Giving Investment Advice Is an SFC-Regulated Activity
Giving investment advice and issuing research reports on securities, such as mutual funds, are Type 4 SFC-regulated activities.
Carrying on a business in an SFC-regulated activity without an SFC license is a criminal offense. The maximum penalty is 7 years imprisonment and a fine of $5 million HKD.
Some ILAS Schemes Explicitly Remunerate Insurance Brokers for Giving Investment Advice
An investment-linked assurance scheme (ILAS) is a type of insurance policy whose value is “linked” to mutual funds. The SFC authorizes the offering documents of all ILAS products. Most ILAS policies are packaged with little or no life cover. They function exactly like investment products and have all the same risks. Currently, insurance brokers who sell ILAS policies and give advice on the underlying funds are not required by the SFC to obtain an SFC license.
Last month, the SFC authorized the offering documents of Standard Life’s new ILAS scheme, the “Aspiration”, which I call the Aspiration Crusher.
The Aspiration Crusher has several layers of high charges. One of them is an “Initial Charge” which varies depending on the level of services which the insurance broker provides. The broker’s services include “market updates” and “portfolio review”. Standard Life refers to the insurance broker as a “financial adviser”.
The Aspiration Crusher also has an optional “Advisory Fee”, which is paid to the “financial adviser” on an ongoing monthly basis. This fee is determined by the level of services which the “financial adviser” provides. The services include market updates, portfolio review, etc.
Clearly, insurance brokers who receive an ongoing “advisory fee” are carrying on a business in an activity which looks very much like Type 4 activity (giving investment advice and issuing analysis / research reports on mutual funds). Standard Life even refers to the insurance brokers as “financial advisers”—not insurance salesmen.
Shockingly, SFC has implicitly sanctioned this apparent unlicensed activity by authorizing the Aspiration Crusher’s offering documents, which openly state what the unlicensed insurance brokers are being remunerated for.
This is not an isolated incident. One of Standard Life’s other ILAS products, the Harvest 101 Investment Scam, also has an optional “Advisory Fee”. The SFC authorized its offering documents in 2008.
SFC Has Irresponsibly Allowed Unqualified Insurance Brokers to Gamble with the Retirement Savings of Hong Kong Investors
According to Section 4 of the SFO, one of the regulatory objectives of the SFC is “to provide protection for members of the public investing in or holding financial products”.
Section 6 of the SFO states, “In performing its functions, the [SFC] shall, so far as reasonably practicable, act in a way which…is compatible with its regulatory objectives.”
The SFC has not been performing its regulatory objectives. It has allowed insurance intermediaries to provide investment advice, even though these intermediaries are unqualified, unlicensed, and unregulated. An unending flow of scandals reported in the media indicates that these intermediaries have likely blown up the retirement plans of countless thousands of Hong Kongers.
Insurance Brokers Who Gave Investment Advice without an SFC License May Have Committed a Criminal Offense
Last week, I published a blog post describing a few common situations in which sales of ILAS appear to fall under the legal definition of dealing in securities. In such situations, if the seller did not hold a Type 1 SFC license, he or she likely committed a criminal offense.
When ILAS sellers give advice regarding the selection of underlying funds, especially if they are explicitly being remunerated for this service (or holding themselves out as being remunerated for it), they may well be regarded as carrying on a business in advising on securities. Doing this without a Type 4 license is likely a criminal offense.
On 13 Aug 2009, the SFC published a circular in which it argued that advising on the underlying funds of an ILAS did not amount to advising on securities. The SFC gave two reasons. The first reason was this:
The SFC claimed that “the underlying funds are not acquired…on behalf of the policyholder”. This statement is false, since the insurance company purchases the funds on behalf of the policyholder.
The SFC supported its false statement by misleadingly suggesting that the insurance company can do whatever it wants with the policyholders’ contributions. The SFC stated, “If the insurer chooses to invest part of the premium income”—as if the insurer had a choice. It doesn’t.
The insurer is contractually obligated to buy the funds selected by the policyholder. This is stated in the offering documents of every ILAS scheme. Here is an excerpt from the Key Facts Statement of Standard Life’s Aspiration Crusher:
The SFC gave a second reason for claiming that advising on the underlying funds of an ILAS is not advising on securities. The second reason is as inaccurate as the first one:
Notice the words “at all”. This is an absurd exaggeration and self-evidently false. After the insurance intermediary gives advice, the policyholder selects funds based on the advice, and then the insurance company acquires the funds and holds them for the policyholder.
Probably realizing that its arguments were unconvincing, the SFC went on to say that, even if insurance intermediaries were to be regarded as advising on securities, the intermediaries still would not be carrying on a business in the regulated activity, since it “appears” they are not remunerated for their service.
The underlined sentence is false. SFC knows it, since it authorizes all ILAS brochures. Standard Life’s Aspiration Crusher, as mentioned above, has an initial charge and an ongoing advisory fee whose sole purpose is to remunerate the insurance broker (aka “financial adviser”) for providing advice regarding the selection of the underlying funds.
The SFC’s 2009 Circular Was Irrational, Inaccurate, Irresponsible
For the reasons described in this blog post and in THIS one, it is obvious that the SFC is either totally incompetent or else has made a deliberate attempt to evade its responsibilities using misleading, irrational, inadequate, and inaccurate arguments. As a result of the SFC’s reckless behavior, thousands of unlicensed ILAS sellers have likely committed criminal offenses, and many of the victims of these unqualified, unregulated sellers have suffered catastrophic financial losses.
It is time for the SFC to take responsibility for its actions and issue a new circular outlining how it plans to regulate ILAS going forward. SFC also needs to explain how it plans to deal with the mess it has helped create over the past two decades.