Year of the Rooster 2017-2018: Regulatory investigations year in review

The Year of the Rooster is about to end. We wish you all a happy, prosperous and (in terms of dealing with regulatory inquiries) uneventful upcoming Year of the Dog.

What was the Year of the Rooster like when it came to regulatory investigations and actions? And what might the Year of the Dog hold in store? We will give our prognosis on the year ahead at a seminar on 14 March 2018. E-invites for this seminar will be sent out shortly after Chinese New Year, and we hope to see you then. In the meantime, we set out below our review of the Year of the Rooster.

Out goes “catch all”, in comes “catch big”

In 2016, during the Year of the Monkey, the Securities and Futures Commission (SFC) foreshadowed that, through a restructuring in its Enforcement Division sub-teams, it would devote much of its enforcement efforts to investor protection-related issues. [1]

This re-focusing took place during the Year of the Rooster. In the six months to 30 September 2017 (being the latest available statistics), the number of new investigations has dropped to 153, being 39% lower than the 251 new investigations in the corresponding period in 2016. [2]

Why this drop? In the past, the SFC took a much more “catch all” approach to enforcement. By way of example, even issues such as omitting to use recorded telephone lines to take client orders used to be the subject of public reprimands and fines. [3]

However, the current Executive Director of the SFC’s Enforcement Division said that by re-setting priorities, investigation caseload has, as at October 2017, reduced by a third. He declared to those subject to the SFC’s powers that: “Now, you do not have to expend resources on matters which are not a priority for us. The bad news is – when we knock on your doors, it will probably be for something quite serious.” [4]

The signal is clear: the SFC is no longer into “catch all”, but is instead into “catch big”. “Bigger” investigations typically take longer to complete. Thus, the number of completed investigations has, in percentage terms, dropped by even more than that of the drop in new investigations, with a 61.9% drop from 294 in the six months to 30 September 2016 to 112 in the corresponding 2017 period. [5]

But what is considered “big”?

The “big” things on which the SFC appears to be focusing are primarily in the realm of alleged corporate fraud and misfeasance. This has manifested itself both in terms of investigations/enforcement actions against listed companies and their directors or senior personnel, as well as against financial industry gatekeepers of listed companies such as sponsors in listings.

On the investigations front, as at October 2017, the SFC had 136 active investigations into alleged corporate fraud and misfeasance, as well as investigations into the work of 15 sponsor firms. [6]

As for completed enforcement actions, typical examples from the past year include:

  • Compensation orders and lengthy directors’ disqualification orders (ranging from three to eight years) for issues associated with a listed company’s handling of certain major financial balances with a connected party. [7]
  • Public reprimand and HK$15 million fine against a listing sponsor for inadequate due diligence into a listing applicant, not ensuring the “Application Proof” of a prospectus is materially complete and not providing adequate information to regulators during the listing process. [8]

“Catch big” collaboratively and pre-emptively

In executing its “catch big” strategy in the past year, the SFC has sought to act in more collaborative and pre-emptive ways to further its work.

On the collaboration front, the SFC’s Enforcement Division has in the past year:

  • Forged closer co-operation with the China Securities Regulatory Commission (CSRC). It now conducts more joint training and mutual staff secondments on the enforcement front. [9] There is also increasing mutual assistance between the SFC and the CSRC in evidence collection processes. In this regard, the SFC’s power to pass on evidence it collated initially for its own Hong Kong investigations to the CSRC was also recently upheld. [10]
  • Worked more closely with local law enforcement agencies. This has led, for example, to the SFC and the Independent Commission Against Corruption (ICAC) recently conducting a joint enforcement operation. [11]
  • Worked more closely with other divisions with the SFC. There now exists an operational team within the SFC known as “ICE”, consisting of members from the Intermediaries, Corporate Finance and Enforcement teams to work on joint investor protection actions. One of the main initiatives of “ICE” is to deal with alleged “nefarious groups of inter-related companies that work in coordination to extract value from unsuspecting investors”. [12]

As for actions the SFC has taken that are either in themselves pre-emptive or seek to encourage pre-emptive behaviour in others, examples in the past year include:

  • Making greater use of its powers under the Securities and Futures (Stock Market Listing) Rules (SMLR) to stop what it considers to be problematic listing applications from proceeding. During July to September 2017, for example, the SFC issued letters of mindedness objecting to five listing applications, of which two led to formal decisions to so object, and another three applications were either withdrawn or lapsed. [13]
  • Issuing (as at October 2017), pursuant to the SMLR, 10 suspensions of trading orders in respect of listed companies’ shares for various investor protection purposes.
  • Issuing a new Guidance Note on Co-operation with the SFC, [14] where more structured and (in some situations) more significant reductions in sanctions to be imposed by the SFC in licensee disciplinary matters are now offered to parties willing to co-operate with the SFC at earlier stages of investigations.

Are intermediaries and their senior personnel out of the SFC’s sights then?

