Challenging the SFC: What Every Compliance Officer Needs to Know
October 29, 2007
By Timothy Loh and Howard Burchfield III
Licensed and registered persons generally prefer to work with the SFC rather than against the SFC. Nevertheless, circumstances may arise where the SFC adopts a hostile posture or takes a position that is commercially undesirable. While it is the rare licensed or registered person who is unafraid to challenge the SFC, the past 4 years have demonstrated that where the SFC acts unreasonably, in bad faith or otherwise improperly, a remedy may be available through the SFAT. In this article, we review strategies for challenging the SFC through the SFAT.
TIMOTHY LOH | Financial Services & Law Review
Vol. 1 (2007) at p. 33
The
Securities and Futures Commission ("SFC")
interacts with licensed and
registered persons in 2 key ways. First, it regulates their conduct of business, bringing enforcement action
where it considers that they have breached applicable laws or regulations. Secondly, it acts as a gatekeeper for
new investment products and services.
In these 2 respects, the powers of the SFC are
broad. In the absence of a final
disciplinary decision, it is the rare licensed or registered person who is
unafraid to challenge the SFC in the exercise of its discretion and to risk
damaging its ongoing relationship with the SFC.
However, the experience in the past 4 years
demonstrates that if nothing else, the SFC is subject to the constraints of the
law. Where it acts unreasonably,
in bad faith or otherwise improperly, it may be successfully challenged through
the Securities and Futures Appeals Tribunal ("SFAT"). Consequently, whilst no decision to
challenge the SFC in an open and adversarial manner should be taken lightly,
the option to challenge the SFC should not be ignored.
BACKGROUND
The SFAT is constituted under the Securities and
Futures Ordinance ("SFO"). As set out in the Government's original
Consultation Document on the SFO, the SFAT is intended to be "independent of
the SFC", to provide a "full merits" review of SFC decisions and to act as "a
powerful safeguard in ensuring thatÉ SFC decisions are correct, proper and
fair."
Independence of the SFAT
The SFAT comprises a judge and 2 lay members. No member of the SFC sits on the
SFAT.
Powers of the SFAT
Under the SFO, the SFAT has the power on review of
an SFC decision to confirm, vary or set aside the SFC's decision and, where the
decision is set aside, to substitute for that decision any other decision which
the SFAT considers appropriate. In
this regard, the SFAT may make any decision, whether more or less onerous, than
the SFC had the power itself to make in respect of the person making the
application for review.
The SFAT also has the power to remit any matter in
question to the SFC with directions it considers appropriate, which may include
a direction to the SFC to make a decision afresh in respect of any matter
specified by the SFAT.
Approach of the SFAT
Based on judicial precedent, on a review of a case
decided by the SFC, the SFAT is required to hear the case anew and decide the
case for itself based on such a re-hearing. It is not bound by the decision of the SFC and may,
therefore, vary or set aside a decision of the SFC even if the decision of the
SFC is not defective by reason of procedural or jurisdictional error.
Thus, unlike judicial review, the SFAT may vary or
set aside the decision of the SFC on the simple basis that it does not agree with the views expressed by the
SFC. However, it is obliged to
give due weight to the fact that the SFC is the regulator and should,
accordingly, be slow to vary or set aside the decision of the SFC unless it
decides that the SFC decision is wrong (rather than simply not right). Regrettably, the line between the SFC
decision being wrong and simply not right is not clear though, in the event of
a procedural or jurisdictional error, it is likely that the SFC decision will
be wrong.
In hearing the case anew, the SFAT is not limited
to reviewing the reasons given by the SFC for their decision. It may examine the original evidence
presented before the SFC when the SFC reached its original decision as well as
new evidence, new submissions, the decision making process of the SFC, any policies
applied by the SFC or any other relevant matter.
SFAT STRATEGIES
Since its inception in April, 2003 to the date of
this article, the SFAT has determined and provided written reasons for 24
cases. From these cases, a number of lessons emerge. Chief among
these is that successful appeals against SFC decisions have usually relied upon
one or more of the following grounds:
- failure to consider the individual merits of a case;
- bad faith on the part of the SFC;
- erroneous or outdated findings of fact; or
- absence of a specific rule or policy to justify the
SFC's position.
Conversely, arguments premised on mere incorrect
exercise of discretion by the SFC have been almost uniformly unsuccessful. Such
arguments are more likely to result in threats of sanctions against the
applicant than in reversal of the underlying SFC decision.
