Alert

If banks and financial intermediaries in Hong Kong are not yet re-assessing their offerings of “professional investor only” investment products and staff sale practices to customers, they should be.

Recent investor complaints have brought into focus financial institutions’ existing sale practices of “professional investor only” products, product-customer suitability assessment tools, and the qualification of staff distributing the products.

In recent months, investors have been quick to blame banks and financial intermediaries marketing “Accumulators” and other types of structured products for their losses suffered in the market downturn, claiming they were misled into purchasing them. Many have claimed the risks were not sufficiently explained whilst others, as in a recent case where a retired couple in Hong Kong sued a major US investment bank, have asserted they were incorrectly categorised as “professional investors”.

Selling financial products to retail investors vs professional investors

Generally, materials for marketing and offering financial products which constitute an invitation or offer to the general public or retail investors to acquire, dispose of, subscribe for, underwrite securities or regulated investment agreements or to acquire an interest in or participate in collective investment schemes, require approval from the SFC (“Securities and Futures Commission”). Where the financial products are sold to a “professional investor”, the Securities and Futures Ordinance (“SFO”), and Code of Conduct for Persons Licensed by or Registered with the SFC (“Code of Conduct”), provides that certain requirements are exempted, notably:

• the need to establish a client’s financial situation, investment experience and investment objectives and the need to ensure the suitability of a recommendation or solicitation
• the need to enter into written client agreement and the provision of relevant risk disclosure statements, and
• the need to confirm promptly with the client the essential features of a transaction after effecting a transaction for a client.

In essence a person who is classified as a professional investor is offered less regulatory protection. Therein lies the potential danger, which makes it all the more critical that staff are properly qualified and trained to ensure that their explanation and recommendations on products are suitable for a particular type of customer, and that there are adequate and proper processes in place when offering the products to such customers.

Who is a professional investor?

A person is a professional investor if he or she falls under paragraph (a) to (j) in Part 1 of Schedule 1 to the SFO. The complainants in recently reported cases were typically “professional investor[s]” falling within the meaning of paragraph (j) in Part 1 of Schedule 1 of SFO, being individuals or associates with joint accounts having a portfolio of not less than HK$8 million or its equivalent in any foreign currency.

The financial institution has the task of assessing whether the person is a professional investor. Paragraph 15.3 of the Code provides that the licensed or registered person should assess and be reasonably satisfied that the person is knowledgeable and has sufficient expertise in relevant products and markets, and should have regard to matters such as:

• the type of products in which the person has traded (a professional investor would be expected to have traded not less than 40 transactions per annum)
• the frequency and size of trades
• the person’s dealing experience (a professional investor would be expected to have been active in the relevant market for at least two years), and
• his awareness of the risks involved in trading in the relevant markets.

Whether the customers are retail or professional investors, the sale processes are subject to the SFC regulations and guidelines.

Dealing with the regulators

The reality is that whilst a customer may satisfy the “professional investor” guidelines under paragraph 15.3 of the Code of Conduct, it is not a complete answer to a claim by an aggrieved investor for negligent, incorrect or inadequate advice. In the current climate the SFC and HKMA will be more inclined to look closely at investor complaints of mis-selling.

Chief amongst the regulators’ focus would be:

• the existence of a proper sales process
• appropriate product-customer suitability assessment procedures; and
• suitably trained and qualified staff for distributing the products.

As part of a risk management exercise relevant institutions may take steps to:

• review their marketing materials of “professional investor” only products
• review suitability of customer agreements, product disclosure statements and product-customer suitability assessment forms, and
• update staff training and qualification evaluation.

The regulators are vested with powers to require from the bank or intermediary, a full explanation of the steps taken to address a customer’s complaint, the production of documents and inspection of records. Therefore, swift internal investigations (carried out by in-house Compliance / Legal personnel), interviews with relevant staff involved in the sale of the product, reviews of sales documents and tapes of phone conversations with the aggrieved customer in question, would all be useful steps to take when coming under the regulators’ spotlight.