LC Paper No. CB(1) 150/99-00

Ref : CB1/HS/1/98

Purpose

This paper reports on the work progress of the Subcommittee on Securities and Futures Bill.

Background

2. The Financial Secretary announced a major overhaul of the legislation governing the securities and futures markets of Hong Kong in his 1999-2000 Budget Speech. The legislative reform will be reflected in a composite Securities and Futures Bill ("the Bill") to be introduced into the Council by the end of 1999.

3. The Panel on Financial Affairs received a briefing by the Administration on the major reform proposals under the Bill on 5 July 1999. In view of the complexity of the Bill, the Panel recommended that a subcommittee be formed under the House Committee to advance the detailed study of the proposals enshrined in the Bill before it is introduced. The establishment of the subcommittee could also facilitate the Administration to incorporate Members' views expressed in the subcommittee into the draft Bill. The recommendation was endorsed at the House Committee meeting on 9 July 1999.

The Bill

4. The Bill seeks to update the regulatory framework for financial markets so as to enable Hong Kong to meet the challenges of global competition.

The Subcommittee

5. The Subcommittee on Securities and Futures Bill (the Subcommittee) first met on 10 September 1999. Hon Ronald ARCULLI and Hon Albert HO Chun-yan were elected Chairman and Deputy Chairman of the Subcommittee respectively. The membership of the Subcommittee is in Appendix I. The Subcommittee has held four meetings with the Administration.

The work of the Subcommittee

6. The Subcommittee was briefed by the Administration on the key proposals of the Bill under the following topics:

- Review of licensing regime for market intermediaries;
- Disciplinary powers of Securities and Futures Commission (SFC);
- Establishment of a Securities and Futures Appeal Tribunal;
- Enhancing inquiry powers into listed companies;
- Establishment of a Market Misconduct Tribunal;
- Disclosure of interests in securities;
- Statutory backing for listing rules and liability for misstatements;
- Regulation of automated trading facilities;
- Statutory private right of action; and
- Powers of intervention in proceedings.

Major concerns raised by members

Enhancing inquiry powers into listed companies: Access to auditors' working papers

7. Section 29A of the Securities and Futures Commission Ordinance is aimed to provide for a preliminary inquiry into suspected misconduct. The section enables SFC to inspect the books and records of a listed company where there are circumstances suggesting fraud, misfeasance or other misconduct in the management of a listed company or that shareholders have not received information to which they are entitled. However, in practice, SFC has only limited ability to place the entries in the books and records in any meaningful context or to check their veracity. To rectify these problems, the Bill seeks to enhance SFC's power in three areas, one of which is to provide SFC with power to obtain the working papers of the auditor of a listed company, its subsidiaries, or any other company substantially under the control of the listed company without the requirement to obtain a court order.

8. The Administration's reasons for requiring access to auditors' working papers are that these working papers could contain helpful information that is not otherwise available or that could curtail the need for further inquiry, and that the veracity of documents and explanations provided by the company, its directors and officers could be tested.

9. Members have raised a number of concerns over the enhancement of section 29A. They are of the view that SFC might be given excessive power and that checks and balances on such power might not be adequate. To avoid any abuse of power, members consider that detailed procedures for SFC in exercising the power, such as under what circumstances the power could be exercised, what kind of papers would be considered as working papers, use of the working papers and the information gained, etc. should be laid down clearly.

10. While appreciating members' concern, the Administration has stressed that SFC has been very careful in exercising its power. Since the enactment of the provision, SFC has only exercised its inquiry power on 9 occasions. As regards SFC's power to gain access to auditors' papers without recourse to a court order, the Administration gives its explanation that such a concept has been accepted both in Hong Kong and overseas. The Independent Commission Against Corruption and the Inland Revenue Department in Hong Kong are currently provided with similar powers. The Administration has assured members that statutory thresholds will have to be met before SFC can begin an investigation. Besides, SFC's internal operations and decision-making process will be subject to scrutiny by the newly formed Process Review Panel.

11. Some members are still not convinced by the Administration's explanation. They consider that given different circumstances, it is not appropriate to directly compare the powers of SFC and other regulatory authorities overseas. In response to various comments from members, the Administration has undertaken to consider members' view, in particular on the definition of "working papers".

Statutory immunity for auditors of listed company

12. The Administration has advised that it will take the opportunity to include in the Bill an earlier proposal to provide statutory immunity to auditors of listed companies if they see the need to report suspected fraud and misconduct to relevant regulatory authorities in the course of their auditing work. This proposal was previously introduced into the Legislative Council on 27 November 1996. Members have expressed divergent views on the proposal in the Subcommittee.

