Insurer Treated Customers Unfairly

There have been complaints to media from time to time against HK insurance companies for not treating their customers fairly, but seldom we've seen disciplinary actions taken by the Insurance Authority and made known to the public.

FSA recently fined Hastings Insurance Services Ltd £735,000 for failing to treat its customers fairly in relation to cancelling around 4,550 incorrectly priced car insurance policies.
During two separate periods between Jul and Sep 2007, Hastings discovered that due to an internal system error, inaccurate insurance quotations were given to customers, which resulted in some of them paying significantly lower premiums than they should have. Hastings cancelled the policies but in doing so failed to give sufficient consideration to paying the premium shortfall to the insurance provider or investigating other possible remedies.

FSA found that the firm had invoked a cancellation clause to cancel the policies which FSA considers was not generally intended to be used in circumstances such as these. The way in which the policies were cancelled and the service that the firm gave to its customers following the cancellation showed the firm focussed on the financial cost to itself and did not properly consider the alternatives or the detrimental effect on customers.

Following these incidents the firm has now strengthened the controls surrounding customer treatment and agreed with FSA to write to all affected customers and review the compensation it offered to ensure that its customers are treated fairly.

It is indeed quite ridiculous that customers have to suffer from an internal system error in this way.

Good Practices on Transaction Monitoring

HKMA has recently developed a guidance paper "Good Practices on Transaction Monitoring" in consultation with the Industry Working Group on Prevention of Money Laundering and Terrorist Financing (IWG). The purpose of transaction monitoring is to alert banks to unusual or suspicious activities for further examination and investigation. Banks should put in place effective monitoring systems to identify and report suspicious transactions for AML/CFT.

During 2007, HKMA completed a round of thematic examinations of selected banks focused on transaction monitoring. While banks have generally established appropriate MIS reports for transaction monitoring, the systems and procedures of certain banks are not considered to be sufficiently effective, having regard to the types of business activities they engage.

The guidance paper seeks to highlight the essential features of an effective transaction monitoring system. Some of those major detailed guidances are set out below:

• Good understanding of customers and updating of their risk profiles on a risk-sensitive b basis are important elements of an effective transaction monitoring system.
• The monitoring system should comprise two components: (a) monitoring by front-line staff; and (b) monitoring of past transactions.
• Front-line staff are in the best position to identify unusual activities because they know most about the customers. They should be well trained to perform this function.
• Periodic MIS reports should at a minimum cover the following transactions: cash transactions, wire transfers, cheque transactions, loan payments and prepayment, and reactivation of dormant accounts followed by unusually large or frequent transactions.
• The current transaction should be compared with the past transaction patterns and risk profile of the customer.
• Suspicious transactions identified by the system should be carefully investigated and followed up.
• An automated transaction monitoring system should be used but it can't replace human awareness in detecting unusual or suspicious activities.
• Parameters or criteria used to generate monitoring reports require regular review and updating.

This guidance paper may not be very practical but at least it alerts us to a more serious attitude towards transaction monitoring.

Insider Dealer Arrested

A recent big news in the HK compliance field is that a former managing director at Morgan Stanley Asia Ltd has been arrested and charged for insider dealing and counselling or procuring another person to deal in a listed company's shares prior to the announcement of an acquisition deal.

Mr Du Jun was detained at the Hong Kong International Airport last Thursday after arriving from Beijing and appeared at the Eastern Magistracy last Friday. He is no longer employed by Morgan Stanley and has been residing mainly in Beijing since last year. No plea was taken and the case was adjourned to 5 Sep 2008 for transfer to the District Court. He was granted bail but was ordered to surrender all travel documents and report to the Police twice a month.

The arrest was made following an SFC investigation with Morgan Stanley's cooperation (by reporting Du's trading to SFC in May 2007). The charges allege that on nine occasions between 15 Feb 2007 and 30 Apr 2007, Du dealt in the shares of CITIC Resources Holdings Ltd (CITIC Resources), a company listed on SEHK, whilst in possession of material and price sensitive information not known to the market. The information related to a proposed deal by CITIC Resources to acquire oil field assets, which was announced on 9 May 2007.

It is alleged that Du obtained the information while he was part of a Morgan Stanley team involved in advising CITIC Resources. The charges relate to a total of 26.7 million shares in CITIC Resources allegedly acquired by Du at a cost of about $86 million. On 30 Apr 2007, the last day Du was alleged to have bought CITIC Resources shares, the share price of CITIC Resources closed at $3.68. The price rose by 13.86% to $4.19 on the day of the announcement. Du is also alleged to have counselled or procured his wife Ms Li Xin, who is not facing any charges, to deal in CITIC Resources shares on 27 Feb 2007.

