The SFC's feedback on their recent round of inspections of Investment Advisers (IAs) was shared with members of the Institute of Financial Planners of Hong Kong on 8 May 2007.  The SFC reported that the main issues they identified were: insufficient knowledge of clients and lack of justification to illustrate suitability of advice.  They also referred to shortfalls by some IAs in the due diligence being performed on products sold, as well as ineffective management supervision and poor documentation.

Importantly, the SFC has advised their plan of response to these findings will be to take rigorous regulatory action against serious breaches of the law, code and rules.  The SFC also stressed the need for senior management of each licensed corporation and registered institution to ensure that there is a strong corporate governance culture, and, that there are appropriate risk management policies and internal controls in place.

To assist IAs to better understand their obligations under the Code of Conduct, (paragraph 5.2), the SFC has issued a new "FAQ" on suitability obligations of licensed and registered persons who are engaged in financial planning and wealth management business activities. The full text of the FAQ can be found on the SFC website (http://sfc.hk).

The FAQ provides practical guidance that IAs should take into account in discharging their suitability obligations.  These include conducting detailed product due diligence; matching the risk return profile of each product with the personal circumstances of individual clients; providing necessary information to help the client make an informed investment decision; ensuring staff are competent and well trained; and documenting the reasons for each product recommendation.

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NOTIFYING CHANGES TO THE SFC

Section 135 of the Securities and Futures Ordinance (SFO) sets out various events to be reported by licensed persons to the SFC and by registered institutions to the HKMA and gives timelines for making these filings.  In addition, Schedule 3 to the Securities and Futures (Licensing and Registration) (Information) Rules specifies additional changes that are required to be notified by licensed corporations, registered institutions, licensed individuals and substantial shareholders of the licensed corporation and registered institution.

For example, basic information such as changes in passport number or residential address of directors, substantial shareholders and licensed persons should be notified the SFC (or to the HKMA in the case of registered institutions).  If a substantial shareholder or director of the licensed corporation or registered institution is subject to any disciplinary action or investigation by a regulatory body or criminal investigatory body, the licensed corporation must also notify the SFC even though the subject matter is not related to the business or the operation of the licensed corporation.  For cases like these, licensed corporations are likely to be asked to demonstrate whether the fitness and properness of the licensed corporation is affected by the disciplinary action or investigation of its parent.

As a general reminder, if there is any change in the information previously submitted to the SFC or the HKMA, this should be notified to the SFC or the HKMA within seven business days of the change. 

A point to note is that licensed corporations or registered institutions are required to notify the SFC or the HKMA seven business days in advance if they want to cease to carry on any regulated activity that is licensed or registered or if they intend to change the address from which they propose to carry on business.  Note that if the new address is where the records and documents are to be kept, the licensed corporation will need prior SFC approval and an application fee is payable.

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sfc enforcement trends

The SFC recently appointed Mr. Mark Steward from the Australian Securities and Investment Commission (ASIC) as Executive Director of Enforcement.  While enforcement initiatives of the SFC under his new leadership are still evolving, reference to the past record of ASIC’s enforcement may provide some hints.  In 2005/2006 at ASIC, civil orders against people or companies increased from 121 to 230 (+90%); people removed from acting as directors of companies from 33 to 44 (+33%); and illegal schemes shut down or other action taken from 76 to 102 (+34%).  The number of criminal convictions was steady; and people banned from participating in financial services slightly rose after a 40% fall in the year 2004/05. 

In the year 2005/06, the SFC had an 5% increase in new enforcement cases from 501 to 524 after a sharp fall from 1,223 in 2003/04.  There was a 11% increase in actions against licensees from 88 to 98 and a fall of 5% in entities successfully prosecuted from 76 to 72. 

Speaking at the Hong Kong Securities Institute on 3 May 2007, Mr. Steward said there would be more focus on identifying the root causes of misconduct, noting that during the past six months, there had been a greater emphasis placed on detection and enquiry.  A review of the enforcement actions during this period indicate enforcement actions taken by the SFC for breaches of the disclosure of interests obligations, unlicensed regulated activities, false/misleading information and short selling.

Mr. Stewart spoke of his particular interest in corporate governance and market misconduct, making clear that the SFC would take action against directors whose inappropriate conduct resulted in losses to shareholders.

As a new development, three areas of the Listing Rules will be given statutory backing, namely (i) periodic financial reporting; (ii) disclosure of price sensitive information; and (iii) certain notifiable transactions and connected transactions which require shareholders approval.  A breach of the relevant provisions under the amended SFO will constitute market misconduct.  This will present new challenges to SFC Enforcement.

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bUSINESS CENTRE OR SHARED OFFICES

On 7 May 2007, the SFC updated the Licensing Related Frequently Asked Questions (FAQs) on its website under the heading, "Other Topics relating to the Securities and Futures Ordinance (SFO)".

The updated FAQs assist licensed corporations or licensed applicants in understanding the SFC's view on factors relating to suitability of business premises.  Although the SFO and its subsidiary codes and guidelines do not prescribe the specific types of premises from which a licensed corporation should conduct its regulated activities, the SFC expects licensed corporations to ensure their office arrangements are appropriate to the business activities being carried out. 

