WILL fully screen-based share trading end front-running? Yes, according to a number of leading stock brokers including William Phillips, managing director of Salomon Brothers Hong Kong. But Paul Phenix, head of compliance at the exchange, says no. The current trading system in Hong Kong involves a computer Automated Matching System which receives buy and sell orders punched in from the floor of the exchange. The big brokerages with dealing rooms at the exchange, will receive their orders by telephone from clients and transfer them on to the floor, again by phone, where they are put into the system. The orders put into the computer are matched on a first-in, first-out basis and trading is carried out as orders come in. For the floor traders, this system produces all kinds of opportunities for graft. Front-running, like insider-dealing, is really simple. If, for instance, a 22-year-old floor trader earning $15,000 a month knows that over the next few hours he and his colleagues will trade hundreds of millions of dollars in one particular stock, he has a piece of information which the rest of the market does not have. The trader's firm will not put the whole order up at once - the price would plummet if it was a sell, and soar if it was a buy. Instead, the order is fed on to the floor a bit at a time. If the young trader's firm is buying a large block of one stock on behalf of a client, it is a fair bet that supply will run short and the price will rise. If the young floor trader is unscrupulous, opportunistic, or just talks too much the information will leak. The unscrupulous trader simply whispers across to a similar trader on a desk nearby. 'Today, we are buying Hutchison shares. Get 100,000.' His equally unscrupulous colleague does not have to hang about asking why. He simply finds a brokerage which will accept orders from another floor trader and buys. Later, when the supply of willing Hutchison sellers has run dry, he sells at a higher price than at the start of the day. If the deal is done on a margin account, it will have cost nothing to set up, and it is almost automatically profitable. The original seller of the Hutchison shares to the traders has been ripped off. So has the buyer who might otherwise have got all his shares for less money. Many market participants believe it is the exchange floor which makes front-running possible. From a technical standpoint, the floor is not needed. The terminals could be moved off the floor and into brokerage dealing rooms relatively easily. But this would alarm many smaller brokers who rely on the exchange floor for cheap office space. Brokers also know the exchange floor helps make the market efficient. News travels fast on the floor. At an extraordinary general meeting of the exchange last year, brokers voted to 'retain the trading floor' - a measure of the degree of worry over its future. The worry was caused because when brokers were allowed to add a second terminal per seat on the exchange, they would be allowed to place it in their own dealing room and trade from there. But Mr Phillips and many others believe it is the way of the future. 'It is the difference between compliance in theory, and having people directly under your supervision.' If floor traders attempt to beat the system from a dealing room they should be caught on the tapes which brokers make of all calls. Mr Phenix believes it will not be so simple. 'I understand Willie's [Mr Phillips'] point,' he said. 'But the inference is that front-running doesn't take place on markets with fully automated systems, like in London and Singapore. That is simply not the case.' In America too, the NASDAQ system has come under fire with accusations of collusion among market makers and claims that front-running is widespread. The truth is unless traders are kept in permanent solitary confinement or 24-hour observation, prevented from leaving the dealing room during trading, front-running will always be something big brokerages and their big clients will have to worry about. It will also be something that ordinary investors have to think about. Those who sell shares to front-runners get ripped off, too.
