HKMA Securities Enforcement Senior Manager

金融管理局高級經理錢曾珙〔Brian Chin Tsang-kung〕，因被航空公司拒絕登機，一怒之下，打傷國泰航空一名地勤人員，早上在荃灣裁判法院，判簽保守行為三年，以及罰款五千元。


裁判官指被告的教育程度，應該清楚什麼是規矩，應為自己行為感到羞恥。國泰本地職員工會主席劉玉光，滿意裁決，認為被告的行為應受譴責。


金管局說，錢曾珙已就事件通知局方，局方會按既定的人事處理機制跟進事件，但發言人現階段不願評論會否對事主進行處分。

案情指被告今年八月，與三名家人乘搭國泰航機往吉隆坡，但因家人遲到，他們在航機起飛前幾分鐘才抵達閘口，地勤人員拒絕四人登機，被告情緒激動，拍打一名地勤人員，對方後來報警將他拘捕。


Hong Kong still has law and order!


I wonder if this "poor guy" can still work in HKMA.

Good News: Chief Executive Officer to leave SFC

SFC just announced that its Chief Executive Officer, Mr Martin Wheatley will be leaving next summer.

The following are standard BS in the press release...

• Chairman of the SFC, Dr Eddy Fong said: "It has been a great pleasure working with Martin, whose leadership has helped the Commission ride out many challenges and strengthen its position as a globally respected regulator. I am thankful to him and I wish him all the best in his future endeavours."
• "My six years with the SFC – hectic and demanding at times – have been very fruitful. The Commission has taken in its stride the many challenges that confronted the financial markets and regulators and we have been able to adopt a pragmatic and sensible approach in our regulation. I am also encouraged to see the work that we have done in tackling market misconduct," Mr Wheatley said.
• "I am very grateful for the support, dedication and professionalism of our staff who carried out their duties conscientiously under very trying circumstances at times. I would like to thank them for their commitment and hard work and I wish the SFC continuing success," he added.
• Mr Wheatley joined the SFC in June 2005 and was appointed as the Commission’s first Chief Executive Officer in 2006.
• Mr Wheatley is a member of the Standing Committee for Standards Implementation of the Financial Stability Board as well as the International Organisation of Securities Commissions (IOSCO) Technical Committee. He currently chairs the IOSCO Technical Committee Task Force on Short Selling.
• Prior to joining the SFC, Mr Wheatley was Deputy Chief Executive of the London Stock Exchange. He was also Chairman of the FTSE International and sat on the Listing Authority Advisory Committee of the Financial Services Authority of England.

Jack's comment: My Xmas wish is that the key personnel change will lead to a much more robust and fair regulatory culture. There are too many power-abusing and irresponsible officials in the world!

Criminal Procedures Not Applicable to SFC Disciplinary Process

This week SFC announced that the Court of Appeal has allowed SFC's appeal against a decision of the Securities and Futures Appeals Tribunal (SFAT) and decided that criminal procedures are not applicable to SFC disciplinary proceedings.


On 19 March 2010, the SFAT altered SFC's decision to revoke the licence of Asser Li Kwok Keung and ban him for 10 years to a suspension for 18 months for lying to SFC and breaching his undertaking to co-operate. In addition, in its determination, the SFAT equated the obligations of the SFC in disciplinary proceedings with that of a prosecutor in criminal proceedings.


SFC appealed to the Court of Appeal against both the penalty imposed by the SFAT and its analogy drawn between SFC's disciplinary process and criminal procedures.


The Court of Appeal, comprising Madam Justice Kwan JA, Mr Justice Stone and Mr Justice Bharwaney, unanimously allowed the SFC’s appeal and increased the penalty for Li from a suspension of licence for 18 months to a prohibition order for three years.


Jack's comment: Many market practitioners believe that SFC's disciplinary process is a kind of "private punishment" and should be subject to the rigidity of criminal procedures. Unfortunately, the Hong Kong court usually supports SFC, especially when SFC can use taxpayers' monies to extend its power.

Synthetic ETFs

Last week SFC and HKEx a new effort to raise investors' awareness of Exchange Traded Funds (ETFs) that primarily adopt synthetic replication strategy (synthetic ETFs). A traditional ETF (also known as physical ETF) invests in securities that replicate or represent the composition of the index it tracks, and a synthetic ETF uses financial derivative instruments to track index performance.


A manager of an ETF may adopt one or more of the following strategies to achieve the fund's index tracking objective:

1. full replication by investing in a portfolio of securities that replicates the composition of the underlying index;
2. representative sampling by investing in a portfolio of securities featuring a high correlation with the underlying index, but not exactly the same as those in the index; or
3. synthetic replication through the use of financial derivative instruments (such as swaps and performance-linked structured products issued by counterparties) to replicate the index performance. 

Synthetic ETFs' managers have agreed to adopt new measures aimed at helping investors to better differentiate between index tracking strategies of ETFs. The new measures, supported by the SFC, HKEx and the industry following extensive discussions, are in line with ongoing efforts to strengthen protection for investors.


Addition of marker to stock short names of synthetic ETFs


Effective from 22 November, 2010, a marker X will be placed at the beginning of the English and Chinese stock short names of all synthetic ETFs listed on SEHK.


The marker will make synthetic ETFs more visible on the stock pages of HKEx's securities trading system and on the HKEx website and the HKExnews website. The stock short names of traditional ETFs will remain the same.


Annotation of names of synthetic ETFs


Building on the preceding measure, by 16 January 2011, managers of synthetic ETFs will be required to put an asterisk (*) and an annotation in English "(*This is a synthetic ETF)" and in Chinese "(*此基金為一隻合成交易所買賣基金)", as the case may be, right after the name of a synthetic ETF whenever it appears in offering documents and marketing materials for a synthetic ETF issued by the manager or on the manager’s behalf to investors in Hong Kong.


This requirement will also be applicable to all notices and other communications with Hong Kong investors in respect of synthetic ETFs whenever the name of the synthetic ETF is mentioned, including information on the corporate websites for Hong Kong investors run by or on behalf of synthetic ETFs' managers.


Investor education initiatives


SFC will continue its investor education efforts to help investors better understand synthetic ETFs.


HKEx is updating its product education material to explain the purpose of the stock short name marker and the risks of ETFs using synthetic replication.


HKEx will also enhance the HKEx website to highlight disclosure of ETF product features. For example, it will indicate which ones use synthetic replication and which ones do not. This will help investors find ETFs by their product features more easily.


HKEx has enhanced the hyperlinks to ETF websites from the HKEx website to provide easier navigation to ETF websites.


Other measure to enhance transparency of ETFs


To assist managers of ETFs in complying with the ongoing disclosure obligations under the Code on Unit Trusts and Mutual Funds and/or Listing Agreement, SFC and HKEx today jointly issued a circular containing a list of potential events that may trigger such disclosure obligation.


