Newsletter – February 2015

Contents:

  1. SFC bans former CEO of Ping An of China Securities (Hong Kong) Company Limited for 12 months over internal control failures
  2. Amendments to Code on Unit Trusts and Mutual Funds take effect
  3. Market Misconduct Tribunal disqualifies Water Oasis’s former CEO and orders disgorgement for insider dealing
  4. Court dismisses judicial review application by CITIC’s former director against SFC
  5. 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

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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

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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

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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

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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

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

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