Hong Kong regulatory enforcement update: Q1 2016

Trends in SFC enforcement actions

Save for several notable exceptions, the broad trends seen in the latest quarterly report from the SFC for October – December 2015 largely reflect those described in earlier updates for 2015 (see our previous enforcement update): 

• The results show a 24.4% year-on-year decrease in the number of s181 trading inquiries

• Perhaps more notably, the speed at which the SFC is working through the backlog of investigations has not improved, with the number of investigations completed within seven months falling away by 1.7% in the last quarter. This stands in stark contrast to the 22.1% increase previously seen in this category, which in hindsight might have reflected a one-off ‘clear-out’.

• The number of compliance advice letters issued by the SFC continues to rise, with the results showing a year-on-year increase of 39.4% (although lower than the 61% rise noted in the previous quarter).

• The trend towards fewer criminal prosecutions continues, as reported in previous enforcement updates though we expect this trend to begin to reverse. More below :*

*Reproduced from the SFC quarterly report October – December 2015

Panama papers leak - all quiet on the eastern front?

The repercussions from the so-called “Panama Papers” continue to be felt around the financial world. The 11.5 million leaked documents laid bare for readers of broadsheet newspapers the mostly mundane (but occasionally lurid) details of the off-shore financial world. The regulatory consequences of this remain to be seen, but it is clear that the Panama Papers have raised interest in the adequacy of established KYC procedures in many financial capitals. In the United Kingdom, the Financial Conduct Authority has requested that several financial institutions provide information about their dealings with the Panamanian law firm at the heart of the affair, Mossack Fonseca. In Singapore, the Ministry of Finance and the Monetary Authority of Singapore are understood to be carrying out “necessary checks” and have said that "if there is evidence of wrongdoing…[they] will not hesitate to take firm action". A thunder clap of regulatory action it may not yet be, but it is clear that financial regulators are watching developments with real interest.

Meanwhile in Hong Kong, despite reports that the Hong Kong office of Mossack Fonseca was one of the busiest in its network, the SFC and HKMA remain silent. Similarly what action (if any) they propose to take remains unknown. As one of the major markets for offshore structures, we anticipate that this is an issue of considerable interest to both the SFC and HKMA. Heightened regulatory scrutiny over AML procedures seems likely. Requests from overseas regulators for information held in Hong Kong must be a distinct probability.

Whatever happens next in Hong Kong, banks and financial institutions would do well to re-assess their AML policies and procedures and their relationships with any clients named in media reports in preparation for any questions which may be asked. Careful attention in particular should be given to any facts which give rise to self-reporting obligations. This is particularly so for those who have connections with the UK, where Parliament is presently considering introducing new legislation to create an offence of failure to prevent the criminal facilitation of tax evasion. Consultation on the proposed legislation closes on 10 July 2016.

Market Misconduct Tribunal

Following the introduction of Part XIVA of the SFO in January 2013, which gave statutory backing to the Stock Exchange rules on timely disclosure of MNPI, it took two and a half years for the first SFC case to surface (see our Hong Kong regulatory enforcement update: July - December 2015 for further details). Unsurprisingly, this trickle has increased, if not to a river then at least a steady stream.

Mayer Holdings Limited

The SFC commenced proceedings in the Market Misconduct Tribunal (MMT) in March 2016 against Mayer Holdings Limited (Mayer). The SFC alleges that Mayer failed to disclose price sensitive information as soon as reasonably practicable. Action has also been taken against 10 current and former senior executives for their allegedly reckless or negligent conduct which is said to have given rise to the alleged breach by Mayer.

The background is as follows. The SFC found that between April and August 2012, while auditing Mayer’s 2011 financial statements, Mayer’s auditors repeatedly informed Mayer’s management that they would qualify their audit opinion if certain identified issues were not resolved. One issue concerned the apparently suspicious nature of the disposal of a wholly-owned subsidiary of Mayer, and another focused on apparently inflated valuations for projects undertaken by Mayer overseas. Mayer’s auditors later resigned in December 2012. However, it was not until January 2013 that Mayer disclosed this fact together with brief details of the outstanding audit issues. Mayer’s shares have been suspended from trading since 09 January 2012. The SFC alleges that the auditors’ resignation, the outstanding audit issues, together with the potential qualified audit report, were price sensitive information which should have been fully disclosed to the public. The SFC considers that the information would have been viewed negatively by investors, and was of sufficient gravity to affect the share price.

Yorkey Optical International

The SFC recently initiated MMT proceedings against Yorkey Optical International (Cayman) Limited (Yorkey) for failing to disclose price sensitive information as soon as reasonably practicable. Similar to the Mayer case noted above, the SFC has also commenced proceedings in the MMT against Yorkey’s management, including its CEO, for their alleged reckless or negligent conduct which the SFC says caused the allegedly breach by Yorkey.

The SFC alleges that contrary to the published expectations of Yorkey’s management of significant growth and increasing profitability, Yorkey had in fact sustained material losses in the second half of 2012, and its financial performance had deteriorated significantly. Although Yorkey and its management are said to have known about such information around December 2012 and January 2013, the SFC says that Yorkey failed to disclose the information to the public until March 2013, when the 2012 annual results were published. The SFC alleges that the information constituted material price sensitive information which was not generally known to the public at the time.