Jack's comment: Retail investors should thank Next Magazine's article published several months ago for reporting the danger of synthetic ETFs. SFC is often working on hindsight when handling products.

False Portfolio Valuation Report to Conceal Stealing

This week SFC banned Ms Pauline Ellen Cousins, a former managing director and responsible officer of Crown Asset Management Limited, from re-entering the industry for life.

Between 2002 and 2006, Cousins produced four false portfolio valuation summaries to a client. The portfolio valuation summaries belonged to other clients and Cousins used them to mislead her client into believing that he had invested a lump sum of $1.75 million in an investment-linked assurance scheme. Instead Cousins had, without her client's authority, invested the lump sum in the shares of a hi-tech company, which was subsequently put into administration.

The disciplinary action follows Cousins' conviction in the District Court on four counts of furnishing false information. Cousins was sentenced to 21 months' imprisonment in December 2009 in proceedings commenced by the police’s Commercial Crime Bureau following referral by SFC.


Jack's comment: In the age of web 2.0, we shouldn't trust any paper produced by intermediaries.

Whistleblower Program

Last week the US SEC voted unanimously to propose a whistleblower program to reward individuals who provide the agency with high-quality tips that lead to successful enforcement actions.

Rules Requirements

Under the proposed rules, a whistleblower is a person who provides information to the SEC relating to a potential violation of the securities laws.

To be considered for an award, a whistleblower must …

Voluntarily provide the SEC …

In general, a whistleblower is deemed to have provided information voluntarily if the whistleblower has provided information before the government, a self-regulatory organization or the Public Company Accounting Oversight Board asks for it.

… with original information …

Original information must be based upon the whistleblower’s independent knowledge or independent analysis, not already known to the Commission and not derived exclusively from certain public sources.

… that leads to the successful enforcement by the SEC of a federal court or administrative action …

A whistleblower's information can be deemed to have led to successful enforcement in two circumstances: (1) if the information results in a new examination or investigation being opened and significantly contributes to the success of a resulting enforcement action, or (2) if the conduct was already under investigation when the information was submitted, but the information is essential to the success of the action and would not have otherwise been obtained. 

… in which the SEC obtains monetary sanctions totaling more than $1 million.

The proposed rules further define and explain these requirements.

Key concepts would include …

Avoiding unintended consequences:

Certain people would generally not be considered for whistleblower awards under the proposed rules. These include:

• People who have a pre-existing legal or contractual duty to report their information.
• Attorneys who attempt to use information obtained from client engagements to make whistleblower claims for themselves (unless disclosure of the information is permitted under SEC rules or state bar rules).
• Independent public accountants who obtain information through an engagement required under the securities laws.
• Foreign government officials.
• People who learn about violations through a company's internal compliance program or who are in positions of responsibility for an entity, and the information is reported to them in the expectation that they will take appropriate steps to respond to the violation.

This last exclusion — which is intended to prevent company personnel from "front running" legitimate internal investigations — ceases to be applicable if the company does not disclose the information to the Commission within a reasonable time or acts in bad faith. In these circumstances, such people can become whistleblowers.

Certain other people — such as employees of certain agencies and people who are criminally convicted in connection with the conduct — are excluded by Dodd-Frank.

The SEC also would not pay culpable whistleblowers awards that are based upon either the monetary sanctions that such people themselves pay in the resulting SEC action, or on sanctions paid by entities whose liability is based substantially on conduct that the whistleblower directed, planned, or initiated. The purpose of this provision is to prevent wrongdoers from benefitting by, in effect, blowing the whistle on themselves.

Providing Information to the SEC and Seeking a Reward:

The proposed rules also would describe procedures for submitting information to the SEC and for making an award claim after an action is brought. The claim procedures would provide opportunities for whistleblowers to fairly present their case before the Commission makes a final award determination.

The SEC also would pay an award based on amounts collected in related actions brought by certain agencies that are based upon the same original information that led to a successful SEC action.

Supporting Internal Compliance Programs:

The proposed rules include provisions to discourage employees from bypassing their own company’s internal compliance programs.

For instance, the proposed rules:

• Would treat an employee as a whistleblower under the SEC program as of the date that employee reports the information internally — as long as the employee provides the same information to the SEC within 90 days. Through this provision, employees will be able to report their information internally first while preserving their “place in line” for a possible award from the SEC.
• Permit the SEC to consider higher percentage awards for whistleblowers who first report their information through effective company compliance programs. 

What’s Next?

The proposal seeks public comment and data on a broad range of issues relating to the whistleblower program. After careful review of the comments, the Commission will consider what further action to take on the proposal.


Jack's comment: I can hardly imagine such a whistle-blowing program would be implemented in any Chinese society!

Medical Researcher Charged With Tipping Inside Information

We often see directors of listed companies or investment bankers being charged with insider dealing.  Recently there is a US case involving a doctor.


This week US SEC charged a French medical doctor and researcher with breaking securities laws by tipping a hedge fund manager with confidential information about a clinical trial that he was involved in.


SEC alleges that Yves M. Benhamou, M.D., breached his duty of confidentiality to Human Genome Science, Inc. (HGSI) when he illegally tipped non-public negative details about a clinical trial for the drug Albumin Interferon Alfa 2-a (Albuferon) ahead of a public announcement by the company.


Benhamou was a member of the Steering Committee overseeing HGSI's clinical trial of Albuferon, a potential drug to treat Hepatitis C. Benhamou learned about two serious adverse events, including one death, occurring during the third phase of the trial. HGSI consequently decided to reduce the dosage for the patients in that arm of the trial and publicly announce the changes.


Benhamou tipped material, non-public information about the trial to the hedge fund portfolio manager upon learning of each new negative development. While serving on the Steering Committee, Benhamou provided consulting services to the portfolio manager with whom he had developed a friendship over the years.


The portfolio manager, based on the confidential information provided by Benhamou, ordered the sale of the entire position of HGSI stock held by six health care-related hedge funds that he co-managed (approximately 6 million shares). These sales occurred during the six-week period prior to HGSI's public announcement on Jan. 23, 2008, that it was reducing the dosage in one arm of the trial. Two million shares were sold in a block trade just before the markets closed on January 22. HGSI's share price dropped 44 percent by the end of the day on January 23. As a result of the sales, the hedge funds avoided losses of at least $30 million.

Fraud in Valuing Side Pocket

Last week SEC charged two hedge fund portfolio managers and their investment advisory businesses with defrauding investors in the Palisades Master Fund, L.P. by overvaluing illiquid fund assets they placed in a "side pocket."


SEC alleges that the hedge fund managers Paul Mannion and Andrews Reckles placed the Palisades hedge fund's investments in World Health Alternatives Inc. in a side pocket and valued those investments in a manner that was inconsistent with fund policy and contrary to an undisclosed internal assessment. They also stole investor money to pay for their own personal investments and made material misrepresentations in connection with a private securities transaction.