13. On members' concern over the possible increase in the scope of auditors' potential liability under the proposal, the Administration stresses that the Bill does not seek to impose any additional duties on auditors, it merely provides "statutory protection to auditors who decide to blow the whistle in good faith". As corporate regulation in Hong Kong relies significantly on auditors and shareholders of a listed company rely on the company's audited accounts, the Administration emphasizes that an auditor has an obligation to report fraud and misconduct in a listed company's accounting. It is therefore the Administration's intention to provide auditors with statutory immunity when they make such reports to regulatory authorities.

14. As regards legal obligation to report fraud in the companies, some members are of the view that auditors as well as other professionals should have the obligation to report fraud and they should also be provided with the same statutory immunity. Nevertheless, other suggestion has also been made to the Administration that it should be stated clearly in the provision that auditors do not have legal obligation to report fraud in a company.

15. The Administration has explained that an express provision in the Bill to state that auditors have no legal reporting duties will give a misunderstanding that other professionals do have such duties. In view of the wide public concern, the Administration has undertaken to further discuss the issue with the relevant professionals.

Other concerns

16. Apart from the above issues, members have also raised other areas of concerns which will be considered by the Administration during the drafting stage of the Bill. A list of the concerns raised by members are set out in Appendix II.

Recommendation

17. The Subcommittee recommends that pending the follow-up action by the Administration to provide a summary of its response to representations received in respect of the proposals under the Bill, the work of the Subcommittee will be held in abeyance until it is transformed into a Bills Committee to study the Bill. It will take over the work of the Subcommittee from then onwards.

Advice sought

18. Members are invited to support the recommendation at paragraph 17 above.

Legislative Council Secretariat
20 October 1999

附錄I
Appendix I

夏佳理議員 (主席)	Hon Ronald ARCULLI, JP (Chairman)
何俊仁議員 (副主席)	Hon Albert HO Chun-yan (Deputy Chairman)
李家祥議員	Hon Eric LI Ka-cheung, JP
涂謹申議員	Hon James TO Kun-sun
張永森議員	Hon Ambrose CHEUNG Wing-sum, JP
陸恭蕙議員	Hon Christine LOH
單仲偕議員	Hon SIN Chung-kai
黃宜弘議員	Dr Hon Philip WONG Yu-hong
曾鈺成議員	Hon Jasper TSANG Yok-sing, JP
劉漢銓議員	Hon Ambrose LAU Hon-chuen, JP
馮志堅議員	Hon FUNG Chi-kin
合共：	11位議員
Total:	11 Members
日期:	1999年9月10日
Date:	10 September 1999

Appendix II

Review of licensing regime for market intermediaries

Members' concern	Administration's response
SFC would become a super regulatory body with too much power.	Adequate checks and balances e.g. Securities and Futures Appeals Tribunal would be built to review decisions of SFC.
Licensed banks actively participating in securities brokering should also be regulated by SFC.	Overlapping in regulation by both Hong Kong Monetary Authority (HKMA) & SFC was not necessary. Close coordination between SFC & HKMA would ensure that regulatory objectives could be achieved.
Definition of incidental advice provided by solicitors and accountants as well as the reporting requirements from the professionals carrying on the business of dealing in securities as principal should be clarified.	SFC would clarify the 'incidental' concept by way of a practice note. The practice note would be subject to public consultation.
A balance should be struck between setting criteria to ensure competence of the licensed intermediaries and leaving room for small scale intermediaries to carry on business in the market.	A pragmatic and flexible approach would be adopted in the consideration of every case of license application.
Whether it was possible to establish a single regulatory body for financial markets to avoid confusion.	No such plan at this stage. Different regulatory bodies would maintain close coordination to achieve effective regulation.
A considerable amount of time would be required for thorough scrutiny of the Bill in view of its complicated nature and wide coverage.	The timetable given by the Administration was too tight. The regulatory framework should be modernized as soon as possible so as to enable the securities and futures industry to remain competitive.

Disciplinary powers of Securities and Futures Commission

Members' concern	Administration's response
On the criteria for determining and calibrating civil fines, given that the size and financial resources of a firm would be a factor of consideration on deciding the level of fines imposed, dishonest market participants might make use of this consideration and carry out large scale market manipulation activities through small intermediaries to minimize the possible fine that might be imposed as a result of misconduct.	This would only be one of the factors to be considered but not the only determining factor. There would be a set of guidelines setting out criteria and circumstances to be taken into account so as to ensure justice in individual case and consistency of judgement across cases. The Administration undertook to consider members' view.
On the transparency of the disciplinary procedures, private reprimand might be unfair to other market participants as they had no information on the misconduct of the intermediary concerned.	Private reprimand would only be given under special circumstances where the misconduct was of minor nature, investors' interests would not be hampered, and where the concerned intermediary had taken appropriate remedial actions.
On what basis the proposed level of maximum fine for misconduct would be set.	The penalties imposed would be the same as those imposed by the Market Misconduct Tribunal to ensure a consistent approach.
How the disciplinary sanctions outside the territory could be enforced.	"Memorandum of Understanding" had been signed between Hong Kong and other jurisdictions to enable extra-territorial investigation and exchange of necessary information.
Whether it was possible to recover investigation cost from the fines collected.	The fines would be put under the Government's general revenue to keep SFC's role impartial in the investigation.

