Another case on suitability and inadequacies in the fund sales process results in HK$7 million fine

The Securities and Futures Commission (SFC) issued a circular on 27 March 2020 reminding the industry of the importance of compliance with the suitability obligation. Deacons’ client alert, which you can access here provides a succinct summary of the sources of the suitability obligation and the SFC’s FAQs on the subject. The alert also drew attention to the sampling and monitoring obligations under FAQ 10, which are frequently overlooked.

On 7 May 2020 the SFC reported that it had publicly reprimanded and fined Mega International Commercial Bank Co., Ltd. (Bank) HK$7 million over the Bank’s internal system and control failures in relation to the sale of collective investment schemes. The SFC’s investigation was triggered by a referral from the Hong Kong Monetary Authority (HKMA). The Bank also engaged an independent reviewer to validate whether the shortcomings had been adequately addressed and undertook to submit the validation review report to the SFC and the HKMA as soon as it is available. The SFC’s statement of disciplinary action can be found here.

The SFC’s investigation revealed significant systems and controls failures in the Bank’s sales process, in particular in relation to:

  • KYC;
  • product due diligence;
  • assessment of fund risk ratings;
  • identifying funds which constituted derivative products requiring investor knowledge of derivatives; and
  • ensuring suitability of recommendations and solicitations, including on switches.

Key takeaways

  • KYC – the design of the customer risk profiling questionnaire is critical. It needs to cover the essential information required by Chapter 5 of the Code of Conduct for Persons Licensed by or Registered with the SFC, and careful consideration needs to be given to the weighting of responses. In this case, no score was given to the customer’s investment objective or investment experience, and the customer’s knowledge of derivatives was not addressed at all.
  • Product due diligence – it is not sufficient to rely entirely on due diligence carried out by another group company on the products being sold. At least there should be enquiries made into the extent of the due diligence conducted by the group company to ensure it covers all the matters required to be addressed under Hong Kong’s regime. For example, in this case the overseas group company did not cover categorisation of products as derivative products. Due diligence must now also cover whether a product is a complex product, which may not be a requirement overseas.
  • The suitability assessment can be triggered on a sale of a product or a switch (and in the case of a complex product, even if there has been no recommendation or solicitation).