SFC publishes consultation conclusions on its proposed amendments to enforcement-related provisions of the SFO
The SFC has decided to proceed with its proposal to extend the territorial scope of the insider dealing regime to cover overseas-listed securities. Conversely, it has taken respondents' submissions into account and put on hold its more contentious proposals to expand section 213 remedial relief and clarify the professional investor exemption under section 103.
On 10 June 2022, the Securities and Futures Commission (SFC) issued the Consultation Paper on Proposed Amendments to Enforcement-related Provisions of the Securities and Futures Ordinance (SFO) which can be found here.
The SFC's stated objective for the proposed amendments was to provide for more effective enforcement action on its part in order to better protect the interests of the investing public and to uphold the reputation of Hong Kong's financial markets.
Before ending in August 2022, the consultation attracted a good degree of engagement; Clifford Chance's written submission was amongst a total of 27 received including from industry associations, professional bodies and other law firms.
The consultation conclusions released on 8 August 2023 can be found here.
In short, the proposed changes to the insider dealing provisions of the SFO will be implemented. Other proposed changes (specifically to sections 103 and 213 of the SFO) have been put on hold or will not be implemented in their current form with the SFC to further consider the complexities raised by respondents and study other options.
What the June 2022 consultation paper proposed
By way of summary and reminder, these are the proposals made in the June 2022 consultation paper:
- Amendment of section 213 of the SFO to provide for a new cause of action to empower the SFC to apply to the Court of First Instance (CFI) for remedial / compensatory and other orders after exercise of its disciplinary powers under section 194 or section 196 of the SFO. Currently, section 213 is primarily triggered by a contravention of a provision of the SFO or breach of licence conditions. It cannot be triggered by breach of SFC codes and guidelines leading to disciplinary action for misconduct or not being fit and proper.
- Amendment of section 103(3)(k) of the SFO to clarify that the professional investor exemption (to the requirement for SFC authorisation for advertisements inviting the public to enter into securities agreements and investment in other cases) only applies to advertisements issued solely to professional investors identified in advance by know your client (KYC) and related procedures. This is to address the Court of Final Appeal decision in SFC v Pacific Sun Advisors Limited and Mantel, Andrew Pieter (FACC 11/2014, 20 March 2015), which gave a wide interpretation of the professional investor exemption such that the exemption was held to apply to advertisements having some connection to investment products that are or are intended to be disposed of only to professional investors.
- Broadening of insider dealing civil and criminal provisions (sections 270 and 291 of the SFO) to cover: (i) insider dealing perpetrated in Hong Kong with respect to overseas listed securities or their derivatives and (ii) expressly for the sake of clarity, insider dealing perpetrated outside of Hong Kong with respect to Hong Kong listed securities or their derivatives. Sections 270 and 291 currently only cover insider dealing in relation to Hong Kong listed securities and dual listed securities in Hong Kong and another jurisdiction and their derivatives.
Proceeding with insider dealing amendments
Respondents generally supported the proposed amendments to the insider dealing provisions of the SFO. The SFC has confirmed in the consultation conclusions that the insider dealing changes will be implemented. As we stated in our submission, we consider the proposal to be acceptable serving as a natural evolution and to clarify the position. It will avoid the unintended use of section 300, which was used in such cases as SFC v Young Bik Fung  HKCFA 45 for insider dealing involving overseas-listed securities. In the CFA judgment itself, it was stated that section 300 should not be used as a catch all provision.
Whilst we suggested a sufficient transition period to give firms time to update their internal compliance policies and manuals, the SFC have stated that there is no need for a transition period, as there will be sufficient time for updating once legislative amendments are published.
In the consultation conclusions, the SFC further clarified the following:
- In bringing overseas-listed securities and their derivatives into the regime, the insider dealing in question will also need to be unlawful in the relevant overseas jurisdiction.
- The scope of instruments covered by the insider dealing regime will remain the same, only the territorial scope will be changed, namely, the extended regime will apply to OTC transactions in Hong Kong and overseas-listed debt securities and the current definition of derivatives in sections 245 and 285 of the SFO will remain unchanged.
- Code of Conduct notification requirements will continue to apply in terms of reporting breaches involving overseas-listed securities.
Section 213 (court ordered compensatory relief in effect for misconduct in the form of breach of SFC codes and guidelines) – watch this space!
The SFC has stated that it will put its section 213 proposal on hold. It acknowledges the complexities raised by respondents and that some of these do call for further consideration. It will also holistically assess the adequacy of current avenues for seeking financial redress for investors and study other options.
