Reliance on Individual Consultants to Conduct Product Due Diligence

As announced on 19 Mar 2020, SFC reprimanded and fined Convoy Asset Management Limited (CAML) $6.4 million for control failures in solicitation and recommendation of bonds to clients.

CAML referred clients to a third party platform between Mar 2015 and Jan 2017 (Relevant Period) to execute 30 transactions of Chapter 37 Bonds, some of which involved solicitation or recommendation made to clients.

In recommending Chapter 37 Bonds to clients, CAML failed to:

• conduct proper and adequate product due diligence on these bonds before making recommendation or solicitation;
• have an effective system in place to ensure that the recommendation or solicitation in relation to bonds was suitable for and reasonable in all the circumstances;
• maintain proper documentary records of the investment advice or recommendation given to its clients and provide each of them with a copy of the written advice; and
• have adequate and effective internal controls and system in place to diligently supervise and monitor the sale of bonds through the third party platform and to ensure its compliance with applicable regulatory requirements.

The SDA revealed further details:

• During the Relevant Period, CAML introduced its clients to a third party platform to execute 30 Chapter 37 Bonds transactions in the secondary market for 28 retail clients. Clients who purchased bonds via the third party platform had to open accounts at both CAML and the third party platform. They were clients of both firms.
• CAML did not have product approval and due diligence procedures on Chapter 37 Bonds. It relied solely on individual consultants to conduct product due diligence (PDD) and to assess the risks of the bonds.
• CAML engaged the bond dealing services of the third party platform to assist its consultants to understand each bond product before recommending such product to clients. The platform offered the services of a designated bond expert to CAML, and provided briefings, presentations and articles to CAML’s consultants on bond products, as well as responded to enquiries from CAML’s consultants. However, the third party platform did not assign a risk rating to the bonds, and did not identify which of the bonds on its platform were Chapter 37 Bonds.
• CAML provided limited guidance to its consultants on how they should conduct PDD on the bonds, including for instance, what features they had to review and the criteria to be adopted, what other factors they should take into account, and the weight to be attributable to those factors. Its consultants were also not required to record in writing what documents they had reviewed, in what respects the bonds were considered suitable for different risk categories of investors, and justification for such findings.

SFC does not disclose the identity of the third party platform, probably due to the fact that another disciplinary action is being taken against this firm.