Recently, the Shanghai Stock Exchange (the “SSE”) and the Shenzhen Stock Exchange (the “SZSE”) restricted trading on 38 securities exchange accounts because of unusual trading behavior. This has caused widespread discussion in the securities market. What is unusual trading behaviour? What are the legal consequences of unusual trading? In the event that a securities account has been found to have engaged in unusual trading and its trading is restricted, what are the legal remedies? This article will explore these questions taking into account the law and practical experience.
“Programmed Trading” is the Focal Point of the Shanghai and Shenzhen Stock Exchanges’ Investigation into “Unusual Trading Behaviour.”
On 31 July and 2 August 2015, the SSE and the SZSE restricted trading on 34 accounts exhibiting unusual trading activity.
On 3 August, the SSE suspended trading by a further 4 securities accounts which had shown significant unusual behaviour, and gave oral warnings to another 5 securities accounts with unusual activity.
On 7 August, the assistant to the Chairman of the China Securities Regulatory Commission (the “CSRC”) Zhang Yujun stated that, the CSRC would strengthen its regulation of programmed trading, and strictly forbid malicious short-selling through programmed trading. On the same day, the SSE stated that misuse of programmed trading would constitute unusual trading behaviour.
It is evident that programmed trading is the target of investigation into stock exchanges and the subject of changes at the regulatory level.
Programmed Trading ≠ Unusual Trading in Securities
Unusual trading in securities means unusual trading that may impact the price or volume of trading. The Trading Regulations of the SSE and SZSE list 12 types of unusual trading activity, mainly the placement of false orders, large orders, frequent orders, placement of large orders at limit-up or limit-down prices, trading between accounts actually controlled by the same person, reverse trading in the same trading day, buying at high-prices and selling at low prices, and other trading behaviour that might impact the price or volume of trading.
Programmed trading involves a system whereby trading signals are formed based on a certain trading model, and computers are then able to automatically execute these trading orders based on those signals. As a strategy, programmed trading has the positive effect of increasing liquidity, and is popular in developed securities markets like Europe and the U.S. However, when there is significant fluctuation in the market, the frequent placing and cancelling of orders through programmed trading will cause price movements up or down. Misuse of programmed trading systems can hinder the market regaining its balance.
In the “Flash Crash” of the American securities market in 2010, the Securities Exchange Commission accused traders of using programmed trading to make enormous placements and flash cancellations in U.S. stock index futures, which brought about the sharp decline in stock prices and constituted fraud.
Due to the relatively short development period of programmed trading in the Chinese securities market, risk control and regulations covering programmed trading are still in their infancy. With the roller-coaster phenomenon in the Chinese stock market recently, the regulation of programmed trading has become a focal point.
The Rules of Real-Time Monitoring of Unusual Securities Trading of the SSE states: “automatic bulk placements through computer programming that impacts the normal trading order of the market or security of the trading system” is considered unusual trading behaviour. However, programmed trading is merely trading through computerized systems that automatically execute trading instructions, and is not a malicious or law-breaking trading method per se. Therefore, programmed trading does not equal unusual trading in securities.
Unusual Trading Behaviour may Constitute Manipulation of the Securities Market
Article 77 of the Securities Law of the People’s Republic of China (the “Securities Law”) prohibits the manipulation of the securities market. The Guidance on Determination of Manipulating Activities in the Securities Market (for Trial Implementation) (the “Guidance”) (Zheng Jian Ji Cha Zi No. 1) of the CSRC provides that manipulating activity in the securities market refers to a party impacting the trading price or volume through misconduct thus disrupting the order of the securities market. The Guidance provides a detailed list of manipulating activities.
By comparing the definition of “unusual trading behaviour” stipulated in the Trading Rules and that of “manipulating activities in the securities market” stipulated in the Securities Law and the Guidance, we can see that the characteristics of most of the unusual trading listed in the Trading Rules are consistent with those of manipulating activities in the securities market. Therefore, if an action is determined to be unusual trading behaviour, it may also constitute a manipulating activity.
