Tackling fraudulent schemes by the SFC
Introduction
The Securities and Futures Commission (“SFC”) recently reported two disciplinary actions, i.e. Securities And Futures Commission v DFRF
Enterprises LLC and Others [2022] HKCU 2092 (the “DFRF Case”) and Securities and Futures Commission v Maxim
Capital Ltd and Another [2022] HKCU 2621 (the “Maxim Case”), both of which show how the SFC
tackled securities fraud.
The two cases share a lot in common in
that both operate deceitful, if not false, investment traps. The DFRF Case is
one of the typical global[1] “Pyramid and Ponzi Scheme” in which the
fraudster purports to operate a business or an investment which promises high
returns to victims with little or no risk at a later pay date and victims are
persuaded to recruit other people to participate in the business or the
investment. Whereas, the Maxim Case can be categorized as the “Boiler Room Fraud” where a bogus
stockbroker cold-calls investors and forces or persuades them into buying
worthless shares.
No matter what these securities frauds are
called, it can be observed that they are swiftly dealt with by the SFC, primarily resorting to legal weaponry available
under sections 109, 114 and 213 of the Securities and Futures Ordinance (Cap 571 of the Laws of Hong Kong) (the
“SFO”).
Brief facts
In the DFRF
Case, from about October 2014, DFRF Enterprises LLC and DFRF Enterprises, LLC
(“DFRF”), and its founder and associates,
represented to the outside world that DFRF operated gold mines and reserves in
Mali, Brazil and the USA. They invited individuals around the world to invest
in DFRF by acquiring “membership units”. Existing DFRF members would extend
memberships to prospective investors – the referring member would receive a 10%
commission of the initial subscription fee of the newly-joined member and there
would be a further 10% to be paid on any re-investment of the returns by the
newly-joined member. From about late March 2015, DFRF claimed that it was
registered with the US Securities and Exchange Commission, its stocks were
about to become publicly traded and current investors may convert their
membership units into stock options at US$15.06 per share. Receipts from
investors soared to more than US$4.3 million and the high rate of investment
continued in April and May 2015. Subsequently, it was discovered that: (1)
there were no gold mines, gold reserves or gold operations as alleged; (2) all
monies received from the members were dissipated to DFRF’s founders and associates; and (3) most
members did not receive any return – whilst some of them did receive a small
amount, it was apparently coming from investments paid by other members.
In the
other Maxim Case, Maxim Capital Limited (“Maxim
Capital”) and some unknown person(s) purporting to carry on the related
securities dealing or asset management business known as Maxim Trader (“Maxim Trader”) were sued. Prospective
investors were solicited to become investors of a fund called “Maxim Fund”,
which was purportedly operated and managed by the Maxim fraudsters. They were
also encouraged to open a Maxim Trader account. After investors deposited
funds, whether through the Maxim Trader accounts or not, the funds would be deposited
into the Maxim Fund and investors would sign up for investment packages
typically for 18 months. The alleged investment returns ranged from 3 to 8% of
the investment principals. Investors who successfully referred new investors
were awarded referral bonus of 6 to 10%. Since about early 2015, the investors
could no longer receive their monthly return or credit balance from their Maxim
Trader accounts as usual. Suddenly, it was announced online that all the
investors’ fund would be converted into shares of a shell company at US$0.8 per
share, and the fraudsters claimed that the shell company would be listed on the
New York Stock Exchange in the first quarter of 2016. The listing never happened,
which meant investors were left with some worthless shares.
DFRF and Maxim’s respective liability
Both DFRF
and Maxim Capital were found to have contravened sections 109 and 114 of the
SFO.[2]
By way of background:
1. Section 109(1) of the SFO provides that a person commits an offence by knowingly
issuing an advertisement in which they held themselves out as being prepared to
carry on the regulated activity whilst unlicensed and unregistered.
2.
3.
