Member Article

Hong Kong’s Securities and Futures Commission (SFC) has reprimanded and fined an intermediary $6.4 million for control failures over a two year period in solicitation and recommendation of bonds to clients for execution on a third party platform.

In recommending bonds to clients, the intermediary failed to:

• conduct proper and adequate product due diligence on the bonds;
• have an effective system in place to ensure that the recommendation or solicitation of the bonds was suitable;
• maintain proper documentary records of the investment advice or recommendation given to its clients and provide each of them with a copy of the written advice; and
• have adequate and effective monitoring systems to supervise the sale of bonds through the third party platform and to ensure its compliance with applicable regulatory requirements.

The SFC’s report mentions that the size of the fine reflects the fact that the intermediary failed to put in place an effective system to ensure product suitability despite the SFC’s repeated reminders to licensed corporations on the importance of compliance with the suitability obligations and the specific guidance regarding the selling of fixed income products, complex and high-yield bonds.

The SFC found that the intermediary did not have product approval or due diligence procedures for the products in question, but relied on its individual consultants to conduct due diligence and assess product risk.

The intermediary engaged the bond dealing services of a third party platform to assist its consultants, which offered briefings and presentations on bond products, but did not assign risk ratings. The intermediary provided limited guidance on how to analyse the products, such as the features they should review, criteria to adopt or factors to take into account, or the weight to be assigned to those factors.

Consultants kept no records of the due diligence conducted, or how the bonds were considered suitable for different categories of investors.

As well as demonstrating a lack of understanding on the intermediary’s part of its obligations in the sales process, the lack of process exposed the intermediary to unreliable and inconsistent risk and suitability assessments from its consultants.

Whilst the intermediary required contemporaneous recording of information provided to clients and the rationale given for its recommendations, the intermediary stated that in practice consultations were conduct face to face and no formal written records were kept. This meant that the intermediary had limited means to monitor, supervise or check that its staff were carrying out their duties effectively or to assess the merits of client complaints about possible mis-selling.

The intermediary had no procedures to monitor staff sales to ensure that they conducted due diligence; disclosed all material information; or conducted adequate suitability assessments.

Key takeaway

Although there was no evidence suggesting that clients lost by reason of their investments, the SFC felt that the case merited a high fine to send a deterrent message to intermediaries: despite the repeated reminders the SFC has given of the importance of the suitability obligation, the intermediary had failed to tighten up its controls.

It would be hard for the SFC to send a clearer message to intermediaries who sell or recommend investment products to review their KYC, client take-on procedures, product due diligence, risk weightings, staff training, supervision, record-keeping and compliance monitoring. Weaknesses in any of these elements of the control structure can lead to significant and expensive compliance failures.

In setting the level of fine, the SFC also noted that the intermediary had ceased selling the bonds to clients, had co-operated with the SFC and was now under new management.

A copy of the statement of disciplinary action is available here