The issues calling for further consideration (and those not) as stated in the consultation conclusions are as follows:
- Conflation of disciplinary regime and section 213. The SFC acknowledged that a new link would be established between the disciplinary regime and section 213 and the fact that when disciplinary decisions become possible grounds for institution of section 213 proceedings, the CFI may consider it necessary to review the merits of an underlying disciplinary decision in determining whether it is "desirable" or not unfairly prejudicial to make an order under section 213 (as per the express requirements for a section 213 order). To the risk of parallel proceedings and outcomes raised by respondents, the SFC responded that it had always considered adopting the administrative solution of not commencing section 213 proceedings until any appeal process before the Securities and Futures Appeals Tribunal (SFAT) or Court of Appeal under the disciplinary regime was exhausted. However, the other concerns raised by respondents will need to be deliberated including whether the CFI, in making any compensatory order, should be required to take into account any disciplinary action already taken by the SFC such as fines and suspensions. See paragraphs 1.25 to 1.32 and paragraphs 1.39 and 1.40 of our submission.
- Fairness and proportionality concerns. The SFC acknowledged the industry's concerns regarding the need for certainty in the circumstances in which the SFC may seek section 213 orders (given the breadth of SFC codes and guidelines and the varying degree of severity in disciplinary sanctions, and the unfairness of all disciplinary action being able to trigger an action under section 213) and the impact of the extension of the limitation period , which was not part of the policy objective of the proposal. The SFC has stated in the consultation conclusions that it will consider these concerns and practical implications in further detail. See paragraphs 1.3 to 1.7 and 1.10 to 1.18 of our submission. To this end, we had suggested an additional test of dishonesty and/or wilfulness for section 213 orders to become available.
- On the other hand, the SFC reiterated its confidence in the independence and competence of the courts (despite concerns expressed as to the CFI's lack of familiarity with SFC codes and guidelines and any potential undue reliance on SFC interpretation), and the different purposes of disciplinary fines (to deter future non-compliance) versus restitutionary or compensatory orders (to restore investors who have suffered harm to the position they would have been in had the misconduct not taken place), despite both being potentially imposed on the same misconduct.
- Legal and jurisprudence concerns. Respondents raised the question of whether it is right to empower the SFC to seek legal remedies in the form of court orders for breach of SFC codes and guidelines which do not themselves have the force of law and the formulation of which are not subject to the same scrutiny as legislation. The SFC responded that the legislative intent of section 213 is to provide for relief for misconduct, as disciplinary action also addresses. Section 213 already allows the SFC to seek remedial orders for breach of licensing conditions, which also do not have force of law.
Taking a holistic view
Whilst the SFC has put the section 213 proposal on hold, it has made clear that it does not agree that the existing legal framework is adequate. It highlighted the inadequacy of civil litigation as an option for retail investors who do not have the resources to litigate in the courts and the lack of a class action mechanism in Hong Kong. The SFC also highlighted the appropriateness of it having the power to seek compensation on behalf of investors in cases where multiple regulated persons perpetuate similar misconduct with respect to similar investment products resulting in large number of investors suffering losses. It appears the SFC is in the process of reconsidering its options in a holistic manner, whilst taking into account the potential far-reaching impact of their proposals on the industry and Hong Kong financial markets.
Section 103 (clarifying professional investor exemption for advertisements) – not current form
Many respondents expressed concerns about the proposal to amend the professional investor exemption in section 103(3)(k) of the SFO. These comments can be categorised into two broad categories:
- The necessity of the amendments. Many respondents questioned the necessity of the amendments, in particular, contending that there is no material risk for retail investors to be exposed to unauthorised advertisements if they are not able to invest in the relevant investment products. Existing regulatory requirements around KYC, suitability assessment and risk disclosure already sufficiently protect retail customers. The issue being addressed is not urgent given the lapse of time since the Pacific Sun judgment and no enforcement action relating to section 103(3)(k) having been taken since. Importantly, given the strength of the existing disciplinary sanctions and criminal penalties for breaches of section 103, amending section 103 as proposed would be disproportionate to the perceived harm being targeted.
- Operational difficulties and impact on business. Many respondents highlighted the operational difficulties and impact on business development and marketing. This is because if implemented, this proposal would effectively require intermediaries to only issue advertisements to professional investors who have already been identified through the firms' KYC, however, professional investors are generally unwilling to provide their KYC information at the preliminary marketing stage. Intermediaries' ability to market would thus be significantly reduced or the marketing process would become disjointed. Further, online marketing efforts would be restricted. See paragraphs 3.1 to 3.7 of our submission.
The SFC acknowledged the practical difficulties highlighted by respondents, in particular: (i) potential clients being unwilling to provide KYC information in the pre-marketing process; and (ii) impact on development of multi-media, multi-jurisdictional online distribution of investment products and how investors access these distribution platforms. It will continue to monitor the need to introduce new policies over the longer term and consult the industry again as necessary.
Meanwhile, the SFC took the opportunity to remind the industry that to invoke the professional investor exemption, a clear intention to dispose of the investment product to professional investors only must be demonstrated. For ease of demonstrating and evidencing such intention, the SFC recommends making plain and apparent from the face of the advertisement that the investment product in question is for professional investors only. The SFC added that clear display of an appropriate message or warning would go a long way in this regard. The SFC is considering providing further guidance on this matter.
The SFC consultation conclusions are welcomed. The SFC has taken into account respondents' submissions and put on hold the more debated proposals over which complexities were raised to reconsider the need for the same and the relevant regime more holistically.