HKSI Licensing Examination Paper 1 (Regulation) — All Questions

Under s.114 of the SFO, a person who carries on a business in a regulated activity in Hong Kong must:

• a.Be licensed by, or registered with, the SFC unless an exemption applies✓
• b.Register the business name with the Companies Registry only
• c.Simply notify HKEX before starting
• d.Obtain approval from the HKMA in every case

SFO s.114 prohibits any person from carrying on (or holding out as carrying on) a business in a regulated activity unless they are a licensed corporation or an authorised institution registered with the SFC. Breach is a criminal offence.

Schedule 5 to the SFO defines the categories of 'regulated activity'. Type 9 refers to:

• a.Dealing in securities
• b.Securities margin financing
• c.Asset management✓
• d.Advising on corporate finance

Under Schedule 5 to the SFO, Type 9 is asset management. Type 1 is dealing in securities, Type 6 is advising on corporate finance, and Type 8 is securities margin financing.

The SFO addresses insider dealing and other market misconduct through:

• a.A dual civil (Market Misconduct Tribunal) and criminal regime, though not both for the same conduct✓
• b.Only a single criminal regime, under which all cases are prosecuted by the Department of Justice in the ordinary criminal courts
• c.Only civil proceedings before the SFC
• d.Arbitration administered by HKEX

Part XIII (civil, before the Market Misconduct Tribunal) and Part XIV (criminal, in the courts) create parallel routes for the same forms of market misconduct. The SFC may pursue one route or the other for the same conduct, but not both.

Under Part XV of the SFO, a person becomes a 'substantial shareholder' of a listed corporation, triggering a disclosure obligation, when they become interested in:

• a.3% of the corporation's non-voting shares
• b.10% or more of the corporation's total shares
• c.Any single share, if they are a retail investor
• d.5% or more of any class of the corporation's voting shares✓

Part XV of the SFO sets the substantial-shareholder threshold at 5% of a class of voting shares. Notification is required within 3 business days of the triggering event and again on crossing each whole percentage level up or down.

A substantial shareholder whose interest crosses a notifiable threshold under Part XV of the SFO must file notice within:

• a.3 business days✓
• b.1 month
• c.7 calendar days
• d.24 hours

Part XV requires notification within 3 business days of the relevant event, such as first reaching 5% or crossing a whole percentage level. Short positions of 1% or more are also disclosable and cannot be netted against long positions.

Which Part of the Securities and Futures Ordinance (SFO) establishes the Securities and Futures Commission and sets out its constitution?

• a.Part XV
• b.Part I
• c.Part XIII
• d.Part II✓

Part II of the SFO (beginning at s.3) establishes the SFC as an independent statutory body and provides for its constitution, board and staffing. Part I contains preliminary provisions and definitions, Part XIII deals with the Market Misconduct Tribunal, and Part XV with disclosure of interests.

Under Schedule 5 to the SFO, Type 2 regulated activity is:

• a.Dealing in securities
• b.Dealing in futures contracts✓
• c.Advising on futures contracts
• d.Leveraged foreign exchange trading

Schedule 5 lists Type 2 as dealing in futures contracts. Type 1 is dealing in securities, Type 3 is leveraged foreign exchange trading, and Type 5 is advising on futures contracts.

A firm that, as a business, enters into leveraged spot foreign exchange contracts with clients is carrying on which regulated activity under Schedule 5 to the SFO?

• a.Type 1 (dealing in securities), on the footing that all leveraged currency positions are treated as ordinary securities dealing
• b.Type 9 (asset management)
• c.Type 8 (securities margin financing)
• d.Type 3 (leveraged foreign exchange trading)✓

Leveraged foreign exchange trading is Type 3 regulated activity under Schedule 5. Note that authorised institutions (banks) are excluded from Type 3, which is why leveraged FX for retail clients is dominated by licensed corporations and banks under separate arrangements.

A person who, for a fee and as a business, gives advice on the merits of buying or selling exchange-traded futures is carrying on:

• a.Type 4 (advising on securities)
• b.Type 6 (advising on corporate finance)
• c.Type 2 (dealing in futures contracts)
• d.Type 5 (advising on futures contracts)✓

Giving advice on the merits of dealing in futures contracts is Type 5 (advising on futures contracts) under Schedule 5. Type 4 covers advising on securities and Type 2 covers dealing (executing) in futures rather than advising.

Operating an electronic platform that brings together buyers and sellers to match orders in securities or futures otherwise than through a recognized exchange is which regulated activity?

