“Mastermind” Nominee And Warehousing Arrangements Under Scrutiny
Nominee and warehousing arrangements can serve important purposes. However, they are also ripe for abuse.
Hong Kong’s Securities and Futures Commission (“SFC”) issued a circular on 9 October 2018 raising concerns about the increasing use of these arrangements to facilitate market and corporate misconduct.
This post outlines the key things you should know about these arrangements and the regulatory concerns that have emerged.
What are “nominee” and “warehousing” arrangements?
- a “nominee arrangement” refers to the appointment of another person to act on your behalf in relation to certain affairs, assets and/or transactions. The nominee might, for example, hold legal title to certain shares or other property, whilst you hold the beneficial interest; and
- a “warehousing arrangement” involves very similar arrangements legally, but typically arises in the context of particular scenarios such as trade finance and securitisation.
Why are they used?
There are many legitimate reasons for which these arrangements might be established. For example, nominee arrangements are very commonly used by brokers to facilitate stock trading on exchanges and other trading venues. Warehousing can also be used as an intermediate step in a securitisation transaction.
However, they can also be used to conceal ownership, obviate legal obligations and engage in market misconduct. For example, they have been the longstanding subject of focus of anti-money laundering and counter-terrorist financing rules.
How “masterminds” control the shots and can impact market integrity
The SFC has also observed that in some instances, nominee clients are taking instructions from “masterminds”. These masterminds are using the nominee arrangement to engage in certain market or corporate misconduct practices.
Examples include the following:
Common sense prevails. Nominee and warehousing arrangements play a critical role in the financial sector, so “de-risking” them entirely from banking and finance transactions is a non-starter.
However, due diligence and ongoing monitoring controls must be able to detect abuse.
For example, the SFC stresses that its licensed intermediaries should be aware of any red flags that may suggest that a “mastermind” is instructing nominees to facilitate market misconduct. They should be able to identify these red flags and take reasonable steps to address them.
Key red flags to be aware of include:
- lack of a credible commercial explanation for frequent and large fund transactions;
- seemingly unrelated clients engaging in the same trading and settlement patterns;
- seemingly unrelated clients authorising the same third party to operate their accounts;
- clients engaging in transactions involving amounts of funds which are not commensurate with their financial profile;
- clients transferring large quantities of stock in circumstances where the executed price is below that of the prevailing market price;
- highly limited trading (eg one or two stock) over a period of time; and
- walk-in clients effecting a single transaction of a large volume of money.
These red flags are not exhaustive. Heightened vigilance is also recommended for:
- repeated patterns of cross-trades;
- stock transfers between seemingly unrelated companies; and
- large stock transactions in the context of corporate actions.
1. There is significant liability at stake
Intermediaries may attract civil, criminal or disciplinary action, not only when they have knowingly facilitated any market or corporate misconduct, but also when they should have had reason to suspect the market misconduct and failed to act. Proceeds emanating from criminal conduct are likely to amount to money laundering.
2. Regulators are watching
The SFC Enforcement Division is currently investigating cases involving “nominee” arrangements. This emphasises the need to have in place robust and adequate systems and controls to be able to identify any potential red flags and take on necessary actions.
3. Risk-based controls are key
This requires intermediaries to be active and engaged in their dealings with clients and have a sound understanding of their client activities. Cross trades between clients should be identified and understood. Large transfers of stock should be followed by appropriate enquiries where necessary.
Suspicious circumstances always require further enquiry and escalation as needed.
4. Reporting is essential and there must be a “willingness to exit”
Senior management approval must be sought where any raised suspicions cannot be quelled. Where necessary, client relationships should be terminated and reports should be made to the SFC and to the Joint Financial Intelligence Unit.
Authors: Urszula McCormack and Kendal McCarthy
Source: King & Wood Mallesons