Manipulation of Korean Market by Hong Kong Trader

As announced on 17 Nov 2016, SFC prohibited Mr Derek Ong, a former representative of Deutsche Securities Asia Limited, from re-entering the industry for 10 years for conspiring to manipulate the Korean Composite Stock Price Index 200 (KOSPI200) in November 2010.

In February 2011, the Securities and Futures Commission in Korea took enforcement action against Deutsche Securities Korea Co. (DSK) for market manipulation through the exploitation of spot-futures and the setting up of speculative derivative position that benefited from the price fall of KOSPI200 during the closing auction period on 11 November 2010.

Traders of Deutsche Bank AG located in Hong Kong were found to have originated the manipulative order instructions. The manipulation was referred to the prosecution office in Korea to criminally prosecute DSK and the involved traders for violation of the Financial Investment Services and Capital Markets Act.

Following a trial at the Seoul Central District Court, DSK and a Korea-based trader, who executed the manipulative orders, were found guilty of manipulating KOSPI200 for the purpose of making illegal profits for Deutsche Bank AG and DSK. Deutsche Bank AG and DSK were ordered to forfeit about KRW43,695 million profit derived from the manipulative trades. The traders in Hong Kong were not convicted because of their absence from the trial. However, the Court concluded that the traders in Hong Kong conspired to manipulate KOSPI200. The Seoul Central District Court sentenced the Korean trader to 5 years of imprisonment and fined DSK KRW1.5 billion on 25 January 2016.

Ong was one of the traders in Hong Kong. He was responsible for the decision to liquidate the holding of Korean stocks, which caused KOSPI200 to fall 2.79%, and to establish an option position to profit from the KOSPI200 fall.

SFC was unable to take a legal action against Ong by using the market misconduct provisions under the SFO because he didn't manipulate the Hong Kong market. But SFC can always cast serious doubts on his fitness and properness to be a licensed person.

Failure to Disclose Notifiable Interests in HK Listed Shares

As announced on 15 Jun 2016, SFC reprimanded and fined Schroder Investment Management (Hong Kong) Limited $1.8 million for failing to disclose all notifiable interests in Hong Kong listed shares.

From Aug 2005 to Jan 2013, Schroder failed to disclose to SEHK and the relevant listed companies all notifiable interests in Hong Kong listed shares held in client portfolios and managed by Schroders plc and certain of its subsidiaries (Schroder Entities) where they did not have or were unable to exercise proxy voting rights. Schroder is responsible for preparing and filing the notices disclosing all notifiable interests in Hong Kong listed shares for the Schroder Entities to SEHK and the relevant listed companies.

Although legal advice obtained by Schroder advised that an "interest" in shares was broadly defined and was not confined to the exercise of a voting right, Schroder failed to properly follow the advice.

According to Schroder, it discovered the disclosure failures in Nov 2012 when it was preparing to implement a new global system for the monitoring and reporting of disclosable interests in shares. In Feb and Mar 2013, Schroder filed a total of 236 substantial shareholders notices to the SEHK to correct the disclosure notices filed for the Schroder Entities from Jul 2010 to Jan 2013.

I am wondering who in Schroder made the decision of disregarding the legal advice.

No Interest is Not the Best Interest

What is the best interest of the client? It is usually manifested when the better interest is neglected.

As announced on 15 Jun 2016, SFC reprimanded and fined State Street Global Advisors Asia Limited (SSGA) $4 million for its failure to comply with regulatory requirements in the management of Tracker Fund of Hong Kong (Fund).

SFC's investigation found that from 1 Dec 2008 to 30 Jun 2013 (Relevant Period), the cash balances of the Fund that were deposited with State Street Bank and Trust Company's (SSBT) demand deposit account did not earn any interest because SSBT's deposit rates on Hong Kong dollars were zero. SSBT was the Fund's trustee and an affiliate of SSGA.

SSGA did not check the rate of interest offered by other banks, while the prevailing commercial interest rates on HKD for a deposit of the same size and term as the Fund's cash balances were above zero during the Relevant Period.

SFC considers that SSGA had failed to ensure that interest received on the Fund's HKD cash balances from its connected person was at a rate not lower than the prevailing commercial rate for a deposit of that size and term as required by the UT Code.

SSGA's internal procedures on the management of the Fund’s cash balances were inadequate. By not following the requirements of the UT Code and the Trust Deed when depositing the Fund's cash balances with SSBT, SSGA had failed to manage and minimise the conflict between the interests of the Fund's investors and the interests of SSGA/SSBT.

SSGA had also wrongly represented in 6 interim and annual reports of the Fund that the Fund’s cash balances were placed in a non-interest bearing current account when in fact the cash was deposited with SSBT in an interest bearing account earning zero interest.

As a result, SSGA agreed to make a voluntary payment of $318,315 into the Fund. It determined such amount by applying an interest rate of 0.01% to the Fund's cash balance for the Relevant Period and from the end of the Relevant Period to the date when the majority of the Fund's cash balance was transferred out of SSBT's demand deposit account.

Mishandling of Clients' Dividend Entitlements

As announced on 14 Mar 2016, SFC reprimanded Unicorn Securities Company Limited and fined it and its former responsible officer, Mr Chan Hoi Shu, $3 million and $200,000, respectively, relating to failures in handling clients’ money and securities. Chan, who was primarily responsible for the failures of Unicorn Securities in this connection, was also suspended for a period of 15 months.

Between Mar 2011 and Dec 2013, Unicorn Securities mishandled its clients' dividend entitlements of shares of HSBC Holdings PLC by going against clients’ instructions in their choices between cash or scrip dividends (i.e. HSBC shares) when submitting their instructions to HKSCC, and giving the clients' dividends to others.