• a.Type 6 (advising on corporate finance)
• b.Type 7 (providing automated trading services)✓
• c.Type 1 (dealing in securities), because any electronic order-matching facility is regarded as a form of ordinary securities dealing
• d.Type 4 (advising on securities)

Providing automated trading services (ATS) is Type 7 under Schedule 5. It covers electronic facilities that match, or provide access to markets for, securities or futures transactions outside a recognized exchange or clearing house.

A company that provides financial accommodation to clients to facilitate the purchase of listed securities and to hold those securities as collateral is carrying on:

• a.Type 10 (providing credit rating services)
• b.Type 1 (dealing in securities)
• c.Type 8 (securities margin financing)✓
• d.Type 9 (asset management)

Securities margin financing is Type 8 regulated activity under Schedule 5. Where a Type 1 dealer provides margin financing to its own dealing clients that activity is treated as ancillary to its dealing and does not require a separate Type 8 licence.

Preparing and issuing credit ratings for use by the public or by subscribers, as a business, is which regulated activity under Schedule 5?

• a.Type 7 (providing automated trading services)
• b.Type 10 (providing credit rating services)✓
• c.Type 4 (advising on securities)
• d.Type 6 (advising on corporate finance)

Providing credit rating services is Type 10 regulated activity under Schedule 5, added to bring credit rating agencies under SFC oversight. It is distinct from advising on the merits of specific investments (Types 4, 5 and 6).

Which of the following is NOT a regulated activity under Schedule 5 to the SFO?

• a.Taking deposits from the public✓
• b.Dealing in securities
• c.Advising on corporate finance
• d.Asset management, which under Schedule 5 is defined to include the taking of deposits from members of the investing public

Taking deposits is banking business regulated by the Hong Kong Monetary Authority under the Banking Ordinance, not a Schedule 5 regulated activity. Asset management (Type 9), advising on corporate finance (Type 6) and dealing in securities (Type 1) are all regulated activities under the SFO.

Under the definition of 'securities' in Schedule 1 to the SFO, which of the following is generally EXCLUDED?

• a.Shares of a listed company, which are specifically carved out of the Schedule 1 definition of securities as an exclusion
• b.Shares or debentures of a private company (as defined)✓
• c.Units in an authorised collective investment scheme
• d.Debentures of a public company

The Schedule 1 definition of 'securities' expressly excludes shares or debentures of a company that is a private company within the meaning of the Companies Ordinance. Listed shares, public-company debentures and CIS interests fall within the definition.

Under s.103 of the SFO, issuing to the public an advertisement or document inviting them to acquire securities is an offence UNLESS the material is:

• a.Printed in both English and Chinese and lodged in advance with the Stock Exchange for its prior clearance and approval
• b.Filed with the Companies Registry
• c.Approved by the issuer's auditors
• d.Authorised by the SFC or falls within a statutory exemption✓

Section 103 makes it an offence to issue, or possess for issue, advertisements or invitations to the public to acquire securities or to enter into investment agreements unless the SFC has authorised the material or an exemption applies (for example, offers only to professional investors).

An investment offer that is directed only at 'professional investors' can benefit from an exemption from the offer-authorisation requirement in s.103 of the SFO. Under the Securities and Futures (Professional Investor) Rules, an individual generally qualifies as a professional investor if they have a portfolio of at least:

• a.HK$1 million
• b.HK$8 million✓
• c.HK$40 million
• d.HK$100 million

The Professional Investor Rules set the threshold for an individual at a portfolio of not less than HK$8 million (or its equivalent). Reaching the monetary threshold is only part of the test; intermediaries must still assess and document a corporate professional investor's knowledge and experience before disapplying certain protections.

Offers to the public of interests in a collective investment scheme (CIS), such as a retail fund, generally require:

• a.Authorisation of the scheme and its offering documents by the SFC✓
• b.Only registration with the Companies Registry, since collective investment schemes are treated as ordinary companies limited by shares
• c.Approval by the Hong Kong Monetary Authority
• d.A resolution of the Legislative Council

Under Part IV of the SFO, a collective investment scheme and its offering documents must be authorised by the SFC before interests are offered to the public in Hong Kong. Offers made only to professional investors may be exempt from this requirement.

