COL Financial Group, Inc. v. Capital Markets Integrity Corp.

September 26, 2019 SEC EN BANC CASE NO. 07-15-377 COL FINANCIAL GROUP, INC. , appellant , vs. CAPITAL MARKETS INTEGRITY CORPORATION , appellee . DECISION This is an Appeal of the Decisions dated 6 February 2015 and 1 June 2015 of the Capital Markets Integrity Corporation, where COL Financial Group, Inc. was held liable for violation of the Know-Your-Customer Rule , enshrined in both the CMIC Rules and the Amended Implementing Rules and Regulations of the Securities Regulation Code. RELEVANT FACTS The CAPITAL MARKETS INTEGRITY CORPORATION (CMIC) is a Self-Regulatory Organization (SRO) that oversees broker-dealers. COL Financial Group, Inc. (COL FINANCIAL) is a domestic corporation, licensed as a broker-dealer of securities. On 2 July 2014 , the CMIC sent a Letter to COL FINANCIAL, requiring the latter to explain suspicious trading activities pertaining to the 43 Million Double Dragon shares worth Php203 Million . The buying and selling were transacted through the trading accounts of spouses Jonathan and Cherryl Faith Gomez (Spouses Gomez) between 14 April 2014 and 16 May 2014. Although the CMIC was initially investigating the possibility of market manipulation through "hype-and-dump" and/or insider trading, it also highlighted that COL FINANCIAL may have violated the Know-Your-Customer (KYC) Rule , when it allowed the Spouses Gomez to trade such a large amount of shares, despite having a Net Income of less than Php1 Million each and an Annual Income of less than Php500,000 each. 1 The Spouses Gomez stated in their Customer Account Information Form (CAIF) that their source of funds is "Business;" Jonathan Gomez indicated Hanna Foods & Beverages Phil., Inc., while Cherryl Faith Gomez indicated Bon Voyage Shipping Agency, Inc. Eventually, the market manipulation through "hype-and-dump" and/or insider trading allegations did not prosper, and the KYC violation became the sole focus of the CMIC investigation. As to the KYC charge, COL FINANCIAL argued that (1) "Financial Status" is not required by the KYC Rule, (2) Clients are generally reluctant to disclose the true amount of their wealth, and (3) the non-disclosure was committed by the Spouses Gomez and cannot be attributed to COL FINANCIAL. 2 It also argued that it kept track of how much money was allocated to the Spouses Gomez' trading account, and that it was aware that the spouses had indeed accumulated more than Php203 Million to merit an upgrade from "COL Starter" to "COL Premium" account. On 6 February 2015 , the CMIC imposed a Fine of Php10,000 on COL FINANCIAL for violation of the KYC Rule, as stated in Article VI, Section 1 (b) (iv), items (b), (e), and (g) of the CMIC Rules, viz. [COL FINANCIAL] was sanctioned for its failure to comply with the KYC Rule by failing to effectively monitor the transactions of its clients Spouses Jonathan Gomez and Cherryl Faith Gomez ("Spouses Gomez"). As declared in the CAIF of Spouses Gomez, their net income is less than One Million Pesos (Php1,000,000.00) and their annual income is less than Five Hundred Thousand Pesos (Php500,000.00). However, from 7 April 2014 to 16 May 2014, the Spouses Gomez were able to buy and sell DoubleDragon Properties Corporation shares with a total value of Two Hundred Three Million Four Hundred Eighty-Five Thousand Five Hundred Fifty-Four Pesos (Php203,485,554.00). The Board also noted that despite the large disparity between the financial condition of the Spouses Gomez and the aforesaid trades, [COL FINANCIAL] did not contact its clients [to] inquire about the transactions. 3 COL FINANCIAL moved for reconsideration, but merely reiterated its arguments. On 1 June 2015 , the CMIC denied COL FINANCIAL's motion for reconsideration. On 2 July 2015 , COL FINANCIAL filed its Memorandum on Appeal to the En Banc. It argued that: 2.38 Thus, the penalty imposed on appellant [COL FINANCIAL] was based solely on the CMIC's allegation that appellant [COL FINANCIAL] was unable to properly establish the 'financial status' of the Spouses Gomez , which in turn was premised on the allegation that the Customer Account Information Form completed by the Spouses Gomez shows assets of an amount less than their total DD transactions. 