Legal Consequences of Unusual Trading in the Securities Market
1. The Exchange may take regulatory measures such as restricting the trading of securities accounts exhibiting unusual trading.
Under Article 115 of the Securities Law, stock exchanges may restrict trading in any securities account in which there is any significant unusual trading activity.
ursuant to the Trading Rules and the Implementing Rules of Restricted Trading of the SSE and the SZSE, where there is unusual trading taking place in a securities account, the Exchange may: give an oral or written warning; organize formal talks; request a written undertaking; restrict trading of the relevant securities account, place a record on the integrity file, and publicly announce the decision depending on the circumstances; report to the CSRC.
2. In the event that the unusual trading constitutes manipulation of the securities market, administrative penalties may be administered
If the unusual trading behaviour is deemed by securities regulatory authorities to constitute manipulation of the securities market, administrative penalties may be administered. These include: (1) order disposal of securities illegally held; (2) confiscation of unlawfully obtained financial gains; (3) fines; (4) disciplinary warnings. Apart from these, securities regulatory authorities may prohibit the violator from participation in the securities market.
3. If the unusual trading behaviour constitutes serious manipulation of the securities market, criminal liability may result
If the unusual trading is serious manipulation, it may constitute the crime of manipulation of the securities or futures market. Violators may be sentenced to imprisonment for up to five years or detention, and/or a fine. Where the degree of criminal activity is extremely high, violators may be sentenced to fixed-term imprisonment of no less than five years but no more than ten years, and may also be fined.
Legal Remedies after a Securities Account has been found to have Engaged in Unusual Trading and Trading has been Restricted
How should a company act if its securities account has been determined by a stock exchange to have engaged in unusual trading, or has its trading restricted? We have the following suggestions based on our experience.
1. Pay close attention to the regulatory measures taken, actively cooperate with the investigation, and seek legal advice from experienced attorneys in a timely fashion
Unusual trading behaviour may lead to regulatory measures which restrict trading on accounts, and may even lead to formal investigation by securities regulatory authorities into market manipulation. A company under investigation by a stock exchange, is advised to respond actively to the investigation. It should set up a special working group to coordinate cooperation with the investigation, and engage specialized attorneys with relevant experience to provide legal advice.
2. Collect the facts, conduct a legal analysis of the data, then report the findings to the stock exchange and regulatory authorities
Based on our experience, both the stock exchanges and the securities regulatory authorities will take into account whether the facts of the case are clear, whether the evidence is sufficient, and whether there is a clear legal basis for any action they might take. Therefore, when a company is facing investigation, it is best to conduct a self-review with fact-finding and data-analysis, and to engage attorneys to give a legal analysis. If the findings of fact or legal opinion differ from those of the stock exchanges or the regulatory authorities, the company should inform them of this. Whereas if the company has clearly engaged in misconduct, by admitting its mistakes, it may be possible to negotiate a feasible action plan to rectify errors and to thereby avoid a sanction.
3. Protect the rightful interests of the company by taking full advantage of its legal rights including making appropriate statements, putting up defences, providing helpful evidence, and making appeals if necessary.
Pursuant to the Trading Rules and the Implementing Rules of Restricted Trading of the SSE and the SZSE, a party may appeal within 15 days of receiving a trading restriction. If a company objects to a finding of unusual trading behaviour, it should provide a reasonable explanation to the stock exchange in an appeal seeking revocation of the trading restriction. Or at the very least, the company should actively defend its position and have the stock exchange acknowledge that the unusual trading does not constitute manipulation of the securities market, and thus avoiding administrative or even criminal penalties in this regard.
Before any appeal, the company should analyze and research the issues of concern to the stock exchange and work out a reasonable explanation. For example: whether there was an intent to affect trading prices or volume; whether the trading was programmed; whether there were unusual characteristics in the number of order placements or cancellations; whether the rate of order cancellations was inconsistent with normal practice; whether the prices clearly deviated from the latest disclosed execution price; whether there were large or continuous placements hitting the limit-up or limit-down price; whether there was an impact on the trading volume or trading price, etc. Of course, the grounds of an appeal will depend on the specific facts of the case.