Under s.115 of the SFO, a person based outside Hong Kong who 'actively markets' regulated services to the Hong Kong public:

• a.Only needs to notify the SFC of their activities
• b.Must instead register with the overseas regulator only
• c.Is always outside the reach of the Securities and Futures Ordinance because the person and their servers happen to be located physically overseas at all times
• d.Is regarded as carrying on a business in a regulated activity in Hong Kong and may require a licence✓

Section 115 deems a person who actively markets regulated activities to the public of Hong Kong to be carrying on that business in Hong Kong, even if the person is located overseas. This 'active marketing' provision prevents firms from avoiding the licensing net by operating from outside Hong Kong.

The maximum penalty for carrying on a business in a regulated activity without a licence, contrary to s.114 of the SFO, on conviction on indictment is:

• a.Imprisonment for life
• b.A fine of HK$5 million and imprisonment for 7 years✓
• c.A public reprimand only
• d.A fine of HK$100,000 only, with no possibility of imprisonment for a first-time contravention of the licensing requirement

Breach of the s.114 licensing requirement is a serious criminal offence: on conviction on indictment the maximum is a fine of HK$5 million and imprisonment for 7 years, plus a further daily fine for a continuing offence. This underlines that unlicensed regulated activity is prosecuted, not merely dealt with administratively.

Under Part VIII of the SFO, when investigating a suspected contravention the SFC may:

• a.Only ask questions on a voluntary basis
• b.Require a person to produce records and documents and to answer questions and give an explanation✓
• c.Do nothing until a court first grants permission in every case
• d.Impose a prison sentence directly on the person under investigation, without any need to involve a court, a judge or a prosecutor at all

Part VIII gives the SFC power to appoint investigators who can compel the production of records and documents and require persons to attend, answer questions and give explanations. It is an offence to fail to comply without reasonable excuse or to provide false or misleading information.

Under its disciplinary powers in Part IX of the SFO, which sanction can the SFC impose on a regulated person for misconduct?

• a.Revocation or suspension of a licence, a public reprimand, a prohibition order or a fine✓
• b.Cancellation of the company's stock exchange listing
• c.A term of imprisonment of up to two years, which the Commission is empowered to order directly against the licensed person concerned
• d.An order winding up the firm made by the SFC itself

Part IX (notably ss.194 and 196) lets the SFC revoke or suspend a licence or registration, publicly or privately reprimand, prohibit a person from re-entering the industry, and impose a fine. Imprisonment and winding up require a court; delisting is a matter for the Stock Exchange.

Where the SFC imposes a disciplinary fine on a regulated person under the SFO, the maximum fine is the greater of:

• a.HK$100,000 or the firm's paid-up capital
• b.HK$50 million in every case
• c.HK$10 million or three times the profit gained or loss avoided as a result of the misconduct✓
• d.HK$1 million or the person's annual salary, whichever of those two particular figures happens to be the greater in the individual case

Under the SFO the SFC may impose a disciplinary pecuniary penalty of up to the greater of HK$10 million or three times the amount of the profit gained or loss avoided by the misconduct. The SFC publishes Disciplinary Fining Guidelines explaining how it sets the figure.

Under s.213 of the SFO, following a contravention of the Ordinance the SFC may apply to the Court of First Instance for:

• a.Injunctions and remedial orders, such as orders restoring parties to their pre-transaction position✓
• b.An order that the defendant be imprisoned without any form of trial, imposed at the sole discretion of the Securities and Futures Commission
• c.A licence for the SFC to operate the defendant's business
• d.The immediate delisting of any company involved

Section 213 allows the SFC to seek civil orders from the court, including injunctions to restrain contraventions and remedial orders (for example, requiring a person to take steps to restore counterparties to the position they were in before a transaction). It is a key investor-restitution tool.

Under s.214 of the SFO, where the affairs of a listed corporation have been conducted in a manner involving misconduct or unfair prejudice to members, the court may make a disqualification order against a responsible person for a period of up to:

• a.5 years at the very most
• b.3 years
• c.1 year
• d.15 years✓

Section 214 empowers the court, on the SFC's application, to disqualify a person from being a director or otherwise being involved in the management of any corporation for up to 15 years, among other orders, where the affairs of a listed corporation involve defalcation, fraud, misfeasance or unfairly prejudicial conduct.

Part XIVA of the SFO imposes a statutory obligation on a listed corporation, once inside information comes to its knowledge, to disclose that information to the public:

• a.As soon as reasonably practicable✓
• b.Only if the Stock Exchange first requests it
• c.Within 30 days
• d.Only at the next annual general meeting

Part XIVA requires a listed corporation to disclose inside information to the public as soon as reasonably practicable after it comes to the corporation's knowledge, unless a safe harbour applies. Breaches are dealt with by the Market Misconduct Tribunal, which may fine the corporation up to HK$8 million.

