The Securities and Futures Commission (SFC)’s two-month consultation on the amendments to the Code of Conduct to facilitate the establishment of the Financial Dispute Resolution Centre Ltd (FDRC) and to enhance the regulatory framework (Consultation) ended in January 2012. The SFC recently published its consultation conclusions (Consultation Conclusions).
The Consultation Conclusions confirm, amongst other things, that the scope of the existing self-reporting requirement under paragraph 12.5 of the Code of Conduct will be extended to include any suspected material breach, infringement or non-compliance with the civil (Part XIII) or criminal (Part XIV) market misconduct provisions of the Securities and Futures Ordinance (SFO) by clients of licensed and registered persons. Some other miscellaneous amendments include a ban on the use of mobile phones for accepting client orders in certain circumstances, the extension of the telephone recording retention period from at least three to six months, a requirement not to accept orders placed by a third party for a client’s account unless that third party is authorised by the client in writing, and a requirement not to prohibit employees from performing expert witness services for the SFC or the Hong Kong Monetary Authority without reasonable excuse.
The amendments to the Code of Conduct in relation to the establishment of the FDRC will come into effect on 19 June 2012 and other miscellaneous amendments, including those in relation to the self-reporting requirement, will come into effect on 1 December 2012. Mark Johnson, Gavin Lewis and Tim Mak provide some observations below.
Extension of the self-reporting requirement
The SFC’s “Consultation paper on proposals to amend the Code of Conduct for Persons Licensed by or Registered with the Securities and Futures Commission in relation to the establishment of the Financial Dispute Resolution Centre Ltd and the enhancement of the regulatory framework” which was published in November 2011, focused on to the establishment of the FDRC and related amendments to the Code of Conduct. The FDRC is aimed at helping customers resolve monetary disputes with financial institutions involving HK$500,000 or less.
Separately, the SFC also proposed a number of miscellaneous amendments to the Code of Conduct, including an extension of the existing self-reporting requirement under paragraph 12.5. The existing self-reporting requirement provides that a licensed or registered person, as a firm, should immediately report to the SFC any actual or suspected material breach, infringement or noncompliance with, amongst others, law, rules, regulations and codes administered or issued by the SFC (whether by themselves or their employees), and to give relevant information and documents. In the Consultation, the SFC proposed to extend the requirement to include any actual or suspected material breach, infringement or non-compliance with, amongst others, law, rules, regulations and codes administered or issued by the SFC by clients of the licensed corporation or registered institution.
Most of the respondents to the Consultation objected to the proposed extension of the self-reporting requirement. Concerns were, for example, raised about potential conflicts with the duty of confidentiality to clients and potentially exposing licensed corporations and registered institutions to possible liability to clients that might arise as a result of filing such self-reports. The SFC, in its Consultation Conclusions, considered these concerns to be misplaced. It considers that the law is clear that the duty of confidentiality can be overridden in various situations including where a firm may have an obligation to disclose information to the proper authorities in the public interest.
Respondents also commented that the proposed reporting obligations were too broad. In response, the SFC has, in its Consultation Conclusions, limited the scope of the extension of the self-reporting requirement. The SFC will now introduce a new paragraph 12.5(f) to require a licensed or registered person, as a firm, immediately to report to the SFC where there is “any material breach, infringement or non-compliance of market misconduct provisions set out in Part XIII or Part XIV of the Securities and Futures Ordinance that it reasonably suspects may have been committed by its client, giving particulars of the suspected breach, infringement or non-compliance and relevant information and documents”. The amendments to the self-reporting requirement will come into effect on 1 December 2012.
In its Consultation Conclusions, the SFC has made various clarifications to address respondents’ concerns in relation to compliance with the extended requirement. The SFC has clarified, for example, that it does not require firms to conduct any investigation or make any decision on whether a client has been guilty of misconduct. Instead, firms will be required to report the facts or matters indicating that a client might be guilty of misconduct (eg, credible information from a third party which suggests that a breach or suspected breach has occurred). There is no duty to make a report based on unsupported speculation or vexatious comments.
At present, firms have a statutory obligation under Hong Kong’s money laundering legislation to report certain types of suspicious transactions to the Joint Financial Intelligence Unit (JFIU). As set out in the Consultation Conclusions, the SFC expects a report to the SFC and the JFIU to be made concurrently if the matter is within the jurisdiction of both. Contrary to concerns expressed by some respondents, the SFC considers that a concurrent report would not give rise to the criminal offence of “tipping-off” under the relevant money laundering legislation as it is a defence to prove that “he did not know or suspect the disclosure concerned was likely to be prejudicial… or that he had lawful authority or reasonable excuse for making that disclosure.” Nonetheless, the SFC expects firms to take care to avoid committing the “tipping-off” offence.
The SFC has also indicated that an investor in a fund would be regarded as a “client” of fund managers for the purpose of the extended self-reporting requirement.
The SFC has noted in its Consultation Conclusions that it considers the requirement for firms to report suspected client market misconduct to the SFC as a very important measure to maintain the integrity of the market. In a recent enforcement case, for example, the SFC’s Executive Director of Enforcement, Mr Mark Steward stressed the importance of timely self-reporting:
“Intermediaries know they have a duty to report misconduct to the SFC immediately upon discovery, not when they have plumbed to the bottom of it. Delay in reporting simply helps the wrongdoer. This public reprimand should make it clear that the SFC condemns such delay in the strongest terms.”
The recent enforcement action illustrates the regulator’s tough stance in enforcing the self-reporting obligation.
In anticipation of the extended self-reporting requirement coming into effect on 1 December 2012, firms will need to ensure that frontline staff are properly trained to monitor their clients’ activities to ensure that compliance concerns are escalated promptly where appropriate. Firms should also maintain good internal controls and be alert for any apparent “red flags” which might give rise to a reporting obligation under the extended self-reporting requirement. Firms might also like to consider how such internal controls interact with the firm’s existing escalation procedures for reporting suspicious transactions to the JFIU.