The Securities and Futures Commission (SFC) has reprimanded and fined Guotai Junan Securities (Hong Kong) Limited (Guotai Junan) $25.2 million for multiple internal control failures and regulatory breaches in connection with anti-money laundering, handling of third party fund transfers and placing activities, as well as detection of wash trades and late reporting (Note 1).
Third party fund transfers
The SFC investigation found that, between March 2014 and March 2015, Guotai Junan failed to take reasonable measures to ensure that proper safeguards were put in place to mitigate the risks of money laundering and terrorist financing in processing 15,584 third party deposits or withdrawals for its clients, totalling approximately $37.5 billion.
Despite red flags suggesting some of the third party fund transfers were unusual or suspicious, Guotai Junan failed to adequately monitor the activities of its clients, conduct appropriate scrutiny of the fund transfers, identify transactions that were suspicious and report them to the Joint Financial Intelligence Unit in a timely manner (Note 2).
Guotai Junan also did not ensure that its policies and procedures regarding anti-money laundering and counter-financing of terrorism (AML/CFT) were properly and effectively implemented with respect to third party fund transfers. Specifically, the SFC found that there were:
- a number of occasions where the reasons for the third party fund transfers, the relationship between the client and the third party, and/or the identity of the third parties were not documented and identified;
- inadequate guidance to its staff on the extent of enquiries they had to make with clients in relation to the third party fund transfers;
- inadequate procedures requiring its money laundering reporting officer to play an active role in identifying suspicious transactions; and
- inadequate communication between its operations and compliance staff to ensure effective monitoring of client activities.
In addition, Guotai Junan processed 5,406 third party deposits from July 2015 to June 2016 without always documenting the identity of the depositors, their relationship with the account holders, and the reasons for these third party deposits, contrary to the firm’s written policies and procedures.
It further failed to identify that two deposits totalling $38.2 million for a share subscription in December 2015 did not come from the relevant client but a third party, nor did it have written procedures for the identification of third party deposits until around September 2016.
While acting as the placing agent for the global offering of a Hong Kong-listed company’s shares between December 2015 and January 2016, Guotai Junan failed to take reasonable steps to ascertain whether the clients’ subscription applications were consistent with its knowledge of their background and source of funds, and make appropriate enquiries when there were grounds for suspicion.
In particular, the funds used by five clients to subscribe for $28.8 million worth of the listed company’s shares were deposited by the same third party into the respective client accounts in amounts far exceeding their self-declared net worth.
Despite such red flags, Guotai Junan did not take reasonable steps to verify the ultimate beneficial owners of the clients’ accounts and their source of funds, nor make appropriate enquiries to ascertain whether the clients were independent of the listed company. In the end, three of the five placees, who were allotted 11% of the listed company’s shares of the total placing under the international tranche, turned out to be the listed company’s employees (Note 3).
Detection of wash trades and reporting obligation
The SFC further found that Guotai Junan failed to detect 590 potential wash trades in a timely manner between January 2014 and July 2016 due to a lack of adequate written trade monitoring procedures or guidelines and technical failures of its transaction pattern monitoring system.
However, despite becoming aware in July 2016 of 210 potential wash trades which could not be detected in a timely manner as a result of the system failure, Guotai Junan did not report these 210 trades to the SFC until seven months later in February 2017.
The above-mentioned findings led the SFC to come to the view that Guotai Junan’s conduct failed to comply with regulatory requirements under the Anti-Money Laundering and Counter-Terrorist Financing (Financial Institutions) Ordinance, the Guideline on Anti-Money Laundering and Counter-Terrorist Financing, the Internal Control Guidelines and the Code of Conduct (Notes 4 & 5).
In deciding the disciplinary sanction, the SFC took into account that:
- there were multiple AML/CFT related failures and Guotai Junan was handling a substantial number or amount of third party fund transfers;
- Guotai Junan’s failures in complying with AML/CFT requirements lasted for an extensive period of time, including its failure to put in place written procedures to identify third party deposits from September 2009 – when the Prevention of Money Laundering and Terrorist Financing Guidance Note came into effect – to around September 2016;
- while the failures in the transaction pattern monitoring system were primarily attributable to the third party vendor, Guotai Junan failed to detect wash trades for more than two years and around 590 potential wash trades were not detected;
- the SFC has sent a clear message in previous disciplinary cases that licensed corporations are required to report misconduct to the SFC immediately upon discovery of such misconduct;
- a strong message is necessary to deter similar misconduct;
- Guotai Junan has taken prompt remedial measures to rectify the deficiencies in its trade monitoring system and procedures once identified, and has proactively enhanced its policies and procedures in relation to AML/CFT; and
- in resolving the SFC’s concerns, Guotai Junan undertook to provide the SFC with a report prepared by an independent reviewer within 12 months confirming that all the identified concerns were properly rectified.
“The disciplinary action against Guotai Junan for serious systemic deficiencies and failures across its internal controls should serve as a stark reminder to licensed corporations the importance of having adequate and effective safeguards in place to mitigate the real risk of becoming a conduit to facilitate illicit activities, such as money laundering, when exposed to potentially suspicious transactions,” said Mr Thomas Atkinson, the SFC’s Executive Director of Enforcement.
- Guotai Junan is licensed under the Securities and Futures Ordinance to carry on Type 1 (dealing in securities) and Type 4 (advising on securities) regulated activities.
- Red flags revealed in a review of some of the fund transfers include: (i) frequent fund transfers to and from third parties that were unrelated to the client, or whose relationship with the client was unverified or difficult to verify; (ii) transactions which have no apparent legitimate purpose and/or appear not to have a commercial rationale, and/or out of the ordinary range of services normally requested of a licensed corporation; (iii) instances where the source of funds was unclear or not consistent with the client’s profile; (iv) unnecessary routing of funds from/to third parties or using the account as a conduit for transfers; and (v) large or unusual cash settlements.
- Pursuant to paragraph 7 of Appendix 6 (Placing Guidelines for Equity Securities) to the Rules Governing the Listing of Securities on The Stock Exchange of Hong Kong Limited, not more than 10% of the total placing may be offered to employees or past employees of the applicant.
- Management, Supervision and Internal Control Guidelines for Persons Licensed by or Registered with the Securities and Futures Commission.
- Code of Conduct for Persons Licensed by or Registered with the Securities and Futures Commission.