Business Conduct and Client Relations

1

FINANCIAL LAW AND FINANCIAL LAW AND REGULATIONSREGULATIONS

WEEK 8

Business Conduct and Client Relations

Business Operations and Practice

2

Code of conduct for persons licensed by or registered with the SFC

- Primary code form which others are developed- Based on nine principles- Effectively deal with the external relationships

of an intermediary- Codes in themselves are not law but can be

enforced- Exemptions for discretionary management of

collective investment schemes

Business Conduct & Client Relations

3

- Principle 1 – Honesty and Fairness

- Representations and information to clients should be accurate and not misleading

- Charges to clients should be reasonable

- Invitations and advertisements should not contain information that is false, misleading or deceptive, and not contain negative comments about competitors

- Awareness of Prevention of Bribery Ordinance

Principles

4

- Principle 2 – Diligence

- An intermediary should take reasonable steps to execute client orders promptly and in accordance with clients, instructions ( prompt execution)

- An intermediary should execute client orders on the best available terms (best execution)

- Orders executed for clients should be promptly and fairly allocated to those clients (prompt and fair allocation)

- Advice to clients should be given with due skill, care and diligence

Principles

5

- Principle 3 – Capability

- An intermediary should have all the resources needed for operating the business and employ them effectively

- The principle refers to the internal operations of the intermediary and is covered in ore detail later

Principles

6

- Principle 4 – Information about clients

- Know your client – not only his/her true identity but also his/her real financial strength, investment experience and investment objectives

- Client agreements should contain full name and address of both parties, undertakings to notify any changes, full description of services and charges and risk disclosure statements

- Discretionary accounts should be in writing, terms and authority should be clear, be renewed annually, opening should be approved by senior management and they must be properly supervised

Principles

7

- Principle 5 – Information for clients

- An intermediary must provide information to its clients in order to maintain transparency and inform them of transactions

- Information about the intermediary includes adequate and relevant information about its business, including details of client contact persons

- Audited financial statements should be provided to clients upon request

- Other information includes prompt confirmation of transactions and statements of account

Principles

8

- Principle 6 – Conflicts of Interest

- An intermediary should avoid conflicts and if unavoidable should act fairly – disclosure

- Priority in handling and recording orders – client order should have priority over those of the intermediary or an employee or agent of the intermediary

- Priority in allocation of orders – if aggregated orders cannot be fulfilled in one transaction priority must be maintained in a follow-up transaction

- An intermediary should not engage in front-running and not engage in insider dealing

Principles

9

- Principle 7 – Compliance

- An intermediary must have a written policy specifying if employees can deal for their own accounts in securities or futures contracts

- Such activities must be transparent, separately managed and supervised

- An intermediary is responsible for acts and omissions of employees and agents

- An intermediary must handle client complaints in a timely and prompt manner

- The code specifies when reports should be made to the SFC. Also covered by the SFO in parallel legislation

Principles

10

- Principle 8 – Safeguarding of Client Assets

- An intermediary or a third party acting on its behalf should account for client assets promptly and properly and ensure adequate safeguard

- This principle is in addition to the Client Securities Rules and Client Money Rules as laid out in the SFO

- Scope of care in code is wider than that in the legislation and clients should be warned of the risks of assets received or held overseas

Principles

11

- Principle 9 – Responsibilities of Senior Management

- They are primarily responsible for ensuring adherence to the code

- They should properly manage the risk associated with the business:

- Nature of the business, internal control systems, risk management policies and the extent of their authority and responsibilities

- They should have access to all relevant information on a timely basis and necessary advice

Principles

12

- It is recognized that because some persons are very skilled and experienced investors, they do not require the level of protection that the ordinary retails investor might need

- PIs are defined in the SFO

Professional Investors “PIs”

13

- Intermediaries and similar investment service providers

- AFIs and similar overseas institutions

- Insurers regulated under the Insurance Companies Ordinance

- Collective authorized investment schemes

- MPF and ORSO schemes

- Governments, central banks and multilateral agencies


14

- All PIs are excluded from:

- The unsolicited calls provision of s174, SFO

- Requirements for offers as specified in s175, SFO

- The professional investor rules extend the above Category 1 PIs to so-called Category 2 PIs:

- Trustee companies responsible for total assets of not less than HKD 40 million


15

- High net worth individuals (HNWIs) having a portfolio of not less than HKD 8 million

