HKSI LE Paper 6 Past Paper (2)

HKSI LE Paper 6 (Dec 2006) - Q&A 21~40 (with explanations):

21(D) - (III) is wrong because the required paid-up capital and reserves is HK$1 million instead.

22(D) - All of those persons should be checked in accordance with the Client Identity Rules under the Code of Conduct.

23(D) - (I) is wrong because a code of conduct is not statutory and thus any breach would not lead to judicial proceedings.

24(B) - (I) & (III) are most related to the principle of honesty and fairness. (II) is related to the principle of information for clients. (IV) is related to the principle of information about clients.

25(C) - (I) & (II) are wrong because entering into a written agreement with a client is necessary. For subscription of authorized CIS, the investor enters into the agreement by the application form accompanied by the offering document.

26(D) - (III) is wrong because the Code does not require the keeping of all allocation records permanently.

27(D) - (I) is wrong because staff of a fund manager may not deal for his personal account within one trading day before a forthcoming recommendation in any circumstance.

28(C) - (I) & (IV) are requirements set out in the UT Code in respect of trustees/custodians. (II) is wrong because there is no requirement that the review must be carried out by qualified members of AIMR. (III) is wrong because the terms of reference is incorporated in the review engagement letter instead.

29(B) - (III) is wrong because it is not reasonable to require trustees to indemnify the MPF scheme against loss.

30(D) - (II), (III) & (IV) are typical examples of suspicious transactions. (I) is wrong because there is no ground to pinpoint property deals in such OECD countries like Australia, Canada and the United States.

31(A) - Both (I) and (III) make sense. (II) is wrong because executive share option scheme may create corporate governance problem. (IV) is wrong because the ICG does not specify such detailed requirement.

32(D) - (I) & (II) are good corporate governance standards. (III) & (IV) describe what MPFA is doing.

33(C) - (III) is wrong because no specific threshold for transactions subject to JFIU reporting has been specified.

34(D) - If only two options could be chosen, then (I) & (II) are least essential as features of corporate governance which is more grounded on independent supervision (say, by non-executive directors or audit committee).

35(C) - (II) is wrong because it can't be an initiative taken by the Government and the SFC.

36(C) - (A), (B) & (C) are under the general considerations of the Guidelines, but (C) is considered by SFC as more serious. (D) is under the specific considerations as one of the "other circumstances", which appears to be less serious than (C).

37(D) - Only (III) & (IV) are included in the definition of market misconduct under the SFO.

38(B) - This question is examining common sense. Obviously if one of the options has to be dropped out (all answers contain only 3 options), it should be (III) - pursuing short term returns is usually not a good practice.

39(B) - Only (I) & (III) are defined as offences of "market misconduct" under Part XIV of the SFO.

40(D) - Directors, employees, substantial shareholders (holding 5% or above) of and persons having access to relevant information through business / professional relationship with a listed corporation and its related corporation are all defined as "connected persons".

HKSI LE Paper 6 Past Paper (1)

Besides Paper 1, so far HKSI has only released the past Q&A for another regulatory exam Paper 6 (Regulation of Asset Management). Again let me provide my own explanations in this blog in 2 parts:

HKSI LE Paper 6 (Dec 2006) - Q&A 1~20 (with explanations):

1(A) - SFC is only responsible for authorizing MPF products and licensing MPF fund managers. (III) & (IV) are handled by MPFA instead.

2(A) - (A) is incorrect because because Insurance Authority does not regulate MPF products.

3(D) - (A) is wrong because advertisements made only to professional investors are exempt from SFC authorization. (B) & (C) are wrong because referring to securities in the ordinary course of media business do not constitute advertisements.

4(A) - Insurance Authority only directly regulate insurers. Insurance agents are directly regulated by the Insurance Agents Registration Board.

5(B) - (IV) is wrong because SFC does not aim at protecting overseas investors as well.

6(C) - (C) is wrong because MPF can't ensure "maximizing investment returns" by regulating MPF schemes.

