Open-ended Questions

In contrast to close-ended questions, open-ended questions asked by business people is another headache to compliance officers. They like to give you a long story (usually disorganized) and then ask a borderless question: Any compliance concern?

What they are looking for is a quick-fix reply which lists out ALL compliance issues and ALL the solutions. They don't even use their brains to figure out at least a few key problems. In applying compliance coaching skills, you should ask them questions to ensure that:

• more relevant information is obtained
• the logic underlying the facts is clarified
• the motivation behind the enquiry is found out

Okay, once you identify a real problem and give them a solution which is however unfavorable to business or quite costly, they would immediately yell to you. When you quote a regulatory piece, they even dare to ask you to get a waiver from SFC without justification (e.g. "Please ask SFC to waive this guy from taking Paper 1 exam when approving his licence"). This is insane.

Some people are even a bit wicked by giving you an email with a chain of forwarded emails & attachments and asked you to endorse the whole stuff. They treat you as an idiot.

Of course not all business people are so unreasonable. But if your company is full of those crazy guys, please carefully think about your career plan!

Close-ended Questions

As compliance officers, we are often required to answer technical questions raised by the management or business units. Since they would take our answers as advice, we must be very careful and tactful, especially when facing with those "tricky questions".

One of the traps come from those "close-ended questions", where you are required answer only yes or no. This kind of questions force us to give a answer without knowing the full picture. As a key principle of compliance coaching, we must first identify the real problem when handling any enquiry.

Just give you a real example of the compliance coaching dialogue:

Business Head (BH): Is it compliant if we organize a free investment seminar for our current customers? (a close-ended question)

Compliance Officer (CO): It depends on the content and context of this event. Could you give me more details?

BH: We will invite our company's investment experts to talk about the macroeconomy and introduce our newly launched funds? The fund has already been authorized by SFC, so there is no compliance problem. (an improper presupposition)

CO: But have the presentation materials been vetted by Compliance & SFC?

BH: Oh sorry, I don't know this is necessary. (really?) I will submit the powerpoint slides to you. So is it ok now? (another close-ended question)

CO: How are the customers selected? Are they either "professional investors" or "existing clients"? (you know what he is asking about)

BH: All customers are existing clients but they can bring guests who would be our prospective customers.

CO: Then I have a compliance concern about cold-calling if your salespersons approach these guests and invite them for account opening or fund subscription...


Some business people like to fool the compliance officers by asking close-ended questions and giving a very tight deadline for reply. Don't Be Stupid!

Reforms to Prospectus Regime

Following last year's consultation, last Friday SFC eventually released the consultation conclusions on the 21 reform proposals to the prospectus regime. This reform is indeed a big re-engineering project for the existing legislations (including CO & SFO).

I would like to discuss some of those conclusions in today's blog:

• In response to public comments, SFC agreed to apply the safe harbors under 17th Schedule of CO to all funds (including unit trusts). This is good as many practitioners are concerned that unit trusts are not entitled to the CO safe harbors and also not exempted by SFO for private placement.
• SFC would not grant a prospectus exemption for off-market offers of listed shares & debentures. This sounds too stringent. Fortunately SFC agrees that the prospectus content requirements for a secondary issue may be significantly less than those for an IPO.
• It is reasonable to differentiate plain vanilla "debenture" (for fund raising purpose and subject only to CO regime) from "structured products" (subject only to SFO investment advertisement regime).
• To avoid abuse of the "private placement" and "small scale offer" exemptions, SFC has proposed to aggregate "closely related offers" (even not by the same entity) made within a period of 12 months. This seems to be a simpler way to close the regulatory gap.
• SFC finally gave up the proposal to extend the prospectus liability to sponsors. I think this is a compromise in view of the implementation of the new sponsor guidelines.
• It is a regret SFC has decided not to extend classes of persons who may claim compensation for a mis-stated prospectus to secondary market purchasers. SFC originally quoted that UK, Australia & Singapore had no express restriction of compensation to only primary market purchasers.
• I strongly support SFC's decision to allow "incorporation by reference" as this can shorten the prospectus and support environment protection. A giant IPO like China Merchants Bank had destroyed so many trees!
• Pre-deal research by connected analysts is really a controversial issue, as the release of such information is both unfair and unreliable. SFC's final proposal (e.g. ban on forward-looking information) of amending Paragraph 16 of CoC would reduce the value of pre-deal research.

