On 8 August 2023, the Securities and Futures Commission (SFC) announced its Consultation Conclusions on the three proposed amendments to the enforcement-related provisions in the Securities and Futures Ordinance (SFO) set out in its June 2022 Consultation Paper:
- The broadening of the basis on which the SFC may apply for remedial orders against a regulated person under Section 213 of the SFO;
- An amendment to the professional investor exemption for issuing advertisements for investment products under Section 103(3)(k) of the SFO; and
- An expansion of the coverage of the insider dealing provisions to address extra-territorial issues.
These proposed enhancements were collectively intended to (a) enhance the remedies available to the SFC to seek compensation for investors suffering loss due to regulatory breaches; (b) address a deficiency that is potentially exposing retail investors to unauthorised advertisements for investment products intended for professional investors; and (c) better align Hong Kong’s insider dealing provisions with other provisions in the SFO (and other major common law jurisdictions) by also addressing extra-territorial aspects of the insider dealing offence. However, in the face of strong concerns and complex implementation issues raised by respondents during the consultation, the SFC has concluded that they will put the first two proposed amendments on hold pending further review, but they will proceed to seek an expansion of the scope of the insider dealing provisions. In this update, we briefly discuss the SFC’s intended approach in respect of the three proposals, the issues raised during the consultation and the implications for the regulatory landscape.
How the insider dealing provisions are being amended and the SFC’s clarifications
Insider dealing of listed securities is prohibited under Section 270 (civil liability) and Section 291 (criminal liability) of the SFO, respectively. Under the existing insider dealing regime, the relevant statutory provisions only apply to securities listed on the Hong Kong stock market, securities dually listed in Hong Kong and another jurisdiction, or their derivatives. However, the SFC had identified two main deficiencies in the statutory regime surrounding extra-territorial application.
The first deficiency involves the SFC lacking jurisdiction to take action against insider dealing in respect of overseas-listed securities or their derivatives, even if the acts are conducted in Hong Kong. The second deficiency relates to the limitations of the insider dealing provisions in policing insider trading, committed in relation to Hong Kong-listed securities or their derivatives, outside Hong Kong. The SFC had previously recognised that almost two-thirds of the insider dealing cases concerned insider dealing perpetrated outside Hong Kong in respect of Hong Kong-listed securities or their derivatives. However, the SFC currently has to rely on alternative means to take enforcement action (i.e., by satisfying the common law test for territorial jurisdiction, which typically requires the insider dealing activities constituting the offence to be substantively committed in Hong Kong).
The SFC had proposed to:
- Amend the definition of “listed” under the insider dealing provisions to include overseas-listed securities or their derivatives;
- Enact new sections in Part XIII and Part XIV of the SFO that expressly prohibit (i) insider dealing involving Hong Kong-listed securities or their derivatives no matter where it is perpetrated; and (ii) insider dealing involving overseas-listed securities or their derivatives as long as one or more acts of insider dealing take place in Hong Kong; and
- Make consequential amendments, including:
- repealing Sections 270(2) and 291(7);
- aligning the mens rea requirement for the above-proposed amendments with Sections 270(2)(b) (civil liability) and 291(7)(b) (criminal liability);
- enacting new subsections under Sections 282 (civil liability) and 306 (criminal liability) to provide that insider dealing in Hong Kong related to overseas-listed securities or their derivatives would not be made out unless the conduct is also unlawful in the relevant overseas jurisdiction; and
- amending Section 271(5) to extend the “off-market transaction” exemption to insider dealing in respect of overseas-listed securities or their derivatives, where transaction counterparties have information symmetry.
Based on the outcome of the consultation, it is noted that while some of the respondents expressed concerns on the scope and application of the proposed amendments, most respondents considered that the proposed amendments would strengthen investor protection, protect the integrity and reputation of the Hong Kong markets, and bring the SFO insider dealing regime in line with other major common law jurisdictions.
The SFC clarified that:
- It is necessary for the SFC to have powers to tackle insider dealing involving overseas-listed securities where the acts are perpetrated in Hong Kong, since such cross-border matters are not always effectively handled by cross-boundary regulatory cooperation and shared intelligence. The SFC may need to take a more proactive investigative role depending on the circumstances.
