Continuing a very busy couple of weeks of fines and enforcement reporting the Hong Kong SFC today announced that it was fining three UBS employees in connection with an issue that was previously covered in this blog involving wash trades and a client of Morgan Stanley.

The SFC reported as follows:

The Securities and Futures Commission (SFC) has publicly reprimanded Mr Frank Hu, Ms Peony Ng and Ms Jenny Chang Pui Chun of UBS AG Hong Kong (UBS) and fined them $800,000, $600,000 and $400,000 respectively, for negligence in handling a client’s trade orders (Note 1).

An SFC investigation found that Hu, Ng, and Chang, were negligent in relation to a series of trades that they carried out on behalf of one of their clients at UBS which constituted wash sales and may have misled the market (Note 2).

Both Hu and Ng are executive directors at UBS and Chang is an associate director.

In February 2008, the client, who was facing margin calls from UBS decided to transfer part of his portfolio at UBS (Note 3) to his account at Morgan Stanley Asia Ltd (Morgan Stanley) in order to ease his margin position with UBS.

This could have been achieved through a simple delivery versus payment arrangement, such as by using the Central Clearing and Settlement System. Instead, a series of on-exchange matched sales and purchases (Note 4) was coordinated among Hu, Ng and Chang at UBS and the client’s account executive and her assistants at Morgan Stanley (Note 5) between 28 February and 26 March 2008.

In deciding the penalty for Hu, Ng and Chang, the SFC took into account that the three individuals had not carried out the matched trades with manipulative intent to interfere with the market, that they had sought internal compliance advice at UBS but failed to follow the advice due to misunderstanding, that they had co-operated with the SFC, and that each of them has a clean disciplinary record.

End

Notes:

1. Hu, Ng and Chang are relevant individuals registered with the Hong Kong Monetary Authority. Hu and Chang are authorized to carry out Type 1 (dealing in securities) and Type 4 (advising on securities) regulated activities whilst Ng is authorized to carry out Type 1 regulated activities.
2. Wash sales are transactions that do not involve any change in beneficial ownership. In this case, the sell orders of UBS and the buy orders of Morgan Stanley were matched on 82 occasions where there was no change in beneficial ownership of the shares involved.
3. The securities involved in the transfer were Fosun International Ltd (stock code 656), Tiangong International Company Ltd (stock code 826), Centron Telecom International Holding Ltd (stock code 1155), and Kingsoft Corporation Ltd (stock code 3888).
4. Upon receiving the client’s instructions, Chang would input sell orders on The Stock Exchange of Hong Kong. She would then inform the account executives handling the client’s account at Morgan Stanley by telephone immediately of the volume and price of the orders who would then arrange for Morgan Stanley, on behalf of the client, to purchase from the market similar quantity of the same stock at the same prices or at prices lower than UBS’ sell orders.
5. The SFC has also taken disciplinary action against the account executive at Morgan Stanley (See SFC press release dated 17 August 2009).

According to the SFC website, the Hong Kong SFC has fined two Merrill Lynch entities at total of HK$3.5m (about US450k) for internal control breaches.

Here is the report:

The Securities and Futures Commission (SFC) has fined Merrill Lynch (Asia Pacific) Limited and Merrill Lynch Futures (Hong Kong) Limited (collectively Merrill Lynch) (Note 1) $3,500,000 for systems and controls failings associated with the mis-marking activities in a trading book.

The SFC’s investigation found that during the period from December 2007 to October 2008, a managing director of Merrill Lynch had mis-marked a trading book in exotics options (Book) by manipulating the volatility marks in the valuation model, and accessed the computer system without authority to alter pricing parameters on various occasions. The mis-marking activities, which did not apply to any other books, resulted in the value of the Book being inflated by approximately US$25 million and caused the actual loss in the Book to be wrongly reported internally.

The SFC found that Merrill Lynch did not have adequate internal controls procedures in place to manage the risks associated with mis-marking, in that:

• there was uncertainty as to supervisory responsibilities over the trader and the Book;
• the price verification mechanism applied to other trading books was not applied to the Book;
• there were inadequate checks and balances over the Book to mitigate operation risks including risks associated with fraud and dishonest activities;
• there was insufficient safeguard over information security and integrity as regards the Book;
• trading and valuation policies were not sufficiently implemented over the Book; and
• senior management failed to adequately manage the risks associated with the Book.

