A great deal of effort was put into enhancing investor protection and raising industry standards in the past year. As events described below indicate, our regulatory work has gone beyond combating market misconduct. By staying alert and keeping an open mind, we also have been ensuring that our regulation stayed relevant and effective and that we could pre-empt potential risks in the markets.
Enhancing investor protection
During the reporting year, enhancing investor protection was high on our agenda. We conducted a public consultation in late 2009 for this purpose and received positive response from the public, which helped us fine-tune our codes and guidelines governing investment products authorization and the selling process of investment products.
Launching product handbook, key facts statements
- We issued a consolidated product handbook comprising revised codes for unit trusts and mutual funds and for investment-linked assurance schemes, as well as a new code for unlisted structured investment products. We set up the Products Advisory Committee to consult and advise on matters related to the handbook.
- Key facts statements (KFS) for investment products authorized under the above product codes were introduced, requiring issuers to prepare an overview summarising the key features and risks of a retail investment product in plain language for investors’ easy reference.
- In promoting a specific investment product to an investor, an intermediary is not allowed to offer any gift other than a discount of fees or charges. The objective is to keep the
investor’s attention on a product’s features and risks so that his/her investment decision is free from the distraction of a gift.
- A post-sale cooling-off period was introduced, allowing investors of unlisted structured investment products with a term of more than one year to opt out of the sales agreement within a given timeframe.
Further conduct requirements will be implemented in phases starting from June 2011. These include, among others, requiring intermediaries to assess a client’s knowledge of derivatives and characterise the client accordingly before selling him/her derivative products, and to disclose to clients sales-related information, including benefits received from the product issuer and their affiliation with the product issuer.
We conducted briefing sessions and workshops, published circulars and frequently asked questions to give practical guidance to market practitioners for a smooth transition to the new regulatory environment. In particular, we provided directional comments to over 140 KFS of retail fund products.
Enhancing transparency of synthetic ETFs
To help investors distinguish between synthetic exchange-traded funds (ETFs) and traditional ETFs, we worked together with Hong Kong Exchanges and Clearing Ltd (HKEx) to introduce measures to enhance disclosure related to synthetic ETFs listed on The Stock Exchange of Hong Kong Ltd (SEHK). Managers of synthetic ETFs are required to put an asterisk and an annotation explaining the product is a synthetic ETF right after the name of a synthetic ETF in all public documents, marketing materials and websites. In addition, the alphabet “X” now must appear as a marker on the English and Chinese stock short names of synthetic ETFs, so that investors can easily differentiate them from traditional ETFs. The ETF corner of HKEx’s website was also enhanced as part of these measures.
To enhance the transparency of synthetic ETFs, fund managers are required to publish and update on their website the gross and net counterparty exposure of a synthetic ETF on a daily basis and information on collateral/invested assets on a monthly basis. Also, all authorized synthetic ETFs had issued their KFS by the end of March 2011, ahead of schedule for other existing authorized schemes.
Together with HKEx, we issued a circular in November 2010 to provide guidance to the management companies of ETFs on compliance with the on-going disclosure requirements so that investors can be informed as soon as practicable of any information concerning the relevant ETFs, which investors will need to appraise their ETF positions.
Expanding our licensing regime
In step with global regulatory developments, we formulated proposals to regulate credit rating agencies (CRAs). In July 2010, we conducted a one-month public consultation in relation to our proposals for the creation of a regulatory regime for CRAs operating in Hong Kong. The consultation generated overwhelming public support for such a regime.
Since the licensing regime for CRAs became effective on 1 June 2011, CRAs operating in Hong Kong and their rating analysts are required to be licensed to conduct business under the newly created Type 10 regulated activity (providing credit rating services). We worked closely with the Government to give effect to the required legislative amendments. As the regulation of CRAs is evolving globally, we will maintain a watchful eye on developments in this area in other jurisdictions and will make such adjustments to our regulatory regime as may be necessary from time to time.
To help Hong Kong stay competitive as a leading international financial centre, we strive to fine-tune our regulatory regime to accommodate market changes and to be on a par with international standards.
We commenced work to build a regulatory regime for the over-the-counter (OTC) derivatives market in Hong Kong to reduce systemic risk, improve transparency and prevent market abuse. The new regulatory regime supports the impending establishment of a trade repository by the Hong Kong Monetary Authority (HKMA) and an OTC derivatives central counterparty clearing house by HKEx. These developments would take a phased approach. The initial phase, currently planned for 2012, would cover mainly interest rate swaps and non deliverable forwards, the major types of derivative products traded in Hong Kong’s OTC market. A public consultation will be launched on the subject in 2011.