Corporations or partnerships having either a portfolio of not less than HKD 8 million or total assets of not less than HKD 40 million

- Corporations that act solely as investment holding companies and are wholly owned by individuals who are professional investors

- Intermediary must inform client of consequences of being treated as a PI and secure written declaration


16

- For all PIs’ intermediaries do not have to:

- Establish a client’s experience and objectives and ensure suitability of recommendation

- Enter into a written contract or provide risk disclosure statements and obtain prior authority for transacting discretionary accounts

- Explain and confirm written authority annually

- Provide information about itself or make prompt confirmation of transactions


17

- Must be included in client contracts and be discussed with clients

- They deal with the particular risks of carrying out the respective activities, need fro obtaining professional advice and degree of protection given by limits the client may put on trades

- There are several forms of risk:

- Risk of securities trading

- Risk of trading futures and options

Risk Disclosure Statements

18

- Risk of Growth Enterprise Market (GEM) stocks

- Risks attaching to clients assets received or held outside Hong Kong

- Risk of providing an authority to repledge (give as security) clients’ collateral

- Risk of providing an authority to hold mail or direct it to third parties


19

- Risk of margin trading

- Risk of trading in leveraged foreign exchange contracts

- There are additional schedule specifying requirements for dealings on the SEHK and HKFE, in securities margin financing and in leveraged foreign exchange contracts


20

Code of conduct for persons licensed by or registered with the SFC

- Focus is on internal operations of an intermediary rather than on clients as in client relations

- Expand on capabilities, competence, compliance and supervision by senior management

- Also review implications of money laundering / terrorist financing, on-line trading activities, additional short selling requirements, unsolicited calls and insurance cover

Business Operations and Practices

21

- These ICG comprise eight key areas

- They match the nine general principles of the code of conduct

- The ICG are like codes in that they do not have the force of law and a failure to observe them will not be an offence leading to prosecution

- However, failure to observe them will impact adversely on the fitness and properness of the intermediary

Management, Supervision and Internal Control Guidelines

22

- Internal control and internal management systems

- Are used by intermediaries to operate a business in an orderly and efficient manner

- To safeguard the assets of its clients as well as its own assets

- To maintain proper records and to rely on the financial and other information they produce

- To comply with all applicable laws and statutory requirements


23

- 1 - Management and Supervision

- Active management which takes responsibility

- Regular and effective reporting to management

- Clear assignment of responsibilities and line reporting

- Clear definition of authorization levels

- Supervision is carried out competently


24

- 2 – Segregation of Duties and Functions

- Reduce opportunities for abuse

- Prevent errors from being undetected

- Avoid potential losses to clients

- Functions such as sales, dealing, accounting and settlement should be segregated from each other

- Compliance and internal audit should report direct to senior management


25

- 3 – Personnel and Training

- Should be adequate to ensure that employees are able to comply with all applicable regulations, the internal systems, controls and laid down procedures

- Employment of competent staff

- Clear communication to staff

- Provision of adequate training including continuing professional training (CPD)


26

- 4 – Information Management

- Ensure integrity, security, availability, reliability and completeness of all information relating to business

- Staff should be qualified

- Systems should be adequate – access controlled

- Information reporting needs should be clear

- Systems are documented and back ups made

- Effective record retention


27

- 5 – Compliance

- Intermediary and staff should be aware of all applicable laws and regulations

- Establish and maintain effective compliance function

- Ensure competence of compliance staff

- Ensure access to all areas of business by compliance

- Establish proper complaints handling procedures

- Promptly report any material non-compliance


28

- 6 – Internal Audit

- Purpose is to independently examine, evaluate and report on the adequacy, effectiveness and efficiency of the intermediary’s management, internal controls and operations

- Should be established by senior management and be independent of operations

- Senior management should ensure adequate planning, control and recording of the internal audit work


29

- 7 – Operational Controls

- Effective policies, procedures and controls over the day-to-day business operations

- Confirm true identity of each client, beneficial owner, person authorized to give instructions and know your client information

- Establish precise terms for discretionary accounts

- Investment advice supported by contractual agreement

- Minimize conflicts of interest - disclose interests to client


30

- 8 – Risk Management

- Ensure proper management of risks

- Identify and quantify such risks

- Provide timely and adequate information to management to enable it to take necessary action

