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1 FINANCIAL LAW AND FINANCIAL LAW AND REGULATIONS REGULATIONS WEEK 9 Market Misconduct, Investor Compensation Arrangements, Privacy and Further Codes

Market Misconduct, Investor Compensation Arrangements, Privacy and Further Codes

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Page 1: Market Misconduct, Investor Compensation Arrangements, Privacy and Further Codes

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FINANCIAL LAW AND FINANCIAL LAW AND REGULATIONSREGULATIONS

WEEK 9

Market Misconduct, Investor Compensation Arrangements, Privacy and Further Codes

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- Part XIII of the SFO covers the application of civil law

- Part XIV of the SFO covers the application of criminal law

- The purpose is to clearly establish dual legal regimes for the same acts. It is modelled on best practice in the UK, Australia and the US

Market Misconduct under the SFO

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- The MMT deals with civil proceedings, is chaired by a judge and has two lay members independent of the SFC, all of whom are appointed by the Chief Executive of the HKSAR

- The MMT can compel and receive evidence relevant to the hearings

- Reports are made public unless the Financial Secretary decides that doing so would be against the public interest

- Findings can be subject to judicial review and appeal to the Court of Appeal

Market Misconduct Tribunal (MMT)

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- The SFC will make a first recommendation on the basis of its investigation in any particular case whether to use the civil or criminal route

- For the civil route, facts are referred to the Financial Secretary who may pass to MMT

- For the criminal route, facts are referred to the Secretary for Justice to decide if a criminal prosecution should be brought before the courts

SFC Procedures

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- The Justice Department’s prosecution policy is based on sufficiency of evidence and the public interest

- SFC has the power under s388 to prosecute minor cases summarily in a Magistrates Court subject to the overriding power of the Secretary for Justice

- SFO makes it clear that both civil proceedings and criminal prosecutions will not be brought against the same person for the same misconduct (no double jeopardy)

SFC Procedures

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- Disqualification for up to 5 years from holding office as director, liquidator, receiver or company manager

- Prohibition on investing or trading in Hong Kong markets for up to 5 years (cold shoulder order)

- Cease and desist order (stop the misconduct)

MMT (Civil) Sanctions

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- Payment or profits made or losses avoided plus compound interest to the government

- Payment of reasonable costs incurred by the government and the SFC

- Disciplinary referral orders recommending that a professional body of which the person is a member should take disciplinary action against him or her

MMT (Civil) Sanctions

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- Up to 10 years imprisonment and / or HK $ 10 million on indictment and conviction; and / or

- Up to 3 years conviction and / or HK $ 1 million on summary conviction; and

- In addition the court may impose a disqualification order (cold shoulder order) or a disciplinary referral order on conviction

Criminal Sanctions

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- Insider dealing

- False trading

- Price rigging

- Disclosure of information about prohibited transactions

- Disclosure of false or misleading information inducing transactions

Market Misconduct Definitions

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- Stock market manipulation

- In addition part XIV specifies:

- Fraudulent or deceptive acts or the use of deceptive devices in Type 1, 2, 3 activities

- Disclosure of false or misleading information inducing others to enter into leveraged FX (LEF) contracts

- Falsely representing that a person has dealt in futures contracts on behalf of another

Market Misconduct Definitions

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- Relevant information is specific information:

- In relation to a corporation, its shareholders or officers, or its listed securities or derivatives

- Which is not generally known to the persons who are accustomed or would be likely to deal in its listed securities

- But if it were generally known to them would be likely to materially affect the price of the securities

Insider Dealing Definitions

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- Connected Persons include:

- Directors, employees or substantial shareholders (holding at least 5% of shares) of a corporation

- Persons who have access to relevant information by reason of having a professional or business relationship with the corporation or related corporation

- Connected person of another corporation when the relevant information relates to transactions between the two corporations

Insider Dealing Definitions

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- Possession of relevant information by a connected person and its use in dealing or getting others to deal; or

- Its disclosure to others knowing they would deal or get others to deal

- In takeover situations, knowledge of the takeover becomes relevant information

Definition of Insider Dealing

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- The making of a profit or avoidance of a loss was not the purpose of insider dealing

