015
A round up on regulatory enforcement developments for the second half of 2015.
Trends in SFC enforcement actions
SFC’s July – September 2015 quarterly report was published on 07 December 2015 and includes the usual statistics showing the number and mix of SFC enforcement activities, as reproduced below. The following are discernible trends:
- There has been a steady decrease in the use of SFO S.181 notices by the SFC.
- The SFC appears to be concluding their investigations more rapidly and clearing some of the backlog. This increase may be attributable to the Process Review Panel’s concerns about lengthy SFC case investigation time (see further below).
- There has been a notable increase (YoY 61%) in the number of compliance advice letters issued by the SFC. Compliance advice letters address areas or standards of conduct/ compliance that need improvement. Topics include cold-calling, disclosure of interests and internal control weaknesses.
- There has been a complete drop-off in criminal prosecutions, a trend that we noted in previous enforcement updates.
HK SFC enforcement activities
*Reproduced from the SFC quarterly report July – September 2015
Quis custodiet ipsos custodes?
The SFC’s activities are reviewed independently by the Process Review Panel (PRP). The PRP is an independent, non-statutory panel that reviews and advises the SFC on the adequacy of its internal procedures and operational decisions and acts as a “check and balance” on the SFC’s regulatory powers. The PRP conducts annual independent reviews of the SFC’s activities.
Among other things, the Process Review Panel for the SFC’s annual report for the year 2014 - 2015 (PRP Report) raised concerns about the investigation time spent by the SFC on certain cases, noting the processing time ranged from 10 months to 11 years. The PRP expressed concern that, out of the 14 cases it reviewed, 5 cases took more than 5 years to complete. Their criticisms of the SFC’s lengthy investigations may have prompted the recent YoY increase in SFC investigations completed within 7 months (see above).
In one case reviewed by the PRP, the SFC took 4 years and 9 months to conduct an investigation. Interestingly, the SFC blamed the delay on legal professional privilege claimed by the licensed corporation over its investigation report and on long and tedious efforts in handling over 2,000 trading records to check for irregularities in trade allocation. On the PRP’s recommendation, the SFC resolved to (i) challenge claims of legal professional privilege (LPP) and (ii) improve its IT forensic capability.
One may question whether waiting to see the investigation work of others is an adequate excuse for delay. In any event, it will be more difficult for the SFC to challenge LPP following the Hong Kong Court of Appeal’s CITIC judgment in June 2015 (CITIC Pacific Limited v Secretary for Justice and Another [2015] 4 HKLRD 20). For further information, please refer to the below article on privilege and investigations:
Enforcement summary
In our last July enforcement update, we reported intermediary misconduct had seen a spike in investigations in the last year. Certain themes continue from the last quarter, and below we highlight some of the more notable enforcement trends and cases observed in the last six months.
Market Misconduct Tribunal
In a previous enforcement update we noted the MMT’s new lease of life and its use as a precursor to SFO S.213 actions in the High Court (a point we revisit further below). Here are a couple of recent developments that caught our attention.
No right for Left
The SFC action against Andrew Left (Mr Left) continues to interest us. The SFC commenced MMT proceedings for market misconduct against Mr Left when he published a research report (the Report) on Citron Research’s website on Evergrande Real Estate Group Limited in 2012 (Evergrande). The Report concluded that Evergrande was insolvent and had consistently published fraudulent information to the investing public (the Conclusions). The Conclusions were based on publicly available information. Mr Left had shorted Evergrande shares before the release of the Report and made a profit as a result of the fall in Evergrande’s share price. The SFC alleged that Mr Left had disclosed false and misleading information inducing transactions under SFO S.277(1).
An interesting aspect of this case was an application Mr Left made to the MMT for an order for production of documents under SFO S.253(1)(b). Documents requested included records (eg contracts and correspondences) in Evergrande’s possession to ascertain whether the information disseminated by Mr Left in the reports was false or misleading; and the documents relied on by the SFC to prove its case, including the audited financial statements (AFS) of Evergrande, analyst reports and an expert opinion on the truthfulness and completeness of the AFS. The MMT on 27 October 2015 rejected Mr Left’s application. Since the Report was based on publicly-available information at the time, and the SFC’s case was that it was not reasonable to draw the Conclusions from that public information, the MMT decided that there was no utility in permitting Mr Left to trawl through private documents to ex post facto prove his point. To quote the Honorable Mr Justice Hartmann in the Evergrande MMT ruling: “…the SFC accepts that market commentators are entitled, on the information available in the public sphere at the relevant time, to disseminate their analysis of the strengths and weaknesses of a particular listed corporation. That is fair comment, no matter the perceived cogency or weakness of the comment. What market commentators are not permitted to do, however, is to distort that information so that, knowingly or being reckless or negligent as to whether it is the case, what is published constitutes false or misleading information about the corporation.”
