"Directed brokerage" is a malpractice often found in the US, where mutual fund managers direct brokerage commissions of portfolio transactions as a reward to those securities firms which are top sellers of fund managers' funds to retail clients.
Such practice violates the so-called "Anti-Reciprocal Rule" by posing a potential conflict of interest in both buy and sell sides. Securities firms which are good sellers of funds may not be the best executors of portfolio transactions. Fund managers using these securities firms may have put their own interests (fund sales results) ahead of the fund investors' interests.
On the other hand, securities firms which advise their clients to purchase the funds managed by fund managers offering directed brokerages may not act in the clients' best interests. They may recommend unsuitable funds to their clients for the purpose of earning more commissions from fund managers.
There have been numerous cases of directed brokerage violations in the US, from the case of Morgan Stanley to the recent cases of ING and American Fund Distributors.
In HK, so far no similar enforcement case has come out. Retail funds are mainly sold by banks and IFAs instead of securities brokers which execute trades for fund houses. Mis-selling of funds is directly driven by commission rebates for funds sales, not indirectly by brokerages of securities dealing.
Thursday, August 31, 2006
Wednesday, August 30, 2006
Mareva Injunction
Yesterday the High Court issued an interim "Mareva Injunction" (資產凍結強制令) against two responsible officers of Tiffit Securities, the recently collapsed broker. Such kind of injecton would restrain them from removing any of their assets from Hong Kong, or dealing with or diminishing the value of any of their assets, whether within or outside Hong Kong. But why is it called "Mareva Injunction"? This was originated from a court case.
Mareva Compania v. International Bulkcarriers SA (1975)
The defendant was a foreign company which intended to move money deposited with a bank in London before trial. The Court of Appeal upheld an injunction banning the defendant from disposing its assets within or moving it outside the jurisdiction of the court.
Mareva Injunction was originally granted only against foreign defendants but now it may also be issued against domestic defendants so long as the plaintiffs establish that substantial risk of dissipation of assets pending trial to their detriment.
Under S.205 of SFO, SFC may issue a written notice to restrict a licensed corporation from disposing of client assets. But Mareva Injunction granted by the court is required to restrain the responsible officers from disposing of their own assets.
Mareva Compania v. International Bulkcarriers SA (1975)
The defendant was a foreign company which intended to move money deposited with a bank in London before trial. The Court of Appeal upheld an injunction banning the defendant from disposing its assets within or moving it outside the jurisdiction of the court.
Mareva Injunction was originally granted only against foreign defendants but now it may also be issued against domestic defendants so long as the plaintiffs establish that substantial risk of dissipation of assets pending trial to their detriment.
Under S.205 of SFO, SFC may issue a written notice to restrict a licensed corporation from disposing of client assets. But Mareva Injunction granted by the court is required to restrain the responsible officers from disposing of their own assets.
Tuesday, August 29, 2006
Market Timing
Market timing is a hot compliance topic in the US. But SFC released a survey report in 2004, which claimed that market timing was not prevailing in HK. Actually we have seen a few cases in HK about late trading, but not market timing.
Market timing means frequent buying and selling of funds in order to exploit inefficiencies in fund pricing. While market timing is not illegal per se, it can harm other fund investors by diluting the value of their units / shares. Such practice can also disrupt the management of the fund's portfolio and cause the fund to incur costs (borne by other investors) to accommodate frequent fund dealing by market timers (typically hedge funds).
The market timing scandals erupted in the US over the past few years involved those firms which secretly allowed selected investors to rapidly trade the mutual funds despite such practice was banned in the fund prospectus. The double standard that favors one group of investors at the expense of another is illegal.
Yesterday in the US, Prudential Equity Group was ordered to pay US$600m in a global settlement of fraud charges in connection with deceptive market timing of mutual funds.
An old dog plays no new trick. Prudential's brokers defrauded mutual funds by misrepresenting their own identities and the identities of their brokerage clients to engage in market timing after the mutual funds had placed blocks attempting to prohibit such trading. The brokers used multiple Financial Advisor (FA) numbers to evade the trading restrictions. If one FA number was blocked, the brokers traded by using another FA number. Prudential failed to put in place an adequate supervisory system to prevent the market timing activities.
In light of those cases happened in the US, we may understand that market timing could not be done without the facilitation by fund distributors.
Market timing means frequent buying and selling of funds in order to exploit inefficiencies in fund pricing. While market timing is not illegal per se, it can harm other fund investors by diluting the value of their units / shares. Such practice can also disrupt the management of the fund's portfolio and cause the fund to incur costs (borne by other investors) to accommodate frequent fund dealing by market timers (typically hedge funds).
