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Globally we are seeing the introduction of new regimes to make it easier for regulators to hold individual executives and board members responsible for corporate misconduct. CSj looks at the implications of this trend for directors, managers and governance professionals in Hong Kong.

They used to tell us in law school that the corporate veil was sacrosanct, that if we could penetrate the veil and hunt down individuals behind it, what would be the point of incorporation? The company would die a slow death, unused and little missed. So we drew the curtains and the company thrived, driving economies and providing wealth for entire communities. But with little oversight, and even less means to do so, fraud and negligence entangled themselves within their pleats and folds. Along came the golden boys, Lehman Brothers, Goldman Sachs, and the seams stretched even further. Finally the financial crisis and the inevitable fallout, and the curtain was torn apart by the enraged public.

Governance and accountability have become the new buzzwords, with CEOs, chairmen and directors now subject to new levels of scrutiny. The global approach has been shaped by the Yates Memorandum, which stressed that one of the most effective ways to combat corporate misconduct is to hold individuals accountable. The author of this memorandum is now a contender for the highest office in the US. This global about-turn has created ripples across financial markets and regulators worldwide have seized the opportunity.

The global picture

Mohan Datwani FCIS FCS, the Institute’s Senior Director and Head of Technical & Research, gives us the backdrop to the regulatory changes. ‘After the 2008 financial crisis,’ he points out, ‘it became clear that corporate governance was weak. Ambiguity around the roles and responsibilities of managers and directors meant that enforcing personal accountability was fraught with difficulty. Neither directors nor those in management positions were really being held accountable for their actions. Hence the introduction of new regimes to make it easier for regulators to hold individual executives and board members responsible for corporate misconduct.’

One of the precursors post-2008 to rebuilding trust in the banking industry was the UK’s senior manager regime (SMR), which was implemented in 2016. Aimed at increasing the personal accountability of senior management in the financial services industry, one of the key features of the SMR is to establish the principle that senior executives, while they may delegate specific tasks, cannot delegate their accountability and personal oversight. A statutory responsibility was imposed on managers to take reasonable steps to prevent regulatory breaches from occurring. With the new regime in place, regulators would have the information available to quickly identify the senior managers responsible for the areas at fault.

Developments in Hong Kong

In Hong Kong, the Securities and Futures Commission (SFC) introduced a Responsible Officer (RO) regime for licensed corporations (LCs) almost 16 years ago. But limitations with this regime quickly became apparent.

‘There were gaps when it came to identifying those persons with real responsibility,’ the SFC says. ‘We have observed that some LCs do not necessarily appoint their most senior managers as ROs. For example, in a review of the management structure of certain firms, we found a senior executive who was supervising six ROs, but was himself only licensed as a representative. In some extreme cases, junior executives were appointed ROs, while the controlling minds of the firm stayed in the shadows, with the intent of escaping regulatory scrutiny.’

The SFC needed a roadmap of the network of senior individuals running LCs in Hong Kong. Therefore in April 2017, the Manager-in-Charge (MIC) regime, similar in essence to the UK’s SMR, came into effect and was fully implemented by the end of the year. Specifically, the SFC identified eight core functions of LCs, including overall management oversight, key business line, risk management and compliance, and required LCs to appoint at least one individual to be in charge of each function. The SFC would have to be notified of all MIC appointments and related changes.

‘Previously there was no systematic way for the SFC to collect management structure information of LCs, particularly for certain core functions such as risk management and compliance that do not constitute an SFC-regulated activity. That is why an important objective of the MIC regime is to provide more guidance on the management structure information which is required to be submitted to the SFC, as well as guidance on who should seek to become ROs,’ the SFC says.

MICs need to be fit and proper. The new regime provided more clarity as to their seniority and authority to properly supervise their respective functions. As of 30 June 2019, nearly 11,000 individuals had been appointed as MICs. Among them, 64% were licensed persons, while the remaining 36% were mainly responsible for managing control and operational functions.

Does the MIC regime work?

The MICs in charge of overall management oversight and key business lines are required to be licensed as ROs. However, regardless of whether an MIC is licensed or not, he or she falls directly within the disciplinary ambit of the SFC under Part IX of the Securities and Futures Ordinance (SFO).  For the SFC, in addition to directors and ROs of a firm, MICs of core functions are regarded as senior management. All of them are regulated persons under the SFO.

The MIC regime attempts to penetrate further behind the corporate veil to target the misconduct of individuals with management responsibility. It allows the regulator to identify individuals who could be held accountable for misconduct or control failures.