- It has no intention to prescribe a list of selected overseas markets to which the amended provisions will apply since this would unduly narrow the scope of application.
- Following the implementation of the proposed amendments, the insider dealing regime would equally apply to both OTC transactions in overseas-listed debt securities and Hong Kong-listed debt securities, unless one of the statutory defences applies. Only the territorial scope changes but not the scope of the instruments.
- A transition period may not be provided since there is sufficient time for firms to update their internal compliance policies and manuals after the legislative amendments have been published.
- The self-reporting requirements under the SFC’s Code of Conduct will also apply to the amended market misconduct provisions and licensed corporations are expected to report suspected breaches to the SFC.
The SFC’s other proposals and why they were held back
Withholding the proposal to broaden the basis for seeking remedial orders against regulated persons under Section 213 of the SFO
With respect to the proposed amendments to Section 213 of the SFO, they were intended to broaden the circumstances in which the SFC would be able to apply to the Hong Kong Court for injunctions and remedial orders to grant remedies to persons adversely affected by regulatory breaches. The current provisions may only be used in circumstances where there are contraventions of any of the “relevant provisions” (e.g., contraventions of the SFO). However, where investors suffer losses as a result of a regulated person’s breaches of the SFC’s Code of Conduct or guidelines, resulting in the SFC taking disciplinary actions under Sections 194 or 196 of the SFO, the SFC is unable to seek remedial orders under Section 213 in the absence of a contravention of the “relevant provisions.”
Following the consultation, the SFC noted that many respondents expressed concerns with the proposed amendments and the issues raised generally revolve around five themes:
- Legal and jurisprudence concerns – The proposed changes to Section 213 would provide for legal remedies based on breaches of codes and guidelines which have no force of law. There is also doubt whether it was the legislative intent to treat regulatory breaches in the same way as statutory offences.
- Implementation and practical concerns – There are practical concerns as to whether parallel proceedings leading to contradictory outcomes may result from the implementation of the proposed amendments (e.g., Section 213 proceedings may run parallel with appeals before the Securities and Futures Appeals Tribunal). Also, Section 213 remedial orders may further compound the disciplinary actions already taken by the SFC (e.g., fines imposed).
- Fairness and proportionality concerns – There are concerns as to the possibility that all forms of disciplinary action may potentially trigger Section 213 proceedings, which may be disproportionate. Also, the level of complexity of the non-statutory requirements contained in the SFC’s codes and guidelines may result in the Court placing greater reliance on the SFC’s interpretation, leading to potentially unfair decisions. Furthermore, it was contended that it would affect the application and finality of the statutory limitation periods because it is possible that both the disciplinary action and the subsequent Section 213 proceedings may take place after the usual limitation period has expired, which in effect extends a cause of action beyond expiry.
- Competitiveness and status of Hong Kong as an international financial centre might be affected - It was argued that it will be difficult to predict the total financial impact of an enforcement action, which may further exacerbate the prevailing trend towards relocating staff or business units with regional remits to other Asia-Pacific jurisdictions. The combined impact of a Section 213 compensation order coupled with disciplinary sanctions may dissuade regulated persons from participating in some types of high-risk regulated activities.
- Existing legal framework in Hong Kong already provides adequate protection - It was argued that investors had adequate legal rights and remedies and it was unnecessary to amend the existing framework. For example, the SFO already provides for rights of action and the investors can commence civil litigation if aggrieved. Also, given the far-reaching impact of the proposed amendments, the matter may be referred to the Law Reform Commission for consideration.
In its responses, the SFC points out that it considers the current framework to be unsatisfactory and there is a regulatory gap that should be closed. However, the respondents have raised certain complexities which will need to be explored and considered further. In particular, the SFC noted the potential for parallel proceedings; the need for certainty about the circumstances in which Section 213 orders will be sought; the consequential extensions to limitation periods; and the potential for far-reaching impacts on the industry and other implementation challenges are the reasons for placing the proposed amendments on hold.
