On 21 November 2016, the SFC banned Mr Benedict Ku Ka Tat (Ku), a licensed representative (LR), from re-entering the industry for one year and fined him HK$150,000 for his failure to comply with the suitability obligation in connection with the sale of a fund to an individual client (SFC Statement of Disciplinary Action available here).
Apart from failings relating to suitability, Ku also failed to tell his client about his personal monetary benefit (see General Principle 5 Information for clients and the disclosure requirements under 8.3A of the Code of Conduct). Ku did not disclose to the client that he would receive a commission of 12% of the client’s intended investment of HK$780,000.
Regarding suitability, the SFC found that Ku was in breach of the following obligations in the Code:
1. Diligence – General Principle 2
Ku did not act with due skill, care and diligence and in the interest of the client and market integrity.
2. Advice to client: due skill, care and diligence – 3.4
Ku did not conduct a thorough analysis and take into account alternatives before providing the advice and did not act diligently and carefully when providing the advice.
3. Know your client: in general – 5.1
Ku did not collect sufficient information about the client’s financial situation, investment objectives and experience, or the client’s risk tolerance.
4. Know your client: reasonable advice – 5.2
When Ku sold the fund to the client, he failed to ensure the recommendation or solicitation was reasonably suitable for the client, after taking into account all the circumstances. In particular, there was no formal suitability assessment and documentary record of the rationale of why Ku considered the fund to be suitable for the client.
More details about the specific suitability obligation in paragraph 4 above can be found in the SFC Suitability FAQs (see circular on 8 May 2007 available here). In 2005, the SFC published a Report on Selling Practices of Licensed Investment Advisers (available here). The SFC has conducted several themed inspections since, which have focused on the sales process and suitability. In 2009, the SFC reminded licensed firms to self-examine whether they comply with the suitability requirements summarised below:
In October 2012, the SFC published another Report on the Thematic Inspection of Selling Practices of Licensed Corporations (available here). The SFC is studying suitability requirements internally (as discussed in the Consultation Conclusions on the Proposed Amendments to the Professional Investor Regime and Further Consultation on the Client Agreement Requirements of 25 September 2014, available here). It is expected that the SFC will issue further guidance but the precise timetable for this is currently unclear.
In the Ku case, Mr Ku was the representative of the Hong Kong licensed manager of a private fund. The investor was a friend of his. It is not clear from the Statement of Disciplinary Action what, if any, information Ku collected from his client. However, it does seem clear he was unable to produce adequate records of such information or of the conduct of the suitability assessment, which was undoubtedly highly damaging. The SFC seems to have assumed that Mr Ku was giving advice and making a recommendation. As Mr Ku was a representative of the manager of the fund, it seems more likely that he was making a solicitation rather than a recommendation. It does not appear that Mr Ku argued the point, which is an important one, as there must be a difference between a recommendation and a solicitation and the position of an intermediary acting as an investment adviser as opposed to one conducting capital raising activity. The former involves advice whereas the latter does not. Where a manager is selling a fund which he manages, particularly if he is a private fund manager, he will have no alternative investment product to sell. He still has an obligation to satisfy himself that the product is suitable for the investor but he is not advising the investor so the availability of alternative products from other providers should not be relevant. This is an issue which needs to be addressed in the SFC’s guidance on the suitability obligation.
In our Client Alert on “Important Change to Client Agreements” of 10 December 2015, we mentioned that the new suitability anti-avoidance clause will become effective on 9 June 2017 and the SFC expects licensed firms to start the relevant process of including this clause in the “client agreement” immediately (also see an article called “SFC FAQs on inclusion of new suitability clause in discretionary investment management agreements” in our recent October newsletter).