Interestingly, the head of the legal division per se is not required to be an MIC albeit he or she may be an MIC under other core functions. ‘This is because general counsels have to deal with privileged information, not because they are not a vital element,’ Mr Datwani says.

One of the key components of the MIC regime is the requirement for the board to adopt a formal document setting out the management structure of the corporation. It should cover information including reporting lines and the roles and responsibilities of senior management personnel. Although this document does not need to be submitted, the SFC may request sight of it at any time.

Has this led to a strengthening of governance structures? ‘At smaller fund companies that have less compliance infrastructure, they tend to recognise that falling foul of this new regulation will potentially impact their ability to remain in the industry,’ says Ignites Asia, an online media portal focusing on the fund management industry. Mr Datwani points out that it is up to an LC board to appoint an individual as the MIC of one or more core functions. LCs can also outsource these functions with management retention of responsibilities.

The SFC believes the MIC regime has heightened awareness of individual MICs regarding their accountability, regulatory obligations and potential liabilities as senior management, including that of MICs who are not required to be licensed.

‘Many LCs have taken concrete measures to enhance their governance and management structures, including strengthening their board composition and establishing new committees comprising senior personnel to manage their business and associated risks. They have also delineated job responsibilities and the reporting lines of individual senior managers. LCs have better aligned their senior management with the existing RO regime. Many of them have identified their chief executives and heads of business at group or regional level to be ROs. Many of these individuals were only licensed representatives or not even licensed in the past and have now applied to be ROs,’ the SFC says.

Accountability backed by enforcement

The true test of the effectiveness of any accountability regime is, of course, whether it is backed up by enforcement. The SFC indicates that it is currently pursuing a number of MIC investigations focusing on serious misconduct that has raised firm-wide compliance and internal control issues. The MIC regime also provides useful information for the SFC’s enforcement work. It has been leveraging this regime to help it identify senior managers in charge of core functions.

It adds that it will investigate activities that suggest misconduct or call into question the fitness and properness of a regulated person. It may initiate an investigation on the basis of information from any source, which may include the public, other regulators or law enforcement agencies within or outside Hong Kong, or which arise from its monitoring of day-to-day trading in the stock exchange and derivatives markets, from its inspection of intermediaries or from investigations into other matters such as civil market misconduct or criminal offences. Following the investigation, it will then consider whether or not there is sufficient evidence to commence disciplinary proceedings.

The sanctions are civil rather than criminal, which is where it differs from the SMR in the UK where convictions may result in jail time.

The SFC is not the only regulator in Hong Kong to recognise the importance of imposing individual accountability. In an interview with this journal (CSj, May 2018 edition), Brent Snyder, Chief Executive Officer, Competition Commission (CC), confirmed that the CC would be seeking to hold individuals accountable for breaches of Hong Kong’s competition law. ‘Companies can only act through their employees and my view is that if you want to deter companies from acting illegally, you have to deter the officers, directors and employees. That means seeking sanctions against them. Holding individuals accountable will be a part of our cases going forward,’ he said.

The CC made good on this promise in September last year when it brought its first direct enforcement action against individuals. ‘These proceedings drive home the deterrent message that not only companies but also individuals…may expect to face the full force of the law, Mr Snyder was quoted in Hong Kong Lawyer as saying (Hong Kong Competition Commission Brings Charges Against Individuals, October 2018).

What should governance professionals be doing?

Mr Datwani emphasises that governance professionals are ‘essential facilitators’ when it comes to advising on the impacts of the new individual accountability trend. Firstly, they need to be clear about which regulatory regimes are most relevant to their organisation. The UK’s SMR may be relevant for multinational banks, for example, while the MIC regime applies to licensed corporations in Hong Kong. ‘If you are in the governance profession you really need to stand back and look at your organisation as a whole, and establish both its weaknesses and strengths. Directors and other key personnel need the relevant training. The governance professional is equipped to understand the different regimes and market developments,’ he says.

Even where no specific regime applies, governance professionals need to alert directors to the global trend towards the enforcement of individual accountability since this is likely to have implications for directors’ general liability. ‘The whole game globally is moving towards individual responsibility and directors have to understand that,’ Mr Datwani says. ‘But we have to educate ourselves if we are to educate others and effectively perform our governance function’.

Sharan Gill
Sharan Gill is a writer and lawyer based in Hong Kong.

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