4 x x x xxx xxx xxx 2.40 Article VI, Section 1(b)(iv) item (e) thus mandates the Trading Participant to be reasonably satisfied with the client's: (a) identity ; and (b) address and contact details of the: (i) person ultimately responsible for originating the instruction in relation to a transaction; and (ii) the person who stands to gain the commercial or economic benefit of the transaction and/or bears the commercial or economic risk. 5 2.41 It is indubitable that Article VI, Section 1(b)(iv) item (e) makes no mention of the term "financial status" and a cursory reading of the provision makes it clear that it only relates to the determination of the identity, address, and contact details of certain persons, no more and no less. 6 x x x On 20 July 2015 , the CMIC filed its Reply Memorandum . Quoting its Decision dated 6 February 2015, the CMIC clarified that: x x x regarding the alleged KYC violations, the CMIC resolved that [COL FINANCIAL] violated Article VI, Section 1(b)(iv), items (b), (e), and (g) of the CMIC Rules. The CMIC declared, inter alia : "[Penalty] is imposed upon [COL FINANCIAL] not because of its failure to comply with the KYC Rule at the time the Spouses Gomez opened their account, but because of its failure to effectively monitor the transactions of its clients, such that the transactions of the Spouses Gomez, though clearly not commensurate to the financial information they provided in their CAIF, were apparently unnoticed by [COL FINANCIAL]. Furthermore, after the execution of the Spouses Gomez's transactions, no effort was made by [COL FINANCIAL] to address or correct the irregularities." 7 xxx xxx xxx Accordingly, the CMIC maintained that "continuing due diligence is necessary in order to ensure that the transactions that go through the [Trading Participant] are consistent with the [Trading Participant]'s knowledge of the client's profile, financial condition , [and] risk profile, including, where necessary, the source of funds." Thus, a Fine of Ten Thousand Pesos (Php10,000.00) was imposed upon [COL FINANCIAL]. 8 On 8 January 2019 , the En Banc directed the Commission's Enforcement and Investor Protection Department (EIPD) to file its Comment, in order to provide a more comprehensive discussion of the KYC Rule. The said rule is a subset of Anti-Money Laundering regulations that are enforced by the Commission through the EIPD. The EIPD highlighted that the CMIC Rules are entirely adopted from the 2004 Implementing Rules and Regulations of the Securities Regulation Code (SRC-IRR), viz. CMIC Rules 2004 SRC-IRR 9 A Registered Person shall take all reasonable steps to establish the true and full identity of each of his clients, the financial situation , investment experience, and investment objectives. 10 A Registered Person shall take all reasonable steps to establish the true and full identity of each of his clients, the financial situation , investment experience, and investment objectives. 11 A Registered Person shall take all reasonable steps to establish the true and full identity of each of his clients, the financial situation, investment experience, and investment objectives. 12 A Registered Person shall take all reasonable steps to establish the true and full identity of each of his clients, the financial situation, investment experience, and investment objectives. 13 A Registered Person shall not do anything to effect a transaction unless he has first complied with requirements of this rule, as required in SRC Rule 30.2 paragraph 4. 14 A Registered Person shall not do anything to effect a transaction unless he has first complied with requirements of this rule, as required in SRC Rule 30.2 paragraph 4. 15 The EIPD further emphasized that the KYC Rule is also found in the "International Conduct of Business Principles" published by the International Organization of Securities Commissions (IOSCO). It is a subset of IOSCO's Ethical Standards Rule under "Information about Customers," viz. INFORMATION ABOUT CUSTOMERS A firm should seek, from its customers, information about their financial situation , investment experience, and investment objectives relevant to the service provided. Comments: This principle includes any obligation to "know one's customer." This principle is a necessary element in enabling the firm to fulfill any suitability requirements. 16 The EIPD also cited the IOSCO's "Principles on Client Identification and Beneficial Ownership for the Securities Industry," viz. KNOW YOUR CLIENT (KYC) Principle 3: Authorized Securities Service Providers should obtain from each client information about the client's circumstances and investment objectives relevant to the services to be provided and should conduct ongoing due diligence regarding the client's accounts. 