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HKMA, as the front-line regulator, will take the lead, but the SFC will take enforcement and regulatory action. Under the SFC's Code of Conduct that applies to registered and licensed persons, the areas of enquiry of the SFC will include breaches of the general principles concerning:
• Honesty and fairness, which includes the duty to ensure that representations made and information given to clients are accurate and not misleading.
• Diligence, which includes the duty to act diligently and carefully in providing advice and ensuring that advice and recommendations are based on thorough analysis and taking into account available alternatives.
• Information about clients, which includes the general obligation to ensure that a recommendation is suitable for the client in all the circumstances, and specifically that the client understands the risks of any derivative or leveraged product and that the client has sufficient net worth to assume the potential losses.
The SFC has identified two types of mis-selling, which are addressed in the Code of Conduct. First, when an investor is given materially wrong information about a financial product which induces him into making an investment decision. Second, when an investor is sold an investment product that is not suitable to his particular risk profile. The degree of public outrage suggests that the minibonds may not have been sold to suitable members of the public; however, it remains to be seen which type of mis-selling (if any) has occurred.
The SFC has already commented that investors need to be presented with a clearer picture of product risks, bearing in mind how the products will operate in market conditions, including extreme market circumstances and bankruptcy. One suspects that the SFC will take particular interest in reviewing the internal controls and procedures in respect of the sale and distribution of the minibonds.
The consequences of a breach of the Code of Conduct, apart from disciplinary sanctions such as public reprimands, fines, suspension and revocation, are inextricably linked with issues of investor confidence and reputation. The repercussions can already be seen in the active approach that some distributing banks have taken to offer to compensate investors where proof of mis-selling is established. It remains to be seen whether this will effectively deal with all the issues that specific investors may have, but the move also has the effect of allaying investor confidence and helps to limit any loss of goodwill or reputation.
The social and political environment has created the regulatory need to be seen to respond promptly. This, in turn, adds another element to the mix. Canny investors may wish to allow the regulators to progress with its enquiries, as the outcome of those enquiries may yield information or outcomes that may influence whether an investor will take the costly and potentially risky step of issuing legal proceedings. The regulatory investigations and the risk of civil proceedings are indirectly, but inextricably, linked.
Regulatory reports
In January 2009, the financial secretary published the SFC's and HKMA's incident reports on the minibonds crisis. The stated aim of the reports was to recommend ways in which the regulatory structure could be strengthened and investors could be better protected. Their impact is significant. The reports are framed as forward-looking documents, although they could be utilised by c