Failure to Consider Individual Merits of Case
It is a general principle of administrative law
that a regulator must consider the unique facts of each case before it or its
decision is subject to reversal. Consistent with this principle, the SFAT has interfered with SFC
decisions where it considered that the SFC had pursued its general policy or
practice without regard to specific circumstances.
Bad Faith
Another general principle of administrative law is
that a regulator must act within the bounds of natural justice. While the SFAT is understandably
reluctant to use the 'bad faith' label in its published decisions, it has
occasionally questioned the motivation behind certain SFC decisions and ruled
accordingly.
Of particular significance, in Application 2 of
2004, the SFAT hinted that the SFC had let a history of bad blood between the
parties cloud its judgment in handing down penalties that were overly harsh.
The SFAT accordingly reduced the penalties from revocations of the two
Applicants' licenses to one-month suspensions plus fines of HK$50,000.
Findings of Fact
Findings of fact made by the SFC, particularly
those which underpin its decisions, may be challenged through the SFAT. Indeed,
the SFAT has broad powers to collect evidence including through viva voce witness
testimony before the SFAT.
In
this regard, the SFAT is on equal footing with the SFC whereas in respect of
regulatory policy and the application of such policy, the SFAT is obliged by
law to be deferential to the views of the SFC.
Absence of Specific Rule or Policy
Decisions of the SFC premised on general principles
may be more susceptible to successful challenge before the SFAT than decisions
premised on specific requirements. This is particularly so where the SFC applies general principles to
prohibit conduct where no specific prohibition has been published, the
prohibition has not been the subject of public consultation and the
desirability of such a prohibition is an issue upon which reasonable men may
differ.
In Application 8 of 2006, for instance, the SFC
sanctioned the Applicant for recommending to a client a "locking" strategy. "Locking" involves taking equal long and short positions on a futures
contract to avoid margin calls should losses occur.
The SFAT wondered why, if the practice was as
deceptive as claimed by the SFC, the SFC had taken no steps "to make it
explicit to market participants that this practice will not be tolerated save
in exceptional circumstances". The
SFC had no answer to this question and so the SFAT reduced the Applicant's
sanction. The sanction might have been lifted in its entirety but for the
existence of a separate cold-calling finding by the SFC against the Applicant
which was not challenged on appeal to the SFAT.
Incorrect Exercise of Discretion
In a handful of cases, applicants for review have
successfully challenged SFC decisions on the basis that the SFC has not
exercised its discretion correctly. However, challenges of SFC decisions which do not bring out new evidence
or new submissions, which do not cast the evidence in a new light and which do
not impugn the decision making process of the SFC are difficult (though, as the
record shows, not impossible) to mount successfully.
PRODUCT INNOVATION AND THE SFAT
One area where the SFAT has been historically
inactive is in challenging SFC action (or inaction) in new products. All 24 cases to date have arisen
because of dissatisfaction with SFC licensing related decisions, including, for
example, decisions to discipline a licensed person, to refuse a license to an
individual or to impose a condition on a license of a licensed person. However, the jurisdiction of the SFAT
is much broader than this case history suggests.
SFAT Jurisdiction in Respect of Investment Products
In respect of new investment products, the SFAT may
review cases relating to refusal of the SFC to authorize the issue of any
advertisement, invitation or document or the imposition by the SFC of any
condition in respect of an offer or invitation to the public to acquire,
dispose of, subscribe for or underwrite securities.
In light of anecdotal evidence of industry
frustration as to perceived rigidity in the approach taken by the SFC to
authorization of innovative investment products, it is surprising that to date
no challenges have been raised to the SFAT in respect of the refusal of the SFC
to authorize a collective investment scheme. It is possible that the financial industry is simply unaware
of the SFAT as an avenue of review or, as noted earlier, is fearful of
perceived adverse repercussions in challenging the SFC through the SFAT.
Challenging Prolonged Delay and Overzealous Vetting
However, a more practical explanation may be that
the new product sponsors simply never reach the stage where discussions with
the SFC in respect of the product end and a decision of the SFC is made.
Two questions arise in such instances, namely:
- whether, in the absence of a final decision from the
SFC, it is possible to engage the SFAT to make an interlocutory ruling so as to
progress the matter, and
- if so, whether it would be wise to force the SFC's
hand by taking the matter to the SFAT.
Expanded Construction of Specified Decisions
Under the SFO, the SFAT only has the jurisdiction
to review a "specified decision". In the case of a new product, a "specified decision" includes a "refusal
to authorize the issue of any advertisement, invitation or document" which is
or contains an invitation to the public to enter into an agreement to acquire
or subscribe for securities.
