Brokerage firms could soon be forced to keep a closer eye on the activities of their clients and try harder to spot instances of market misconduct
SINGAPORE (Aug 12): Jack Ng Kit Kiat, 70, made waves in court earlier this year describing how he had procured the “very pretty” Quah Su-Ling as a client through an introduction, and how Quah and later John Soh had directed trades through him for accounts that were in neither of their names. But it was not long before the former OCBC Securities remisier undermined his own credibility by admitting under cross-examination that he had committed some market infractions of his own.
In particular, Ng had failed to obtain written third-party authorisation from holders of the accounts used by Quah and Soh. Ng also admitted to “front running” trading instructions from Quah and Soh, using a trading account in his wife’s name. On top of that, he had initially lied to the authorities about his involvement in the activities of the duo, who have been charged with numerous counts of stock manipulation and cheating in connection with the huge run-up and sudden collapse of shares in Blumont Group, LionGold Corp and Asiasons Capital (now Attilan Group) back in 2013, dubbed the penny stock crash.
Ng, who was the first prosecution witness to be called by prosecutors in the ongoing trial of Quah and Soh, was no anomaly. Four other remisiers who subsequently took the stand as witnesses for the prosecution provided similar testimony, casting an unflattering light on the free-wheeling culture of the brokerage industry and leaving themselves vulnerable to accusations of complicity and helping the authorities pin charges on Quah and Soh to cover up their own wrongdoing.
This past week, the Monetary Authority of Singapore said in a consultation paper that it is proposing to impose new requirements on financial institutions (FIs) that deal in capital market products. “These new requirements aim to improve controls and facilitate investigations into cases of market abuse such as market manipulation and insider trading, to maintain a fair, orderly and transparent market,” MAS stated in the consultation paper.
Separately, MAS and the regulation arm of Singapore Exchange jointly put out a guide on trade surveillance for brokerages, which outlines a host of good practices to be adopted and highlights poor practices to be avoided. “Brokers are strongly encouraged to adopt the good practices stated within this practice guide,” MAS and Singapore Exchange Regulation (SGX RegCo) stated. “Regulators will refer to the practice guide in future inspections to evaluate the brokers’ trade surveillance programmes.”
While MAS has said it did not come up with the consultation paper and practice guide specifically because of the so-called penny stock case, there is arguably no better time than while the case is still being tried in the courts to press for reforms that many brokers are likely to view as costly and cumbersome. Indeed, some brokers have already publicly raised concerns about the impact that the new requirements could have on their engagement with their clients.
MAS is proposing to introduce four new requirements on FIs. The first of these is a “client identification rule” where FIs will be required to obtain information on the ultimate beneficial owner of an account within five days of a request by a law enforcement agency. The rule will also cover transactions where FIs are the counterparty of another FI in a separate jurisdiction. This rule will require FIs to update their terms and conditions for customers.
“In enforcing the rule, MAS will take into consideration whether the FI has acted in good faith and with reasonable care to comply with the requirement,” said MAS in the consultation paper.
The second new requirement that MAS plans to introduce is for FIs to record all communications of orders and trades (O&T) between a customer and its trading representative. Should the order come in via a TR’s personal mobile device, the TR is required to do a callback on a recorded line to the person who issued the instructions. FIs will be required to record communications, including instant messages, between the customer and the TR, and retain those records for five years.
“Such records would also constitute critical evidence in market abuse investigations into the identities of persons who instructed the O&T. In our investigations into suspected market abuse, we have come across cases where perpetrators attempted to hide their identities by giving O&T instructions for accounts [that] they were not authorised to operate,” said MAS.
Thirdly, FIs will be required to capture their customer’s mobile device identification (ID) for orders and trades placed using their mobile application. This is an effort to tighten communications between TRs and customers, as well as identify individuals who place orders on the mobile application.
Finally, MAS will require FIs to keep a centralised electronic database of cash and third-party payments. FIs will need to record the identity of the payer, including their national ID number, residential address and contact number, the reason for paying cash and the source of funds. For cash payments by a third party, the FIs will also need to record the relationship of the third party with the account holder, whether the third party exercises trading authority over the account, and the reason for making payment on behalf of the account holder. In addition, due diligence checks will be triggered on third parties that make non-cash payments of $20,000 or more in a single instance or several instances over a rolling one-month period.
“Investigations into cases of market misconduct have shown that persons looking to hide the trail of illicit trading activities often exploit FIs’ practices and policies on account funding,” said MAS.
Changing the culture
While the four new requirements that MAS is proposing to impose on FIs will make it harder for stock manipulation schemes to occur, much ultimately depends on the FIs seeing themselves as having a role in deterring such behaviour. In fact, the trade surveillance practice guide put out by MAS and SGX RegCo last week hints at the need for a change in culture.
Specifically, the practice guide calls for adherence to five guiding principles in trade surveillance, namely strong senior management oversight; sound detection mechanisms and assessment framework; sufficient resources; proper record keeping and quality assurance; and prompt and confidential communications on potential market misconduct. According to MAS and SGX RegCo, the practice guide was developed following supervisory reviews of 10 retail brokerage firms conducted from 2016 to 2018 that turned up mixed results.
