Introduction

In recent years, the Securities and Futures Commission (the “SFC”) has taken out numerous disciplinary actions against licensed corporations for failures in complying with anti-money laundering and counter-terrorist financing (“AML/CTF”) regulatory requirements when handling third party fund transfers. In this article, we will examine the proper steps for licensed corporations to handle third party fund transfers with reference to the recent SFC disciplinary action against Yardley Securities Limited (“YSL”).

Disciplinary action against YSL

In March 2021, the SFC publicly reprimanded and fined YSL $5 million for failures in complying with AML/CTF regulatory requirements when handling third party fund transfers pursuant to section 194 of the Securities and Futures Ordinance.

Failure to conduct proper enquiries 

Between February and May 2016, YSL processed a number of third party deposits/withdrawals in the margin accounts belonging to two clients, namely Client A and Client B (the “Third Party Fund Transfers”). The SFC found that the Third Party Fund Transfers were large, frequent and/or unusual and appeared to display red flags,  as illustrated in Paragraphs 7.14 and 7.39 of the Guideline on Anti-Money Laundering and Counter-Financing of Terrorism (the “AML Guideline”)[1] :

1. frequent and significant sums of monies transferred to and from third parties unrelated to the client and/or whose identities were unknown and/or not verified;
   
2. clients’ accounts were used as a conduit for transfers where substantial sums of money were deposited to the accounts by a third party and then withdrawn and transferred to another third party on the same date;
   
3. transactions which were unnecessarily complex and do not constitute the most logical, convenient or secure way to do business and/or is out of the ordinary range of service normally requested of a licensed corporation; and
   
4. “U-turn” transactions, i.e. money passes from one person or company (e.g. a company involved in the casino and gaming industry) to another, and then back to the original person or company.
   

Despite the above indicators suggesting that the Third Party Fund Transfers appeared to be unusual and/or potentially suspicious, YSL approved the fund transfers without documenting the reasons to justify such approvals at the relevant time. After the SFC’s inspection, YSL tried to retrospectively document the evaluation it claimed to have made when approving the Third Party Fund Transfers, which demonstrated that YSL failed to make adequate enquiries before approving such transfers.

Furthermore, records of enquiries which YSL claimed to have been made were absent since:

1. there was no record of company search or enquiry made on the third party who deposited $30,000,000 into Client A’s margin account and this sum was subsequently transferred to another third party;
   
2. there was inadequate enquiry and/or record of enquiry made to Client B as to why his margin account was used as a conduit for receiving a deposit of $30,000,000 from an unknown third party, and transferring $28,415,000 to another third party involved in the casino and gaming industry on the same day;
   
3. there was no record that enquiries/searches were made on certain third parties’ identities and/or their relationships with Client B; and
   
4. four third parties involved in the casino and gaming industry deposited a total of $296 million into Client B’s margin account purportedly to be used as proof of Client B’s financial ability to act as a guarantor to repay a loan to a company but there was inadequate enquiry made as to why (i) Client B would act as a guarantor for a company in which he was not a shareholder and held no position and (ii) third parties would transfer funds to Client B to be used as proof of his financial soundness.
   

As a result, the SFC determined that YSL failed to conduct proper enquiries and sufficient scrutiny on the unusual or suspicious Third Party Fund Transfers and failed to adequately record enquiries allegedly made on the Third Party Fund Transfers. The SFC found that YSL was in breach of section 5(1) of Schedule 2 to the Anti-Money Laundering and Counter-Terrorist Financing (Financial Institutions) Ordinance (“ALMO”) and paragraphs 5.1, 5.10, 5.11 and 5.12 of the AML Guideline which require licensed corporations to continuously monitor their business relationship with their clients by, inter alia:

1. monitoring clients’ activities to ensure that they are consistent with their nature of business, risk profile and source of funds;
   
2. identifying complex, large or unusual transactions or patterns of transactions with no apparent economic or lawful purpose and which may indicate money laundering and/or terrorist financing; and
   
3. making enquiries and examining the background, purpose and/or circumstances of potentially suspicious transactions, and making a report to the JFIU when there is any suspicion. Findings and outcomes of these examinations should be properly documented in writing and be available to assist the relevant authorities.
   

Failure to implement procedures to comply with AML/CTF regulatory requirement

The SFC also found that YSL did not have adequate policies, procedures, controls and did not provide adequate training to its staff to ensure compliance with the AML/CTF regulatory requirements:

1. apart from adding a new chapter to its operations manual to set out its procedures on AML/CTF, YSL failed to provide written policies and procedures on AML/CTF;
   
2. YSL failed to ensure that its staff were made aware of its AML/CTF policies and procedures. In particular, its staff member responsible for processing money deposits/withdrawals was not aware of YSL having a money laundering reporting officer;
   
3. YSL failed to provide adequate AML/CTF training to its staff; and
   
4. YSL failed to ensure that its staff followed the requirements set out in its operations manual.
   

As such, the SFC took the view that YSL’s conduct was in breach of the ALMO and AML Guideline. In deciding the disciplinary sanction, the SFC took into account that YSL’s failures lasted for at least nine months and that it adopted a lax attitude when handling a substantial amount of third party transfers in its clients’ accounts.

Recommendations on handling third party fund transfer

In the AML Guideline and the circular published by the SFC in relation to third-party deposits and payments of the licenced corporations (“LCs”), LCs are encouraged to implement robust systems and procedures that can be reasonably expected to protect client assets as well as to detect and prevent risks associated with third-party payment arrangements. A few recommendations made by the SFC which should be complied with by LCs include:

1. clearly define in their policies and procedures the exceptional and legitimate circumstances under which third-party deposits and payments may be permitted and provide examples of acceptable third-party payors and payees;
   
2. only accept any third-party payment arrangements when effective monitoring systems and control measures are implemented to mitigate the associated risks and the applicable legal and regulatory requirements are adhered to;
   
3. designate the Manager-In-Charge of AML/CTF to oversee the design, implementation and ongoing monitoring of the policies and procedures for handling third-party deposits and payments;
   
4. conduct due diligence on any third-party deposit or payment requests to determine including but not limited to the identity of the third-party payor or payee, the relationship between the client and the third-party payor or payee and the reason and the need for receiving the deposit from or making the payment to the third-party; and
   
5. monitor client accounts involving third-party deposits and payments, and stay alert to red flags.
   

Takeaway

The disciplinary actions by the SFC serve as a reminder of what LCs should and should not do, as well as the potential consequences of breaching AML/CTF requirements. When dealing with third party fund transfer or implementing the papered policies concerning third party fund transfer, it is important to consider the AML Guideline and circulars issued by the SFC to make sure that all requirements are incorporated into working practices and the suggested measures by the SFC are duly enforced. Proper record keeping is also a crucial exercise which should be regularly followed through and monitored by LCs, particularly where written decisions of LCs would offer justifications of the actions taken by them.

[1] The Guideline on Anti-Money Laundering and Counter-Financing of Terrorism was in effect between 1 April 2015 and 28 February 2018. This guideline has been superseded by the Guideline on Anti-Money Laundering and Counter-Financing of Terrorism (For Licensed Corporations) dated November 2018.