Newsletter – August 2015

 

Content

  1. SFC reprimands and fines Nomura International (Hong Kong) Limited HK$4.5 million for regulatory breach
  2. SFC fines BNP Paribus Securities (Asia) Limited HK$15 million for dark liquidity pool-related failures
  3. SFAT affirms SFC decision to revoke approval of Miranda Sham Sze Wai as responsible officer over internal control failures
  4. SFC issues first quarterly report
  5. SFC recovers HK$23 million for investors from restoration orders against insider dealer Du Jun

1. SFC reprimands and fines Nomura International (Hong Kong) Limited HK$4.5 million for regulatory breach
On 30 July 2015, the Securities and Futures Commission (“SFC”) publicly reprimanded and fined Nomura International (Hong Kong) Limited (“Nomura Hong Kong”) HK$4.5 million for failing to report significant misconduct by a former trader in a timely manner.

Background

On 11 June 2013, Nomura Hong Kong made a report to the SFC (“11 June Report”) that Mr. X, a trader on secondment from Nomura Securities Co., Ltd in Japan (“Nomura Japan”), had incurred a US$3.3 million trading loss and had been repatriated to Japan on 5 June 2013. Nomura Hong Kong informed the SFC that a review of Mr. X’s trades was being undertaken, and it would report to the SFC should any issues be identified.

In fact, at the time of the 11 June Report, Mr. X had already admitted to making false entries in Nomura Hong Kong’s risk management system and to providing false information to Nomura Hong Kong. None of these matters were promptly disclosed to the SFC, as required under the Code of Conduct for Persons Licensed by and Registered with the SFC (“Code of Conduct”).

The SFC also found that by the time Mr. X left Hong Kong following the termination of his secondment, Nomura Hong Kong had already noticed some apparent discrepancies between his actual trading activities and the information he had provided to management. Mr. X was sent back to Nomura Japan before the SFC had been properly alerted and before Nomura Hong Kong had completed its internal investigation into his conduct.

Nomura Hong Kong also failed to provide its draft preliminary report of its investigation in to Mr. X’s activities (the “Draft Report”), or the information contained therein, until one month after the Draft Report was completed and after the SFC had made further enquiries. The Draft Report set out a number of preliminary findings, including that Mr X had made certain misrepresentations to management concerning his trading activities, and had made manual adjustments to Nomura Hong Kong’s risk management system with no legitimate reason. It was eventually provided to the SFC on 19 July 2013, despite being completed on 19 June 2013.

Disciplinary Action

Under the circumstances, the SFC was of the view that Nomura Hong Kong omitted highly relevant information from the 11 June Report and had to be chased to report properly. As a result, Nomura Hong Kong’s fitness and properness to be a licensed person was called in to question. Nomura Hong Kong’s explanation that it needed to conclude its investigation in to Mr. X’s conduct in order to finalize the report and determine whether the matter was reportable to the SFC was rejected as being contrary to the duty to report misconduct or suspected conduct immediately. This principle is entrenched in paragraph 12.5 of the Code of Conduct.

In arriving at its decision, the SFC took into account the SFC’s previous statements emphasizing that intermediaries have an obligation to report misconduct to the SFC immediately, as well as Nomura Hong Kong’s co-operation with the SFC’s investigation.

Mr Mark Steward, the SFC’s Executive Director of Enforcement, commented: “There can be no excuses for such delays in reporting matters requiring our immediate attention. Delays, like these, contribute to misconduct and prejudice investigations. Intermediaries must report problems to us immediately – not after internal investigation, not after legal advice has been obtained but straightaway, without leaving out any important information.”

Comment

Under Section 194 of the Securities and Futures Ordinance (SFO), the SFC is empowered to discipline regulated persons (including licensed persons and any other person involved in the management of the business of a licensed corporation) for misconduct or for failing to be fit and proper persons. Such disciplinary action may involve fines of up to HK$10 million or three times the relevant profit gained or loss avoided (whichever is the greater).

Paragraph 12.5 of the Code of Conduct provides that a licensed or registered person is required to notify the SFC immediately on the happening of any material breach, infringement, non-compliance with any rules, laws, regulations and codes administered or issued by the SFC, or where it suspects any such breach, infringement or non-compliance by itself or persons it employs or appoints to conduct business with clients.

