SFC takes steps to tackle the problem of "rolling bad apples" in Hong

Introduction

On 01 February 2019, the Hong Kong Securities and Futures Commission (SFC) announced that it has revamped a number of its licensing forms and issued a new edition of its Licensing Handbook.

One of the changes made by the SFC is likely to be of particular interest to HR managers and in-house employment lawyers because it is aimed at combating the problem of so-called “rolling bad apples” - namely, the movement of individuals with poor conduct records between firms without their misconduct being disclosed to their new employer.

What has changed?

When a licensed representative or responsible officer ceases employment, the employer is required to notify the SFC of the cessation of employment.

Until now, this required an employer to complete the SFC’s Form 5 and choose between several tick-box reasons for employment ending. Where the reason was “dismissal” or “other”, the employer also had to provide brief details in a free text box, but nothing more was required.

What has changed is that an employer must now also:

• disclose whether a licensed representative or responsible officer was under an internal investigation during the six months preceding cessation of employment (and provide details, if not previously provided to the SFC), and
• notify the SFC if an internal investigation (involving the employee) is commenced after submission of the initial notification.

This new requirement is intended to address the problem of employees who resign during an investigation, typically in the expectation that this would result in their employer simply ticking the “resignation” box, leaving them free to move on to another firm without disclosure of their misconduct to either the SFC or their new employer.

In this article, we consider the implications of this change for employers in Hong Kong.

What are the implications for employers?

The new question in the SFC’s Form 5U is likely to give rise to a number of questions for employers, such as:

• What constitutes an “investigation” for this purpose?
• Will this new requirement expose the firm to increased legal risk?
• What if an investigation is still ongoing when employment ends?
• What are the implications for hiring decisions?
• What are the implications for negotiated departures?

We consider some of these issues below.

What is an investigation?

The SFC has not yet provided any guidance on the meaning of “investigation”, so it is unclear exactly what kind of internal processes will fall in scope. For example, if an organisation takes informal steps to review or look into misconduct concerns, would this be covered or is it only intended to capture formal investigations? The SFC’s expectations in this regard are likely to become clear over time. In the interim, employers would be prudent to assume that the SFC will expect any allegations of fraud, dishonesty or serious misconduct to warrant an investigation (and hence disclosure) for these purposes.

Employers may wish to ensure that they have a clear framework in place for investigations, including clarity over when the requirement for an investigation will be triggered and how such investigations will be conducted. Detailed and proper investigation processes may need to be set up if not already in place.

Will this new requirement expose the firm to increased legal risk?

Concern about potential legal risk has until now been one of the principal reasons why regulated firms have tended not to share information about prior misconduct voluntarily. Providing information to the SFC about investigations may expose firms to increased legal risk.

There are several possible causes of action available to employees, but the one most likely to arise in this context is negligent misstatement. All employers are under a common law duty to provide references that are true, fair and not misleading. Failure to do so may expose the employer to the risk of liability for substantial damages, with scope for multiple years’ loss of earnings.

As a consequence, employers will need to take care when completing this part of Form 5U to minimize the risk of exposure to claims from a former employee if an incomplete, inaccurate or unfair notification means that they are unable to secure a new role at another firm.

What if an investigation has not concluded when employment ends?

One of the most difficult (and highest risk) areas arising from this new requirement is the situation in which an investigation has not concluded when employment ends - typically because the employee resigns at an early stage of the process. Here, there is a risk that disclosure of the fact of the investigation may imply wrongdoing by the individual in circumstances in which information has not been fully verified and no conclusions have been drawn.

In those circumstances, we suggest adopting the following approach:

• the notification should only contain statements which are true and factually accurate and, when read as a whole, are complete and not misleading
• the fact that the investigation is ongoing, and no findings have yet been made, should be clearly stated
• if the outgoing employee has provided an explanation for their misconduct or has denied the allegations, this should be stated, and
• if the outgoing employee has been given an opportunity to respond but has declined to do so, this should be stated.

The new regime is also likely to mean that where an employee resigns before an investigation has begun or at an early stage, it will nevertheless be desirable for the employer to complete the investigation. This should include offering the former employee an opportunity to take part in that investigation. Employers should expect that the SFC may request an update once any such investigation has been completed.

What are the implications for hiring?

As well as using the information for its own purposes, it is anticipated that the SFC may pass on the information received to any potential new employer. The onus is then likely to be on the new employer to decide whether, in light of this information, they are satisfied that the candidate is fit and proper.

Depending on the circumstances, but particularly if the previous employment ended while an investigation was ongoing, this may necessitate the new employer asking questions of a candidate in order to understand their response to the allegations and whether there are any extenuating or mitigating circumstances. The candidate’s response will need to be given careful consideration before proceeding with a hiring decision.

What are the implications for negotiated departures?

When negotiating exits, employers need to be careful not to fetter their ability to make true, accurate and complete disclosure to the SFC. Although the new Form 5U will not prevent firms from agreeing references and terms relating to confidentiality and non-disparagement in the usual way, it will be important for employers to reserve the right to deviate from the agreed content, should the need arise.

Employers may also wish to include a provision in any separation agreement which requires an outgoing employee to cooperate with any ongoing or future investigation. 

Conclusion

The new SFC forms must be used from 11 April 2019. Until then, there is a transition period during which either the old or new versions can be used. Firms are encouraged to consider how they will approach the new Form 5U before its use becomes mandatory.

Please feel free to contact us if you wish to discuss the implications of the new Form 5U for your organisation.