Email Fraud

As announced on 29 Jul 2013, SFC reprimanded A One Investment Company Limited and fined it $1.2 million for internal control failures relating to the unauthorized sales of client securities and the unauthorized transfers of more than $7 million in client funds held by A One to third party accounts. SFC also suspended Ms Alysia Ann Lee's RO approval and her licence for 8 months.

The disciplinary action follows an SFC investigation into a self report by A One about suspected fraudulent activities in the account of one of its clients.

Between 4 Jul 2012 and 10 Aug 2012, 538,000 shares of Li & Fung Limited in the relevant client's account were sold and a total of EUR676,000 and GBP160,000 were transferred out of the client's account in 13 transfers to third party bank accounts in Italy, Norway, Singapore and the United Kingdom. The sales and transfers were carried out pursuant to instructions that were sent to Lee at A One's email account (the Email Instructions) from an email account that the client had previously used in his communications with A One. The client denied that the instructions were given by him and claimed that his email account had been compromised.

SFC found that:

• A One did not have any manual, written policy or procedure for handling client requests to transfer funds to third party accounts.
• A One claimed that clients who requested to transfer funds to third party accounts were required to provide a signed authorization letter, so that the client's signature could be verified by comparing it against the signature on his/her account opening documents. However, A One never received the original signed authorization letters for the above 13 transfers. It received a scanned copy of the signed authorization letter on the day it processed the client's request for only one of the transfers. In all other cases, scanned copies of the signed authorization letters were received only after the transfers had been completed.
• A One did not take any other step to verify the identity of the person who gave instructions for the sales and the transfers, or to verify the authenticity of the instructions.
• Although two ROs were required to endorse the remittance application form (which gives the bank instructions to effect a remittance), it does not appear that they bore any responsibility for verifying the authenticity of the client's instructions.
• The circumstances of the transfers did not accord with the historical pattern of transfers from the relevant client's account to third party bank accounts, but A One made no enquiries to satisfy itself that the transfers were reasonable.

SFC also found that in response to the Email Instructions, Lee set in train the chain of events that facilitated the unauthorized transfers from the relevant client's account. She acted negligently in handling the relevant transfers and failed to properly discharge her managerial duties. Therefore, A One's failures are attributable to her.

Taking of client instructions by email is not unacceptable, but authentication of client identity is a headache. In this case, there were too many alarms to be ignored by a reasonable man.

Apex Horizon

On 13 May 2013, Cheung Kong (Holdings) Limited, Cheung Kong Property Development Limited, Pearl Wisdom Limited (PWL) and Horizon Hotels & Suites Limited (collectively the Cheung Kong parties) entered into an agreement with SFC to unwind the sale of hotel room units at Apex Horizon.

Apex Horizon (雍澄軒) is a development in Kwai Chung comprising 360 hotel room units. On 18 Feby 2013, Cheung Kong announced at a press conference that its subsidiary PWL was offering 65 of the 360 hotel room units in the development at an average selling price of $5,200 per sq. ft. On offer were 660 sq. ft. 2-bedroom hotel room units and 909 sq. ft. 3-bedroom hotel room units. All 65 units were sold on the same day with the rest of the units sold shortly afterwards.

SFC has been investigating whether the offer to purchase hotel room units at The Apex Horizon development constituted an offer to acquire an interest in or to participate in a Collective Investment Scheme (CIS) under the SFO. A total of 360 hotel room units were individually sold to purchasers by the vendor, PWL, in Feb 2013.

PWL will issue a letter to all purchasers informing them that it wishes to cancel each contract and, in return, it will:

• reimburse every purchaser the deposit and any part payments together with interest at the rate of 2% p.a. above the prime rate specified by HSBC for the period from the date each amount was paid respectively until 30 May 2013; and
• offer an amount of $10,000 as reimbursement of any reasonable legal and other expenses.

SFC formed the view that the offer to purchase hotel room units at Apex Horizon appeared to be an invitation to acquire an interest in or to participate in a CIS as defined in the SFO.

A CIS has 4 relevant elements:

• it must involve an arrangement in respect of property;
• participants do not have day-to-day control over the management of the property even if they have the right to be consulted or to give directions about the management of the property;
• the property is managed as a whole by or on behalf of the person operating the arrangements; and
• the purpose of the arrangement is for participants to participate in or receive profits, income or other returns from the acquisition or management of the property.

In this case, SFC considered the fact that day-to-day management of the hotel was to be in the hands of a separate operator appointed to operate the hotel on behalf of the purchasers and the hotel operator would control key functions necessary to manage and supervise the hotel including allocation of guests to rooms.

The Cheung Kong parties do not agree with SFC’s view and contend that the purchasers have effective day-to-day control of their rooms and that it is an investment in real estate. However, SFC informed the Cheung Kong parties that it intended to commence proceedings under S.213 of the SFO in the Court of First Instance to seek orders unwinding the sale and returning all deposit moneys and part payments to purchasers. The agreement avoids these proceedings being commenced at this stage.

