Guidance to the Securities and Futures Ordinance, Cap. 571

One licensing concept (Part V of the Securities and Futures Ordinance)

Under the SFO, there would be a universally applicable single licensing system, with one licence and therefore one set of Financial Resources Rules returns each month and one annual return which covers all of the regulated activities (s. 116). The SFC regulated activities that could be covered under such a licence include :

• dealing in securities (“Type 1”);
• dealing in futures contracts (“Type 2”);
• trading in leveraged foreign exchange contracts (“Type 3”);
• advising on securities (“Type 4”);
• advising on futures contracts (“Type 5”);
• advising on corporate finance (“Type 6”);
• providing automated trading services (“Type 7”);
• providing securities margin financing (“Type 8”); and
• providing asset management services (“Type 9”) (Schedule 5).

The licence would be granted to the applicant to carry on one or more than one SFC regulated activities only if the SFC is satisfied that the applicant is a fit and proper person to be licensed for the regulated activities. In considering whether a person is fit and proper, the SFC or the HKMA (as the case may be) may consider the following factors concerning the applicant :

• the financial status or solvency ;
• the educational or other qualifications or experience;
• the ability to carry on the regulated activity competently; honestly and fairly; and
• the reputation, character, reliability and financial integrity (s. 129).

1.1.4.

Concept of “management liability” (Part V of the Securities and Futures Ordinance)

1.2.1.

Since licensed intermediaries would be registered as corporations and the fact that it is no longer adequate for the SFC to rely solely on it day-to-day supervision of intermediaries to promote ongoing compliance, the SFO introduces the concept of “management liability” under which the managerial staff responsible for the management of the licensed corporation would shoulder the responsibility for the acts of the corporation. Thus, all executive directors of the licensed corporation should be licensed as representatives and designated as responsible officers and not less than two individuals, at least one of whom is an executive director, should be licensed as responsible officers for each regulated activity.

1.2.2.

The responsible representatives as well as the corporation itself would be held liable if the corporation breaches fundamental licensing requirements (ss. 125 & 126). However, a responsible officer would not be liable if he honestly and reasonably believes that the corporation is in compliance and he acts promptly in notifying the SFC of the relevant breach once it becomes known to them.

1.3.

Transitional arrangement (Schedule 10 to the Securities and Futures Ordinance)

1.3.1.

Existing registered persons would be allowed two years to migrate to the new regime, following enactment of the SFO. The deeming provisions in respect of Part V of Schedule 10 provide that existing corporations would become deemed licensed corporations; the existing representatives/dealing directors would become deemed licensed representatives/deemed responsible officers; the existing sole proprietorships/partnerships would become deemed licensed corporations; and the exempt authorized financial institutions would become deemed registered institutions. Any application for registration of a licence made before the commencement of Part V in any capacity specified in column 1 of the table below should be treated as an application for a licence in respect of certain deemed activities during the transitional period as specified opposite thereto.

1.3.2.

In addition, dealers who are currently providing internet trading services would be deemed to be licensed for Type 7. It is advised that the existing corporate registrants may consider consolidating existing businesses under one corporate entity with a view to saving cost, whereas the existing sole proprietors are required to incorporate their businesses before the end of the transitional period.

2.1.

Disclosure of interests in securities (Part XV of the Securities and Futures Ordinance)

In order to make informed investment decisions, investors should have equal and timely access to full and accurate data on the shareholdings of listed companies which is price-sensitive. The international trend is to move to full disclosure of relevant information by the listed corporation, so that investors may take responsibility for themselves in assessing the risks and returns. As such, the SFO tightens the Hong Kong disclosure of interest regime. Those who acquire, or dispose of, an interest in 5% (formerly 10 %) or more of the issued voting share capital of a listed company would be required to disclose their acquisition or disposal and their new holding to the Stock Exchange within 3 business days (formerly 5 business days). Directors and chief executive officers remain required to disclose any acquisition or disposal of their company’s share, irrespective of percentage (ss. 313, 315 & 319). For greater transparency certain disclosure requirements are also extended to securities interests of any kind whatsoever, e.g. purchase of shares, acquisition of a call option, borrowing of shares, interests in unissued shares, interests under equity derivatives.

2.2.

Clear statutory private right action against market misconduct (Parts XIII & XIV of the Securities and Futures Ordinance)

Under common law, a person who suffers loss as a result of market misconduct may be able to seek redress through civil action against a person responsible for the misconduct, however, the consequence of which could be costly and riddled with obstacles. The SFO creates a right of civil action in respect of market misconduct for which the aggrieved party can claim compensation for loss and other remedies (ss. 281 (1) & 305 (1)). The availability of the findings of the Hong Kong Market Misconduct Tribunal, criminal charge or conviction is not a must (ss. 281 (5) & (305 (4)), but would be admissible as evidence of market misconduct in private action (ss. 281 (7) – (9) & 305 (6) – (8)).

