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Enforcement action for defective sales process

On 2 November 2015 Hong Kong’s Securities and Futures Commission (SFC) issued a press release giving details of action taken against a securities firm which is licensed to provide dealing and investment advisory services in Hong Kong.

The SFC publicly reprimanded the firm and fined it $4 million for failure to:

  1. ensure adequate product due diligence had been conducted on various unlisted bonds before making recommendations or solicitations to its clients;
  2. ensure that the recommendations or solicitations made to its clients were suitable for and reasonable in all the circumstances of each of its clients;
  3. maintain adequate documentary records of the investment advice given to its clients and failure to provide clients with a copy of such advice; and
  4. make adequate disclosure to clients of the mark-up / down it derived from these transactions.

The case provides a timely reminder to those engaged in distributing or advising on investment products of the SFC’s expectations in relation to product due diligence, suitability and disclosure. It highlights the importance of being able to demonstrate a robust sales process, maintaining a well-documented process, adequate supervision and training of sales staff.

Between January and September 2013, the firm solicited and executed 51 buy and sell transactions in unlisted bonds for its retail clients.

Due diligence

The SFC found that:

  1. the firm did not have adequate written policies or procedures on conducting product due diligence or for evaluating investment products;
  2. the firm did not adequately record its due diligence work other than the “product offer sheets”, obtained from the prospectuses, Bloomberg and bookrunners, nor did they record any verification work or their criteria for selecting the products for distribution to its clients;
  3. the firm relied primarily on the credit rating of the products in its due diligence potentially overlooking other factors that are relevant to their risk return profiles and/or growth prospects, such as liquidity, past performance, the experience and reputation of the issuers, fees and charges, etc.

Suitability of recommendations

The SFC was not satisfied that the firm’s sales staff were in a position to make suitable recommendations to clients as the firm did not provide adequate guidance on product due diligence and the suitability assessment, and in some cases failed to maintain complete client profiles or to make a proper assessment of clients’ risk tolerance level.

Documentation of investment advice

The firm did not adequately document its investment advice or its rationale and did not provide a copy to its clients.

The absence of such records raised concerns about the firm’s ability to supervise its sales representatives or to assess its position regarding possible mis-selling of products.

Disclosure of monetary benefit

The percentage or amount of trading profit that the firm made from back-to-back transactions should have been disclosed to its clients.

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