This is an important case illustrating the very wide scope of CIS under the SFO.

Issue of Advertisements of Unauthorized Fund

As announced by SFC on 21 Mar 2013, the Eastern Magistracy acquitted Pacific Sun Advisors Limited (Pacific Sun) and its director Mr Andrew Mantel for 4 counts of issuing advertisements to promote a collective investment scheme (CIS) without SFC's authorization, in contravention of S.103 of the SFO.

SFC alleged that between Nov and Dec 2011, the defendants issued an advertisement on the corporate website of Pacific Sun promoting a CIS called "Pacific Sun Greater China Equities Fund" (the Fund) without SFC's authorization. On or around 2 and 3 Nov 2011, the defendants issued an advertisement regarding the launch of the Fund to the public by email without SFC's authorization.

During 3 days of evidence, the defendants submitted that they intended to sell interests in the units of the Fund only to professional investors and so the advertisements did not require SFC's authorization under a statutory exemption. But SFC submitted that the exemption did not permit advertisements that had not been authorized by SFC to be issued to the public and that in this case there was no evidence that the interests in the Fund had only been sold to professional investors.

The Magistrate accepted the defendants' argument and ruled also that the advertisements did not constitute invitations to the public to invest in the Fund. SFC will consider an appeal of the decision.

This case is interesting. For my previous interpretation of S.103 of the SFO, advertising an unauthorized fund without SFC's authorization is no doubt illegal, even if the promoter has the "intention" of selling the fund to PI only. The court judgement has overturned this thought!


Subsequent update on 10 Jun 2014:

• Following SFC's appeal concerning the acquittal in which the Court of First Instance in Jan 2014 issued a ruling clarifying that the advertisements in question did not fall within the exemption and ordered the case to be returned to the Magistrates’ Court for reconsideration.
• The Court of First Instance made it clear that the exemption only applies where the advertisement states on its face that the terms of the offer are limited to professional investors. SFC considers this ruling protects retail investors from the risks of direct marketing of inappropriate or risky investment products.
• As a result, Pacific Sun and Andrew Mantel were convicted at the Tsuen Wan Magistrates' Court on 4 charges of issuing advertisements to promote a CIS without SFC's authorization. Pacific Sun was fined $20,000 and Andrew Mantel was sentenced to 4 weeks' imprisonment suspended for 12 months.

Subsequent update on 20 Mar 2015:

• The Court of Final Appeal (CFA) upheld an appeal by Pacific Sun and Andrew Mantel in relation to issuing advertisements to promote a CIS without SFC's authorization. The ruling of the CFA overturned a decision by the Court of First Instance on the interpretation of S.103 of the SFO.
• The CFA decided the Court of First Instance erred in its ruling in that the exclusion applies even if the intention to dispose of the securities or interests in a CIS only to professional investors is not expressed in the advertisement, invitation or document. The CFA made it clear that the burden of establishing the exclusion applies rests on the defendant and not on SFC.
• The CFA also stated that the professional investor exemption would not apply if a person published an unauthorized offer to the public and sold the advertised securities to a retail investor.
• This ruling means advertisements of unauthorized CIS can be issued to the general public if the issuer only intends to sell them to PI. It also means a contravention of S.103 of the SFO can only be established well after the offer to the public has been issued.
• SFC alleges that it will study the CFA's decision to determine whether there should be any proposal to amend S.103 of the SFO.

Inadequate Investor Profiling

As announced on 4 Mar 2013, SFC reprimanded Manulife Asset Management (Hong Kong) Limited (MAM) and fined it HK$24 million for inadequate internal controls in relation to the distribution of Manulife Global Fund (authorized by SFC) from 2007 to 2012.

SFC's findings focus on MAM's systems and processes for understanding its customer’s financial situation, investment experience, and investment objectives in soliciting or recommending the sale of the Fund to them.

Between 2007 and 2009, Manulife Asset Management obtained this information by performing an investor profile for each customer. However, 73% of the customers in 2009 were not profiled or their information was either incomplete or outdated for at least 12 months.

Needless to say, "not profiled" is more severe than "incomplete" which is in turn more severe than "outdated". However, SFC gave only the total percentage (73%) of all these deficiencies but did not provide the breakdown.

After 2010, MAM introduced a questionnaire to assess each customer's risk profile. By Feb 2012, the new process had not been fully implemented to all customers and MAM still had not secured a completed risk profile questionnaire from 70% of the Fund's customers.

Together with concerns about the quality and extent of its record-keeping, these failures have jeopardised MAM's capacity to ensure that recommended securities are suitable for each customer.

Despite these failures, SFC said there has been no default in any of the sub-funds of the Fund nor has any customer complained about the performance or suitability of the fund. Then how did SFC come up with such a huge amount of penalty? Of course, MAM is a big firm. If it was a small IFA incurred with the same deficiencies, I don't think SFC could impose a fine of $24 million.

Victims from Taiwan

Don't presume victims of Lehman Brothers related products sold in Hong Kong were limited to local residents. Some of them may be overseas investors.