Some of the factors which would generally be taken into account in considering whether the premises are suitable are as follows: 

• The security of the premises and a properly segregated office area.

• Essential office equipment and telecommunication systems should be situated in an area accessible only by the firm’s personnel.

• Sufficient measures have been taken to ensure there is no confusion to clients due to the co-existence of other firms in the same premises. 

• Confidential or non-public information and client privacy will be sufficiently safeguarded against unauthorised access or leakage.

• The premises are always accessible for visits by regulators. 

The guidelines are generally considered to make it difficult for a licensed entity to operate from a serviced office.

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MODIFICATION or waiver of certain sfo provisions

A licensed corporation, registered institution, licensed individual, substantial shareholder of a licensed corporation, corporate licence applicant or an individual licence applicant can apply to the SFC to have certain sections of the Securities and Futures Ordinance (SFO) or any provision of rules made by the SFC modified or waived under the SFO according to section 134 of the SFO.

The application should set out the section of the SFO, or the SFC rule, to which the application relates and the reason for the why the modification or waiver is being sought.  The application should be submitted with an application fee, which varies depending on the modification or waiver being sought.

Once the application is approved, the SFC will publish a notice in the Government Gazette.  A modification of the Securities and Futures (Professional Investor) Rules was gazetted recently.

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E-REPORTING IN THE CAYMAN ISLANDS
by John P. Wolf of Campbells

Electronic reporting for Cayman Islands registered funds is now fully operational and ushers in a new era in Cayman funds.  There are over 8,000 funds registered with the Cayman Islands Monetary Authority (CIMA).  E-Reporting will make the process for CIMA receiving and accessing general and financial information for these funds much more efficient.

Commencing 27 December 2006, all funds registered with CIMA are required to make their annual filings with CIMA electronically.  The introduction of E-Reporting was one of the features of the Mutual Funds (Amendment) Law 2006 which came into effect on 14 November 2006.  The following information is required to be filed electronically within six months of a fund’s financial year end:

• A fund annual return (also known as the FAR Form); and

• The annual audited accounts. 

The FAR Form is an Excel document consisting of some 60 questions often with "drop down" answers to choose from.  The form asks for general information (such as whether the fund is a fund of funds or master feeder) information as to service providers and financial information such as total assets, beginning net asset value and ending net asset value.

E-Reporting does not change the type of information that funds are required to report to CIMA; most of the information contained in the FAR Form should be contained in funds' audited accounts and offering documents and, hence, should be readily available.  However, the submission of this information in electronic format will enable CIMA to more efficiently handle the audited accounts and to provide better aggregate industry statistics.  This will benefit both CIMA, in its capacity as regulator, and the industry as a whole through the availability of better aggregate industry statistics.  Notably, no information about individual funds will be disclosed to the public.

Ultimate responsibility for these filings rests with the fund "operator", i.e. its directors, trustees or general partner.  Of course, a fund may appoint a service provider (for instance its administrator) to complete the FAR form on the fund’s behalf.  However, the form itself, once completed, has to be filed through the fund's Cayman Islands auditors which will submit it to CIMA through a secure internet portal.  Hence, all Cayman registered funds should ensure that appropriate arrangements are in place for the required filings to be made through their auditors.

The FAR Form can be downloaded from CIMA’s website (www.cimoney.com.ky) where further guidance on completion of the form and general information can be found.

John P. Wolf is a partner of Campbells, one of the leading law firms in the Cayman Islands. John can be contacted by telephone on +345 914 5856 or email jwolf@campbells.com.ky.

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QDII Update

In May 2007 Deacons issued a Legal Update entitled "Chinese Investors Allowed to Invest in Overseas Equities and Mutual Funds under QDII Scheme" providing an overview of the recently amended Qualified Domestic Institutional Investors scheme.  To read the full article, please click here.

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Deacons fspg charity golf challenge 2007

Braving the drizzling rain and strong winds, 22 golfers took part in the 5th Deacons FSPG Charity Golf Challenge on Friday, 16 March 2007.  Over $46,000 was raised bringing the total of charity monies raised by the five FSPG golf days to $326,600 for the Hong Kong Community Chest.

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Deacons awarded 2007 Asia pacific firm of the year

After being named the "Hong Kong Law Firm of the Year" by IFLR Asian Awards, Asian Legal Business Law Awards, and Asian Legal Business China Law Awards respectively in 2006, Deacons recently won the prestigious 2007 Asia Pacific Firm of the Year award from the leading UK legal publication Legal Business.  The publication described Deacons in the following terms: "a long-time fixture on the Hong Kong scene, Deacons has adeptly managed strategic expansion across the region. Now… this independent firm vies with the major global law firms for the top instructions."

In March 2007, Deacons was also awarded the "Hong Kong Firm of the Year" at the Who's Who Legal Awards by The International Who's Who of Business Lawyers.

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Deacons Financial Services Seminar Series

The next seminar in our 2007 Financial Services Series will be held on Friday 29 June, 2007 in our Hong Kong Office.

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Whilst every effort has been made to ensure the accuracy of this publication, it is for general guidance only and should not be treated as a substitute for specific advice.