Financial regulators in Hong Kong are scrutinising non-compliance and market misconduct through robust enforcement actions and increasingly severe sanctions against companies and individuals to maintain fairness and stability in this major international financial centre. This is evidenced by the increasing number of investigations and prosecutions commenced. For example in 2014, the Securities and Futures Commission (SFC), a key securities and futures regulator in Hong Kong, has commenced over 2,000 investigations, whereas the Independent Commission Against Corruption (ICAC), Hong Kong’s anti-graft body, instigated over 200 prosecutions.
Against this backdrop, companies that are subject to various financial regulatory regimes (for instance, financial institutions licensed under the Securities and Futures Ordinance (SFO)) are increasingly seeing the need to conduct internal reviews either on their own initiatives to ensure compliance with the relevant rules and regulations, or prompted by a regulator. Internal investigation is more than asking employees questions and compiling a report. Mishandling an internal inquiry process may have adverse consequences, for instance, ongoing non-compliance and delay in reporting misconduct to regulators and even employment issues.
This chapter will explore the different considerations and issues involved in internal inquiries conducted in Hong Kong.
Landscape of regulatory enforcement in Hong Kong
We have mentioned the SFC, which is responsible for promoting the fairness, efficiency, competitiveness, transparency and orderliness of the securities and futures industries by regulating the participants in the markets including financial advisers, intermediaries, companies listed on the Hong Kong Stock Exchange and even investors, and the ICAC. Other financial regulators include the Hong Kong Exchange and Clearing Limited, which comprises its two wholly owned subsidiaries, namely the Stock Exchange of Hong Kong Limited (SEHK) and the Futures Exchange, both being the primary regulators of the Stock Exchange and Futures Exchanges participants with respect to trading matters.
The Hong Kong Monetary Authority (HKMA) is the frontline regulator of banking activities in Hong Kong. The Office of the Commissioner of Insurance (OCI) is the insurance regulator, empowered by the Insurance Companies Ordinance to oversee the financial conditions and operations of authorised insurers. The Monetary Provident Fund Scheme Authority is a statutory body set up to regulate and supervise privately managed provident fund schemes. The Hong Kong Police Force also plays a role in tackling issues that challenge Hong Kong’s financial stability (eg, fraudulent commercial activities).
While the financial regulators have their own specific mandates (with the common goal of helping to maintain Hong Kong’s status as an international financial hub), they are armed with different investigative and enforcement powers. For instance, compared with the SEHK, the SFC has teeth in terms of its powers to investigate and its enforcement options. The SFC has the power to initiate investigations and compel people to assist in such investigations by answering all questions put to them if it has reasonable cause to believe certain misconduct or offences have been committed. It can bring civil and criminal proceedings to seek a wide range of civil remedies and orders such as monetary compensation and injunction orders, or seek a sanction of fines and imprisonment in prosecutions. The SEHK has no such power though it works hand in glove with the SFC with respect of any impropriety in the trading activities concerning companies listed on the Main Board and Growth Enterprise Market of the Stock Exchange. The HKMA has the power to compel an ‘authorised institution’ (such as a bank) to produce documents and its personnel to attend interviews if it has reasonable cause to believe that the authorised institution may have contravened a reporting, clearing or trading obligation. The ICAC, on the other hand, has wide statutory powers to combat corruption in both the public and private sectors.
With market dynamics changing fast, regulators do see the need to increase their powers. Currently the OCI has limited investigative powers under the current self-regulatory regime. OCI’s existing functions will be soon replaced by the new Independent Insurance Authority (IIA) in one to two years’ time. The IIA will be conferred with much broader supervisory powers to investigate and prosecute non-compliant insurance companies with a view to heightening protection of policyholders’ interests.
Below are a few pointers that should be borne in mind when handling internal investigations. However, the approach adopted might be different depending on the nature of the matters concerned and the regulatory authority concerned.
Scope of the investigation
The objective and approach of an internal review could well be different where it is triggered by a complaint from a whistleblower as opposed to an investigation by a regulator. Where the company initiates its own investigation after having received complaints from its staff members or customers or an incident has happened, the prime objective of the investigation is to find out the truth, resolve the complaint and improve the current system with a view to preventing further occurrences. When the company first receives a complaint, the scope of the matter would be restrictive. However, as the internal inquiry progresses, it might be discovered that the matter complained of is just the tip of the iceberg and a wider problem exists, and the scope of the investigation may have to be adjusted or expanded.
If a company is subject to a regulatory investigation, there will be a need to initiate an internal investigation, the main purpose of which would be to enable the company to properly respond to the regulator and, more importantly, to assess whether or not there is non-compliance before the regulator completes its inquiry and comes to a verdict. As regulatory investigations and litigations could be costly and time-consuming and would inevitably have an adverse impact on the reputation of the company under investigation, one should try to minimise the damage, which is achievable by having an early assessment of the strengths and weaknesses of its case and adopting a correct approach in dealing with the regulator. The scope of such internal investigation is normally dictated by the area the regulator is investigating. For instance, receipt of a section 183 notice from the SFC would require the company to produce certain documents or certain employees to attend interviews. The section 183 notice will normally set out the direction to investigate issued under section 182 of the SFO indicating the nature of suspected misconduct, which will predetermine the scope of the internal investigation.