The SFC’s actions against Mayer and Yorkey reflect a recent drive to enhance the quality of disclosures by listed companies in Hong Kong. In the latest Corporate Regulation Newsletter published in March 2016, the SFC has, as it did in the previous Newletters, reminded listed companies to disclose inside information in an accurate, clear, and balanced manner, and to ensure equal, timely, and effective access by the public. Directors should beware: the MMT has the power to disqualify a listed company director for up to five years. In the two cases above, there are a total of 12 directors and officers facing potential sanctions.

SFC and HKMA embrace Fintech challenges

The SFC established a Fintech Contact Point on 01 March 2016 along with a Fintech Advisory Group. A Fintech Facilitation Office was set up by the HKMA three weeks later. These proactive developments reflect the regulators’ intention to support the development of Fintech businesses in Hong Kong while also looking to protect those who interact with them in the financial markets.

In the SFC announcement in relation to the setup of the Fintech Contact Point, the SFC has identified the following areas in Fintech industry that may fall within its regulatory regime :

• Automated trading systems, including those driven by algorithms
• Financial product investment and distribution platforms, including robo-advisors and fund distribution platforms
• Financing platforms, including peer-to-peer lending and equity crowdfunding platforms that offer securities or collective investment schemes
• Distributed ledger technology, including application of blockchain to licensed intermediaries, securities and capital markets
• Big data, data analytics and artificial intelligence to support front and back office operations of licensed intermediaries
• Compliance, risk, and regulatory technologies, including technologies that support regulatory compliance, regulatory reporting and know-your-client, and
• Cyber and data security technologies, including secure client authentication technologies.

The SFC’s increased interest in adapting its regulatory approach to market developments is also reflected in the SFC’s recent conclusions on proposed amendments to the Guidelines for the Regulation of Automated Trading Services (Guideline). The revised Guideline is scheduled to be implemented on 01 September 2016, when mandatory clearing of over-the-counter derivative transactions is also implemented.

A truce by any other name: the SFC and DOJ sign a memorandum of understanding

The SFC announced on 04 March 2016 that it had signed an MOU with the Department of Justice (DOJ). The MoU is intended to improve cooperation between the DOJ and SFC on criminal prosecutions. Regular readers of this newsletter will have seen how we have tracked a declining number of criminal prosecutions over the last few years. In the meantime, neither Mark Steward nor Kevin Zervos (the then Director of Public Prosecutions) seemed inclined to mend their differences since their very public ‘bust-up’ over the SFC’s prosecutorial powers and the DOJ’s record of prosecuting (or rather not prosecuting) SFC-referred cases. The aim of the MOU is to align the efforts of the SFC and DOJ to combat wrongdoing in the financial markets. With both Steward and Zervos having recently moved on, it seems the timing is no coincidence. It could well usher in a new age of regulation through more severe criminal prosecutions.

For further information, please refer to our Hong Kong regulatory enforcement newsflash.

SFC appoints Thomas Atkinson as the new Executive Director of Enforcement

On 23 March 2016, the SFC announced that Mr Thomas Atkinson had been appointed as Executive Director of Enforcement starting from 03 May 2016. The appointment will last for a period of three years. He will replace Mark Steward who left the SFC last September to join the Financial Conduct Authority in the United Kingdom.

For further information and our views on what enforcement practices he will have brought over with him on CX825 from Toronto, please refer to our Hong Kong regulatory enforcement newsflash.

With the new Executive Director of Enforcement taking office, we expect the SFC to continue to push toward higher financial remedies and settlements, but with increasing criminal prosecutions, faster investigations and perhaps some innovative methods.

IPFUND acquitted of unlicensed dealing

The District Court recently acquitted IPFUND Asset Management Limited (IPFUND) and Mr Ronald Sin Chung Yin of charges of dealing in securities without a licence under section 114 of the SFO. The case was initially commenced in the Eastern Magistrates’ Court by the SFC. Due to the complexity of the subject matter, the number of witnesses, and the estimated length of the trial, the case was then transferred to the District Court and prosecuted by the DOJ. This is the first indictable prosecution for an offence of unlicensed dealing under section 114 of the SFO.

It is alleged that between February 2011 and December 2011, IPFUND and Sin, neither of whom were licensed by the SFC, offered and disposed of interests in 16 collective investment schemes to investors. The collective investment schemes managed by IPFUND and Sin were not authorized by the SFC.

Although the Court held that IPFUND was indeed carrying on a business by operating 16 collective investment schemes at the relevant time, it was held that this did not constitute a regulated business under section 114 of the SFO. The Court held that when the relevant investments took place, the investors were in fact acquiring shares in private shell companies which held interests in commercial properties in Hong Kong, profits from the sale of which would provide returns to investors and IPFUND. As the definition (in schedule 1 to the SFOC) of “securities” excludes shares of private companies, the Court held that there was no “dealing in securities” in this instance, and the defendants were acquitted.  

Enforcement dashboard

(i) Enforcement activities

(ii) SFC complaints against intermediaries and market activities*

* Reproduced from the SFC quarterly report October - December 2015

(iii) HKMA complaints volume tracker (December 2015 to March 2016)*

* Obtained from the HKMA press releases