This is a high profile case for SFC to demonstrate its teeth to hunt a tiger. Morgan Stanley's surveillance system and whistle blowing also take the credit.

Beware of IT Guys

A listed company should have the policy of prohibiting certain employees from dealing in the company shares during the "blackout period" prior to results announcement because they are likely in possession of unpublished price sensitive information. Such employees usually comprise all directors and senior management as well as staff carrying out sensitive functions like finance, company seretary, etc. However, IT people may be missed out.

FSA recently fined John Shevlin £85,000 for market abuse. He was employed as an IT technician at the Body Shop International plc ("Body Shop"). On 10 Jan 2006 he established a short position equivalent to 80,000 Body Shop shares through a Contract for Difference ("CFD"), in effect betting that the share price would fall. This trade was made on the basis of inside information. He obtained the inside information by improperly accessing confidential emails which had been sent or received by senior Body Shop executives in connection with the company's Christmas trading announcement. The emails contained details of Body Shop's Christmas trading results and a draft announcement that the Body Shop had underperformed expectations.

Shevlin closed out his CFD position on 11 January 2006 after Body Shop announced its Christmas trading results to the market and made a profit of £38,472. He even borrowed £29,000 (more than his annual salary) to effect the trade.

FSA finds there is cogent and compelling circumstantial evidence against Shevlin, including that:

• He was able to log into the email accounts of certain senior executives from their computers, given that it would have been in the name of the account holder, such access is unlikely to be traceable as being by Mr Shevlin;
• He arranged substantial finance on an urgent basis to enable him to effect the CFD trade before the surprise announcement;
• He placed the CFD trade on the day before the announcement and was keen that his trade took place on that day;
• His CFD trade was of a considerable size, one which accounted for approximately 26.7% of the trading volume in that stock on that day;
• His CFD trade was significantly larger than any CFD he had previously traded. The underlying value of the trade was £213,536 which represented more than double Mr Shevlin's net assets;
• The level of financial risk undertaken by Shevlin was much higher than he had undertaken on previous trades and was such that it could have resulted in serious financial hardship if the trade had gone against him.

As a result, FSA does not accept Shevlin's assertions that he based his trading strategy on information obtained by research or analysis using public information; instead, his CFD trade was based on inside information obtained from the computers of Body Shop's senior executives.

QFII-Related Lawsuit in China

Today I've read a news article from Finance Asia about the first QFII-related lawsuit in China. Nanning Sugar, a company based in Guangxi province, has filed a lawsuit against Martin Currie Investment Management (MCIM) and Martin Currie Incorporated (MCI) with the Nanning Intermediate People's Court for alleged breaches of Article 47 under the PRC Securities Law. Nanning Sugar has successfully obtained court orders to freeze Martin Currie's assets in China, with a total of RMB 39.6 million under MCIM's QFII account, until the case is heard in court.

Article 47 stipulates that if a shareholder purchases and sells a stake of over 5% in a listed company within six months, the listed company is entitled to the proceeds of the trade. This rule was originally designed to deter short-term and insider trading. Nanning Sugar claims that Martin Currie should pay back the profit it made from trading the company's stock between Aug 2007 and Jan 2008, as well as accrued interested and incurred legal costs.

However, Martin Currie argues that:

• the action taken by Nanning Sugar is wholly unwarranted because Nanning Sugar has misunderstood how the current system works for foreign investors;
• the fact that Martin Currie companies owned more than 5% of the issued shares is clearly incorrect;
• MCIM has only held a maximum of 1.6% of Nanning Sugar's shares in the period of the alleged breach; and
• the rest of the stake that totals over 5% as Nanning Sugar has claimed belonged to four different clients and was invested across three different QFII accounts, some of which are advised by MCI (a separate legal entity from MCIM).

There is a widespread concern about its impact of this case on the further reforms amid expectation for a coming QFII scheme expansion. The PRC Securities Law in China was first adopted in 1999 and later revised in 2005. Given the short history of the asset management industry in China, most of the rules remain untested and are subject to regulators' interpretation and revision as the market expands. Market partitiorners have been concerned about the legal loopholes and overlapping regulations.

QFII investors are currently subject to regulation by the CSRC and rules on foreign exchange by SAFE. Given China's legal system is based on a civil law system, instead of case law, rulings follow the word of the law without reference to precedence. The inconsistencies between the securities law and the regulation on disclosure of equity interest could lead to potential conflicts when applied to foreign investors under the QFII scheme.

Let's see how this case is finally adjudicated by the PRC court.