Hong Kong Regulatory IN THIS ISSUE NEWSLETTER NEWS

Transcription

1 Hong Kong Regulatory OCTOBER 2017 IN THIS ISSUE NEWS Prosecution of Corporate Executives Latest Developments...1 REGULATORY STANDARDS/UPDATES...3 INTERMEDIARIES/MARKET SUPERVISION...4 KEY PRODUCT DEVELOPMENTS...4 SIGNIFICANT ENFORCEMENT ACTIONS...5 NEWS PROSECUTION OF CORPORATE EXECUTIVES LATEST DEVELOPMENTS In this article, we discuss four areas where notable enforcement actions against corporate executives occurred in the first half of 2017: Civil liability facing executive directors for serious conflicts of interest Criminal prosecution for conspiracy to defraud facing executives for inflating revenue and profit figures The largest civil penalties imposed on senior executives, including non-directorate staff, for falsification of financial statements Inescapable personal lability facing executives for late disclosures under Part XIVA Each action highlights a sterner approach to corporate fraud and misfeasance and the risks faced by corporate executives of listed companies regardless of whether they have a seat on the board. Where there is evidence of systemic fraud, the appropriate sanction is normally liquidation of the company. While cases involving isolated acts alone may not be sufficient to justify winding up a company, the fact that the offending activities have ceased does not mean that a more lenient approach will be taken. Executives are expected to adopt a questioning mind. However, relatively few cases remain where criminal charges are brought against corporate executives. Cases brought against executives resident in mainland China continue to falter, leaving regulators with no option but to pursue civil disqualification proceedings. Visit sidley.com for more information on Sidley s regulatory practice. Executives Face Civil Liability for Serious Conflicts of Interest In January, following a two-year-long investigation, the Securities and Futures Commission (SFC) initiated a civil lawsuit to disqualify five directors of a troubled solar equipment supplier for up to 15 years. Trading was suspended indefinitely by the regulator since May 2015 after shares lost half their value within an hour wiping out more than HK$20 billion market capitalization. The SFC argued that the company s main source of revenue came almost entirely from sales to its mainland parent. The company later issued a profit warning signaling a record loss, disclosing concerns about its ability to recover receivables from connected parties and worries over the future viability of its business model given its financial dependence on its mainland parent. All five directors (believed to reside in mainland China) agreed to not contest the civil case. In September, the civil court found that the directors (who have all since resigned) failed to take proper steps to recover receivables by putting the interests of connected parties before the company and thereby failing to act in the company s best interest. The former chairman was disqualified for eight years and ordered to procure payment of all outstanding receivables from the mainland parent. The remaining four independent non-executive directors were disqualified for up to four years. Hong Kong Regulatory OCTOBER

