Summary Review of SFC's Disciplinary Action against Swiss-Asia

On 8 November 2022, SFC fined Swiss-Asia Asset Management (HK) Limited $3 million for internal control failings and regulatory breaches in relation to the monitoring of trading activities in discretionary accounts and record keeping.

In mid-April 2015, a client signed an asset management mandate granting Swiss-Asia full discretionary power to manage the account, subject to certain management restrictions, e.g.

• Swiss-Asia could sell covered call options on existing securities and option strategies which have defined risk.
• It should not include any option strategies that involved uncapped risk or purchase options as a speculative strategy for the portfolio.

In late August 2016, the client complained to Swiss-Asia that its licensed representative conducted option trading in the account which was much riskier than agreed.

From May 2015 to August 2016, the licenced representative placed a total of 869 options trades in the account. Swiss-Asia only submitted to SFC in April 2017 that it had identified 225 of these options trades to be outside the management restrictions.

Swiss-Asia asserted that its responsible officers would randomly select five to seven portfolios on a monthly basis and conduct rough high-level reviews on them, which is considered inadequate by SFC. It did not maintain records of such random sample checks.

As a result of this case, Swiss-Asia has revised its internal control policies and procedures such that post-trade checks would be conducted on all accounts on a weekly basis. Any breaches in investment strategies or exceptions in the investment restrictions would be documented and escalated to executive management.

Swiss-Asia claimed that it operated with the support of the three lines of defence, i.e. (1) management supervision, (2) oversight by the legal and compliance team, and (3) audit by external auditors. SFC questions how legal and compliance as well as external auditors could perform their functions properly and effectively without records of the sample checks. I also question if legal and compliance (rather than risk management) would have the expertise in option strategies to identify breaches of investment mandate.

SFC highlights that the monitoring of trading activities are important for the detection and prevention of potential market misconduct (i.e. not just breaches of investment mandate). If this case involved also market misconduct, the penalty would be much higher.

SFC's Statement of Disciplinary Action is found here.

Proposed Amendments to SFO: Advertisements of Investment Products

In June 2022, SFC published a consultation paper on proposed amendments to the SFO. The proposal contains 2 enforcement-related amendments and the other one relating to the professional investor (PI) exemption (PI amendment) under section 103 of the SFO. I discuss the PI amendment in this article.

The PI amendment is triggered by the Pacific Sun case happened many years ago, summarized as follows:

• SFC announced on 21 Mar 2013 that Pacific Sun Advisors Limited and its director Andrew Mantel were charged for issuing an advertisement on the corporate website promoting "Pacific Sun Greater China Equities Fund" (the Fund) without SFC's authorization. The defendants submitted that they intended to sell the Fund only to PIs and so the advertisements did not require SFC's authorization under the PI exemption. Surprisingly, the Magistrate accepted the defendants' argument and acquitted them.
• SFC announced on 10 Jun 2014 that following its appeal, the Court of First Instance (CFI) issued a ruling in Jan 2014 clarifying that the advertisements in question did not fall within the PI exemption and ordered the case to be returned to the Magistrate for reconsideration. The CFI made it clear that the exemption only applies where the advertisement states on its face that the terms of the offer are limited to PIs. As a result, the defendants were convicted at the Magistrate.
• SFC announced on 20 Mar 2015 that following the defendants' appeal, the Court of Final Appeal (CFA) overturned the ruling of the CFI in that the PI exemption applies even if the intention to sell the Fund only to PIs is not expressed in the advertisement, unless the Fund is subsequently sold to a retail investor. It follows that contravention of section 103 of the SFO can only be established well after the offer to the public has been issued.

SFC has definitely thought the CFA's ruling is not in line with the intention of the PI exemption. SFC expressed on 20 Mar 2015 that it will study the CFA's decision to determine whether there should be any proposal to amend section 103 of the SFO. However, SFC has not taken any action until Jun 2022.

In the consultation paper, SFC proposes an amendment to section 103(3)(k) to restore the PI exemption to the original point in time when the advertising materials are issued. Therefore, following the proposed amendments, unauthorized advertisements of investment products which are intended to be sold only to PIs may only be issued to PIs who have been identified as such in advance by an intermediary through its know-your-client and related procedures, regardless of whether or not such an intention has been stated on the advertisements.

My views:

• The CFA's ruling was weird. Even the CFA made it clear that the burden of establishing the PI exemption applies rests on the defendants, it didn't say expressing the intention to sell the Fund only to PIs was a must.
• SFC's proposed amendments overshoot. It sounds impractical to require an intermediary to identify the PIs (esp. corporate and individual clients) in advance before issuing unauthorized advertisements of investment products.
• My stance is close to the Magistrate's decision in 2014. Section 103 should be amended to require an intermediary to express prominently in the advertisements that the unauthorized product is intended to be sold only to PIs, otherwise the PI exemption won't apply. SFC can subsequently sample check if the intermediary has sold the product to retail investors.