Section 114(1) of
the SFO provides that a person commits an offence by either actually carrying on a business in a regulated
activity (section 114(1)(a) of the SFO) or holding
out as carrying on businesses in regulated activities (section 114(1)(b) of
the SFO) in Hong Kong whilst unlicensed and unregistered and without reasonable
excuse.
Section 114 of the SFO
In Hong Kong,
“advising on securities” is a Type 4 regulated activity and a license should be
obtained from the SFC to conduct the same:
In the DFRF
Case, the breadth of the meaning and definition of “advising” and “securities”
allows the SFC to easily capture the misconduct of fraudsters. The solicitation of subscribing
into the membership units of DFRF does not by itself constitute “advising on
securities”. But persuading the members on the option of converting their
membership units into shares of DFRF to be listed in the USA and explaining the
benefits in exercising their options do. The emails sent to the members
inviting them to ask questions about exercising the options indicated DFRF’s
inclination to give further advice. Promoting and publicising the purported
options and shares conversion, which induce current as well as prospective
members to invest in securities was counted towards “advice”.
Similarly,
Maxim Capital and Maxim Trader have never been licensed by the SFC to carry on
any regulated activities. Again, on top of what had been stated above, section
114 of the SFO holds two limbs which make it wide enough to cover potential
misconduct. Maxim Capital and Maxim Trader had “held themselves out by representation” to purportedly
offer asset manager services, i.e. Type 9 regulated activities. Further, the
management and handling of investors’ funds, or their Maxim Trader’s account,
or at least holding out that it would manage these funds by conducting currency
exchange, buy, sell or hold securities and etc, constituted “advising on
securities”, i.e. Type 4 regulated activities.
Section 109 of the SFO
With the
wide definition and interpretation of “advertisement”, both DFRF and Maxim were
found to have contravened section 109(1) of the SFO. “Advertisements” do not
bear the traditional and narrow meaning (as if in traditional newspaper
generally available to public), it shall suffice if it bears the “promotional”
element made to a group of persons, i.e. the investors in these cases. In both DFRF
and Maxim’s Case, all the investment
opportunities were made through representations in websites, social medial,
seminars and meetings. The fact that they all served to promote financial
services, i.e. the regulated activities, the fraudsters purported to provide,
made it possible to constitute as “issuance of advertisement”.
Remedies granted under section 213 of the SFO
A list of
remedies under section 213 of the SFO will be available once the Court rules
that there is a breach of any provisions in the SFO. In these two cases the Court ruled
that the fraudsters had breached sections 109 and 114 and therefore made the
following orders:
1.
Prohibitory
injunction: For the fullest protection of the investing public, in both DFRF’s Case
and Maxim
Case, traditional injunctions are granted against the fraudster to restrain
them from contravening or continuing to contravene sections 109 and 114 of the
SFO.
2.
3.
Restitutionary
order: In both disciplinary actions, interim injunctions were sought and granted
at an earlier stage to freeze all the relevant bank accounts. The monies seized
from these accounts will be used to compensate the victims.
4.
5.
Appointment of
administrators: Professional administrators were appointed as an attempt to
recover as much money as possible, so as to give effect to the restitutionary
order, i.e. the distribution.
Conclusion
The two cases above illustrated how the SFC uses different provisions
within the SFO to compensate victims of fraudulent investment schemes,
especially when the fraudsters are nowhere to be found. At this juncture, it would be
interesting to observe whether the proposed amendments to the SFO (in
particular section 213 of the SFO)[3], once implemented, would be able
to further enhance its protection to the investors in Hong Kong.
For enquiries, please feel free to contact us at: |
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Connaught Place, Central, Hong Kong |
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 © 2022 |
[1] This is a
global scam as the British Columbia Securities Commission of Canada and the US Securities and Exchange Commission have also taken legal action against it.
[2] DFRF fraudsters have also been
found to have contravened sections 103(1) and 107(1) of the SFO.
[3] Reference is made to our June 2022 Newsletter.