Practice Guide for Financial Planners

Yesterday I talked about financial planning from investors' perspectives. Today I turn to the compliance issues faced by financial planners. Many IFA do not have a robust compliance system to ensure giving fair treatments to clients.

Last week FSA fined an IFA £63,000 for failing to properly apportion roles and responsibilities to its senior management and for not having systems in place to ensure that its advisers were trained and competent. Even FSA did not highlight any serious mis-selling cases of this firm, poor management had already been a subject of penalty.

In setting a compliance system for financial planners, an operating manual which incorporates all essential regulatory requirements should be prepared. But many firms (especially those not parented by large financial groups) do not put resources on this aspect.

Recently the Institute of Financial Planners of Hong Kong (IFPHK) has published the Practice Guide for Financial Planners. This handbook, which sets out the compliance issues in the six-step planning process, may provide very useful reference materials for the practising firms.

I appreciate the following merits of this handbook:

• Comprehensive - All essential regulations in HK in connection with financial planning are summarized there.
• Practical - A large number of examples and case studies are given to facilitate learning.
• Remindful - Tipping points and self-assessment checklists are included in each chapter.

I think this handbook can be used by financial planning firms for preparing their operating manuals and training materials.

Engagement of Investment Advisers

Last week SFC published a survey report on engagement of investment advisers (IA) of banks, SFC licensed firms and insurance agents/brokers, which was based on interviews with 100 investors (half of them with tertiary education). Some of those findings are remarkable.

• When choosing an IA, most investors looked at: product/market knowledge (74%); willingness to understand client's circumstances and address client's concerns (68%); and ability to explain matters clearly (62%).
• Almost half of investors have no clear investment objectives before discussing with IA, but some (32%) set their goals based on results of "financial health analysis".
• 44% of investors did not receive a written financial plan from IA.
• Among those investors who received a written financial plan, more than half just flipped through it or did not read it at all.
• Only 7% of investors indicated that their IA disclosed the commission/rebate arising from selling an investment product.
• Only 34% of investors claimed that they read the investment documents carefully before signing.
• Besides stocks & funds, investment-linked assurance schemes (30%) became the third popular investment products.
• 60% of investors thought that risk warning statements in the offering documents and product advertisements were not sufficient to alert them.
• In evaluating IA's services, the less satisfactory areas were: fees & commissions and financial planning skills.
• For service improvement, 57% of investors hoped to see more suitable product recommendations.

My remarks:

• As HK investors are generally short-sighted, IA are hardly motivated to enhance their financial planning skills.
• Besides product knowledge, soft skills (including listening & communication skills) are very important for financial planning. But many IA are lacking soft skills.
• Most people do not set goals. That's why goal setting is a key job of financial planning.
• Laziness is one of the 7 deadly sins of investing. HK investors are too lazy to review the documents. They could blindly rely on IA.
• As emphasized in Barber Asia's case, making risk warnings simply by documentation does not work. Effective communication is essential.
• What are "suitable" product recommendations? SFC would say suitability is based on investment objectives and personal circumstances. But investors may equate "suitable" with "making profits" (no matter the risk level).

Option Backdating

This year one of the major scandals in the US securities market should be the improper stock option backdating practices. SEC is now busy for conducting the investigations and filing the charges.

Stock options are generally granted to senior executives of listed corporations. Granting stock options was once a cheaper way for remunerating staff than paying salaries & bonues, but now the options should also be expensed.

With "backdating", the option grant document reflects a date in the past, when the stock price was much lower than the level at the real grant date. Apparently the options are granted at-the-money, but actually in-the-money. Such practice is both unfair and fraudulent because the real option expenses are not properly reflected in earnings & taxes and thus not clearly communicated to the shareholders.

