HKMA reminds registered institutions of their Internal Investigation Disclosure Obligation

Authors: William Hallatt, Hannah Cassidy, Natalie Curtis, Tess Lumsdaine and Isabelle Lamberton

The Hong Kong Monetary Authority (HKMA) has issued a circular to registered institutions (RIs) in relation to the frequently-asked questions (FAQs) released by the Securities and Futures Commission (SFC) on 21 May 2019, which sought to clarify the SFC’s Internal Investigation Disclosure Obligation.

In the circular, the HKMA reminds RIs that they also must comply with the Internal Investigation Disclosure Obligation, when notifying the SFC that an individual has ceased to act as its executive officer (EO), reflecting the SFC’s guidance in Question 9 of the FAQs.

The Internal Investigation Disclosure Obligation

On 1 February 2019, the SFC announced significant changes to its licensing forms and processes. Included in these changes was the introduction of the compulsory Internal Investigation Disclosure Obligation through the new Form 5U, which came into effect on 11 April 2019.

The Internal Investigation Disclosure Obligation requires RIs to provide information to both the SFC and the HKMA regarding:

  • whether departing EOs were the subject of an internal investigation in the six months prior to their cessation; and
  • details of this investigation, if such details have not previously been provided to the regulators.

Firms are also required to notify the SFC and HKMA as soon as practicable if an internal investigation into that individual is commenced subsequent to making the initial notification of cessation (for more details, please see our February 2019 bulletin).

The FAQs

On 21 May 2019, the SFC released the FAQs to clarify various aspects of the Internal Investigation Disclosure Obligation, including:

1. The scope of reportable investigations

It is now clear that the scope of reportable investigations is very wide, given that:

  • firms are required to proactively disclose information about all “investigative actions” (no matter how they are described in internal policies), regardless of whether the subject matter covers regulated or unregulated activities; and
  • no materiality threshold will apply to exclude low-level investigations that are of minimal significance from the obligation.

2. The level of detail required for disclosures

When making an internal investigation disclosure, firms are required to provide information on:

  • factual matters, including a description of the matter, background, relevant dates, duration, the role played by the outgoing employee, and status of the investigation;
  • an assessment of the (potential) impact to the market and clients, and materiality; and
  • if the investigation is completed, the outcome of the investigation and the basis of its conclusion.

3. The confidentiality applied to any disclosures made

In the FAQs, the SFC reiterated its statutory obligation under section 378 of the Securities and Futures Ordinance, and confirmed that it will not disclose information obtained under the new obligation to any other persons, including the outgoing employee and his/her prospective employer, unless otherwise permitted by law.

Although the HKMA’s circular is silent on this point, it is likely that the HKMA will take a similar approach to the sharing of information obtained under the obligation. However, given the scope of the obligation and the sensitive nature of the disclosures, a positive statement from the HKMA would be welcomed.

Final Thoughts

The HKMA’s circular has made clear that the HKMA is supportive of the SFC’s intention to ensure that individuals will no longer be permitted to escape regulatory scrutiny by simply resigning during the course of an investigation.

However, the Internal Investigation Disclosure Obligation is a significant enhancement of the prior notification requirements. We anticipate that firms will face a number of key issues in complying with this requirement, including navigating potential litigation risk from former employees, and considering what constitutes an “investigative action”.

William Hallatt
William Hallatt
Asia Head of Financial Services Regulatory, Hong Kong
+852 2101 4036
Hannah Cassidy
Hannah Cassidy
Partner, Hong Kong
+852 2101 4133
Natalie Curtis
Natalie Curtis
Partner, Singapore
+65 6868 9805
Tess Lumsdaine
Tess Lumsdaine
Registered Foreign Lawyer (New South Wales, Australia), Hong Kong
+852 2101 4122

Isabelle Lamberton
Isabelle Lamberton
Registered Foreign Lawyer (New South Wales, Australia), Hong Kong
+852 2101 4218

Disclosure of internal investigations – the Hong Kong SFC’s FAQs fail to relieve industry concerns

The Hong Kong Securities and Futures Commission (SFC) has released frequently-asked questions (FAQs) to clarify its Internal Investigation Disclosure Obligation – a measure introduced in February 2019 to stop the “roll” of “bad apples” within the financial industry.

