In the Hong Kong securities sector, it is a fundamental tenet that “in conducting its business activities, a licensed or registered person should act honestly, fairly, and in the best interests of its clients and the integrity of the market.”[1] A recent enforcement action by the Hong Kong Securities and Futures Commission (SFC) indicates the potentially severe consequences when a firm systematically disregards that tenet.
On January 28, the SFC announced that it had reprimanded and fined Citigroup Global Markets Asia Limited (CGMAL) US$45 million (HK$348.25 million) “for allowing various trading desks under its Cash Equities business to disseminate mislabelled Indications of Interest (IOIs).”[2] As part of that decision, the SFC found that “such pervasive dishonest behaviour would not have continued but for serious lapses and deficiencies in its internal controls, compliance function and management oversight.” This post will summarize the SFC’s key findings, conclusions, and sanctions, and offer some observations on the significance of the SFC’s action.
Key Findings
The SFC’s Statement of Disciplinary Action identified three categories of sanctionable conduct:
- Mislabelled IOIs: Since at least 2008, according to the SFC,
CGMAL’s Equities Sales Trading Desk had sent IOIs tagged as “Natural”, “In Touch With” and/or “P:1” to clients when there was no genuine client interest or specific client with which CGMAL was in touch. These mislabelled IOIs, which were generated with reference to certain percentage of the average daily volumes of selected blue-chip stocks in the market, were designed to provoke client enquiries with the purported belief that traders would be able to find natural opposite flows to cross with the client order given the active trading of the stocks and the size of CGMAL’s trading platform. The Facilitation Desk of CGMAL would step in to provide liquidity when traders failed to source natural liquidity on an agency basis upon client enquiry.
The SFC found that “CGMAL’s mislabelling of IOIs was not only contrary to the relevant industry guidelines that it claimed to have adopted but, more importantly, inconsistent with the fundamental principles of being honest with clients and treating them fairly.”[3]
- Misrepresentation and Non-Disclosure to Conceal the Principal Nature of Facilitation Trades: After reviewing 174 sample facilitation trades[4] that CGMAL’s various trading desks executed from January 2014 to December 2018, the SFC found that in 127 of them (73 percent), the heads and traders of the desks:
- “gave factually incorrect information to the client or took positive steps to conceal the principal nature of the trade;
- “made misleading statements that could be interpreted by the client as indicating that the trade would be executed on an agency basis, or sometimes remained silent notwithstanding some indication of the client’s belief that the trade was an agency trade; and/or
- “remained silent or were not explicit with the client about the involvement of the Facilitation Desk and failed to obtain client’s consent before routing the client’s order to the Facilitation Desk for execution. . . .”
The SFC explained that “[c]lients generally prefer transactions on an agency basis (ie, natural liquidity) over facilitation. By misrepresenting a facilitation trade as an agency trade or refraining from informing the client about the involvement of the Facilitation Desk, CGMAL could avoid losing a trade to a competitor.”[5]
- Internal Control Failures: The SFC also found that “[t]he prevalence of the misconduct among the desks over a period of more than 10 years indicates serious and systemic lapses across CGMAL’s controls framework and its first and second lines of defence.” In particular, it found that before November 2018, CGMAL failed to:
- “put in place any policies or controls to monitor the issuance of “In Touch With” and “P:1” IOIs and ensure that such IOIs were backed by specific client interest;
- “have adequate internal guidelines and enforce them in relation to pre-trade disclosure of and obtaining client consent for facilitation trades. Instead, CGMAL deliberately excluded the requirement for obtaining client consent for facilitation trades when revising its compliance guidelines in 2018;
- “implement effective compliance monitoring in respect of its facilitation activities to ensure that traders had made pre-trade disclosure of CGMAL’s principal capacity and obtained clients’ prior consent;
- “provide training to traders on IOIs and pre-trade consent for facilitation activities;
- “record and monitor communications and ensure sufficient segregation between agency and facilitation desks; and
- “identify and rectify system errors that had led to the sending of erroneous post-trade messages to clients, which incorrectly indicated that CGMAL acted in an agency capacity when in fact it acted as principal . . . .”