The scandals may have erupted from the Wall Street Journal's findings that at several companies the option grants almost always occurred on days when the stock price was much lower than normal (or even the lowest during the fiscal year). Then a number of US companies were found to have played the backdating trick.

In the past, when SEC regulations are less strict, the executives were permitted to report the option grants very late, thus leaving room for backdating. Now under Sarbanes-Oxley Act, companies must report option grants within two business days. Many backdating cases did occur in the last decade. Those companies caught so far by SEC have not yet let us see the full iceberg.

Malpractices made by senior executives of listed companies are so innovative. But I think, in many times, such acts would not be made feasible without the implicit consent of the Board. Corporate governance is always the fundamental challenge to regulators and compliance officers.

Market Commentary

Market commentary is common stuff we frequently read. Sometimes it is issued for a marketing purpose, while in other situations it is made by research analysts. Market commentary is usually concerning compliance when it is related to a specific product.

This week SFC finalized the Guidelines on Marketing Materials for Listed Structured Products (effective from 1 Oct 2006) following the announcement of the Six-Point Plan in the Report for Derivatives Warrant Market.

There is no new thing under the sun. The Guidelines reiterate the high level principle that marketing materials should not be false, biased, misleading or deceptive and should include appropriate & prominent risk warnings. What interested me is just the requirement that the issuer should ensure disclosure of its commercial / business relationship with any person making a market commentary about its specific products. If such relationship exists, then the objectivity or independence of those comments would be undermined.

I was once asked whether market commentary covered by the Guidelines would also be subject to Paragraph 16 of the Code of Conduct. My answer is No. Paragraph 16 is governing investment research (which is supposed to be neutral), while the Guidelines are covering marketing materials (which would never be neutral). Both kinds of stuff should be clearly differentiated.

The problem is: When we now see a firm's employee appearing in the media, it is not easy to ascertain whether he is a salesperson or an analyst.

CPT

The "peak season" (last calendar quarter) of Continuous Professional Training (CPT) is coming. No matter how you hate taking a course, you are required to show up in order to maintain your license.

Having been a CPT trainer for several years, I have witnessed many interesting phenomena in those classes.

Some participants are only physically present (i.e. mentally absent). I had seen several senior executives of large banks who were "sleeping" (eyes kept closing) for the whole 3 hours. They just consider CPT as "Counter-Productive Time".

Some people carried anger to the classes as they felt they were "forced" to take a "too basic", "useless" course. My question is: Have you spent at least some minutes to select a suitable course for you? (A failing person keeps on complaining without doing anything to improve his situation.)

Once a time a funny guy told me that his 3 criteria for picking a CPT course is:

• C - Cheap
• P - Provide attendance record
• T - Take it easy

That's why many firms like to organize in-house CPT courses for their staff. I recalled an incident about the in-house training I had done for a well-known IFA firm. The staff were not just continually chatting in the class, some of them formed a circle to hold a meeting. Really professional! (Needless to say, I've blacklisted this firm.)

I still remember many years ago adult education was so treasured by those citizens who did not receive too much formal education. Today people are wasting their time and social resources (including CEF) by getting around real attendance.

Of course, the world is not full of negative things. I had also met many participants who were friendly, eager for learning, asking sensible questions and giving positive feedback. I appreciate and salute their attitudes.

Retirement Planning

The MPF system has been implemented for almost 6 years, but people in HK are generally not so alert to the importance of retirement planning. I have quite a few friends who are finance professionals but maintained most of their wealth in bank deposits. Hopefully they will soon realize that lack of investments would create a big difficulty for retirement.

But even you are so smart to find a financial consultant for retirement planning, please take their advice with caution. An unsuitable advice would have a far-reaching negative impact on your remaining life.

Last week NASD fined Securities America for US$2.5m for failing to supervise a broker David McFadden who lured long-term employees of Exxon Corporation into retiring prematurely with unreasonable and exeggerated promises of high returns from reinvested funds. Securities America must also pay US$13.8m in restitution to 32 former Exxon employees.