Last year, Hong Kong saw an increase in the number of alternative liquidity pools, including dark pools. To facilitate our monitoring of the development of these alternative liquidity pools, we supported SEHK in introducing a flagging requirement for reporting trades in Hong Kong-listed securities executed via such alternative liquidity pools. From 1 February 2011, exchange participants have been reporting these trades to SEHK with an "ALP" indicator.
Work to launch a new short-position reporting regime also began during the reporting year. The data on short positions will complement the information the SFC has on short sales. Information collected under this new reporting regime will give us more insight into market dynamics and serve as early warning signs of large short positions, which may require prompt regulatory actions. We are planning to consult the public in 2011 on the draft subsidiary legislation required to implement this new regulation.
We continued to supervise intermediaries to ensure compliance through on-site inspections and off-site monitoring of their operations. We also engaged in constant dialogue with industry participants to raise awareness of compliance matters.
Reviewing intermediary activities
Last year, we conducted 235 risk-based, on-site inspections of licensed corporations to assess their level of compliance and identified 402 internal control deficiencies, breaches and violations. In addition, 28 cases involving serious breaches by licensed corporations and individuals, such as, misappropriation of client assets, unauthorized trading, serious internal control failure and serious breaches of liquid capital requirement, necessitated further investigation. Upon our request, some of these licensed corporations appointed independent accountants to conduct circularisation of client balances and stock positions and to review in detail their internal control systems.
We also carried out some specialised programmes to look into the activities of intermediaries:
- Concurrently with HKMA, we engaged an external service provider to conduct a mystery shopping programme to look into the selling practices of intermediaries regarding unlisted securities and futures products. The exercise helped to assess licensed corporations’ extent of compliance with regulatory requirements, including the “know your client” procedures and explanation of product features and risk disclosure.
- We launched anti-money laundering theme inspections, which will continue into the second half of 2011, to gauge licensed corporations’ compliance with key requirements of the new anti-money laundering bill and to raise their awareness and readiness level.
We also continued to monitor closely the financial standing of high-impact and higher risk brokerages by doing stress tests on their liquid capital and analysing their financials. When appropriate, we asked them to tighten risk controls and to improve capital adequacy.
Inspecting sponsors’ work
In light of the market conditions and the fact that the Sponsor Guidelines have been effective since 2007, we considered it appropriate to gather more information on the sponsor landscape and to assess the level of compliance of sponsors.
We conducted a survey on all sponsors and collected information about the sponsors’ work concerning listing applications on SEHK. In addition, we formed a specialised team and conducted a theme inspection of 17 licensed sponsors. Focusing on the sponsors’ work in IPO applications, particularly due diligence, our inspections revealed certain deficiencies in their work and inadequacies in their internal systems and controls. The findings were published in March 2011.
- We organised 352 meetings with representatives of licensed corporations and industry bodies to discuss operational and market development issues. For instance, a meeting was held with six industry bodies to discuss daily operational and compliance issues concerning securities and futures trading, eg, various fraud cases identified by our supervision teams.
- In view of several mega-sized rights issues and the increase in market turnover in late 2010, we issued a circular to remind brokerages to monitor their operational capabilities and put in place appropriate contingent arrangements.
- At the seminars co-organised with the Independent Commission Against Corruption, we reminded about 370 participants of the importance of business ethics, highlighted corruption-prone areas in the securities sector, recommended preventive measures, and cautioned them to implement proper policies and procedures.
- We updated about 500 market participants on the latest international and domestic anti-money laundering development in two training seminars jointly offered with the Government and the police.
- Participating in industry forums held by the Institute of Financial Planners of Hong Kong and the Hong Kong Institute of Bankers, we shared with the industry the key concerns in the financial planning and advisory arena, other major regulator’s actions to enhance intermediary selling practices, and the latest international regulatory developments.
- We discussed with the industry common control deficiencies and information technology management at a seminar hosted by the Hong Kong Securities Professionals Association.
Our enforcement actions over the last 12 months dealt swift blows to misconduct in the securities and futures markets. Through civil proceedings and criminal sanctions, we sent a strong message to would-be rule-breakers. We are determined to fulfil our mandate in all areas, including market misconduct, corporate governance and intermediary misconduct.