The Obligation requires licensed corporations (LCs) and registered institutions (RIs) to provide the SFC with extra information about the circumstances of any licensed employee’s departure. This includes whether the individual was subject to an internal investigation in the six months prior to their departure.

The FAQs cover:

  • what must be reported under the Obligation;
  • the level of detail required for an Internal Investigation Disclosure; and
  • how the SFC will treat the confidentiality of information reported under the Obligation.

While the aims of the Obligation and the clarity provided by the new FAQs are generally welcomed by the industry, serious concerns remain about the practicalities of implementation by firms and the usefulness of the disclosed information to the SFC.

We have been following the developments of the Obligation since its introduction in February and have been part of the industry discussion on this new requirement led by the Asia Securities Industry & Financial Markets Association (ASIFMA). Herbert Smith Freehills and ASIFMA are holding a joint briefing in Hong Kong to explain how the new Obligation and the FAQs will impact LCs and RIs in Hong Kong, and you are welcome to attend.

EVENING SEMINAR IN HONG KONG – 28 May 2019

Date:Tuesday, 28 May 2019
Time:6pm – Registration

6.30-7.30pm – Seminar

7.30-9pm – Cocktail reception

Venue:Eaton Club, 5/F Champion Tower

Three Garden Road, Central, Hong Kong

Please click here to view a map

If you are interested in attending the joint briefing, please email our Events Team for registration.

BACKGROUND

On 20 April 2018, the Financial Stability Board (FSB) released its regulatory toolkit for misconduct risk. Amongst its aims, the FSB encouraged regulators to do more to prevent individuals who engage in misconduct moving between financial institutions without their misconduct being disclosed to their new employer (for further details, please see our April 2018 bulletin).

On 1 February 2019, the SFC announced significant changes to its licensing forms and processes. Included in these changes was the introduction of the new compulsory Internal Investigation Disclosure Obligation through the new Form 5U, which came into effect on 11 April 2019.

Specifically, under the new Form 5U, firms need to:

  • identify whether departing licensed representatives, responsible officers and executive officers (outgoing employees) were the subject of an internal investigation in the six months prior to their departure;
  • provide details of this investigation if such details have not previously been provided to the SFC; and
  • notify the SFC as soon as practicable if an internal investigation into that individual is commenced after making the initial notification of cessation.

Back

SUMMARY OF THE SFC’S FAQS

Apart from providing an introduction and explaining the purpose of the new Obligation, the SFC has clarified various key aspects of this new requirement, including:

  • the scope of reportable investigations;
  • the level of detail required for disclosures; and
  • the confidentiality applied to any disclosures made.

Scope of reportable investigations

The SFC acknowledges that firms may adopt different terms, such as checking, inquiry, enquiry, review, examination, inspection or investigation, in respect of their investigative actions. However, the SFC has made it clear that it expects firms to proactively disclose information about all “investigative actions” (no matter how they are described), regardless of whether the subject matter covers regulated or unregulated activities.

The SFC has further provided a non-exhaustive list of examples of investigations involving an outgoing employee that should be reported:

  • investigations about suspected or actual breaches of applicable laws, rules and regulations;
  • investigations about suspected or actual breaches of a firm’s internal policies or procedures;
  • investigations about misconduct that is likely to give rise to concerns about the fitness and properness of an outgoing employee;
  • investigations about any matter that may have an adverse market or client impact; and
  • investigations about any matter potentially involving fraud, dishonesty and misfeasance.

In addition, the SFC has clarified that, even where a firm has completed its investigation and made no negative findings against an outgoing employee, the firm will still be required to notify the SFC of the investigation. However, in such situations, only a brief description of the nature of the matter and an explanation about the basis of conclusion will be required.

