Insider Trading 101

David Li Kwok-po, head honcho of Bank of East Asia (which recently bought a substantial stke in Affin Bank), has strongly denied he passed on information that allowed a Hong Kong couple to reap an estimated US$8.2 million (HK$63.96 million) profit from alleged insider trading of Dow Jones shares. Li is Dow Jones' only Asian board member. The selection of Li to the board of Dow Jones was based on his very long and successful business career in HK/China. The case is fresh and hot, coming off just on events happening over the last 2 weeks.

An internal investigation has started into whether Li leaked confidential information to a friend, Michael Leung Kai-hung, about an imminent offer by Rupert Murdoch's News Corp to buy Dow Jones.

Leung is the father of Charlotte Wong Leung Ka-on who, with her husband Wong Kan-king, is under investigation by the US Securities and Exchange Commission for suspected insider trading.

Li admitted he had knowledge of Murdoch's interest in Dow Jones before News Corp made public its intentions. But he denied leaking information relating to the deal to anyone. "Not even my wife," Li told WSJ.

Murdoch indicated his interest in Dow Jones to company chief executive Richard Zannino in the week of April 9, followed by a telephone conference held by the board April 13. News Corp sent a formal takeover offer to the Dow Jones board April 17. The next day Leung transferred US$3.1m to his daughter. The key dates of the cash transactions and the following share purchase dates basically would seal the fate of the accused.

US federal regulators said the couple snapped up 415,000 Dow Jones shares just before News Corp announced its US$5 billion takeover bid. According to a lawsuit filed Tuesday by the SEC in a New York district court, the Wongs engaged in "widespread and unlawful trading activity" that positioned them to make an estimated US$8.2 million profit. If convicted, they are liable for a penalty of more than HK$100 million and possible imprisonment.

Leung had lent US$3.1 million to his daughter to facilitate the couple's purchase of the shares, according to the WSJ. The couple also reportedly used margin financing to leverage their purchases. They purchased 415,000 shares between April 13 and April 30 for US$15 million - representing about 20 percent of the daily trading turnover in Dow Jones shares. The US$15 million in the Wongs' account with the Hong Kong branch of Merrill Lynch is made up of US$4 million from their account in a Belgian bank, borrowings of US$3.1 million from Charlotte Wong's father and margin financing from banks.Sources say Merrill Lynch detected unusual movement in the Wongs' account and reported the matter to the US federal regulator.

On May 1, Dow Jones' stock price soared 58 percent after News Corp said it would make a US$60 per share offer to acquire the company. On May 4 the Wongs sold all their Dow Jones shares for about US$23 million. Cheryl Scarboro, associate director at the enforcement division of the SEC, said the purchase by the Wongs was a "highly profitable and timely purchase."

Charlotte Wong is a former executive director of China Mobile Peoples Telephone. Her father co-founded Peoples Telephone, which was acquired by China Mobile in a deal completed early last year . Leung is a board member of the Canadian subsidiary of Bank of East Asia, while both Leung and Li were shareholders of two firms whose shares were acquired by Avon Products. Leung is vice chairman at a Hong Kong social service organization which Li heads.

Obviously the accused did not attend Insider Trading 101. The mistakes they made were so glaring and unforgivable.

a) The Dates - In building an insider trading case, the sequential events plays a big part, it alludes to planning and motive. April 9 - Murdoch phones the CEO about his interest; April 13 - teleconference with board members of Dow Jones on the matter; April 17 - formal offer sent to board of Dow Jones; April 13-30 the accused bought 415,000 shares of Dow Jones; May 1 - Dow Jones stock rose 58% on the release of the news. This is what we call, die standing.

b) Unusual Patterns - Being novices to insider trading, the accused should have been wary of the patterns of trading they will be making. An examination of their trading records show they traded in infrequently. The timing of the father's loan of US$3.1m to leverage the account is very bad as its the father who had the close link to David Li.

How to do better next time (lol):

a) Spread trading pattern / Backup research - If I got the same tip from David Li, I would generate tons of research reports on all media companies in the US. In particular highlighting recent media deals over the last 6 months. Then I would buy 3 media stocks equally (including Dow Jones). This will not be a bad move because a buyout for Dow Jones would also lift valuations on similar media type companies instantaneously. The research would validate your interest in those stocks.

b) Beware of unusual moves - If you do not always go on margin, don't suddenly go on margin. Beware of the dates involved, e.g. in the above case, having narrowed to 3 media companies, I would not go and buy Dow Jones first, why not buy Reuters first followed by the other two.

c) The Links - If everybody knows that I know David Li, I would never use my account or even immediate family. It is at times like these you need to have a couple of friends you can trust with your life (lol). No one should be able to link the trades back to Li.

d) UMA - Beware of too aggressive buying because all exchanges have sophisticated trading systems to alert staff on unusual buying activity. The accussed buying amounted to 20% of total turnover during that period, waah you think you are Coper Aul? UMA is not only defined as a percentage of overall trades, but also a deviation from your account's usual trading value.

Its unfortunate for David Li to have his reputation tainted in this silly event, and he probably did not profit from it at all. He is worth billions in HKD but you cannot undo the mud splattered all over his resume. Of course, the news could have been leaked by other sources to Michael Leung or the accused: the advisors or bankers, senior News Corp staffers. So, David Li could still get to keep his stature and status. In fact, it is quite incomprehensible for a person such as David to even consider leaking or even be careless enough to leak such information, esp. when he does not stand to benefit materially. Any court of law is likely to give David Li a large dose of the benefit of doubt.

When rich people get caught doing these type of things, there is little sympathy. As Gekko would say "Greed is good"... but at least try and be smart about it. Not easy to be a successful culprit.

I guess, if the SEC watchdog is transplanted in KL, there would be a lot of very nervous and worried corporate senior mgmt, or are we still in denial that there is a problem with insider trading in this country that needs to be corrected?