2015 – Page 3 – CompliancePlus Consulting Limited

On 26 March 2015, the Securities and Futures Commission (“SFC”) reprimanded and fined JS Cresvale Securities International Limited (“JS Cresvale Securities”) HK$2.5 million over serious deficiencies in relation to its sale of two unlisted investment products involving US$99 million between 2008 and 2010.

Background

JS Cresvale Securities is licensed under the Securities and Futures Ordinance (“SFO”) to carry on Type 1 (dealing in securities) and Type 4 (advising on securities) regulated activities. JS Cresvale Securities’ license for Type 2 (dealing in futures contracts) regulated activity has been suspended since September 2014.

The disciplinary action followed an SFC investigation which found serious deficiencies in JS Cresvale Securities’ systems and controls for ensuring the suitability of the recommendations or solicitations it made to clients when selling the two products, namely, 浩騰科技信用連結債券 and 浩騰11海外可轉換公司債. The products were recommended and sold to 59 clients in 2008, 26 clients in 2009 and 4 clients in 2010.

Specifically, the SFC found that JS Cresvale Securities:

Did not conduct any product due diligence or risk assessment on the products;
Did not have complete risk profiles of its clients as no steps were taken to assess the clients’ risk tolerance levels;
Had no systems and controls to guide its representatives to conduct proper suitability assessment when selling the products; and
Did not maintain documentary records of the investment advice or recommendations given to its clients nor provide clients with a copy of the written advice.

In determining the penalty, the SFC took into account that:

JS Cresvale Securities co-operated in resolving the disciplinary proceedings;
It agreed to conduct an independent review of its systems and controls for distribution of unlisted investment products and to enhance its complaint handling procedures; and
There is no evidence of client loss suffered from its distribution of the two unlisted products.

Comment

Readers should note that pursuant to General Principle 2 (diligence), paragraphs 3.4 (advice to clients: due skill, care and diligence) and 5.2 (know your client: reasonable advice) of the Code of Conduct, licensed corporations are required to ensure that, through the exercise of due diligence, the investment recommendations to clients are based on thorough analysis and are reasonable in all the circumstances. Further, paragraph VII(3) of, and paragraph 3 of the Appendix to, the Management, Supervision and Internal Control Guidelines for Persons Licensed by or Registered with the SFC provide that a licensed corporation in the business of offering investment advice should take steps to document and retain the reasons for its recommendations or advice given to the client and to implement special procedures to document (and provide a copy to the client) the rationale underlying investment advice rendered or recommendations made.

To view the Statement of Disciplinary Action issued by the SFC, please visit:

http://www.sfc.hk/edistributionWeb/gateway/EN/news-and-announcements/news/openAppendix?refNo=15PR29&appendix=0

For details, please refer to:

http://www.sfc.hk/edistributionWeb/gateway/EN/news-and-announcements/news/doc?refNo=15PR29

2. SFC welcomes U.S. CFTC exemption for Hong Kong brokers to deal directly with U.S. customersOn 26 March 2015, the SFC welcomed the issuance of an order by the U.S. Commodity Futures Trading Commission (“CFTC”) permitting SFC-licensed corporations to deal directly with U.S. customers in relation to trading of futures or options products on exchanges under the SFC’s oversight without having to register as futures brokers in the U.S.

Background

The CFTC is the regulatory body overseeing the U.S. futures and swaps markets including the regulation of intermediaries. The relevant order in this case was granted under CFTC’s Regulation 30.10.

The exchanges covered by the order include Hong Kong Futures Exchange Limited and non-U.S. exchanges authorized by the SFC under the SFO. Licensed corporations interested in exemption under the order which permits them to solicit and accept orders and funds directly from U.S. customers are required to submit applications with the U.S. National Futures Association via the SFC. Details of the application procedures will be announced in due course.

Further information on the CFTC order, please refer to the CFTC’s website:

http://www.cftc.gov/index.htm

For details, please refer to:

http://www.sfc.hk/edistributionWeb/gateway/EN/news-and-announcements/news/doc?refNo=15PR31

3. Court grants order compelling attendance of SFC investigation interviewOn 26 March 2015, the SFC obtained an order in the Court of First Instance (“CFI”) against Mr Joe Chong Wai Moon (“Mr Chong”), compelling him to attend an interview with the SFC in relation to investigations after he repeatedly failed to do so as required.

Background

Between August and October 2013, Mr Chong rendered various excuses for his non-attendance after receiving five notices issued by the SFC to attend an interview and subsequently failed to attend the interview. In granting the order, the court was satisfied that Mr Chong has no reasonable excuse for not attending the interview.

The Order

Mr Chong was ordered to attend an interview with the SFC on a specified date and answer any questions relating to the investigations that the investigator may raise with him, and to give the investigator all assistance in connection with the investigations which he is reasonably able to give. He was also required to pay the costs of the SFC’s application to the court.

The notices were issued in relation to three ongoing investigations into suspected market manipulation and false or misleading representations being made in certain applications to the SFC.

Comment

Under sections 182 and 183 of the SFO, the SFC has a general power to investigate, amongst other things, possible breaches of the SFO, misfeasance and activities that are not in the public interest. Under those sections, the SFC may authorize an employee (or any other person with the consent of the Financial Secretary) to carry out an investigation. The person so authorized may investigate any person. A person under investigation is required to:

Provide documents and explanations;
Attend before the investigator to answer questions;
Give the investigator all reasonable assistance;
Support his evidence by making a statutory declaration; or
Make a statutory declaration that he is unable to provide the evidence for reasons to be stated, if such is the case.

For details, please refer to:

http://www.sfc.hk/edistributionWeb/gateway/EN/news-and-announcements/news/doc?refNo=15PR30

4. SFC survey: Hong Kong hedge fund assets hit record highOn 30 March 2015, the SFC published the Report of the Survey on Hedge Fund activities of SFC-licensed Managers/Advisers stating that Hong Kong’s hedge fund AUM reached a record high in 2014.

Background

The abovementioned report shows that as of 30 September 2014, hedge fund AUM in Hong Kong reached US$120.9 billion, an increase of 39% from the amount reported in the previous survey in September 2012.

The major findings are summarized below:

The number of hedge funds managed by the SFC-licensed hedge fund managers has increased to 778 (15% increase from 676 two years ago);
Hong Kong hedge fund assets were allocated mainly in the Asia Pacific region using equity long/short and multi-strategy, and of the total AUM, 63.9% was allocated to the Asia Pacific markets which included 31.7% allocated to Hong Kong and mainland China;
92% of hedge fund investors were from outside Hong Kong and most were institutional investors.

The survey was conducted in conjunction with a data collection exercise concerning global hedge fund activities coordinated by the International Organization of Securities Commissions.

For the purpose of the survey, the term “hedge fund managers” includes those fund managers that manage hedge fund assets as well as those that advise hedge funds. The survey was sent to 401 SFC-licensed corporations which were identified as hedge fund managers as of 30 September 2014. They were asked to provide information and data about their hedge fund portfolios managed in Hong Kong as of that date. All licensed hedge fund managers participated in the survey.

For further details, please refer to:

http://www.sfc.hk/edistributionWeb/gateway/EN/news-and-announcements/news/doc?refNo=15PR27

5. SFC obtains disqualification order against former executive director of Tack Fiori International Group Limited

On 30 March 2015, the SFC obtained a disqualification order in the CFI against Mr Lam Yick Sing (“Mr Lam”), a former executive director of Tack Fat Group International Limited (“Tack Fat” or the “Company”), now known as Tack Fiori International Group Limited.

Background

On 14 March 2014, the SFC commenced proceedings to disqualify four former directors of the Company. In particular, the SFC alleged that:

The Company proposed to acquire a 40% interest in a timber company in Cambodia, shortly before the Company was placed into provisional liquidation, falsely announcing that the vendor was an independent third party when in fact the transaction was a sham involving an undisclosed connected party.
The Company failed to ensure shareholders were given all information they might reasonably expect in relation to various loan agreements entered into between the Company and various money lenders between June and July 2008, again shortly before the Company entered provisional liquidation. Some of these loan agreements involved the pledging of significant assets of the Company, which indicated a serious deterioration in the financial position of the Company.
Again, shortly before the Company was placed into provisional liquidation, the Company allotted share options in respect of 40 million shares in the Company, which were converted without payment and sold for the benefit of the former chairman between June and July 2008, gaining an unfair advantage not only over other members of the Company but also the investing public, in particular approximately 110 counterparties. The former chairman possessed material non-public price sensitive information in respect of the Company and made a profit of approximately HK$20 million out of the information.
The Directors failed to discharge their duties required of executive directors and manage the Company with the necessary degree of skill, care, diligence and competence as reasonably required.

