A securities probe that rooted out an alleged rat trader was limited in scope by regulations that may be letting the big ones get away.
Song Yanhua and Zhang Bing 8 June 2009
(Caijing Magazine) A recent investigation into alleged price manipulation by a fund manager has exposed regulatory loopholes in China’s investment fund sector and lenient attitudes toward crooked stock trading.
Zhang Ye, a fund manager at Rongtong Fund Management Co., was fired after his connection to the case was investigated by the China Securities Regulatory Commission (CSRC), which declared the probe’s completion on May 12.
The case involves so-called rat trading, in which brokers or floor traders manipulate share prices by using inside information. CSRC’s announcement signalled that, apparently, it found a rat.
However, a Rongtong employee recently told Caijing that the company has not been notified by CSRC about any possible penalties stemming from the investigation.
Moreover, no progress has been reported in the case’s ties to a private account under the name Zhou Qiang, which was found to be closely tracking stock investments made by Rongtong funds. Zhou is the young daughter of a Beijing investor with ties to Zhang.
Complicating the probe are legal questions. For example, whether criminal laws can be applied to any parties tied to the Zhang case remains an open question. And Caijing learned that, under current regulations, CSRC only has the power to penalize and bar from market participation individuals found to be involved in market-rigging.
Smelling a Rat
Information released by authorities showed that several funds controlled by Rongtong and Zhou were among the 10 largest shareholders, simultaneously or consecutively, of the following firms: Xinjiang Chalkis Co. Ltd. (SZSE: 000972), Guangzhou Refrigeration Co. Ltd. (SZSE: 000893), Hainan Haiyao Co. Ltd. (SZSE: 000566), and Sichuan Chemical Co. Ltd. (SZSE: 000155). These parallel holdings raised suspicions of rat trading.
Public attention also focused on fund managers like Zhang, who might be responsible for Rongtong’s funds. Caijing unsuccessfully tried several times to interview these managers.
Rongtong issued a statement after the markets closed May 14 identifying Zhang as the manager responsible for illegal practices. The firm also announced his dismissal. Earlier that day, information about Zhang’s behaviour was posted on the Caijing.com Web site.
Zhang, who has a master’s degree in business and worked 14 years in the securities industry, managed two index funds. Data from Morningstar’s Chinese branch shows the aggregate rate of return for one fund since 2003 was 207.6 percent, while the other’s return since 2005 was 193.1 percent.
Stock investments by Zhang’s fund could not have been a profit source for Zhou, since index funds cannot be easily manipulated or tracked.
Fund managers are currently banned from all forms of stock trading in China. Moreover, fund management company employees cannot invest in stocks, while shares bought by an employee’s immediate relatives must be reported to his or her company, according to CSRC guidelines.
But the guidelines do not cover associates who are not family members. And since there is no tracking system or monitoring, employees are supposed to take the initiative to report stock investments by their relatives.
In addition, a senior fund manager who asked not to be named told Caijing that fund managers often exchange stock views internally, at their offices, with the goal of determining investment strategies at rival funds. This process of data sharing among fund managers is encouraged by firms. A slip side is that sensitive information can be passed around, the fund manager said.
Rat trading does not require in-depth knowledge of a fund’s investment strategies, according to the manager. For example, a fund manager can open a position on a stock that he knows another fund plans to buy in bulk.
In the United States, fund managers and associates are required to submit details immediately to a firm after each stock trade. This reporting system means employees at U.S. securities firms can trade stock, although some firms don’t let employees buy stocks related to funds they manage, while others bar stock investments within 60 days of a fund’s trading activities.
Zhang Investigation
At CSRC, the Zhang investigation moved more rapidly than previous probes. The commission completed the preliminaries just a few days after the media began questioning the possibility of rat trading at Rongtong on April 9. A CSRC official confirmed personnel had violated fund operation regulations.
It’s noteworthy that this case – as is typical for rat trading cases – has been identified as an “individual’s problem,” not a fund management issue. This approach to enforcing regulations may appear misleading, but it prevents a probe from damaging the reputation of a fund management company.
Nevertheless, loose internal control and a lack of external supervision can be blamed for rat trading. Some say Rongtong, for example, could have done better in protecting investor interests after the probe began. The firm replied to these charges by promising publicly to release relevant information as the case progressed.