A side pocket is a type of account that hedge funds use to separate particular investments that are typically illiquid from the remainder of the investments in the fund. SEC's Asset Management Unit has been probing whether funds have overvalued assets in side pockets while charging investors higher fees based on those inflated values.


According to SEC's allegations:

• Mannion and Reckles stole more than approximately $1.6 million worth of warrants belonging to the fund. They also improperly used investors' cash on at least two occasions to make personal investments, and they deceived a securities issuer by making false representations about their trading positions in order to participate in a private offering by the issuer.
• Mannion and Reckles defrauded investors for at least a three-month period in 2005 through PEF Advisors LLC and PEF Advisors Ltd., two investment adviser entities they controlled. The fraudulent valuations of a convertible debenture, restricted stock, and bridge loans enabled Mannion and Reckles to report to investors misleadingly inflated net asset values, allowing them to take excessive management fees from the fund.

Jack's comment: That is one of the reasons why hedge fund managers are richer than their clients!

SEC's Largest-Ever Financial Penalty Against a Public Company's Senior Executive

Last week SEC announced that former Countrywide Financial CEO Angelo Mozilo will pay a record $22.5 million penalty to settle SEC charges that he and two other former Countrywide executives misled investors as the subprime mortgage crisis emerged. The settlement also permanently bars Mozilo from ever again serving as an officer or director of a publicly traded company.


Mozilo's financial penalty is the largest ever paid by a public company's senior executive in an SEC settlement. Mozilo also agreed to $45 million in disgorgement of ill-gotten gains to settle SEC's disclosure violation and insider trading charges against him, for a total financial settlement of $67.5 million that will be returned to harmed investors.


Former Countrywide chief operating officer David Sambol agreed to a settlement in which he is liable for $5 million in disgorgement and a $520,000 penalty, and a three-year officer and director bar. Former chief financial officer Eric Sieracki agreed to pay a $130,000 penalty and a one-year bar from practicing before the Commission. In settling SEC's charges, the former executives neither admit nor deny the allegations against them.
The penalties and disgorgement paid by Sambol and Sieracki will also be returned to harmed investors.


SEC filed charges against Mozilo, Sambol and Sieracki on June 4, 2009, alleging that they failed to disclose to investors the significant credit risk that Countrywide was taking on as a result of its efforts to build and maintain market share. Investors were misled by representations assuring them that Countrywide was primarily a prime quality mortgage lender that had avoided the excesses of its competitors. In reality, Countrywide was writing increasingly risky loans and its senior executives knew that defaults and delinquencies in its servicing portfolio as well as the loans it packaged and sold as mortgage-backed securities would rise as a result.


SEC's complaint further alleged that Mozilo engaged in insider trading in the securities of Countrywide by establishing four 10b5-1 sales plans in October, November, and December 2006 while he was aware of material, non-public information concerning Countrywide's increasing credit risk and the risk regarding the poor expected performance of Countrywide-originated loans.


Jack's comment: Don't invest in financial stocks until their risks taken are sufficiently transparent to you.

Proposed Establishment of an Independent Insurance Authority

During August 2010, FSTB issued the Consultation Paper on Proposed Establishment of an Independent Insurance Authority. This Monday (11 October 2010) was the due day for submission. I provided the comments to FSTB on behalf of the International Academy of Financial Management - Hong Kong Chapter ("IAFMHK"), which are set out as follows:

Consultation Questions

1. Do you agree that an independent IA should be established along the principles set out in paragraph 2.6?

IAFMHK: We agree to the establishment of an independent IA for more effective regulation of the insurance industry. This is in line with the regulatory practices of banking and securities industries in Hong Kong.

2. Do you think that there are other important principles in addition to those set out in paragraph 2.6 that the Administration should adopt in working out the detailed legislative proposals for the establishment of the independent IA? If so, what are they?

IAFMHK: We think that the independent IA should also adopt two more principles: (a) protection of the interests of insurance agents working for insurance companies; and (b) education of the general public about insurance products and industry practices.

3. Do you agree that the independent IA should have an expanded role beyond the existing functions of the IA as set out in paragraph 3.1? If so, do you agree that the independent IA should assume the additional functions as proposed in paragraphs 3.3 and 3.4?

IAFMHK: Agree, especially the independent IA should be able to directly supervise insurance intermediaries.

4. Do you agree the independent IA should also have a duty to enhance the competitiveness of the insurance industry, which will help to reinforce Hong Kong’s status as an international financial centre?

IAFMHK: The fundamental responsibility of the independent IA remain the enforcement of insurance regulations. However, it should adopt a pragmatic regulatory approach to avoid hindering the industry from product innovation and business versatility.

5. Do you agree that the independent IA should be vested with additional powers as proposed in paragraph 4.7 to enable it to regulate insurers more effectively?

IAFMHK: Agree. The additional powers are necessary for the independent IA to enforce the relevant laws and regulations.

6. Do you consider that the existing self-regulatory arrangements for insurance intermediaries should be changed, and if so, do you support that Option 2 (i.e. direct supervision of insurance intermediaries by the independent IA) should be pursued? If not, why?

IAFMHK: We support Option 2.

7. Do you consider that in relation to the sale of insurance products in banks, the HKMA should be vested with powers similar to those for the independent IA to allow HKMA to regulate bank employees selling insurance products given the different client profile and sale environment in banks?

IAFMHK: Different client profile and sale environment is not a sufficient reason to justify that sale of insurance products in banks should be regulated by the HKMA. For avoidance of regulatory arbitrage, sale of insurance products by insurance companies, insurance brokers, independent financial advisors and banks should be regulated by a single and specialist regulatory body.

8. Do you agree that the recommendations as set out in paragraphs 6.5 to 6.8 should be pursued for the independent IA to operate as an independent entity? Any other views?

IAFMHK: We largely agree to the recommendations but suggest that the incentive pay should be linked to the meeting of certain objective performance pledges.

9. Do you agree with the proposed checks and balances and governance arrangements for the independent IA as set out in this Chapter?

IAFMHK: We agree to the proposed checks and balances and governance arrangements. In addition, we suggest the establishment of a mediation and arbitration mechanism to resolve the commercial disputes among insurance companies, insurance intermediaries and/or insurance policyholders.

10. Do you agree that the Government should provide a lump sum to support the independent IA in its initial years of operation and the independent IA should seek to reach full cost recovery in six years?

IAFMHK: We agree that the Government should provide financial assistance to the support the independent IA in its initial years of operation. However, we suggest a longer period (say, 10 years) for full cost recovery to reduce the burden of the insurance industry.

11. Do you agree with the proposed fee structure as set out in paragraphs 8.2 and 8.6?

IAFMHK: We agree to the proposed fee structures.

Regulatory Framework for Pre-Deal Research

Last week SFC started a two-month public consultation on proposals to expand the scope of the present requirements governing conflicts of interest for analysts so that not only research reports on listed securities but also those on IPOs are covered.

