Annual Reports

Enforcement Division

Mark Dickens is Executive Director responsible for the Enforcement Division, and Information Technology Planning.

HIGHLIGHTS

l	Concluded a total of 186 investigations during the year;

l	Initiated 13 cases of suspected insider dealing and 9 cases of suspected market manipulation resulting from suspensions of trading in listed company shares;

l	Secured two prosecutions for breaches of Securities (Disclosure of Interests) Ordinance;

l	Five cases of suspected insider dealing referred by SFC either completed or currently before the Insider Dealing Tribunal:

l	Conducted surveillance of trading on SEHK and HKFE to detect unusual price and volume movements; and

l	Conducted special inspections of stock brokerages and associated finance companies in cooperation with SFC's Intermediaries Supervisions Department.

FUNCTIONS

3.1	The statutory functions of the SFC which are of an enforcement nature include:
	l	ensuring compliance with laws relating to the securities and futures industries, leveraged foreign exchange trading, and investment arrangements;
	l	reporting suspected insider dealing to the Financial Secretary;
	l	suppressing illegal, dishonourable or improper practices in dealing in securities, trading in futures and leveraged foreign exchange contracts, entering into investment arrangements, and providing investment advice or other financial services;
	l	inspecting the books and records of listed companies when directors and officers are suspected of impropriety in the management of a listed company's affairs; and
	l	cooperating with domestic or overseas regulatory bodies concerned with securities, futures, leveraged foreign exchange trading, banking, insurance or other financial services, or with the affairs of corporations.

3.2	In performing these functions, the SFC's Enforcement Division :
	l	collects evidence to:
		-	support prosecutions for breaches of the various laws administered by the SFC;
		-	institute disciplinary proceedings for misconduct by licensed intermediaries;
		-	refer to the Stock Exchange of Hong Kong Ltd (SEHK) and the Hong Kong Futures Exchange Ltd (HKFE) apparent breaches of their rules; and
		-	detect impropriety by directors and officers in the management of a listed company's affairs;
	l	issues warnings, and advice on remedial action, for minor transgressions;
	l	prepares cases triable summarily for prosecution by the SFC's Legal Services Division;
	l	forwards to the Director of Public Prosecutions cases involving offences that appear to warrant prosecution on indictment;
	l	reports to the Financial Secretary circumstances which suggest that inspections under the Companies Ordinance or the Securities (Disclosure of Interests) Ordinance should be initiated;
	l	cooperates with inspectors appointed by the Financial a Secretary, the Insider Dealing Tribunal, and other regulatory and investigative authorities in Hong Kong (such as the Hong Kong Monetary Authority, the Independent Commission Against Corruption and the Hong Kong Police - especially its Commercial Crime Bureau); and
	l	arranges, on behalf of the SFC, bilateral agreements with overseas regulatory authorities regarding mutual cooperation in the exchange of information and other assistance.

3.3	The Executive Director, Enforcement coordinates and prioritises enforcement activity Commission-wide to ensure the range of cases investigated is well balanced, covers the full ambit of the SFC's statutory compliance responsibilities, reinforces regulatory policy objectives and demonstrates the SFC's vigilance in protecting investors.


Redeployment of Staff for Market Surveillance and Inspections of Intermediaries
3.4	Volatile market conditions during the year required that resources be reallocated to market surveillance, and to urgent investigations stemming from the suspension of trading of shares of listed companies in which unusual trading activities persisted.

3.5	Enforcement Division staff were also redeployed to assist the Intermediaries Supervision Department in special inspections of stock brokerages and their associated finance companies, especially those with large margin lending exposures.

3.6	These redeployments were conducted on a number of occasions during the year resulting in a decrease in both prosecutions and disciplinary actions when compared with the previous year.

Surveillance
3.7	The SFC's surveillance team monitors trading on the SEHK and the HKFE, using computer analysis to identify unusual price and volume movements. When appropriate, the surveillance team also conducts preliminary enquiries to determine whether the movements raise suspicions of market manipulation and/or insider dealing.

3.8	The first step in such surveillance work is to analyse trading information from the SEHK or the HKFE. If this information raises suspicions of insider trading or market manipulation, then client details and records are obtained from brokers. If further analysis of these records suggests the occurrence of insider dealing or market manipulation or other misconduct, an investigation is initiated.

3.9	During the year trading records were obtained from brokers on 83 occasions. In 24 of these cases, full investigations were initiated.

3.10	Another area to which the surveillance team paid particular attention during the year was activity in shares that may be designed to affect the pricing of derivatives including, for example, Hang Seng Index futures contracts and options traded on the HKFE.

Suspension of Stock Trading
3.11	On 21 May 1997, the SEHK and the SFC jointly published an announcement expressing their concern about the unusual price and volume movements in the shares of some listed companies which appeared to bear no relationship to the assets, profitability or prospects of the companies concerned. (See paragraph 1.14)

3.12	The joint announcement, and the suspension of shares of a number of listed companies, had an initial salutary effect on the market. However, unusual price and volume movements increased again in the speculative and volatile environment of the 3rd quarter, and did not diminish until the downturn in the market beginning in the 4th quarter.