Caijing.com’s news that Zhang had been suspected of wrongdoing came a day after Rongtong’s public relations manager emphasized that the company had not received any orders from CSRC, and that no one had been dismissed. These claims were made when Caijing called the company on May 13.
Rongtong’s next-day statement identifying Zhang as a target also said the firm had suspended the fund manager’s operations as early as April 14, putting other managers in charge of his funds. Rongtong also said it dismissed Zhang on April 14 – a full month before its public announcement, and even though the first-quarter reports from each fund managed by Zhang listed him as the manager.
“Investors were completely at loss about who was actually managing their capital for a month,” said a fund analyst.
In delaying news about Zhang, Rongtong not only broke its promise about releasing timely information but also violated two regulations: One that says a fund management company must report to local CSRC offices when a firm makes a fund manager change, and another that says fund manager adjustments must be reported to regulatory authorities within two days of a decision. In addition, public information must include reasons for any change, and a new manager’s resume must include basic information and a record of his or her fund management.
Zhang’s exposure turned a spotlight on the Zhou account. The media learned that Zhou is a Beijing girl born in 1988. When she supposedly invested in Xinjiang Chalkis in 2006, she was only 18 years old. And in 2009, while trading Sichuan Chemical stock, she was only 21 years old.
Caijing learned that Zhou’s father is Zhu Xiaoming, who was born in 1955 and, along with the girl, were on a list of the 10 largest shareholders of Xinjiang Chalkis in 2006.
Zhou and Zhu opened positions in the second and third quarters of 2006, respectively, while three other funds controlled by Zhang bought the company’s stock in bulk in the fourth quarter.
A source close to Zhu said he has a large social network, and that “Zhang happens to be a friend of Zhu.”
Zhu once owned a software company focusing on auto insurance management. Zhu tried to get his company listed in 2002 after “he met some people in the field of securities management,” the source said.
Research for developing this software began at the China Vehicle Inspection Center, a branch of the Ministry of Public Security. Zhu sold more than 5,000 copies of the software to the People’s Insurance Co. of China, reportedly earning more than 100 million yuan.
Another possible line of evidence is that Xinjiang Chalkis’ stock price rose to 17.08 yuan a share by the end of 2006 from 11.17 yuan in late September. Zhou and Zhu held 517,000 shares and 528,000 shares of Xinjiang Chalkis respectively in September 2006.
These details, however, apparently do not provide enough evidence to prove that Zhou or any other wire-puller behind the scenes was involved in rat trading.
The case of Tang Jian, who was convicted for rat trading in May 2007, was more clear-cut. The former manager at China International Fund Management Co. used his father’s identity card to open an account that could be manipulated. Because capital for the illegal trading came from Tang’s account -- and every deal was handled by Tang – the father was not implicated.
Tang was one of only two fund managers to be punished for rat trading in China. He was found guilty of arranging 1.52 million yuan in illegal gains, while Wang Limin at Southern Fund Management Co. Ltd. was convicted for more than 1.5 million yuan in rat trade earnings.
It’s hard to determine the amount of the allegedly illegal gains by Zhou, although Caijing learned that the girl’s account was not controlled by Zhang. A lawyer familiar with capital market crimes said identities can be misappropriated to hide actual collaborators.
Loose regulations and lenient punishment have contributed to rat trading, which is a chronic problem on China’s stock markets.
A fund analyst who declined to be named said current rules make it difficult to deter rat trading, especially because investigations are rare and rulings lenient.
In the cases of Tang and Wang, CSRC seized all rat-trading gains and fined each convicted market manipulator 500,000 yuan. Regulators also banned them from the markets.
A new law that took effect March 1 sets sentences of five to 10 years for “serious” cases of rat trading. Fines range from twice to five times the gains from illegal activity. But the law does not define “serious,” prompting the Supreme People’s Court to recently start work on a judicial interpretation.
Yin Xiuchao, a partner at Beijing-based B&J Partners Law Firm, said the severity of a case should be measured by the amount of capital involved, or the proportion of rat trading capital to equity fund invested capital. He also called for stricter penalties for anyone involved in rat trading.
“This law will only be effective in stopping such activity if the penalties and sentences are tougher,” Yin said.
