Introduction

Keeping proper audit trail of client orders is a basic and fundamental requirement expected of persons licensed under the Securities and Futures Ordinance (Cap. 571) as it assists the management of licensed corporations to detect and prevent irregularities and fraudulent activities.  It also provides reliable evidence if any dispute arises between a broker and its clients about trade orders.

In this regard, the Code of Conduct for Persons Licensed by or Registered with the Securities and Futures Commission (the “Code of Conduct”) and Management, Supervision and Internal Control Guidelines for Persons Licensed by or Registered with the Securities and Futures Commission (the “Internal Control Guidelines”) published by the Securities and Futures Commission (“SFC”) set out, among others, the requirements and procedures in relation to order recording and operation of discretionary accounts.  However, very often licensed persons misuse discretionary accounts and contravene the order recording requirements under the Code of Conduct.

In November 2014, SFC took disciplinary action against Mr. Leung Wai Hung (“Leung”) for (i) his failure to comply with the order recording requirements under the Code of Conduct; and (ii) the misuse of discretionary account arrangement to circumvent the order recording requirements.  As a result of Leung’s misconduct, SFC banned him from re-entering the industry for 18 months.

Leung’s Misconduct

Leung was licensed as a representative under the SFO to carry on Type 1 (dealing in securities) regulated activities.  He was accredited to and employed as an account executive of Fulbright Securities Limited (“Fulbright”) between during 14 June 2010 and 31 October 2013.

In around March 2013, Fulbright discovered some unusual trading activities in Leung’s own trading account and some client accounts (which include some discretionary accounts managed by Leung).  Fulbright suspected that Leung might have committed market misconduct and reported to the SFC accordingly.

SFC commenced investigation and discovered that:-

1.        During Leung’s employment at Fulbright, he was responsible for managing seven discretionary accounts.

2.        According to Leung, shortly after he commenced working in Fulbright, he was found to have failed to record his clients’ orders, whereupon someone in Fulbright suggested he could open discretionary accounts for his clients.  He further alleged that it was to his understanding that he did not need to record the orders placed by clients who have given him discretionary authority.

3.        According to one of the discretionary clients, while she had given Leung discretionary authority to operate her account, orders in her account were in fact placed at her specific instructions.

4.        Another discretionary client told the SFC that order instructions for transactions in his account were given to Leung by mobile phone.  Further, he was told by Leung that Fulbright prohibited the taking of client orders by mobile phone, and Leung could not take his orders by mobile phone unless he authorized Leung to operate his account on a discretionary basis.

5.        Telephone order recording existed for only a small proportion of transactions effected in the accounts of Leung’s discretionary clients even though as mentioned above, specific order instructions had been given by the relevant clients.

Relevant Requirements under the Code of Conduct and
the Internal Control Guidelines

Order Recording

Paragraph 3.9 of the Code of Conduct requires a licensed person to use a telephone recording system to record order instructions received from clients through telephone and maintain such telephone recordings for at least six months.  Further, a licensed person and its staff shall not receive client order instructions through mobile phones when they are on the trading floor, in the trading room, usual place of business where order is received or usual place where business is conducted (“Specified Places”).  They may only do so when they are not at the Specified Places and upon doing so, they should immediately call back to the telephone recording system of the licensed person and record the time of receipt and the order details.

Discretionary Accounts

Paragraph 7.1 of the Code of Conduct provides, among others, that a licensed person should not effect a transaction for a client unless prior to the transaction (i) the client has specifically authorized the transaction; or (ii) the client has given written authorization to the licensed person (or its employee, who must also be a licensed person) to effect transactions for the client without the client’s specific authorization.  Where a client gives authorization as described in (ii) above, his account is known as a discretionary account.

According to the Appendix to the Internal Control Guidelines, a discretionary account agreement should be executed, which sets out the investment objectives and strategies of the client and the terms under which such discretion will be exercised.  Regular reviews of the performance of discretionary accounts should be conducted by designated staff members independent of the staff handling the account.  Further, in order to keep the client informed, a licensed person should provide the client with regular statements and timely ad hoc reports on account balance and transaction details, particularly when the account balance falls below agreed levels or when large orders for the account are pending or executed.

SFC’s Findings

SFC’s investigation revealed that the order recording requirements in paragraph 3.9 of the Code of Conduct have been incorporated into Fulbright’s Compliance Manual.  The Code of Conduct and Fulbright’s Compliance Manual both do not provide any exemption from compliance with the order recording requirements for order instructions which are received from discretionary clients.  In other words, order instructions received from discretionary clients must also be recorded in the same way as order instructions from other clients.  In failing to keep proper records of order instructions received from clients through his mobile phone, Leung was in breach of the order recording requirements under the Code of Conduct.

Further, SFC did not find Leung’s explanation that he believed that it was not necessary to record orders given by clients with discretionary accounts to be credible.  In reaching this view, SFC considered the following relevant matters:-

1.        The circumstances leading to the opening and the actual operation of the discretionary accounts (including the evidence of one of Leung’s discretionary clients that transactions were effected upon her specific instructions) as mentioned above;

2.        The Code of Conduct and Fulbright’s Compliance Manual do not provide any exemption from compliance with the order recording requirements for discretionary accounts; and

3.        Leung had previously attended Fulbright’s in-house training on SFC’s order recording requirements.

As such, SFC considered that Leung had misused the discretionary account arrangement in order to circumvent the order recording requirements and avoid Fulbright’s scrutiny on order recordings for his discretionary accounts.  His conduct was also dishonest and in breach of General Principle 1 – Dishonesty and Fairness of the Code of Conduct.

As a result of Leung’s misconduct, the SFC has banned Leung from re-entering into the industry for 18 months from 31 October 2014 to 30 April 2016.

Conclusion

SFC’s disciplinary action against Leung shows that SFC accords great importance to the order recording requirements under the Code of Conduct.  Further, while a licensed person is entitled to exercise his judgment and discretion to conduct trades in respect of a discretionary account in accordance with the terms of the discretionary account agreement, there may be occasions on which the discretionary client gives specific order instructions to the licensed person (as in the case of Leung).  In such circumstances, the order recording requirements are equally applicable even though the client in question is a discretionary client.  Licensed persons should therefore be mindful of such requirements as compliance with which are relevant to the SFC’s determination of whether a licensed person is fit and proper to remain licensed.