Hong Kong's Securities and Futures Commission has reprimanded two brokerages, Celestial Commodities Ltd and Celestial Securities Ltd and fined them HK$4.9 million (US$621,222) and HK$1.4 million (US$177,394) respectively because of their mishandling of clients' money and of related lapses in internal control.

The regulator’s Intermediaries Division conducted a presumably routine inspection of CCL in 2015 and spotted that staff had made various payments out of the trust accounts of both firms' clients in circumstances that the Securities and Futures (Client Money) Rules did not permit. It then embarked on a full-blown investigation of Celestial’s practices and controls in relation to the handling of clients' money. It found that:

• between January 2009 and December 2015, CCL paid monthly commission rebates to its account executives on 180 or so occasions using money from the trust accounts of its clients that it was holding at two unnamed banks (banks A and B);
• CCL transferred amounts equal to the Payments Out from its house account to its client trust account at a third bank (bank C) to replenish the shortfalls (Payments In);
• the time gap between the Payments Out and Payments In normally lasted between one and four days but on two occasions (14 days and 41 days) was much longer;
• the Payments Out ranged from HK$249,000 (US$31,520) to more than HK$1 million (US$126,690) each month and amounted to approximately HK$44 million (US$5,578,320) over the whole period; and
• there was no evidence that any clients had lost money through these manoeuvres.

The SFC says that CCL had been paying commission rebates to its account executives through the above arrangements for operational convenience, so that it could pay directly into its account executives’ accounts held at banks A and B through those banks’ electronic transfer system. This had probably been standard practice at CCL for 20 years or more.

The SFC also found that CSL effected three payments totalling HK$40 million (US$5 million) on 8 July 2015 from its client trust accounts into CCL’s client trust accounts at various banks in a fund swap arrangement (Fund Swaps):

For fund swap 1, there was a transfer of HK$20 million (US$2½ million) from CSL’s client trust account at bank D to CCL’s client trust account with bank D. In return, there was a transfer of HK$20 million from CCL’s client trust account at bank C to CSL’s client trust account at bank D.

Fund swap 2 consisted of a transfer of HK$10 million (US$1,268,200) from CSL’s client  trust account at bank D to CCL’s client trust account at bank D and a transfer of HK$10 million from CCL’s client trust account at bank C to  CSL’s client trust account at bank D.

Fund swap 3 consisted of a transfer of HK$10 million from CSL’s client trust account at bank A to CCL’s client trust account at bank D and a transfer of HK$10 million from CCL’s client trust account at bank C to CSL’s house account at bank C and subsequently to CSL’s client trust account at Bank C.

The SFC says that Celestial’s accounting staff told it that the firms conducted the fund swaps to ensure that CCL’s client trust account with bank D, which was its designated settlement bank account with the Hong Kong Exchanges and Clearing Ltd (HKEx) at the time, would have enough funds to meet various margin calls made by HKEx to CCL on a timely basis. The primary purpose of the fund swaps, in other words, was operational convenience.

The SFC also found that Celestial gave its accounting and treasury staff a free rein to handle clients' money. They received little supervision, instructions or guidance from Celestial's responsible officers (a Hong Kong regulatory term) and senior managers.

Safe custody of client assets is a duty for financial firms under sections 4(1) and 5(1) of the SFC's Client Money Rules. These oblige each licensed corporation to hold these monies in a segregated account and keep them there until it is paid to the client in question, or paid by his permission, or used to meet his settlement or margin requirement. Section 5(3) also says that a licensed corporation must not pay a client's money to one of its employees (unless he is the client).

General Principles 2 and 8 of the Code of Conduct for Persons Licensed by or Registered with the SFC also require every firm to act with due skill, care and diligence in the best interests of its clients and to ensure that their assets are accounted for promptly and properly and safeguarded adequately. Paragraph 11.1(a) also obliges it to account for them properly and promptly. Paragraph 4.3 obliged CCL and CSL to follow effective internal control procedures to protect their operations and clients from financial loss, employing the necessary resources to do so in accordance with General Principle 3. Paragraph 4.2 obliged CCL and CSL to have adequate resources to supervise people they employ to do business on their behalf.

The SFC says that CCL broke sections 5(1) and 5(3) of the Client Money Rules. It subsequently replenished the shortfalls in the clients' funds, its transfers exposed the money to unnecessary risks, particularly as the shortfalls were often only made whole days (and occasionally weeks) after the payments out. CSL, it says, has also breached section 5(1) of those rules, exposed its clients' money to unnecessary risks also. Both firms put their own interests ahead of those of their clients, contrary to General Principle 2. Their failures to safeguard the money were also contrary to General Principle 8 and paragraph 11.1(a). By failing to have proper controls in place they broke paragraph 4.2, paragraph 4.3 and General Principle 3.