Hong Kong’s SFC voices concerns about “nominees” and “warehousing” arrangements

Hong Kong’s Securities and Futures Commission (SFC) has earlier today published a circular to intermediaries voicing its concerns about the growing use of “nominees” and “warehousing” arrangements, which often facilitate corporate misconduct.

The SFC has observed cases where nominee clients took instructions from “masterminds”, and participated in activities to manipulate share prices or voting results in general meetings of listed companies, or to conceal the actual shareholding in a listed company to evade regulatory requirements.

The regulator warns intermediaries that they should be wary of potential red flags and critically review and enhance their systems and controls for the purpose of complying with related legal and regulatory requirements.

For instance, Paragraph 5.4 of the Code of Conduct, requires intermediaries to be satisfied on reasonable grounds about (i) the identity, address and contact details of (a) the person or entity ultimately responsible for originating the instruction in relation to a transaction; and (b) the person or entity that stands to gain the commercial or economic benefit of the transaction and / or bear its commercial or economic risk; and (ii) the instruction given by the person or entity referred to in (i).

Intermediaries are advised to be vigilant in looking out for potential red flags that may suggest use of “nominee” and “warehousing” arrangements for illegitimate purposes. For example, suspicions are likely to be triggered when:

• clients effect transactions involving large amounts of funds that are not commensurate with their financial profiles;
• clients only transact in one or two stocks over an extended period. The circumstances would be more suspicious if the clients are walk-in clients, opening an account to effect a single transaction involving a large sum of money;
• there is a large number of seemingly unrelated clients having authorised the same third party (who is not a licensed representative or registered individual of the intermediary) to operate their accounts;
• there is a large number of seemingly unrelated clients that share the same trading and settlement patterns (for example, investing in same stocks) or the same correspondence address;
• there are frequent and large fund transfers to and from third parties absent a credible commercial rationale or explanation; and
• clients transfer a large quantity of stock (representing a sizeable portion of the typical daily turnover of the stock on the stock exchange) to and from third parties by way of bought and sold notes which do not appear to have been concluded on a normal commercial basis (for example, the executed price is substantially below the prevailing market price or the stock has been transferred to the client unaccompanied by any payment).

The regulator expects intermediaries to meet certain standards. They should take reasonable steps to establish the true and full identify of each client and the beneficial owner. Intermediaries are also expected to implement proper controls and approval procedures for the opening of third party operated accounts. Furthermore, they are expected to make payments directly to their clients and discourage third party payments.

Regarding third-party fund deposits, the SFC says intermediaries should take all reasonable steps to tighten their controls to monitor third party fund deposits. They are expected to inquire about and document the reasons for the deposits and the relationship between the client and the third party.

Intermediaries should also implement proper transaction monitoring procedures and pay special attention to transactions which may be indicative of potential illegal or manipulative activities.

The Intermediaries Supervision Department is set to continue to look for signs that may suggest dubious “nominee” and “warehousing” arrangements in the course of the supervisory reviews (covering both onsite inspections as well as offsite monitoring work). All material issues and deficiencies identified as well as Manager in Charge responsibilities in this regard will be investigated. These will include situations where there is reason to suspect that intermediaries and their senior management have knowingly facilitated such arrangements as well as situations where it appears that they have failed to detect and act on any red flags, including inadequate systems and controls.

The SFC says it will not hesitate to initiate criminal or other proceedings and impose disciplinary penalties where it establishes any failings on the part of intermediaries, including suspension or revocation of a licence or a registration, as well as fines on intermediaries and senior management.