2 Executives Face Criminal Prosecution for Conspiracy to Defraud The case was the first public interest petition issued by the SFC to wind up a company listed in Hong Kong. The court held that the appropriate sanction where there has been fraud, or a listing has been obtained by fabrication of accounts, is normally the winding up of the company. This latest development marks the first criminal indictment following the SFC s investigation for misfeasance, now nearly a decade old. The pair face a maximum prison sentence of 14 years. In May, the SFC issued a statement reporting that Hong Kong police have charged a board member and a staff member of mainland China s now defunct scrap metal recycler, with one count of conspiracy to defraud. As we previously reported, in March 2015, following the appointment of provisional liquidators, the SFC wound up the company, which was said to have published fictitious/inflated sales revenues and later delisted. The case was the first public interest petition issued by the SFC to wind up a company listed in Hong Kong. The court held that the appropriate sanction where there has been fraud, or a listing has been obtained by fabrication of accounts, is normally the winding up of the company. This latest development marks the first criminal indictment following the SFC s investigation for misfeasance, now nearly a decade old. The pair face a maximum prison sentence of 14 years. Largest-Ever Disgorgement Order Imposed on Senior Executives and Non-Directorate Staff In June, the Market Misconduct Tribunal (MMT) 1 found that five senior executives of Greencool had knowingly falsified the now delisted refrigerant company s accounts over a five-year period. The SFC alleged that the company s net asset value had been grossly inflated by nearly HK$1 billion. The former chairman, a People s Republic of China (P.R.C.) national who failed to contest the proceedings, was disqualified for five years and ordered to pay nearly HK$490 million in disgorgement and other penalties. This represents the single largest disgorgement order obtained by the SFC to date. Three other directors, all P.R.C. nationals, were also disqualified for five years. As mainland China does not extradite its own citizens, the four did not face criminal charges. A fifth, the financial controller and full-time qualified accountant under the Growth Enterprise Market (GEM) Listing Rules, 2 was disqualified for three years even though he had no actual knowledge of the accounting fraud and was not a director of the company. Nevertheless, the MMT stated that his role carried a higher duty of care to monitor the accounting systems of all onshore subsidiaries, which he had allowed the board to limit to financial reporting at the group level only. Even if not intended, the MMT stated this was tantamount to deceit on the Stock Market authorities and on the market. A sixth executive, with responsibility for managing the Hong Kong office and who was kept outside the loop, escaped penalty. Two other independent non-executive directors also escaped liability as they had made reasonable inquiries following mounting negative press speculation regarding the veracity of the company s finances. Inescapable Personal Liability for Late Disclosure 11 Executives Shown no Leniency In February, the MMT found two senior executives, the Chief Executive Officer (CEO) and Chief Financial Officer (CFO) employed by digital camera manufacturer, Yorkey Optical International (Cayman) Ltd., who had recklessly failed to publish any profit warnings for 13 weeks after becoming aware of material losses that contradicted forecasts for significant growth. Each executive was ordered to pay penalties of HK$1 million, and they were disqualified for 18 months and 15 months respectively. The MMT rejected a plea for leniency as unjustified as the admissions were not made at the earliest practical moment but came shortly before the hearing on liability. It also expressly disapproved of executives who attempt to shift blame to others. The MMT regarded the obligation to comply with the disclosure requirements under Part XIVA of the Securities and Futures Ordinance as an inescapable personal responsibility for executives of listed corporations. In April, the MMT found nine executives employed by a steel pipe manufacturer, Mayer Holdings Limited (whose shares had been suspended) liable for waiting 23 days before disclosing details about its auditor s resignation. Seven executives were ordered to pay 1 The statutory body responsible for deciding whether any person (whether or not licensed or registered with the SFC or resident in Hong Kong) has engaged in market misconduct. 2 The MMT noted that the role of a qualified accountant under Rule 5.11 of GEM Listing Rules is not limited to that of a holding company but extend to taking such steps as may be necessary to implement internal controls and other procedures in all the companies making up the Group. Hong Kong Regulatory OCTOBER

3 Moving forward in 2017 and beyond, tackling corporate fraud will likely remain the largest priority for the SFC faced with a growing number of problem stocks and increasing cross-border collaboration with mainland regulatory authorities and the Hong Kong police to combat financial crimes. penalties of HK$900,000 each and disqualified for 12 months. Two executives, the CFO and a director responsible for day-to-day management of the company, were singled out as the persons who ran the show. The CFO and the director each were fined HK$1.5 million and disqualified for 20 months. The MMT expressly rejected the pair s argument for leniency because the auditor s resignation came while the stock was suspended. The MMT held that the statutory disclosure requirements under Part XIVA of the Securities and Futures Ordinance continue to operate during trading suspensions. It added that executives duty to disclose the resignation of auditors is a straightforward matter to be made within a day or two. Even if executives disagree with the reasons for resignation, the MMT held that executives ought to state their disagreement in the announcement rather than delay disclosure. Conclusion Moving forward in 2017 and beyond, tackling corporate fraud will likely remain the largest priority for the SFC faced with a growing number of problem stocks and increasing crossborder collaboration with mainland regulatory authorities and the Hong Kong police to combat financial crimes. REGULATORY STANDARDS/UPDATES The SFC Proposes Amendments to the Professional Investor Rules March 2017: Following the recent reform of the professional investor regime and client agreement requirements, the SFC launched a one-month consultation to expand the categories of persons who will qualify as high net worth (HNW) professional investors and to allow the aggregation of certain assets and alternative forms of evidence to satisfy the relevant asset/portfolio thresholds to qualify as a professional investor. If implemented, the proposals will standardize ad hoc modifications previously granted by the SFC without altering the asset/ portfolio thresholds for HNW investors. Expanded Short Position Reporting Regime Implemented March 2017: Effective March 15, market participants are required to report short positions in all designated securities, including collective investment schemes, such as exchange-traded funds, real estate investment trust and other listed unit trusts/mutual funds. Expanded Derivative Position Limit Regime Implemented June 2017: Effective June 1, the SFC implemented legislative reforms to update the position limit rules for different exchange-traded futures and options contracts. The rule updates (among other things) triple the statutory limit for stock options contracts and allow asset managers to seek the SFC s authorization to hold or control exchange-traded futures and options contracts in excess of the statutory limit for fund management activities. New Electronic DI Filing Regime Implemented July 2017: Effective July 3, to improve the accuracy of disclosures of interest (DI) by substantial shareholders, directors and chief executives holding five percent or more interest in listed securities or their derivatives, DI filings must be submitted electronically through a new online system (subject to a three-month transition period). Hong Kong Regulatory OCTOBER