Whilst it was understood that a firm had to disclose any investigations that began after the departure of its outgoing employee as soon as practicable, the SFC has further clarified that such investigations must be disclosed regardless of the length of time that has elapsed since the outgoing employee left the firm, i.e. there is no time limit on the on-going requirement.

Level of detail required for disclosures

Broadly speaking, firms should disclose information that they can lawfully disclose to the SFC for its thorough understanding of the subject matter of an investigation.

Generally, firms should include in their disclosures:

  • the nature and background of the matter;
  • the date(s) when the matter occurred;
  • the duration of the matter;
  • the role played by the outgoing employee in the matter;
  • the actual and/or potential impact to the market and client(s) and assessment of materiality;
  • the status of the investigation; and
  • the outcome of the investigation and basis of its conclusion (if the investigation is complete).

Where there are any developments such as new information or updates on the status of an investigation that has already been disclosed to the SFC, firms should provide such information to the SFC as soon as practicable, irrespective of whether the investigation had previously been concluded.

Confidentiality applied to any disclosures made

The SFC has reiterated its statutory obligation under section 378 of the Securities and Futures Ordinance (SFO) to preserve secrecy in respect of information obtained during the performance of its regulatory functions including disclosures made to the SFC under the new Obligation and will treat such information as confidential.

In particular, the SFC will not disclose information obtained under the new Obligation to any other persons, including the outgoing employee and his/her prospective employer unless otherwise permitted by law.

Back

CHALLENGES

Won’t this be a heavy administrative and logistical burden on firms?

The SFC has made clear that no materiality threshold will apply to exclude investigations that are of minimal significance and/or impact to the market and client(s) from the Obligation.

The scope of reportable investigations is therefore very wide given that any and all potentially wrongful acts committed by an outgoing employee could trigger the Obligation regardless of the eventual outcome of investigations.

The administrative and logistical burden therefore imposed on firms raises issues as to the practicality of implementing the requirement properly, especially for smaller firms in Hong Kong with limited resources.

How should firms navigate the potential pitfalls as to conflicts with other laws and regulations?

Whilst the SFC has clarified that disclosures need only be made where the same would be lawful, no further guidance has been published on how this would work in practice.

As such, firms will likely have to consider each reportable investigation on a case-by-case basis and decide whether a disclosure may breach any laws or regulations, e.g. relating to personal privacy, data privacy or employment, in turn increasing the burden on firms to ensure compliance.

What is the utility of collecting so much information and won’t this cause undue delays in the licensing process?

The information collected through the disclosures could potentially assist the SFC in considering whether an individual is a fit and proper person to remain licensed under the SFO.

However, the catch-all nature of the Obligation raises questions as to the utility of this information if the SFC is flooded with disclosure reports that are not relevant for these purposes. It also raises concerns as to the length of time required by the SFC to complete the licensing process in circumstances where a disclosure has been made on Form 5U.

Back

CONCLUSION

The new Internal Investigation Disclosure Obligation is a significant enhancement of the prior notification requirements. It is clearly the intention of the SFC to ensure that individuals will no longer be permitted to escape regulatory scrutiny by simply resigning during the course of an investigation.

Whilst the enhanced Obligation, which forms part of a broader focus by the SFC on individuals’ fitness and properness, is generally welcomed by industry participants, serious concerns remain about the practicalities and challenges of implementation, as well as the scale and usefulness of the information to be disclosed to the SFC.

Back

William Hallatt
William Hallatt
Head of Financial Services Regulatory, Asia Hong Kong
+852 2101 4036
Hannah Cassidy
Hannah Cassidy
Partner, Hong Kong
+852 2101 4133
Natalie Curtis
Natalie Curtis
Partner, Singapore
+65 6868 9805
Tess Lumsdaine
Tess Lumsdaine
Registered Foreign Lawyer (New South Wales, Australia), Hong Kong
+852 2101 4122

Jennifer Fong
Jennifer Fong
Associate, Hong Kong
+852 2101 4244

The month ahead in financial services regulatory developments…

In this blog post, we round-up forthcoming developments in the UK and at EU and International levels in financial services regulation for June 2019.