The market timing scandals erupted in the US over the past few years involved those firms which secretly allowed selected investors to rapidly trade the mutual funds despite such practice was banned in the fund prospectus. The double standard that favors one group of investors at the expense of another is illegal.
Yesterday in the US, Prudential Equity Group was ordered to pay US$600m in a global settlement of fraud charges in connection with deceptive market timing of mutual funds.
An old dog plays no new trick. Prudential's brokers defrauded mutual funds by misrepresenting their own identities and the identities of their brokerage clients to engage in market timing after the mutual funds had placed blocks attempting to prohibit such trading. The brokers used multiple Financial Advisor (FA) numbers to evade the trading restrictions. If one FA number was blocked, the brokers traded by using another FA number. Prudential failed to put in place an adequate supervisory system to prevent the market timing activities.
In light of those cases happened in the US, we may understand that market timing could not be done without the facilitation by fund distributors.
Monday, August 28, 2006
Cold Calling
Cold calling, which is prevailing in other industries, is basically prohibited by SFO in connection with investment products / services. Why? We may first refer to the definition of "unsolicited calls".
SFO defines unsolicited calls in a clumsy way. To make things simplier, I would say a "call" means the initiation of any interactive dialogue requiring instant responses. By using this measure, the following communications are not considered as "calls":
Investment is a significant financial decision which should be made with careful considerations. It should not be driven by heavy selling pressure created by a "call". Usually the so-called "vulnerable persons" (e.g. elderly people, housewives, etc.) are typical victims of cold calling.
But from the eyes of more strong-willed or educated people, cold calling is viewed as an ineffective selling skill. Cold callers usually use "closed-end" questions (e.g. Have you heard about XYZ product?) or preset introductions (e.g. "Let me introduce XYZ to you."). This is no respect of the recipient's interest (why I am supposed to listen to you). These cold callers are lacking real communication skills and just following the sales scripts.
In the age of information overload, I expect "warm calling" (attracting targeted customers to approach you) would sooner or later replace "cold calling".
SFO defines unsolicited calls in a clumsy way. To make things simplier, I would say a "call" means the initiation of any interactive dialogue requiring instant responses. By using this measure, the following communications are not considered as "calls":
- Send letters / emails / SMS
- Present in a sales talk (esp. if the no. of audience is large)
Investment is a significant financial decision which should be made with careful considerations. It should not be driven by heavy selling pressure created by a "call". Usually the so-called "vulnerable persons" (e.g. elderly people, housewives, etc.) are typical victims of cold calling.
But from the eyes of more strong-willed or educated people, cold calling is viewed as an ineffective selling skill. Cold callers usually use "closed-end" questions (e.g. Have you heard about XYZ product?) or preset introductions (e.g. "Let me introduce XYZ to you."). This is no respect of the recipient's interest (why I am supposed to listen to you). These cold callers are lacking real communication skills and just following the sales scripts.
In the age of information overload, I expect "warm calling" (attracting targeted customers to approach you) would sooner or later replace "cold calling".
Friday, August 25, 2006
Thanks for Comments
Since my compliance blog was open at early August, I am glad to see there have been comments in response to my topics. This is a surprise gift. My original intention of creating this blog is just to write out my views on what I've observed. Reading comments from others is another kind of learning.
I understand commentators in general won't like to disclose their real names, but I can't respond to an anonymous guy. May I suggest any commentator at least identify yourself by using a pseudo name (just like Kira in the comic Death Note)?
If you want to start a discussion on any compliance topic, please let me know. Perhaps we can make this blog an open forum.
Have a nice weekend!
I understand commentators in general won't like to disclose their real names, but I can't respond to an anonymous guy. May I suggest any commentator at least identify yourself by using a pseudo name (just like Kira in the comic Death Note)?
If you want to start a discussion on any compliance topic, please let me know. Perhaps we can make this blog an open forum.
Have a nice weekend!
Thursday, August 24, 2006
Compliance Profession
Have the jobs of compliance officers been professionally recognized? In today's society, we typically define a professional field by the establishment of a well recognized professional association together with a qualifying examination (as a barrier to entry). By this standard, of course legal and accounting fields are professional, whilst compliance field is not.
Compliance jobs dominate in the financial industry because it is key sector in HK and is highly regulated. Following the continuous tightening of financial regulations, the burdens of compliance officers are getting heavier. Nevertheless, the barrier to entry in this field is low in the sense that people from other fields (e.g. audit, risk management, operations and even sales) can easily transform themselves into compliance officers. If they enter into this field at a junior level, I don't see there is any big problem. But how do you think if a senior level person without compliance background pretends to be a compliance expert? I had seen a Head of Compliance who was ignorant of all regulations and lacking in compliance sense but managing a large compliance team!