The proposed changes to existing regulatory requirements are summarized in SFC's consultation questions below. My initial comments are also provided.

1.   Do you agree that the requirements in paragraph 16 of the Code of Conduct should be extended to cover research analysts in relation to Pre-deal Research reports?

Jack: It makes sense for paragraph 16 to cover analysts issuing pre-deal research reports as well.

2.   Do you agree that the requirements of paragraph 16 of the Code of Conduct should be extended to cover research analysts covering proposed listings of and listed SFC-authorised REITs in Hong Kong?

Jack: It makes sense for paragraph 16 to cover research reports on REITs as well.

3.   Do you agree that the firm employing research analysts preparing pre-deal research reports on a Applicant should be required to establish, maintain and enforce a set of written policies and control procedures to ensure that these analysts are not provided by the firm with any material information or forward looking information (whether qualitative or quantitative), concerning the Applicant that are not: (a) reasonably expected to be included in the prospectus; or (b) publicly available?

Jack: Agree, but SFC should issue some guidelines on (i) the benchmark for such policies and control procedures (e.g. additional Chinese Wall procedure); and (ii) what constitutes material information or forward looking information that will not be included in the prospectus or publicly available. Also, SFC should specify which party can make the final judgement on such unprovided information.

4.   Do you agree that a research analyst preparing a research report on an Applicant should not seek to obtain from the Applicant or its advisers, any material information or forward looking information (whether qualitative or quantitative), that are: (a) not reasonably expected to be included in the prospectus; or (b) publicly available?

Jack: Ditto

5.   Do you agree that the proposed amendments to Paragraph 16 of the Code of Conduct set out in Appendix 1 implement the above proposals?

Jack: The proposed amendments are not adequate. See above comments.

6.   Do you agree that sponsors should take steps to ensure that all material information or forward looking information (whether qualitative or quantitative), disclosed or provided to analysts is contained in the relevant prospectus or where the proposed listing does not involve a prospectus the relevant listing document, offering circular or similar document?

Jack: Agree in principle, but what steps should be taken by sponsors? Shall a sponsor review the pre-deal research reports to ensure that all material or forward looking information provided to analysts is contained in the prospectus. If the reports contain information gathered by the analysts through their own due diligence, how can the sponsor confirm that such information is not obtained from the Applicant? If the sponsor reviews the research reports, would the independence of analysts be compromised?

7.   Do you agree that the proposed amendments to the CFA Code of Conduct set out in Appendix 2 implement the above proposal?

Jack: The proposed amendments are not adequate. See above comments.

Scripless Securities Market

Last week SFC announced the plan to introduce a scripless securities market in Hong Kong after the consultation. The key features of the proposed scripless model are summarized below:

• Dual system : The existing paper-based system will be retained for the time being so that it runs in parallel with the proposed scripless system. Investors will be allowed to dematerialise securities held in paper form into uncertificated form and also to rematerialise them back into physical form, as long as the dual system exists. The duration of maintaining the dual system will be kept open for now.
• Full dematerialisation ultimately : Dematerialisation will be made compulsory eventually i.e. the paper-based option will be removed altogether.
• Phased approach : Existing securities will be dematerialised in batches starting with shares of companies incorporated in Hong Kong.
• Register to comprise two parts : The register of holders will consist of a certificated sub-register which is maintained by the share registrar and an uncertificated sub-register which is maintained by HKSCC. To facilitate inspection, corporate action processing and corporate entitlements calculation, HKSCC will provide the respective share registrars with a day-end record of the uncertificated sub-register. The day-end record will also allow share registrars to reconcile the two sub-registers.
• Removal of the immediate credit arrangement : One of the consequences of the register of holders comprising two sub-registers is the removal of the immediate credit arrangement by HKSCC.
• Account types to hold uncertificated securities : Investors will be able to hold their uncertificated securities through four different account types. Only one of these, namely the Issuer Sponsored Account (ISA), is a new account type under the proposed model. The other three are essentially modified versions of the existing CCASS Participant Account (CPA), Stock Segregated Account and Investor Participant Account (IPA).
• Name on register : Investors will be able to hold securities in CCASS in their own names i.e. they will have the option of becoming the legal owner of the securities and of enjoying the full benefits of legal ownership.
• Unique identification numbers : Currently, investors who hold securities within CCASS are required to provide an identity proof (such as their HKID) during the account opening process with a broker/bank/custodian or HKSCC, as the case may be. Building on this practice, we propose that investors' identification numbers be made available to both HKSCC and the relevant share registrar.
• Attending and voting at shareholders' meetings : The Working Group is keen to preserve the status quo of allowing beneficial owners to attend and vote at shareholders' meeting and considers that the better way to achieve this may be to simply allow the appointment of multiple proxies. This way, brokers / banks / custodians who hold shares on behalf of clients will be able to appoint their clients as proxies to attend and vote at meetings. For clients who merely wish to vote but not to attend the meeting, their interest can be represented by brokers / banks / custodians through appointing the chairman of the meeting as a proxy to vote on their behalf.
• Disseminating corporate communications and providing corporate action services to securities holders : As HKSCC Nominees will no longer be the registered holder of uncertificated securities in CCASS, there will be changes in the dissemination of corporate communications and provision of corporate action services to holders of uncertificated securities. Accordingly, we propose that share registrars will disseminate corporate communications to all registered holders (both certificated and uncertificated) and HKSCC will continue to provide additional services like providing receivable notices to uncertificated holders who hold their securities through a CPA, Participant Sponsored Account (PSA) or IPA.
• Regulation of share registrars : Share registrars will be able to become a new category of participants in CCASS (if they meet the admission criteria). This will allow them to use the existing CCASS infrastructure to communicate electronically with other CCASS Participants and to handle instructions relating to uncertificated securities. Additionally, in view of their more active and involved roles and functions in the scripless environment, share registrars will be more directly and robustly regulated.
• IPOs : In the scripless environment, the existing four ways to apply for an IPO (applications via a white form, a white form eIPO, a yellow form and CCASS eIPO) will remain largely unchanged. The main difference will be that applicants under the white form and white form eIPO options will be able to choose if their securities should be issued in uncertificated or physical form.
• Scope : Pending resolution of certain practical issues, the scripless proposals will be implemented in relation to shares of listed companies - starting first with those incorporated in Hong Kong and then those incorporated overseas.
• Shares and debentures of companies incorporated overseas and listed in Hong Kong : We will focus first on companies incorporated in Bermuda, Cayman Islands, Mainland China and UK mainly because companies incorporated in these four jurisdictions make up the vast majority of overseas companies listed on the SEHK and will therefore have a greater impact on the scripless initiative.
• Roll-out plan for implementing a scripless securities market : There will be two distinct implementation timelines which are independent of one another - one for existing securities and the other for IPOs. In both cases however, there will first be a pilot run.

Jack's comment: There are so many advantages of the scripless model. It should have been implemented since ten years ago!

