The Internet is a growing medium in the marketing of funds in Hong Kong. However, its use as a distribution channel for funds in Hong Kong is still relatively low. This chapter describes the rules applicable to the use of the Internet in marketing and distributing hedge funds in Hong Kong.There are different considerations for funds authorized by the Securities and Futures Commission (SFC) and for unauthorized funds.
Use of the Internet for authorised hedge funds
Overview of regulatory regime
The primary regulatory guidance in Hong Kong in relation to promoting investment funds is the SFC’s CIS Internet Guidance Note, the Guidance Note for Persons Advertising or Offering Collective Investment Schemes on the Internet, which the SFC re-issued in April 2003.
It supplements the SFC’s Guidance Note on Internet Regulation, which was first issued in March 1999, and provides guidance on dealings over the Internet. This should now be read in conjunction with the relevant regulatory provisions under the Securities and Futures Ordinance (SFO), which came into effect on 1 April 2003.
SFC’s regulatory approach
A common thread among regulators worldwide is to emphasise that they regulate the activity, rather than the means by which that activity is carried out and that the goal is regulation which is technology neutral. That is the SFC’s approach which is reflected in the statement in the CIS Guidance Note that:
The fundamental principles of regulation for the advertisement, offering and dealing of [investment funds] are not premised on the use of a particular medium of communication or delivery. Regulated activities should be uniformly regulated irrespective of whether such activities are conducted via paper-based or electronic media.
Accordingly, in marketing authorised hedge funds through the Internet, you have to comply with all of the existing and applicable licensing and regulatory requirements.
When are you subject to SFC regulation?
As a general principle, the SFC has stated that it will not seek to regulate the provision of financial services that are conducted from outside Hong Kong and over the Internet, unless such activities are targeted at people residing in Hong Kong or are detrimental to the interests of the investing public in Hong Kong or to the market integrity of Hong Kong.
In determining whether or not an activity conducted over the Internet is targeted at people residing in Hong Kong, the SFC will consider the following factors:
• Whether the information is targeted, via ‘push’ technology, to people whom the financial services provider knows, or should reasonably know, reside in Hong Kong. ‘Push technology’ refers to any technology which broadcasts or directs information to a particular person or group of persons and includes e-mail, direct mailshots and the like.
• Whether the information available over the Internet is presented in a manner which gives the appearance that people residing in Hong Kong are targeted. Common examples cited by the SFC that may suggest Hong Kong people are targeted include the:
- use of local distribution agents in Hong Kong;
- use of references to Hong Kong dollars;
- use of Chinese language; and
- publication in Hong Kong newspapers/magazines of the Internet address.
• Whether the information presented includes a disclaimer clearly indicating that the services or products are not available to people residing in Hong Kong. A general statement that the service or product is not being made available in any jurisdiction in which the service or product would or could be illegal is not sufficient (either for the SFC or for other regulators). What is required is either a positive statement of the countries in which the service or product is available (eg, this service/product is only available to Hong Kong residents) or a negative statement that the service or product is not available to Hong Kong residents.
• Whether reasonable precautions are taken to guard against the acceptance of purchases from, or provision of services to, people residing in Hong Kong.
These precautions may include checking the mailing addresses of potential clients and the use of blocking technology to restrict access to the information and services provided. As a matter of practice, blocking technology is likely to be only partially effective at best and so other precautions will need to be adopted.
A simple check box on a website for a person to indicate that he or she is, or is not, a Hong Kong resident would not by itself be a sufficient precaution.
The SFC’s Guidance Note on Internet Regulation makes it clear that the use of precautions or disclaimers will not necessarily preclude the SFC from exercising its powers of enforcement if the conduct of the people who are responsible for the particular activity over the Internet or some other circumstances so warrant.
If a website is considered to be targeted at Hong Kong investors, the person responsible for the website needs to be licensed for the relevant regulated activity carried on via the website.