Customer Supplied Systems

On 30 Dec 2021, SFC announced that it reprimanded and fined Grand International Futures Co., Limited (GIFCL) $8,000,000 and suspended the licence of GIFCL's responsible officer, Mr Liang Benyou for 8 months.

Liang has been accredited to GIFCL and approved to act as its responsible officer for RA2 and RA5 since 3 October 2017. Liang has been GIFCL's MIC of the OMO, OCR, Compliance and IT since 1 Sep 2017, and MIC of KBL since 4 Apr 2018. This is probably the first time a MIC of Compliance was sanctioned by SFC, though obviously Liang was not a full-time compliance professional.

Summary of Facts

• SFC received a complaint against various LCs, including GIFCL, for allowing clients to place orders to their broker supplied systems (BSS) through a software called Xinguanjia (XGJ). XGJ was developed and/or provided by Hengxin Software Limited.
• The complainant alleged that XGJ permitted the LCs' clients to create sub-accounts under their accounts maintained with the LCs, and the clients had solicited investors in Mainland China to trade through the sub-accounts via XGJ without having to open separate securities accounts with the LCs in Hong Kong.
• Between Oct 2017 and Oct 2018 (Relevant Period), GIFCL has permitted 103 clients to use their designated customer supplied systems ("CSSs", including XGJ) for placing orders. From Dec 2017 to Oct 2018, the number of futures contracts transacted by GIFCL clients through orders placed via CSSs accounted for 93.92% to 99.25% of its monthly trading volume.

Failure to perform adequate due diligence on the CSSs and assess and manage the associated ML/TF and other risks

• Before allowing its clients to connect their CSSs to its BSS, GIFCL would require its clients to: (a) complete an application form and risk disclosure statement; and (b) apply for authorisation from its BSS Supplier. But GIFCL did not perform any due diligence or testing on the CSSs used by its clients.
• While GIFCL claimed that it relied on the BSS Supplier to conduct due diligence on the CSSs, the BSS Supplier stated that GIFCL had never instructed it to, and it did not, conduct any due diligence or test on the CSSs to examine their design and functions.
• In the absence of proper control over the use of CSSs by its clients, GIFCL has exposed itself to the risks of improper conduct such as unlicensed activities, money laundering, nominee account arrangement and unauthorized access to client accounts.

Failure to conduct proper enquiries on client deposits which were incommensurate with the clients' financial profiles

• SFC's review of the fund movements in sample client accounts showed that the amounts of deposits made into the accounts of four clients (Four Clients) were incommensurate with their financial profiles declared in their account opening documents, which were unusual and/or suspicious (Anomalies).
• GIFCL claimed that it was aware of the Anomalies during the Relevant Period. As part of its monthly monitoring measure, it had contacted the top clients (including the Four Clients) via WeChat to understand the client situation (Monthly Monitoring).
• However, the Monthly Monitoring was inadequate:
• GIFCL did not document the policies and procedures governing the Monthly Monitoring.
• The scope of the Monthly Monitoring was limited to top 10 clients with the highest number of transactions and top 10 clients with the highest amount of deposits.
• GIFCL has not maintained any record of the Monthly Monitoring, including its enquiries allegedly made with the Four Clients and their responses to the enquiries.

Failure to maintain effective ongoing monitoring system to detect and assess suspicious trading patterns in client accounts

• SFC’s review of the transactions in sample client accounts showed that there were 100,989 self-matched trades (i.e. the client’s order matched with his/her own order in the opposite direction) (Matched Trades) in nine client accounts during the Relevant Period. But GIFCL was not aware of the Matched Trades at the material time.
• During the Relevant Period, GIFCL relied on its dealing department to monitor client trading activities. However, it did not provide its staff with any guidelines or procedures for such monitoring.

As a result, SFC remarked that LCs should assess the risks of any new products and services (especially those that may lead to misuse of technological developments or facilitate anonymity in ML/TF schemes) before they are introduced and ensure appropriate additional measures and controls are implemented to mitigate and manage the associated ML/TF risks. Approving the use of CSSs by clients is indeed a new challenge to LCs.

In addition, as SFC said, the LCs' clients had solicited investors in Mainland China to trade through the sub-accounts via XGJ without having to open separate securities accounts with the LCs in Hong Kong. This may even facilitate the breach PRC's regulations which restrict cross-border online brokers.