RMB Products

RMB products are getting hot in our city. Therefore HKMA recently issued a circular to remind all banks to ensure that the material features and risks of such products are adequately taken into account in the product due diligence process and the suitability assessment of customers. Key points are summarized below:

Proper disclosure of the nature of RMB products

Banks should ensure that customers understand the nature of the RMB product including any underlying investments and whether any deposit protection is available.

Proper disclosure of the risks of RMB products

The following paragraphs highlight some of the key risks relevant to RMB products.

RMB currency risk

When a customer opens a RMB deposit account, the bank should disclose to the customer the RMB exchange rate risk and the fact that RMB is currently not freely convertible and conversion of RMB through banks in Hong Kong is subject to certain restrictions. Such risks should also be disclosed to its customers during the marketing and selling process of RMB investment and insurance products. In particular, for personal customers, the bank should explain that as the conversion of RMB is subject to a daily limit, the customer may have to allow time for conversion of RMB from/to another currency of an amount exceeding the daily limit.

For RMB products which are not denominated in RMB or with underlying investments which are not RMB-denominated, banks should disclose to their customers that such products will be subject to multiple currency conversion costs involved in making investments and liquidating investments, as well as the RMB exchange rate fluctuations and bid/offer spreads when assets are sold to meet redemption requests and other capital requirements (e.g. settling operating expenses).

Other risks associated with RMB products

• Limited availability of underlying investments denominated in RMB – For RMB products that do not have access to invest directly in Mainland China, their available choice of underlying investments denominated in RMB outside Mainland China may be limited. Banks should explain to the customers that such llimitation may adversely affect the return and performance of the RMB products.
• Projected returns which are not guaranteed – If the RMB investment product (e.g. RMB ILAS) is attached with a statement of illustrative return which is (partly) not guaranteed, banks should clearly disclose to their customers that the return which is not guaranteed and the assumptions on which the illustrations are based, including, e.g. any future bonus or dividend declaration.
• Long term commitment to investment products – For RMB products which involve a long period of investment (e.g. RMB ILAS), banks should remind customers that if they redeem their investment before the maturity date or during the lock-up period, they may incur a significant loss of principal where the proceeds may be substantially lower than their invested amount. Customers should be reminded of the early surrender/withdrawal fees and charges as well as the loss of bonuses as a result of redemption before the maturity date or during the lock-up period.
• Credit risk of counterparties – Banks should disclose to their customers the credit risk of counterparties involved in the RMB products. To the extent that the RMB products may invest in RMB debt instruments not supported by any collateral, AIs should ensure customers' understanding that such products are fully exposed to the credit risk of the relevant counterparties. Where a RMB product may invest in derivative instruments, counterparty risk may also arise as the default by the derivative issuers may adversely affect the performance of the RMB product and result in substantial loss.
• Interest rate risk – For RMB products which are, or may invest in, RMB debt instruments, banks should disclose to their customers that such instruments are susceptible to interest rate fluctuations, which may adversely affect the return and performance of the RMB products.
• Liquidity risk – Banks should remind customers of the liquidity risk associated with the RMB products, and where applicable, the possibility that the RMB products may suffer significant losses in liquidating the underlying investments, especially if such investments do not have an active secondary market and their prices have large bid/offer spreads.
• Possibility of not receiving RMB upon redemption – For RMB products with a significant portion of non-RMB denominated underlying investments, banks should disclose to their customers that there is a possibility of not receiving the full amount in RMB upon redemption. This may be the case if the issuer is not able to obtain sufficient amount of RMB in a timely manner due to the exchange controls and restrictions applicable to the currency.
• Additional risks associated with leveraged trading – Banks should note that leveraged trading facilities should not be offered to personal customers and Designated Business Customers (DBCs) in respect of RMB products. While banks may extend RMB loans to corporate customers, prior to conducting leveraged trading of RMB products for corporate customers, banks should ensure that the customers understand and are willing to accept the risks and the terms and conditions of the borrowing arrangement. Banks should explain to customers that leveraging heightens the investment risk by magnifying prospective losses. Customers should be properly informed of the circumstances under which they will be required to place additional margin deposits at short notice and that their collateral may be liquidated without their consent. Banks should also ensure their customers' understanding of the risk that market conditions may make it impossible to execute contingent orders, such as "stop-loss" orders. In addition, customers should be reminded of their exposure to interest rate risk, and in particular, their cost of borrowing may increase due to interest rate movements.

Jack's comment: HKMA almost treats RMB products like Lehman minibonds. My concern is that people buying RMB products are too distracted by the expectation of RMB appreciation, ignoring the scene behind these products.

Basel III

(Extracted from BIS Basel Committee's Press Release 2010.09.12)

At its 12 September 2010 meeting, the Group of Governors and Heads of Supervision, the oversight body of the Basel Committee on Banking Supervision, announced a substantial strengthening of existing capital requirements and fully endorsed the agreements it reached on 26 July 2010. These capital reforms, together with the introduction of a global liquidity standard, deliver on the core of the global financial reform agenda and will be presented to the Seoul G20 Leaders summit in November.

The Committee’s package of reforms will increase the minimum common equity requirement from 2% to 4.5%. In addition, banks will be required to hold a capital conservation buffer of 2.5% to withstand future periods of stress bringing the total common equity requirements to 7%. This reinforces the stronger definition of capital agreed by Governors and Heads of Supervision in July and the higher capital requirements for trading, derivative and securitisation activities to be introduced at the end of 2011.

Increased capital requirements

Under the agreements reached today, the minimum requirement for common equity, the highest form of loss absorbing capital, will be raised from the current 2% level, before the application of regulatory adjustments, to 4.5% after the application of stricter adjustments. This will be phased in by 1 January 2015. The Tier 1 capital requirement, which includes common equity and other qualifying financial instruments based on stricter criteria, will increase from 4% to 6% over the same period.

The Group of Governors and Heads of Supervision also agreed that the capital conservation buffer above the regulatory minimum requirement be calibrated at 2.5% and be met with common equity, after the application of deductions. The purpose of the conservation buffer is to ensure that banks maintain a buffer of capital that can be used to absorb losses during periods of financial and economic stress. While banks are allowed to draw on the buffer during such periods of stress, the closer their regulatory capital ratios approach the minimum requirement, the greater the constraints on earnings distributions. This framework will reinforce the objective of sound supervision and bank governance and address the collective action problem that has prevented some banks from curtailing distributions such as discretionary bonuses and high dividends, even in the face of deteriorating capital positions.

A countercyclical buffer within a range of 0% – 2.5% of common equity or other fully loss absorbing capital will be implemented according to national circumstances. The purpose of the countercyclical buffer is to achieve the broader macroprudential goal of protecting the banking sector from periods of excess aggregate credit growth. For any given country, this buffer will only be in effect when there is excess credit growth that is resulting in a system wide build up of risk. The countercyclical buffer, when in effect, would be introduced as an extension of the conservation buffer range.

