Illicit Mark-Up/Down of Execution Prices

As announced on 29 Feb 2016, SFC reprimanded and fined Yuanta Securities (Hong Kong) Company Limited  $4 million for failing to disclose the actual execution price and properly and adequately disclose the financial gains it made whilst handling bond transactions for its clients.

From 1 Jul to 31 Dec 2012, Yuanta Securities, acting as its clients' agent, made approximately $3.1 million in commission by marking-up or marking-down the execution prices in some of the 256 bond transactions for 96 clients without making proper and accurate disclosure to the clients.

After receiving a client’s buy order, Yuanta Securities' financial product team would buy the product through a counterparty and mark-up the trading price before passing it to the sales team which would further mark-up the price before selling it to a client. The same approach was used in executing sell orders by marking down the trading prices.

Whilst some of the clients appeared to be aware of the amount of the commission the sales team earned from the trades, such commission was not always properly disclosed in the trading instruction form and was not mentioned in the daily statements sent to the clients. Furthermore, the clients were charged additional fees by Yuanta Securities without their knowledge and consent since they were not informed of the financial product team’s mark-up/mark-down.

Under para 8.3 of the Code of Conduct, where a securities firm enters into a back-to-back transaction concerning an investment product, it should disclose to the client the trading profit to be made. The trading profit should be disclosed as a percentage ceiling of the investment amount or the dollar equivalent. Secret mark-up/mark-down is definitely an illicit practice.

Landmark Ruling on S.300 of SFO

On 15 Jan 2016, the Court of First Instance found that two solicitors, Mr Eric Lee Kwok Wa and Ms Betty Young Bik Fung, and Eric Lee’s sister, Ms Patsy Lee Siu Ying, contravened the SFO by insider dealing in the shares of Asia Satellite Telecommunications Holdings Ltd (Asia Satellite) and engaged in fraud or deception in transactions involving securities of Hsinchu International Bank Company Ltd (Hsinchu Bank).

Hsinchu Bank was a listed company on the Stock Exchange of Taiwan in Sep 2006 and Asia Satellite was a listed company on SEHK in Feb 2007.

The court's decision is a landmark ruling on the interpretation of S.300 of the SFO which prohibits the use of fraudulent or deceptive schemes in transactions involving securities.

SFC started civil proceedings in the court against Eric Lee, Betty Young, Patsy Lee and Ms Stella Lee, both sisters of Eric Lee, in Dec 2010 under S.213 of the SFO and alleged the defendants made a total profit of $2.9 million in these transactions.

SFC alleged that, in relation to Hsinchu Bank transactions in Sep 2006:

• Betty Young obtained information about a tender offer for Hsinchu Bank shares while working as a lawyer seconded to a client of her employing law firm;
• the client she was seconded to intended to make the tender offer and she was working on the offer;
• the information about the offer was non-public, confidential and materially price sensitive;
• subsequently, Betty Young bought Hsinchu Bank shares and tipped off Eric Lee and his sisters to buy the shares before the announcement of the tender offer; and
• this amounted to fraud or deception under S.300 of the SFO because Betty Young owed duties to her employer and their client including the duty to refrain from using such information for personal gain.

SFC further alleged that, in relation to Asia Satellite transactions in Feb 2007:

• Eric Lee obtained information about the proposed privatization of Asia Satellite shares when the law firm he worked for advised on this transaction;
• that information was non-public, confidential and materially price sensitive;
• subsequently Eric Lee tipped off Betty Young and his sisters to buy Asia Satellite shares before the announcement of the proposed privatization; and
• this amounted to insider dealing under S.291 of the SFO.

The court found that these allegations were proven against Betty Young, Eric Lee and Patsy Lee, but there was not enough evidence to prove the allegations against Stella Lee. Nevertheless, the court may exercise its power under S.213 of the SFO against her to remove the illicit profit from her and restore the victims in the transactions.

Since Hsinchu Bank is not a HK listed company, SFC can't initiate legal proceedings based on the insider dealing provisions under the SFO, but it can now effectively make use of S.300.

Corrupted Analyst

As announced on 16 Nov 2015, SFC banned Mr Gong Yueyue, a former licensed representative, from re-entering the industry for 15 years following his conviction by the Eastern Magistrates' Court on 25 February 2015 for an offence of bribery.

The Court found that, in Mar 2014, Gong accepted $100,000 for the publication of a research report on a listed company. The target share price proposed by the research report was not an independent and fair assessment of the listed company.

In late 2013, a third party asked Gong to prepare a research report on the listed company. Draft reports were prepared by Gong and after they were shown to the management of the listed company, the third party indicated to Gong that the target share price should be revised upwards. On the day the research report with the revised target share price was published, Gong received $100,000 from the third party.

This analyst was so severely penalised by SFC because he was convicted for bribery.

Mis-selling of Overseas Fund

As announced on 16 Jun 2015, SFC reprimanded and fined Phillip Securities (Hong Kong) Limited $1 million for failings over its sale of a fund to 4 clients. Phillip Securities also agreed to repurchase the fund from the clients at the principal amount less dividends plus interest if the amount had been invested in a 12-month fixed term deposit over the same period of time.

Phillip Securities sold the American Pegasus Fixed Income Fund – Series II Segregated Portfolio to the four clients around Aug 2004, involving transaction amount of approximately $819,000.

The American Pegasus Fixed Income Fund – Series II Segregated Portfolio is a viatical settlement which invested in senior life settlement insurance policies issued by investment grade insurance companies in the United States. It is not a product authorized by SFC. In June 2010, investors were notified that the fund would be wound up as it did not have sufficient value to continue to pay life insurance policy premiums until the expected maturity of the life settlement policies held by it. The fund was liquidated in Jul 2011 and the clients have not been able to recover their investment.

Phillip Securities failed to:

• conduct adequate due diligence on the fund before selling it to clients;
• provide adequate training and/or sufficient product information to its sales staff to ensure they fully understand the nature of the fund, the risks involved, and for which types of investors the fund would have been suitable; and
• implement sufficient measures to ensure that its sales staff had assessed the suitability of the fund to clients, and to monitor and review the selling process.

This case illustrates that for mis-selling of only one fund to just a few clients, involving a non-material total amount, more than 10 years ago, SFC would still take disciplinary action against the firm. I guess in this case the affected clients of Phillip Securities had lodged their complaints to SFC.

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.