Advertisements on the Internet
If a website is subject to the SFC’s regulation, web pages on the site that contain information about hedge funds must not be accessible by the public in Hong Kong unless the fund is itself authorised by the SFC and the relevant pages, each of which constitutes an ‘advertisement’, must be submitted to the SFC for approval under the terms of the Code on Unit Trusts and Mutual Funds. That means submitting a hard copy of the relevant web pages and, where there will be audio and/or video as part of the web page, the script and a description of the presentation (as for advertisements on radio or television).
As a general rule, ‘banner’ advertisements promoting brand names do not require SFC approval unless they can be construed as product advertisements. However, where ‘banner’ advertisements contain an embedded hyperlink to another website, it is important to ensure that the other website is appropriately authorised. Analytical tools that generate recommendations on specific hedge funds are considered to be advertisements and will need to be approved.
Finally, the information on the website must be kept up to date. One of the key regulatory requirements is that advertisements must not be false, misleading, disparaging or deceptive. Outdated information must be removed or archived in order to avoid confusion.
Offering authorised hedge funds on-line in Hong Kong
Where an authorised hedge fund is offered on-line, the SFC requires that the relevant person provide adequate information to investors, including an electronic prospectus and, where applicable, the scheme’s audited annual report and accounts.
In this context, offering a fund on-line means making the fund available for subscription on-line or providing for on-line switching into a new fund. Normally, it involves the provision of dealing facilities or transaction capabilities such as an application form or a web page for giving instructions for the execution of an order.
Advertisements for funds on a website are not regarded by the SFC as on-line offerings in the following circumstances:
• where there is no transaction capability; and
• where the most an investor can do is provide contact details and ask for an application form to be sent to him or her by post.
The electronic prospectus must:
• be presented in a format that is relatively easy for investors to access (the most common being as a PDF file that can be viewed on Acrobat Reader);
• be capable of being effectively read, printed and downloaded;
• be made available to investors prior to investors being able to access an application form or the web pages for executing orders;
• contain the same content in the same sequence as the most up-to-date paper prospectus (although the electronic prospectus can incorporate addenda into the body of the prospectus and can include search facilities and navigation tools within the prospectus);
• be clearly demarcated from other areas of the website; and
• not contain hyperlinks to other documents or web pages, other than documents that must be made available for inspection or are incorporated into the prospectus by reference (such as annual and semi-annual reports and material contracts).
In addition, hard copies of the prospectus must be made available on request, and there should be a prominent statement on the website that printed copies of the prospectus are available, as well as where and how they can be obtained.
An electronic prospectus can be made available on the relevant website, via hyperlink to another website, via e-mail or in some other manner agreed with the SFC.
Where made available on the relevant website or via hyperlink to another website, it must be possible to read, print and download the prospectus. Any hyperlink must be to the cover page or contents page of the prospectus. The SFC wants to avoid a situation where a prospective investor who has chosen to view the prospectus must view a number of additional web pages before being able to access the prospectus, or a situation where only certain parts of the prospectus are presented to investors.
As noted above, a prospectus must be available ‘up front’ so investors view the prospectus before they gain access to an application form or the web pages for the execution of an order to purchase an interest in the fund. The SFC requires:
• a prominent statement on the website to advise investors to read the prospectus prior to executing an order;
• measures to ensure that investors can access a web page for executing an order only if they have been given sufficient opportunity to read or access the electronic prospectus;
• measures to ensure that investors can access a web page for executing an order only if they have confirmed that they have had sufficient opportunity to read or access the electronic prospectus; and
• a positive declaration from investors that they have been provided with sufficient opportunity to access or read the relevant prospectus and the information disclosed in the prospectus before they are given access to the web page for executing an order to purchase an interest in a fund.
Electronic dealings
The SFC’s Guidance Note on Internet Regulation states that an intermediary or fund manager should only accept an electronic application for investment in a fund from investors who already maintain an account with them.
Intermediaries or fund managers who allow investors to deal in funds electronically need to:
• ensure that proper account-opening procedures have been followed to establish the client’s full identity and, where appropriate, the client’s financial situation, investment experience and investment objectives; and
• ensure that their computer systems have sufficient operational integrity and, in particular, address issues of security and reliability.