4 INTERMEDIARIES/MARKET SUPERVISION The SFC Signs MoUs with the SEC and the FCA to Increase Supervision of Cross-Border Regulated Entities January 2017: The SFC entered into a memorandum of understanding (MoU) with the U.S. Securities and Exchange Commission (SEC) and with the UK Financial Conduct Authority (FCA) that supplements the International Organization of Securities Commissions Multilateral MoU signed in The MoUs, which came into effect on January 18 and July 7 respectively, entitle the regulators to share upon request information (or arrange for such information to be provided on a voluntary basis even though the other regulator has made no request) on supervisory issues that enhance oversight of cross-border entities regulated by one or both agencies, including investment fund managers and investment advisers. The MoUs also entitle each regulator to conduct on-site inspections of entities physically located in the other s jurisdiction (even where regulatory inspections would not be available to the overseas regulator) and provides for notification of pending enforcement or regulatory actions or sanctions. The SFC Warns Asset Managers Involved in Improper Activities July 2017: Following a supervisory review, the SFC published a circular warning asset managers that it will take enforcement action for improper activities in managing private funds and discretionary accounts. The SFC identified a series of problematic practices that directly impugn managers fitness and properness, including (i) back-to-back arrangements for substantial shareholders to divest their interest to a fund and in turn invest in the fund through a discretionary account; (ii) situations that give rise to the perception of potential conflicts of interests; and (iii) poor liquidity risk management arising from investments in highly concentrated illiquid or interconnected stocks. September 2017: The SFC Launches FinTech Sandbox September 2017: Effective September 29, the SFC announced the launch of a new Sandbox initiative to allow licensed corporations and start-up firms to carry out regulated activities through the use of financial technology (FinTech) in a controlled regulatory environment before adoption on a fuller scale, subject to conditions that limit the scope of operations. For instance, firms that are approved by the SFC for entry to the Sandbox will be required to notify clients of the potential risks whilst operating in the Sandbox environment and, in some cases, put in place adequate measures to limit exposure or offer compensation to clients pending completion of the normal licensing process. KEY PRODUCT DEVELOPMENTS The SFC Proposes New Guidelines on Robo-Advisory Platforms May 2017: The SFC launched a three-month consultation with new set of specific guidelines applicable to online platforms that allow investors to select and purchase investment products without any interaction with a sales representative. If implemented, the proposed guidelines will (among others) extend the suitability requirements under the Code of Conduct to the sale of complex products on online platforms regardless of whether there has been any solicitation or recommendation. Hong Kong Regulatory OCTOBER