On its face, it is arguable that a specified
decision is a final decision. However, the SFO itself does not expressly provide that the decision
must be final. Accordingly, it may
be possible to treat communications with the SFC prior to a final decision (e.g. an SFC request for
information) as a de facto decision not to authorize the marketing materials for the product without the
information and to seek SFAT review for that decision on the same grounds as
any other.
While the matter is not beyond doubt, there are
good reasons to believe that the SFAT would, or should, agree to treat a
communication from the SFC prior to a final decision as a specified decision
within the meaning of the SFO.
SFAT Jurisdiction Not Limited to Actual Decision
At the outset, it is significant to note that the
jurisdiction of the SFAT is not limited to reviewing the actual decision of the
SFC to refuse authorization.
In Berich Brokerage
Limited and Securities and Futures Commission, [2005] 2 HKLRD 583, the applicant alleged impropriety on
the part of SFC staff in the conduct of an SFC investigation into the
applicant. As a result of the allegations,
the SFC conducted an internal inquiry which found no wrongdoing on the part of
its staff. Once the inquiry
completed, the SFC imposed disciplinary sanctions on the applicant.
The applicant challenged the propriety of the SFC's
internal inquiry through judicial review. The Court refused judicial review to the applicant holding that because
the internal investigation was tangentially connected to an SFC licensing
decision, jurisdiction to determine whether the internal investigation was
properly conducted belonged to the SFAT.
Whilst in this case there was a final decision made
by the SFC, it is notable that the Court held that the jurisdiction of the SFAT
was not limited only to the actual disciplinary decision but also included
matters precedent to the disciplinary decision.
No Unreasonable Delay
If matters precedent to a decision of the SFC are
properly within the jurisdiction of the SFAT, it presumably follows that
unreasonable delay and other procedural error on the part of the SFC in
reaching a decision lies within the jurisdiction of the SFAT.
Administrative law provides that a regulator must
act without unreasonable delay. Failure to act within a reasonable time may result on judicial review in
a court issuing a writ of mandamus directing the regulator to take the action
in question.
From a policy perspective, it is desirable for the
SFAT to assume jurisdiction in the event of unreasonable delay on the part of
the SFC in making decision. One
underlying purpose of the SFAT is to supplant the need to seek remedy through
judicial review in the courts. If
the SFAT did not have jurisdiction to address procedural and substantive
matters such as unreasonable delay ahead of a final decision, this purpose
would not be served.
In an extreme case, this would mean that the SFAT
would not have the jurisdiction to entertain a review even if the SFC
unreasonably and in bad faith deliberately refused to make a final decision.
Advantages of Resorting to SFAT Before Final
Decision
If the SFAT does have interlocutory jurisdiction (i.e. jurisdiction to
review decisions of the SFC precedent to a final decision as to whether or not
to authorize marketing materials for a new investment product), sponsors of new
products may be able, whether gently or forcibly, to progress authorization
applications more quickly:
- the SFC may be subject to review by the SFAT if it takes an unreasonable
time to consider applications;
- the SFC may be subject to review by the SFAT if it
requests information which is not, viewed objectively, relevant to an
application;
- the SFC may be subject to review by the SFAT if it
follows a general policy without sufficient regard to individual merits of the
application; and
- the SFC may be subject to review by the SFAT if it
imposes conditions on authorization which, viewed objectively, are
unreasonable.
This is not to say that resort to the SFAT will
necessarily result in authorization. The SFAT is highly unlikely to make a decision to authorize marketing
materials for a product.
However, in cases where there is significant delay
or the product sponsor considers that the SFC is acting unreasonably, the SFAT
may be a viable option. Particularly if the SFAT has jurisdiction prior to a final decision, a
product sponsor may be able define the relevant issues and the appropriate
range of regulatory responses to those issues through the SFAT. At the same time, the product sponsor
can continue to work with the SFC following an SFAT hearing to continue to
progress the application, no final decision having been made.
CONCLUSIONS
The SFAT's work in the past 4 years demonstrates
that the SFC is subject to real constraints under the law, particularly where
it fails to consider the individual merits of a case, where it acts in bad
faith, where it proceeds on erroneous facts or where it acts in the absence of
specific rules.
While much of the SFAT's work has focused on
licensing and licensing related matters, licensed and registered persons may
wish to bear in mind that the SFAT is available as a means to challenge the SFC
on a wide range of decisions, including new product authorizations.
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