- The insider dealer acted as an agent and did not select or advise on the selection of the listed security or derivative, and was unaware that the principal was a connected person

- The dealing was a market contract

Possible Defences - Insider Dealing

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- Trading by a person on the knowledge of their own trading activities and those facilitating such trading (broker – merchant bank)

- Introduction of a person to trade with a substantial shareholder whom the other person knows or should know is a substantial shareholder

Possible Defences - Insider Dealing

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- When a person intentionally or recklessly creates a false or misleading appearance:

- Of active trading or with respect to the market price; or

- When a person is directly or indirectly involved, intentionally or recklessly in transaction:

- Which create an artificial price or maintain a price at an artificial level

- Issuers (> HK$ 100 M) may support price for 30 days subject to prior disclosure

False Trading s274, s295 SFO

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- These general definitions are expanded to cover certain non-off-market transactions:

- Wash Trades: sale and purchase without a change in beneficial ownership

- Matched Orders: sale or purchase matched by actual or proposed purchase or sale of the same securities, of the same quantity at the same price

- Off-market transactions are those not required to be recorded or notified under stock exchange rules

False Trading s274, s295 SFO

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- Price rigging is a sub-set of false trading as it focuses on unacceptable forms of price-fixing:

- Where a person enters into a wash trade which has the effect of maintaining, increasing, reducing, stabilizing or causing fluctuations in the price of securities; or

- Enters into, or carries out, a fictitious or artificial transaction or device, intentionally or recklessly, which has the effect of maintaining, increasing, reducing, stabilizing or causing fluctuations in the price of securities or futures contracts

Price Rigging s275, s296 SFO

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- Where a person enters, directly or indirectly into two or more transactions

- Which by themselves or together with another transaction

- Have the effect or are likely to have the effect

- Of increasing, decreasing, maintaining or stabilizing the price of securities – with the intention of influencing the investment decisions of other persons

Stock Market Manipulation s278, s299 SFO

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- The SFC is empowered to make rules that exclude acts defined as market misconduct from the definition

- Securities and Futures (Price Stabilizing) Rules

- These however permit price stabilizing action by issuers or underwriters in regard to public offerings

Safe Harbour Rules s 282, s306 SFO

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- A person who directly or indirectly:

- Employs any device, scheme or plan with the intention of committing fraud or deception: or

- Engages in any fraudulent or deceptive act

Fraud and Deception s300 SFO

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- Boiler room activities – high pressure selling tactics

- Churning – excessive trading to generate commissions

- Corporate mis-governance

- Front running – using client knowledge for personal gain

- Naked short selling

- Rat trading – deliberate trading to disadvantage clients

- Cold calling – unsolicited calls

Improper (Unethical) Trading Practices

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- SFC - Investor Compensation Fund established April 2003

- Investor Compensation Company to operate the fund

- Securities and Futures (Investor Compensation – Levy) Rules chargeable on transactions to sellers and buyers

- Securities and Futures (Investor Compensation – Claims) Rules – who can make a claim and how

- Securities and Futures (Investor Compensation – Compensation Limits) Rules – maximum is set at HK $ 150,000 per investor per default case

Investor Compensation Arrangements

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- Objective is to protect personal data of individuals:

- Any data relating directly or indirectly to a living individual that can ascertain that persons identity

- Applies to any data user that controls its collection, holding or processing

- Data user must comply with six principles:

Personal Data (Privacy) Ordinance (PDPO)

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- 1. Purpose and manner of collection

- 2. Accuracy and duration of retention

- 3. Use of personal data

- 4. Security of personal data

- 5. Information to be generally available

- 6. Access to personal data

Personal Data (Privacy) Ordinance (PDPO)

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- The code applies to intermediaries (fund managers) conducting discretionary management of CIS whether or not the schemes are authorized by the SFC

- As with the other codes any breach may reflect adversely the fitness and properness of a fund manager

- The adverse impact may be ignored if circumstances adequately the breach

Fund Manager Code of Conduct (FMCC)

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- If there are overlaps with other codes the stricter provisions prevail. Focus is on client relations

