Misuse of Name & Logo

SEC recently settled enforcement proceedings against HSBC Bank USA, N.A., which will pay a US$10m civil penalty and US$500,000 in disgorgement for allowing its name and logo to be used in connection with a Florida-based offering fraud by Pension Fund of America, L.C. (Pension Fund).

SEC issued a settled cease-and-desist Order finding that from Aug 2003 to Mar 2005, HSBC served as trustee for the investment component of Pension Fund and its affiliated entities' trust plans. Since at least 1999, Pension Fund sold retirement and college "trust plans" that purportedly provided term life insurance and the opportunity to invest in one or more pre-selected mutual funds. However, Pension Fund failed to disclose, among other things, that it was taking up to 95% of the investors' funds to pay commissions and fees. Pension Fund raised at least $127 million from more than 3,400 investors, primarily from Central and South America.

In Mar 2005, SEC filed an emergency action in the U.S. District Court for the Southern District of Florida against Pension Fund and its principals to halt the offering fraud. The Court appointed a receiver over Pension Fund, who shut down its operations, marshaled its assets, and developed a claims process to distribute recovered funds to its investor victims.

It was found that HSBC allowed the use of its name and logo in Pension Fund's offering materials. HSBC also allowed Pension Fund to use marketing materials that falsely suggested that the trust plans were co-developed by HSBC and Pension Fund, and that investors' funds would be "totally safe" because the money would be deposited in a trust account at HSBC. In reality, Pension Fund deposited investors' funds in an ordinary checking account in its name at HSBC, and used up to 95% of such funds to pay its own undisclosed sales commissions, expenses and fees. Pension Funds' marketing brochures provided a list of mutual funds offered as part of the trust plans, but did not disclose any information about the sales commissions, administrative expenses, or the front-load mutual fund fees charged to investors. However, HSBC failed to follow its own internal procedures in reviewing and approving certain Pension Fund offering materials.

Additionally, HSBC actively participated in the selection of offshore, high front-load mutual funds to be offered to prospective investors under a negotiated fee arrangement between HSBC and Pension Fund. However, neither the amount of the funds' sales loads, nor HSBC's role in the funds' selection, were disclosed to investors. In Oct 2003, shortly after HSBC became trustee for Pension Fund's plans, HSBC drafted a letter on its own letterhead announcing the new relationship and inviting certain of Pension Fund's existing investors to transfer their funds to HSBC. Pension Fund sent the letter to approximately half of its existing investors, and enclosed a form bearing HSBC's logo that listed new mutual fund selections available upon transfer to HSBC. Neither the letter nor the enclosure disclosed that investors would incur new front-load fees in connection with such transfers, or the amounts of those prospective costs.

A globally known institution should be very cautious when associating its name & logo with a third party. Who in HSBC should ultimately bear the responsibility for this incident?

Records Kept at Overseas Premises

According to S.130 of SFO, a licensed corporation must obtain SFC's pre-approval before keeping records at a particular premise. In recent years, some firms have outsourced their back office functions to third parties located at overseas countries. However, SFC recently released a FAQ to clarify that it would not approve overseas premises for the keeping of records or documents under S.130.

The reason why the SFC will only approve premises located in Hong Kong is that while SFC is empowered by SFO to enter an intermediary's premises to inspect the records, it may be precluded from exercising this power in the event of the premises being located outside HK.

Accordingly, if an intermediary enters into an overseas outsourcing arrangement, it must ensure that all relevant records or documents, which are kept by an overseas third party, are also contemporaneously kept by the intermediary at the HK premises approved by SFC under S.130.

If records at overseas premises are maintained in electronic format, then it would not be a big problem making a copy to the intermediary's local office. But it could be a hardship for the overseas third party to remit hard copy records back to HK.

"Free Lunch" Investment Seminars

"There is no such thing as a free lunch" is a famous quote of the late economist Milton Friedman.

US securities regulators recently released a joint report summarizing the results of their examinations of "free lunch" investment seminars. The year-long examination was conducted by the SEC, FINRA and state securities regulators. They scrutinized 110 securities firms and branch offices that sponsor sales seminars and offer a free lunch to entice attendees.

The report's key findings include:

• 100% of the "seminars" were instead sales presentations. While many sales seminars were advertised as "educational", "workshops" and "nothing will be sold", they were intended to result in the attendees' opening new accounts and, ultimately, in the sales of investment products, if not at the seminar itself, then in follow-up contacts with the attendees.
• 59% reflected weak supervisory practices by firms. While some exams found effective supervisory practices, many examinations found indications that firms had poorly supervised these sales seminars, including failure to review seminar presentations or materials as required.
• 50% featured exaggerated or misleading advertising claims. Examples included "Immediately add $100,000 to your net worth", "How to receive a 13.3% return" and "How $100K can pay 1 Million Dollars to Your Heirs".
• 23% involved possibly unsuitable recommendations. In 25 of the 110 examinations, examiners found indications that unsuitable recommendations were made, for example, a risky investment recommended to an investor with a "conservative" investment objective, or an illiquid investment recommended to an investor with a short-term need for cash.
• 13% appeared to be fraudulent and have been referred to the most appropriate regulator for possible enforcement or disciplinary action. Examiners found indications of possible fraudulent practices in 14 examinations that involved apparent serious misrepresentations of risk and return, possible liquidation of accounts without the customer's knowledge or consent, and possible sales of fictitious investments.

Free lunch sales seminars are routinely targeted at senior citizens and are commonly held at upscale hotels, restaurants, retirement communities and golf courses. FINRA found that 78% of seniors received a free lunch seminar invitation and 60% received six or more invitations in the past three years.

In HK, such "free lunch" seminars are also prevailing. Has SFC conducted the similar examination?

Unauthorized Access

TSFC's control guidelines have emphasized the importance of preventing unauthorized access to a licensed firm's key systems and documents. Could you imagine how serious the case may be if such unauthorized access is made by an outsider for a prolonged period?

Last week SFC reprimanded Emperor Securities Ltd and fined it $130,000 for the reason that it had insufficient systems and controls to monitor the use of its equipment, confidential information and client assets. SFC found that an unauthorized person, the girlfriend of one of Emperor's authorized representatives, had been accessing Emperor's premises, equipment, confidential information and client assets. She had also been dealing directly with clients accepting orders and handling settlement instructions for about three years.

Her unauthorized handling of settlement instructions caused Emperor's settlement department in Apr 2003 to redirect a deposit of $120,000 from a client into an account controlled by her. She repaid the $120,000 and has since been prosecuted by the police. In addition, though not mentioned by SFC, she might have conducted unlicensed dealing in breach of SFO.

As a good security control, a licensed firm should strictly enforce the policy of restricting entrance into the office premise by outsiders, even they are relatives / friends of staff members. In Emperor's case, I wonder how the company could turn a blind eye to the physical existence of this "mysterious employee" in its office for such a long period.