17 Finally, the EIPD highlighted that KYC is also a key principle implementing in Anti-Money Laundering Act (AMLA). 18 DISCUSSION In context, the CMIC Rules allegedly violated read as follows: ARTICLE 6 CONDUCT REGULATION OF TRADING PARTICIPANTS Section 1. Ethical Standards Rule. xxx xxx xxx (b) In considering whether a Registered Person is conducting his business in an ethical and fair manner, CMIC, in addition to requirements imposed under other SRC Rules, will be guided by the following principles and requirements which incorporate International Organization of Securities Commission [IOSCO] standards. xxx xxx xxx (iv) Information about clients xxx xxx xxx (b) A Registered Person shall take all reasonable steps to establish the true and full identity of each of his clients, their financial situation, investment experience, and investment objectives. xxx xxx xxx (e) A Registered Person should be reasonably satisfied about the identity, address, and contact details of the person ultimately responsible for originating the instruction in relation to a transaction, the person who stands to gain the commercial or economic benefit of the transaction, and/or bears the commercial or economic risk; provided, however, that in relation to an investment company, or discretionary account, the person referred to above is the investment company or account, not those who hold a beneficial interest therein. xxx xxx xxx (g) A Registered Person shall not do anything to effect a transaction unless he has first complied with the requirements of this rule, as required in SRC Rule 30.2, paragraph 4. Here, COL FINANCIAL is alleged to have violated the KYC Rule because it did not ascertain the "financial situation" of the Spouses Gomez. In particular, it did not verify how exactly the Spouses Gomez were able to trade Php203 Million worth of shares, despite their relatively meager Net Income of less than Php1 Million. There is no merit in COL FINANCIAL's argument that it is not required to verify the "financial situation" of the Spouses Gomez. It is clear from the KYC Rule that this is not the case. Not only must COL FINANCIAL be aware of its clients' financial situation but it is also required to conduct ongoing diligence to update itself as to the changes in the financial situation of its clients. COL FINANCIAL argues that it went beyond the CAIF and was aware that the Spouses Gomez had allocated millions of pesos into their Trading Account. It alleges that it upgraded the Spouses Gomez's account from "COL Starter" to "COL Premium," which enabled the DoubleDragon trades in the first place ( i.e. , a COL Starter account, capped at a mere Php24,999 cannot trade Php203 Million worth of shares), viz. 2.56 In understanding the financial profile of its clients, appellant [COL FINANCIAL] does not solely rely on the declarations made in the CAIF. Appellant [COL FINANCIAL] recognizes that, as the CAIF is executed by the client, the CAIF is likely to be self-serving. Further, appellant [COL FINANCIAL] takes reasonable steps in establishing the financial situation of its clients by periodically reviewing other information that it may have on the client, including the client's account ledgers. a. As part of its review process, appellant [COL FINANCIAL] periodically classifies and reclassifies clients into three (3) account types: [1] COL Starter (Php5,000 to Php24,999); [2] COL Plus (Php25,000 to Php999,999); and [3] COL Premium (Php1 Million or more). 19 xxx xxx xxx 2.57 In the case of the Spouses Gomez, had appellant [COL FINANCIAL] relied solely on the CAIF provided by them, their account would have been tagged as a COL Plus account. However, a review of the account shows that they have the status of COL Premium, a category that is more reflective of their true financial status. 20 This retagging could only have been achieved as a result of appellant [COL FINANCIAL] going beyond what is stated in the CAIF, through a review of other information regarding the Spouses Gomez and their trading activities, which allowed appellant [COL FINANCIAL] to ascertain the financial condition of the spouses with greater accuracy than what the CAIF alone would have allowed. 