Frequent Fund Management Irregularities: The SFC Strikes Back—Three Major Cases Exposing Industry Risks

In the current landscape where most financial institutions in Hong Kong are struggling, which companies will the Securities and Futures Commission (SFC) target for action? Based on data from the first half of 2024, one of the SFC's key focuses for investigation and penalties has been asset management companies, with three related disciplinary actions issued.

Case 1: PICC AM Penalized for Fund Management Failures

PICC Asset Management (PICC AM) was fined HKD 2.8 million due to deficiencies in fund management, and its Licensed Representative had their license revoked. Between 2018 and 2020, PICC AM acted as the investment manager for a fund with the objective of achieving long-term capital preservation and stable capital appreciation through a diversified portfolio. However, the fund was heavily concentrated in two Hong Kong stocks, which the SFC deemed a violation of the Fund Manager Code of Conduct (FMCC) Section 3.1. PICC AM failed to manage the fund properly and ensure that investments complied with the stipulated objectives and restrictions, leading to public censure and the fine in February this year.

Additionally, one of the stocks held was not on PICC AM's approved list and lacked the necessary approvals from the investment decision committee and compliance department. This breach of internal policy also violated FMCC Section 1.7.1. The SFC found that PICC AM did not have adequate internal controls to ensure compliance with investment authorizations and failed to implement stop-loss procedures.

After publicly reprimanding PICC AM, the SFC revoked the license of the Licensed Representative responsible for the fund for seven months in June, indicating that there was sufficient evidence to demonstrate that the representative acted independently and was primarily responsible.

Case 2: Ruifeng Securities Fined for Fund Management Failures

Another company penalized for fund management deficiencies was Ruifeng Securities, which served as the lead underwriter and joint bookrunner for a preferred note, earning USD 120,000 in underwriting fees. Ruifeng Securities found itself in a conflict of interest by purchasing preferred notes for the fund. The SFC's investigation found no evidence that Ruifeng Securities took reasonable steps to identify, prevent, manage, or minimize the conflicts arising from its underwriting activities or disclosed these conflicts to the fund's investors. This behavior violated FMCC Sections 1.5 and 10.1.

Similar to PICC AM, Ruifeng Securities failed to establish specific limits to control and ensure that the fund's portfolio did not over-invest in any single issuer. The fund managed by Ruifeng Securities had purchased two notes that accounted for approximately 90% of the fund's net asset value. Despite identifying several adverse factors and negative issues in its analysis reports, Ruifeng Securities did not take any measures to mitigate risks. The SFC publicly reprimanded Ruifeng Securities and fined them HKD 5.2 million at the end of last year.

Unlike PICC AM, the Responsible Officer managing Ruifeng Securities' fund activities had their licenses revoked, which is a more common practice.

Case 3: Hedge Fund Management Company Accused of Insider Trading

Segantii Capital Management Limited, a licensed financial institution by the SFC specializing in hedge fund management, was charged in May by the SFC along with two of its employees for insider trading related to a significant transaction in 2017 involving shares of a company listed on the Hong Kong Stock Exchange. This case is still under judicial review.

Insider trading involves obtaining confidential information from insiders to buy shares before their prices rise, resulting in profit. Insider trading has long been one of the misconducts that the SFC actively combats, with offenders facing criminal prosecution.

How to Mitigate Compliance Risks?

In the market, it is not uncommon for a fund to be heavily concentrated in one or two stocks, and such situations are not difficult to uncover during investigations. To minimize compliance risks in cases of prolonged concentration in investments, it is essential to provide reasonable explanations, detailed analytical reports, appropriate stop-loss procedures, and sufficient risk management measures. Companies must also have comprehensive monitoring systems in place to ensure employees adhere to internal processes.