Insider traders: As furtive as a fox in a chickensuit
You could argue, I suppose, that if you came by information allowing you to make a quick buck, it would be rude not to use it. The gods have smiled upon you, so seize the day.
Indeed, this is exactly what a chap named Zhu Bo Shi argued in his defence of insider trading charges late last year.
In recording its judgment, the Supreme Court of New South Wales noted submissions on behalf of the defendant that, "in Chinese circles, one was considered foolish if you did not take advantage of an opportunity that presented itself to you, especially if the advantage was to make money.
Further, it was contended, based on the evidence presented for the offender, that Chinese people traded in securities with inside information as being one such opportunity and it was not considered to be serious criminal conduct".
It turned out the court was not big on cultural sensitivity: Zhu was sentenced to 15 months in jail.
Still, Chalkie reckons the culture of opportunism must be widespread in the Lucky Country, because people seem to be pinged for insider trading on a regular basis.
Since January 2009, the Australian Securities & Investment Commission has prosecuted 27 cases alleging insider trading, 19 of them successfully.
New Zealand is obviously a different place. Insider trading has been illegal here since March 2008 and we've had not a single case. We are fortunate that our culture is so discouraging of such anti-social behaviour.
Or could it be that insider trading happens here but just doesn't get prosecuted?
Pah and pshaw! New Zealand is 100 per cent pure, surely? And yet Chalkie's eye has been drawn on more than one occasion to some odd trading patterns.
In a recent example, on June 28, retailer Pumpkin Patch announced that its profit for the year to July 31 would be hit by aggressive discounting in the Australian market over the previous five weeks. That day Pumpkin Patch shares fell from 86c to 78c, a drop of 9 per cent.
There's nothing strange about that, except that during the previous week the share price fell more steeply on rising volume from 99c to 86c, a drop of 13 per cent.
A premonition? Perhaps investors were spooked by a profit warning from Hallenstein Glasson on June 13 citing aggressive discounting and price-based promotion in Australian womenswear. If so, it was a delayed spook, because between June 13 and 20 Pumpkin Patch shares eased just 5c to 99c.
Curious, Chalkie asked to see the company's share register for the period, which was kindly provided by registrar Link Market Services. Unfortunately, the information reveals nothing because the main sales volume came from NZ Central Securities Depository, a custodian nominee that holds shares on behalf of fund managers, banks, insurance companies and the like, so it's impossible to tell who was doing most of the selling.
Dead end. But within days, a similar example appeared when Rakon, a maker of crystal components for electronics, announced a significant deal on July 5 with Chinese company ZheJiang East Crystal Electronic Company.
Among other things, the arrangement heralded the release of US$18.8 million (NZ$24m) to pay down debt and the Chinese company's purchase on market of 5 per cent of Rakon's shares.
Rakon stock, which had been trading at or below 20c for the whole previous month, hit 27c on the news.
The funny thing is, there was a distinct uptick immediately before the announcement. From a close of 20c on July 2 the shares went to 22c on July 3 and 24c on July 4. In the hour and a half before a trading halt was put in place on July 5, the shares rose to 25c.
That's a gain of 25 per cent in three days.
On Tuesday last week, Chalkie asked Rakon's registrar, Computershare, for access to the share register for the period between June 4 and July 9. Computershare, apparently after contacting the company, refused the request, citing "privacy reasons".
Privacy is all very well, said Chalkie, but the register, which includes the names and dates of share transfers for the previous 10 years (as per Section 87 of the Companies Act), is a public document (as per section 215). No, can do, said Rakon.
Never mind. Even if there were some dodgy trades, they would probably not show up in the register anyway - any insider trader worth their salt would find more circuitous routes to market.
Just look at what Zhu got up to.
In 2006 and 2007 he was working for investment bank Caliburn and was part of its deal team for a takeover bid for listed company Veda Advantage, giving him access to information about the timing and price of the pending bid.
Six weeks before the potential bid was publicly announced Zhu got a friend, a Ms Chen, to open a trading account with IG Markets, which was used to buy contracts for difference, or CFDs, in Veda shares.
CFDs, as their name implies, are contracts with a financial services company and are not actual shares. Trades in CFDs may be matched with another client or hedged in the real sharemarket. Either way, the name of the trader never appears on the register.
Using his friend's CFD account, Zhu was able to buy and sell Veda stock to benefit from his advance knowledge of the takeover. His share of the total profit was A$55,814.50 (NZ$65,034.26).
Zhu then moved to Credit Suisse, where he used Chen's trading account at Commonwealth Securities to generate profit from his knowledge of a transaction involving Adelaide Managed Funds.
His third series of offending went much further in its circuitous effort to avoid detection. By 2010, Zhu was working for Hanlong Mining, an Australian company ultimately owned by colourful Chinese businessman Liu Han (regular readers may recall a discussion by Chalkie of Hanlong in May).
According to the Supreme Court ruling, Zhu and several more senior Hanlong executives set up a company in Hong Kong called Golden Stone Partners. None of them was an officer or shareholder of Golden Stone.
They then set up an Australian company, Wingatta, as a subsidiary of Golden Stone. A junior Hanlong employee was the sole director of Wingatta.
Zhu and his accomplices created companies in the British Virgin Islands to operate bank accounts in Hong Kong which channelled money to and from Golden Stone and Wingatta.
Meanwhile, the junior Hanlong employee was named as the sole operator of Wingatta's Australian bank account and its CFD trading accounts with financial services company CMC Markets, although all were in fact operated by Zhu.
Wingatta was involved in several trades, but taking the biscuit was its dealing around Hanlong's takeover attempts for Australian mining companies Bannerman and Sundance Resources.
To summarise intricate details, Zhu and his cohorts were involved in creating takeover situations that allowed them to make profitable insider trades, some of them funded by lending from Hanlong itself. The total profit for the offenders was A$1.26m, of which Zhu's share was A$305,074.
Over the years, Zhu's dodgy trading went from small-scale and opportunistic to large-scale and carefully planned. Catching him would not have been easy.
In New Zealand, the Financial Markets Authority has examined six insider complaints in the past year involving trading before price-sensitive market announcements. The value of trades ranged roughly between $10,000 and $60,000.
Nothing illegal was found in four cases. Two are still being probed.
Meanwhile, the Shareholders Association has asked NZX to look at the Rakon case, although NZX can't do much if the trading was done through CFDs - and it has limited investigative resources anyway. Rakon has said no company directors or staff, or their related parties, had sought or been granted approval to trade shares before the announcement.
But if Zhu's insider trading tells us anything, it is surely that an insider trader is as furtive as a fox in a chickensuit. Catching one therefore means looking not for a fox, but for a chicken with a foxy look.
Chalkie reckons that with New Zealand's apparent dearth of insider traders, you have to wonder whether our regulators are busy tally-hoing over the countryside on horseback rather than hanging around the coop with a cluckalyser.
- Chalkie is written by Fairfax Business Bureau deputy editor Tim Hunter.