2.3.

Proportionate disciplinary sanction for improper conduct by intermediaries (Part IX of the Securities and Futures Ordinance)

2.3.1.

In case that a licensed person engages in any improper conduct, the disciplinary sanctions that the SFC may currently administer are public or private reprimands, and suspension or revocation of the intermediary’s registration. Reprimands could be too lenient in many cases, yet suspending or revoking an intermediary’s registration might be excessive.

2.3.2.

In line with US law and regulations, the SFO gives the SFC two additional sanction options :

• civil fines up to the higher of $10 million or three times the amount gained or loss avoided ; and
• suspension or revocation of an intermediary’s licence in respect of part of its business only (ss. 194 – 196).

Protection of investors’ assets (Part VI of the Securities and Futures Ordinance)

Under the SFO, the SFC is empowered to transfer the custody of investors’ property or other business property of an intermediary to an appropriate custodian to avoid dissipation (s. 148). Since basic law protection of private rights of property, the SFC must go to court as soon as reasonably practicable to get court directions.

2.5.

Civil liability for false or misleading disclosure to market (Part XVI of the Securities and Futures Ordinance)

Persons disclosing false information to the market would be held liable to pay compensation to others who suffer loss as a result of reliance. In order to strike a balance, the SFO, while creating statutory cause of action, also provides that victim must demonstrate that it is “fair, just and reasonable” to ask for compensation. Meanwhile, suitable defence is given to innocent parties acting in good faith, including the media (s. 391).

3.1.

Establishment of Hong Kong Market Misconduct Tribunal (“MMT”) (Part XIII of the Securities and Futures Ordinance)

Under current law, market manipulation is a criminal offence. However, in view of sophisticated market practices and techniques, it is difficult to obtain sufficient evidence to prove market manipulation. The SFO builds on the strength of the Insider Dealing Tribunal and expands it into a MMT which would then handle insider dealing and specified market misconduct activities, and would apply the civil standard of proof, i.e. a balance of probabilities in determining whether it is satisfied that cases referred to it have been proved.

A judge of the Court of First Instance, assisted by two market practitioners appointed by the Chief Executive, would chair the MMT (s. 251). It would subsume the work of the Insider Dealing Tribunal. The Financial Secretary would be able to initiate civil proceedings before the MMT. The MMT may :

• order disgorgement of profits plus compound interest thereon;
• order payment of legal costs and investigation expenses;
• issue a “disqualification” order to disqualify a director from being a director of any listed company for a periods of up to five years;
• issue a “cold shoulder” order (i.e. a person is denied access to market facilities) for a period of up to five years;
• issue a “cease and desist” order (i.e. an order not to breach the provisions of Part XIII); and
• refer to relevant professional bodies for possible disciplinary action (ss. 257 – 259).

Preliminary inquiry into the management of a listed company (Part VIII of the Securities and Futures Ordinance)

The SFC, under the current law, is authorized to review the books and records of a listed company or members of its group in the event that there is a likelihood of misconduct in the management of the company. In practice, however, the SFC has only limited power to place the entries in those documents in any meaningful context or to check their veracity.

Under the SFO, the SFC is entitled to seek explanations of an entry from the listed company or a member of its group as well as given the power to access the working papers of such company’s auditors. In addition, the SFC may make inquiries of counterparties to transactions that such company has entered into. Nevertheless, to exercise these powers, the SFC must have reasonable cause to believe the working papers relate to the affairs of the company and the grounds for inquiry (s. 179).

Criminal route to further deter market misconduct (Part XIV of the Securities and Futures Ordinance)

As an alternative to proceedings before the MMT, the SFO provides a criminal route for dealing with market misconduct activities where there is sufficient evidence to meet the criminal standard and it is in the public interest to bring prosecution before the Courts. Due protection consistent with human rights requirements would be afforded to all defendants. The maximum penalty under the criminal route is 10 years’ imprisonment or a fine up to $10 million (s. 303). The rule against double jeopardy applies as a person cannot be tried in the MMT and the Courts for the same market misconduct.

There are currently two compensation schemes – the Unified Exchange Compensation Fund and the Commodities Exchange Compensation Fund. Both rely in part on deposits paid by members of the exchanges and statutory transaction levies. The schemes provide a maximum level of compensation for each broker – $ 8 million and $ 2 million for per stockbroker and per futures broker respectively.

8.2.

The SFO provides a new investor compensation system in Hong Kong to substitute the existing schemes. Contrary to the present per broker limits, the new regime would be based on a per investor compensation limit. This would enable more transparency and allow investors to know precisely what level of compensation would be available to them should their intermediaries fail.

8.3.

The new regime would be administered by an independent investor compensation company, which would be required to apply prudent principles to managing its funds, inter alia, the possibility of seeking insurance to minimize costs to the industry (ss. 79 – 90).