As such, the SFC sought orders that the former chairman repays to the Company or other entities as the court thinks fit HK$26 million, being the subscription price of the 40 million shares in the Company allotted to his nominees, and/or accounts for any profits he has made through the trading of those shares.

On 9 October 2014, the SFC obtained a disqualification in the High Court against the former executive director, Mr Norman Ho Yik Kin (“Mr Ho”). Mr Ho was disqualified from being a director or being involved in the management of any listed or unlisted corporation, without leave of the court, for a period of six years effective today. In delivering his judgment, The Honourable Mr Justice Lam stated that Mr Ho was acting irresponsibly and with marked indifference to his duty as a director of Tack Fat, therefore a disqualification order for six years would be appropriate.

The disqualification order

As a result of the disqualification order, Mr Lam was disqualified from being a director or being involved in the management of any listed or unlisted corporation, without leave of the court, for a period of six years effective from 27 March 2015.

The order was made after Mr Lam admitted that he:

Failed to ensure that Tack Fat gave its shareholders all the information they might reasonably expect, and to comply with the disclosure requirements under the Listing Rules of the Stock Exchange of Hong Kong Limited;
Abdicated his responsibilities as a director of a publicly listed company;
Breached his duties as a director in failing to exercise reasonable care and diligence in the management of Tack Fat, to act in good faith and in the best interests of Tack Fat, and to implement a sound and prudent system of financial control so as to minimise the risk of misappropriation of company assets; and
Was partly responsible for the business or affairs of Tack Fat having been so conducted.

Mr Lam also admitted that he signed documents pledging the Company’s and subsidiary’s assets to secure loans to related parties which were improperly hidden from shareholders. He further signed attendance sheets for two board meetings in which Tack Fat approved a sham transaction involving an undisclosed connected party in an acquisition of 40% of a Cambodian timber company. Mr Lam further admitted that he did not know any information about the vendor or other details of the transaction. He conceded that he only did what he was told without any due exercise of independent commercial judgement nor was he clear on the duties of disclosure by a listed company.

In granting the order, the Honourable Mr Justice Lam said a six-year disqualification period was appropriate because Mr Lam was demonstrably lacking in diligence, competence and independence as a director, and had disregarded the responsibilities he owed to the Company and those who had interests in it.

The SFC’s Executive Director of Enforcement, Mr Mark Steward, said: “Lam’s misconduct was deplorable. His duty was to protect the interests of the Company and its shareholders; instead he betrayed them – to the financial detriment of both. The SFC will continue to take action to uphold appropriate standards of conduct expected from listed company directors.”

The SFC had earlier obtained a disqualification order against another former executive director of Tack Fat and was also seeking similar orders against two other former executive directors, including the former chairman and executive director, Mr Kwok Wing (“Mr Kwok”). Last week, Mr Kwok sought a stay of these proceedings pending the conclusion of criminal proceedings also arising from the affairs of Tack Fat but was refused by the CFI.

Comment

Readers should note that pursuant to section 214 of the SFO, the court may, inter alia, make orders to disqualify a person from being a director or being involved, directly or indirectly, in the management of any corporation for a period of up to 15 years, if the person is found to be wholly or partly responsible for the company’s affairs having been conducted in a manner, amongst others, involving defalcation, fraud, misfeasance or other misconduct towards it or its members. To prevent this type of disciplinary action, licensed corporations or persons may consult external compliance firms such as CompliancePlus Consulting Limited, to implement extensive internal checks and procedures.

For further details, please refer to:

http://www.sfc.hk/edistributionWeb/gateway/EN/news-and-announcements/news/doc?refNo=15PR33

6. Court sets trial date for indictable prosecution for unlicensed dealing

On 31 March 2015, the District Court fixed a date for the trial of IPFUND Asset Management Limited (“IPFUND”) and Mr Ronald Sin Chung Yin after IPFUND and Sin pleaded not guilty to charges related to unlicensed dealing.

Background

On 13 January 2015, the Eastern Magistrates’ Court granted an application by the Department of Justice (“DoJ”) to transfer to the District Court the first prosecution of a case for unlicensed dealings involving a collective investment scheme (“CIS”).

On 31 May 2014, the SFC commenced the criminal proceedings at the Eastern Magistrates’ Court against IPFUND and its sole director and shareholder Mr Ronald Sin Chung Yin. Both pleaded not guilty to four summonses on 3 July 2014. IPFUND and Sin were accused by the SFC of carrying on a business, or holding out as carrying on a business, in a regulated activity in dealing in securities without a licence in contravention of section 114 of the SFO. The securities in question are CIS.

The SFC alleged that between February 2011 and December 2011, IPFUND and Sin, both of whom have never been licensed by the SFC, offered and disposed of interests in 16 CIS to investors. IPFUND and Sin managed and controlled those CIS which were not authorized by the SFC. The funds contributed by the investors were allegedly pooled for use in purchasing commercial properties in Hong Kong. Upon the sale of those properties, part of the profit earned would be distributed among the investors in proportion to their contribution towards the purchase price, and IPFUND would receive consultancy fees based on profits earned from the trading of these commercial properties.

On 4 September 2014, the Eastern Magistrates’ Court gave directions to the SFC to consider whether it would be appropriate for the summonses to be tried in the District Court because of the complexity of the subject matter, the number of witnesses and the estimated length of the trial. The case was adjourned several times to the final date of 13 January 2015.

This is the first indictable prosecution for an offence under section 114 of the SFO, and will be prosecuted by the Prosecutions Division of the DoJ. The trial is set down to commence on 2 November 2015 for 12 days.

Specifically, IPFUND was charged with the offence of carrying on a business in a regulated activity, contrary to section 114(1)(a) and 114(8) of the SFO; alternatively, holding out as carrying on a business in a regulated activity, contrary to section 114(1)(b) and 114(8) of the SFO). Sin was charged with the offence of carrying on a business in a regulated activity, contrary to section 114(1)(a), 114(8) and 390(1) of the SFO; alternatively, holding out as carrying on a business in a regulated activity, contrary to section 114(1)(b), 114(8) and 390(1) of the SFO

Comment

Readers should note that section 114 states that, no person shall carry on a business in a regulated activity, or hold himself as carrying out a business in a regulated activity except for:

A corporation licensed under section 116 or 117 for the regulated activity;
An authorized financial institution registered under section 119 for the regulated activity;
A person authorized under section 95(2) for the regulated activity;
When a person is carrying out Type 8 regulated activity by reason only of carrying on one or more activities specified in Part 3 of Schedule 5 to the SFO; or
Where in relation to Type 8 regulated activity, a person is only providing financial accommodation and reasonably believes that the financial accommodation is not to be used to facilitate (a) the acquisition of securities listed on a stock market (whether a recognized stock market or any other stock market outside Hong Kong), or (b) the continued holding of such securities.

Further, section 390 SFO states that where the commission of an offence under the SFO by a corporation is proved to have been aided, abetted, counselled, procured or induced by, or committed with the consent or connivance of, or attributable to any recklessness on the part of, any officer of the corporation, or any person who was purporting to act in any such capacity, that person, as well as the corporation, is guilty of the offence and is liable to be proceeded against.Therefore, readers should be aware that all relevant licenses are applied for. To avoid doubt, readers may find it useful to consult external compliance firms with extensive expertise in licensing such as CompliancePlus Consulting Limited.

For details, please refer to:

http://www.sfc.hk/edistributionWeb/gateway/EN/news-and-announcements/news/doc?refNo=15PR34

7. SFC reprimands and fines Merrill Lynch Far East Limited HK$2 million for regulatory breaches

On 1 April 2015, the SFC reprimanded and fined Merrill Lynch Far East Limited (“Merrill Lynch Far East”) HK$2 million for regulatory breaches and internal control failings relating to position limit failures.

Background

Merrill Lynch Far East is a licensed corporation under the SFO to carry on Type 1 (dealing in securities), Type 2 (dealing in futures contracts), Type 4 (advising on securities), Type 6 (advising on corporate finance) and Type 7 (providing automated trading services) regulated activities.The abovementioned decision follows a SFC investigation into the holding of Merrill Lynch International (“MLI”) in 14,181 contracts in Hang Seng China Enterprises Index (“HSCEI”) on 30 May 2013 in breach of the prescribed position limit of 12,000 contracts. Merrill Lynch Far East controlled the trading or part of the trading for MLI and had discretion to make trading decisions for MLI for hedging at the material time.

