In a recent enforcement action, the Securities and Futures Commission (the "SFC") has publicly reprimanded and fined China Everbright Securities (HK) Limited ("CESHK") HK$2.5 million for relying on expired standing authority when pledging its clients' securities with banks for financial accommodation. In deciding the sanction to be imposed, the SFC took into account all relevant considerations, including CESHK's self-reporting to the SFC of its breach.
On 20 August 2018, CESHK made a self-report to the SFC that it had failed to renew its clients' standing authority which had expired on 31 March 2018. The clients' standing authority was given at the time they opened an account with CESHK and the standing authority authorised CESHK to deposit their securities collateral with an authorised financial institution as collateral for financial accommodation provided to CESHK and to deposit their securities collateral with a recognised clearing house as collateral for the discharge and satisfaction of CESHK's clearing and settlement obligations and liabilities.
Upon receiving the self-report of CESHK, the SFC investigated into the matter and discovered that CESHK relied on expired standing authority of its clients during the period from 1 April 2018 to 19 August 2018 to pledge their securities with banks in Hong Kong as collateral for financial accommodation provided to CESHK.
The incident happened as a result of the amalgamation of two groups, namely China Everbright Securities International Group (the "CESHK Group") and Everbright Sun Hung Kai Group (the "EBSHK Group"). The respective standing authority renewal exercise of the CESHK Group and the EBSHK Group was handled at different points of time of the year, namely March every year for the former and August every year for the latter. When the EBSHK Group took over the compliance work of CESHK, it was not made aware that the standing authority of CESHK's clients should also be handled.
Breach of the regulations
As a licensed intermediary, CESHK is subject to, among others, the Code of Conduct for Persons Licensed by or Registered with the SFC (the "Code of Conduct") and the Securities and Futures (Client Securities) Rules (the "CSR").
The Code of Conduct requires a licensed or registered person to ensure that client assets are promptly and properly accounted for and adequately safeguarded; whereas under the CSR, a standing authority is valid for 12 months if the client is not a professional investor and may be renewed for one or more periods not exceeding 12 months and is deemed to have been renewed if written notice is given at least 14 days prior to the expiry to remind the client of the impending expiry and to inform the client that the standing authority will be renewed unless he objects.
CESHK failed to give the written notice 14 days prior to the expiry of the standing authority of its clients, and by pledging the client securities without valid standing authority of clients, CESHK has used clients' securities as collateral for financial accommodation without client's authorisation, which is in breach of the Code of Conduct and the CSR.
The SFC stressed that safe custody of client assets is a fundamental obligation of licensed corporations, and any transgression of this obligation, even if clients' funds/securities were subsequently returned to the client trust account, cannot be tolerated.
Accordingly, CESHK was publicly reprimanded and fined HK$2.5 million. In reaching the decision, the SFC had taken into account, among other things, the fact that the incident was a result of the amalgamation and the miscommunication between CESHK's former and current compliance team; and there was no evidence of client loss and systemic failure on the part of CESHK. CESHK also self-reported its breach to the SFC and redeemed all client securities upon discovering its breach. It is believed that the amount of the fine aptly reflects all the above mitigating factors.
Importance of self-reporting
Particular emphasis should be placed on the initiative taken by CESHK to self-report the incident to the SFC and CESHK's cooperation with the SFC in resolving the SFC's concerns. Self-reporting is not just about lessening the level of sanction, but is in fact an obligation required under the Code of Conduct.
Paragraph 12.5 of the Code of Conduct stipulates that intermediaries should report to the SFC immediately upon the happening of, among other things, any material breach, infringement of or non-compliance with any law, rules, regulations and codes administered by the SFC or any such suspected breach, infringement or non-compliance. Further, the SFC has issued a circular on 14 September 2018 to remind intermediaries to promptly report breaches or non-compliance.
In particular, all material breaches and non-compliance, actual or suspected and irrespective of whether these were identified by the intermediary itself, stemmed from customer complaints or were identified through other sources, should be reported to the SFC as soon as practicable upon identification but not after the intermediary has already completed its investigation, obtained legal advice or taken remedial actions.
In the present case, credit should be given to CESHK for having promptly reported the matter to the SFC on 20 August 2018, when the EBSHK Group began the process of renewing the standing authority of its client in mid-August 2018 and found that CESHK had not delivered the written notice for renewal.
It is worthy to note that failure to comply with the reporting obligation may result in disciplinary action being taken against the intermediaries and their management. Therefore, to avoid committing any breach of the Code of Conduct, it is fundamental that intermediaries comply with the self-reporting rule, instead of acting on it as a mitigation action. For that purpose, intermediaries should ensure that incident escalation and reporting mechanisms are in place with appropriate controls to comply with the notification requirement.
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