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FDRC (and one more thing)

Steve Jobs used to give some entertaining new product releases where he would finish off the event with the words "and one more thing. . ."  This last thing would often be really interesting and worth waiting for.

On 21 May, the SFC in Hong Kong announced the results of a consultation to form the Financial Dispute Resolution Centre that will provide a forum for resolving issues between buyers and sellers of financial products.  This is very important for banks and those in the retail industry, but it was the 'one more thing' at the back that interested us the most.

In this case 'the one more thing' is actually a few more things and they have nothing at all to do with the FDRC.

In the consultation relating to the FDRC the SFC slipped in a section where it asked the industry to continue an extension of the time that tapes are held for (not a big issue really), the banning of the use of mobile phones to take client orders (a bit more important), a requirement that firms provide expert witnesses to the SFC on request or have their fitness to hold a license called into question (now that is a doozy), and a requirement to report any suspicion of a breach of legislation, code or guideline by a client of a licensed firm to the SFC (that got our attention).

The last two items are important because of two separate points.  In relation to provision of witnesses, surely the SFC's relationship with the industry is now not so bad as to require compelling witnesses to help it in clear conflict with the common law duty that an employee has to devote his working time to his employer and not some third party.  The SFC has watered down a little bit its original proposal, but new amendments to the code of conduct will require firms to co-operate in this area.  The visual image of Hogan's Heroes and 'vee haff vays of making you talk' comes to mind.  The SFC was wrong to proceed in this direction.

The requirement for a firm to report on another firm has likewise been reduced.  That is very good news.  Previously there were significant concerns about how a firm could demonstrate compliance in this area.  It was certainly one of the weirdest SFC proposals that this writer has seen.

The revised proposal (and thus the new rule) only applies now to market misconduct issues and reduction to those issues is sensible and was really something worth waiting for from the SFC. 

The new rules (which come into effect in December) will require firms to report a suspicion of insider dealing, false trading, price rigging, market manipulation or rumour mongering.  Previously the consultation paper was too wide in calling for reporting of any breach of legislation, a code or a guideline. 

The SFC described the requirement to report as follows:

In response to feedback concerning the threshold for reporting clients and difficulties in determining whether clients have complied with applicable laws and regulations, we wish to clarify that we do not require firms to conduct any investigation or make any decision on whether or not a client has been guilty of misconduct. We simply require firms to report the facts or matters indicating that a client may be guilty of misconduct. This would include credible information received by a firm from a third party suggesting a breach or suspected breach has occurred. We would add that there is no duty on firms to report clients to the SFC based merely on unsupported speculation or vexatious comment.

Notwithstanding that guidance, firms will still need to engage in training about how to detect and report these issues and this will be costly.  It adds to the current range of actions that the SFC can take against an intermediary caught up in the actions of their client and has the effect of shifting more of the burden of proof to the intermediary to establish that they could not have known what the client was up to.

While the reduction in scope is welcome, the SFC has also not really gone far enough, in our view, of assuaging the serious concerns the industry had about a lack of legislative backing for these provisions.  The new provisions may still give rise to claims against firms making a disclosure either under the AML related laws of Hong Kong or in relation to breach of client confidentiality.  The SFC set out some cases and defences that firms may wish to raise if pursued for doing what the SFC wants them to do, but that is not an ideal way to do business when compared to the statutory protection that AML legislation provides in similar reporting circumstances.

Which brings me back to the 'one more thing' theme of this blog.  These new provisions are very serious.  Why they were lumped in with an important, but less controversial, topic like the FDRC is unclear and seems strange.  More thought is what is needed on these issues rather than the current amendments.  Financial intermediaries want to be sure that when they do (in good faith) what a regulator wants them explicity to do, that they are protected from action by their clients.  We are concerned that these new provisions do not appear to go far enough in that respect given that a decision has been made to proceed with the changes to the Code of Conduct.


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