At the end of 2000, the SFC issued a consultation paper on the regulation of on-line trading of securities and futures. The consultation paper was primarily aimed at on-line brokerages. However, a number of the points raised are also relevant for electronic dealings in funds.
Risk disclosure
The SFC indicated that it did not consider that the risk disclosure on many of the on-line brokerage websites was sufficiently comprehensive or prominently displayed. It recommended that risk disclosure should be highly visible to an investor, eg, through use of a pop-up box.
Privacy issues
The SFC requires disclosure of information privacy practices on the website. The SFC emphasised that compliance with the Personal Data (Privacy) Ordinance is an element in determining whether a person is, or remains, fit and proper to be licensed by the SFC.
System integrity
System integrity is a key SFC concern. The SFC indicated that, based on inspections it has conducted, system integrity is an issue that many brokers have not come to grips with. System integrity includes issues of security, reliability and capacity and contingency planning.
Qualified personnel
With electronic dealing, the role and importance of a firm’s IT personnel increases — what they do has a significant impact on the front end of the business. The SFC noted that ‘from a regulatory point of view, there is a real need to be satisfied of IT competence as part of the ‘fit and proper’ assessment for a registered firm engaged in on-line trading’.
Communication with investors via electronic means
The SFC permits the giving of notices, delivery of financial statements, etc, to investors by electronic means where the relevant investors have consented to receive notices or documents in this manner. Electronic means may include e-mail or placing the documents on a website, with notification to investors that the documents can be viewed at the website.
Consent should be obtained from investors in a manner that assures its authenticity and a record should be retained. For new investors, the simplest approach would be to include this consent in the application form.
Where documents are made available on a website, those documents should remain available for as long as it is necessary for investors to have a reasonable opportunity to access or read them. Investors should have the opportunity to retain the information by printing or downloading the documents or have ongoing access equivalent to personal retention.
Currently, it is not possible to do away with hard copies of documents entirely. The SFC expects hard copies to be available and requires that investors have the option to revoke their consent to electronic delivery at any time and so receive hard copies instead. Having said that, the SFC have indicated that they do not have an objection, in principle, to pure electronic offerings and communications as the market and technology continue to develop, as long as investors are made fully aware of the situation at the time they invest.
Use of the Internet for unauthorised hedge funds
Overview
Unauthorised funds are funds that have not been authorised by the SFC for sale to the public in Hong Kong.
Before discussing the use of the Internet for the marketing and distribution of unauthorised hedge funds in Hong Kong, it is useful to understand the regulatory regime that applies generally to the promotion of unauthorised funds in Hong Kong.
Hong Kong’s securities legislation is aimed at preventing the unauthorised offer of securities and investment arrangements to the public. Specialist legal advice should be sought if an offer is to be made. It is important to determine whether authorisation of the fund and/or offering material is necessary or, if in the particular circumstances and taking into account the manner of the offer, the offer can be considered as not being one made to the public.
There are a limited number of situations in which an information memorandum or other document which contains an invitation to subscribe for interests in a fund which will be made available to potential investors in Hong Kong is not required to comply with the requirements of the Companies Ordinance or be authorised by the SFC before issue.
The ‘professional investor’ exception
The first situation is known as the ‘professional investor’ exception and arises as a result of specific exemptions contained in the Companies Ordinance and the SFO.
Under both the Companies Ordinance and the SFO, it is possible to make an offer to an unlimited number of ‘professional investors’ as defined in the SFO. The definition is considerably wider than under previous law and includes:
• any intermediary or any other person carrying on the business of the provision of investment services regulated outside Hong Kong;
• any authorised financial institution or any bank regulated outside Hong Kong;
• any authorised insurer or any other person carrying on insurance business and regulated outside Hong Kong; and
• any authorised collective investment scheme or any other scheme which is similarly constituted and regulated outside Hong Kong.