The SFC found that Merrill Lynch Far East failed to implement adequate internal controls to monitor MLI’s positions in HSCEI futures and options contracts to ensure compliance with the prescribed position limit. Specifically, although Merrill Lynch Far East had a system in place to alert traders to reduce MLI’s position when its aggregate position reached 80% of the prescribed position limit, the system failed to capture MLI’s expiring short positions and their potential impact on the prescribed position limit. This resulted in Merrill Lynch Far East’s failure to detect the expiry of a large short position in HSCEI futures contracts on 30 May 2013 and the corresponding increase in MLI’s long position which contributed directly to the position limit breach.

In determining the penalty, the SFC took into account Merrill Lynch Far East’s co-operation and that it had taken steps to strengthen its internal controls on monitoring position limits.

Comment

Readers should note that pursuant to Rule 4(1) Securities and Futures (Contracts Limited and Reportable Positions) Rules (the “Rules”), no person, except persons authorized by the SFC or the Hong Kong Exchanges and Clearing Limited, may hold or control futures contracts or stock options contracts in excess of the prescribed limit. Further, Section 5(a) of the Rules provides that the limit on the number of contracts that may be held or controlled, in the case of futures contracts, is specified in Schedule 1 of the Rules. Schedule 1 of the Rules supplements that the prescribed limit for HSCEI contracts is 12,000 long or short position delta for all contract months combined.

Additionally, General Principle 7 of the Code of Conduct for Persons Licensed by or Registered with the Securities and Futures Commission (the “Code of Conduct”) requires a licensed person to comply with all regulatory requirements applicable to the conduct of its business activities. Paragraph 12.1 of the Code of Conduct further requires a licensed person to comply with and maintain appropriate measures to ensure compliance with all applicable regulatory law, rules, regulations and codes administered or issued by the SFC, exchanges, clearing houses and other regulatory authorities which apply to the licensed person. It is therefore prudent for licensed persons and corporations to implement extensive internal policies and procedures.

For a copy of the SFC’s Statement of Disciplinary Action, please visit:

http://www.sfc.hk/edistributionWeb/gateway/EN/news-and-announcements/news/openAppendix?refNo=15PR35&appendix=0

For further details, please refer to:

http://www.sfc.hk/edistributionWeb/gateway/EN/news-and-announcements/news/doc?refNo=15PR35

8. Takeovers Panel publishes reasons for breach of Takeovers Code by Chow Yei Ching, Joseph Leung Wing Kong and Oscar Chow Vee Tsung

On 16 April 2015, the Takeovers and Mergers Panel (“Takeovers Panel”) published its written decision setting out the reasons for finding Mr Chow Yei Ching (“Mr Chow Y.C.”), Mr Oscar Chow Vee Tsung (“Mr Chow V.T.”) and Mr Joseph Leung Wing Kong (“Mr Kong”) in breach of The Codes on Takeovers and Mergers and Share Repurchases (the “Takeovers Code”). Background

On 20 November 2013, the SFC commenced disciplinary proceedings before the Takeovers Panel against the chairman of Chevalier Group, Mr Chow Y.C., Mr Chow V.T., and Mr Kong over a serious breach of the Takeovers Code. The SFC alleged that the three actively co-operated to assist the late Ms Nina Kung (“Ms Kung”) to obtain or consolidate control of ENM Holdings Limited (“ENM”) and avoid the triggering of a mandatory general offer under the Takeovers Code.

At the relevant time, Ms Kung was the largest shareholder of ENM. She was also the chairwoman and the sole beneficial owner of the Chinachem Group. Mr Chow Y.C., Mr Chow V.T., and Mr Kong were closely connected to Ms Kung. Mr Chow Y.C. had known Ms Kung as a close friend and business partner with numerous commercial dealings for more than 40 years. Mr Chow V.T. is alleged to have acted in concert with his father, Mr Chow Y.C., under the Takeovers Code. Mr Kong was a trusted friend and close business associate of Ms Kung. He has been working at the Chinachem Group as a director since April 1987.

Between 2000 and 2002, Mr Chow Y.C. acquired a total of 160 million shares of ENM (approximately 9.69% of ENM’s issued share capital) on Ms Kung’s behalf and at her request. Mr Chow Y.C. paid for the purchase of the ENM shares and was subsequently reimbursed by Ms Kung. The reimbursement was handled by Mr Chow V.T. and Mr Kong. Mr Chow Y.C. held the ENM shares under four British Virgin Island (“BVI”) companies he owned through the issuance of bearer shares until December 2009. To comply with the changes to BVI law requiring greater transparency in the ownership of bearer shares, Mr Chow Y.C. arranged for the ownership of the 160 million ENM shares to be split equally between one of his daughters and Mr Chow V.T. in December 2009.

Since the Takeovers Code treats persons acting in concert as being the equivalent of a single person and aggregates their shareholdings, Mr Chow Y.C.’s acquisitions increased the collective shareholding of the concert group in ENM from 34.64% to 44.33%. As a result, the mandatory general offer obligation under the Takeovers Code was triggered. However, none of the share acquisitions in ENM by Mr Chow Y.C. on Ms Kung’s behalf were publicly disclosed and remained undisclosed for a protracted period. This type of arrangement, which is commonly known as “warehousing”, enabled Ms Kung to secretly hold the ENM shares and avoid an obligation under the Takeovers Code to make a general offer. In consequence ENM shareholders were deprived of their fundamental right to receive a general offer to buy their shares. Mr Chow Y.C. brought the matter to the SFC’s attention after receiving a letter in late April 2012 from the joint administrators of Ms Kung’s estate making enquiries about shares of ENM that belonged to the estate.

On 13 March 2015, the Takeovers Panel found that Mr Chow Y.C., Mr Kong and Mr Chow V.T. breached the mandatory offer requirement under the Takeovers Code. It was announced on that date that written reasons would be issued in due course by the Takeovers Panel.

As such, on 16 April 2015, the abovementioned written reasons were published by the Takeovers Panel. The Takeovers Panel invited submissions from the parties on sanctions to be imposed and will make a decision in due course.

Comment

Readers should note that Rule 26 is the overriding rule in the Takeovers Code and provides the circumstances in which a mandatory general offer must be made. This reflects General Principle 1 of the Takeovers Code and underpins the requirement for equal treatment of shareholders. Failure to make an offer that is required to be made under Rule 26.1 constitutes a serious breach of the Takeovers Code. Rule 26.1 (in force in December 2000) required a mandatory general offer to be made for all the shares in the company if a person or group of persons acting in concert acquired shares resulting in either:

The person or concert group collectively holding 35% or more of the voting rights (known as the “trigger”). The trigger threshold was reduced to 30% on 19 October 2001; or
The person or concert group collectively holding between 35% and 50% of the shares and then going on to acquire, either individually or as a group, more than 5% in any 12 month period (known as the “creeper”). The creeper threshold was reduced to 2% on 19 October 2001.

Readers should therefore have this provision in mind when acquiring voting rights and/or shares to avoid breaching the Takeovers Code. It should also be noted that licensed persons may be acting in concert, in which case all the shares held are aggregated to calculate whether the threshold has been triggered.

To view the Takeovers Panel’s written decision, please refer to:

http://www.sfc.hk/web/EN/files/CF/pdf/Panel%20Decision/ENM_Panel%20Decision%20(final).pdf

For further details, please refer to:

http://www.sfc.hk/edistributionWeb/gateway/EN/news-and-announcements/news/doc?refNo=15PR38

The article is for general information purpose only and is not intended to constitute legal or other professional advice.
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Regulatory News (Apr 2015)

April 14, 2015/in Regulatory News /by Tony Chan

Newsletter – March 2015

March 25, 2015/in Newsletter /by Tony Chan

Contents:

SFC bans Katherina Lo Ka Shun for two years for improper trading arrangement
SFC obtains court order to wind up China Metal Recycling (Holdings) Limited
SFC seeks comments on Principles of Responsible Ownership
SFC seeks disqualification and compensation orders against former chairman and directors of Inno-Tech Holdings Limited
SFC bans Wong Chun Yin for life for misconduct
SFC bans Luo Jianglan for six months for failing to adhere to short selling regulations
Market Misconduct Tribunal sets date for hearing on alleged false research report
Court of Final Appeal allows appeal of Pacific Sun Advisors Limited and its director

1. SFC bans Katherina Lo Ka Shun for two years for improper trading arrangement

On 25 February 2015, the SFC banned Ms Katherina Lo Ka Shun (“Lo”) from re-entering the industry for two years from 24 February 2015 to 23 February 2017. Lo was licensed under the Securities and Futures Ordinance (“SFO”) to carry on Type 1 (dealing in securities) and Type 2 (dealing in futures contracts) regulated activities and was accredited to Quam Securities Company Limited from 21 October 2010 to 1 January 2014. Lo is currently not a licensed person.