Establishment of a Securities and Futures Appeal Tribunal

Members' concern	Administration's response
Under the proposal, the final decision of the Tribunal would be made only by the Chairman of the Tribunal. Members however considered that lay members assisting the Chairman should also be allowed to participate in the decision-making.	Members' views were accepted and amendments in the draft Bill would be made accordingly.
Interlocutory hearing by the Tribunal should be allowed so that a firm subject to immediate suspension of business could have means of deferring the suspension pending the result of an appeal.	Views accepted.
Whether a representative from the Hong Kong Society of Accountants could be appointed to the Tribunal.	Members of the Tribunal would be appointed on the basis that they had no conflict of interest with the work of the Tribunal and had adequate market knowledge to advise the judge on aspects of market operations. Hence, representatives of any particular professional association or interest group would not be the major concern in the appointment.
Members supported the establishment of the Tribunal and suggested that similar appeal tribunal could be set up for other sectors e.g. the insurance agents.	This should be subject to the special needs of different sectors and be considered by the relevant regulatory bodies.

Enhancing inquiry powers into listed companies

Members' concern	Administration's response
Under the proposed enhancement of section 29A of the Securities and Futures Commission Ordinance, SFC would be empowered to seek access to an auditor's working papers. Members considered that to avoid abuse of power, detailed procedures for SFC in exercising such power should be laid down such as under what circumstances the power could be exercised, what kind of papers would be considered as working papers, use of the working papers and the information gained, etc.	Access to auditors' papers without recourse to a court order had been an accepted concept both in Hong Kong and overseas. ICAC & IRD were provided with similar powers. Statutory thresholds had to be met before SFC could begin an investigation. SFC's internal operations and decision-making process would be subject to scrutiny by the Process Review Panel. Nevertheless, the definition of "working papers" would be clarified.
Controversial views on whether auditors and other professionals as well, should have legal obligation to report fraud in the companies. Immunity from legal prosecution should also be extended to other professionals in reporting suspected fraud or misconduct. Reference should be made to HKMA.	The proposal aimed to enhance SFC to discharge its supervisory and investigatory duties effectively without unnecessary and undue intrusion into the affairs of companies and individuals.
The circumstances under which auditors had to report to SFC as well as definitions of "fraud" and "misconduct" should be clarified.	Views noted.

Disclosure of interests in securities

Members' concern	Administration's response
Definition of "settlor" should be clarified.	Views noted.
To improve market transparency, provision should be made to require dissemination of information on internet.	Information had already been made available on the website of the Stock Exchange of Hong Kong (SEHK) and in SEHK's publications.

Statutory backing for listing rules and liability for misstatements

Members' concern	Administration's response
Listing Rules should be subject to the scrutiny of the Legislative Council.	Listing Rules should be market-oriented and flexible.

Regulation of automated trading facilities

Members' concern	Administration's response
Whether it was possible to preserve the existing monopoly held by SEHK in respect of trading in securities if the proposal of granting authorization to automated trading systems (ATSs) was to be implemented.	In view of the global trend of ATS operations, the Bill would not seek to change the existing SEHK's monopoly as presently prescribed in the law but to incorporate ATS activities into the regulatory regime.
It could be difficult to regulate transactions carried out in offshore markets.	Subject to the "Memorandum of Understanding" signed with other jurisdiction, Hong Kong could exercise investigation power to investigate misconduct in offshore markets.
Definition of ATSs involving transactions of Hong Kong stock should be clarified.	Instead of using a single set of rules and definitions, ATSs would be assessed individually according to the type of services they provided and the scale of transactions involved.

Statutory private right of action

Members' concern

Administration's response

The proposal could only benefit those big companies or individuals with adequate financial resources to pay for the cost of the legal proceedings and could not help the majority small investors. Limiting the right of action to action against the company would not hold if the company went into liquidation. The Administration should balance the practicability of the proposal against the current requirement of having independent non-executive directors. A special fund, similar to the Consumer Legal Action Fund, should be set up to assist small investors in taking collective action to sue for damages.

The suggestion of a special fund would not fall within the scope of the Bill.

Powers of intervention in proceedings

Members' concern	Administration's response
SFC power to intervene in third party proceedings might be acceptable if it was limited to circumstances when it was in the public interest to do so. Other reasons for intervention, including in the interest of the just and equitable resolution of the proceedings, were not justifiable.	The Administration agreed to reconsider the circumstances requiring intervention.

Legislative Council Secretariat
20 October 1999