Hong Kong's securities regulator has reprimanded Sun Hung Kai Investment Services (SHKIS) and fined it HK$1.5 million for internal control failures relating to an erroneous buy order for 2 billion shares of China Life Insurance.
On September 8, 2011, an account executive of SHKIS received an order from a client to buy 25,000 shares of China Life at HK$18.82. But the account executive inputted 2,500,018,000 shares as the order quantity.
SHKIS’s dealing system automatically split the order into 834 smaller orders, which were sent to the market. SHKIS’s real-time credit controls failed to filter the erroneous order due to an incorrect setting in the credit rules.
The Securities and Futures Commission's (SFC) investigation revealed weaknesses in SHKIS’s internal controls that contributed to the incident, in particular that:
- SHKIS’ system did not impose a limit on the maximum number of splits allowed for large orders;
- amendments or changes to the credit rules were not migrated from the testing environment to the production environment directly, but were manually entered into the production environment by a staff member of the credit department, increasing the likelihood of input errors; and
- there was a lack of segregation of duties between the ‘maker’ and the ‘checker’ for changes to the credit rules/policies. In implementing the new credit rules on August 29, 2011, the relevant credit officer deployed, checked and also approved the changes. No post-deployment validation was performed by any independent third party to ensure the changes were implemented accurately and completely.
In deciding the disciplinary sanction, the SFC took into account that SHKIS:
- informed the SFC about the erroroneous trade in a timely manner;
- promptly investigated the incident to ascertain the factors that contributed to the erroroneous trade and engaged an external audit firm to conduct a review independently and give recommendations for system and control enhancements;
- took remedial actions to prevent the same incident from re-occurring in the future;
- cooperated with the SFC in resolving the disciplinary action; and
- agreed to further engage an independent reviewer to review its order entry risk controls in relation to its cash equities dealing and to implement all recommendations to be made by the reviewer.
The account executive realised the error shortly after she inputted the order and immediately sought assistance from other dealing staff members to cancel the execution of the split orders. At the end, about 97% of the orders were cancelled while the remaining 3% (i.e. 81,978,000 shares) were filled and executed at the price of $18.82 each.
SHKIS is licensed under the Securities and Futures Ordinance to carry on type 1 (dealing in securities) and type 4 (advising on securities) regulated activities. The maximum order size of a stock that is accepted by the Stock Exchange of Hong Kong is 3,000 board lots. For China Life, one board lot is 1,000 shares.
This is not the first time SHKIS has been penalised over internal-control issues, with previous instances including in October 2009, when it received a HK$4 million fine, and in early 2009, relating to its sale of Lehman Brothers minibonds.
Separately, retail investor Stephen Yenn Man Han has been convicted in Hong Kong of false trading in the shares of Kaisa Group Holdings on November 8, 2010, having in May last year pleaded not guilty to the offence.
He was sentenced to three months’ imprisonment, suspended for three years and fined HK$560,000, the profit he earned from the false trading activity. Yenn was also ordered to pay the SFC's investigation costs of HK$32,879.
The court heard that his order-placing activities had created a false or misleading appearance with respect to the demand for Kaisa shares.
Yenn, who employed a bid-placing and -cancellation strategy commonly known as ‘scaffolding’ (known as ‘spoofing’ or ‘layering’ in some markets), repeatedly varied or cancelled his bid orders and re-inputted them at the same prices. His bid orders had raised the aggregate demand at the top five bid queues by more than 30-fold on average.
Yenn had placed 80 bid orders for a total of 199,699,000 shares and then varied or cancelled over 90% of the orders. This facilitated his sale of 24,084,000 Kaisa shares on the same day, earning him a profit of HK$568,735.
The SFC alleged that many of these orders were not genuine and they were subsequently varied or cancelled shortly before execution or after the orders were partly executed. Yenn cancelled all bid orders after he sold his entire Kaisa shareholding at price levels artificially inflated by his fake bid orders.
Yenn was formerly a licensed person under the Securities and Futures Ordinance. In August 2009, the SFC suspended his licence for 12 months from August 25, 2009, to August 24, 2010, for manipulative order-placing activities in six different stocks during the pre-opening sessions in 2008.