Compliance in Handling Client Money is Regulatory Focus in Asia

The Hong Kong Securities and Futures Commission (SFC) recently reprimanded Unicorn Securities Company and fined it HK$3 million, suspending its former responsible officer, Chan Hoi Shu. He was suspended for a period of 15 months until June 11, 2017, and was also fined HK$200,000 for breaches in relation to handling client money and assets. 

This case is an example of a complete compliance failure where both senior managers and the firm ignored standard procedures in handling client funds that resulted in a significant abuse of trust. This is not an isolated case as regulators in Asia are focusing on this area, and even some of the major banks have fallen short of standards.

Improper Handling of Clients’ Dividend Entitlements 

The SFC found that between March 2011 and December 2013, Unicorn mishandled its clients' dividend entitlement of shares of HSBC Holdings by going against clients' instructions concerning their choices between cash and script dividends for HSBC shares when submitting clients' instructions to the Hong Kong Clearing Company and by giving clients' dividends to other people on ten separate occasions.   

Unicorn's records show that the instructions which it received from the HSBC clients were for a mixture of cash dividends and script dividends for each of the ten dividend events. 

The HSBC clients whom the SFC interviewed confirmed that they were eventually allotted the forms of dividend they selected, but they did not know that Unicorn had elected for them a form of dividend inconsistent with their instructions. In relation to the ten events, the SFC found Unicorn was involved in malpractice in handling dividend entitlements for the benefit of Chan and Client L.

The SFC found, where the dividend events were script, Chan would instruct Unicorn staff to deposit those script dividends contrary to those clients' instructions into his or Client L's account. Chan then would sell the shares under the client script dividends in his or Client L's account and arrange payment to Unicorn, which would in turn make payment to the clients who elected a cash dividend.

In the circumstances, where the dividend events were cash, Chan would instruct Unicorn staff to allocate the cash dividends received contrary to clients' instructions, to himself. Unicorn would then pay Chan the amount equivalent to the dividends. Chan would then use the money to purchase HSBC shares for Unicorn to distribute to the clients' who elected script dividends.

As a result of the malpractice, Chan was able to aggregate profits of HK$95,000 and Client L, HK$26,000. There is no evidence clients suffered any loss as a result of the malpractice.

Failure to Safeguard Client Money and Assets

Chan was authorised by Client L to handle sale proceeds of stock in receipt of cash dividends. At Client L's request, Chan would transfer money to his bank account in Singapore via Chan's own accounts. These transfers totalled HK$913,000 and took place on 21 occasions. 

Unicorn was aware that Chan was retaining client money in his own personal accounts but took no action to stop the conduct. There was also a circumstance when Chan instructed Unicorn to withdraw shares from Client L's account, without the client's consent, for distribution to the HSBC clients who wished to receive script dividends to cover up a failure of its staff to input script dividend instructions in the CCASS system.

Failure of Senior Managers

The evidence showed that Chan masterminded the malpractice and had used Unicorn staff to generate a profit for himself and Client L. In particular, the SFC found that as a member of the senior management, Chan had failed to ensure that it had in place effective internal controls to safeguard client assets and ensure compliance with the relevant regulatory requirement, which were in breach of Principles 7, 9 and 12 of the Code of Conduct. 

The SFC was of the view that Chan had breached the trust that the clients placed in Unicorn, by acting contrary to their instructions and that his conduct cast serious doubt on his ability to carry on regulated activities as well as his character and the appropriateness to remain licensed.

Tips for Compliance in Relation to Client Money

  • Ensure there are adequate internal control procedures and operational capabilities to properly account for handling client assets under General Principle 8 of the Code of Conduct and there is an audit trail to show they work effectively.
     
  • Ensure that the current measures used by the firm, are appropriate to ensuring that compliance with regulatory requirements related to the handling of client money and securities, and they comply with General Principle 7 of the Code of Conduct.
     
  • Ensure that when dealing with clients' accounts in relation to withdrawals, that there are written directions from clients before withdrawals are made in accordance with Sections 6 and 10 of the Client Securities Rules.
     
  • Ensure that staff and senior managers understand the clear requirements of the Client Money Rules and in particular, Sections 4(4) and 4(6) that prohibit the payment of client money to any officers or employees of the firm.
     
  • Ensure that staff understand the requirements in relation to segregation and a proper handling of client assets.
     
  • If there are compliance concerns, consider engaging an external consultant to review systems and controls to ensure compliance with the applicable regulatory requirements, in particular, consider what automated operated systems are being used to reduce compliance failures or risk of fraud.

Regulators are Focusing on Client Money

This recent case in Hong Kong is not in isolation. As recently as a month ago, the Australian Securities and Investments Commission (ASIC) took action against Macquarie Bank (Macquarie) and imposed additional conditions on the Australian Financial Services (AFS) licence of Macquarie, relating to breaches of the client money provisions of the Corporations Law between March 2004 and 2014. 

The conditions require the bank to engage an expert and conduct a review to ensure that it complies with its legal obligations. 

The investigation arose out of a number of breach reports lodged by Macquarie in relation to its obligation to disclose compliance failures. Macquarie has filed an application for review of ASIC's Decision in the Administrative Appeals Tribunal and has sought a stay of the decision pending the outcome of a review. 

Complete Failure by Senior Managers

The Unicorn case highlights a complete failure by senior managers where there was no desire to ensure that adequate control procedures were met. The "connivance" between Unicorn and Chan, and shows they had no regard for the Code of Conduct and the clear requirements and high standards in dealing with client funds. 

In these circumstances, where there is a total breach of trust, then it is appropriate that the regulator deals with such cases seriously and appropriately to set high standards.

Jurisdictions: 

Niall Coburn is the Asia-Pacific regulatory intelligence expert for Thomson Reuters. He is a barrister and former director of enforcement at the Dubai Financial Services Authority and senior specialist adviser to ASIC. He is based in Brisbane, Australia.