In reliance on its powers to make rules under the SFO, the SFC has provided for additional categories of ‘professional investor’ in the Securities and Futures (Professional Investor) Rules.
Accordingly, offers of securities and/or collective investment schemes will not need to be authorised if the investors fall within one or other of the following definitions:
• Trust corporations with at least HK$40 million in assets. The SFC will require the offeror to obtain the following proof of assets:
- audited financial statements not more than 16 months old; or
- current custodian and bank statements.
• High net worth individuals with portfolios of at least HK$8 million. Documentary proof required is:
- a statement of account not more than 12 months old issued by the individual’s custodian stating the current total relationship balance; or
- financial statements verified by accountants (more than one custodian statement may be used for the purpose of determining the individual’s portfolio value).
• Corporation or partnership with assets of HK$40 million or a portfolio of at least HK$8 million. Documentary proof required is:
- audited financial statements not more than 16 months old; or
- current statement of accounts from custodians.
Corporations which act solely as investment holding companies and are wholly owned by individuals who are themselves professional investors will also qualify.
The ‘private placement’ exception
The second situation arises where information is distributed in such a manner that it does not constitute an offer to the public and, therefore, does not fall within the prohibition contained in the SFO or the definition of ‘prospectus’ in the Companies Ordinance. This is the ‘private placement’ exception. The legal situation is slightly different, depending upon whether the fund is structured as a company or in a non-corporate form, such as a unit trust or limited partnership.
For corporate funds — The Companies (Amendment) Ordinance 2004 clarifies some situations where a document used in a private offer by a corporate issuer will not constitute a ‘prospectus’. These situations are set out in Part I of the 17th Schedule to the Companies Ordinance and include:
• An offer to not more than 50 persons, which includes a prescribed warning statement to the effect that the document has not been reviewed by any regulatory authority in Hong Kong.
• An offer in respect of which the total consideration does not exceed HK$5 million (or its equivalent in another currency), which includes a prescribed warning statement (small-scale offering).
• An offer in respect of which the minimum subscription per investor is not less than HK$500,000 (or its equivalent in another currency), which includes a prescribed warning statement (minimum subscription offering).
• An offer to professional investors within the meaning of the SFO.
All offers which are excluded under Part I of the 17th Schedule to the Companies Ordinance (other than the small- scale offering and minimum subscription offering exclusions) may be combined and the entire offer will remain excluded from the prospectus regime. For example, an offer to not more than 50 persons (who do not qualify as ‘professional investors’) combined with an offer to an unlimited number of ‘professional investors’ will not constitute a prospectus and, hence, will remain exempted under the Companies Ordinance.
Furthermore, an offer to persons who are outside Hong Kong does not constitute an ‘offer’ under Part I of the 17th Schedule to the Companies Ordinance and can be disregarded in determining whether a relevant exclusion applies.
An offer that is treated as a private offer under the Companies Ordinance is also treated as a private offer under the SFO.
For non-corporate funds — Funds that are structured in a non-corporate form, such as unit trusts and limited partnerships, are subject to the SFO and do not have the benefit of the small scale offering or minimum subscription offering exemptions under the Companies Ordinance.
For funds which are not structured as companies, the SFO permits a private offer to an unlimited number of professional investors within the meaning of the SFO and up to 50 non-professional investors.
Use of the Internet for marketing unauthorised hedge funds in Hong Kong
If a website is used to market unauthorised hedge funds in Hong Kong, it is necessary to ensure that the website (or the relevant part of the website) complies with either the private placement exception or the professional investor exception as described above. That means being able to restrict access to the website (or the relevant parts of the website) to identified persons. Identification may be through means of a digital certificate, password or PIN number.
The same considerations that apply in using hard copies of documents to market unauthorised hedge funds in Hong Kong will apply to allowing Hong Kong investors to access a website containing information/marketing materials on unauthorised hedge funds. The goal is to ensure that, if the SFC raise questions about the website, it is possible to show the SFC that all reasonable precautions have been taken to ensure that there is not an offer of securities to the public in Hong Kong.
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