Background

The SFC found that Lo sold 30 million shares in Grand Peace Group Holdings Limited (“Grand Peace”) held by her and her daughter on a pre-arranged basis. The transaction was executed on market on 11 September 2012 at prices which Lo knew that they were not the price she privately agreed with the purchaser. The actual terms Lo agreed to dispose the shares included a cash discount payable to the purchaser amounting to a total sum of HK$700,000.

Although Lo claimed that she did not know that the disposal of shares was improper, the SFC found that as a licensed person with over 10 years of experience in the industry, it is not an excuse that Lo was ignorant to the improperness of such a trading arrangement as she is expected to know the consequences of her conduct. In addition, Lo’s eagerness to sell the shares was not found to be a valid excuse for agreeing to and taking part in the misconduct which had the effect of giving an inaccurate share price to the market. As such, there was no reasonable explanation for the payment of the cash discount and for such a transaction being executed on-market. On-market transactions should reflect what has actually been agreed between the parties.

The SFC considered that this transaction casts considerable doubt on Lo’s fitness and properness to be a licensed person, and subsequently banned her from re-entering the industry for two years.

Comment

Readers should note that pursuant to section 245 of the SFO, false trading is a type of market misconduct. These may be tried both as a criminal offence and in the Market Misconduct Tribunal (“MMT”), which determines its proceedings based on the civil standard, “on the balance of probabilities”. If the SFC, after investigation into any particular case, decides that the civil route is appropriate, it may, with the consent of the Secretary for Justice, institute proceedings in the MMT. At the conclusion of the proceedings, the MMT will issue a public report which states whether any market misconduct has taken place, make orders and give reasons for such orders. False trading is considered particularly damaging because it is disadvantageous to innocent investors and would destabilize the market.

Further information can be found in the Statement of Disciplinary Action issued by the SFC:

http://www.sfc.hk/edistributionWeb/gateway/EN/news-and-announcements/news/openAppendix?refNo=15PR17&appendix=0

For details, please refer to:

http://www.sfc.hk/edistributionWeb/gateway/EN/news-and-announcements/news/doc?refNo=15PR17

2. SFC obtains court order to wind up China Metal Recycling (Holdings) Limited

On 26 February 2015, the Court of First Instance (“CFI”) ordered that China Metal Recycling (Holdings) Limited (“China Metal Recycling”) be wound up in the public interest on the application of the SFC. China Metal Recycling was incorporated in the Cayman Islands on 18 July 2007. On 10 June 2009, it issued a prospectus for Global Offering. On 22 June 2009, its shares were listed on the Main Board of the Stock Exchange of Hong Kong Limited (“SEHK”). About HK$1,685 million, net of listing expenses, were raised by the initial public offering of the company. Trading in shares of China Metal Recycling has been suspended since 28 January 2013.

Background

On 26 July 2013, the SFC presented a petition to the CFI to wind up China Metal Recycling under section 212 of the SFO and obtained an order to appoint Cosimo Borrelli and Jocelyn Chi Lai Man, both of Borrelli Walsh Limited, as joint and several provisional liquidators for China Metal Recycling. This case is particularly seminal as it is the first time that the SFC obtained a court order to wind up a Hong Kong-listed company under section 212 of the SFO for the purpose of protecting the company’s minority shareholders, creditors and the investing public.

The SFC alleged that the affairs of China Metal Recycling involved a highly complex, sophisticated and dishonest scheme spanning Hong Kong, Macao, the Mainland and the United States of America (“US”). The scheme inflated China Metal Recycling’s performance, revenue and profit dating back to the time of its IPO prospectus in 2009 and becoming larger and more complex in the subsequent years until it was brought to an end when the SFC commenced these proceedings in July 2013. The scheme involved the use of China Metal Recycling’s wholly owned off-shore subsidiary in Macao, Central Steel (Macao Commercial Offshore) Limited (“Central Steel Macao”) which was the conduit for a substantial part of the company’s annual profits between 2007 and 2012 and was also a factory for generating false documents and instruments by which these profits were falsified. Further, the scheme also involved fake shipments of scrap metal between the US and the Mainland, false shipping documents, false accounts, and highly complex round robin transactions spanning continents.

As a result, the aggregate revenue and gross profit of China Metal Recycling for the years 2007 to 2009 appears to have been overstated by around 46% or over HK$8 billion and 72% or over HK$1 billion respectively. By way of illustration, Central Steel Macao made 431 payments totaling around US$2.4 billion to its purported key suppliers in the US and Hong Kong in 2012. About 98% of the funds were passed on to its purported customers and eventually circulated back to Central Steel Macao through a multitude of bank accounts, all through multiple entities set up around the world yet controlled centrally within China Metal Recycling.

Moreover, there was no sign of the scheme terminating or at least curtailing in scale after the IPO, or even after the SFC started investigating into the matter. On the contrary, the fictitious circulation of funds increased both in terms of scale and complexity.

The former management of the company and its subsidiaries prior to the appointment of the provisional liquidators denied any impropriety and, until recently, opposed the SFC’s case. However, without accepting any liability, the former management withdrew from the case and took no part in the hearing.

The Order

After considering the SFC’s evidence, the Honorable Mr. Justice Harris granted the order to wind up China Metal Recycling, and indicated that he would deliver reasons for the decision in due course.

Mr. Mark Steward, the Executive Director of Enforcement, said, “This is an audacious and dishonest scheme using multiple secret nominees established all around the world to deceive Hong Kong investors and creditors into believing this company had a track record and a performance that it simply did not have. It has been stopped and control will vest with independent, court appointed liquidators. The liquidators will be able to conduct an independent assessment of the company’s real position, in the best interests of all those with a financial interest in the case.”

Further, he added, “This has been a very challenging investigation, an unparalleled dogged pursuit to uproot this misconduct in as many parts of the world as the company falsely claimed its containers had travelled. The SFC will continue this pursuit to combat corporate misconduct like this and there is no doubt our work in this matter is not finished yet.”

Comment

Readers should note that pursuant to section 212 of the SFO, the SFC is permitted to apply for a winding-up order against companies if it appears to the SFC that it is desirable in the public interest to do so, and the Court may grant the order on the ground that it is just and equitable to wind up those companies. This case illustrates that an example of public interest is the protection of investors and creditors against fraud.

For details, please refer to:

http://www.sfc.hk/edistributionWeb/gateway/EN/news-and-announcements/news/doc?refNo=15PR18

3. SFC seeks comments on Principles of Responsible Ownership

On 2 March 2015, the SFC launched a three-month consultation on proposed Principles of Responsible Ownership which provide guidance for how investors should fulfil their ownership responsibilities in relation to their investment in a listed company.

Background

The seven principles of responsible ownership asks investors to do the following:

To establish and report to their stakeholders their policies for discharging their ownership responsibilities;
To monitor and engage their investee companies;
To establish clear policies on when to escalate their engagement activities;
To have clear policies on voting;
To be willing to act collectively with other investors when appropriate;
To report to their stakeholders on how they have discharged their ownership responsibilities; and
When investing on behalf of clients, to have policies on managing conflicts of interests.

The principles, which are non-binding and voluntary, operate on a “comply-or-explain” basis. Investors are encouraged to “sign up” to the principles and either disclose how they comply with the principles, or else explain why some or all of the principles do not, or cannot, apply. The principles are relevant to individual and retail investors in that they provide general guidance on share ownership engagement, although some elements of the principles, such as reporting to stakeholders, do not expressly apply to individuals.

“Whilst the primary responsibility for a company’s success rests with the company’s board, investors in a company also play a significant role by holding the board to account for the fulfillment of its responsibilities,” said Mr. Ashley Alder, the SFC’s Chief Executive Officer. “Recognizing the importance of responsible ownership benefits the company, its investors and the economy as a whole,” he added.

The public is invited to submit their comments to the SFC on or before 2 June 2015. Readers may submit written comments via the SFC website (www.sfc.hk), by email to [email protected], by post or by fax to 2810 5385.