Which of the following is one of the forms of 'market misconduct' set out in the SFO?

• a.Failing to hold an annual general meeting
• b.Charging clients a high but fully disclosed commission
• c.Late filing of an annual return with the Companies Registry
• d.Price rigging✓

The SFO identifies six forms of market misconduct: insider dealing, false trading, price rigging, stock market manipulation, disclosure of information about prohibited transactions, and disclosure of false or misleading information inducing transactions. Administrative filing failures and disclosed fees are not market misconduct.

A trader repeatedly places and rapidly cancels large orders they never intend to execute, to push a stock's price in a chosen direction and profit from other participants' reactions. This conduct is best described under the SFO as:

• a.Stock market manipulation / a form of market misconduct✓
• b.Lawful, because the orders were cancelled before execution
• c.Permitted market making
• d.A breach only of the broker's internal policy

Creating an artificial or manipulated price through transactions or orders is stock market manipulation under Parts XIII and XIV of the SFO. Placing orders with no genuine intention to trade in order to move the price ('spoofing/layering') falls within the manipulation and false-trading prohibitions.

Deliberately spreading materially false information that is likely to induce others to buy or sell securities, knowing the information is false or being reckless as to its truth, is:

• a.Disclosure of false or misleading information inducing transactions, a form of market misconduct✓
• b.Only actionable in law if the person who spread the false information actually went on to trade in the securities that were concerned themselves
• c.A matter solely for the Stock Exchange Listing Rules
• d.Lawful if posted anonymously online

The SFO prohibits disclosure of information that is false or misleading in a material way and likely to induce transactions or affect price, where the person knew it was false/misleading or was reckless/negligent. It is one of the six forms of market misconduct and can be pursued civilly (Part XIII) or criminally (Part XIV).

Where market misconduct such as insider dealing is prosecuted criminally under Part XIV of the SFO, the maximum penalty on conviction on indictment is:

• a.Life imprisonment
• b.A caution with no financial penalty
• c.A fine of HK$1,000 only, together with a formal written warning letter that is placed on the offender's regulatory file for future reference
• d.A fine of HK$10 million and imprisonment for 10 years✓

Criminal market misconduct offences under Part XIV carry, on conviction on indictment, a maximum fine of HK$10 million and imprisonment for 10 years. This is separate from the civil route before the Market Misconduct Tribunal under Part XIII.

Under Part XV of the SFO, a director or chief executive of a listed corporation must notify their interests in the corporation's shares:

• a.In respect of all their interests (and short positions), with no minimum percentage threshold✓
• b.Only when they sell the shares
• c.Only if the interest reaches 5% of a class of voting shares, exactly mirroring the ordinary substantial-shareholder disclosure threshold
• d.Only if the interest reaches 10%

While substantial shareholders are caught at the 5% level, directors and chief executives of a listed corporation must disclose all of their interests, and short positions, in the corporation's shares and debentures under Part XV, regardless of size. Notifications are generally due within 3 business days.

For the purposes of the insider dealing provisions of the SFO, a 'connected person' of a listed corporation includes:

• a.Only the company's external auditor
• b.A director, employee or substantial shareholder of the corporation or of a related company, and a person with a business or professional relationship giving access to relevant information✓
• c.Only the Stock Exchange
• d.Any member of the investing public who happens to buy or sell the shares, since the insider dealing rules are said to apply identically to every participant in the market regardless of any relationship with the listed corporation

A 'connected person' includes directors, employees and substantial shareholders of the corporation or a related corporation, and persons who, because of a professional or business relationship, may have access to relevant (price-sensitive) information. Dealing while connected and in possession of such information can amount to insider dealing.

Under the SFO, communicating (tipping) inside information to another person, knowing or having reasonable cause to believe that person will use it to deal, is:

• a.Only a civil matter and never criminal
• b.Itself capable of amounting to insider dealing/market misconduct✓
• c.Permitted, because the tipper did not personally place any order to buy or sell the securities that were in question at any point at all
• d.Outside the scope of the insider dealing regime

The insider dealing regime covers not only dealing while in possession of relevant information but also counselling or procuring another to deal, and disclosing the information to a person the discloser knows or believes will deal. The tipper can be liable even without trading personally.