7(D) - (A) is wrong because no forecast of a scheme's performance is allowed. (B) is wrong because performance data must be actual rather than simulated results. (C) is wrong because use of past records are subject to certain restrictions (e.g. minimum track period).

8(B) - (I) is wrong because reference to past performance of SFC CIS managed by the investment managers may only be made on a restrictive basis and successful past records would not assist in predicting future performance. (IV) is wrong because the Code requires all client payments to be made payable to the trustee of the scheme.

9(B) - Leverage foreign exchange funds are definitely not permissible investment for a MPF constituent fund, but now MPFA has already permitted investment in REITs. The answer is outdated.

10(B) - (I) is wrong because warning statements should be audibly read out at the end of each broadcast (only in printed form are not acceptable). (III) is wrong because there is no such requirement.

11(D) - Simply speaking, both (I) and (II) are not requirements specified in the UT Code in respect of hedge fund authorization.

12(D) - "Insurance linked hedge fund" is not mentioned in this Code. Hedge fund should be covered by the UT Code instead.

13(B) - (II) is wrong because superiority of returns is supported by facts, not opinions. (IV) is wrong because it is not a requirement specified in the Code.

14(A) - (II) is wrong because the average portfolio maturity should not exceed 90 days instead. (IV) is wrong because the fudn may only hold up to 30% value in Government securities in the same issue.

15(C) - (I) is wrong because an executive director must be a responsible officer, but not the reverse. (IV) is wrong because this is not a requirement specified by SFO.

16(C) - (I) & (II) are requirements specified by SFO, but (IV) is not the case because the financial statements and auditor's reports of a licensed corporation must be filed with SFC within 4 months of the year end instead. The answer is wrong.

17(A) - (I) & (II) are items that must be reported to SFC under the Rules because they would materially affect an intermediary's financial soundness which is highly concerned by SFC.

18(D) - A person licensed or registered to deal in securities, as per (III) & (IV), is not deemed as engaging in asset management if his asset management activity (w.r.t. securities only) is wholly incidential to dealing in securities. A person licensed or registered to deal in futures contracts, as per (II), is also not deemed so if his asset management activity (w.r.t. futures contracts only) is wholly incidental to dealing in futures contracts.

19(A) - (III) & (IV) refer to advice not specific to the underlying fund investments of a MPF scheme and thus do not fall within Type 4 regulated activity.

20(B) - (I) and (III) are not requirements specified by MPFA.

Facilitation Trading

Yesterday SFC issued a reprimand to Deutsche Securities Asia Ltd (DSAL) and fined it HK$6m. This case is definitely a serious one in terms of financial penalty (the maximum fine under SFO is HK$10m), involving the issues of "facilitation trading".

As explained by SFC, facilitation trading involves brokers and clients executing transactions on a principal to principal basis rather than on an agency basis, which can give advantages to clients by providing them with liquidity and more certain execution. As the nature of the relationship with client may change in a facilitation transaction (because the broker is no longer an agent but dealing with the client as principal), conflicts of interest may arise. Therefore, brokers offering facilitation services need systems in place to identify, manage and control any conflicts that may arise in the provision of facilitation services.

SFC's investigation into DSAL's services provided to institutional clients through its facilitation trading desk found that, from May 2001 to Sep 2005, DSAL failed to:

• put in place an adequate system to identify and resolve potential conflicts of interest arising from commingled proprietary and client trades executed by the facilitation trading desk;
• maintain an appropriate and effective compliance function to detect and manage the risks to clients involved in dealing with clients as principal; and
• keep adequate audit trails of client order instructions.

In issuing the reprimand and imposing a fine of HK$6m, SFC has taken into account all the circumstances of the case including:

• as a result of DSAL's report to SFC in Nov 2005, the control deficiencies were discovered; and
• DSAL has been co-operative with SFC and has agreed to accept the reprimand and fine.