Making further progress in LB-related issues
Concerning structured products related to Lehman Brothers (LB), we made yet another breakthrough – this time with DBS Bank (Hong Kong) and Standard Chartered Bank (Hong Kong). Jointly with HKMA, we negotiated two separate agreements so that eligible investors of certain LB-related investment products could recover all or part of their investment.
DBS agreed to pay a total of $651 million in principal plus interest to its eligible Constellation Note customers. Standard Chartered’s repurchase offer of $1.48 billion covered more than 95% of its customers of equity-linked notes issued and guaranteed by LB. Since it would have been unlikely to achieve the same levels of resolution amounts using disciplinary actions, we believe that the agreements were in the best interest of investors.
We were also pleased with the announcements by the 16 LB Minibond distributing banks and PricewaterhouseCoopers, the receivers of Minibond collateral, concerning the recovery and proposed distributions of the net value of the underlying collateral assets of some Minibond series. This outcome was the result of the Minibond agreement between the SFC, HKMA and the 16 banks on 22 July 2009.
Taking swift and firm actions
In the review period, we deployed a wide range of enforcement actions to penalise violators and to send deterrent messages to market participants.
As a result of our enforcement actions, jail sentences were imposed on 11 individuals. During the year, we successfully prosecuted 12 individuals, two of whom were convicted of 40 counts of market manipulation. We now have civil actions pending before the courts to seek disqualification and compensation orders against a total of 44 individuals and corporations, as well as 120 counts of criminal charges against 24 persons. Below are the highlights of our
enforcement actions processed through the courts:
- In the first indictable case against manipulation of derivative warrants, we prosecuted two traders for creating a false and misleading appearance of active trading in 20 derivative warrants. The District Court found that the trading conducted by Patrick Fu Kor Kuen and Francis Lee Shu Yuen falsely inflated the turnover of the warrants by 80% or over $450 million in value and jailed them for 33 and 36 months respectively. Subsequently, the Court of Appeal (CA) dismissed the appeals by Fu and Lee but reduced the jail sentences to 20 and 21 months respectively. The CA also declined the duo permission to appeal to the Court of Final Appeal (CFA).
- We successfully sought review from the Eastern Magistracy to substitute its original decision to sentence Pablo Chan Pak Hoe to serve 240 hours of community service with a term of four-month imprisonment and a fine of $120,000. Chan was convicted of insider dealing in the shares of Universe International Holdings Ltd while representing the controlling shareholder in a proposed acquisition. The CA will hear Chan’s further appeal in June 2011.
- In light of further insider dealing allegations, we amended our proceedings against Tiger Asia Management LLC (Tiger Asia), a New York-based asset management company, and three of its senior officers to freeze an additional $8.6 million of Tiger Asia’s assets, on top of the $29.9 million that we applied to freeze in August 2009, and to prohibit it from dealing in all listed securities and derivatives in Hong Kong.
- Our proceedings against Li Han Chun, the former CEO of China Forestry Holdings Co., Ltd (China Forestry) had resulted in interim freezing orders over assets of up to $398 million held by Li and his company, Top Wisdom Overseas Holdings Ltd (Top Wisdom). We alleged that Li and Top Wisdom disposed of 119 million China Forestry shares before the company’s announcement of accounting irregularities. The effect of the interim order is to freeze the proceeds of the sale of those shares by Li and Top Wisdom.
- We obtained an order from the High Court (HC) to freeze assets of up to $997 million in relation to Hontex International Holdings Company Ltd (Hontex), equivalent to the net proceeds raised by the company in its initial public offering in 2009. Hontex was alleged to have disclosed materially false or misleading information about its financial position in its prospectus. The injunction was obtained to prevent the dissipation of assets and to ensure that there were sufficient assets to satisfy any restoration or compensation orders for Hontex investors.
- The HC also gave an order to disqualify Steven Li Wang Tai, former executive director of Styland Holdings Ltd (Styland), from being a director or being involved in the management of any listed company for six years. Li accepted that he failed to manage the company with the necessary degree of skill and diligence. Our application to the HC to disqualify the other Styland directors and to seek compensation for losses caused was heard in January 2011 and is awaiting court decision. The case represented our first proceeding against former executives of a listed company for payment of compensation to the company they managed.
- We prosecuted Li Jialin, chairman of VST Holdings Ltd (VST), in the District Court, for rigging the price of VST shares and breaching the disclosure of interest requirements. This case, our second indictable prosecution for market manipulation, will be heard in September 2011.