21 To date, however, the CAIF dated 25 October 2013 still indicates that the Spouses Gomez's individual Net Income was less than Php1 Million and their individual annual income was less than Php500,000.00. Neither the spouses nor COL FINANCIAL took any steps to update the CAIF, which is a key component of KYC regulation. Despite COL FINANCIAL's claim to know the "true financial condition" of the Spouses, it did not fulfill its obligation to update the CAIF. "Know Your Customer" is not just for the benefit of the Trading Participant ( i.e. , COL FINANCIAL). As mentioned by the EIPD, the KYC Rule is in place to prevent Money Laundering and other illegal acts . It is consistently required by the IOSCO, the SRC-IRR, and the CMIC. In other words, the KYC Rule is for the benefit of the whole financial community, if not the whole country, and falls within the Commission's broad mandate to preserve the integrity of the capital markets. There is likewise no merit in COL FINANCIAL's argument that clients are reluctant to state their true wealth , since the KYC Rule imposes a strict duty on Trading Participants to determine the true financial condition of their clients. If the true financial condition becomes known, then COL FINANCIAL should have updated the CAIF accordingly. Finally, there is no merit in the argument that the misrepresentation should be borne by the Spouses Gomez and not COL FINANCIAL , because the duties imposed by the KYC Rule falls on the Trading Participant, not the client. Moreover, COL FINANCIAL is not obligated to retain dubious clients such as the Spouses Gomez. It remains unexplained how, within less than a year ( i.e. , from 25 October 2013 when the account was opened to 14 April 2014 when the suspicious trades began), the Spouses Gomez accumulated over Php203 Million Pesos . Even a profitable year in the respective businesses of the spouses cannot explain such a sudden growth. It would appear, to a reasonable person, that there must be a source of income that COL FINANCIAL knows nothing about. Moreover, COL FINANCIAL upgraded the Spouses Gomez's trading account without updating the source of funds and the net income of the spouses. Even though it was unaware of the reason for vast and abrupt change in Spouses Gomez's financial situation, it actively facilitated the trades by upgrading the spouses' account to COL Premium. As mentioned, a "COL Starter" account cannot trade Php203 Million in shares. The Spouses Gomez were only able to conduct the suspicious trades through the upgrade provided by COL FINANCIAL. There is, thus, no reason to reverse the Decisions of CMIC. WHEREFORE , the Decisions of CMIC dated 6 February 2015 and 1 June 2015 are hereby AFFIRMED . SO ORDERED. Pasay City, Philippines, September 26, 2019. (SGD.) EMILIO B. AQUINO Chairperson (SGD.) EPHYRO LUIS B. AMATONG Commissioner (SGD.) JAVEY PAUL D. FRANCISCO Commissioner (SGD.) KELVIN LESTER K. LEE Commissioner (SGD.) KARLO S. BELLO Commissioner Footnotes 1. COL FINANCIAL Customer Account Information Form No. 0700-0963, Joint Trading Account in the name of Spouses Jonathan and Cherryl Faith Gomez, opened on 25 October 2013 , which is attached to CMIC's Letter to COL Financial dated 3 September 2014 ( Annex G of the Memorandum on Appeal). 2. Reiterated in the Memorandum of Appeal, viz. "Regardless of the fact that clients are required to vouch for the truthfulness of their answers in the CAIF, it cannot be denied that some clients are not forthcoming with their disclosures. Nor is it possible for appellant [COL FINANCIAL] to somehow guarantee that its clients shall provide answers that are completely honest or accurate, or for appellant [COL FINANCIAL] to coerce such answers. (Page 17) "Hence, any inconsistencies were purely a result of the client's inaccurate CAIF disclosures and not attributable to any negligence on the part of appellant COL." (Page 20) 3. Page 2 of CMIC Decision dated 1 June 2015. 4. Page 14 of COL FINANCIAL's Memorandum on Appeal. 5. Id. 6. Page 15 of COL FINANCIAL's Memorandum on Appeal. 7. Page 8 of the CMIC's Reply Memorandum. 8. Id. 9. These rules have been retained in the current 2015 SRC-IRR. 10. Article VI, Section 1 (b) (v) item (b) of the CMIC Rules. 11. SRC Rule 30.2-1 (B) (iv) (b) of the 2014 SRC-IRR. 12. Article VI, Section 1 (b) (iv) item (e) of the CMIC Rules. 13. SRC Rule 30.2-1 (B) (iv) (e) of the 2014 SRC-IRR. 14. Article VI, Section 1 (b) (iv) item (g) of the CMIC Rules. 15. SRC Rule 30.2-1 (B) (iv) (g) of the 2014 SRC-IRR. 16. Pages 4-5 of EIPD's Comment. 17. Page 5 of EIPD's Comment. 18. Page 7 of EIPD's Comment. 19. Page 19 of COL FINANCIAL's Memorandum on Appeal. 20. Id. 21. Page 20 of COL FINANCIAL's Memorandum on Appeal.