Dark Pool No Longer for Individual Investors

On 15 May 2015, SFC released consultation conclusions on proposals to enhance and unify the regulatory regime for alternative liquidity pools (ALPs). ALPs are commonly known as "dark pools". Unlike “lit” trading venues, they do not provide for pre-trade price and volume transparency.

Highlights of the enhanced regime include:

• no individual investors (including individual professional investors and their wholly owned investment holding corporations) will be allowed to use ALPs;
• client facilitation orders will be treated as proprietary orders, which will have a lower execution priority in ALPs than agency orders; and
• there will be no mandatory "opt-in" requirement before client orders can be routed to ALPs, but ALP operators should permit their clients to opt out of having their orders transacted in ALPs. [This requirement is obviously originated from the previous disciplinary action against HSBC Securities.]

The new regime, which involves amendments to the Code of Conduct, will come into effect on 1 Dec 2015. This is a new game plan.

Unlicensed Advising by Holding Courses

As announced by SFC on 11 May 2015, the Eastern Magistrates Court convicted Hong Kong Game Theory Association Limited and Mr Sze Ching Lok, its sole director and shareholder, of advising on futures contracts without a license following a 10 day trial. Sze was sentenced to one month’s imprisonment suspended for two years, while Hong Kong Game Theory was fined $7,000.

Between July and August 2010, Sze ran courses via Hong Kong Game Theory on trading in Hang Seng Index futures contracts in which real time investment advice was provided to attendees as to when and at what price to trade the futures contracts. This constituted advising on futures contracts, a regulated activity under the SFO, but both Hong Kong Game Theory and Sze were not licensed to do so.

Hong Kong Game Theory and Sze were acquitted of another two counts of unlicensed dealing in securities as the Magistrate gave the defendants the benefit of the doubt that Sze and the investor involved might have worked as partners in trading the stock options concerned.

Holding of investment courses in general is not prohibited by the SFO, but this is another story if the course is giving advice on how to invest in particular products.

Subsequent update on 29 Jun 2017:

• The Court of First Instance dismissed the appeal of Hong Kong Game Theory and Sze against their convictions for carrying on a business in advising on futures contracts without a licence.
• In dismissing the appeal, Deputy High Court Judge C P Pang ruled that there are no merits in any of the grounds advanced on behalf of Hong Kong Game Theory and Sze and their convictions are not unsafe nor unsatisfactory.
• While the Court also dismissed Hong Kong Game Theory’s appeal on sentence, holding that a fine of $7,000 is not manifestly excessive, it allowed Sze’s appeal against his suspended imprisonment sentence and replaced it with a fine of $5,000.

Improper Trading Arrangement

As announced on 25 Feb 2015, SFC banned Ms Katherina Lo Ka Shun from re-entering the industry for 2 years.

Lo sold 30 million shares in Grand Peace Group Holdings Limited held by her and her daughter on a pre-arranged basis. The transaction was executed on market at prices which Lo knew that they were not the price she privately agreed with the purchaser. The actual terms Lo agreed to dispose the shares included a cash discount payable to the purchaser.

There was no reasonable explanation for the payment of the cash discount and for such a transaction being executed on-market. On-market transactions should reflect what has actually been agreed between the parties.

Transactions with artificially inflated prices and secret discounts are prevailing in many markets (esp. property market). Unfortunately, they are not so regulated like securities market.

Improper Activities in Principal Trading Books

As announced on 12 Jan 2015, SFC banned Mr Jagjit Singh Dhillon, a former trader at Credit Suisse Securities (Hong Kong) Limited and Credit Suisse (Hong Kong) Limited (collectively Credit Suisse), from re-entering the industry for life over improper activities in two principal trading books for which he had responsibility.

SFC referred the matter to the police in June 2012. Dhillon was arrested by the police and holding charges were laid against him. The holding charges were withdrawn in May 2013 due to lack of co-operation from key witnesses and Dhillon left Hong Kong immediately!

Dhillon, who was responsible for trading equity derivatives, took various steps to cover up the losses and the real level of risk exposure in his trading books between 8 and 17 May 2012, including booking fictitious trades and entering incorrect market data in the trading books.

The SDA of this case disclosed the following details:

Failure to update market prices or entering incorrect market prices

• In several instances, Dhillon did not enter or update market prices, or entered incorrect market prices, in the System for his trading books. As a result, outdated or incorrect market prices were used to calculate the P&L position of his trading books, causing a misstatement in the P&L position of such trading books.

Booking of fictitious trades and subsequent cancellations

• Dhillon entered a number of fictitious trades for listed futures and options in his trading books which he subsequently cancelled before the settlement day in order to disguise the level of equity market risk exposure and mask daily losses for his trading books.

Transferring profits from other traders' books into Dhillon's trading books

• Dhillon booked a number of transactions in his trading books and in trading books managed by other traders in an attempt to transfer profits from those trading books to his own.

Dhillon's conduct led to an overstatement in the level of profits and an understatement in the level of risk exposure in his trading books, resulting in Credit Suisse having to make negative adjustments of USD5.4 million to the cumulative monthly profit and loss figures for its trading books on 18 May 2012, and recalculate the level of risk exposure recorded in its risk management systems.

Dhillon also provided his supervisors with false information when they first became suspicious of the activities in his trading books.

Whenever a rogue trader has incurred a big boss for his employer, the regulator would no doubt question how robust the firm's risk control mechanism is.