“Licensed corporations must have effective procedures in place to manage risks of trading books. For books that deal in illiquid assets which have low price transparency, more robust measures must be in place. The proper implementation of an effective risk management framework could have enabled Merrill Lynch to detect the mis-marking earlier,” said Mr Mark Steward, the SFC’s Executive Director of Enforcement.

Merrill Lynch accepts that its systems and controls fell short of those expected in respect of the Book.

The SFC accepts that Merrill Lynch’s misconduct was not intentional and Merrill Lynch has taken remedial steps to address the compliance weaknesses. In deciding on the sanctions, the SFC took into account Merrill Lynch’s co-operation in resolving the case.

End

Notes:

1. Merrill Lynch (Asia Pacific) Limited is licensed under the Securities and Futures Ordinance (SFO) to carry on Type 1 (dealing in securities), Type 4 (advising on securities), Type 6 (advising on corporate finance) and Type 7 (providing automated trading services) regulated activities. Merrill Lynch Futures (Hong Kong) Limited is licensed to carry on Type 2 (dealing in futures contracts) regulated activity under the SFO.

The Hong Kong SFC website reported as follows:

SFC bans Edmond Chau Chin Hung for life

The Securities and Futures Commission (SFC) has publicly reprimanded Mr Edmond Chau Chin Hung, fined him $2 million and prohibited him for life from re-entering the industry for engaging in market misconduct (Note 1).

The disciplinary action follows the Market Misconduct Tribunal’s (MMT) determination that Chau, a former responsible officer of Sun Hung Kai Investment Services Ltd (SHKIS), and three other parties had engaged in market misconduct by false trading and price rigging in the shares of QPL International Holdings Ltd (QPL). The MMT made certain orders against Chau, including recommending that the SFC take disciplinary action against him (Note 2).

During the period from 6 May to 10 June 2003, Chau engaged in scaffolding activities by placing numerous buy orders for QPL shares and subsequently cancelling, reducing these orders or allowing them to lapse in order that two SHKIS clients could sell their holdings of QPL shares more actively and quickly.

Not only was Chau in breach of SHKIS’s internal policies, he also abused his senior position as responsible officer by procuring the assistance of or conniving with his subordinate to conduct these unlawful activities.

When he attended interviews with the SFC during the investigation, he denied having conducted any scaffolding activities or engaged in any market misconduct. However, during the MMT proceedings, he admitted that he had done so.

In deciding upon the sanctions against Chau, the SFC took into account that Chau:

• played a primary role in perpetrating the market misconduct for five weeks and his misconduct was only put to an end by the intervention of the SFC with its inquiry into the trading of QPL shares;
• abused his senior position at SHKIS by procuring the assistance of his subordinate to conduct unlawful activities;
• co-operated with the SFC by consenting to the disciplinary action; and
• has a clear disciplinary record with the SFC.

End

Notes:

1. Chau was licensed under the Securities and Futures Ordinance to carry on business in Type 1 (dealing in securities), Type 2 (dealing in futures contracts) and Type 3 (leveraged foreign exchange trading) regulated activities. He was a responsible officer of Bali Securities Co Ltd, SHKIS, Sun Hung Kai Commodities Ltd, and Sun Hung Kai International Commodities Ltd. He ceased to be a licensed person and the approval for him to act as a responsible officer was revoked on 27 February 2009.
2. The MMT’s press release and report (http://www.info.gov.hk/gia/general/200903/18/P200903180162.htm) can be found on the MMT’s website (www.mmt.gov.hk).

The Hong Kong SFC website reports a case against a Hong kong firm where the SFC concluded that they had misreported their financial results when sending in returns under Hong Kong's rules regarding prudential requirements for securities firms, the Financial Resources Rules.  The case again illustrates that the penalties in Hong Kong are going up for breaches.

The SFC website states as follows:

The Securities and Futures Commission (SFC) has resolved certain compliance issues with Asia Pacific Securities Ltd (APSL) and one of its responsible officers, Mr Canice Chan Yau Fung (Note 1).

Under the resolution, the SFC has reprimanded and fined APSL $1.4 million (Note 2), and revoked the licence of Chan.

The SFC found that APSL and Chan had engaged in window dressing activities designed to inflate the amount of liquid capital the firm was required to hold under the Securities and Futures (Financial Resources) Rules (Financial Resources Rules).