3 Jun
5 Jun
8-9 Jun
  • G20 ministerial meetings:
    • finance ministers and central bank governors (Fukuoka, Japan)
    • trade and digital economy (Tsubuka, Japan)
10 Jun
11 Jun
12 Jun
13-14 Jun
14 Jun
15-16 Jun
19-20 Jun
20-21 Jun
21 Jun
26 Jun
27 Jun
28-29 Jun
29 Jun
  • Deadline for responses to the European Securities and Markets Authority (ESMA) CP on ELTIF RTS
By 30 Jun
End Jun
Jun
Jun/Jul
Jun-Aug

Updated DOJ Guidance Steers Effective Compliance and Remediation Programmes

Authors: Kyle Wombolt, Jeremy Birch and Charlotte Benton

The US Department of Justice Criminal Division (DOJ) has issued updated guidance on the Evaluation of Corporate Compliance Programs (guidance). Under the guidance, DOJ prosecutors evaluate the effectiveness of a company’s compliance programme when conducting an investigation, determining whether to bring charges or negotiating plea or other arrangements.

“Whether in the US, Asia Pacific or elsewhere, the guidance sets out useful prompts for a best practice compliance framework” observes Hong Kong corporate crime and investigations partner, Jeremy Birch. “Given the propensity of regulators to borrow from each other’s procedures and practices, it will also be of interest to companies subject to regulatory scrutiny, investigation or enforcement outside the US, as a benchmark for appropriate remediation and resolution.”

The guidance covers many of the same areas as the previous version, providing additional context to the multifactor analysis of a compliance programme.

Continue reading

Key themes from the FCA’s Approach to Enforcement

Authors: Benedicte Perowne and Kimberly Everitt

On 24 April 2019 the FCA published its final “Approach to Enforcement” document, following a consultation period which ended in June 2018. The approach document attempts to provide transparency and explain the FCA’s approach in greater depth.

The FCA’s overriding principle in its approach to enforcement is substantive justice – a commitment to achieve fair and just outcomes in response to misconduct. It intends to conduct consistent and open-minded investigations in order to achieve the right outcomes. Continue reading

Report into supervision of the Co-operative Bank: lessons not just for regulators but also for firms

Authors: Jenny Stainsby, Vicky Man and Cat Dankos

While there have been other reviews1 into the near failure of the Co-operative Bank (“Co-op Bank”), on 6 March 2018, HM Treasury announced that it had directed the Prudential Regulation Authority (“PRA”) to conduct a further investigation, specifically focused on the prudential supervision of Co-op Bank between 2008 and 2013 with a view to reporting on any lessons learned and making appropriate recommendations (“the Review”). The review period covers a significant period for the Co-op Bank, including its merger with Britannia Building Society (“Britannia”) in 2009 and its withdrawal from the bidding process to purchase 632 bank branches from Lloyds Banking Group in 2013.

This is the first example of the use of a statutory power enacted in 2012 whereby the Treasury may require the PRA (or Financial Conduct Authority (“FCA”)) to investigate where it considers that it is in the public interest that the PRA (or FCA) should carry out an investigation into ‘relevant events’ and it does not appear to the Treasury that such an investigation has been or is being undertaken2. The Government had announced its intention to invoke this power in 2013, stating at that time that the review would not commence until the conclusion of all regulatory enforcement action relating to Co-op Bank.

With Treasury’s approval, the PRA appointed Mark Zelmer as independent reviewer to conduct the Review. Mr Zelmer’s report was published on 27 March 2019. In it, Mr Zelmer addresses the eight areas of investigation which were set out by HM Treasury; and provides eight recommendations. The PRA and the Bank of England’s (“BoE”) Joint Response was published on the same day and welcomed the report.