In seminars directed at long-term Exxon employees (aged between 50 & 60), McFadden recommended that they could retire early by liquidating the assets of their pension plans, depositing those assets in accounts with Securities America, and making investments in variable annuities, Class B / C mutual funds and ETFs.

McFadden also said returns on those investments would allow the employees to replace their current salary with monthly withdrawals from the new accounts. However, he illustrated the investment returns of 11% to 14%, which would be necessary to sustain the promised annual withdrawals.

Most of the customers entrusted McFadden with the entire pension proceeds and forfeited their right to receive a lifetime monthly benefit under their pension plan. Then they found that McFadden's program could not sustain the recommended withdrawals.

NASD has particularly released a new Investor Alert for those misleading retirement pitches.

In the UK, recently FSA also fined a financial planning firm for recommending people aged 50 or above to "unlock" their pensions by taking some or all of the pension benefits before they retire. This practice was considered by FSA as a "high risk business".

When HK people have become more concerned about retirement planning over time, more cases for unsuitable retirement advice would come out.

How Compliance is Different?

How compliance is different from the other three internal control functions in a financial institution, i.e. legal, internal audit and risk management? Today I would like to make some comparisions & contrasts based on my observations.

Compliance v Legal

Compliance officers should of course have certain legal knowledge but not necessarily experience of legal practices. Lawyers are responsible for legal documentation, giving legal opinions on critical issues, and handling legal proceedings. Usually compliance officers are "generalists" and lawyers are "specialists" (that's why they are paid higher).

The mindsets of these 2 kinds of professional are quite different. Lawyers focus more on legal interpretation and reasoning, while compliance officers are more solution-based and people-oriented. Lawyers like to ask "what" questions, while compliance officers like to ask "how" questions.

Compliance v Internet Audit

Compliance officers are not happy to see non-compliance, while internal auditors are happy to find out "something wrong". Therefore, compliance officers can make "friends" with business people, while internal auditors must keep a distance with their (presupposed) "enemies".

Originally internal auditors pay attention only to internal control issues. In recent years, they have begun to put a hand on compliance reviews and therefore creating a conflict of interest with compliance officers.

Compliance v Risk Management

Risk managers are dealing with all sorts of risk factor, at least including market risk, credit risk, liquidity risk, legal risk and operational risk. Compliance has an overlap with risk management in the areas of legal risk and operational risk, which are more qualitatively (rather than quantitatively) measured.

In terms of mindset, compliance officers are also doing their jobs on a risk-based approach (which is also supported by the regulators). Risk managers and compliance officers should work closely to manage operational risk because sometimes control issues that are not highly risky could be considered serious by the regulators.

Compliance Coaching

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I have applied the "coaching" approach in the compliance field for a few years. But what is coaching?

The coaching discipline is in contrast to the authoritative management style. Traditional managers perceive themselves as experts to offer directions & solutions to their peers & subordinates. By giving advice, the experts are also taking up the accountability to the results. People seeking compliance advice would, intentionally or unintentionally, shift their compliance burden to others.

In a knowledge economy, nobody can claim to be experts in too many areas, especially within a large organization. While compliance officers are familiar with the regulations, they may not fully understand the business operations in every details. To upgrade the overall compliance standard in a firm, compliance officers should endeavor to inspire the people's "compliance mentality". This is what coaching can help.

Coaching is a newly evolved profession over the past two decades. It has attained great results by improving the performances of many people and businesses. Many top performers (e.g. Tiger Woods), political figures (e.g. Bill Clintion) and CEOs have recruited their own coaches.

The essence of coaching is "asking the right question" rather than "giving the right answer". But what are the practical skills applied by professional coaches? I recommend you to read a new book titled 《教練達之路》 which was co-authored by me with two other coaches. This book does not touch on compliance coaching but gives a comprehensive overview of the applications of coaching in different areas (e.g. leadership, career, financial, etc).

Later on I will elaborate more about the application of compliance coaching here.