On 7 occasions, Unicorn Securities chose and received scrip dividends for all clients regardless of the clients’ instructions. After allocating the dividends to clients who elected to receive scrip dividends, Unicorn Securities deposited the remaining scrip dividends into the account of Chan or the account of a client. Chan would then sell these HSBC shares in the market and pay Unicorn Securities an amount equivalent to the clients' cash dividend entitlements for making payments to the clients who chose cash dividends. Chan kept the profit arising from the difference between the amount he received from selling the HSBC shares and the amount he had to pay to the firm.

Separately, Unicorn Securities chose and received cash dividends for all the clients on two occasions. For clients who opted for scrip dividends, Unicorn Securities would give the clients' cash dividends to Chan who would then buy HSBC shares in the market to meet clients' requests for scrip dividend, and he made a profit in the process.

Unicorn Securities had connived in Chan's transfer of client money into his personal account and withdrew securities from a client's account without the necessary written direction from the client.

The conduct of Unicorn Securities demonstrated its failure to put in place adequate and effective internal controls to ensure compliance with relevant regulatory requirements in relation to segregation and proper handling of client assets.

Chan masterminded and involved the firm in the malpractice in handling its clients' dividend entitlements, initiated and directed his staff to act contrary to clients' instructions and to transfer clients' money and securities to his personal accounts and instructed the share withdrawal from the client account without the required written direction.

Chan had acted like an unauthorized portfolio manager to handle clients' dividend entitlements but then stole their profits. What a thief!

Illicit Mark-Up/Down of Execution Prices

As announced on 29 Feb 2016, SFC reprimanded and fined Yuanta Securities (Hong Kong) Company Limited  $4 million for failing to disclose the actual execution price and properly and adequately disclose the financial gains it made whilst handling bond transactions for its clients.

From 1 Jul to 31 Dec 2012, Yuanta Securities, acting as its clients' agent, made approximately $3.1 million in commission by marking-up or marking-down the execution prices in some of the 256 bond transactions for 96 clients without making proper and accurate disclosure to the clients.

After receiving a client’s buy order, Yuanta Securities' financial product team would buy the product through a counterparty and mark-up the trading price before passing it to the sales team which would further mark-up the price before selling it to a client. The same approach was used in executing sell orders by marking down the trading prices.

Whilst some of the clients appeared to be aware of the amount of the commission the sales team earned from the trades, such commission was not always properly disclosed in the trading instruction form and was not mentioned in the daily statements sent to the clients. Furthermore, the clients were charged additional fees by Yuanta Securities without their knowledge and consent since they were not informed of the financial product team’s mark-up/mark-down.

Under para 8.3 of the Code of Conduct, where a securities firm enters into a back-to-back transaction concerning an investment product, it should disclose to the client the trading profit to be made. The trading profit should be disclosed as a percentage ceiling of the investment amount or the dollar equivalent. Secret mark-up/mark-down is definitely an illicit practice.

Landmark Ruling on S.300 of SFO

On 15 Jan 2016, the Court of First Instance found that two solicitors, Mr Eric Lee Kwok Wa and Ms Betty Young Bik Fung, and Eric Lee’s sister, Ms Patsy Lee Siu Ying, contravened the SFO by insider dealing in the shares of Asia Satellite Telecommunications Holdings Ltd (Asia Satellite) and engaged in fraud or deception in transactions involving securities of Hsinchu International Bank Company Ltd (Hsinchu Bank).

Hsinchu Bank was a listed company on the Stock Exchange of Taiwan in Sep 2006 and Asia Satellite was a listed company on SEHK in Feb 2007.

The court's decision is a landmark ruling on the interpretation of S.300 of the SFO which prohibits the use of fraudulent or deceptive schemes in transactions involving securities.

SFC started civil proceedings in the court against Eric Lee, Betty Young, Patsy Lee and Ms Stella Lee, both sisters of Eric Lee, in Dec 2010 under S.213 of the SFO and alleged the defendants made a total profit of $2.9 million in these transactions.

SFC alleged that, in relation to Hsinchu Bank transactions in Sep 2006:

• Betty Young obtained information about a tender offer for Hsinchu Bank shares while working as a lawyer seconded to a client of her employing law firm;
• the client she was seconded to intended to make the tender offer and she was working on the offer;
• the information about the offer was non-public, confidential and materially price sensitive;
• subsequently, Betty Young bought Hsinchu Bank shares and tipped off Eric Lee and his sisters to buy the shares before the announcement of the tender offer; and
• this amounted to fraud or deception under S.300 of the SFO because Betty Young owed duties to her employer and their client including the duty to refrain from using such information for personal gain.

SFC further alleged that, in relation to Asia Satellite transactions in Feb 2007:

• Eric Lee obtained information about the proposed privatization of Asia Satellite shares when the law firm he worked for advised on this transaction;
• that information was non-public, confidential and materially price sensitive;
• subsequently Eric Lee tipped off Betty Young and his sisters to buy Asia Satellite shares before the announcement of the proposed privatization; and
• this amounted to insider dealing under S.291 of the SFO.

The court found that these allegations were proven against Betty Young, Eric Lee and Patsy Lee, but there was not enough evidence to prove the allegations against Stella Lee. Nevertheless, the court may exercise its power under S.213 of the SFO against her to remove the illicit profit from her and restore the victims in the transactions.

Since Hsinchu Bank is not a HK listed company, SFC can't initiate legal proceedings based on the insider dealing provisions under the SFO, but it can now effectively make use of S.300.