Year of the Dog 2018-2019: Regulatory investigations and proceedings year in review

Thank you all for your positive feedback after we published an e-bulletin to review the regulatory goings-on in the Year of the Rooster (ie 2017-2018) this time last year. As a result, we are doing it again this year. Before we begin, we wish you a healthy and prosperous upcoming Year of the Pig.

As the Year of the Dog ends, what were the highlights (or, depending on one’s perspective, lowlights) in the Hong Kong regulatory enforcement world?

The Police? The ICAC? Oh, it’s the SFC!

In late 2018, advertising billboards across Hong Kong were plastered with posters calling on the public to “speak up” on corporate fraud, and to “report it” when they see a “rigged regime”. At first glance, they looked like yet another campaign by the Police or Independent Commission Against Corruption (ICAC) calling on the public to report crime.

But take a closer look, and it will become apparent that these were instead Securities and Futures Commission (SFC) posters, seeking reports from members of the public on corporate malpractice and insider dealing. To facilitate this, the SFC has an e-mail address and an online reporting form[1] as public hotlines. The SFC website even has a law-enforcement ‘wanted persons’ style page.[2] It has links to further pages where it asks for leads on specific persons subject to arrest warrants[3] and persons of interest in ongoing investigations.[4]

Further, when speaking of its enforcement work, the SFC has also sought to highlight its greater use of more law enforcement-like search and seizure powers when collating evidence. In a speech in October 2018, the SFC’s Executive Director of Enforcement said:

“Over the past 12 months, we mobilised over 700 colleagues from across three divisions to conduct 20 search operations against 200 corporate and residential premises.”[5]

Taken together, it appears that the SFC has, in the past year, sought to project a more law enforcement-like image.

Lesser means weaker?

With the SFC now talking a more high-profile game in terms of its enforcement activities, what do the enforcement-related statistics tell us about recent trends? In the six months ended 30 September 2018 (being the most recent statistics available at the time of publication), the number of new inquiries into listed companies misconduct, new directions to investigate issued and new investigations have fallen further from the corresponding period in 2017.[6] This continues a started in the Year of the Rooster.

Given this, one may be tempted to speculate whether attempts by the SFC to project a tougher public image during the Year of the Dog were in fact bluster that belies stance weakening in overall enforcement efforts. A closer examination of the overall situation during 2018 would suggest otherwise.

Lesser but more up front

First, in a trend that was already gathering pace in the Year of the Rooster, the SFC continued in the Year of the Dog to make greater use of “front-loaded regulation”,[7] where the focus shifts from post-problem enforcement to pre-problem prevention. This approach arguably had an impact in causing the continuing drop in the number of investigations.

On the SFC-licensed entities side of things, this has meant more targeted themed inspections to identify shortcomings before they become serious. The focus of such inspections are on what the SFC perceives to be “high-impact problems, such as serious internal control failures which result in actual harm to investors as well as the risks arising from significant margin lending activities secured by few highly-illiquid stocks.”[8]

With listed companies, various measures were employed during the Year of the Dog. They included the tightening of Growth Enterprise Market listing requirements, extra rules surrounding capital raisings, making delisting of long-suspended companies easier, and the robust use of statutory powers to halt listings that are considered problematic and to force the suspension of trading of the stocks of listed companies where misconduct is suspected. This has led to a drop in misconduct “warning signs” measures such as unusual stock price movements, suddenly surging listed companies market capitalisation, and extreme price-to-sales ratios in listed companies’ shares.[9]

As for more novel parts of the financial markets such as virtual assets, the SFC took active steps in March 2018 to halt an initial coin offering where it was believed that the offering constituted potentially illegal conduct.[10] It also issued a statement in November 2018 outlining how firms that distribute or invest in virtual assets would be regulated, both in terms of licensing and supervision.[11]

Lesser but bigger

Second, the continuing trend towards a lower number of investigations can be attributed to the SFC’s changing enforcement priorities, where “[it] prioritised [its] investigations so that [it] could focus our finite resources on the most important cases.”[12] These investigations involve focusing on defined clusters of companies and individuals, with a small number of cases (28 as at October 2018) considered “particularly serious”.[13] 

Big investigations necessitated the seizure of “massive” amounts of data,[14] as well as working collaboratively with other local law enforcement agencies and Mainland Chinese regulators.[15] This has fed a cycle where, by focusing on an approach where the SFC’s investigations have become lesser in number but bigger in scope, and bigger investigations means large volumes of evidence to analyse, which then fed back to a scenario where finite manpower within enforcement could only be focused on bigger cases.