Section 129 of the SFO further provides that, in considering whether a person is fit and proper, the SFC may consider, in addition to other relevant matters, the person’s ability to carry on the regulated activity competently, honestly and fairly.

This enforcement action highlights the importance of reporting misconduct or suspected misconduct to the SFC without delay. Licensed corporations, in particular intermediaries, are reminded that failure to comply with such obligations may result in heavy fines and reputational damage.

For details, please refer to:
http://www.sfc.hk/edistributionWeb/gateway/EN/news-and-announcements/news/doc?refNo=15PR80

2. SFC fines BNP Paribus Securities (Asia) Limited HK$15 million for dark liquidity pool-related failures

On 3 August 2015, the SFC fined BNP Paribus Securities (Asia) Limited (“BNPP Securities Asia”) HK$15 million over its failures in relation to its dark liquidity pool trading services.

Background

The disciplinary action follows an SFC investigation into BNPP Securities Asia’s dark liquidity pool services, known as BNP Internal Exchange (“BIX”). It was taken according to an agreement pursuant to section 201 of the SFO, which allows the SFC to resolve disciplinary cases without completing the formal hearing process set out in the SFO if the other party agrees.

Failure to ensure BIX operated as intended

BNPP Securities Asia stated in its business plan of its license application to the SFC for Type 7 regulated activities (“Business Plan”) that orders in the BIX would be matched and executed in accordance with order price priority. For example, a buy order with a higher price would have priority over a buy order with a lower price. The same representation was also made to its clients.

In reality, BIX failed to give priority to higher priced orders and treated all orders as having equal priority with allocations on a pro rata basis between November 2009 and April 2011. This potentially affected all BIX auctions with two or more orders at different order prices and did affect some BIX actions.

Under General Principle (“GP”) 2 of the Code of Conduct, BNPP Securities Asia was required to act with due skill, care and diligence in conducting its business activities and act in the best of its clients. This obligation was breached by BNPP Securities Asia’s failure to operate as represented in materials provided to clients. In particular, clients who placed higher priced orders into BIX, believing their orders would receive execution priority were adversely affected.

Failure to report a disruption in BIX services

In April 2011, BNPP Securities Asia suspended BIX services upon discovery that order matching was not conducted in accordance with order price priority. BIX services were not fully restored until seven months later, and the SFC was not informed until 21 months later in January 2013

Among the licensing conditions imposed on its Type 7 regulated activities, BNPP Securities Asia was required to notify the SFC about incidents of material service breakdown or disruption of the operations of the BIX affecting its users. The failure to report the disruption constituted a breach of BNPP Securities Asia’s licensing condition.

Failure to notify the SFC of a significant change in its Business Plan

The Business Plan stipulated that client consent would be obtained before their orders were placed in to BIX for matching. However, client orders intended for execution on the Stock Exchange of Hong Kong were automatically enabled on the BIX without BNPP Securities Asia seeking positive client consent. The SFC was not notified of this change of BNPP Securities Asia’s Business Plan.

According to GP 7 and paragraph 12.1 of the Code of Conduct, BNPP Securities Asia is obliged to comply with all applicable laws and regulations. Section 4 of the Securities and Futures (Licensing and Registration)(Information) Rules (“Licensing Information Rules”) requires a licensed corporation to give written notice to the SFC where there is a significant change in its Business Plan within 7 business days of the change. BNPP Securities Asia’s failure to notify the SFC within the prescribed time period constituted a breach of the Licensing Information Rules and the Code of Conduct.

Failure to maintain sufficient records relating to BIX and document the BIX

As a result of the failure to maintain sufficient trade records and coherently document the matching logic of BIX, the SFC was unable to calculate the precise impact of BNPP Securities Asia’s failure to implement the intended match logic.

The SFC considers coherent documentation of the matching logic of BIX essential to the transparency of the operations of BIX. Clients are entitled to understand how the BIX operates in order to make an informed decision as to whether or not to use the services.

Mitigating factors

In determining the disciplinary action, the SFC took into account the following considerations:

  1. BNPP Securities Asia had co-operated with the SFC.
  2. Since 2012, BNPP Securities Asia has obtained consent from clients before allowing their orders to be matched in the BIX
  3. BNPP Securities Asia had taken steps to rectify the matching logic in the BIX in 2011
  4. BNPP Securities Asia had agreed to engage an independent reviewer for the future operation of the BIX
  5. BNPP Securities Asia had an otherwise clean disciplinary record in relation to its Type 7 regulated activities.