Comment

The SFC states in its Consultation Paper that in any mature market economy, there is reliance upon shareholders to evaluate investment opportunities and allocate their capital according to their assessment of risk and likely returns and to then monitor the performance of the company and assess the effectiveness of their capital allocation. In order for them to do so, they need to seek information and monitor the progress of their investee companies. By doing so, responsible shareholders carry out a function that is essential for effective capital allocation that contributes to the economic growth of a society. For instance, while directors are required by law to act in the interests of the shareholders of the company, shareholders are similarly expected to take action where they believe that directors are not acting in the interests of the company or its shareholders. As such, the law provides all shareholders with voting rights and other rights to enable them to engage with directors and to monitor the progress of their investment in the company.

Further, the SFC notes that in the past several decades, there has been a notable increase in institutional ownership of publicly listed companies, and that the importance of the roles and responsibilities of institutional investors in corporate governance has been placed under scrutiny following the global financial crisis of 2008. The SFC therefore emphasizes the importance of encouraging proactive ownership engagement between investors and publicly listed companies. Therefore, whilst the Hong Kong market retains a relatively high proportion of shares held directly by individuals, like all markets, much of each individual’s wealth invested in listed companies is not held directly. Individuals are thus dependent on others to exercise shareholder rights in a way that benefits them individually and society generally. The Consultation is therefore aimed towards providing guidance: (i) to assist investors in determining how best to meet their ownership responsibilities whether these are exercised directly or through intermediaries; and (ii) for intermediaries on whom investors are depending to exercise ownership responsibilities. This guidance is currently provided in the form of the Principles of Responsible Ownership set out in Appendix A of the Consultation, and the SFC is seeking market comments on the said Principles.

It is particularly important to note that since investors pursue different investment objectives, the aim of the Principles is not to advocate any particular investment strategy or to prescribe, quantify or identify the degree of investor engagement necessary to qualify an investor as a responsible investor or good corporate citizen. Instead, the Principles seek to encourage each investor to consider the shareholder engagement policies that are suitable to its circumstances and to then implement these policies, either directly or by selecting intermediaries to do so on its behalf.

To view the Consultation Paper on the Principles of Responsible Ownership, please visit: http://www.sfc.hk/edistributionWeb/gateway/EN/consultation/doc?refNo=15CP2

For further details, please refer to:

http://www.sfc.hk/edistributionWeb/gateway/EN/news-and-announcements/news/doc?refNo=15PR19

4. SFC seeks disqualification and compensation orders against former chairman and directors of Inno-Tech Holdings Limited

On 9 March 2015, the SFC commenced legal proceedings in the CFI against the former chairman and directors of Inno-Tech Holdings Limited (“Inno-Tech”) over alleged misconduct that caused the company to lose more than HK$125 million.

Background

Inno-Tech is a company that has been listed on the Growth Enterprise Market of the SEHK since 12 August 2002. Up to 2002, it was principally engaged in the provision of intranet design for residential communities and electronic property management software consultancy. According to its website, Inno-Tech is now engaged in the business of development and sale of intelligent home electronic application system and development of outdoor advertising business on the Mainland. Trading in Inno-Tech shares was suspended since 26 January 2015.

The SFC alleges that Inno-Tech’s former chairman and director, Ms Wong Yuen Yee, and three former directors, namely Mr. Robert Wong Yao Wing, Mr. Wong Kwok Sing and Mr. Lam Shiu San (collectively the “Four Former Directors”), breached their duties as directors in relation to the acquisitions and/or disposals of interests in three hotels and a gold mine on the Mainland between 2007 and 2010 resulting in substantial and material losses to Inno-Tech. The hotels and gold mine concerned are Xindu Hotel, Kaiping Hotel, Changlin Hotel and De Xing City Zhang Jia Fan Gold Mine. The total losses caused by the transactions amounted to more than HK$125 million.

Specifically, the SFC alleges that the Four Former Directors have failed to:

Carry out adequate investigation into or due diligence prior to the acquisitions of the interests in the three hotels and the gold mine;
Negotiate the consideration for acquiring the interests in the three hotels and the gold mine;
Assess or to obtain any independent assessment of whether an investment in the gold mine was a commercially suitable or an appropriate one for Inno-Tech;
Assess the purchase price of the interests in the gold mine properly;
Give adequate consideration to who would be appropriate to appoint as directors and/or who to put in charge in respect of gold mining matters; and
Supervise the running of the gold mine properly.

Orders sought

The SFC is seeking orders that the Four Former Directors be disqualified as company directors and that Inno-Tech bring proceedings against them for compensation or, alternatively, that they be ordered to pay compensation to Inno-Tech directly.

The first hearing of the petition presented by the SFC will be heard in the CFI on 29 April 2015.

Comment

Readers should note that the SFC has the power to commence legal proceedings under section 214 of the SFO, under which the court may, among other things, make orders to disqualify a person from being a director or being involved, directly or indirectly, in the management of any corporation for up to 15 years. The court may also order a company to bring proceedings in its own name against any person specified in the order and may make any other order it considers appropriate.

For a details on the material events and allegations made by the SFC, please refer to:

http://www.sfc.hk/edistributionWeb/gateway/EN/news-and-announcements/news/openAppendix?refNo=15PR20&appendix=0

For further details, please refer to:

http://www.sfc.hk/edistributionWeb/gateway/EN/news-and-announcements/news/doc?refNo=15PR20

5. SFC bans Wong Chun Yin for life for misconduct

On 10 March 2015, the SFC banned Mr. Wong Chun Yin (“Wong”), a former relationship manager of the Standard Chartered Bank (Hong Kong) Limited (“SCBHK”), from re-entering the industry for life. Wong was a relevant individual engaged by SCBHK to carry on Type 1 (dealing in securities) and Type 4 (advising on securities) regulated activities under the SFO from September 2009 to June 2012.

Background

The SFC found that, between October 2011 and May 2012, Wong effected fund transactions in clients’ accounts without their authorization to meet his sales targets and tried to conceal his misconduct by tampering with one client’s contact information. Further, it was found that Wong also falsified client instructions for the transactions by misleading the clients into signing fund order forms which were blank or with essential instruction particulars missing from the forms.

The SFC found that Wong’s dishonest conduct was not in the best interests of clients and was in breach of the SFC’s Code of Conduct by or Registered with the SFC (“Code of Conduct”). As a result, the SFC concluded Wong is not a fit and proper person to be licensed.

The case was referred to the SFC by the Hong Kong Monetary Authority (“HKMA”). The affected clients have been made whole by SCBHK.

Comment

The HKMA’s linkage with the SFC relates primarily to the supervision of banks, since authorized financial institutions (“AFIs”) which are regulated by the HKMA have to be registered with the SFC as registered institutions if they wish to carry out an SFC-regulated activity. In supervising these AFIs, the HKMA applies all SFC criteria, including the “fit and proper” criteria. If the HKMA suspects malpractice by registered institutions in respect of an SFC-regulated activity, it may refer such cases to the SFC, which may directly review those institutions.

Further, readers should note that pursuant to section 194 of the SFO, if the SFC finds that a “regulated person is guilty of “misconduct” or is not a fit and proper person, the SFC may:

In the case of a licensed corporation or representative, revoke or suspend the license in respect of all or part of the licensed corporation or representative, revoke or suspend the license in respect of all or part of the regulated activity;
In the case of the responsible officer, revoke or suspend approval as a responsible officer;
Publicly or privately reprimand the regulated person;
Prohibit the regulated person from applying for a license, registration, approval as a responsible officer or entry in the HKMA register, or to act as an executive officer; and
Separately or in addition order the regulated person to pay penalty up to the greater of HK$10 million or three times the profit gained or loss avoided as a result of his misconduct.

For the Statement of Disciplinary Action issued by the SFC, please refer to:

http://www.sfc.hk/edistributionWeb/gateway/EN/news-and-announcements/news/openAppendix?refNo=15PR21&appendix=0

For further details, please refer to:

http://www.sfc.hk/edistributionWeb/gateway/EN/news-and-announcements/news/doc?refNo=15PR21

6. SFC bans Luo Jianglan for six months for failing to adhere to short selling regulations

On 11 March 2015, the SFC banned Ms Luo Jianglan (“Luo”) from re-entering the industry for six months from 10 March 2015 to 9 September 2015.

Background

The SFC found that on 22 August 2013, Luo, who was an associate of her employer’s Client Facilitation Desk, created a short sell order of 300,000 shares in China Resources Land Limited (“CRL Order”) and released part of the order to the market without ensuring a relevant stock borrow arrangement in place as required by her employer’s procedures for ensuring compliance with short selling regulations. At the time when Luo created the CRL Order, J.P. Morgan as a group held sufficient CRL shares to cover the order.

