New Approach of SFC Disciplinary Proceedings

This week SFC published their investigation findings that:

• South China Capital Ltd, in acting as a sponsor for a listing applicant, had failed to conduct adequate due diligence of its client and keep a proper audit trail of work done; and
• South China Research Ltd failed to adequately enforce its staff dealing policy which resulted in failures of two staff members to avoid conflict of interests.

Subsequently SFC entered into agreement with both companies, where they agree:

• to undertake to engage an independent audit firm to carry out an internal control review within three years of the agreement, with the time of the review and terms of reference to be determined by the SFC; and
• that the relevant entity be sanctioned if it is found to have committed failures similar to those which they are currently being sanctioned for within three years from the agreement.

In case of repeated breach, South China Capital would be suspended from sponsorship activities for 18 months and South China Research would be suspended for a minimum of three months.

This agreement reflects a new approach of SFC's disciplinary proceedings - "suspended sentence". Under this approach, the SFC will suspend or postpone the imposition of formal disciplinary sanctions if the firm agrees to an independently conducted review of its activities without prior notice (i.e surprise checking) and the same kind of misconduct is not repeated within a period time.

Independent reviews used by SFC before to resolve cases about internal control failures reviews have been conducted on a "with notice" basis. A surprise review is a more meaningful test of whether the firm is on top of its internal control systems. This kind of agreement is a positive and forward-looking one. South China's decision to accept this agreement is considered as a strong commitment to compliance and prevention of misconduct.

I am curious whether SFC would apply this new approach to individual licensees in future.