- Honesty and Fairness

- Representations should be accurate and not misleading – charges should be fair and reasonable

- A FM should not offer or accept inducements which are likely to conflict with its duties to clients

Fund Manager Code of Conduct (FMCC)

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- An FM should have written policy guidelines regarding gifts and maintain a record of any materials gifts received

- Diligence An FM should execute client orders on the best terms available

- Information about clients

- AN FM should take all reasonable steps to identify the client

Fund Manager Code of Conduct (FMCC)

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- Information for clients

- There should be a client mandate agreement which states portfolio objectives, investment restrictions and guidelines

- Where a FM provides services to a CIS there should be a written client agreement

- An FM is required to adhere to all relevant legal and statutory requirements in respect of reporting

Fund Manager Code of Conduct (FMCC)

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- Conflicts of interest

- Client priority – an FM should not be involved in insider trading.

- Rebates, soft dollars and connected transactions - an FM should not carry out client transactions with a connected person unless it is at arm’s length

- Other potential conflicts of interest – Trades between client accounts (cross-trades) should be fairly conducted. Cross-trades between the house account and the client are only permitted with client consent. In any event client trades should have priority

Fund Manager Code of Conduct (FMCC)

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- Compliance

- The FMCC requires an FM to have an effective compliance function and s designated compliance officer

- Employee dealings and employee supervision – Relevant Persons – permission max 5 days – hold for min 30 days

- Treatment of complaints – similar to Code of Conduct

- Client assets – similar to other codes and legislation

- The responsibilities of senior management are similar to those in the Code of Conduct

Fund Manager Code of Conduct (FMCC)

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- Corporate finance advising means:

- The listing of securities on the SEHK

- Their offer and disposal

- The rule and codes relating thereto

- Giving advice concerning corporate restructuring in respect of securities

- Excludes advice given by accountants and lawyers

Corporate Finance Adviser Code of Conduct (CFA)

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- Breach of the codes will reflect adversely on the fit and properness of the CFA

- Because of the special nature of CFA the codes do not fit in easily with the nine general principles

- Competence – honesty and fairness

- A CFA should be honest and of good repute and character, and should maintain a high standard of integrity and fair dealing

- The CFA should not offer or make inducements in connection with client business without proper disclosure and should have written policies

Corporate Finance Adviser Code of Conduct (CFA)

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- Standard of work – diligence

- A CFA must act with due skill, care and diligence and observe proper standards of market conduct

- Conduct of business – capabilities

- A CFA must ensure that its business is properly established and conducted

- CFAs and their staff must be able to demonstrate resources, competence and suitability

Corporate Finance Adviser Code of Conduct (CFA)

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- Duties to client – information about and for clients

- A CFA is encouraged to record the terms of its engagement in writing with the client

- The CFA should understand the business of the client

- The CFA should use all reasonable efforts to ensure the client understands the relevant regulations and report any non-compliance to the regulators

- A CFA should ensure proper representations, full and comprehensive information, adequate disclosure and provide a full and fair account of the work done when requested

Corporate Finance Adviser Code of Conduct (CFA)

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- Conflict of interest

- A CFA should take all reasonable steps to avoid conflicts of interest

- It should put clients interests first

- Conflicts should be dealt with according to listing rules, code on takeovers and mergers and the share repurchase code

Corporate Finance Adviser Code of Conduct (CFA)

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- Compliance

- Provisions regarding personal account dealings of CFAs and their relevant persons are the same as for fund managers

- All personal account dealings should be monitored by the designated compliance officer

- A watch list and restricted list system should be maintained for the proper monitoring of account dealings and proprietary trading

Corporate Finance Adviser Code of Conduct (CFA)

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- Share registrars are members of the Federation of Share Registrars which is approved by the SFC under the Securities and Futures (Stock Markets Listing) Rules

- They maintain registers of holders of listed securities and ancillary matters

- They issue certificates for securities offerings and transfers

- They provide company secretarial services

- Their clients are issuers of listed securities for whom they provide services (outsourcing)

Code of Conduct for Share Registrars (SR Code)