Luo did not report her breach in respect of the CRL Order to her employer but took various steps to conceal it, including falsely represented to the compliance department that she had arranged prior internal stock transfer to cover the short position.

The SFC considered Luo’s conduct called into question her fitness and properness to be a licensed person. The SFC considers Luo’s failure to adhere to her employer’s short selling procedures and the steps she took to cover up the error from her employer as unacceptable.

Comment

Pursuant to General Principle 1 of the Code of Conduct, all licensed persons are required to act honestly, fairly, and in the best interests of their clients and the integrity of the market when conducting regulated activities. Further, General Principle 2 of the Code of Conduct requires all licensed persons to act with due skill, care and diligence, in the best interests of its clients and the integrity of the market.

Readers should note that Section 170(1) of the SFO prohibits “naked” or “uncovered” short selling. It creates a criminal offence for a person to sell securities at or through a recognized stock market unless at the time of the sale, he (or his client, if he is an agent) has a presently exercisable and unconditional right to vest the securities in the purchaser of them, or believes and has reasonable grounds to believe that he (or his client, as the case may be) has such a right.

For the avoidance of doubt, section 170 applies only to short sales conducted at or through a recognized stock market, i.e., at present, the SEHK. It does not apply to off-exchange short sales.

7. Market Misconduct Tribunal sets date for hearing on alleged false research report

On 19 March 2015, the Honorable Mr. Justice Hartmann, chairman of the MMT, has fixed a hearing date for the proceedings commenced by the SFC against Mr. Andrew Left (“Mr. Left”) of Citron Research in relation to alleged market misconduct involving the publication of a research report on Evergrande Real Estate Group Limited (“Evergrande”) in June 2012.

Background

On 22 December 2014, the SFC commenced proceedings in the MMT against Mr. Left, alleging market misconduct involving the publication of a research report on Evergrande, a company listed on the SEHK on 5 December 2009, in June 2012. Mr. Left resides in the US and is the head of Citron Research, a US-based publisher of research reports on listed companies.

The SFC alleges that on 21 June 2012, Mr. Left published a report on Citron Research’s website (www.citronresearch.com) that contained false and misleading information about Evergrande. The report stated, inter alia, that Evergrande was insolvent and had consistently presented fraudulent information to the investing public. Following the publication of the report, the share price of Evergrande fell sharply on the same day. In fact, the share price of Evergrande reached a high of HK$4.52 in the morning but then declined sharply to a day low of HK$3.6, down 19.6% from the previous day’s close of HK$4.48. The stock closed at HK$3.97 which was 11.4% down from the previous day’s closing price. By comparison, the Hang Seng Index declined 1.3% on the same day

Further, the SFC alleges that shortly before publishing the report, Left short sold 4.1 million shares of Evergrande which he subsequently bought back, making a notional profit of over HK$2.8 million. Mr. Left made a total realized profit of approximately HK$1.7 million.

The MMT has now reserved 22 February to 8 March 2016 for the hearing.

For further details, please refer to:

http://www.sfc.hk/edistributionWeb/gateway/EN/news-and-announcements/news/doc?refNo=15PR24

8. Court of Final Appeal allows appeal of Pacific Sun Advisors Limited and its director

On 20 March 2015, the Court of Final Appeal (“CFA”) today upheld an appeal by Pacific Sun Advisors Limited (“Pacific Sun”) and its director Mr. Andrew Pieter Mantel (“Mr. Mantel”) in relation to issuing advertisements to promote a collective investment scheme (“CIS”) without the authorization of the SFC.

Background

On 21 March 2013, the Eastern Magistracy acquitted Pacific Sun and its director Mr. Mantel for four counts of issuing advertisements to promote a CIS without the authorization of the SFC in contravention of section 103 of the SFO.

The SFC alleged that between November and December 2011, the defendants issued an advertisement on the corporate website of Pacific Sun promoting a CIS called “Pacific Sun Greater China Equities Fund” (the “Fund”) without the authorization of the SFC. It was also alleged that on or around 2 and 3 December 2011, the defendants issued an advertisement regarding the launch of the Fund to the public by email without the authorization of the SFC.

During three days of evidence, the defendants submitted that they intended to sell interests in the units of the Fund only to professional investors and so the advertisements did not require authorization by the SFC under a statutory exemption. The SFC, on the other hand, submitted that the exemption did not permit advertisements that had not been authorized by the SFC to be issued to the public and that in this case there was no evidence that the interests in the Fund had only been sold to professional investors. The Magistrate accepted the defendant’s argument and ruled that the advertisements did not constitute invitations to the public to invest in the fund.

The case in the CFI

Subsequently, the SFC appealed the decision. On 27 January 2015, the CFI overturned the acquittals of Pacific Sun and Mr. Mantel. The SFC argued that the acquittal decision was based on legal errors. The CFI agreed and ordered the case to be remitted back to the Magistrate for reconsideration as the advertisements in question did not fall within the exemption in section 103(3)(k) of the SFO, which applies if the securities are or are intended to be disposed of only to professional investors. The CFI made it clear that the exemption only applies where the advertisements states on its face that the terms of the offer are limited to professional investors. As a result, Pacific Sun and Mantel were charged with four counts of issuing advertisements to promote a CIS without the authorization of the SFC in contravention of section 103 of the SFO.

The SFC considered that this ruling protects retail investors from the risks of direct marketing of inappropriate or risky investment products.

The case in Tsuen Wan Magistrate’s Court

On 10 June 2014, Pacific Sun and Mr. Mantel were convicted at the Tsuen Wan Magistrates’ Court on four charges of issuing advertisements to promote a CIS without the authorization of the SFC. Pacific Sun was fined HK$20,000 and Mantel was sentenced to four weeks’ imprisonment suspended for 12 months.

The case in the CFA

The ruling of the CFA on 20 March 2015 overturned the abovementioned decision of the CFI on the interpretation of section 103 of the SFO. Pacific Sun and Mantel were acquitted after they argued successfully that they could rely upon an exclusion contained in section 103(3)(k) of the SFO. As a result, the acquittal verdict at the Eastern Magistracy stands.

The CFA held that the CFI erred in its ruling in that the exclusion applies even if the intention to dispose of the securities or interests in a CIS only to professional investors is not expressed in the advertisement, invitation, or document. The CFA clarified that the burden of establishing that the exclusion applies rests on the defendant and not on the SFC, and that the professional investor exemption would not apply if a person published an unauthorized offer to the public and sold the advertised securities to a retail investor.

The SFC will further study the CFA’s decision to determine whether there should be any proposal to amend section 103 of the SFO.

Comment

Pursuant to section 103 of the SFO, it is an offence to make an offer of investments to the public unless the circumstances of the offer are in accordance with the permitted routes of doing so (e.g. with the authorization of the SFC). However, there is an exemption under section 103(3)(k) of the SFO, which states that an advertisement does not need SFC authorization where the advertisement is in respect of securities, structured products or interests in a CIS that are or are intended to be disposed of only to professional investors.

The significance of the CFA’s ruling is that advertisements of CIS that may be unsuitable for retail investors can be issued to the general public even if the issuer only intends to sell them to professional investors. It also means a contravention of section 103 of the SFO, which occurs upon the issue of a relevant unauthorized offer to the public, can only be established well after the offer to the public has been issued.

Despite this, readers should take care in issuing such offers of investment to the public. For the avoidance of risk, readers may consider explicitly stating on the face of the document that the terms of the offer are limited to professional investors.

For further details, please refer to:

http://www.sfc.hk/edistributionWeb/gateway/EN/news-and-announcements/news/doc?refNo=15PR26

The article is for general information purpose only and is not intended to constitute legal or other professional advice.

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Regulatory News (Mar 2015)

March 5, 2015/in Regulatory News /by Tony Chan

Newsletter – February 2015

March 5, 2015/in Newsletter /by Tony Chan

Contents:

SFC bans former CEO of Ping An of China Securities (Hong Kong) Company Limited for 12 months over internal control failures
Amendments to Code on Unit Trusts and Mutual Funds take effect
Market Misconduct Tribunal disqualifies Water Oasis’s former CEO and orders disgorgement for insider dealing
Court dismisses judicial review application by CITIC’s former director against SFC
SFC issues third-quarter report

1. SFC bans former CEO of Ping An of China Securities (Hong Kong) Company Limited for 12 months over internal control failures

On 23 February 2015, SFC has banned Mr. He Zhi Hua, former CEO of Ping An of China Securities (Hong Kong) Company Limited (“Ping An”), for 12 months in relation to any regulated activities for contributing to Ping An’s serious internal control deficiencies and other matters between August 2010 and April 2011 (“Relevant Period”).