These capital requirements are supplemented by a non-risk-based leverage ratio that will serve as a backstop to the risk-based measures described above. In July, Governors and Heads of Supervision agreed to test a minimum Tier 1 leverage ratio of 3% during the parallel run period. Based on the results of the parallel run period, any final adjustments would be carried out in the first half of 2017 with a view to migrating to a Pillar 1 treatment on 1 January 2018 based on appropriate review and calibration.

Systemically important banks should have loss absorbing capacity beyond the standards announced today and work continues on this issue in the Financial Stability Board and relevant Basel Committee work streams. The Basel Committee and the FSB are developing a well integrated approach to systemically important financial institutions which could include combinations of capital surcharges, contingent capital and bail-in debt. In addition, work is continuing to strengthen resolution regimes. The Basel Committee also recently issued a consultative document Proposal to ensure the loss absorbency of regulatory capital at the point of non-viability. Governors and Heads of Supervision endorse the aim to strengthen the loss absorbency of non-common Tier 1 and Tier 2 capital instruments.

Transition arrangements

Since the onset of the crisis, banks have already undertaken substantial efforts to raise their capital levels. However, preliminary results of the Committee’s comprehensive quantitative impact study show that as of the end of 2009, large banks will need, in the aggregate, a significant amount of additional capital to meet these new requirements. Smaller banks, which are particularly important for lending to the SME sector, for the most part already meet these higher standards.

The Governors and Heads of Supervision also agreed on transitional arrangements for implementing the new standards. These will help ensure that the banking sector can meet the higher capital standards through reasonable earnings retention and capital raising, while still supporting lending to the economy. The transitional arrangements include:

• National implementation by member countries will begin on 1 January 2013. Member countries must translate the rules into national laws and regulations before this date. As of 1 January 2013, banks will be required to meet the following new minimum requirements in relation to risk-weighted assets (RWAs): 3.5% common equity/RWAs; 4.5% Tier 1 capital/RWAs, and 8.0% total capital/RWAs. The minimum common equity and Tier 1 requirements will be phased in between 1 January 2013 and 1 January 2015. On 1 January 2013, the minimum common equity requirement will rise from the current 2% level to 3.5%. The Tier 1 capital requirement will rise from 4% to 4.5%. On 1 January 2014, banks will have to meet a 4% minimum common equity requirement and a Tier 1 requirement of 5.5%. On 1 January 2015, banks will have to meet the 4.5% common equity and the 6% Tier 1 requirements. The total capital requirement remains at the existing level of 8.0% and so does not need to be phased in. The difference between the total capital requirement of 8.0% and the Tier 1 requirement can be met with Tier 2 and higher forms of capital.
• The regulatory adjustments (ie deductions and prudential filters), including amounts above the aggregate 15% limit for investments in financial institutions, mortgage servicing rights, and deferred tax assets from timing differences, would be fully deducted from common equity by 1 January 2018.
• In particular, the regulatory adjustments will begin at 20% of the required deductions from common equity on 1 January 2014, 40% on 1 January 2015, 60% on 1 January 2016, 80% on 1 January 2017, and reach 100% on 1 January 2018. During this transition period, the remainder not deducted from common equity will continue to be subject to existing national treatments.
• The capital conservation buffer will be phased in between 1 January 2016 and year end 2018 becoming fully effective on 1 January 2019. It will begin at 0.625% of RWAs on 1 January 2016 and increase each subsequent year by an additional 0.625 percentage points, to reach its final level of 2.5% of RWAs on 1 January 2019. Countries that experience excessive credit growth should consider accelerating the build up of the capital conservation buffer and the countercyclical buffer. National authorities have the discretion to impose shorter transition periods and should do so where appropriate.
• Banks that already meet the minimum ratio requirement during the transition period but remain below the 7% common equity target (minimum plus conservation buffer) should maintain prudent earnings retention policies with a view to meeting the conservation buffer as soon as reasonably possible.
• Existing public sector capital injections will be grandfathered until 1 January 2018. Capital instruments that no longer qualify as non-common equity Tier 1 capital or Tier 2 capital will be phased out over a 10 year horizon beginning 1 January 2013. Fixing the base at the nominal amount of such instruments outstanding on 1 January 2013, their recognition will be capped at 90% from 1 January 2013, with the cap reducing by 10 percentage points in each subsequent year. In addition, instruments with an incentive to be redeemed will be phased out at their effective maturity date.
• Capital instruments that do not meet the criteria for inclusion in common equity Tier 1 will be excluded from common equity Tier 1 as of 1 January 2013. However, instruments meeting the following three conditions will be phased out over the same horizon described in the previous bullet point: (1) they are issued by a non-joint stock company1; (2) they are treated as equity under the prevailing accounting standards; and (3) they receive unlimited recognition as part of Tier 1 capital under current national banking law.
• Only those instruments issued before the date of this press release should qualify for the above transition arrangements.

Phase-in arrangements for the leverage ratio were announced in the 26 July 2010 press release of the Group of Governors and Heads of Supervision. That is, the supervisory monitoring period will commence 1 January 2011; the parallel run period will commence 1 January 2013 and run until 1 January 2017; and disclosure of the leverage ratio and its components will start 1 January 2015. Based on the results of the parallel run period, any final adjustments will be carried out in the first half of 2017 with a view to migrating to a Pillar 1 treatment on 1 January 2018 based on appropriate review and calibration.

After an observation period beginning in 2011, the liquidity coverage ratio (LCR) will be introduced on 1 January 2015. The revised net stable funding ratio (NSFR) will move to a minimum standard by 1 January 2018. The Committee will put in place rigorous reporting processes to monitor the ratios during the transition period and will continue to review the implications of these standards for financial markets, credit extension and economic growth, addressing unintended consequences as necessary.

Deficient AML Controls Over Omnibus Accounts

US SEC charged Pinnacle Capital Markets LLC with failing to comply with an anti-money laundering (AML) rule that requires broker-dealers to identify and verify the identities of its customers and document its procedures for doing so. SEC also charged Pinnacle's managing director Michael A. Paciorek with causing Pinnacle's violations.

Pinnacle is a broker-dealer based in Raleigh, N.C., with more than 99% of its customers residing outside the United States. Pinnacle's business primarily involves order processing with direct market access (DMA) software for foreign institutions comprised mostly of banks and brokerage firms and foreign individuals.

SEC found that Pinnacle established, documented and maintained a customer identification program (CIP) that specified it would identify and verify the identities of all of its customers. However, during a six-year period, Pinnacle failed to follow the identification and verification procedures set forth in its CIP.

Many of the firm's foreign entity customers hold omnibus accounts at Pinnacle through which the entities carry sub-accounts for their own corporate or retail customers. Pinnacle treats the sub-account holders of the foreign entity omnibus accounts in the same manner as it does its regular account holders. The vast majority of Pinnacle's regular account holders, as well as the omnibus sub-account holders, use DMA software to enter securities trades directly and instantly through their own computers. As a result, these account holders have direct, unfiltered control over how securities transactions are effected in the accounts. The foreign entity holding the omnibus account does not intermediate these trades. The DMA software allows the omnibus sub-account holders to route their securities transactions directly to the relevant market centers without intermediation.