The focus on “big” also manifested itself in the SFC’s enforcement approaches in its ongoing and completed cases during the Year of the Dog. For example:

• “Big” in issues being tested: The SFC has launched a case in the Market Misconduct Tribunal to test the scope of the “pre-deal negotiation” exemption to statutory inside information public disclosure requirements.[16] It also had a clean sweep of victories in the Court of Final Appeal. These cases covered areas such as dealing intent when in possession of non-public information in insider dealing cases,[17] the use of statutory prohibitions against the use of securities of fraudulent or deceptive conduct in connection with or in relation to securities transactions in cases involving insider dealing of non-Hong Kong listed companies shares,[18] and conduct issues relating to credit rating agency.[19]
• “Big” when measured against its primary enforcement focus: One of the SFC’s major enforcement focus in recent years has been the work of sponsors in initial public offerings. As at October 2018, the SFC “investigated 30 cases of suspected sponsor misconduct involving 28 sponsor firms and 39 listing applications”.[20] This focus had translated into disciplinary actions in the past year against big Chinese[21] and international[22] institutions, with HK$24 million and HK$57 million in fines issued respectively.

Lesser but with a bang

The SFC’s smaller number of new investigations in the Year of the Dog should not be seen as a sign of weakness on its part. It is seeking instead to deal pre-emptively with preventable issues so that they do not become part of the investigation statistics. The SFC’s focus on a small range of large-scale and high profile investigations and enforcement actions seems to be an attempt to send clearer and louder messages to both the financial sector and to the public. Its cultivation of a more law enforcement-like image appears not to be bluster, but may instead be an attempt to remind everyone of its powers and its reach.

Thus, when it comes to the number of investigations during the Year of the Dog, size was not everything.

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[1] https://www.sfc.hk/web/EN/reporting-listed-company-fraud-and-market-misconduct/reporting-form-corporate-fraud-and-market-misconduct/

[2] https://www.sfc.hk/web/EN/regulatory-functions/enforcement/have-you-seen-these-people/

[3] https://www.sfc.hk/web/EN/regulatory-functions/enforcement/have-you-seen-these-people/people-subject-to-arrest-warrants/

[4] https://www.sfc.hk/web/EN/regulatory-functions/enforcement/have-you-seen-these-people/persons-of-interest/

[5] Speech at the 2018 Refinitiv Pan Asian Regulatory Summit by Thomas Atkinson, SFC’s Executive Director of Enforcement, 10 October 2018:

https://www.sfc.hk/web/EN/files/ER/Speech%20-%20TA%20at%202018%20Refinitiv_final.pdf

[6] SFC Quarterly Report July-September 2018:

https://www.sfc.hk/web/EN/files/ER/Reports/QR/201807-09/Eng/Enforcement_p.13-15.pdf

[7] Speech at the HKIFA 12^th Annual Conference by Brian Ho, SFC’s Executive Director of Corporate Finance, 26 November 2018:

https://www.sfc.hk/web/EN/files/ER/PDF/Speeches/Synopsis_BH_20181126_Final.pdf

[8] Speech at the HKSI Institute Roundtable Luncheon by Ashley Alder, SFC’s Chief Executive Officer, 27 November 2018:

https://www.sfc.hk/web/EN/files/ER/PDF/Speeches/Ashley%20Alder_181127.pdf

[9] Note 7 above.

[10] https://www.sfc.hk/edistributionWeb/gateway/EN/news-and-announcements/news/enforcement-news/doc?refNo=18PR29

[11] https://www.sfc.hk/web/EN/news-and-announcements/policy-statements-and-announcements/reg-framework-virtual-asset-portfolios-managers-fund-distributors-trading-platform-operators.html

[12] Note 9 above.

[13] Note 5 above.

[14] Note 5 above.

[15] Note 9 above.

[16] https://www.sfc.hk/edistributionWeb/gateway/EN/news-and-announcements/news/enforcement-news/doc?refNo=18PR49

[17] Securities and Futures Commission v Yiu Hoi Ying Charles [2018] HKCFA 44

[18] Lee Kwok Wa v Securities and Futures Commission [2018] HKCFA 45

[19] Moody’s Investors Service Hong Kong Limited v Securities and Futures Commission [2018] HKCFA 42

[20] Note 5 above.

[21] https://www.sfc.hk/edistributionWeb/gateway/EN/news-and-announcements/news/enforcement-news/doc?refNo=18PR77

[22] https://www.sfc.hk/edistributionWeb/gateway/EN/news-and-announcements/news/enforcement-news/doc?refNo=18PR51