Background

On 9 July 2014, Ping An was reprimanded and fined HK$6 million over the internal control deficiencies and other matters between the Relevant Period. Ping An is licensed under the SFO to carry on business in Type 1 (dealing in securities), Type 4 (advising on securities) and Type 9 (asset management) regulated activities.

Mr. He acted as a nominee and was complicit in a number of suspicious transactions at Ping An which were not reported to the SFC and the Joint Financial Intelligence Unit (“JFIU”).

As the CEO, Mr He failed to ensure:

Ping An had in place sufficient internal control procedures aimed at preventing and impeding money laundering (“AML”);
identify and report suspicious transactions in a timely manner, resulting in delayed notification to the Joint Financial Intelligence Unit (JFIU) and the SFC of such suspicious transactions;
provide AML training to its staff;
establish and follow appropriate and effective procedures to protect client assets, by effecting: i) third party payments without having obtained either written confirmation of the client’s direction or any evidence of the client’s instruction; ii) a client payment to its employee at the time; iii) hird party payments without having conducted assessment on payment recipients and reasons for payments;
communicate and enforce its internal policies on employee dealings;
enforce its account opening procedures. SFC found that 15 client accounts were opened without valid address proof. Ping An was in breach of paragraph 1 under Part VII of the Internal Control Guidelines, and paragraph 5.4, GP2 and GP7 of the Code of Conduct; and
have in place an effective compliance function. Ping An had no independent designated compliance officer during that Relevant Period.

Mr. He, who was the most senior person at Ping An and in a position of authority in managing its business at the Relevant Period, tried to abdicate responsibility and offload blame to subordinates when these deficiencies were uncovered. Such management conflict with his subordinates aggravated the internal control deficiencies of Ping An. Ping An has since removed him from his position and appointed a new CEO.

Comment

Licensed corporations should have in place proper systems and controls for the identification and reporting of suspicious transactions. The first and foremost step is to gain sufficient knowledge about a customer’s business and financial circumstances (through customer due diligence and ongoing monitoring) to recognize that a transaction, or a series of transactions, is unusual. There should also be procedures in place for reporting internally by escalation to senior management and reporting externally to the JFIU. In addition, there should be procedures in place for Responsible Officers to properly supervise the regulated activities of the Company to discharge their duties in the Company with proper supervision and control.

For details, please refer to the SFC articles:

http://www.sfc.hk/edistributionWeb/gateway/EN/news-and-announcements/news/doc?refNo=15PR16

To view the Statement of Disciplinary, please visit:

http://www.sfc.hk/edistributionWeb/gateway/EN/news-and-announcements/news/openAppendix?refNo=15PR16&appendix=0&lang=EN

2. Amendments to Code on Unit Trusts and Mutual Funds take effect

On 30 January 2015, the Securities and Futures Commission (“SFC”) announced that amendments to the Code on Unit Trusts and Mutual Funds (“the Code”) were gazetted, thereby taking effect.

Background

On 24 June 2014, the SFC issued a consultation paper inviting public comments on proposals to amend the Code requirements in relation to the publication of offer and redemption prices or net asset values (“NAVs”), and notices of dealing suspension of collective investment schemes authorised by the SFC under the Code. The consultation ended on 23 July 2014, with the SFC receiving a total of five submissions from professional bodies, market participants and other interested parties, including CompliancePlus Consulting Limited.

The proposals were set out in the Consultation Conclusions on the proposals to amend publication requirements relating to offer and redemption prices or NAV, and notices of dealing suspension under the Code, published on 11 December 2014. Subsequently, amendments were made to implement the proposals, to give public funds greater flexibility in determining the means for making public their offer and redemption prices, NAV and notices of dealing suspension.

Updated frequently asked questions and circular are now available on the SFC website to provide further guidance to the industry on implementation of the proposals.

Comment

Readers should note that further guidance to the industry implementation of the proposals may be found on the frequently asked questions and circular, which are now available on the SFC website.

To view the Consultation Conclusions, please visit: http://www.sfc.hk/edistributionWeb/gateway/EN/consultation/conclusion?refNo=14CP5

For details, please refer to:

http://www.sfc.hk/edistributionWeb/gateway/EN/news-and-announcements/news/doc?refNo=15PR10

3. Market Misconduct Tribunal disqualifies Water Oasis’s former CEO and orders disgorgement for insider dealing

On 5 February 2015, the Market Misconduct Tribunal (“MMT”) made a disqualification order against Ms Salina Yu Lai Si, former chief executive officer (“CEO”) of Water Oasis Group Limited (“Water Oasis”), and ordered her to disgorge HK$281,346 after making the determination that Yu engaged in insider dealing in the shares of Water Oasis.

Background

On 14 August 2014, the SFC commenced proceedings in the MMT against Ms Yu for alleged insider dealing in Water Oasis shares. Water Oasis, which was listed on the Stock Exchange of Hong Kong Limited (“HKSE”) in March 2002, principally distributes skincare products in Hong Kong, Macau, Taiwan, Singapore and the Mainland and operates beauty salons, spas and medical beauty centres in Hong Kong and the Mainland. At the material time, Ms Yu was the CEO, a substantial shareholder and an executive director of Water Oasis. Ms Yu resigned as Water Oasis’ CEO and executive director on 6 July 2012.

The SFC alleged that:

On 20 January 2012 at around 10 am, H2O Plus LLC (H2O) informed Ms Yu that it would terminate Water Oasis’s exclusive distributorship in H2O’s products in the Mainland and Taiwan with immediate effect;
Shortly after being notified by H2O, Ms Yu proceeded to sell all her Water Oasis shares in one of her securities trading accounts on the same day prior to an announcement by Water Oasis, and avoided a loss of around HK$281,346. The announcement concerned the termination of the exclusive distribution rights in H2O products on 20 January 2012 at 10:13 pm; and
Both the news and the termination of the exclusive distribution rights and the significance of the contribution of H2O’s operations in the Mainland and Taiwan to the net profit of Water Oasis were not publicly known and were material to Water Oasis’s share price. On 26 January 2012, the first trading day after Water Oasis made the announcement on 20 January 2012, its share price dropped by 14.08% to close at HK$1.22. On the same day, the Hang Seng Index rose 329 points or 1.64% to the level of 20,439.

Specifically, the SFC alleged that Ms Yu had engaged in insider dealing since at the time of her trading in the shares of Water Oasis, Ms Yu knew that H2O Plus LLC would terminate Water Oasis’s exclusive distributorship of H2O’s products in Mainland China and Taiwan with immediate effect, and that this information constituted inside information.

Further, on 4 November 2014, the MMT directed that the hearing of the proceedings in the MMT be held on 15 January 2015. The MMT also reserved 16 January 2015 for the hearing.

The disqualification order

The disqualification order prohibits Ms Yu from being a director or being involved in the management of any listed corporation, without leave of the court, for a period of two years effective 15 February 2015. The sum of disgorgement is equivalent to the benefit she received in avoiding a loss through insider dealing in the shares of Water Oasis on 20 January 2012.

The MMT’s decision on 5 February 2015 followed a hearing before the MMT at which Ms Yu admitted she engaged in insider dealing in the shares of Water Oasis.

In making the decision on the disqualification order, the MMT is concerned that “if Ms Yu is tempted within the next couple of years to return to a management position in Water Oasis or is tempted to take up a position in some other listed corporation, she may pose a threat to the integrity of the workings of such a business, a threat which may well reach out to undermine compliance with market regulations.”

Comment

Readers should note that pursuant to section 245 of the Securities and Futures Ordinance (“SFO”), insider dealing is a type of market misconduct. These may be tried both as a criminal offence and in the MMT, which determines its proceedings based on the civil standard, “on the balance of probabilities”. If the SFC, after investigation into any particular case, decides that the civil route is appropriate, it may, with the consent of the Secretary for Justice, institute proceedings in the MMT. At the conclusion of the proceedings, the MMT will issue a public report which states whether any market misconduct has taken place, make orders and give reasons for such orders.