Setting up the investigation team
Companies should make a decision as to who should handle the internal investigation. Ideally, a committee comprising key staff should be formed to handle the process and control the flow of information. In some situations, however, management should not be in charge of the internal investigation, for example when the alleged misconduct involves senior management.
It is important to involve in-house counsel and an external legal team as they are well trained to formulate the right questions to elicit useful information and analyse the facts revealed in the investigation in light of the relevant law and regulation. Experienced regulatory lawyers will also be able to advise the company as to what needs to be done in terms of improvements to the current system and how it should deal with the relevant regulator. Another reason legal advisers should be brought into the scene early in the process relates to legal advice privilege, which will be elaborated further below.
Sometimes, it makes sense to involve the human resources personnel in the internal investigation to deal with any employment or disciplinary issues that may arise. Some of these issues are discussed below.
Having said that, to minimise the risk of inadvertent disclosure of sensitive information or breach of the secrecy obligations imposed by the regulator, it would be prudent to include as few personnel as possible in the core team that handles the internal investigation.
Collecting the evidence
One of the key purposes of conducting an internal investigation is fact-finding, collecting information and materials to enable the company to know what has happened and to defend its position in case a regulator knocks at its door. Therefore, it is important that at the beginning of the process the relevant employees are reminded to preserve relevant documents.
During an internal investigation, the company will obtain materials relating to the matter concerned and will inevitably create communications and new documents (eg, interview notes). Documents that relate to the matter under investigation and exist prior to the investigation are generally not privileged. However, communications between the company and its lawyers (whether in-house counsel or external lawyers), documents evidencing such communications and documents intended to be such communications (eg, draft e-mails to lawyers) will generally be protected by legal advice privilege provided that they are created with the sole or dominant purpose of obtaining legal advice. This is a reason why it is always advisable to involve lawyers as early as possible in an internal investigation, including any interview conducted with relevant employees. Companies should ensure that privilege is preserved and not waived accidentally during the internal investigation, in particular if a regulatory investigation is imminent.
The law on legal advice privilege in the common law jurisdictions has been in a state of flux for the past decade as a result of the decision of the English Court of Appeal in Three Rivers District Council v Governor and Company of the Bank of England (No. 5)  QB 1556 (Three Rivers (No. 5)). In that case, the Court of Appeal held that legal advice privilege only applies to communications between a limited group of employees within a company (ie, the ‘client’) that is entrusted to handle a particular investigation, for example the company’s legal department and the company’s external lawyers. Accordingly, employees of the Bank of England outside the Bingham Inquiry Unit (which was set up in respect of the Bingham Inquiry into the collapse of Bank of Credit and Commerce International) were not regarded as ‘clients’ and hence their communications with the company’s external legal advisers were not privileged even though they were created for the sole or dominant purpose of obtaining legal advice.
The Hong Kong Court of Appeal has recently revisited the issue of legal advice privilege in the case of Citic Pacific Ltd v Secretary for Justice and another  HKCA 293. The Court of Appeal declined the restrictive approach adopted in Three Rivers (No. 5) in identifying the ‘client’ and held that for the purpose of considering whether legal advice privilege applies to a particular document, one should apply the dominant purpose test, (ie, whether the document was created with the sole or dominant purpose of obtaining legal advice)rather than focusing too much on whether or not the particular employee of the client company creating or sending the document should be considered a ‘client’.
Based on this decision, clients can now take some comfort in the fact that documents and communications created by its employees with the sole or dominant purpose of obtaining legal advice will be covered by privilege.
It is advisable that, when reviewing documents and communications during internal investigations, an exercise be conducted to segregate privileged documents and communications from those that are not so protected. This will prove helpful in the event that a regulator conducts a dawn raid at the company’s premises, trying to seize documents. One would then have less difficulty in identifying which documents are privileged and which are not.
Employees who are implicated in the alleged misconduct and employees who are not but may have information relevant to the investigation should be interviewed.
The interviews should be conducted in the presence of the company’s in-house counsel or external lawyers. The company should carry out a thorough review of all relevant materials prior to arranging the interviews to avoid multiple interviews of multiple employees, which is likely to be disruptive to employees’ work and affect employee morale. The in-house counsel or external lawyer should also explain in clear and unequivocal terms to the employee that he or she represents the company and not the employee, that legal advice privilege applies and that only the company has the authority to waive that privilege. This is to avoid the risk of employees having a mistaken belief that the external lawyers or in-house counsel are acting for them, or that the privilege belongs to them. In fact, many companies will allow or even encourage employees to retain separate independent lawyers and reimburse the employees for the legal costs arising from their engagement in the internal investigation to ensure fairness in the process.