Many of the observations made in the report are unsurprising, and to a considerable degree, as acknowledged in the report itself, the shortcomings in supervision during the period of the review will have been addressed during the restructure of the UK regulatory regime in 2013. While a clear theme coming from the Review is the need to ensure ongoing compliance with regulatory and statutory requirements, there are a handful of forward-looking points from the Review and Joint Response of particular note:

  • the Review draws particular attention to the importance of stress testing, and it seems likely that as stress testing methodology continues to evolve, it will do so with a particular eye to incorporating “the inherent uncertainty that would prevail as a stress scenario unfolds in real life”, the most recent ‘real life’ example to be included in stress tests being cyber stress tests;
  • the Review considers various threats to the safety and soundness arising from technology, (for example, cyber-attacks), but notably draws out the potential impact of Open Banking on bank runs which may highlight for some firms the need to review both “early warning” detection strategies and crisis management preparedness;
  • in the joint response, the PRA explains that it is considering whether to set either formal or informal asset encumbrance limits; should the PRA proceed with limits, this will have an impact on balance sheet calculations; and
  • the Review also notes that the PRA said that it intends to assign firms’ senior managers (as designated under the Senior Managers and Certification Regime or “SMCR”) to be accountable for actions in letters to the largest UK deposit takers; the September 2018 letter on LIBOR transition is an illustration of this.

Below we consider in more detail some of the key recommendations, the BoE and PRA response, and implications for firms.

Continue reading

HKMA and SFC issue joint circular following co-ordinated inspections which reveal risky financial arrangements and deficient lending practices

Authors: William Hallatt, Hannah Cassidy and Valerie Tao

On 24 April 2019, the Hong Kong Monetary Authority (HKMA) and the Securities and Futures Commission (SFC) issued a joint circular on their recent co-ordinated inspections of a bank and an SFC licensed corporation (LC) within a Mainland-based group.

The inspections identified two key areas of concern:

  • The group had adopted complex structures and opaque financing arrangements, which may have concealed financial risks and made it difficult to conduct rigorous risk assessment.
  • There were deficiencies in the lending practices of the bank within the group.

The regulators have indicated that this is not a one-off case and encourage institutions with similar structures and arrangements to conduct a review urgently and take action to mitigate risks.

This is not the first time the HKMA and the SFC have undertaken co-ordinated inspections, but is a relatively new collaborative approach. The SFC has recently stated that, as part of its front-loaded regulation, it will be conducting more joint supervisory exercises with the HKMA.

The regulators have indicated in the circular that they have also been coordinating with Mainland regulators to share information and observations derived from their supervisory work.

Continue reading

High Court refuses permission for collateral use of disclosed documents and witness statements to respond to US grand jury subpoena

In a decision illustrating the court’s strict approach to the rule prohibiting the use of disclosed documents and witness statements for a collateral purpose, the High Court has refused a party permission to provide disclosed documents and witness statements to the US Federal Bureau of Investigation (FBI) for the purpose of complying with a US Grand Jury subpoena: ACL Netherlands BV v Lynch [2019] EWHC 249 (Ch).

The court’s permission was required because under CPR 31.22 (in relation to disclosed documents generally) and 32.12 (in relation to witness statements), a party may only use disclosed material for the purpose of the proceedings in which it is disclosed, subject to certain exceptions including where the court gives permission.

On the facts of the case, the court held that the applicant had not established cogent and persuasive reasons in favour of granting permission, as it was required to do. The court also considered that the grant of permission might have occasioned injustice, particularly given that the trial in the civil proceedings was imminent.

The decision highlights that the fact that a party may be facing legal compulsion to produce documents is not a “trump card” leading necessarily to the grant of permission (although in any event the court was not satisfied here that compulsion had been established). Courts considering such applications will not apply a mechanistic approach and will consider all the circumstances in weighing the competing public interests involved. That is the case even if refusing permission may result in a party finding itself effectively stuck between a rock and a hard place, unable to comply with a legal demand from an enforcement or regulatory agency – though that will be a relevant factor. Continue reading

Corporate Crime Update – Winter 2019

Welcome to the Winter 2019 edition of our corporate crime update – our round up of developments in relation to corruption, money laundering, fraud, sanctions and related matters. Our update now covers a number of jurisdictions.

For the full update on each jurisdiction, please click on the name of the jurisdiction below. Below we provide a brief overview of what is covered in each update.

Continue reading