AcrossAsia
In July 2015, the SFC commenced proceedings in the MMT against AcrossAsia Limited (AcrossAsia), the Chairman and the CEO of AcrossAsia under SFO Part XIVA (disclosure of inside information) to determine whether a breach of a disclosure requirement had taken place and who breached the disclosure requirement. AcrossAsia is listed on the Growth Enterprise Market (GEM) of the Hong Kong Stock Exchange. AcrossAsia had failed to repay money owed to its subsidiary PT First Media Tbk (PT First Media), and litigation proceedings commenced in Indonesia. Copies of court documents (which were in the language of Bahasa Indonesian) were received by AcrossAsia’s Hong Kong offices and the English translations were circulated to the Chairman and CEO of AcrossAsia. AcrossAsia did not disclose this information until 13 days later. The SFC alleged that the insolvency-related proceedings in Indonesia and the contents were price sensitive information at the material time, because the proceedings threatened AcrossAsia with loss of control of its major asset, including its stake in PT First Media in Indonesia, and could lead to AcrossAsia being put into liquidation.
This is the first set of proceedings in the MMT brought by the SFC in relation to the disclosure obligations imposed on listed companies under the SFO since they became effective on 01 January 2013.
Asia Telemedia
In a rare defeat for the SFC, the MMT decided on 26 November 2015 that certain former executives and the former chairman of Asia Telemedia Limited (now known as Reorient Group Limited) had not engaged in insider dealing.
Something to note from these cases is the extra-territorial element. Mr Left is based in the US, the former Director of Finance and Executive Director of Asia Telemedia Limited suspected of misconduct was recruited in the People’s Republic of China and worked the majority of the time there, whilst the events that precipitated AcrossAsia’s reporting requirement under SFO Part XIVA took place in Indonesia. It can sometimes be forgotten that the scope and reach of the SFO and SFC are not delimited by the borders of Hong Kong.
Maybe crime can pay…
The cases of Du Jun and Tsoi Bun, whereby compensation is paid to the affected investors, is the sort of outcome the SFC aims for: malfeasants brought to justice, investors made whole and the reputation of Hong Kong’s financial market restored. However, we have for some time questioned the relevance or rationale behind restoration orders in the context of insider dealing. This was brought into sharp focus in the latest instalment of the Du Jun saga.
Du Jun, a former managing director of Morgan Stanley Asia Ltd convicted of insider dealing, was in 2013 ordered by the court to distribute restoration payments to investors of approximately HK$23 million. At the time, the SFC’s then Executive Director of Enforcement, Mark Steward, explained: “The effect of today’s orders will be to restore investors who transacted with Du to their pre-transaction positions…the 297 investors had no means to detect they were dealing with Du, who was engaged in illegal insider dealing. If they had known, they would not have sold their shares to him and certainly not at the same price.”
Of the 297 individuals who had traded with Du Jun, however, 3 could not be contacted. Bizarrely, this meant that Du Jun received HK$813,686 of his ill-gotten gains from the restoration fund. This is doubly strange when one bears in mind that:
- The Court of Final appeal had previously reduced Du Jun’s fine (from his conviction) in order that more money would be available to compensate investors, and
- Du Jun cannot now be ordered to disgorge his profits by the MMT as the SFC had chosen the criminal route (ie SFO Part XIV, instead of SFO Part XIII).
It will be interesting to see if there is a similar outcome in the case of Tsoi Bun. Tsoi Bun, a futures trader convicted of price rigging, was ordered by the court to pay HK$13 million to compensate investors affected. As of 19 March 2015, HK$4,663,944.72 remained unclaimed, and as per the SFC notice on 23 September 2015, HK$4.7 million remains unclaimed by 207 counterparties.
Alternative liquidity pools and dark pools – a dark and mysterious place?