The SFC further found that “[s]ince at least 2014, CGMAL had multiple opportunities to identify and rectify the above failures but failed to do so until the misconduct was discovered during an SFC on-site inspection in late 2018 . . . .”[6]
Conclusions and Sanctions
The SFC concluded that CGMAL had failed to comply with various provisions in the Code of Conduct for Persons Licensed by or Registered with the SFC, and the Management, Supervision and Internal Control Guidelines for Persons Licensed by or Registered with the SFC.[7] In deciding on disciplinary sanctions, the SFC stated that it took into account all relevant circumstances, including:
-
- “the dissemination of mislabelled IOIs, misrepresentation of the source of liquidity when executing facilitation trades and the exclusion of the requirement for prior consent for facilitation trades from CGMAL’s internal guidelines were dishonest and intentional;
- “the duration of the misconduct exceeded 10 years and only came to light as a result of the inspection in 2018;
- “CGMAL’s senior management turned a blind eye to the misconduct by allowing the desks to adopt mislabelled IOIs and perpetrate misrepresentation with a view to achieving business growth;
- “CGMAL’s compliance function failed to properly discharge its duties;
- “CGMAL has since then taken disciplinary actions against and summarily dismissed employees who had engaged in the misconduct;
- “CGMAL has taken remediation steps and enhancement measures to stop the misconduct and address the SFC’s regulatory concerns;
- “CGMAL’s cooperation with the SFC in resolving the SFC’s concerns and accepting the SFC’s findings and disciplinary action; and
- “a strong message needs to be sent to the industry to deter other market participants from permitting similar failures to occur.”[8]
Accordingly, the SFC not only imposed the $45 million fine, but also identified as a key concern
the failure of CGMAL’s senior management to ensure the maintenance of appropriate standards of conduct and adherence to relevant regulatory requirements, and to understand, manage and monitor its business and risks. The prevalence of the misconduct for a prolonged period reflects a failure on the part of CGMAL’s senior management to properly discharge their management and supervisory responsibilities.
It further stated “that CGMAL’s failures and misconduct were attributable to the failures by certain former members of its senior management to discharge their supervisory duties. The SFC will commence disciplinary proceedings against these individuals in due course . . . .”
Observations
The lessons to be learned from this SFC action extend well beyond Hong Kong. CGMAL certainly deserves credit for its ultimate cooperation with authorities and its remedial and disciplinary measures. Nonetheless, chief compliance officers in financial institutions should take careful note of the range and severity of those failures. They should therefore brief not only their own compliance teams but senior executives about the critical elements of the SFC action, including the corporate and individual consequences of the systematic misconduct, and incorporate those elements into targeted training for first- and second-line compliance officers and executives as appropriate. No financial firm should ever allow its operations to devolve into persistent disregard of its fiduciary obligations to clients.
Footnotes
[1] Securities and Futures Commission, Securities and Futures Commission, Code of Conduct for Persons Licensed by or Registered with the SFC (2020), https://www.sfc.hk/-/media/EN/assets/components/codes/files-current/web/codes/code-of-conduct-for-persons-licensed-by-or-registered-with-the-securities-and-futures-commission/Code_of_conduct-Dec-2020_Eng.pdf (PDF: 1.1 MB) [hereinafter Code of Conduct].
[2] Securities and Futures Commission, Release: SFC reprimands and fines Citigroup Global Markets Asia Limited $348.25 million for serious regulatory failures over client facilitation activities (January 28, 2022), https://apps.sfc.hk/edistributionWeb/gateway/EN/news-and-announcements/news/doc?refNo=22PR6 [hereinafter Release]. IOIs are “a common industry practice to express trading interests to source and unlock liquidity in the market.” BNP Paribas Securities (Asia) Limited, Indications of Interest (“IOI”) https://cib.bnpparibas/app/uploads/sites/2/2018/12/bnp-paribas-securities-asia-indication-of-interest.pdf (PDF: 981 KB). In Hong Kong, licensed corporations providing client facilitation services disseminate IOIs from time to time “as a way to source potential clients with an interest in trading.” Securities and Futures Commission, Circular to licensed corporations on client facilitation (February 14, 2018), https://apps.sfc.hk/edistributionWeb/gateway/EN/circular/intermediaries/supervision/doc?refNo=18EC11 [hereinafter Circular].
[3] Securities and Futures Commission, Release, supra note 2.
[4] “Typically, clients use facilitation services to obtain liquidity or achieve a guaranteed execution price. As the nature of the client relationship may change in a facilitation transaction due to the fact that LCs assume a risk-taking principal position rather than an agency position, conflicts of interest may arise.” Securities and Futures Commission, Circular, supra note 2.
[5] Id.
[6] Id.
[7] See Securities and Futures Commission, Code of Conduct for Persons Licensed by or Registered with the SFC (2020), https://www.sfc.hk/-/media/EN/assets/components/codes/files-current/web/codes/code-of-conduct-for-persons-licensed-by-or-registered-with-the-securities-and-futures-commission/Code_of_conduct-Dec-2020_Eng.pdf (PDF: 1.1 MB); Securities and Futures Commission, Management, Supervision and Internal Control Guidelines for Persons Licensed by or Registered with the SFC (April 2003), https://www.sfc.hk/-/media/EN/assets/components/codes/files-current/web/guidelines/management-supervision-and-internal-control-gu/management-supervision-and-internal-control-guidelines-for-persons-licensed.pdf (PDF: 175 KB).
[8] Securities and Futures Commission, supra note 1.
Jonathan J. Rusch is a Senior Fellow at New York University School of Law’s Program on Corporate Compliance and Enforcement; Adjunct Professor at Georgetown University Law Center, American University Washington College of Law, and Washington and Lee Law School; and Principal of DTG Risk & Compliance LLC. He is a former Deputy Chief in the U.S. Department of Justice’s Fraud Section, and former Senior Vice President and Head of Anti-Bribery & Corruption Governance at Wells Fargo.
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