In some cases, trade surveillance frameworks had been approved by the brokerage firms’ compliance units, but senior management was not informed of surveillance findings. MAS and SGX RegCo also found that the majority of brokers performed trade surveillance manually, instead of using automated trade surveillance systems. And, only half of the brokers had processes to periodically review their surveillance programmes, while the rest only conducted reviews on an ad-hoc basis.
The review by MAS and SGX RegCo also found that more than half of the brokers did not have an established timeline for case closure, and only one broker provided regular structured training to its surveillance staff. Meanwhile, some brokers were found to have inadequate escalation policies. These brokers had also not reported any suspicious trading activities to SGX RegCo in the preceding three years.
The supervisory reviews conducted by MAS and SGX RegCo found that the trade surveillance mechanisms used by brokers varied in terms of the kinds of market misconduct they detected and their general efficacy. The practice guide seeks to fix this problem by providing brokers with information on trade surveillance practices that would enable them to more effectively detect and deal with misconduct such as wash trades, front running, ramping, security dominance, insider trading and unauthorised trading.
Interestingly, the practice guide notes that “most brokers” did not adopt mechanisms to detect unauthorised trading, which refers to trades executed for accounts on the instruction of third parties that do not have proper authorisation. This form of misconduct is enabled by brokerage firms relying on their TRs to do the necessary checks and obtain the requisite written third-party authorisations from clients. In fact, all five remisiers who have taken the stand in the penny stock trial have admitted that the lure of commissions persuaded them to overlook the need for proper third-party authorisations from the owners of accounts used by Quah and Soh in their alleged stock manipulation scheme.
In order to curtail unauthorised trading, the practice guide calls for brokerage firms to prohibit the use of mobile phones or unrecorded phone lines to accept orders from clients unless a callback is performed from a recorded line. It is also recommended that “hold mail” arrangements, where remisiers hold or retain contract notes and statements for clients, be disallowed except in extenuating circumstances. Broking houses are also encouraged to review payments from or to third parties and ensure that payments are not passed to remisiers unless authorised by clients.
Lukewarm reaction
The reaction to all of this has — perhaps not surprisingly — been lukewarm. While many across the brokerage industry agree that the new MAS requirements and trade surveillance practice guide could deter market misconduct, many also bemoan the possibly higher costs and inconvenience they might have to endure.
Dennis Hong, chairman of the Securities Association of Singapore, says members of his organisation support regulatory controls that promote a fair, orderly and transparent market. But he points out that certain aspects of the proposed measures are not new. “Most brokerage firms already have internal processes and practices aligned with the spirit of these measures [that] seek to detect and deter market abuse,” says Hong, who is also managing director of OCBC Securities. “It is important that investors and the broking community understand the rationale behind the proposed measures in order to facilitate the adoption.”
Carol Fong, CEO of CGS-CIMB Securities, says her firm has internal processes and practices that are aligned with some of the proposed measures. “As such, we do not think that the revised rules to deter market misconduct will have too much impact on the way we manage our clients,” she adds.
While she welcomes the new requirements and practice guide, she notes that there needs to be a balance between regulation to restore investor confidence and over-regulation that might put a spoke in the market’s wheels. “We agree that investors’ confidence impacts their willingness to trade or invest. However, there is a need to balance this and not over-regulate and inadvertently stifle market activities,” she says.
For its part, MAS says the new requirements go beyond the processes that most brokers have in place, and will make it easier to investigate cases of market misconduct. “Financial institutions, including brokers, are already required under existing requirements to identify and verify a customer’s identity. The proposed requirements serve a different purpose — to help raise industry standards and strengthen MAS’s enforcement capabilities to detect and deter market abuse,” MAS says in an email to The Edge Singapore.
“For instance, where the customer’s account has been used by unauthorised third parties to facilitate illicit trades, having records of the device ID as well as communications between the trading representatives and persons who provided trading instructions will help to establish the identities of the third parties,” MAS adds.
Indeed, the sharp rise and sudden fall of Blumont, LionGold and Asiasons Capital in 2013, and the fact that the case is still unresolved, clearly indicate that the brokers did not have sufficient processes in place to deter the likes of Quah and Soh and their associates. Regulators cannot fix every problem, but they should act when market participants do not do enough to maintain the integrity of the ecosystem.
Proposed MAS requirements mirror Soh and Quah’s alleged misdeeds
The Monetary Authority of Singapore insists that the new requirements it is proposing to impose on financial institutions are not specifically motivated by the alleged manipulation of Blumont Group, LionGold Corp and Asiasons Capital (now Attilan Group) that resulted in their sharp rise and sudden crash in 2013. Yet, the new requirements as well as the trade surveillance practice guide by MAS and Singapore Exchange Regulation seem to address exactly the forms of market misconduct allegedly perpetrated by John Soh and Quah Su-Ling and their associates involving an extensive web of 189 trading accounts, which led to the penny stock crash.