- We sought orders in the High Court to disqualify Andy Wong Shu Wing, a former chairman and executive director of Sunlink International Holdings Ltd (Sunlink) and Lee Chak To, a former chief financial officer of Sunlink, as company directors for alleged misconduct. We alleged that Wong and Lee failed to manage Sunlink with the necessary degree of skill, care, diligence and competence.
- We have commenced civil proceedings against two solicitors Young Bik Fung and Lee Kwok Wa, and Lee’s two sisters Patsy Lee Siu Ying and Stella Lee Siu Fan in the High Court for alleged insider dealing in the shares of Hsinchu International Bank Co Ltd and Asia Satellite Telecommunications Holdings Ltd.
During the year, we disciplined 47 licensees for various offences and improper conduct. The value of fines imposed amounted to $21.4 million. We disciplined 12 licensed corporations and six of their respective responsible officers, and fined them a total of $18.3 million for internal control deficiencies. Relatively more significant are the following instances:
- Julius Baer (Hong Kong) Ltd was reprimanded and fined $3 million for failing to take adequate steps to identify clients as professional investors before treating them as such. The status of professional investors would allow certain provisions of the Code of Conduct to be waived.
- Merrill Lynch (Asia Pacific) Ltd and Merrill Lynch Futures (Hong Kong) Ltd (collectively Merrill Lynch) were fined $3.5 million for systems and controls failings associated with the mis-marking activities in a trading book. Jugurtha Harchaoui, formerly a managing director and senior trader at Merrill Lynch, was banned from re-entering the industry for life for masterminding the mis-marking activities.
- Christfund Securities Ltd, Christfund Futures Ltd and their respective responsible officers were fined a total of $2.5 million over internal control deficiencies in handling some Mainland clients’ accounts.
- Three employees of UBS AG Hong Kong were fined a total of $1.8 million for carrying out clients’ trades that constituted wash sales and may have misled the market.
- Zhang Bijia was banned from re-entering the industry for life for engaging in insider dealing.
- The licence of Chun Peng Fai was revoked and he was banned from re-entering the industry for five years for derivative warrants trading that had the effect of falsely inflating market turnover.
|Number of trading inquiries issued
|Number of investigations started
|Number of investigations completed
|Number of investigations completed within
seven months (%)
|Number of persons charged in criminal proceedings
|Number of criminal charges laid
|Number of Notices of Proposed Disciplinary Actions
|Number of Notices of Final Decision
|Number of persons subject to civil proceedings
|Compliance advice letters issued
* We brought a total of 361 criminal charges against 58 persons, with 76 charges laid against nine people for market manipulation.
Enforcement prosecutions affirmed
Last year, the Securities and Futures Appeal Tribunal (SFAT) upheld five disciplinary appeal actions against five individuals for trading malpractice and insider dealing, but reduced the penalties imposed by the SFC in two cases under certain circumstances.
Separately, the CA allowed our appeal against an SFAT decision and ruled that criminal procedures are not applicable to disciplinary proceedings. The CA affirmed that the Securities and Futures Ordinance (SFO) is a self-sufficient statutory code for dealing with regulatory disciplinary matters. In this case, the CA increased the penalty the SFAT had imposed on the licensee from a licence suspension of 18 months to a prohibition order of three years.
The CA also dismissed appeals by Ng Chiu Mui and Law Kai Yee, two former responsible officers of Hantec International Ltd, against the SFAT’s decision to revoke Ng’s licence and prohibit her from reapplying for a licence for 10 years and suspend Law for two years and three months for their involvement in unlicensed leveraged foreign exchange trading operation. The CA ruled that their serious misconduct had deprived their clients of the statutory protection and was detrimental to the integrity of the markets.
The CFA dismissed appeals by Sammy Ma Hon Kit and his wife Cordelia Tso Kin Wah against their convictions for insider dealing in shares of Egana Jewellery Pearls Ltd.
This followed an earlier ruling by the CA rejecting their appeals and marked the end of the first indictable prosecution since insider dealing was made a criminal offence under the SFO in 2003.
Regulating listing matters
We supervise and oversee SEHK’s performance in its regulation of listing-related matters. Our work in this area for the period under review is highlighted as follows:
- We commented on 192 listing applications received via SEHK under the dual filing regime and deferred commenting on nine cases due to serious deficiencies in the initial submissions. Such deficiencies included inaccurate information, misleading or significant errors in the initial listing documents, which necessitated substantial improvements to be made to the draft listing documents.