From October 2003 to August 2006, Pinnacle did not verify the identities of 34 out of a sample of 55 corporate account holders. The Commission also finds that from October 2003 through November 2009, Pinnacle did not collect or verify identifying information for the vast majority of the beneficial owners of sub-accounts maintained by Pinnacle's omnibus brokerage accounts. Consequently, the order finds that Pinnacle's documented procedures differed materially from its actual procedures.

Pinnacle and Paciorek agreed to settle SEC's enforcement action without admitting or denying the allegations, and Pinnacle will pay $25,000 in financial penalties. As part of an action taken by FINRA in February 2010, Pinnacle also has agreed to certain undertakings, including extensive AML training for its employees, as well as the hiring of an independent consultant to review its AML compliance program.

Jack's comment: DMA plus omnibus account is really a perfect mix for not only keeping privacy, but also money laundering. KYC is always the No.1 fundamental compliance issue.

Sales of Inverse Floater CMOs

FINRA recently fined HSBC Securities (USA) Inc. $375,000 for recommending unsuitable sales of inverse floating rate Collateralized Mortgage Obligations (CMOs) to retail customers. HSBC failed to adequately supervise the suitability of the CMO sales and fully explain the risks of an inverse floating rate or other risky CMO investment to its customers.

As a result of HSBC not implementing an adequate supervisory system and procedures relating to the sale of inverse floating rate CMOs to retail customers, six of its brokers made 43 unsuitable sales of inverse floaters to retail customers who were unsophisticated investors and not suited for high-risk investments.

In addition, HSBC's procedures required a supervisor's pre-approval of any sale in excess of $100,000; FINRA found that 25 of the 43 CMO sales were in amounts exceeding $100,000 and that in five of these instances, customers lost money in their inverse floating rate CMO investments. HSBC has paid these customers full restitution totaling $320,000.

A CMO is a fixed income security that pools mortgages and issues tranches with various characteristics and risks. CMOs make principal payments throughout the life of the security with the maturity date being the last date by which all of the principal must be returned. The timing of the return of principal payments can vary depending on interest rate changes.

One of the more risky CMO tranches is the inverse floater, a type of tranche that pays an adjustable rate of interest that moves in the opposite direction from movements of an interest rate index, such as LIBOR. Since 1993, FINRA has advised firms that inverse floating rate CMOs "are only suitable for sophisticated investors with a high-risk profile."

HSBC did not provide its brokers with sufficient guidance and training regarding the risks and suitability of CMOs. In particular, the firm did not inform its registered representatives that inverse floaters were only suitable for sophisticated investors with a high-risk profile. In addition, the firm did not provide its registered representatives with information regarding the risks associated with the specific inverse floaters that were available to be sold.

HSBC also failed to comply with a FINRA rule, adopted in November 2003, which requires firms to offer certain educational materials before the sale of a CMO to any person, other than an institutional investor. The educational materials must include, among other things, the characteristics and risks of CMOs, in general, and the specific characteristics and risks associated with the different tranches of a CMO.

During the relevant time period, HSBC did not advise its registered persons that they were required to offer written educational material to their customers before they sold them CMOs. Although HSBC provided its brokers with a CMO brochure, the brokers did not offer the brochure to every CMO investor, nor did they know that they were required to give the materials to all potential CMO investors before selling them a CMO. Moreover, the brochures did not comply with FINRA's content standards. In particular, the brochure failed to discuss inverse floaters and failed to include a section on risks associated with purchasing CMOs.

Jack's comment: Investor floater is a highly risky product, no matter it is associated with CMOs or not. Such kind of product should not be offered to retail investors unless they can demonstrate full understanding of its risk profile. Distribution of education materials to retail investors is certainly not enough.

Review of Insider Dealing Sentence

Last week The Eastern Magistracy today sentenced Mr Pablo Chan Pak Hoe, who was earlier convicted of insider dealing in a proposed takeover, to serve 240 hours of community service. Chan was also ordered to pay the SFC investigation costs totalling $44,478.

Magistrate Anthony Yuen Wai Ming (who recently put Amina Mariam Bokhary on one year's probation with respect to her third conviction for assaulting a police officer) had earlier found Chan guilty of one count of insider dealing in the shares of Universe International Holdings Ltd between 2 May 2008 and 19 June 2008 when he acted as a representative of the controlling shareholder in a proposed acquisition.

SFC had informed the Magistrate that Chan made a profit in the order of $120,000 when he sold the shares following the announcement of the acquisition. Under the community service order, Chan does not have to repay or disgorge any profit from his insider dealing and is able to retain it.

SFC is seeking a review of this sentencing decision.

Jack's comment: Compared with previous cases of insider dealing, the sentence in this case was really "exceptional"...no imprisonment, and even no disgorgement of profit. I am not informed that the defendant in this case has also suffered from bipolar disorder!

Morgan Stanley Breached the Research Rules Again

Recently FINRA censured and fined Morgan Stanley & Co., Inc. $800,000 for failing to make public disclosures required by FINRA's rules governing research analyst conflicts of interest. The firm also failed to comply with a key provision of the 2003 Research Analyst Settlement by failing to disclose the availability of independent research in customer account statements.

In addition to the censure and fine, Morgan Stanley must review a sample of its research reports and certify to FINRA that they comply with FINRA's research analyst conflict-of-interest rules. These reviews and certifications must take place every six months for two years.

FINRA found that from April 2006 to June 2010, Morgan Stanley issued equity research reports that failed to disclose accurate information about the relationships Morgan Stanley, or its analysts, had with companies covered in its research reports. Overall, these inaccuracies resulted in approximately 6,836 deficient disclosures in about 6,632 equity research reports and 84 public appearances by research analysts. Among the deficient disclosures were:

• Securities holdings of an analyst, or a member of the analyst's household, in a subject company;
• Morgan Stanley's receipt of investment banking and non-investment banking revenue from subject companies;
• Morgan Stanley's role as a manager, or co-manager, of a public offering of securities for subject companies;
• Morgan Stanley's role as a market maker for certain subject companies' securities; and
• Price charts for securities covered in equity research reports and the valuation method used to support published price targets.

Morgan Stanley also did not disclose in approximately 127,600 monthly account statements sent to customers from August 2007 to February 2008 that it had available independent, third-party research. The requirement to provide customers with this notification was part of SEC's final agreement with Morgan Stanley as part of the 2003 Research Analyst Settlement and was incorporated into a separate agreement with FINRA.

