The Securities and Futures Commission (SFC) has resolved its concerns with Merrill Lynch Far East Limited (MLFE) and Merrill Lynch (Asia Pacific) Limited (MLAP) over internal control failures. Under the resolution, the SFC reprimanded and fined them a total of $15 million for breaches of the Code of Conduct and the Internal Control Guidelines.
In the last quarter of 2016, the SFC, MLFE and MLAP jointly engaged an independent reviewer to review MLFE’s and MLAP’s internal controls related to its reporting of Large Open Positions (LOP), electronic trading systems, distribution of research reports involving futures contracts, and disclosure of market making activities in research reports.
The review findings revealed that:
- MLFE failed to ensure compliance with requirements for LOP reporting under the Securities and Futures (Contracts Limits and Reportable Positions) Rules and the Rules of the Hong Kong Futures Exchange in some instances since May 2006;
- in respect of the electronic trading system for trading in futures contracts, MLFE failed to:
- put in place formal governance including key policies and procedures when the electronic trading regulations under the Code of Conduct came into effect on 1 January 2014;
- effectively manage, adequately supervise and keep proper records on the design, development, deployment and operation of the electronic trading system; and
- ensure the integrity and reliability of the electronic trading system, and that the algorithmic trading system and trading algorithms are adequately tested to ensure they operate as designed;
- MLAP failed to ensure compliance with the applicable legal requirement to obtain a licence for Type 5 regulated activity before carrying on business in advising on futures contracts between May 2005 and August 2016; and
- MLFE failed to disclose it was a market maker in the relevant securities in research reports distributed to clients between May 2011 and November 2016.
In reaching this resolution, the SFC took into account that MLFE and MLAP:
- self-reported to the SFC the unlicensed activity and non-disclosure of market making activities in its research reports;
- involved their senior management in the liaison with the SFC about the regulatory concerns at an early stage;
- took the initiative to bring this matter to an early conclusion by fully and frankly discussing the regulatory concerns with the SFC;
- undertook a credible review with the SFC to address the regulatory concerns and identify the deficiencies in its internal controls; and
- co-operated with the disciplinary action by resolving the SFC’s regulatory concerns.
The SFC also took into consideration MLFE’s board of directors have undertaken that the problems unveiled in the review findings concerning the compliance with requirements for LOP reporting will be rectified within 12 months and will not reoccur after 12 months.
The SFC considers MLFE’s and MLAP’s prompt cooperation has significantly expedited the disciplinary proceedings. Otherwise, similar failures would have resulted in a substantially higher level of fine.