The Hong Kong Securities and Futures Commission has fined a securities house for failing to take all reasonable steps to handle risks relating to money laundering and terrorist financing with respect to third-party fund transfers.

Despite receiving signs that some of the third-party fund transfers were unusual and/or suspicious, the regulator says that Guotai Junan failed to do enough to monitor the activities of its clients, scrutinise the fund transfers properly, spot suspicious transactions and report them to Hong Kong's Financial Intelligence Unit in time. These transgressions took the following forms.

• Frequent fund transfers to or from third parties who were unrelated, unverified or difficult to verify. Firstly, among the 15,584 third-party deposits/withdrawals that the firm executed for its clients, 11,501 were allegedly made between 'friends' whose relationships with each other were difficult to verify. Secondly, on a sample review of the activities of seven clients of Guotai Junan's, the SFC found that there were frequent and significant sums of monies transferred between 61 of those seven clients’ accounts and some third parties who were unrelated to these clients and/or whose identities were unverified by Guotai Junan. Thirdly, in the account of one of the seven clients, frequent transfers took place to six different clients of Guotai Junan's which were all of the same amount and sat just below the HK$2 million threshold which would otherwise have obliged Guotai Junan’s staff to report them to the compliance officer and/or money-laundering reporting officer (MLRO) in accordance with the firm’s policies.
• Transactions which had no apparent legitimate purpose or commercial rationale, perhaps being out of the ordinary range of services normally requested of a licensed corporation. Although the firm asked its clients to provide reasons for the third-party deposits/withdrawals and their relationships with the third parties, their answers were inadequate. For example, “??  (incoming and outgoing)” was stated to be the reason for the transfers on 4,956 occasions. Although the clients gave vague reasons for the transfers, Guotai Junan accepted those transfers without question. Additionally, 'friend,' 'business' or 'business partner' was usually given as the client’s relationship with the third party and 'repayment,' 'incoming and outgoing,' 'loan,' 'co-operative investment' or 'transfer on behalf of friend' was often given as the reason for the transfers without any further elaboration. None of the reasons given could properly explain why the clients had to use their securities accounts at Guotai Junan, which they should have been using primarily for trading in securities, to receive or route funds from or to third parties. There were also occasions when the client in question gave the no details about the third-party depositor and did not explain the reason for using his/her securities account to receive the deposit. Guotai Junan also accepted these without question.
• Source of funds unclear or not consistent with the client’s profile. The initial deposits made into the accounts of two of the seven clients (exceeding HK$77 million and HK$39 million respectively) were all from third parties who were not clients of Guotai Junan's and whose identities the firm had not verified. The sources of the funds deposited into these clients’ accounts were also not known properly. Meanwhile, the activities in the accounts of three of the seven clients were inconsistent with their net worth and/or annual income as recorded in their account-opening documents. For example, one of the seven clients claimed to be an 'investor' with an annual income of less than HK$500,000 and a net worth of less than HK$2,500,000. However, Guotai Junan’s records show that he withdrew and transferred a total of more than HK$185 million to four third parties and a total of more than HK$167 million to six third parties in February 2015 and March 2015 respectively. Also, in a Withdrawal Instruction Form regarding a transfer of more than HK$43 million from the account of one of the seven clients to a third party, it was stated that the third party was his 'employer.' This was, however, inconsistent with the information recorded in his account-opening documents which stated that he was an 'investor' with no indication that he was employed.
• Unnecessary routing of funds from/to third parties or using the account as a conduit for transfers. The account of one of the seven clients received a total sum of more than HK$39 million through 11 separate deposits from unverified third parties between 7 May 2014 and 15 May 2014 and the entire sum was transferred to a third party on 16 May 2014. The amount substantially exceeded that client’s declared net worth and there was no securities trading in the account between 7 and 16 May 2014. The account might have been used as a depository account or a conduit for transfers, much to the alarm of the regulators.
• Large and unusual cash settlements. On two consecutive trading days, 22 separate cash deposits (involving a total of more than HK$2 million) were made into the account of one of the seven clients.

Guotai Junan and its staff failed to make proper enquiries in relation to those transactions and did not identify them as suspicious and bring them to the attention of its Legal and Compliance Department.

Other problems

Operations staff were responsible for reviewing and approving third-party deposits/withdrawals, conducting enquiries with clients and spotting suspicious transactions to be reported to the Legal and Compliance Department, but they did not confront the clients with questions, according to the regulator. With this in mind, the regulator has accused the firm of breaking section 5(1) Schedule 2 Anti-Money Laundering and Counter-Terrorist Financing (Financial Institutions) Ordinance (AMLO) and paragraphs 5.1, 5.10 and 5.11 of the AML Guideline which requires a licensed corporation to monitor its business relationships with its clients continuously.

There were also no written procedures to identify third party deposits, or to have them approved. This, according to the SFC, ran contrary to "the expectation" set out in the “Circular to Licensed Corporations and Associated Entities – Anti-Money-Laundering/Counter Financing of Terrorism – Suspicious Transactions Monitoring and Reporting” that the SFC issued on 3 December 2013 that such fund transfers should be discouraged and should only be accepted after approval by the designated senior staff member. In doing this, the regulator says that the firm broke section 23 Schedule 2 AMLO and paragraph 2.1 of the AML Guideline. Its failure to identify third-party deposits, which may potentially be suspicious transactions, also broke paragraph 5.1 of the AML Guideline.

Trouble with placees

Guotai Junan was the sole global co-ordinator, sole bookrunner and sole lead manager of a listing application of the Listed Company on the Main Board of The Hong Kong Stock Exchange and the regulator has also made it pay penalties for its alleged failures in that capacity.

In January 2016, an aggregate of 21,338,000 shares of the listed company were placed by or through Guotai Junan to five HNW placees (investors to whom shares, holdings etc, are sold by direct or private placement, i.e. a capital-raising event that involves the sale of securities to a relatively small number of select investors) for the total consideration of HK$28.8 million. The five people settled their allocations with funds deposited to their Guotai Junan accounts from a third-party company.

On 29 December 2015, Guotai Junan received five fund transfer instructions which showed that five deposits, in the total sum of HK$29,103,610, were made by a company to Guotai Junan’s bank account. Each of the instructions contained similar handwritten notes instructing Guotai Junan to deposit funds into the respective accounts of the five placees, adding that the five had entrusted their friend’s company to deposit the money on their behalf because they were not able to come to Hong Kong on time. The regulator says that the third-party deposits appeared unusual and suspicious. All placees applied to open securities accounts with Guotai Junan on the same day, all lived in Zhejiang Province and their employment, annual income and net worth (as declared in their account-opening forms) were identical. The third-party deposits received by each of them substantially exceeded their declared annual income and net worth. Guotai Junan, however, accepted the third-party deposits and effected the fund transfers without making any enquiries.

The regulator also accuses the firm of not scrutinising the placees' subscriptions properly. It failed to detect a total of 590 potential wash trades quickly enough between January 2014 and July 2016.

Despite such warning signs, Guotai Junan did not take reasonable steps to verify the ultimate beneficial owners of the clients’ accounts and the sources of their funds, nor try hard enough to ascertain whether the clients were independent of the listed company. In the end, three of the five placees, who were allotted 11% of the listed company’s shares of the total placing under the international tranche, turned out to be the listed company’s employees.