Barber Paradox

Many market practitioners know Susan Field v Barber Asia is a classic court case in HK about mis-selling of investment products. This case is so prominent because it demonstrates the interpretation and enforcement of investment sales regulations. In addition, the defendant had entangled with SFC in a long appeal process.

Yesterday the Court of Appeal dismissed the appeal by Andrew Barber againat the decision of Securities & Futures Appeal Tribunal (SFAT) to suspend his licence for giving unsuitable investment advice. If you have not heard about this case before, please see the following brief summary.

Civil Proceedings Against Barber Asia

In the civil case initiated by Susan Field against Barber Asia Ltd in 2003, the Court of First Instance (CFI) decided that Barber Asia had, through Barber, owed Field (an inexperienced & conservative investor) a tortious duty of care when giving negligent advice to her in a high risk investment strategy. As a result, the CFI awarded damages (millions in HK$) to Field.

Disciplinary Proceedings Against Barber

To "beat the dog under water", SFC suspended Barber's licence for 6 months after the CFI judgment was affirmed by the CA. Then Barber lodged an appeal to the SFAT against the SFC’s decision.

At the SFAT hearing, Barber submitted "new evidence" (for his provision of investment documentation to Field), which had not been previously submitted to SFC or the courts in civil proceedings. Finally the SFAT decided to reduce the suspension period from 6 months to 1 month but insisted that Barber had failed to ensure suitability of advice and sufficient risk disclosures to Field.

Court of Appeal’s Ruling

In 2005 Barber lodged an appeal against the SFAT’s decision on the ground that, in view of the new evidence, the SFAT should not have reached the decision to suspend him. But the CA decided that the SFAT was fully entitled to suspend Barber. The CA considered that an independent investment adviser was not merely an agent or product marketer. Barber had the duty to diligently assess the suitability of the investment for the particular client. He should also emphasize the potential losses to let the client make an informed decision.

The Paradox

Perhaps Barber has not realized his blind spot. He may want to advise only those clients who need only documentation but not suitability assessment. But if he was not required to care about client suitability, should he claim himself to be an adviser?

Just kidding: Let me call the above thought "Barber Paradox"! (stolen the idea of the 20th-century philosopher Bertrand Russell)

Treat Customers Fairly

"Treat Customers Fairly" (TCF) is a regulatory slagon used by FSA in the UK. As a high level principle, TCF standards have extensively been enforced by FSA to protect retail customers throughout the product life-cycle, i.e.

• product design & governance
• identifying target markets
• marketing & promoting the product
• sales & advice processes
• after-sales information
• complaint handling

Sometimes retail customers are protected from mis-selling of not only investment products, but also other financial products (e.g. insurance). A recent case illustrated how FSA was taking care of the citizens.

Last week FSA fined Carphone Warehouse Ltd £245,000 for not treating its telesales insurance customers fairly. Carphone's primary business is the sale of mobile phones and airtime contracts through its branches, telesales and the internet. It also offers a range of insurance policies covering the theft of and accidental damage to moblie phones (I can't imagine such kind of insurance would prevail in HK).

From Jan to Oct 2005, Carphone breached FSA's Principles by failing to sending 118,000 customers who had bought mobile phone insurance through its telesales a Statement of Demands & Needs (SDN). The SDN is viewed as an important document to make customers aware that the insurance was unnecessary or inappropriate for their particular circumstances (so that they can cancel the policy within the cooling-off period). But Carphone continued to sell insurance via its telesales (on an advised basis) when it knew it was not complying with the SDN requirement.

FSA also challenged Carphone's failure to resource its compliance function in proportion to risks posed by the complex multi-channel distribution model.

TCF is a vague concept. In the past, "not cheating customers" is our business ethics, now treating them fairly may become the bottom line. But what is "fairly"? I would say the degree of fair treatment should be relative to the civilization of retail customers. Won't you expect the shopkeeper issues a SDN when selling a plasma TV to you?

SFC Staff

When you are contacted by SFC staff by phone, would you suspect on their identity?

