Hong Kong's Securities and Futures Commission released its 2012-2013 annual report last month. It opens with a well-crafted piece about the benefits of "quality" regulation and "sustainable" markets, which generally sounds consistent with news stories about the new, tougher SFC. But the tables at the end of the report tell a story that financial crooks won't miss: criminal prosecutions for insider trading have dwindled. The SFC won exactly one new criminal insider trading conviction last year.
Only the most hard-core apologists still call insider trading a victimless crime. Hong Kong got religion in 2008, when it began a flurry of criminal prosecutions for insider trading, its first ever. Prison sentences for Du Jun, and several others in 2008 and 2009, gave the crackdown credibility and generated international praise. Du, a Morgan Stanley banker, was convicted of insider trading in September 2009, sentenced to seven years in prison (reduced to six on appeal) and hit with HK$23 million in financial penalties (reduced to HK$1.688 million, so there will be money for victims' claims).
It was a strong start, but it's a golden oldie and a few cases aren't enough to send a sustainable deterrent message. If there's one lesson that came out of the late 1980s, Ivan Boesky era in the US, it's that a few high-profile cases, even with prison sentences, are soon forgotten. By 2006, when US authorities started looking closely at the problem again, insider trading was rampant.
Hong Kong, with a past reputation as a safe haven for insider trading, needs steady, regular criminal prosecutions followed by prison sentences for those found guilty.
Nobody said it would be easy and no doubt it has been a learning experience. Some of the legal issues the SFC faces require thought and testing in the courts. Others require co-ordination with regulators in other markets. The Tiger Asia case, currently in the news, required both and highlights a practical challenge for the SFC: what to do when crooks who steal in Hong Kong markets are offshore?
According to the US Securities and Exchange Commission (SEC), in December 2008 and January 2009, New York-based hedge fund Tiger Asia, managed by Bill Hwang Sung-kook and Raymond Park, "entered into 'wall-crossing' agreements for three private placements of Chinese bank stocks, subsequently violated the wall-crossing agreements by short selling the Chinese bank stocks, and then covered these short positions with private placement shares purchased at a discount". "Wall crossing" is industry jargon that meant Park and Huang agreed not to do exactly what they did - trade on the confidential information the Chinese banks' investment bankers gave them. The illegal profits of US$16.2 million they made is about as close to free money as you can get.
The SFC applied for an injunction to freeze some of Tiger Asia's assets in August 2009, which started a protracted legal battle. Within weeks, the SEC issued subpoenas for Tiger's records.
Last December, Tiger Asia Management, the company, pleaded guilty to criminal wire fraud in US federal court. It also, along with Tiger Asia Partners, Huang and Park, entered civil consent judgments with the SEC and paid some US$60 million in disgorgement and penalties. The SEC's complaint details a long list of bad behaviour, including multiple attempts to manipulate Hong Kong's markets to show inflated month-end figures so they could overcharge their investors for their good performance.
The problem with the US resolution and one at the same time in Tokyo was the same: the bad guys just paid a large amount of money and walked.
After finally getting the go-ahead from Hong Kong's courts, the SFC made the decision last week to pursue the matter civilly, not criminally.
The practical limitation the SFC faces - how to arrest people who aren't in Hong Kong - points out one of the big challenges. About half of the trading done in Hong Kong's equity markets comes from offshore. If the worst regulators can do is grab crooks' gains and ban them from further trading - the route taken with Tiger Asia - the odds look good to those who want to cheat.
The SFC deserves credit for the progress made since 2008, but the fight can't be over. The crackdown in the US has seen almost 80 inside traders convicted, and the FBI has disclosed that it was likely to bring charges in many more cases it's investigating. Judges, who understand the value of clean markets to our society, are handing down record prison sentences.
Let's hope the lull in criminal prosecutions of inside traders was temporary and Hong Kong also finds a way to get the offshore financial rogues, wherever they are. In a world where inequality is soaring, governments can't afford not to go after these guys in the most deterrent way possible.
Quality in regulating Hong Kong's financial markets sounds like a good thing, but quantity in criminal insider trading prosecutions is better. Hong Kong's honest investors, saving for retirement and their children's education, or to buy an overpriced, tiny flat many miles from where the finance guys live overlooking Hong Kong harbour, need to know that the markets are fair. The best way to make this clear is a sustainable criminal crackdown on insider trading.
Robert Boxwell is director of the consultancy Opera Advisors