5 Open-Ended Fund Companies the SFC Publishes Further Consultation on New Code June 2017: The SFC published further consultation on the detailed regulatory and operational requirements for the new open-ended fund companies (OFC) regime, including the new draft of the OFC rules and OFC code. Because OFCs (whether public or private) will be set up as investment fund vehicles, the day-to-day management and investment functions of OFCs must be delegated to investment managers licensed by or registered with the SFC to carry out Type 9 (asset management) regulated activity and must comply with the Fund Manager Code of Conduct. The OFC code prescribes (among others) basic investment restrictions, disclosure and operational requirements applicable to nonpublic/private OFCs. All public OFCs will have to comply with the SFC Products Handbook. Effective July 3, Bond Connect, the pilot scheme to connect China s interbank bond market giving international investors access to trade Chinese bonds without quota restrictions commenced operation and reportedly saw US$1 billion worth of bonds traded on the first day. Pilot Scheme for Northbound Trading of Bond Connect Launches July 2017: Effective July 3, Bond Connect, the pilot scheme to connect China s interbank bond market giving international investors access to trade Chinese bonds without quota restrictions commenced operation and reportedly saw US$1 billion worth of bonds traded on the first day. This marks the third cross-border trading link between mainland China and Hong Kong within as many years. The launch date for southbound trading, giving mainland investors the opportunity to trade in major overseas bond markets though Hong Kong, has not yet been announced. SIGNIFICANT ENFORCEMENT ACTIONS We highlight below several noteworthy enforcement actions, court rulings and sentencings related to issues of interest to responsible officers, licensed representatives, intermediaries and others operating in the Hong Kong financial markets. Internal Control Failures January 2017: A licensed corporation agreed to pay a fine of HK$3 million to resolve its failure to implement adequate controls to monitor compliance with the minimum investment experience requirements for responsible officers. January 2017: Two licensed fund managers agreed to pay a fine totaling HK$4 million after issuing shares in excess of the authorized share capital of the funds under management. January 2017: A broker-dealer agreed to pay a fine of HK$700,000 to resolve failures to adequately monitor a series of cross-trades conducted by staff on a cash account basis for the purpose of delaying settlement. March 2017: A sponsor agreed to pay a fine of HK$15 million to resolve serious due diligence failures relating to a failed listing application. May 2017: A broker-dealer agreed to pay a fine of HK$3.5 million after failing to adequately safeguard client securities from the risk of misappropriation. Life Bans and Disqualification Orders Life bans and disqualification orders were imposed on more licensed representatives and directors of listed companies: Two life bans were imposed on two relevant individuals employed by financial institutions after criminal convictions and sentencing for various counts of theft and fraud relating to misselling investment products to fictitious retail customers in a sales commission scam. A 12-year disqualification order was imposed on a former chairman of a listed company for embezzling HK$84 million cash deposits held in a mainland Chinese bank account and Hong Kong Regulatory OCTOBER

6 obstructing provisional liquidators from performing their duties. Two other executive directors (the chairman s son and son-in-law) were also disqualified for eight years. Licensing-Related Issues March 2017: A group of financial institutions agreed to pay a fine totaling HK$15 million after it self-reported (among others) that it had published research reports that contained commentaries on futures contracts to more than 4,000 clients based in Hong Kong without being licensed. AML Breaches March 2017: A licensed corporation agreed to pay a fine of HK$3 million to resolve antimoney-laundering (AML) compliance failures when screening third-party payments. April 2017: A broker-dealer agreed to pay a fine of HK$4.5 million to resolve failures to report suspicious transactions involving large and frequent simultaneous money transfers in and out of client accounts and unidentified third parties that were inconsistent with the relevant client s declared net worth or annual income. April 2017: A futures dealer agreed to pay a fine of HK$3 million to resolve AML compliance failures when processing third-party deposits and payments. Obstruction June 2017: A broker-dealer and its former responsible officer were convicted and fined HK$10,000 each for deceiving the SFC about the true reasons for termination of the responsible officer s licensing status, which had been due to admitted misconduct. July 2017: A licence applicant pleaded guilty to three counts of failing to disclose her previous criminal record when applying for a SFC licence and was fined HK$15,000. CONTACTS Constance Choy Partner, Head of China Corporate and Finance cchoy@sidley.com Effie Vasilopoulos Partner, Co-head of Investment Funds in Asia evasilopoulos@sidley.com Dominic James Counsel, Securities & Derivatives Enforcement and Regulatory dominic.james@sidley.com AMERICA ASIA PACIFIC EUROPE sidley.com Sidley Austin provides this information as a service to clients and other friends for educational purposes only. It should not be construed or relied on as legal advice or to create a lawyer-client relationship. Attorney Advertising - Sidley Austin LLP, One South Dearborn, Chicago, IL Sidley and Sidley Austin refer to Sidley Austin LLP and affiliated partnerships as explained at sidley.com/disclaimer. Hong Kong Regulatory OCTOBER