The Stock Exchange of Hong Kong Limited operates as a recognized exchange company. The SFC's power to recognise (and to withdraw recognition from) an exchange company is found in the SFO under:

• a.Part XV (disclosure of interests)
• b.Part IV (offers of investments)
• c.Part III (recognized exchange companies and clearing houses)✓
• d.Part XII (investor compensation), which is also said to govern the recognition and the ongoing supervision of exchange companies and clearing houses

Part III of the SFO governs the recognition and supervision of exchange companies, clearing houses, exchange controllers and investor compensation companies. The SFC recognises these entities and oversees their rules, while HKEX is the recognized exchange controller that owns the operating companies.

Subsidiary legislation and rules made by the SFC under the SFO (such as the Financial Resources Rules) generally take effect subject to:

• a.Approval by the Stock Exchange board before the rules can be published and then brought into operation by the Commission across the market
• b.Ratification by the courts
• c.Being laid before the Legislative Council for negative vetting✓
• d.A public referendum

Rules made by the SFC under the SFO are subsidiary legislation and are subject to the negative vetting procedure of the Legislative Council. This provides legislative oversight while allowing the SFC to make detailed technical rules within its statutory powers.

The SFO consolidated ten previous ordinances into a single statute. It came into operation on:

• a.1 January 2000
• b.1 July 1997
• c.1 April 2003✓
• d.1 January 2013

The Securities and Futures Ordinance (Cap. 571) commenced on 1 April 2003, consolidating and modernising ten separate ordinances (including the former Securities Ordinance and Commodities Trading Ordinance) into one comprehensive law governing Hong Kong's securities and futures markets.

Under Part XII of the SFO, the Investor Compensation Fund is designed to:

• a.Compensate investors for pecuniary loss caused by a default (such as insolvency or misappropriation) of a licensed intermediary or authorised institution✓
• b.Guarantee investors against all trading losses, so that any fall in the value of an exchange-traded product they hold is automatically reimbursed to them by the Fund on demand at any time and in full
• c.Compensate investors whenever a share price falls
• d.Reimburse investors for poor investment advice

Part XII establishes the Investor Compensation Fund to compensate investors who suffer loss because a licensed intermediary or authorised institution defaults (for example, becomes insolvent or misappropriates client assets) in relation to exchange-traded products. It does not cover ordinary market losses or bad advice.

A person aggrieved by certain specified decisions of the SFC, such as a refusal or revocation of a licence, may seek a review of that decision by:

• a.The Stock Exchange Listing Committee
• b.The Market Misconduct Tribunal, which is said to hear reviews of the Commission's licensing and disciplinary decisions in these cases
• c.The Securities and Futures Appeals Tribunal (SFAT)✓
• d.The Hong Kong Monetary Authority

Under Part XI of the SFO, the Securities and Futures Appeals Tribunal, chaired by a judge, reviews specified decisions of the SFC (such as licensing and disciplinary decisions). The Market Misconduct Tribunal instead adjudicates alleged market misconduct.

Under the SFO, a futures contract eligible for regulation as such is generally one that is:

• a.Any private bet between two friends about the future direction of the market, provided that some money actually changes hands between them
• b.A physical purchase of goods for immediate delivery
• c.Only a contract cleared overseas
• d.A contract traded on a recognized futures market or through authorised automated trading services✓

The SFO's concept of a 'futures contract' centres on contracts made on or subject to the rules of a recognized futures market, or through authorised ATS. This ties the regulated product to organised, cleared markets rather than private bilateral wagers.

Under Part X of the SFO, where client assets or the interests of the investing public appear to be at risk, the SFC may:

• a.Only write a letter of concern to the firm with no further power to act at all, since intervention is said to require a fresh court order in every single case before it may be used
• b.Automatically take ownership of the firm
• c.Exercise intervention powers, such as restricting a licensed corporation's business or prohibiting dealings with certain assets✓
• d.Impose a prison sentence on the directors

Part X gives the SFC intervention powers to protect clients and the public, including imposing prohibitions and restrictions on a licensed corporation's business and on dealing with property, and requiring the maintenance of assets in Hong Kong. These are protective, not punitive, and can be used urgently.

The Financial Resources Rules, which require licensed corporations to maintain minimum capital, are made under the SFO principally to:

• a.Guarantee that firms make a trading profit in each financial year so that they can always remain solvent and continue to meet their obligations
• b.Ensure firms remain financially sound and able to meet their liabilities and protect client assets✓
• c.Fix the commissions firms may charge
• d.Set the price of listed securities

The Securities and Futures (Financial Resources) Rules impose minimum paid-up capital and liquid capital requirements so that licensed corporations remain solvent and can meet obligations, reducing the risk of failure and loss to clients. They do not regulate profitability or pricing.