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Rongtong Rat Trading Exposes Loopholes
A securities probe that rooted out an alleged rat trader was limited in scope by regulations that may be letting the big ones get away.
Song Yanhua and Zhang Bing
8 June 2009
(Caijing Magazine) A recent investigation into alleged price manipulation by a fund manager has exposed regulatory loopholes in China’s investment fund sector and lenient attitudes toward crooked stock trading.
Zhang Ye, a fund manager at Rongtong Fund Management Co., was fired after his connection to the case was investigated by the China Securities Regulatory Commission (CSRC), which declared the probe’s completion on May 12.
The case involves so-called rat trading, in which brokers or floor traders manipulate share prices by using inside information. CSRC’s announcement signalled that, apparently, it found a rat.
However, a Rongtong employee recently told Caijing that the company has not been notified by CSRC about any possible penalties stemming from the investigation.
Moreover, no progress has been reported in the case’s ties to a private account under the name Zhou Qiang, which was found to be closely tracking stock investments made by Rongtong funds. Zhou is the young daughter of a Beijing investor with ties to Zhang.
Complicating the probe are legal questions. For example, whether criminal laws can be applied to any parties tied to the Zhang case remains an open question. And Caijing learned that, under current regulations, CSRC only has the power to penalize and bar from market participation individuals found to be involved in market-rigging.
Smelling a Rat
Information released by authorities showed that several funds controlled by Rongtong and Zhou were among the 10 largest shareholders, simultaneously or consecutively, of the following firms: Xinjiang Chalkis Co. Ltd. (SZSE: 000972), Guangzhou Refrigeration Co. Ltd. (SZSE: 000893), Hainan Haiyao Co. Ltd. (SZSE: 000566), and Sichuan Chemical Co. Ltd. (SZSE: 000155). These parallel holdings raised suspicions of rat trading.
Public attention also focused on fund managers like Zhang, who might be responsible for Rongtong’s funds. Caijing unsuccessfully tried several times to interview these managers.
Rongtong issued a statement after the markets closed May 14 identifying Zhang as the manager responsible for illegal practices. The firm also announced his dismissal. Earlier that day, information about Zhang’s behaviour was posted on the Caijing.com Web site.
Zhang, who has a master’s degree in business and worked 14 years in the securities industry, managed two index funds. Data from Morningstar’s Chinese branch shows the aggregate rate of return for one fund since 2003 was 207.6 percent, while the other’s return since 2005 was 193.1 percent.
Stock investments by Zhang’s fund could not have been a profit source for Zhou, since index funds cannot be easily manipulated or tracked.
Trading Rules
Fund managers are currently banned from all forms of stock trading in China. Moreover, fund management company employees cannot invest in stocks, while shares bought by an employee’s immediate relatives must be reported to his or her company, according to CSRC guidelines.
But the guidelines do not cover associates who are not family members. And since there is no tracking system or monitoring, employees are supposed to take the initiative to report stock investments by their relatives.
In addition, a senior fund manager who asked not to be named told Caijing that fund managers often exchange stock views internally, at their offices, with the goal of determining investment strategies at rival funds. This process of data sharing among fund managers is encouraged by firms. A slip side is that sensitive information can be passed around, the fund manager said.
Rat trading does not require in-depth knowledge of a fund’s investment strategies, according to the manager. For example, a fund manager can open a position on a stock that he knows another fund plans to buy in bulk.
In the United States, fund managers and associates are required to submit details immediately to a firm after each stock trade. This reporting system means employees at U.S. securities firms can trade stock, although some firms don’t let employees buy stocks related to funds they manage, while others bar stock investments within 60 days of a fund’s trading activities.
Zhang Investigation
At CSRC, the Zhang investigation moved more rapidly than previous probes. The commission completed the preliminaries just a few days after the media began questioning the possibility of rat trading at Rongtong on April 9. A CSRC official confirmed personnel had violated fund operation regulations.
It’s noteworthy that this case – as is typical for rat trading cases – has been identified as an “individual’s problem,” not a fund management issue. This approach to enforcing regulations may appear misleading, but it prevents a probe from damaging the reputation of a fund management company.
Nevertheless, loose internal control and a lack of external supervision can be blamed for rat trading. Some say Rongtong, for example, could have done better in protecting investor interests after the probe began. The firm replied to these charges by promising publicly to release relevant information as the case progressed.