3.13	During the year, there were a total of 69 cases of suspension of trading, of which 56 were initiated by the companies concerned, 7 were directed by the SEHK and 6 were directed by the SFC under Rule 9 of the Securities (Stock Exchange Listing) Rules. However, suspensions were usually lifted on a day after a company had issued an announcement to disseminate news which might have an impact on its stock or stating that it was unaware of the reason for the unusual price/volume movement in its shares.

3.14	If unusual trading persisted after such an announcement, the SEHK would normally request a suspension pending a detailed announcement from the company. The suspension would normally be lifted once the detailed announcement had been issued, ensuring that market was fully informed. However, in exceptional circumstances where the SFC was also inquiring into the trading activities to determine whether the movements were the result of market manipulation, insider trading and/or other market malpractices, a suspension would continue. During the year, suspensions resulted in the commencement of 9 investigations into potential market manipulation and 13 investigations into possible insider dealing.

3.15	Trading would not remain suspended pending the outcome of an investigation even if market manipulation or insider dealing were suspected, as discussions would be held with the company concerned to find a way of allowing the stock to resume trading at the earliest opportunity in a fair and orderly manner. Only in exceptional cases would a stock remain suspended, for example, when a company declined to disclose information that the SFC considered relevant to maintaining a fair and orderly market or if a company was facing serious financial difficulties.

3.16	A listed company's banks, creditors, customers and suppliers may perceive a suspension of trading as reflecting on the company, and this may negatively impact its business. In view of this concern, the SFC issued letters to companies explaining that the suspension was not related to the financial position, operation, or conduct of the company's affairs. The company concerned could pass the letter to its banks, creditors, customers and suppliers so that the reason for suspension would not be misunderstood.

Complaints and Enquiries
3.17	Of the 6,239 complaints and enquiries received during the year by the Investor Education Unit (see paragraph 9.11), the vast majority were resolved without full investigation being necessary. However, in 17 cases, formal investigations were initiated.

Investigations - An Overview
3.18	Although the SFC is limited in its capacity to comment on investigations by the secrecy provisions of the Securities and Futures Commission Ordinance (SFCO), there are some cases where information is already in the public domain and others where general information can be given.

3.19	A total of 169 cases were carried forward as ongoing enquiries from the previous year. During the year a further 191 cases (including the cases referred to in paragraphs 3.9, 3.14 and 3.17) were referred to the Division by the public, foreign regulators, law enforcement agencies in Hong Kong, the Exchanges, and from within the SFC.

3.20	Out of the total of 360 cases handled, 186 have been concluded. The remaining 174 are the subjects of continuing enquiries, hearings or prosecutions.

Investigations - "Rat Trading"
3.21	During the year, action continued against registered persons involved in 'rat trading', a generic term used in the local securities and futures markets covering a wide range of malpractices by staff of brokers, particularly floor traders and account executives, trading to the disadvantage of clients. Rat trading is usually detected during routine inspections both by the SFC's Intermediaries Supervision Department and the Financial Regulation Unit of the SEHK, who then refer their findings to the Enforcement Division for investigation. There has, however, been a significant reduction in the number of cases detected since the introduction by the SEHK in 1993 of the Automatic Order Matching and Execution System (AMS).

3.22	Investigations culminated in disciplinary action being taken against 20 registered persons who were involved in, or actively facilitated rat trading. These persons had their registrations suspended for periods ranging from one month to three years. Nineteen dealers and a major shareholder of a corporate securities dealer, whose lack of supervision or system inadequacies allowed rat trading to occur, were all publicly reprimanded except in a more serious case in which a dealer's registration was suspended for six months.

Joint Disciplinary Action by SEHK and SFC
3.23	During the year, procedures were agreed with the SEHK, which introduced new rules allowing for joint disciplinary action. Such action can be taken by the SFC and SEHK in cases where parties agree to join action, and accept the disciplinary findings and penalty, of both the SEHK and the SFC. Joint action was taken in two 'rat trading' cases, both of which were investigated by the SFC.

Appeals
3.24	In two instances, the Securities and Futures Appeals Panel upheld the SFC's decision to suspend the registrations of dealer's representatives for two years and three years respectively for their rat trading activities. In both decisions, the Panel noted the rat trading involved serious misconduct and that the length of suspension was fully justified. The dealer's representatives were each ordered to pay the costs of their appeal amounting to $126,750 and $34,004 respectively.

Investigations - Short Selling
3.25	During the year, 15 persons were prosecuted for short selling, details of which can be found in Table 1. Short selling contravenes section 80(1) of the Securities Ordinance, which prohibits the sale of securities when the seller does not have a presently exercisable and unconditional right to sell.

3.26	Of the 15 persons prosecuted for shortselling, five were registered persons. Four were publicly reprimanded for their short selling activities whilst one was also disciplined for other activities, including 'rat trading'. In addition, one dealer's representative was reprimanded for failing to ascertain clients had scrip to settle transactions, and a dealer had his registration suspended for 14 days for condoning short selling by both clients and staff of his company. These failings jeopardise the settlement process which could affect the smooth running of the securities market.

Investigations - Unregistered Dealing
3.27	Continued enforcement action against unregistered activities in the securities, commodities and leveraged foreign exchange trading markets resulted in 22 persons being prosecuted and disciplinary action being taken against ten registered and licensed persons. In respect of disciplinary action, five were issued with public reprimands, and in five cases, which involved serious transgressions or repeated offences, suspensions of between three months and two years were awarded. Details of prosecutions can be found at Table 2.