Introduction

The Securities and Futures Commission (“SFC”) has reprimanded Taiping Securities (HK) Co Limited (“TSCL”), holder of Type 1 licence under the  Securities and Futures Ordinance (“SFO”), and fined it $1,300,000 pursuant to section 194 of the SFO for its failure to communicate its personal dealing policy to employees and putting in adequate and effective internal controls over monitoring of employee dealings.

TSCL’s Personal Dealing Policy

TSCL claimed that its Compliance Manual contains a personal dealing policy (“Personal Dealing Policy”) updated in August 2014 and finalised in 2015, and was in force throughout the period between 1 January 2016 and 30 November 2018 (“Relevant Period”).

The Personal Dealing Policy provides that employees should not engage in speculative trading activities and day-trading is prohibited in principle. “Day-trading” is defined to include any one trade involving the buying and selling of the same stock within the same day (regardless of the amount and quantity involved), and the term “prohibited in principle” in the context of day-trading means that the activity was strictly prohibited save for extreme situations such as there being a “flash crash” in stock prices. TSCL claimed that it had communicated the definition of this requirement to its employees orally during daily communications and meetings.

TSCL’s communication failure

Contrary to the Personal Dealing Policy, seven employees of TSCL conducted day-trading according to TSCL’s definition during the Relevant Period. Among them, four employees claimed that the Personal Dealing Policy was not circulated to them or officially implemented during the Relevant Period, and most of them considered that TSCL did not prohibit day-trading generally but only those that were speculative in nature and where the employees did not have sufficient money in the account for trade settlement. TSCL’s lack of action against their trades over the years also reinforced such views.

In fact, TSCL did not maintain any record to demonstrate that it had distributed the Personal Dealing Policy to all employees and clearly informed them that the policy was finalised and implemented during the Relevant Period. TSCL’s employees were not required to sign any acknowledgement of receipt or understanding of the Personal Dealing Policy either.

Breach of SFC codes and guidelines

The following provisions in the Code of Conduct for Persons Licensed by or Registered with the SFC (“Code of Conduct”) are relevant:

1.       General Principle (“GP”) 2 (Diligence) provides that in conducting its business activities, a licensed or registered person should act with due skill, care and diligence, in the best interests of its clients and the integrity of the market;

  

2.       Paragraph 12.2(a) (Employee dealings) provides that a licensed or registered person should have a policy which has been communicated to employees in writing on whether employees are permitted to deal or trade for their own accounts in securities, futures contracts or leveraged foreign exchange contracts;

  

3.       Paragraph 12.2(b)(i) (Employee dealings) provides that In the event that employees of a licensed or registered person are permitted to deal or trade for their own accounts in securities, futures contracts or leveraged foreign exchange contracts, the written policy should specify the conditions on which employees may deal for their own accounts;

 

Apart from the above, section III.2 (Personnel and training) of the Management, Supervision and Internal Control Guidelines for Persons Licensed by or Registered with the SFC (“Internal Control Guidelines”) also provides that all staff and other persons performing services on the firm’s behalf shall be provided with adequate and up-to-date documentation regarding the firm’s policies and procedures which should include those relating to internal controls and personal dealing.

The SFC concluded that TSCL has failed to communicate the Personal Dealing Policy to all employees and ensure that they understood and followed the requirements therein, thus breaching the above provisions of the Code of Conduct and Internal Control Guidelines.

Inadequate internal controls

According to the Personal Dealing Policy, the Compliance Department and the Senior Management were responsible for monitoring employee dealings. It is TSCL’s practice that its employees were not required to obtain pre-clearance before conducting trades in their personal accounts. TSCL’s Settlement Department would prepare daily reports of all transactions in the employees’ personal accounts and pass them to TSCL’s then Head of Dealing cum responsible officer (“RO”) and its senior management for review.

TSCL did not maintain records of any reviews performed by the RO, the senior management and / or its Compliance department on the daily transaction reports, or any follow-up action taken by them in that regard. Nor were there any written manuals, guidelines or procedures specifying how the review or monitoring of employees’ transactions should be performed, including the types of patterns or potential irregularities that had to be watched out for.

As for the personnel responsible for monitoring employee dealings, none of the senior management, the Compliance department or the RO considers the monitoring of employee dealings a responsibility of its/his own. During the Relevant Period, the RO placed 814 trade orders in his personal account with TSCL, out of which 293 exceeded the trading limit prescribed by TSCL for his personal account (“Limit-Exceeding Transactions”). The RO’s personal transactions, including his Limit-Exceeding Transactions, during the Relevant Period were not subject to any independent review and approval.

Breach of SFC codes and guidelines

On top of GP2, the following provisions in the Code of Conduct are relevant:

 

1.       Paragraph 4.3 (Internal control, financial and operational resources) requires a licensed person to have internal control procedures and financial and operational capabilities which can be reasonably expected to protect its operations, its clients and other licensed or registered persons from financial loss arising from theft, fraud, and other dishonest acts, professional misconduct or omissions;

   

2.       Paragraph 12.2(b)(vi) requires transactions of employees’ accounts and related accounts to be reported to and actively monitored by senior management of the licensed person who should not have any beneficial or other interest in the transactions and who should maintain procedures to detect irregularities and ensure that the handling by the licensed person of these transactions or orders is not prejudicial to the interests of the licensed person’s other clients;

 

Further, section V.4 (Compliance) of the Internal Control Guidelines also requires a licensed person to establish, maintain and enforce effective compliance procedures, which should cover, amongst others, internal control matters and staff dealing requirements. Paragraph A4 of the Appendix to the Internal Control Guidelines also provides that the licensed person should put in place procedures to ensure that its staff’s trading activities are not prejudicial to the interests of its clients and all transactions for staff accounts are separately recorded and diligently monitored by independent senior management.

The SFC is of the view that TSCL has failed to put in place adequate and effective internal controls over monitoring of employee dealings in breach of the above provisions of the Code of Conduct and Internal Control Guidelines.

 

Key takeaways

Licensed and registered persons should be reminded to adhere strictly to the Code of Conduct and Internal Control Guidelines. Especially for firms with more delineation of management and other working staff, they should ensure that internal policies and guidelines are properly communicated to the employees and it is prudent to keep written record of such communications. Internal control mechanisms penetrating all departments and teams of the firm is also necessary to ensure that employees’ conduct are always under the supervision of appropriate personnel who has a clear understanding of its own responsibility to supervise and monitor the same.

 

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Important: The law and procedure on this subject are very specialised and complicated. This article is just a very general outline for reference and cannot be relied upon as legal advice in any individual case. If any advice or assistance is needed, please contact our solicitors.

Published by ONC Lawyers © 2023