Caijing.com’s news that Zhang had been suspected of wrongdoing came a day after Rongtong’s public relations manager emphasized that the company had not received any orders from CSRC, and that no one had been dismissed. These claims were made when Caijing called the company on May 13.
Rongtong’s next-day statement identifying Zhang as a target also said the firm had suspended the fund manager’s operations as early as April 14, putting other managers in charge of his funds. Rongtong also said it dismissed Zhang on April 14 – a full month before its public announcement, and even though the first-quarter reports from each fund managed by Zhang listed him as the manager.
“Investors were completely at loss about who was actually managing their capital for a month,” said a fund analyst.
In delaying news about Zhang, Rongtong not only broke its promise about releasing timely information but also violated two regulations: One that says a fund management company must report to local CSRC offices when a firm makes a fund manager change, and another that says fund manager adjustments must be reported to regulatory authorities within two days of a decision. In addition, public information must include reasons for any change, and a new manager’s resume must include basic information and a record of his or her fund management.
How to Hide a Rat
Zhang’s exposure turned a spotlight on the Zhou account. The media learned that Zhou is a Beijing girl born in 1988. When she supposedly invested in Xinjiang Chalkis in 2006, she was only 18 years old. And in 2009, while trading Sichuan Chemical stock, she was only 21 years old.
Caijing learned that Zhou’s father is Zhu Xiaoming, who was born in 1955 and, along with the girl, were on a list of the 10 largest shareholders of Xinjiang Chalkis in 2006.
Zhou and Zhu opened positions in the second and third quarters of 2006, respectively, while three other funds controlled by Zhang bought the company’s stock in bulk in the fourth quarter.
A source close to Zhu said he has a large social network, and that “Zhang happens to be a friend of Zhu.”
Zhu once owned a software company focusing on auto insurance management. Zhu tried to get his company listed in 2002 after “he met some people in the field of securities management,” the source said.
Research for developing this software began at the China Vehicle Inspection Center, a branch of the Ministry of Public Security. Zhu sold more than 5,000 copies of the software to the People’s Insurance Co. of China, reportedly earning more than 100 million yuan.
Another possible line of evidence is that Xinjiang Chalkis’ stock price rose to 17.08 yuan a share by the end of 2006 from 11.17 yuan in late September. Zhou and Zhu held 517,000 shares and 528,000 shares of Xinjiang Chalkis respectively in September 2006.
These details, however, apparently do not provide enough evidence to prove that Zhou or any other wire-puller behind the scenes was involved in rat trading.
The case of Tang Jian, who was convicted for rat trading in May 2007, was more clear-cut. The former manager at China International Fund Management Co. used his father’s identity card to open an account that could be manipulated. Because capital for the illegal trading came from Tang’s account -- and every deal was handled by Tang – the father was not implicated.
Tang was one of only two fund managers to be punished for rat trading in China. He was found guilty of arranging 1.52 million yuan in illegal gains, while Wang Limin at Southern Fund Management Co. Ltd. was convicted for more than 1.5 million yuan in rat trade earnings.
It’s hard to determine the amount of the allegedly illegal gains by Zhou, although Caijing learned that the girl’s account was not controlled by Zhang. A lawyer familiar with capital market crimes said identities can be misappropriated to hide actual collaborators.
Legal Ambiguity
Loose regulations and lenient punishment have contributed to rat trading, which is a chronic problem on China’s stock markets.
A fund analyst who declined to be named said current rules make it difficult to deter rat trading, especially because investigations are rare and rulings lenient.
In the cases of Tang and Wang, CSRC seized all rat-trading gains and fined each convicted market manipulator 500,000 yuan. Regulators also banned them from the markets.
A new law that took effect March 1 sets sentences of five to 10 years for “serious” cases of rat trading. Fines range from twice to five times the gains from illegal activity. But the law does not define “serious,” prompting the Supreme People’s Court to recently start work on a judicial interpretation.
Yin Xiuchao, a partner at Beijing-based B&J Partners Law Firm, said the severity of a case should be measured by the amount of capital involved, or the proportion of rat trading capital to equity fund invested capital. He also called for stricter penalties for anyone involved in rat trading.
“This law will only be effective in stopping such activity if the penalties and sentences are tougher,” Yin said.
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