Something amiss when traders moulder in jail and bank goes scot-free

The SFC found that [Chun Peng-fai's] trading could mislead other investors because it would falsely inflate the turnover of the relevant [Macquarie Bank] warrants, creating a false or misleading appearance that they were actively traded. This is the last in the series of SFC enforcement actions arising from related incidents.

Securities and Futures Commission

Press release, Oct 21

Hold on there, fellas. Make it the latest in the series if you wish, but do not make it the last. There are a few questions still to be answered here.

Let's set the scene. Starting more than eight years ago, Macquarie Equities Asia set up a commission rebate scheme to stimulate trading in selected Macquarie Bank warrants. Under this rebate arrangement, Macquarie agreed to reimburse investors, through their participating brokers, either in full or in part, the brokerage costs they were charged for trading specified warrants. These rebates were as high as 0.25 per cent of the transaction value.

Not surprisingly, this rang the dinner bell for a number of traders. If they could get their transaction costs below 0.25 per cent while still collecting that 0.25 rebate from Macquarie, they could make guaranteed money from just flipping these warrants back and forth between each other.

It is, in fact, what the SFC says this latest malefactor, Chun Peng-fai, did. His broker charged him only 0.05 per cent commission and he then repeatedly bought and sold the same derivative warrant at or near the same price within short time intervals. The trouble is that such activity may give other investors the impression that there is genuine active trading in these securities when this trading is really only an illusion to draw in the gullible and lumber them with illiquid securities.

Now you might say, and I certainly do, that you have to be pretty dumb or greedy to fall for this trick. If you get stung by it, well, chalk that up as a good lesson. Caveat emptor. If you use no more brain than a fish when looking at a fisherman's bait, then expect to be hooked occasionally.

Yet securities regulators would be out of work if they adopted this commonsense view of things and their rule book says it is a no-no to create such investment lures. In fact, it is more than a no-no. They have made it a crime. Two securities traders are at present sitting in jail, one for 36 months and one for 33, for having traded these same Macquarie warrants in a misleading fashion in 2004 and 2005.

That's right. No one was killed, no one hurt, no one robbed and the penalty was still three years in the slammer. Hanging judges in Hong Kong? No, of course not, no way. This isn't North Korea, you know.

Yet now what about the people at Macquarie Equities Asia? They created this rebate scheme and they did it in the securities of their own bank. We are talking here of a firm of investment professionals who knew that these securities were illiquid, knew that a greater volume of trading would make them more attractive and caused that greater volume to be created.

No, they did not get off completely free. They were given a letter of reprimand (Ow ... so painful) and fined HK$4 million, which a bank like this takes out of the petty cash box. The SFC says it warned them in 2002 of what could happen with these warrants, told them it could lead to a false market, but, alas, Macquarie still proved 'in breach of its obligation to act with due skill, care and diligence in the best interests of the integrity of the Hong Kong market'.

There is a not-quite-right feel about all this. A bank concocts a rebate scheme that inflates the volume of trading in its own illiquid securities, is warned this could create a false market, has plenty of opportunity over a number of years to observe that it has indeed done so, but still operates the scheme for more than a year after the evidence has become obvious.

And yet all it gets is a slap on the wrist while two traders whom the rebates attracted to engage in such a false market languish in jail.

Why was no one from Macquarie put in the dock with these two? Inducing people to commit a crime is itself a crime and it is only made worse if you continue to induce them after you know they have committed the crime.

I am not saying that anyone at Macquarie should also have been jailed. The question of guilt is a question for our courts of law. But I do say that it should have been put to a court of law rather than left to a regulator alone to administer a light tap on the wrist.

It's all very mysterious.