More on SFC's Cardinal Principle – "Suitability"

The Securities and Futures Commission's Code of Conduct puts investor protection at its core.

Paragraph 5.2 of the Code ("Know your client: reasonable advice") is the "suitability obligation"; namely, when a licensed or registered person makes a recommendation or solicitation they should ensure its suitability for the client is reasonable in all the circumstances.

Paragraph 6.2 of the Code ("Minimum content of client agreement") at sub-paragraph (i) contains a "suitability term" for client agreements which came into effect on 9 June 2017.

Both the "suitability obligation" and the "suitability term" are (in effect) the SFC's two-pronged attempt to ensure the reasonableness of recommendations given by financial intermediaries and their representatives to their clients. The former is a regulatory standard but it is not usually thought to give rise (of itself) to a personal cause of action – the latter is a mandatory contractual provision for certain client agreements that does give rise to a potential civil claim.

Against this background, a SFC "Statement of Disciplinary Action", made publicly available on its website on 18 March 2019, is significant. It confirms the SFC's decision to reprimand and fine (HK$10 million) a securities trading subsidiary of a major bank for (among other things) systematic deficiencies in the past regarding the suitability assessment in the sale or distribution of certain investments. These deficiencies are stated to have occurred before 9 June 2017 (when the "suitability term" came into effect pursuant to the Code).

In order to mitigate its position, the respondent securities company put in place certain remedial measures, offered cooperation and an enhanced complaints handling procedure (see "Industry Insights", December 2018, "Self-reporting", for some potential lessons in an attempt to minimise a regulatory sanction).

The fine and reprimand may be a sign of further regulatory sanctions to come as regards other market participants. Targeted regulatory sanctions also tend to make other market participants pay attention and regulators know it.

In addition to regulatory sanctions, going forwards aggrieved retail investors will be looking to the "suitability term" in client agreements to enhance their position as regards civil claims and settlement options. If not settled through financial dispute resolution, such claims still face hurdles in establishing a breach and quantifying a loss. What the "suitability term" does do is get around the previous common law loophole whereby some banks' and financial intermediaries' representatives appeared to offer investment advice but were apparently able to hide behind contractual disclaimers and the like – to the effect that they were not giving investment advice and were only executing instructions.

Editorial Note: Also see "Industry Insights", February 2017, "SFC FAQs on Suitability Obligations".


Regulatory & Compliance