“The Financial Resources Rules are a key prudential safeguard protecting clients and creditors of licensed firms who find themselves in financial difficulty. The SFC has little sympathy for firms which manipulate their monthly returns,” said Mr Mark Steward, the SFC’s Executive Director of Enforcement.

APSL had wrongly included the ledger balance in its “amounts due by directors” account, representing money advanced to its directors, into the calculation of its liquid capital. If the “amounts due by directors” had not been included, APSL would have failed to maintain the minimum required level of liquid capital during intra-month periods for the four financial years since 2003. Average deficits in the required liquid capital ranged from around $250,000 to $1,000,000 (Note 3).

The SFC found a recurring pattern of APSL advancing money to its directors under the “amounts due by directors” account immediately after month-ends, with reimbursements by approximately the same amounts of money at month-ends, when APSL had to submit its financial returns to the SFC. These attempts by APSL to window dress its liquid capital position were made under Chan’s instructions.

APSL and Chan both note the views of the SFC in respect of the compliance lapses and regret that these lapses occurred.

In reaching this resolution, the SFC took into account that:

• both APSL and Chan fully co-operated with the SFC;
• neither APSL nor Chan has previous disciplinary record; and
• APSL immediately ceased to include the ledger balance in the “amounts due by directors” account in the calculation of its liquid capital when notified by the SFC.

According to the SFC website the Securities and Futures Commission (SFC) has publicly reprimanded Sun Hung Kai Investment Services Ltd (SHKIS) and fined it $4,000,000 for internal control failures that contributed to market misconduct (Note 1).  The offences relate to a failure to enforce controls relating to the separation of agency and proprietary trading.

The amount of the fine, HK$4 million (or USD514,000), is high for this type of offence and reflects the overall trend of increasing fines against corporates in Hong Kong where the SFC determines that a breach has occurred.

The SFC website reports as follows:

Following an inquiry into dealing in the shares of QPL International Holdings Ltd in 2003, the Market Misconduct Tribunal (MMT) found on 22 January 2009 that Mr Edmond Chau Chin Hung (a former responsible officer of SHKIS) and Ms Connie Cheung Sau Lin (a former account executive of SHKIS) engaged in false trading and price rigging, contrary to the Securities and Futures Ordinance, for the period from 6 May to 10 June 2003.

The MMT further found that:

• the misconduct of Chau was attributable to SHKIS of whom he was an executive director and responsible officer, and to Cheeroll Ltd (now renamed Sun Hung Kai Strategic Capital Ltd) for whom Chau was authorised to trade; and
• SHKIS was vicariously liable for the misconduct of Cheung.

On 25 February 2009, the MMT made certain orders including recommending that disciplinary action be taken by the SFC against SHKIS, Chau and Cheung (Note 2).

The SFC found that there were internal control failures at SHKIS that contributed to the market misconduct because:

• despite policies to segregate proprietary trading and client trading, SHKIS gave Chau the authority to conduct both types of trading which gave him the opportunity to misuse information gathered on the client trading side of the business to engage in unlawful activities in a proprietary account;
• at material times, SHKIS allowed Chau and Cheung to place orders in the same dealing room by open “outcry”, which was inconsistent with SHKIS’ formal policy to physically separate proprietary and client trading functions; and
• SHKIS did not detect Chau and Cheung’s misconduct for five weeks until brought to its attention by the SFC.

In deciding on this outcome, the SFC took into account that:

• Chau and Cheung acted without SHKIS’ sanction and in breach of its internal policies;
• SHKIS did not profit from Chau and Cheung’s actions;
• SHKIS co-operated with the SFC by entering into a settlement resolution; and
• SHKIS has made improvements to its framework of controls and reporting in the period since.

Mr Mark Steward, the SFC’s Executive Director of Enforcement, said: “Sun Hung Kai Investment Services Ltd had in place appropriate policies segregating client and proprietary trading which, in this case, were not properly implemented or policed. Policies designed to prevent market misconduct must be actively monitored and supervised by senior management and the SFC will hold firms to account for their failure to ensure their compliance systems are working properly.”

End

Notes:

1. SHKIS is licensed under the Securities and Futures Ordinance to carry on business in Type 1 (dealing in securities) and Type 4 (advising on securities) regulated activities.
2. The MMT’s press release and report can be found on the MMT’s website www.mmt.gov.hk

(see http://www.info.gov.hk/gia/general/200903/18/P200903180162.htm)