Comment

The use of dark liquidity pools (also known as “alternative liquidity pools” or “ALPs”) for trading has been on the rise in recent years. Providers and operators of ALP trading services must ensure that its users are provided with sufficient information to enable them to understand how their orders are executed. They “must have clear rules and procedures in place for operating dark pools, and equally important, they should operate consistently with representations to clients,” as stated by Mr. Mark Steward, SFC’s Executive Director of Enforcement at the conclusion of the case.

The SFC announced earlier this year that an enhanced regulatory regime on ALPs would come into force on 1 December 2015. Among other changes, individual investors (including individual professional investors and their wholly-owned investment holding corporations) will not be allowed to participate in ALPs under the new regime.

SFC licenses applicants must ensure the information they provide in the business plan submitted to the SFC may be true and accurate. Section 383(1) of the Securities and Futures Ordinance (“the Ordinance”) states: “A person commits an offence if –  (a) he, in support of any application made to the Commission under or pursuant to any provision of this Ordinance, whether for himself or for another person, makes a representation, whether in writing, orally or otherwise, that is false or misleading in a material particular; and (b) he knows that, or is reckless as to whether, the representation is false or misleading in a material particular.” The punishment for this offence is a fine of up to HK $1 million and imprisonment for up to 2 years.

For details, please refer to:
http://www.sfc.hk/edistributionWeb/gateway/EN/news-and-announcements/news/doc?refNo=15PR82

3.  SFAT affirms SFC decision to revoke approval of Miranda Sham Sze Wai as responsible officer over internal control failures

On 13 August 2015, the Securities and Futures Appeals Tribunal (“SFAT”) affirmed the decision of the SFC to revoke the approval of Ms. Miranda Sham Sze Wai (“Sham”) to act as a responsible officer (“RO”) over findings that she was involved in serious internal control deficiencies at Ping An of China Securities (Hong Kong) Company Limited (“Ping An”) between August 2010 and April 2011.

Background

Sham oversaw Ping An’s compliance function and was one of two ROs between August 2010 and April 2011 (“the Relevant Period”). In a Decision Notice issued on 27 January 2015, the SFC alleged that Sham had failed to identify and follow up on suspicious transactions between the CEO of Ping An’s parent company and three of Ping An’s clients. She also failed to establish anti-money laundering (“AML”) internal policies for Ping An and to provide AML training to Ping An’s staff.

Upon investigation, the SFC found that Sham had failed to follow appropriate procedures in relation to third party payments (3PPs). Additionally, she failed to communicate and enforce Ping An’s internal polices relating to employee dealing and account opening procedures. Sham’s awareness of the importance of compliance appeared to be low, and there was a general lack of compliance function during the Relevant Period.

Due to the above internal deficiencies, the SFC revoked the approval given to Sham to act as RO. In her application for review by the SFAT, Sham did not challenge the findings of culpability and liability made by the SFC. Instead the appeal was limited to the appropriateness of the penalty.

SFAT Determination

The SFAT noted that Sham’s failings as RO, taken as a whole, were serious and systematic. In the present case, a major concern of the SFC related to the lack of AML policies within Ping An during the Relevant Period. The SFAT recognized that money laundering is an enormous area of concern to national governments, banks and financial institutions worldwide.

The SFAT emphasized that the RO of licensed corporations bears primary responsibility for compliance with all applicable regulatory standards. In the present case, the extent of Sham’s culpability in establishing and implementing effective internal controls was serious. Her failings threatened the integrity and reputation of the financial market in Hong Kong. Furthermore, the absence of losses to clients and absence of breaches of fiduciary duty counted for very little by way of mitigation.

The SFAT was of the view that the order for revocation of approval given to Sham to act as RO was appropriate and proportionate. The revocation was directed only at Sham’s status as RO. Thus, she may continue to assume less critical positions in the financial industry as a licensed representative under section 120 of the SFO.

Comment

The present case brings in to focus what the proper role and responsibilities of ROs are within the regulatory scheme. Of importance in the present case are GPs 2 and 9 of the Code. GP 2 provides that a licensed person should act with due skill, care and diligence, in the best interest of its clients and the integrity of the market. GP 9 provides that senior management should bear primary responsibility for ensuring the maintenance of appropriate standards of conduct in the firm.