In Hong Kong, there is no statutory requirement obliging an employee to assist his or her employer in an internal investigation. However, an employee will likely find himself or herself having no choice but to assist. If the employment contract expressly stipulates that the employee is required, among other things, to promote the business and interests of the company (such provision usually exists in employment contracts with people of a senior rank in the organisation), one could take the view that he is required to disclose any misconduct concerning his colleague or any irregularity concerning the company, and attend interviews by the company to ensure that the best interests of the company are protected. Even if the employment contract concerned does not contain the above-mentioned provision, it would still be in the employee’s interests to assist in the internal investigation at the request of their employer, as failure to obey a lawful and reasonable order by an employer could constitute a ground for summary dismissal under the Employment Ordinance and the common law.
Where an employee is suspected of misconduct, an employer has a right under section 11 of the Employment Ordinance to suspend his or her employment for up to 14 days without notice or payment in lieu: (i) as a disciplinary measure for any reason for which the employer could have summarily dismissed the employee; (ii) pending a decision by the employer as to whether or not to summarily dismiss the employee; or (iii) pending the outcome of any criminal proceedings against the employee arising out of or connected with his or her employment. If the criminal proceedings are not concluded within the period of 14 days, the suspension may be extended until the conclusion of the criminal proceedings. It is not clear from the Employment Ordinance whether any suspension after the initial period of 14 days should be paid or unpaid. However, bearing in mind that an employee who is suspended from employment has a right to claim constructive dismissal by the employer at any time during the period of suspension, it is suggested that the employer ask the employee to take paid leave of absence if a suspension of more than 14 days is required.
If at the conclusion of an internal investigation, an employee is found to have committed misconduct or non-compliance, the company should take legal advice as to whether the conduct on the part of the employee justifies summary dismissal. Indeed, leaving aside the legal issues, the company should consider whether the employee should be laid off right away or whether he or she should be kept in the organisation so that he or she could assist in any future regulatory investigation. Having said that, an employer may have no choice but to dismiss the offending employee if the employee is a licensed person under the SFO given the company’s overall fitness and properness may be adversely affected if the employee is retained.
If an internal investigation is prompted by a regulatory investigation, the company would need to take into account any relevant secrecy obligations. For example, a notice issued under section 183 of the SFO imposes certain statutory obligations, including the secrecy obligation imposed by section 378 of the SFO on the persons who were in receipt of the section 183 notice. The secrecy obligation is subject to limited exceptions, such as disclosure to employers, insurers and legal advisers. Therefore, during the interviews conducted in the course of the internal investigation, the company should not divulge to the interviewees the existence of an SFC investigation or disclose any relevant allegations, unless they are designated persons for handling the regulatory investigation. Also, the company should not ask the employee interviewees who have attended interviews with the regulators what they have been asked during the interviews.
Communications with regulators
Licensed or registered persons under the SFO are obliged under paragraph 12.5 of the SFC’s Code of Conduct to report to the SFC immediately for any material non-compliance with any applicable law, rules, regulations or codes or any suspected non-compliance. The SFC stresses time and time again that any suspected misconduct must be reported to the SFC immediately upon discovery rather than after completion of an intermediary’s own internal investigations into the matter. Therefore, companies should ensure they notify the SFC promptly upon discovering non-compliance or a suspected case of non-compliance during the course of internal investigation as otherwise there might be serious consequences. Millions of dollars in fines might be imposed on licensed corporations for failing to report significant misconduct to the SFC in a timely manner.
If the internal investigation reveals any shortcomings in the company’s policy, the company should seek legal advice as to how its policies and procedures should be improved to demonstrate to the regulators, if necessary, that it is making a serious effort to prevent a recurrence of the misconduct.
It should not be forgotten that financial regulators in Hong Kong may refer a case to one another for further or separate investigation if they consider it appropriate. The authors have handled a case where the SFC referred matters to the Commercial Crime Bureau of the Hong Kong Police Force for a fresh investigation into suspected fraud after concluding that no enforcement action should be taken against a listed company under the SFO. In addition, we have seen inquiries conducted by SEHK into breach of disclosure of interest under Listing Rules being referred to the SFC for further investigation into suspected insider dealing.
Regulators in the territory would also speak to and cooperate with the equivalent authorities in other jurisdictions. For instance, the mutual assistance arrangement allows both the SFC and overseas regulators (eg, the Australian Securities and Investments Commission and the Japanese Securities and Exchange Surveillance Commission) to collect and share information in relation to their own local investigations. As such, it is important to bear in mind that information collected during an internal investigation in Hong Kong for the purpose of answering a local regulator’s enquiries or investigations may be accessible by regulatory bodies abroad.
Therefore, when conducting an internal investigation, apart from considering the above pointers, one should assess at the outset whether other regulators are likely to be involved and to take a much broader view of the matter concerned. Sometimes the situation even warrants the engagement of foreign regulatory lawyers.