SFC highlighted in its circular that it had recently received a number of reports that licensed corporations or their overseas affiliates had received calls from someone who pretended to be SFC staff asking for information about their companies. Therefore, SFC reminds the firms to be vigilant to such calls and take some precautionary steps (e.g. ask the callers to provide more information about themselves or contact SFC directly to clarify).

But what has SFC done to alleviate the concern of market practitioners? From time to time we may be contacted by persons claiming to be SFC staff but we don't have acquaintance with them before.

I suggest the following measures:

• SFC disseminates to each licensed corporation an official list of relationship managers (RM) assigned to that corporation.
• The list should be updated from time to time (e.g. for change of RM). Resigned staff should be immediately removed from the list.
• Display of telephone numbers should be enabled in SFC's calls.
• Enquiry about sensitive information should be made by encrypted emails instead of phone.

While SFC always requires timely notification & all sort of formality from us, shall we expect the same service standard from this organization?

911

It's 911 again. Hopefully "no news is a good news" today.

After watching in TV how the World Trade Center was blown up, we have to face up with (at least) the following compliance matters:

• The fund houses were so fuzzy about suspension of dealings during the time of market disruption.
• Terrorist financing was added to the anti-money laundering guidelines.
• Business continuity plan has become a must for all financial institutions.

Terrorism is really uplifting the compliance cost globally. The most terrible element of terrorism is that the behaviors are not motivated by economic interests, and the terrorists do not care about the punishment (even life could be sacrificed). Terrorism is also a "highly leveraged business" -- you can just spend a few thousands to do a harm costing millions of dollars.

Various governments have put a huge amount of resources on combating physical terrorist attacks. I am pondering whether in future terrorists would evolve into non-physical attacks through manipulation of the financial markets (e.g. spreading rumors of crisis around). Then the regulators would have to differentiate international speculators from terrorists.

Last Friday (one business day before 911), SFC issued a circular to remind all licensed / registered firms to update any change of "emergency contact person". Is such gesture a bit sensitive?

Reporting Violations

Transaction report failures have become one of the big regulatory challenges to those international financial firms in the UK and the US. Two recent cases are remarkable.

Merrill Lynch

ML was fined £150,000 by FSA for failing to accurately report the capacity in which it executed transactions in non-UK European equities from Sep 1996 to Dec 2001.

When dealing with US clients of the US affiliate, ML acted as principal on a back-to-back basis, but its transaction reports indicated its status as agent. This is because the transaction reporting system was set to report trades from the client's perspective instead of the firm's perspective.

Morgan Stanley

MS was fined US$2.9m by NASD for widespread violations of NASD Rules from 1999 to 2006.

In those significant violations, MS:

• failed to adequately price, sell & report corporate & municipal bond transactions
• failed to timely or correcty report thousands of transactions in listed and OTC securities
• executed thousands of short sales trades without ensuring delivery or borrowing of securities by settlement date
• failed to execute thousands of customer trades at the best available price

Transaction reporting reflects the disclosure-based regulatory approach, which is extensively implemented in the UK and the US. My curiosity is:

1. How could the reporting violations last for such a long period?
2. How were the violations finally detected by the regulators?
3. How would the compliance officers be made responsible for the violations?

Staff Dealing

As required by SFC's codes of conduct, every licensed / registered firms should have laid down its staff dealing policy. In general SFC does not specify the dealing restrictions, unless the regulated activities are Type 6 (a more sensitive business) & Type 9 (involving investment discretion over client trades).

Today I would like to highlight a few more controversial issues about staff dealing.

Spouse accounts

An employee should identify all related accounts which are supposed to be under his control or influence (e.g. minor child a/c, company a/c, etc). How about spouse accounts? Nowadays a couple could be quite financial independent from each other. Obliging your spouse to disclose his/her personal dealing accounts may a pose a family problem! Many firms allow their staff to declare independence of their spouses to avoid disclosure.