Sections 270 and 291 of the SFO provides insider dealing can be thought of as comprising two different ways of engaging in market misconduct, also referred to as dealing and tipping-off. Under those sections, “inside information” (also referred to as “relevant information” in the SFO prior to 1 January 2013) is specific information in relation to a corporation, its shareholders or officers, or listed securities or their derivatives (i) which is not generally known to the persons who are accustomed to dealing, or would be likely to deal in its listed securities; but (ii) where, if such information were generally known to them, it would be likely to affect the price of the listed securities materially.

Pursuant to sections 257 and 259, the MMT can make the following orders in respect of persons found to have committed market misconduct:

disqualification for up to 5 years from holding office as a director, liquidator or receiver or from taking part in the management of a corporation (a “disqualification order”);
prohibition on investing or trading in Hong Kong markets for up to 5 years (a “cold shoulder order”);
prohibition of any conduct constituting such market misconduct as specified in the order;
the payment of any profit made or loss avoided to the Government, plus compound interest (a “disgorgement order”);
the payment of reasonable costs and expenses incurred by the Government and the SFC; and
disciplinary referrals, recommending that a professional body of which persons are members should take disciplinary action against them. This could lead to a licensed or registered person’s fitness and properness being called into question, with attendant potential consequences for his licensed or registered status.

Further information can be found in the MMT’s report: www.mmt.gov.hk/eng/reports/Water_Oasis_Group_Limited_Report_e.pdf

For details, please refer to:

http://www.sfc.hk/edistributionWeb/gateway/EN/news-and-announcements/news/enforcement-news/doc?refNo=14PR100

4. Court dismisses judicial review application by CITIC’s former director against SFC

On 16 February 2015, the Court of First Instance (“CFI”) dismissed an application for leave to apply for judicial review by Mr Leslie Chang Li Hsien, former deputy managing director of CITIC Limited (“CITIC”), against a decision by the SFC to initiate proceedings before the MMT against him. The Honourable Mr Justice Au indicated that the court would hand down reasons at a later date.

Background

On 11 September 2014, the SFC instituted proceedings in both the CFI and the MMT against CITIC and five of its former executive directors, namely Mr Larry Yung Chi Kin, managing director Mr Henry Fan Hung Ling, deputy managing directors Mr Leslie Chang Li Hsien, Mr Peter Lee Chung Hing, and executive director Mr Chau Chi Yin (“the five directors”).

The SFC alleged that the five directors engaged in market misconduct involving disclosure of false or misleading information on CITIC’s financial position arising from the massive losses incurred by CITIC over its investment in leveraged foreign exchange contracts in 2008 contrary to sections 227 or 298 of the SFO. Both market misconduct provisions prohibit the distribution of materially false or misleading information that is likely to induce another person to subscribe for or buy securities or is likely to have a price effect on the company’s securities.

Further, according to the SFC, CITIC and the five directors engaged in market misconduct involving disclosure of false or misleading information on CITIC’s financial position arising from the massive losses incurred by CITIC over its investment in leveraged foreign exchange contracts in 2008. The allegations concern a circular on 12 September 2007 that was alleged to contain a false or misleading statement about CITIC’s financial position (the “Circular”). The Circular was published on the HKSE listed company announcement system on the Hong Kong Exchanges and Clearing Limited website on 12 September 2008 after market close, and was distributed to its shareholders on 16 September 2008. It concerned a disclosable and connected transaction in respect of an acquisition by its subsidiary, Dah Chong Hong Holdings Limited, of a 49% interest in FAW Toyota 4S company and a 50% interest in Lexus 4S Company and related shareholders’ loans. The Circular disclosed that “the Directors were not aware of any adverse material change in the financial or trading position of the Group since 31 December 2007”. However, in a market announcement on 20 October 2008, CITIC disclosed that it suffered a massive realised and mark to market loss up to that date arising from a number of leveraged foreign exchange contracts which CITIC had entered into to manage currency risk of its Australian iron ore mining project exposure (“the Profit Warning”). The SFC therefore alleges that the five directors were aware of the huge financial exposure arising from those contracts on 7 September 2008, before the Circular was issued.

The prices of CITIC shares, which were suspended from trading on 20 October 2008 before the Profit Warning, fell 55% from HK$14.52 to close at HK$6.52 on 21 October 2008 when trading resumed.

Relief sought

The SFC sought restoration or compensation orders in the CFI to restore or compensate up to 4,500 investors who purchased CITIC shares between the date on which the SFC alleged the false or misleading information was announced and the date the true financial position was disclosed. The SFC also sought that CITIC and the five directors be sanctioned by the MMT.

The amount that CITIC may be required to pay will need to be the subject of assessment by the CFI if liability is established. During the period between the date of the Circular and the date of the Profit Warning, there were total purchases of over approximately HK$1.9 billion at various acquisition prices between HK$14.26 and HK$24.5 with an average acquisition price of HK$18.97. The restoration or compensation amount, if any, may depend on a number of additional variables, including each purchaser’s acquisition price, whether the purchaser continues to hold the shares or, alternatively, the sale price.

The MMT

On 15 December 2014, the Honourable Mr. Justice Hartmann, chairman of the MMT, directed that the hearing of the proceedings shall commence on 16 November 2015. The MMT reserved 16 November 2015 up to the end of December 2015 for the hearing. The current estimated length of the hearing is 30 days.

Comment

The SFC was given the power to directly present cases in the MMT under section 242A of the SFO. Readers should note that, as mentioned above, if the MMT makes a finding of market misconduct, it is empowered to a range of orders with severe consequences. These include orders prohibiting a person from acquiring or disposing of or otherwise dealing in securities, futures contracts or leveraged foreign exchange contracts in Hong Kong without leave of the Court for a period of up to five years (e.g. cold shoulder orders, cease and desist orders, etc).

Under the market misconduct provisions of the SFO, licensed persons are prohibited from distributing materially false or misleading information that is likely to induce another person to subscribe for or buy securities or is likely to materially affect the price on the relevant securities. It is therefore important that licensed individuals and ensure at all times that promulgated information is accurate. If a licensed person is found guilty of market misconduct provisions, he may thus not be considered fit and proper to continue being licensed. This is because according to Paragraph 7.1 of the Fit and Proper Guidelines, a person may not be fit and proper if that person was found to be of poor reputation, character or reliability, lacking in financial integrity, or dishonest, which may be evidenced by that person’s being found by a court for fraud, dishonesty, misfeasance or other market-related crimes, or even by the SFC’s findings in the absence of an unfavourable court’s finding.

Readers should also note that this case will be very significant in establishing precedent governing the calculation of what may be required to restore a shareholder who has traded in a market affected by false or misleading information.

For further details, please refer to:

http://www.sfc.hk/edistributionWeb/gateway/EN/news-and-announcements/news/doc?refNo=15PR14

5. SFC issues third-quarter report

On 17 February 2015, the SFC published its Quarterly Report summarising key developments from October to December 2014.

The regulatory highlights featured in the report included:

Regulatory enhancements – the SFC concluded a joint consultation with the Hong Kong Monetary Authority on the mandatory reporting and related record-keeping obligations under the new over-the-counter (“OTC”) derivatives regime. Additionally, the Legislative Council’s Bills Committee began a detailed examination of the Securities and Futures and Companies Legislation (Uncertified Securities Market Amendment) Bill 2014, which would abolish the need for physical share certificates.
Intermediaries – the SFC received 1,706 new licensing applications this quarter, and launched a consultation regarding the SFC’s provision of supervisory assistance to overseas regulators in December.
Product development – the SFC authorised 12 unlisted Renminbi Qualified Foreign Institutional Investor (“RQFII”) funds and one RQFII exchange-traded fund this quarter;
Listing matters – under the dual filing regime, the SFC received 32 listing applications via the SEHK during the quarter;
Market infrastructure and trading – as part of the preparation for the 17 November launch of the Shanghai-Hong Kong Stock Connect pilot programme, the SFC signed a memorandum of understanding with the China Securities Regulatory Commission on strengthening regulatory and enforcement cooperation;
Enforcement – the SFC disciplined 9 licensees and their disciplinary actions during the quarter resulted in total fines of over HK$1.3 million. Further, the SFC obtained interim injunctions to freeze bank accounts which allegedly hold the proceeds of unlicensed or boiler room activities carried out by three companies.

To view the quarterly report, please visit:

http://www.sfc.hk/web/EN/files/ER/Reports/QR/201410-12/Eng/00_final.pdf

For further details, please refer to:

http://www.sfc.hk/edistributionWeb/gateway/EN/news-and-announcements/news/doc?refNo=15PR13

The article is for general information purpose only and is not intended to constitute legal or other professional advice.

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