Incorrect Client Statements

On 24 Jun 2021, SFC announced that it reprimanded Deutsche Securities Asia Limited (DSAL) and fined it $2.45 million for issuing incorrect statements to its prime brokerage (PB) clients and delaying reporting its failures to SFC.

Since 2006, DSAL has booked information regarding corporate actions (CA) (including issuance of bonus shares) by listed companies which its PB clients hold shares in to its front office system (FO System).  The FO System would transfer these CA details to another system responsible for the generation of periodic statements issued to the PB clients (Statements).

However, due to a design defect in the FO System, it did not distinguish between ex-entitlement dates (Ex-Dates) and settlement dates (Pay Dates) of bonus share events.  The FO System only extracted the Ex-Dates when transferring the relevant data to the other system for generation of the Statements.

As a result, where there was an interval between the Ex-Dates and the Pay Dates, the transaction records and shareholding positions displayed in the Statements showed the bonus shares as settled and tradable as of the ExDates, when in fact these shares had not become unconditional for long sale until the Pay Dates (Error).  Disposing of such bonus shares during the interval without borrowing the requisite shares could constitute naked short selling.

One of DSAL’s PB clients (Client) appeared to have relied on the Statements containing the Error (Impacted Statements) and oversold bonus shares issued by three Hong Kong-listed companies in Jul 2018, between the respective Ex-Dates and Pay Dates of the relevant bonus issuances.

DSAL had likely issued Impacted Statements to some of its PB clients since the FO System was implemented in 2006, until the Error was remedied in Nov 2018:

• 34 PB clients received Impacted Statements from DSAL between Jan and Oct 2018;
• 75 PB clients likely received Impacted Statements between 2011 and 2017; and
• DSAL was unable to identify the number of PB clients who may have received Impacted Statements before 2011 since the data is no longer available.

Although DSAL first discovered in Jul 2018 that Impacted Statements had been issued to the Client and became aware in the following month that the Error was attributable to a design defect in the FO System, it delayed reporting its failures to SFC for over 6 months until Feb 2019 when it completed its internal investigation.

In this case, only one client was misled to conduct naked short selling.  Does DSAL deserve such a high penalty (though you may say $2.45 million is not much for it)?  But SFC might have considered the facts that:

• The system design defect had not been discovered over a long period (10+ years).
• DSAL failed to immediately report such material non-compliance to SFC (it should not wait until the completion of internal investigation).