Keeping the Trading at Home in Hong Kong

In hastily backing away from a plan to extend the blackout period on directors’ share trading, Hong Kong’s stock exchange has exposed the weakness of its regulatory clout and the cabal of influential tycoons used to calling the shots have the satisfaction of knowing that they can ensure that ‘Asia’s world city’ is free from implementing international best practices in the regulation of its financial affairs.

The formidable lobbying power of the oligarchs has never been in question but rarely has it secured such a rapid response and rarely have business leaders so blatantly combined to ensure the right to engage in dubious practices to the distinct disadvantage of their minority shareholders.

Just before the New Year the directors of 238 listed companies published a statement condemning the stock exchange’s plan to extend the blackout share trading from the closing of their books to the release of their results. The modest proposal, to replace an existing blackout period of just one month prior to results announcements, was designed to crack down on insider trading.

In effect the most prominent leaders of Hong Kong’s business community lobbied to ensure that possibilities for insider trading should be preserved and within the space of just 24 hours they managed to get the stock exchange to backtrack.

In a rather unconvincing statement announcing the retreat, the exchange’s listing committee said it would not withdraw the new rule but postpone its implementation until April; it remains to be seen what will happen then but the most unlikely outcome is that the exchange will implement its ban without modification. Meanwhile the exchange’s retreat means it has disregarded a motion by legislators endorsing the extension of the trading blackout period and it ignored the results of its own consultation exercise which came down decisively in favor of reform.

Why then were the directors of Hong Kong’s leading companies so keen to thwart a measure that would have helped to diminish the chances of insider information being responsible for share price movements prior to the announcement of company results?

One answer may be found in the fact that 34 percent of disclosed directors’ trading has occurred within the timeframe of the new blackout period.

But the suspicion lingers that Hong Kong directors seem to feel entitled to use insider knowledge when trading in the shares of their own companies. It is not simple to judge when this access to privileged information slips over into an area where criminality occurs.

The Stock Exchange has declined to conduct studies on the extent of insider trading prior to the announcement of price-sensitive announcements but it is widely known in Hong Kong that barely a single announcement of this kind has been made by a listed company that was not preceded by a significant movement in the company’s share price suggesting, at the very minimum, that some insider knowledge was responsible for the movement.

Studies of this phenomenon have been entirely confined to academic circles. Three of the biggest pieces of research by scholars have found clear evidence of insider trading connected to share price movements surrounding company announcements. The Hong Kong academics, Louis Cheng, T.Y. Leung and Rickey Szeto, looked at 3,177 instances of price movements in the period from 1993 to 1999 and concluded that there was widespread insider trading around earnings and dividend announcements. Coincidently, although published later, was a study covering the same period by three other academics: Eric Chang, Jun Zhu and J. Michael Pinegar which found that insider trades in Hong Kong were far more widespread than in the US and were rewarded with abnormally high profits. Meanwhile another research paper, by Elizabeth Wong at Stanford University, found ‘strong evidence that points towards suspicious insider-trading activities’ among the companies listed in Hong Kong which are controlled in the Chinese mainland.

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Insider trading is very hard to prove and only became a Hong Kong criminal offense in 2003 although no prosecutions were secured until 2008. The situation in Hong Kong is even more complicated than in many other jurisdictions because not only do majority shareholders routinely hold more than half of listed company equity (compared with no more than 20 percent in the US) but they are also far more prone to trading in the shares of their own companies than counterparts in the United States and Europe.

Naturally the companies campaigning against the new blackout trading rules do not stress insider trading issues in their efforts to ensure that their directors be allowed to trade in their own shares close to results announcements. Instead they dangle the prospects of companies being deterred from listing in Hong Kong and raise the old canard of Hong Kong loosing its status as an international financial centre.

This last argument is the most bizarre because the effect of the rule change is to bring Hong Kong more into line with best international practices and it is significant that although the campaign to thwart the rule change has clearly been well organized and widespread the organizers only managed to find one international company, the Swire group, to sign up to its aims. Major foreign banks and broking houses operating in Hong Kong are notable by their absence from the list signatories.

However the list does include some of Hong Kong’s most prominent leaders who are no strangers to problems with insider trading. Among them is David Li, the chairman and chief executive of the Bank of East Asia who last year was among three people reaching an out-of-court settlement with the US Securities and Exchange Commission over insider trading allegations concerning the Dow Jones Corp. Sir David was a member of the Dow Jones board at the time when merger talks were underway with Rupert Murdoch’s News Corp. He did not admit or deny liability for passing information to two friends who bought Dow Jones shares ahead of the merger but agreed to pay a civil penalty of $8.1 million in settlement of the case.

Perhaps the most prominent signatory of the list is Li Ka-shing, chairman of the Cheung Kong group of companies who, in 1986, when insider trading was not a criminal offense and investigations were rare, was nevertheless found to have been culpable of insider dealing in a transaction related to the shares of one of his companies called International City Holdings.

The Hong Kong directors bleat about the possibility that the new blackout period will mean that directors are prevented from trading in their own shares for up to seven months in the case of companies making six-monthly results announcements and up to nine months for those making quarterly announcements. However this is only because most Hong Kong companies wait until the last moment before announcing their results, long after the figures are already available to them. It is entirely within their own power to shorten the gap between the close of books and the announcement of results so this piece of special pleading is hard to sustain.

As for the directors’ argument that a longer blackout period would discourage individuals from becoming directors of listed companies, this inadvertently reveals the crux of the campaigners’ fundamentally flawed thinking. Surely company directors’ primary responsibility is to ensure the proper management of a corporation’s affairs, not to be dabbling in its shares. Only a body of directors primarily intent on yielding profits from trading in their own shares could even think this was a problem.