- Establish a competent risk management function

- Monitor


31

- Process by which money obtained through criminal activities is cleaned so as to disguise its origins and give the appearance that it comes from a legitimate source

- Cash transactions are preferred as they do not create bank records

- Cash is difficult to distinguish unless all banknote serial numbers can be identified

- Cash can be broken down into smaller sums which are less noticeable

Money Laundering and Terrorist Financing

32

- SFC produced the Money Laundering and Terrorist Financing Guidance Note (MLGN) under s399 of the SFO

- Applies to licensed corporations, licensed representatives and associated entities that are not AFIs

- HKMA issued similar guidelines to AFIs

- Both guidelines do not have the force of law but failure to follow their spirit may adversely affect on fitness and properness


33

- Three stages identified:

- Placement – the first stage is the physical disposal of the illegal money

- Layering – the second stage is the separation of the money from the illegal source by creating a number of financial transactions (layers)

- Integration – Final stage is when the money has obtained the appearance of being legal and can be used openly without fear of being connected with a crime


34

- The Drug Trafficking (Recovery of Proceeds) Ordinance – (DTRPO) – makes it an offence to deal with property which is known or believed to be the proceeds of drug trafficking

- The Organised and Serious Crimes Ordinance – (OSCO) – gives the police powers to obtain a court order to secure information and conduct searches

- The United Nations (Anti-Terrorism Measures) Ordinance (UNATMO) makes it a criminal offence to supply funds or make funds or financial services available to terrorists or their associates

Hong Kong Legislation

35

- Client identification

- Record keeping and retention

- Recognition and reporting of suspicious transactions

- Procedures for disclosure

- Education and training

Money Laundering Terrorist Financing Guidance Note

36

- Large or unusual cash settlements

- Buying and selling financial instruments with no obvious purpose

- A number of different buy transactions which are then sold in one transaction to another person

- Cash provided by parties from countries with a reputation for drug trafficking

- Parking idle funds with no trading activity. Engaging in wash trades

- Changes in staff lifestyle and or behaviour

Examples of Suspicious Transactions

37

Class work

Evelyn de Rothschild is the former chairman of NM Rothschild & Sons, a very famous investment bank based in London, founded in 1811. He wrote an article in FT and suggested “one must go back to basics” for the financial institutions in trouble Read the article. What are these “basics”?

38

Appendix

39

- Guidance Note on Internet Regulation

- Circular to all Registered and Licensed Firms on Internet Trading and Advising

- Guidance for Registered Persons using the Internet to Collect Applications for Securities in an Initial Public Offering (IPO)

- Circular on Provision of Financial Information on the Internet

- CIS Internet Guidance Note (for persons advertising or offering CIS on the Internet)

Online Trading and Advising

40

- Such services describe any automated system that provides by means of electronic facilities a trading mechanism for securities and futures contracts other than the operations of SEHK and HKFE

- They include trade matching systems, broker run ATSs, exchange run ATSs, broker to broker to broker automated linkages and internet systems

- A person may be authorised under s95 SFO to provide ATS services

- A person may be licensed or registered under Part V SFO

Automated Trading Services (ATS)

41

- Securities and Futures (Short Selling and Securities Borrowing Lending (Miscellaneous)) Rules

- Guidance Note for Short Selling Reporting and Stock Lending Record Keeping Requirement

- Short Selling Requirements in Schedule 3, the Code of Conduct

- Short Selling regulations in the Eleventh Schedule of the SEHK

Short Selling Requirements (additional)

42

- An intermediary may during an unsolicited call to a person who is already a shareholder of a corporation:

- Enter into an agreement to buy or sell securities of that corporation, and

- Make a permissible communication

- However, communications only permissible if NOT made in the course of a visit in person, a telephone conversation or any other interactive dialogue consisting of statements and responses exchanged immediately

Securities and Futures (Unsolici

ted Calls Exclusion) Rules

43

- Maintenance of insurance cover by a licensed corporation (or security deposit with SFC) which is an exchange participant (SEHK or HKFE) and holds clients assets is a necessary condition for the granting of a licence by the SFC

- SFC may approve master policies for specified regulated activities. Risks covered include:

- Fraudulent or dishonest acts of employees, robbery or theft of client assets, forgery, fraudulent use of information systems and forged or fraudulent instructions relating to client assets

Securities and Futures ( Insurance) Rules

Documents

Business Conduct and Client Relations