On 15 May 2015, the SFC released consultation conclusions on the regulation of alternative liquidity pools. On 03 August 2015, BNP Paribas Securities (Asia) Limited (BNP) was fined HK$15 million for failures in relation to its alternative liquidity pool trading services. BNP had breached its licensing condition, failed to notify the SFC of its change of business plan as required and failed to maintain sufficient trade records. In addition, the services were not operated as represented in materials provided to clients. Mark Steward said “No one should dive into dark water without knowing what is hidden. Operators must have clear rules and procedures in place for operating dark pools, and equally important, they should operate consistently with representations to clients whose consent to enter the dark pool is clear and well-informed” (our emphasis).
More recently, JP Morgan was reprimanded and fined HK$30 million by the SFC for failing to implement adequate systems and controls in the area of short selling activities, client facilitation and principal trading business and operations of dark liquidity pool trading services.
Remember to self-report
Increasingly, we have noticed that often the first question the SFC asks on an investigation is: “when did you first find out …?”, followed by: “why did you not report sooner…?”
This continues to be a hot topic for the SFC, as illustrated recently by the reprimand and HK$4.5 million fine received by Nomura International (Hong Kong) Limited for failing to report significant misconduct by a former trader in a timely manner, as required by Section 12.5 of the SFC Code of Conduct. Mark Steward commented: “Intermediaries must report problems to us immediately - not after internal investigation, not after legal advice has been obtained but straightaway, without leaving out any important information” (our emphasis).
Readers can be reassured that the right to legal advice still remains enshrined in the Basic Law. Nevertheless, seek that legal advice quickly, ideally as soon as a problem arises.
Anti-Money Laundering (AML)
AML has always been in the forefront of the regulators’ minds (both the SFC and the HKMA). On 31 July 2015, the HKMA reprimanded and fined the State Bank of India’s Hong Kong Branch (SBIHK) HK$7.5 million for AML failures under the Anti-Money Laundering and Counter-Terrorist Financing (Financial Institutions) Ordinance (AMLO). The HKMA said: “While SBIHK has taken positive and intensive remediation work to address its contraventions and did not have any previous disciplinary record, the HKMA’s disciplinary action took into account the need to send a clear deterrent message to the market about the importance of effective internal AML/CFT controls and procedures” (our paraphrase and emphasis).
On 25 September 2015, the SFC launched a Money Laundering Risk Assessment Survey to selected licensed corporations and associated firms to collect information on the money laundering risk of Hong Kong’s securities sector in accordance with the Financial Action Task Force Recommendations. From July to December 2015, the SFC issued 19 advisory circulars to enhance industry participants’ awareness about the latest developments in AML and counter-terrorist financing. The SFC continues to use onsite inspections and offsite monitoring as a means to ensure its licensed corporations are in compliance with the law and regulatory requirements, and in particular, it is interesting to note from the below statistics the increase (YoY 154%) relating to non-compliance with AML guidelines.
Nonetheless, new AML changes and requirements should be carefully implemented, with sufficient training provided to the relevant client facing staff. The HKMA’s fifth issue of Complaints Watch, issued on 08 October 2015, reveals that from May to August 2015, banks’ account opening processes and closure of customer accounts continue to be one of the major areas of customer complaints. Complaints were related mainly to improper execution of banks’ customer due diligence (DD) measures (required when opening an account or if the bank is required to update DD information or documents) in the banks’ compliance with the requirement in the AMLO whereby banks need to ensure customer data is up to date and relevant.
*Reproduced from the SFC quarterly report July – September 2015
Executive Director of Enforcement, Mark Steward, has left the building
Executive Director of Enforcement, Mr Mark Steward left the SFC on 24 September 2015 after serving nine years there, to take up a similar position with the UK Financial Conduct Authority. In summing up his reign, it is fitting that the final word goes to Mark (as it so often did): “Nothing has ever stopped the SFC doing what it needs to do.” (interview with Mark Steward by the SCMP published on 27 August 2015) The interim Head of Enforcement was announced on 18 September 2015 as Maureen Garrett, Deputy Chief Counsel of the SFC. His successor remains a mystery.
Enforcement dashboard
(i) Enforcement activities
(ii) SFC complaints against intermediaries and market activities*
* Reproduced from the SFC quarterly report July – September 2015
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