In determining the appropriate sanctions in this matter, FINRA considered Morgan Stanley's self-review and self-reporting of some of its disclosure violations and remedial steps taken by the firm, as well as a prior FINRA settlement in 2005 that found the firm violated FINRA's research analyst disclosure rules.In settling this matter, Morgan Stanley neither admitted nor denied the charges, but consented to the entry of FINRA's findings.

Jack's comment: The credibility problem of research analysts has not fundamentally changed since the burst of the IT bubble. The financial penality is just a piece of cake to a giant investment bank.

Introducing Non-SFC Authorised Fund to Clients

SFC has just suspended the licence of Ms Kou Sao Peng for three months from 4 August 2010 to 3 November 2010. SFC's investigation found that Kou, while acting as a consultant of TTG (HK) Ltd, an investment adviser, introduced a non-SFC authorised fund to several clients in 2008.

The introduction of the fund preceded the completion of due diligence process by TTG. As such, the fund was not yet approved by TTG for recommendation to clients. In order to sell the fund to her clients, Kou asked her clients to sign a form acknowledging themselves as "execution only" clients who specifically requested to purchase the fund. Kou should not have done so given the fund was actually introduced by her to the clients.

An "execution only" transaction usually means a transaction executed by a firm upon the specific instructions of a client without solicitation or recommendation by the firm, where the firm does not, and is not expected to give investment advice relating to the merits and suitability of the transaction.
Moreover, Kou did not consider TTG’s due diligence on the fund before introducing it to the clients and ignored an instruction from her supervisor to monitor the fund for a longer period before introducing it to any clients.

In suspending Kou, SFC did not consider that Kou had acted dishonestly. Had there been a finding of dishonesty, the SFC would have imposed a more severe sanction.

Jack's comment: In the past, there were many investment consultants who attempted to deny solicitation of clients for purchasing non-authorized products by asking the clients to sign the "execution only" acknowledgement. This case reveals that such arrangement may not work.

Breach of Money Laundering Checks

This week FSA fined members of the Royal Bank of Scotland Group (RBSG) £5.6m for failing to have adequate systems and controls in place to prevent breaches of UK financial sanctions. FSA's Decision Notice

UK firms are prohibited from providing financial services to persons on the HM Treasury sanctions list. The Money Laundering Regulations 2007 (the Regulations) require that firms maintain appropriate policies and procedures in order to prevent funds or financial services being made available to those on the sanctions list.

During 2007, RBSG processed the largest volume of foreign payments of any UK financial institution. However, between 15 December 2007 and 31 December 2008, RBS Plc, NatWest, Ulster Bank and Coutts and Co, which are all members of RBSG, failed to adequately screen both their customers, and the payments they made and received, against the sanctions list. This resulted in an unacceptable risk that RBSG could have facilitated transactions involving sanctions targets, including terrorist financing.

FSA considers that RBSG’s failings in relation to its screening procedures were particularly serious because of the risk they posed to the integrity of the UK financial services sector. This is the biggest fine imposed by the FSA to date in pursuit of its financial crime objective. It is also the first fine imposed by the FSA under the Regulations.

As RBSG agreed to settle at an early stage of the FSA investigation, it qualified for a 30% reduction in penalty. The FSA would have otherwise imposed a financial penalty of £8m.

Jack's comment: It appears that many financial institutions in the world (especially private banks) have not yet changed their lax attitude towards the compliance with money laundering rules.

Regulation of Life Settlements

Last week US SEC released a staff report recommending that life settlements be clearly defined as securities so that the investors in these transactions are protected under the federal securities laws.

A life settlement is a transaction in which an individual with a life insurance policy sells that policy to another person, who then assumes responsibility for paying the premiums. Typically, the seller no longer wants the policy or can no longer afford to pay the premiums. In exchange, the insured party typically receives a lump sum payment that exceeds the policy's cash surrender value, but is less than the expected payout in the event of death.

The staff report by SEC's Life Settlements Task Force, which SEC Chairman Mary Schapiro established in August 2009, notes that the market for life settlements has grown over the past decade, raising questions about its regulation and oversight.

In particular, the report notes that there is inconsistent regulation of participants in the life settlements market, including those who arrange for the buying and selling of policies and those who provide estimates of an insured's life expectancy. In addition, the report notes that investors in individual life settlement transactions, or pools of life settlements, would benefit from the application of baseline standards of conduct to market participants.

In the report, the staff outlines the Task Force's findings about the life settlements market and recommends ways to improve market practices and regulatory oversight. It recommends that the Commission should:

• Consider recommending to Congress that it amend the definition of security under the federal securities laws to include life settlements as securities.
• Instruct the staff to continue to monitor that legal standards of conduct are being met by brokers and providers.
• Instruct the staff to monitor for the development of a life settlement securitization market.
• Encourage Congress and state legislators to consider more significant and consistent regulation of life expectancy underwriters.

SEC also issued an investor bulletin regarding investments in life settlements, consistent with one of the recommendations of the Task Force.

Amending the federal securities laws to define life settlements as securities could have several benefits:

• The amendment would clarify the status of life settlements under the federal securities laws and provide for a more consistent treatment of life settlements under both federal and state securities laws.
• The amendment would bring intermediaries in the life settlement market within the regulatory framework of SEC and FINRA. This would subject them to regulatory requirements designed to protect investors from abusive practices and to promote business conduct that facilitates fair, orderly and efficient markets.
• The amendment would give SEC and FINRA clear authority to police the life settlements market, which could lead to early detection of abuses and help deter fraud.

Jack's comment: It appears that life settlement is not regarded as securities under SFO, but would they be treated as regulated investment agreement, or structured product in future?

Responsible Lending

Last week UK FSA has today outlined proposals to ensure all mortgages are carefully assessed to make sure borrowers can afford them.

Reflecting FSA's enhanced consumer protection strategy and intensive day-to-day supervision, the proposed changes aim to ensure all lenders get back to the basics of responsible lending and that problems are prevented before they can develop or get out of control.

Some of the key proposals include:

• Imposing affordability tests for all mortgages and making lenders ultimately responsible for assessing a consumer's ability to pay;
• Requiring verification of borrowers' income in every case to prevent over inflation of income and to prevent mortgage fraud;
• Extra protection for vulnerable customers with a credit-impaired history.

The tough new proposals, published in the consultation paper, form part of a major review by FSA into the UK mortgage market and are based on detailed analysis of past lending decisions, looking at the causes of arrears and repossessions since 2005.

FSA found that:

• 46% of households either had no money left, or had a shortfall after mortgage payments and living costs were deducted from their income;
• Almost half of new mortgages between 2007 and the first quarter of 2010 were provided without a customer having to verify their income;
• The share of interest-only mortgages has been increasing. At the peak of the market, over 30% of all mortgages were interest-only;
• Many consumers with no repayment vehicle count on future house price rises or uncertain life events to repay their mortgage and some have no plan at all;
• Borrowers with a credit-impaired history are particularly vulnerable.

Jack's comment: While FSA is enforceing responsible lending, it may have failed to ensure responsible borrowing.