Counterparty Risks of Lousy Broker

In May 2016, Guotai Junan Securities (Hong Kong) Limited was fined $1.3 million by SFC for the Client Identity Rule Policy. In Jun 2016, there was another enforcement case against Guotai Junan, which was much more severe.

As announced on 22 Jun 2020, Guotai Junan was fined $25.2 million by SFC for for multiple internal control failures and regulatory breaches in connection with AML, handling of third party fund transfers and placing activities, as well as detection of wash trades and late reporting.

Third party fund transfers

• Between Mar 2014 and Mar 2015, Guotai Junan failed to take reasonable measures to ensure that proper safeguards were put in place to mitigate the risks of money laundering and terrorist financing in processing 15,584 third party deposits or withdrawals for its clients, totalling approximately $37.5 billion.
• Despite red flags suggesting some of the third party fund transfers were unusual or suspicious, Guotai Junan failed to adequately monitor the activities of its clients, conduct appropriate scrutiny of the fund transfers, identify transactions that were suspicious and report them to the JFIU in a timely manner.
• Guotai Junan processed 5,406 third party deposits from Jul 2015 to Jun 2016 without always documenting the identity of the depositors, their relationship with the account holders, and the reasons for these third party deposits.

Placing activities

• While acting as the placing agent for the global offering of a Hong Kong-listed company’s shares between Dec 2015 and Jan 2016, Guotai Junan failed to take reasonable steps to ascertain whether the clients’ subscription applications were consistent with its knowledge of their background and source of funds, and make appropriate enquiries when there were grounds for suspicion.
• In particular, the funds used by five clients to subscribe for $28.8 million worth of the listed company’s shares were deposited by the same third party into the respective client accounts in amounts far exceeding their self-declared net worth.
• Despite such red flags, Guotai Junan did not take reasonable steps to verify the ultimate beneficial owners of the clients’ accounts and their source of funds, nor make appropriate enquiries to ascertain whether the clients were independent of the listed company. In the end, 3 of the 5 placees, who were allotted 11% of the listed company’s shares of the total placing under the international tranche, turned out to be the listed company’s employees.

Detection of wash trades and reporting obligation

• Guotai Junan failed to detect 590 potential wash trades in a timely manner between Jan 2014 and Jul 2016 due to a lack of adequate written trade monitoring procedures or guidelines and technical failures of its transaction pattern monitoring system.
• However, despite becoming aware in Jul 2016 of 210 potential wash trades which could not be detected in a timely manner as a result of the system failure, Guotai Junan did not report these 210 trades to SFC until 7 months later in Feb 2017.

More details of this case can be found from the Statement of Disciplinary Action.

If your firm is a financial institution conducting business with such a lousy broker, how would you evaluate the counterparty risks (regulatory risk, reputation risk, operational risk, etc.) in light of this enforcement case?