Issue of Advertisements of Unauthorized Fund

As announced by SFC on 21 Mar 2013, the Eastern Magistracy acquitted Pacific Sun Advisors Limited (Pacific Sun) and its director Mr Andrew Mantel for 4 counts of issuing advertisements to promote a collective investment scheme (CIS) without SFC's authorization, in contravention of S.103 of the SFO.

SFC alleged that between Nov and Dec 2011, the defendants issued an advertisement on the corporate website of Pacific Sun promoting a CIS called "Pacific Sun Greater China Equities Fund" (the Fund) without SFC's authorization. On or around 2 and 3 Nov 2011, the defendants issued an advertisement regarding the launch of the Fund to the public by email without SFC's authorization.

During 3 days of evidence, the defendants submitted that they intended to sell interests in the units of the Fund only to professional investors and so the advertisements did not require SFC's authorization under a statutory exemption. But SFC submitted that the exemption did not permit advertisements that had not been authorized by SFC to be issued to the public and that in this case there was no evidence that the interests in the Fund had only been sold to professional investors.

The Magistrate accepted the defendants' argument and ruled also that the advertisements did not constitute invitations to the public to invest in the Fund. SFC will consider an appeal of the decision.

This case is interesting. For my previous interpretation of S.103 of the SFO, advertising an unauthorized fund without SFC's authorization is no doubt illegal, even if the promoter has the "intention" of selling the fund to PI only. The court judgement has overturned this thought!


Subsequent update on 10 Jun 2014:

• Following SFC's appeal concerning the acquittal in which the Court of First Instance in Jan 2014 issued a ruling clarifying that the advertisements in question did not fall within the exemption and ordered the case to be returned to the Magistrates’ Court for reconsideration.
• The Court of First Instance made it clear that the exemption only applies where the advertisement states on its face that the terms of the offer are limited to professional investors. SFC considers this ruling protects retail investors from the risks of direct marketing of inappropriate or risky investment products.
• As a result, Pacific Sun and Andrew Mantel were convicted at the Tsuen Wan Magistrates' Court on 4 charges of issuing advertisements to promote a CIS without SFC's authorization. Pacific Sun was fined $20,000 and Andrew Mantel was sentenced to 4 weeks' imprisonment suspended for 12 months.

Subsequent update on 20 Mar 2015:

• The Court of Final Appeal (CFA) upheld an appeal by Pacific Sun and Andrew Mantel in relation to issuing advertisements to promote a CIS without SFC's authorization. The ruling of the CFA overturned a decision by the Court of First Instance on the interpretation of S.103 of the SFO.
• The CFA decided the Court of First Instance erred in its ruling in that the exclusion applies even if the intention to dispose of the securities or interests in a CIS only to professional investors is not expressed in the advertisement, invitation or document. The CFA made it clear that the burden of establishing the exclusion applies rests on the defendant and not on SFC.
• The CFA also stated that the professional investor exemption would not apply if a person published an unauthorized offer to the public and sold the advertised securities to a retail investor.
• This ruling means advertisements of unauthorized CIS can be issued to the general public if the issuer only intends to sell them to PI. It also means a contravention of S.103 of the SFO can only be established well after the offer to the public has been issued.
• SFC alleges that it will study the CFA's decision to determine whether there should be any proposal to amend S.103 of the SFO.

Inadequate Investor Profiling

As announced on 4 Mar 2013, SFC reprimanded Manulife Asset Management (Hong Kong) Limited (MAM) and fined it HK$24 million for inadequate internal controls in relation to the distribution of Manulife Global Fund (authorized by SFC) from 2007 to 2012.

SFC's findings focus on MAM's systems and processes for understanding its customer’s financial situation, investment experience, and investment objectives in soliciting or recommending the sale of the Fund to them.

Between 2007 and 2009, Manulife Asset Management obtained this information by performing an investor profile for each customer. However, 73% of the customers in 2009 were not profiled or their information was either incomplete or outdated for at least 12 months.

Needless to say, "not profiled" is more severe than "incomplete" which is in turn more severe than "outdated". However, SFC gave only the total percentage (73%) of all these deficiencies but did not provide the breakdown.

After 2010, MAM introduced a questionnaire to assess each customer's risk profile. By Feb 2012, the new process had not been fully implemented to all customers and MAM still had not secured a completed risk profile questionnaire from 70% of the Fund's customers.

Together with concerns about the quality and extent of its record-keeping, these failures have jeopardised MAM's capacity to ensure that recommended securities are suitable for each customer.

Despite these failures, SFC said there has been no default in any of the sub-funds of the Fund nor has any customer complained about the performance or suitability of the fund. Then how did SFC come up with such a huge amount of penalty? Of course, MAM is a big firm. If it was a small IFA incurred with the same deficiencies, I don't think SFC could impose a fine of $24 million.