Employees of another licensed / registered firms

SFC discourages, but not prohibit (except for Type 3 licensees), employees of a licensed / registered firm to deal with another firm. When opening an account for any employee (even unlicensed / unregistered) of the other firms, you should obtain his / her employer's letters of consent.

But how about if the client is working in a bank which is also a registered institution? Normally most of the staff of a retail bank are not engaging in regulated activities. Would it become unduly burdensome to request for the letter of consent from a bank employee working under credit card department? My suggestion is that such request should only be made to bank staff registered with HKMA and all of those staff supporting the investment service operations (e.g. securities settlement).

Dealing in unlisted funds

Should dealings in unlisted funds (which are also regarded as securities) be monitored by the senior management and/or compliance? SFC does not mention about this, but obviously such dealings in general would not create any conflict of interest problem. Some firms choose to waive unlisted fund transactions from the pre-approval requirement.

Aiding & Abetting Unlicensed Activities

"Aiding & abetting" is a common legal term, which means helping others commit a crime. Today I mention a pair of cases about aiding & abetting unlicensed activities.

In July 2005, SFC successfully prosecuted a guy Micheal Ng for advising on futures contracts whilst unlicensed. Between Aug and Nov 2004, Ng set up a website and invited the public to join as members. By paying a monthly subscription, members had access to the advice given by Ng on the website regarding trading in HSI futures contracts.

This was a typical case about unlicensed online advising, but not the end of the story. Yesterday SFC suspended another guy Kimball Chan, a licensed representative of a licensed stockbroker Ho Fung Shares Investment, for 6 weeks. Chan was found to have aided and abetted Ng to set up the website and publish advice on futures trading in the paid section of the website.

Chan acted as a channel of communication for the website’s technical and administrative matters, and an intermediary for the transfer of funds relating to the website between Ng and other parties.

I think if Chan was not licensed dealer, he would not be prosecuted for aiding & abetting unlicensed activities; otherwise web hosting companies as a conduit may face a legal risk for hosting an illegal website.

P.S. According to SFC's press release, Kimball Chan has been suspended since 5 Sep 2006 (i.e. yesterday). But up to this morning (6 Sep), the disciplinary record has not yet been reflected in SFC's online register for him.

Sponsor Guidelines

Having finished the consultation process, last Friday SFC gazetted the new guidelines for sponsors & compliance advisers, which take effect from 1 Jan 2007. Today my blog attempts to do a quick overview of those major requirements.

Simply speaking, a special category of Type 6 licensees has been created: sponsors & compliance advisers working for companies listed on SEHK. Additional requirements (focused on sponsors) have been inserted as Appendix I of the Fit & Proper Guidelines. Compliance adviser is basically a continuum of sponsor.

Major Requirements for Sponsors

(1) Competence

• A transaction team with sufficient HK regulatory experience (including at least one Principal) is appointed for each sponsor job.
• Management is ultimately responsible for supervision of the sponsor work and compliance with relevant regulations.
• A sponsor should have at least 2 Principals at all times.
• A Principal must be a RO with minimum 5 years of relevant corporate finance experience (where playing a substantial role in at least 2 completed IPO) for companies listed on SEHK.
• A sponsor should put in place adequate systems & controls and carry out an annual assessment.
• Records for appointment of transaction team & principal and annual assessment should be kept.

Comment: While SFC is quite dissatified with the working quality of some sponsors, it takes the approach of defining clearly the "responsible" parties. My concern is whether adequate Principals with qualified experiences could be recruited.

(2) Minimum capital requirements - HK$10m (must be met by 31 Aug 2007)

Comment: This is nothing special, simply repeating the same requirement for GEM sponsors. But what is the purpose of this $10m? This is of course not enough to compensate for investors buying a bad IPO stock or pay the SFC fine ($30m was paid for settlement in ICEA's case). But a financially sound sponsor could afford taking out indemnity insurance.

(3) CPT - Sponsor staff should attend CPT on topics relevant to sponsor work (at least 50% of 5 CPT hours)

Comment: This requirement creates a demand for more CPT courses on sponsor topics. But qualified trainers are not easy to find. Don't you think practitioners in this field would have time to conduct such trainings?

