Independent Pricing Verification

FSA recently fined the London branch of Toronto Dominion Bank (TD Bank) £490,000 for systems and controls failings in relation to one of its trading books. FSA has also prohibited a former employee of the firm, Mr Simon Richard Brignall, from performing any regulated activity.

Mr Brignall was employed as a senior fixed income trader at the firm. On 9 Mar, he resigned and revealed to TD Bank that he had been attributing false values to his trading positions for a period of almost two years. He had done this in order to hide significant losses on his trading book. He had also entered a number of fictitious trades during the two weeks leading up to his resignation.

TD Bank did not identify, through its own systems and controls, either the extent of the mispricing of the trades or the fictitious trades. FSA identified three main system and control failings in relation to Mr Brignall's trading book:

• the absence of a system of independent price verification;
• a lack of effective trading supervision; and
• a failure to implement effective trade break escalation procedures.

The most important of these was the failure to have in place a system of independent price verification in relation to Mr Brignall's trading book. This meant that there was no independent third party check on the valuations that Mr Brignall had attributed to his own trading positions. FSA regards this as a fundamental control.

The net total loss caused by Mr Brignall was CAD $8.8 million and this was borne by TD Bank. No client or third party suffered any loss and Mr Brignall made no personal gain.

This case appeared to be another Barings story. Lacking of independent pricing verification is hardly conceivable. Fortunately TD Bank was not killed by this trader.

Guidance on PEPs

Handling of politically exposed persons (PEPs) is a big challenge in the Customer Due Diligence (CDD) process for AML. Recently the Industry Working Group on Prevention of Money Laundering and Terrorist Financing (IWG) has issued a guidance paper about PEPs (in a FAQ format) to banks. Though the practices recommended in the paper do not form part of the formal regulatory requirements, HKMA would consider that the adoption of these practices would strengthen a bank's systems and procedures for AML and CFT.

Certain points of this guidance paper are highlighted below with comments:

• Some jurisdictions and groups have put forward differing definitions of PEPs. Definitions in US and EU only refer to "foreign" individuals. (Comment: If HK banking industry generally follows this approach, even Donald Tsang or Joseph Yam would not be classified as a PEP.)
• While the focus tends to be on senior functions at the national level, individuals serving in a public capacity at more local levels can still be considered as PEPs if their position brings with it sufficient prominence and influence. A bank may adopt a risk based approach, taking into consideration the political environment and other relevant information. (Comment: Usually when an ambiguous answer is given, the term "risk based approach" would be used, which is effectively an empty term.)
• It is irrelevant whether the PEP is serving in an elected or appointed position.
• Individuals who have been entrusted with prominent public functions are also considered as PEPs. There is therefore no set time frame, but by using a risk based approach, a bank can make an informed decision. (Comment: The term "risk based approach" has been abused.)
• Any parties closely connected to PEPs, whether by blood or otherwise, could be considered as PEPs themselves. How broad this definition becomes depends on the specific risk factors of each PEP. (Comment: Ditto)
• The PEP process will also apply whenever a PEP has power of disposal over the assets of the individual or entity with which the bank is dealing. (Comment: How does a bank ascertain the existence of such "power"?)
• Political parties do not necessarily fall within the definition of PEPs.

Perhaps the most practical guidence on handling PEPs is to subscribe for a powerful external database of PEPs.

Securities & Futures Appeal Tribunal

Under SFO, people who are not satisfied with SFC's certain decisions (e.g. disciplinary action) may appeal to the Securities & Futures Appeal Tribunal (SFAT). Usually SFAT upholds SFC's decisions to impose penalities on the applicant, but in some cases SFAT may reduce the penalty level.

SFAT recently upheld SFC's decision to ban Mr Lee On Ming Paul, formerly a Type 1 representative of Fullbright Securities Ltd, for life. SFC found that Lee had deceived his employer by opening two nominee accounts in false names and concealing his personal trades. In doing so, Lee also forged the signatures of his sister-in-law on the account opening documents as well as on cheques issued for settlement. Lee lodged an application to SFAT on 31 July 2007 to review SFC's decision against him. SFAT issued the Determination on 9 Nov 2007.

SFAT rejected the argument that Lee had merely been "foolish" or "sloppy" in the manner in which he had conducted his affairs. No kidding - many people would utter such argument after they are caught red-handed - just like children! SFAT was satisfied that SFC's findings plainly were borne out by the evidence, and could not reasonably be criticized, far less set aside by this tribunal.

Although SFAT upheld SFC's reasoning, it varied the period of Lee's ban from life to 18 months. This is a fundamental difference - it appears that SFC's original decision was considered "too harsh"!

SFC's Power to Audio Record an Interview

The High Court has made a ruling dismissing a challenge lodged by a person under investigation in respect of the SFC’s power to audio record an interview held under section 183(1)(c) of SFO.

SFC was seeking to audio record an interview with a person who can only speak in Putonghua under an insider dealing investigation because the SFC investigator is not a fluent Putonghua speaker. Initially SFC proposed to video record the interview. Given this person's objection, SFC proposed to audit record the interview but the person objected also to this and brought judicial review proceedings. The proceedings were held in chambers (not open to the public) and the name of the applicant is suppressed by order of the court.

The lawyer appearing for the person put through the following major arguments:

• There is no express power under SFO enabling the investigator to insist on audio recording the interview.
• Nothing in section 183 allows the investigator to insist on the person's "audio signature" to the interview record.
• Audio recording is "invasive" of a person's privacy.

However, the Judge concluded that the power to record an interview by audio means is reasonably incidental and necessary to the power under section 183(1)(c) of SFO to compel a person under investigation to attend an interview and answer questions and that in insisting upon an audio recording of an interview SFC and its investigators did not act ultra vires. An audio recording does not involve any kind of "signature". Audio recording is an important way of ensuring the integrity of the interview process and does not interfere illegally with any privacy right.