Introduction

The Securities and Futures Commission (“SFC”) recently reported two disciplinary actions, reprimanded and fined Rifa Futures Limited (“Rifa”) for failures in complying with know-your-client, anti-money laundering and counter-terrorist financing when operating its clients’ order placing system and reprimanded and fined TC Capital International Limited (“TC Capital”) for failures in discharging its duties as the sponsor to duly enquire third party payments involved when handling the listing application of China Candy Holdings Limited (“China Candy”).

Despite slight difference in the context, the two cases of Rifa and TC Capital share a lot in common in that both concerned procedural failures of the licensed corporations (“LCs”) in scrutinizing money transferals of their clients. Although no loss was reported to have been suffered, the SFC had made it clear that the two cases are intended to be a strong deterrent message to the market warning that such failures are unacceptable and will not be tolerated.

KYC failures by Rifa

The SFC investigation against Rifa was originated from complaints received by the SFC (the “Complaints”) reporting various LCs’ use of a software system called Xinguanjia (“XGJ”) for allowing clients to place orders to the broker supplier system (“BSS”) in providing electronic trading services to investors. The Complaints alleged that XGJ permitted the LCs’ clients to create sub-accounts and solicited investors in Mainland China to trade through such sub-accounts through XGJ without the need to open their own securities accounts with those LCs. Between 2016 and 2018, Rifa permitted 310 clients to use its customer supplied systems (“CSSs”), including XGJ, which were further connected to Rifa’s BSS, for placing orders. However, Rifa did not perform any due diligence or testing on the CSSs. As such, the SFC was of the view that Rifa was unable to properly assess the risks of money laundering and terrorist financing (“ML/TF”) associated without thorough knowledge of the features and functions of the CSSs and thus was exposing itself to risks of improper conduct such as unlicensed activities, ML/TF, nominee account arrangement, and unauthorized access to client accounts.

The SFC’s investigation further revealed that, the amounts of deposits paid into the accounts of 5 clients were incommensurate with their financial profiles, including their income and net worth, as declared in their account opening documents. Although Rifa had performed periodical and ad hoc reviews, conducted know your client (“KYC”) checks, and made telephone enquiries regarding the deposits, the SFC opined that the KYC checks were superficial as it consisted only of the name searches on Dow Jones Risk & Compliance and the SFC’s public register of licensed persons and registered institutions, and the telephone enquiries were not made timely nor sufficiently.

Sponsor failures by TC Capital

In another case involving TC Capital, which was the sponsor for listing application of China Candy on the Growth Enterprise Market of The Stock Exchange of Hong Kong Limited in September 2015. As the sponsor, the SFC found that TC Capital had failed to conduct reasonable due diligence on the third party payments made by 32 different third party payers on behalf of two top customers of China Candy totalling 50% of China Candy’s revenue during the track record period. The SFC stressed that third party payments by a customer, particularly by a top customer, is an apparent red flag as they could be used to disguise the original source of funds and/or facilitate a fraudulent scheme. By failing to conduct proper due diligence and enquiries to understand the reasons of such third party payments and background and relationship between parties, TC Capital had failed to exercise professional scepticism when conducting due diligence work in relation to the listing application of China Candy and accordingly, TC Capital could not properly assess whether the use of third party payers by the two top customers was material information needed to be disclosed in China Candy’s prospectus. Further, TC Capital did not maintain proper records of the due diligence work allegedly done in relation to the listing application of China Candy. Therefore, the SFC was of the view that TC Capital had failed to discharge its duties as a sponsor. TC Capital was reprimanded and fined HK$3 million but the SFC had made it clear that but for the financial position of TC Capital, the SFC would have imposed a heavier fine against it.

Relevant rules and regulations

The two disciplinary actions serve as useful reminder to all LCs in light of their obligations to take a positive and active role in surveiling the flow of clients’ funds and operations of clients’ accounts, to conduct proper and sufficient due diligence and enquiry if one smells a rat, and to maintain proper records of all enquiries and investigations made.

It is prudent for LCs to be minded of the overarching general principle 2 of the Code of Conduct for Persons Licensed by or Registered with the Securities and Futures Commission (“Code of Conduct”) and paragraph 5.1 of the Corporate Finance Adviser Code of Conduct which requires LCs to act with due skill, care and diligence, in the bests interests of their clients and integrity of the market in conducting their business activities. Paragraph 5.1 of the Code of Conduct specifically requires LCs to identify the true and full identity of its clients and the financial situation of each of the clients. Paragraphs 17.2, 17.4 and 17.6 of the Code of Conduct requires sponsor to conduct all reasonable due diligence on the listing applicant before submitting the listing application, with the exercise of its reasonable judgement in doing so.

LCs should also ensure their compliance of the Anti-Money Laundering and Counter-Terrorist Financing Ordinance, particularly section 23 of Schedule 2, and the Guideline on Anti-Money Laundering and Counter-Terrorist Financing which expects LCs not only to establish and implement adequate and appropriate internal anti-money laundering and counter-financing of terrorism policies, procedures and controls, but also to review client information, its business relationship with clients, and to identify complex, large or unusual transactions.

Conclusion

The two disciplinary actions above illustrated the high expectation of the SFC on LCs to scrutinize money flows and monitor transactions and operations of accounts of their clients. Third party payments or unidentified users operating clients’ accounts always raise a red flag such that LCs should take immediate actions to enquire sufficiently. Failure to enquire or making insufficient enquiries are both unacceptable to the SFC.