While there were many overseas enforcement cases in respect of failures to monitor facilitation trading, DSAL's case was probably the first one in Hong Kong. I wish SFC could also disclose the following details:

• Did clients of DSAL suffer any losses from the mis-managed facilitation trading?
• How was the fine of HK$6m determined?
• Would any responsible officer or other regulated persons (e.g. compliance officer) be penalized?

Investor Education or Client Solicitation?

In recent years, there are so many "financial actors" working in intermediary firms but at the same time maintaining public exposures through media or investment courses. Their employers may not be able to adequately monitor their activities outside their employment.

SFC has recently banned Mr Law Chun Pon from re-entering the industry for 32 months and fined him $260,000. The case arose from complaints by Law's clients alleging improper trading of foreign exchange contracts by Law in the clients' accounts. SFC found that Law, while acting as an account executive of Delta Asia Credit Ltd (once a DTC regulated by HKMA):

• contravened the law by cold calling the students of his investment course and inducing them to trade leveraged foreign exchange contracts;
• improperly provided discretionary account services to his clients against his employer's policies; and
• failed to act in the interests of his clients by churning their accounts and holding simultaneously equal long and short positions in the same foreign exchange contracts without any reasonable justifications when trading for his clients.

In deciding to ban Law for 32 months, SFC considered the fact that he had caused his clients to suffer significant trading losses in a relatively short period of time. SFC also fined him $260,000 which is the profit he made from his (mis)conduct.

Many trainers of investment course actually aim at soliciting clients rather than providing investor education.

Money Laundering Reporting Officer

Anti-money laundering (AML) is one of the key initiatives of financial regulators who are keen on penalizing firms with lax AML controls. But it is rare that even the money laundering reporting officer (MLRO) would also be fined.

UK FSA recently fined Sindicatum Holdings Limited (SHL) £49,000 and its MLRO, Michael Wheelhouse, £17,500 for not having adequate AML systems and controls in place for verifying and recording clients' identities. This is the first time the FSA has fined a MLRO.

FSA found a number of failings including:

• the firm failed to implement adequate procedures for verifying the identity of its clients;
• it failed to verify adequately the identity of a significant number of its clients;
• it failed to keep adequate records with regard to the verification of the identity of its clients; and
• Wheelhouse failed to take reasonable steps to implement adequate procedures for controlling money laundering risk.

SHL and Mr Wheelhouse have taken robust steps to review and improve the firm's systems and controls in relation to financial crime. FSA did not find any evidence of money laundering at the firm (otherwise I believe the penalty would be much more severe).

More details about Wheelhouse are found at FSA's Final Notice against him:

• Mr Wheelhouse jointly founded SHL and has been a director of the firm since it commenced regulated activities in Aug 2002.
• SHL is a corporate advisory firm with approximately 35 clients for whom it has periodically advised and arranged dealing in investments. Its clients are predominantly small and medium corporates based overseas. During the relevant period, SHL provided 26 of these clients with services which constituted the carrying on of regulated activities and were thus subject to the identification requirements of FSA's AML regime.
• Although Wheelhouse set up a New Business Committee in Nov 2006 to monitor the introduction of new business and took advice from independent consultants, this was insufficient to ensure or improve compliance with SHL's procedures and FSA's requirements.
• In respect of 13 clients (who were not low risk), although some customer due diligence ("CDD") evidence was available, Wheelhouse failed to ensure that the documentation was adequate to verify their identity.
• Wheelhouse did not ensure that all client acceptance checklists were completed. In 7 cases, client acceptance checklists were not fully completed for significant periods of time (up to 3 years) after client take-on and in some cases they were not completed at all.
• On one occasion, Wheelhouse applied an exemption from identification to a deposit-taking bank in Lithuania, despite Lithuania not appearing on the "equivalence" list for regulated entities. On this occasion, Mr Wheelhouse acted as the account executive collecting the identification evidence and also as the officer reviewing and signing off the account. Such an arrangement decreased the likelihood of this failure being identified.

I really suspect if Wheelhouse was a competent and independent MLRO.