Withholding the proposal to amend the professional investor exemption from the prohibition of certain advertisements under Section 103(3)(k) of the SFO
Section 103(1) of the SFO prohibits the issue of advertisements and other documents containing prescribed content unless authorised by the SFC. The provision is intended to regulate advertising and prevent the exposure of retail investors to investment products which are risky and unsuitable. Certain exceptions are provided for under the SFO, including Section 103(3)(k), which waives the prohibition where the relevant advertisement was targeted only to professional investors (PI Exemption). The proposed amendment was prompted by the finding of the Court of Final Appeal (CFA) in the 2015 case of SFC v. Pacific Sun Advisors Ltd et al. (2015) 18 HKCFAR 138, where the CFA upheld the application of the PI Exemption provided that the advertisement has “some connection or relation to” investment products that are, or are intended to be, disposed of only to professional investors. This meant that retail investors could be at risk of exposure to advertisements meant only for professional investors.
Pursuant to the consultation, the SFC noted that a majority of the respondents expressed concerns with the proposed amendment, which commonly related to the following two themes:
- Relevant amendments are not necessary - It is argued that the amendments are unnecessary since there is no material risk for retail investors to be exposed to unauthorised advertisement of investment products if they are unable to invest in them. Also, given the CFA decision was handed down in 2015 and there have been no significant enforcement cases involving Section 103(3)(k) of the SFO since, the proposed amendment would appear to be reactive to a perceived risk as opposed to a real risk.
- Operational difficulties and business development and marketing processes might be hindered - The respondents flagged that in practice, professional investors are often unwilling to provide Know Your Client (KYC) information at the preliminary marketing stage and implementing the proposed amendment would unduly fetter an intermediary’s ability to properly market to prospective investors. This would also have the effect of giving large financial institutions a strategic advantage given they have a pre-existing client base to which they can market their new products without conducting KYC checks.
In its responses, the SFC points out that the policy objective remains to enhance retail investor protection by avoiding exposure to unauthorised advertisements of investment products intended only for professional investors and to reduce the risk of the PI Exemption being abused by advertisers. It should therefore be “plainly apparent” from the contents of advertisements subject to the PI Exemption that the investment products being promoted are intended for disposal to professional investors only. Such intention may be demonstrated by the inclusion of a clear disclaimer in the advertisements that the underlying investment products are solely targeted at professional investors. Any attempt to misuse the PI Exemption will likely attract the SFC's scrutiny. With this said, the SFC acknowledged two practical difficulties highlighted by the respondents, including (i) potential clients may be unwilling to provide detailed KYC information in pre-marketing stage; and (ii) the emergence of multi-media and multi-jurisdictional online distribution platforms for investment products which are becoming more accessible to investors. Given the potential difficulties raised by the respondents, the SFC agreed not to proceed with the proposed amendment in its current form. The SFC would nevertheless continue to monitor market developments and reassess the need for amendments to the SFO in this regard in due course.
The SFC’s decision to press forward with the proposed amendments to the insider dealing provisions, while holding back the proposed amendments to Sections 213 and 103(3)(k) of the SFO, is a sensible and measured decision in view of the broad range of concerns highlighted by the respondents to the consultation. Some of the key implementation challenges raised will no doubt require further consideration as to whether there are proper and appropriate work-arounds. While it is certainly within the regulator’s purview to close identified regulatory gaps and implement measures to further enhance investor protection, it is also important to adopt a balanced perspective and have regard to the potential ripple effects that may arise from the proposed amendments. The COVID pandemic and its aftermath have visibly taken a significant toll on the general economic conditions and business confidence in Hong Kong. Any substantive escalation of the regulatory requirements and potential regulatory risks may further heighten the challenges and hurdles faced by market participants.
The SFC has returned to the drawing board to reconsider and reframe its proposed amendments for Sections 213 and 103(3)(k). It remains to be seen whether the proposals will resurface again under a different formulation or whether the SFC will consider alternative options to achieve its policy objectives. For now, licensed entities should primarily focus on ensuring compliance with the upcoming changes to the insider dealing provisions, which may include making adjustments to existing monitoring, detection and reporting measures and protocols, while also assessing whether any advertisements relying on the PI Exemption aligns with the SFC's expectations and guidance. Licensed entities are reminded to regularly review their internal policies and procedures to ensure that they are up-to-date and properly reflect the compliance requirements and expectations of the regulators. They should also ensure that their staff are adequately trained to recognise red flags and potential compliance issues and to take decisive steps, as needed, to report and investigate the matter.
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