Jake's View

Smell a rat? Let the market deal with it

Efforts by the CSRC to stop 'rat trading' across the border should be applauded, but the regulator may not know the extent of the problem

PUBLISHED : Tuesday, 20 May, 2014, 12:41am
UPDATED : Tuesday, 20 May, 2014, 12:41am

Probe into rat trading spurs fund managers to quit

SCMP headline, May 19

I have never been quite certain what they mean across the border by "rat trading". It seems on this occasion that the offence is defined as overly active trading by stockbrokers in discretionary accounts managed on behalf of relatives.

I have also heard it defined there as collusion with other brokers to split the difference in profits from executing client trades at bad prices.

That's what comes of using meaningless pejorative terms favoured by regulators. You know they refer to badness in the market but you never know what particular badness.

To me rat trading has never meant more than good old-fashioned front running. Jump in first when the client gives you a big buy order, wait until his buying has pushed the price up and then sell. Best do it through a blanket account at a big New York bank to be safe.

Hold true and the market will support you. Betray it and the market will drop you

It works just as well in reverse for a client sell order and you can always make it work even better by doing a clumsy job of putting the order through the market.

The best way I have ever seen it done was by the chief trader at one brokerage for which I briefly worked. He put few orders through the back office until well after the market had closed. The interval was devoted to deciding which trades of the day should go to his personal account and which to his clients.

It cannot be done any longer, of course. Where paper is still used for passing orders along, the slips are time-stamped and the cheat would quickly be uncovered.

Then again, however, time-stamping machines need occasional maintenance, which, no doubt, explains how a friend could once point out to me that the head of his dealing desk wore a key to the desk's time stamper around his neck. Well maintained machine, that was.

And it is not just the denizens of dealing rooms who play the game. I remember a time when a prominent thug, who shall remain nameless on the grounds that I prefer kitchen knives used on my dinner only, would call up a number of dealing desks every morning and say, "What have you got on today?"

He then held a Christmas party with special door prizes for his talkative erstwhile "friends". They got BMWs.

I applaud the efforts of the China Securities Regulatory Commission to stop this sort of thing across the border but I wonder if it really understands the scale of the problem.

When these practices reach a certain stage they become all pervasive. Imagine yourself the delivery boy whose parents are grinning from ear to ear because he has just landed himself a job on a dealing desk.

At the end of his first week a colleague drops a blank envelope on his lap. Inside he can feel banknotes.

"What's this?" he asks. "Your share," says his colleague. So what can he do now?

If he takes it he's on the game, sharing the loot and sharing the guilt. If he refuses it his colleagues will contrive to push him out of the job as he's dangerous to them. Inevitably he takes it.

Is the CSRC ready to send the whole lot back to the delivery van and then completely change the compensation system for securities dealers? I doubt it.

In my experience, however, the market does a better job of seeing off rat traders than any regulator does. Last year I once again met that chief trader who only sent his tickets in after the market closed. He hadn't found an employer in years, nor clients.

Trust is valued in the market. Hold true and the market will support you. Betray it and the market will drop you.

And if you are the client here is a word of advice: Don't deal so often. Rat traders can only get you when you deal. You're safe from them when you don't.

Be honest now, how often have you not had to tell yourself in hindsight that you dealt for fatuous reasons? Ignore that stockbrokers' babble. It's an old stockbroker who says so.