Notification to SFC

SFC is now requesting the Type 6 firms to indicate their intention to act as a sponsor after 1 Jan 2007 - if no, they will be imposed a licensing condition; if yes, they have to make an application.

In the FAQ, there is such a question: Should a Type 6 firm act as a sponsor before its application has been approved by SFC? SFC's answer is quite tricky: The firm should consider carefully beforehand whether it will meet all the requirements under the Sponsor Guidelines during the interim period.

Vietnam Story

Don't be misled by the title. This is not a love story but a horrible lesson to financial institutions operating in a developing country.

According to an article in Wall Street Journal, a promising executive at a state-owned bank in Vietnam is potentially facing a death penalty and 4 employees of ABN Amro could be jailed for up 20 years.

Ms Van, aged 35, was deputy head of trade financing at Incombank, one of Vietnam's biggest state banks. She traded foreign currencies through a number of intermediaries, including ABN Amro. Vietnamese police alleged that Ms. Van lost US$5.4m in a series of speculative but unauthorized trades from Apr 2003 to Feb 2006. Her manager approved these trades because he couldn't read English well to understand what she was doing!

Police arrested Ms Van for allegedly "mis-handling state assets", which could be subject to a capital punishment in Vietnam! In order to recover its losses, Incombank has sued ABN Amro to return the US$5.4m, even though ABN Amro only received a commission as the middleman in the currency deals. At the same time, Vietnamese police are pursuing a criminal investigation into whether ABN Amro staff knowingly helped Ms Van execute unauthorized trades.

Police have so far detained two Vietnamese ABN Amro employees without charges and denied them access to lawyers or their families. One currency trader has been in a top security prison for more than 4 months. Two other ABN Amro workers have been put under house arrest. Police have also barred the U.S. general manager of ABN Amro's Hanoi branch, from leaving the country, although she is 6-month pregnant!

ABN Amro officials say there is nothing wrong with the bank's role in Ms. Van's currency transactions. People familiar with the situation say Vietnam's central bank has also examined ABN Amro's trades with Incombank and found nothing wrong.

This case may illustrate to what extent certain jurisdictions have been civilized. We may not be alerted if one of the parties involved is not an international bank.

Business Continuity

In recent years, the incidents of terrorist attacks, natural disasters and contagious diseases (such as SARS and Avian Flu) have alarmed us the substantial risk of major operational disruptions to the financial system. Many financial institutions have seriously formulated their business continuity plan (BCP).

The three international financial regulators, namely IOSCO, Basel Committee under BIS, and IAIS, have just jointly released a paper titled "High-level Principles for Business Continuity". The purpose of this paper is mainly to support financial regulators to develop national / sector business continuity arrangements in order to improve resilience of financial systems to major operational disruptions.

The 7 high-level principles are:

1. Board and senior management responsibility
2. Major operational disruptions
3. Recovery objectives
4. Communications
5. Cross-border communications
6. Testing
7. Business continuity management reviews by financial authorities
   

It is too boring to detail these principles here. You may find this paper for your own reading. I have just been drawn attention to its case study about the impact of 2003 SARS outbreak on HK's securities markets. The HK securities industry did not experience major operational disruptions as a result of the outbreak. None of the staff at any of the major investment banks contracted SARS. Staff at smaller retail brokers and other market participants also avoided infection.

I would like to highlight the following measures taken in the financial industy during the SARS outbreak:

• Some working teams were split into two (each of which was capable of backing the other up) and members of one team would work from home.
• Non-essential meetings with external parties were cancelled.
• A casual dress code was introduced to facilitate the cleaning and disinfecting of clothing.
• Flexible work hours were introduced to reduce taking public transport within rush hours.
• Business travel in Asia was severely curtailed.
  

You may think the above measures, which can make our working life easier, should continue even after the SARS outbreak. With the advance of communication technology (e.g. Blackberry), we can make our working places more mobile and reduce the physical operation risk.