In considering the conduct of representatives, the SFC will consider their levels of responsibility within the firm, as provided in paragraph 1.3 of the Code. Paragraph 4.2 states that a licensed person must supervise diligently persons employed or appointed by it to conduct business on its behalf. Senior management of licensed firms is required to perform periodic valuations of its risk management processes under Paragraph 14.1 of the Code.

Licensed corporations are reminded to maintain 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, and the officer responsible for compliance should act as a central reference point to facilitate onward reporting to the Joint Financial Intelligence Unit (“JFIU”). Paragraph 7.21 of the Guideline on Anti-Money Laundering and Counter-Terrorist Financing (“AML Guideline”), expressly provides that compliance officers are required to play an active role in the reporting of suspicious transactions.

For further details, please refer to:
http://www.sfc.hk/edistributionWeb/gateway/EN/news-and-announcements/news/enforcement-news/doc?refNo=15PR84

4.  SFC issues first quarterly report

On 17 August 2015, the SFC published its quarterly report summarizing key developments from April to June 2015.

Among the regulatory highlights featured in the report, the SFC concluded a consultation on proposals to enhance and standardize the regulatory obligations of ALP operators and a consultation on proposed amendments to the SFO for the SFC to provide supervisory assistance to regulators outside Hong Kong in certain situations. The revised Securities and Futures (OTC Derivative Transactions – Reporting and Record Keeping Obligations) Rules has also been gazetted in May 2015 for the implementation of the new over-the-counter derivatives regime.

Additionally, the SFC entered into a memorandum of regulatory cooperation with the China Securities Regulatory Commission as part of preparations for the launch of the Mutual Recognition of Funds scheme, which allows qualified funds in the Mainland and Hong Kong to be sold directly into the other market.

On enforcement, the SFC prosecuted two corporations and seven individuals for market misconduct and disciplined eight licensees. Proceedings against the Descartes Athena Fund SPC were also resolved to recover HK$191 million of a collapsed private hedge fund’s assets for about 340 overseas investors.

The SFC reported that it received 1,805 license applications this quarter, up from 15.1% year on year.

The full report is available on the SFC website at http://www.sfc.hk/web/EN/files/ER/Reports/QR/201504-06/Eng/00_final.pdf.

For further details, please refer to:
http://www.sfc.hk/edistributionWeb/gateway/EN/news-and-announcements/news/doc?refNo=15PR83

 

5.  SFC recovers HK$23 million for investors from restoration orders against insider dealer Du Jun

Court appointed administrators, Mr John Lees and Mr Mat Ng of JLA Asia Limited, have completed distributions of restoration payments to all but 3 of the 297 counterparties to the insider dealing of Mr Du Jun (“Du Jun”).

Background

Du Jun, a former managing director of Morgan Stanley Asia Limited, was previously convicted for insider dealing in shares of CITIC Resources Holdings Limited (“CITIC Resources”). By a restoration order made by the Hong Kong Court of First Instance, Du Jun was required to pay HK$ 23.9 million to 297 investors.

As of 18 August 2015, a total of HK$23,086,314 has been paid out of the restoration fund. The SFC and the administrators have taken all possible steps to contact the 3 remaining investors with no success. The remaining sum of HK$813,686 due to the remaining 3 investors has been returned to Du Jun after approval from the court.

The China Securities Regulatory Commission, the US Securities and Exchange Commission, the Thailand Securities and Exchange Commission and the administrators provided assistance to the SFC in locating overseas investors.

Comment

The purpose of restoration orders, which are not compensation orders, is to make insider traders financially accountable to those with whom they trade. The amount payable to investors is intended to restore those counterparties to the same position, in financial terms, as they were in before the insider dealing. It represents the difference between the actual price at which the affected investors sold the CITIC Resources shares to Du Jun, and the price at which the investors could have sold the shares had the price sensitive information concerning CITIC Resources been made known to the market at the time.

SFC has stated clearly and publicly of their enforcement philosophy on insider dealing: “Insider dealing destroys fairness and orderliness of the market and undermines market confidence. We use all remedies available to attack insider dealing by prosecuting insiders and referring cases to the Market Misconduct Tribunal for imposition of criminal or civil penalties. Through the court, we also seek orders to freeze insider-dealing gains and to remediate damages caused by the misconduct.”

For further details, please refer to: http://www.sfc.hk/edistributionWeb/gateway/EN/news-and-announcements/news/doc?refNo=15PR85

 

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

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