- In parallel with the Government’s proposal to impose a statutory obligation on listed corporations to disclose price-sensitive information, we conducted a public consultation in March 2010 on the draft SFC guidelines regarding the type of information covered and how exemptions could be applied. Guidelines on how to implement the new requirements were released along with the consultation conclusions in February 2011. The bill prepared by the Government to codify the relevant requirements is expected to be gazetted and introduced to the Legislative Council by July 2011.
- In a consultation paper issued in September 2010, we proposed expanding the scope of the present requirements governing conflicts of interest for analysts to cover research reports on IPOs (including public offers of real estate investment trusts (REITs)), in addition to those on listed securities. We are analysing the responses received and discussing the proposal with market participants and industry representatives. The conclusions will be published in due course.
- The Takeovers Executive1 publicly criticised Glamour House Ltd and its sole director Xie Xuan for breaching the Takeovers Code in July 2010. Xie failed to make an announcement immediately after the acquisition of voting rights of Asian Capital Resources (Holdings) Ltd, which gave rise to a general offer obligation for the shares in that company.
- The Takeovers Executive publicly censured Templeton Asset Management Ltd (Templeton) for breaches of dealing disclosure over Denway Motors Ltd (Denway) in December 2010. As an associate of Denway holding more than 5%, Templeton failed to disclose its dealings in the shares.
- During the year, we handled 37 takeovers-related cases (including general offers, privatisations and share repurchases), 30 whitewashes and 237 applications under the Codes on Takeovers and Mergers and Share Repurchases. The Takeovers Panel met three times to rule on issues regarding live transactions and/or policy matters.
- We continued to supervise SEHK’s performance in its regulation of listing matters. In our annual review of SEHK’s regulatory performance in 2009, we noted that the operational procedures and decision-making processes reviewed were appropriate to enable SEHK to discharge its statutory obligation, which is, to maintain an orderly, informed and fair market.
1 The Takeovers Executive refers to the Executive Director of the Corporate Finance Division of the SFC or any delegate of the Executive Director.
Enhancing other regulatory areas
- In a consultation we conducted last October, we proposed to refine the requirements for proving whether a person qualifies as a high-net-worth professional investor, using a principles-based approach. Such an approach would allow market participants flexibility in establishing whether an investor would qualify as a professional investor. We received 16 written submissions expressing general support of the proposal. The conclusions were published in February 2011 and the amendment will be gazetted in due course.
- To ensure that minority unit holders of REITs would be treated fairly in a takeover, certain changes were made to the REIT Code regarding appointment and removal of REIT managers and the application of the Codes on Takeovers and Mergers and Share Repurchases was extended to REITs. The changes became effective in June 2010 following a two-month consultation. This change was in line with international practice and reflected our commitment to continue developing the Hong Kong REIT market.
- Following our release of the conclusions paper in April 2010 and gazettal of the Securities and Futures and Companies Legislation (Structured Products Amendment) Bill 2010 in July 2010, we have assisted the Government in the process of enacting the Bill. The regulation of structured products, irrespective of their legal form, was brought under the SFO when the relevant Ordinance took effect in May 2011.
- We also provided support to the Government to develop the Anti-Money Laundering and Counter-Terrorist Financing (Financial Institutions) Bill, which codifies the customer due diligence and record keeping requirements, in line with the prevailing international standards. We would continue to support the Government by addressing relevant questions from the Legislative Council over the bill and developing uniform generic guidelines with other financial regulators.
Handling complaints, compensation
Last year, we received 203 public complaints related to the collapse of the LB group and 38 of them were referred to HKMA for preliminary review.
We also received 1,734 non-LB related complaints, 324 of which were reviewed by our various operational divisions, including 140 cases investigated by our Enforcement Division. In addition, 158 of non-LB related cases were referred to HKEx, HKMA or other financial regulators, as appropriate.
Public complaints overview
|Nature of complaints
|Conduct of licensed
|Listing-related matters and
disclosure of interests
|Other financial activities
|Complaints related to
Under our supervision, the Investor Compensation Co, Ltd (ICC) continued to process claims from clients of three brokerages that had defaulted in previous years, as well as claims against four brokerages concerning individual disputes. During the year, the ICC completed the processing of 54 claims and paid out $5.29 million in compensation to 38 investors.