As announced on 4 Dec 2012, SFC reprimanded President Securities (Hong Kong) Limited and fined it $2 million for failing to act in the best interests of its clients when accepting subscriptions for a number of Lehman Brothers related structured products by 21 Taiwanese clients in 2008.

SFC's investigation found that the selling process of the products gave rise to a number of regulatory concerns:

• The Taiwanese clients were referred to President Securities by its parent company in Taiwan, President Securities Corporation (PSC). They opened accounts with President Securities before they purchased the products, but the account opening process was handled by PSC.
• President Securities staff signed as witnesses on the Taiwanese clients’ account opening documents when, in fact, they had never met the clients.
• No one from President Securities contacted the Taiwanese clients to verify their identities, explain the account opening documents to them, establish their financial situation, investment experience, and investment objectives, and make risk disclosure to them.
• President Securities did not sufficiently ensure that the Taiwanese clients understood the products and accepted the risks associated with them before accepting their subscriptions for the products. It relied on standard risk disclaimers signed by the Taiwanese clients even though no explanation of the disclaimers had been given to the clients.
• A number of the products prescribed minimum subscription requirements to restrict the categories of investors eligible to invest in them. Since some of the Taiwanese clients' subscriptions amounts did not meet the minimum subscription requirements, President Securities pooled their orders together so as to meet the minimum subscription requirements. However, President Securities did not inform such clients that their orders would be pooled together.

It appears that President Securities was only a booking center for the product distribution, while all the (lousy) jobs were done by its parent company.

Product Due Diligence Totally Outsourced

As announced on 16 Aug 2012, SFC reprimanded and fined RBC Investment Management (Asia) Limited (RBC) HK$4 million in relation to its provision of investment advice to clients on a number of non-SFC authorized funds between Nov 2006 and Jul 2008. RBC also agreed to make repurchase offers to eligible customers and compensation to eligible former customers in a resolution made under S.201 of the SFO.

SFC's investigation found that:

• RBC did not provide adequate guidance to its staff on conducting due diligence on funds before making investment recommendations or solicitations to clients.
• RBC relied on its Singapore office to conduct due diligence on investment products but it saw no record of any due diligence conducted by its Singapore office, and therefore was not aware of the scope and the extent of any due diligence carried out by its Singapore office.
• RBC did not provide adequate practical guidance to relationship managers (RMs) in providing investment advice or recommendations. RBC also did not have any measure for the overall risk of investment products it sold.
• RBC's RMs did not record or document any product suitability assessment they had undertaken to demonstrate that RBC was reasonably satisfied that the investment products recommended by the RMs were suitable for their clients.
• RBC relied only on e-mails, meeting call reports, file notes and telephone recordings as records of investment advice and recommendation. However, such records are incomplete and do not provide a substantiated account of the advice and/or recommendation given and the underlying rationale.

While a licensed firm may outsource the product due diligence work to an external specialist, it can't turn a blind eye to the whole process.

More User-Friendly Law

Today SCMP reports that the Department of Justice (DoJ) is now planning to make Hong Kong legislation more accessible to the public by adopting a simpler and gender-sensitive writing style. Such initiative will be applied to all legislation starting from this year.

Eamonn Moran, a law draftsman of DoJ, cited Australia and New Zealand as examples of countries that effectively used plain language in legislation to make laws more accessible to the public.  Then people don't need to be a legal professional in order to understand what the law is saying.

Under the new style, "he" will no longer be used to denote "she", and we will see "police officer" instead of "policeman" or "lay person" instead of "layman".  My puzzle is whether in future legislation we must use "she/he" (lady first).

The word "shall" will be replaced by "must" to impose an obligation.  No kidding, in the past I really heard a guy arguing that "shall" is only a future tense expression!

In addition, law drafters will limit unbroken text to about 50 words.  Interestingly, SCMP's article mentions one sub-clause under Section 187 of the Securities and Futures Ordinance  (SFO), which uses 179 words to explain the use of incriminating evidence in proceedings.  Let me end this blog post by reproducing this sub-clause below:

QUOTE

(2) Notwithstanding any other provisions of this Ordinance, where-
(a) an authorized person within the meaning of section 179 requires a person to provide or make an explanation or statement under that section; or
(b) an investigator requires a person to give an explanation or further particulars or to give an answer to any question under section 183,
and the explanation or statement, the explanation or further particulars, or the answer (as the case may be) might tend to incriminate the person and the person so claims before providing or making the explanation or statement, giving the explanation or further particulars, or giving the answer (as the case may be), then the requirement as well as the explanation or statement, the explanation or further particulars, or the question and answer (as the case may be) shall not be admissible in evidence against the person in criminal proceedings in a court of law other than those in which the person is charged with an offence under section 179(13), (14) or (15) or 184, or under section 219(2)(a), 253(2)(a) or 254(6)(a) or (b), or under Part V of the Crimes Ordinance (Cap 200), or for perjury, in respect of the explanation or statement, the explanation or further particulars, or the answer (as the case may be).

UNQUOTE