Did you hear the one about the two Hong Kong day traders who engaged in a blizzard of “matched trades” to take advantage of Macquarie Bank to the tune of around $1 million?
Hong Kong’s Court of Final Appeal quashed their convictions because their intention had not been to mislead the market but to “farm” Macquarie’s commission rebate scheme.
They wouldn’t get away with it here, however, because the defence is not available in New Zealand law.
A sweet arrangement (except for Macquarie)
The scheme relied on the fact that the traders received discounted brokerage from the volume of their trading, and that these discounts brought their transaction costs on each trade lower than commission rebates paid by Macquarie on its derivative warrants.
The margins were small: a brokerage rate of 0.04% and Macquarie rebates which were typically between 0.1% and 0.25% of the consideration for a trade. But, by making repeated matched trades back and forth between themselves on 19 or 20 days (the judgment is inconsistent on this point) between January 2004 and January 2005, they were able to pocket around $1 million.
On each of the days they traded, their trades dominated the traffic in that warrant – accounting for 76% of all trades on one occasion.
They usually traded the warrants between themselves at the same price and exited them often at the same price they bought them, and generally back to Macquarie. Sometimes they sold them to third parties, and sometimes they sold them at a small profit or a small loss (not counting their rebate income). One day, for example, they started with warrants worth $208,000 which they sold at the end of the day to a third party at a modest $6,000 loss, but this was off-set by commission rebates of $87,572 to yield a profit of $81,372.
The men did not escape scot free. The District Court found that the matched trades breached Hong Kong’s market manipulation laws and sentenced one to two years and nine months in jail and the other to three years. The Court of Appeal later reduced both sentences to 15 months, and at the time of the appeal hearing, they had each served almost all of this time. But the Court of Final Appeal was unanimous that the appeal should be allowed.
The Hong Kong defence
Although the Hong Kong statute deals specifically with wash sales and matched orders of the sort engaged in by the two traders, it provides a defence if the conduct was not entered into for the purpose of manipulating the market.
Or, in the words of the Court of Final Appeal: “It is the state of mind (intention or recklessness as to the creation of a certain appearance) with which anything is done that gives rise to the contravention”.
And, although their conduct “created a false appearance of active trading in securities and the appellants were at least reckless as to that”, it was clear from the evidence “that they acted with a commercial purpose (rebate or commission farming) that at the time was not otherwise unlawful”. (Commission rebate schemes were outlawed in Hong Kong, but not until 2006.)
Accordingly, their convictions should be quashed and there should be no order for a new trial.
But their fate would have been entirely different under New Zealand law.
Don’t try this at home
New Zealand’s law (refer box below) is effects-based. If the case happened here, the only test would be whether their actions had the effect of creating a false or misleading appearance, and whether they knew or ought to have known that this would be, or would be likely to be, the effect. No proof (or even analysis) of intention is required.
Our legislation also specifically deals with matched orders (deeming them to be manipulative), but only where you have traded with yourself or your “associate”. The Act’s definition of “persons associated with each other” is limited to relatives and related companies, which makes our deeming provision narrower than Hong Kong’s. So the two day traders would have fallen outside this presumption, but would nonetheless have been caught by the underlying offence anyway.
In New Zealand, you are not so deemed (and have a defence to the underlying offence) if you prove that the trading was for a “legitimate” reason. This test hasn’t been judicially considered yet and isn’t defined. But given that the intention of the Securities Markets Act is to provide transparency in the market, making the market appear more liquid than it is in order to profit from a commission rebate is unlikely to be a “legitimate reason”.
“I was simply trying to take advantage of Macquarie Bank” was an acceptable defence in Hong Kong, but it wouldn’t be in New Zealand.
New Zealand market manipulation law
The New Zealand equivalent law is the Securities Markets Act 1988 (SMA), sections 11B to 11D. In New Zealand the effect of the conduct, not the intention of the participants, is the relevant focus for liability provisions. The SMA contains civil and criminal sanctions, which commenced February 2008. To date, there have not been any court proceedings, or publicised regulatory intervention, against any SMA market participant for breach of the regime.
Prior to the 2008 amendments, New Zealand did not have any specific legislative restriction on stock market manipulation, although some provisions of the Crimes Act could apply to deliberate manipulative conduct.
Our thanks to Sarah Farquhar for writing this Brief Counsel. For further information, please contact the lawyers featured.