Bright Smart Fined for Advertisement with False/Misleading Information

On 29 July 2014 SFC announced that it fined Bright Smart Securities International (H.K.) Limited ("BSSI") $700,000 for allowing an advertisement which contains false/misleading information to be published.

The advertisement, published in four newspapers and on BSSI's website (www.bsgroup.com.hk) from 27 August to 14 September 2013, gave the false impression that the gold bullion business of Bright Smart Securities and Commodities Group Ltd ("BS Group", listed on SEHK) is regulated and that Bright Smart Global Bullion Limited ("BS Bullion") is regulated by SFC. In fact, gold bullion business is not a regulated activity under SFO, and BS Bullion is not licensed by SFC.

The advertisement's wording:

"坊間金業冇皇管, 上市耀才有監管 !

(耀才金業為上市大行耀才證券全資附屬, 受證監監管)" 

Translation: 

"The gold bullion business in the market is not regulated, but the listed company, BS Group, is regulated!

(BS Bullion is a wholly owned subsidiary of a large listed company BS Group, [and is] regulated by SFC)"

I would say this "misleading" advertisement is a borderline case. First, BS Group, though not a licensed corporation, is regulated by SEHK and SFC as a listed company. Second, the bracketed sentence may be arguably interpreted as saying that BS Group (instead of BS Bullion) is regulated by SFC! But of course, such ambiguous wording could make the public to perceive that BS Bullion is regulated by SFC, thus deserving a disciplinary action.

Interestingly, immediately after SFC's announcement of this sanction, BSSI published a newspaper advertisement (which "thank" SFC for the reminder) as "crisis management":

Actually this is not first time BSSI was penalized by SFC for providing false/misleading information to the public:

• In 2004, SFC reprimanded and fined BSSI for publishing 13 statements in two newspapers, which stated incorrectly that clients of BSSI could make direct payment to CCASS for settlement.
• In 2005, SFC reprimanded and fined BSSI for posting misleading contents in a newsletter on BSSI’s website in June 2004, which stated that one of the duties of BSSI’s customer services officers was to provide investment analysis. It held the customer services officers out as performing Type 4 regulated activity when three of them were unlicensed.

I just wonder if BSSI has the internal procedure of asking its compliance officers to vet their newsletters/advertisements.

Enhanced Competency Framework for Private Wealth Management Practitioners

HKMA recently announced the launch of an Enhanced Competency Framework (ECF) for private wealth management (PWM) practitioners in Hong Kong.

HKMA said it has led a Task Force, comprising representatives from the newly established Private Wealth Management Association (PWMA), Hong Kong Institute of Bankers (HKIB), Hong Kong Securities and Investment Institute (HKSI), and Treasury Markets Association (TMA), in developing the ECF.  Industry consultation on the ECF was completed in 2013, with general support from the industry.

The ECF is a non-statutory framework that sets out an enhanced level of core competence and on-going professional development of PWM practitioners who undertake customer-facing roles.  New entrants and relevant industry practitioners may meet the ECF benchmark by self-study and / or taking accredited training programmes, and passing examinations.  The training programmes and examinations will consist of two modules: Module 1 on technical, industry and product knowledge, and Module 2 on ethics and compliance.  Providers of the initial programmes and examinations will be HKSI for Module 1 and HKIB for Module 2.  The PWMA will be responsible for certifying qualified practitioners as Certified Private Wealth Professional (CPWP).

Following the financial tsunami, the professionalism of PWM practitioners has been severely criticized.  I had read the ECF consultation paper and found the contents of the CPWP programmes quite comprehensive and advanced.  The ECF is expected to serve as a benchmark of competency for private bankers, but how about PWM practitioners not working in the banking sector?  I don't see SFC has formally given any acknowledgement or blessing on the ECF, seemingly it is a single-handed project of HKMA, though HKMA's circular about the ECF was copied to SFC.

My questions:

• Can PWM practitioners licensed by SFC also complete the CPWP programmes and obtain SFC's recognition?
• Can other PWM related professional qualifications, like CFA, CWM, etc., get any exemption from the CPWP programmes?

Without covering all PWM practitioners (from banks and non-banks) in Hong Kong, I am afraid the ECF is only "a small circle game".

Ernst & Young's Dilemma

SFC announced that on 20 June 2014 Ernst & Young (EY) filed a Notice of Appeal in respect of the court order to produce documents held by its Mainland affiliate, EY Hua Ming (EYHM), having produced a disc of documents it held in Hong Kong.

EY's Notice of Appeal relates to documents held by EYHM, EY's agent in carrying out specific audit activities as part of EY's engagement as reporting accountant and auditor of Standard Water Limited.

The disc of documents produced to SFC were found by EY on various hard drives in its Hong Kong office on the eve of the trial in this case, in March 2013, when production of the documents were refused by EY on the basis that the hard drives belonged to EYHM.

EY had argued during the trial that it was prevented from producing audit working papers held by EYHM because of restrictions under PRC law. SFC argued and the court accepted that PRC law does not prohibit the production of these documents and there is no blanket prohibition against their production under PRC law.

SFC also argued that EY had not done anything to follow the process under PRC law for obtaining clearance of these documents. EY has informed the SFC that it has provided these documents to China Securities Regulatory Commission (CSRC) as part of this process.

My comments/queries:

1. Why didn't EY seek the clearance from CSRC earlier when dealing with SFC (given that the communication between CSRC and SFC is so fantastic)?
2. While those PRC authority figures can see no difference between "without legal basis" and "illegal", is "PRC law does not prohibit" really a protection for EY?