All of the foregoing might give the impression that the SFC is only interested in corporate fraud and misfeasance. That is not the case. The SFC has continued, in the past year, to discipline or otherwise to expand its potential disciplinary reach against licensed entities and individuals for their roles in systems and controls shortcomings. Some of main developments from the past year include:

  • Disciplining licensed entities and senior individuals as regards the handling of the receipt of third party payments in the context of anti-money laundering and counter terrorist financing requirements. [15]
  • Disciplining a financial institution for systems and controls issues in the selling of investment products, with the disciplinary fine of HK$400 million being calculated by reference to the number of client complaints rather than merely the overall nature of the issues in question. [16]
  • Implementing (in October 2017 [17]) the Manager-In-Charge regime first announced in December 2016, [18] assigning specific functions to individuals within licensed entities.
  • Launching [19] and concluding [20] consultations for more prescriptive requirements for licensed entities in enhancing cybersecurity in their operations, with a new proposed regime due to come into force in 2018.

 

Footnotes

  1. Speech at the 7th Pan Asian Regulatory Summit by Thomas Atkinson, SFC’s Executive Director of Enforcement, 9 November 2016:
    http://www.sfc.hk/web/EN/files/ER/PDF/Speeches/Atkinson_20161109.pdf
  2. SFC Quarterly Report, July to September 2017, chapter on Enforcement:
    http://www.sfc.hk/web/EN/files/ER/Reports/QR/201707-09/Eng/02e_enforcement.pdf
  3. SFC press releases of 26 September and 5 December 2013:
    http://www.sfc.hk/edistributionWeb/gateway/EN/news-and-announcements/news/enforcement-news/doc?refNo=13PR97
    http://www.sfc.hk/edistributionWeb/gateway/EN/news-and-announcements/news/enforcement-news/doc?refNo=13PR118
  4. Speech at the 8th Pan Asian Regulatory Summit by Thomas Atkinson, SFC’s Executive Director of Enforcement, 11 October 2017:
    http://www.sfc.hk/web/EN/files/ER/PDF/Speeches/Thomas_20171011_final.pdf
  5. Footnote 2 above.
  6. Footnote 4 above.
  7. Re Hanergy’s Thin Film Power Group Limited, Court of First Instance (Case Number: HCMP166/2017), 4 September 2017:
    http://legalref.judiciary.hk/doc/judg/word/vetted/other/en/2017/HCMP000166_2017.doc
  8. SFC press release of 15 March 2017:
    http://www.sfc.hk/edistributionWeb/gateway/EN/news-and-announcements/news/enforcement-news/doc?refNo=17PR34
  9. Footnote 4 above.
  10. Tang v SFC, Court of First Instance (Case Number: HCAL 229/2016), 8 December 2017:
    http://legalref.judiciary.hk/doc/judg/word/vetted/other/en/2016/HCAL000229A_2016.docx
  11. ICAC press release of 7 December 2017:
    http://www.icac.org.hk/en/press/index_id_498.html
  12. Footnote 4 above.
  13. SFC Quarterly Report, July to September 2017, chapter on Listings and Takeovers:
    http://www.sfc.hk/web/EN/files/ER/Reports/QR/201707-09/Eng/02c_listings_and_takeovers.pdf
  14. http://www.sfc.hk/web/EN/assets/components/codes/files-current/web/guidelines/guidance-note-on-cooperation-with-the-sfc/guidance-note-on-cooperation-with-the-sfc.pdf
  15. SFC press releases of 6 March, 13 March, 14 March, 5 April, 12 April, 22 May and 19 June 2017:
    http://www.sfc.hk/edistributionWeb/gateway/EN/news-and-announcements/news/enforcement-news/doc?refNo=17PR27
    http://www.sfc.hk/edistributionWeb/gateway/EN/news-and-announcements/news/enforcement-news/doc?refNo=17PR29
    http://www.sfc.hk/edistributionWeb/gateway/EN/news-and-announcements/news/enforcement-news/doc?refNo=17PR32
    http://www.sfc.hk/edistributionWeb/gateway/EN/news-and-announcements/news/enforcement-news/doc?refNo=17PR43
    http://www.sfc.hk/edistributionWeb/gateway/EN/news-and-announcements/news/enforcement-news/doc?refNo=17PR48
    http://www.sfc.hk/edistributionWeb/gateway/EN/news-and-announcements/news/enforcement-news/doc?refNo=17PR75
    http://www.sfc.hk/edistributionWeb/gateway/EN/news-and-announcements/news/enforcement-news/doc?refNo=17PR84
  16. In Re a Decision made by the Securities and Futures Commission under section 194 of the Securities and Futures Ordinance, Securities and Futures Appeals Tribunal (Case Number: SFAT Application 3/2015), 21 November 2017:
    http://www.sfat.gov.hk/english/determination/AN-3-2015-Determination.pdf
  17. https://www.sfc.hk/edistributionWeb/gateway/EN/news-and-announcements/news/doc?refNo=17PR131
  18. http://www.sfc.hk/edistributionWeb/gateway/EN/circular/intermediaries/licensing/doc?refNo=16EC68
  19. http://www.sfc.hk/edistributionWeb/gateway/EN/consultation/doc?refNo=17CP4
  20. http://www.sfc.hk/edistributionWeb/gateway/EN/consultation/conclusion?refNo=17CP4