Well, shall a professional education system set up to maintain the minimum quality of the compliance field? I am open to this topic. In overseas countries, some universities have organized Master degrees about regulations and compliance. In HK, I think the LLM in Corporate & Financial Law offered by HKU is the most relevant program. As a graduate of this program, I would say it is actually a series of professional compliance seminars. I opin that regulators and compliance officers may benefit from this program more than lawyers.
If I was invited to design a higher education program to train new compliance officers of the financial industry, I would include not only financial laws and regulations, but also related disciplines such as accounting, economics, finance and risk management. I view compliance as a social science as it is about human behaviors. Therefore the program should also cover some topics in psychology, politics and people management.
Compliance jobs dominate in the financial industry because it is key sector in HK and is highly regulated. Following the continuous tightening of financial regulations, the burdens of compliance officers are getting heavier. Nevertheless, the barrier to entry in this field is low in the sense that people from other fields (e.g. audit, risk management, operations and even sales) can easily transform themselves into compliance officers. If they enter into this field at a junior level, I don't see there is any big problem. But how do you think if a senior level person without compliance background pretends to be a compliance expert? I had seen a Head of Compliance who was ignorant of all regulations and lacking in compliance sense but managing a large compliance team!
Well, shall a professional education system set up to maintain the minimum quality of the compliance field? I am open to this topic. In overseas countries, some universities have organized Master degrees about regulations and compliance. In HK, I think the LLM in Corporate & Financial Law offered by HKU is the most relevant program. As a graduate of this program, I would say it is actually a series of professional compliance seminars. I opin that regulators and compliance officers may benefit from this program more than lawyers.
If I was invited to design a higher education program to train new compliance officers of the financial industry, I would include not only financial laws and regulations, but also related disciplines such as accounting, economics, finance and risk management. I view compliance as a social science as it is about human behaviors. Therefore the program should also cover some topics in psychology, politics and people management.
Wednesday, August 23, 2006
Disabled Investors
Yesterday I wrote on elderly investors. Today I share a case about "disabled investors", though they were not the victims.
In the US, NASD recently fined Citigroup Global Markets US$400,000 in relation to a ploy by more than 100 of its brokers to improperly obtain waivers of mutual fund sales charges by falsely claiming that their customers were disabled. It was also ordered to pay US$715,000 in restitution to the affected mutual fund companies.
The false claims relate to the Contingent Deferred Sales Charge (CDSC) waivers. CDSC is the sales charge imposed by mutual fund companies on investors who redeem their Class B shares within a certain period after purchase. CDSC may be waived under certain circumstances such as death, disability, etc. To claim the disability waiver for a customer, a broker should obtain and/or submit certain documentation evidencing the customer's eligibility. The waiver is generally available only when the customer becomes disabled after the mutual fund purchase.
NASD found that, from 1 June 2001 to 30 June 2002, Citigroup brokers improperly entered disability waivers for hundreds of customers for 2,419 fund transactions amounting to US$47m. In several instances, they even entered CDSC waivers for hedge funds by claiming that they were "disabled individuals"!
One broker entered disabiliy waivers for over 80% of his customer base, where most of those customers were, of course, not disabled. In many cases, they subsequently used the proceeds to make new investments.
NASD also found that Citigroup failed to maintain and enforce reasonable internal procedures and systems to prevent and detect the above abusive practices. In particular, the firm did not ensure compliance with the documentation requirements for the customers' eligibility.
I think this case was considered serious given the long period of violation (13 months), significant numbers (of brokers, customers & transanctions) involved and lack of monitoring.
Now I've realized claiming "disability" may not only cheat the government of money, but also the fund houses! I wonder whether these mutual fund companies had maintained a robust system in handling the waiver claims.
In the US, NASD recently fined Citigroup Global Markets US$400,000 in relation to a ploy by more than 100 of its brokers to improperly obtain waivers of mutual fund sales charges by falsely claiming that their customers were disabled. It was also ordered to pay US$715,000 in restitution to the affected mutual fund companies.
The false claims relate to the Contingent Deferred Sales Charge (CDSC) waivers. CDSC is the sales charge imposed by mutual fund companies on investors who redeem their Class B shares within a certain period after purchase. CDSC may be waived under certain circumstances such as death, disability, etc. To claim the disability waiver for a customer, a broker should obtain and/or submit certain documentation evidencing the customer's eligibility. The waiver is generally available only when the customer becomes disabled after the mutual fund purchase.
NASD found that, from 1 June 2001 to 30 June 2002, Citigroup brokers improperly entered disability waivers for hundreds of customers for 2,419 fund transactions amounting to US$47m. In several instances, they even entered CDSC waivers for hedge funds by claiming that they were "disabled individuals"!
One broker entered disabiliy waivers for over 80% of his customer base, where most of those customers were, of course, not disabled. In many cases, they subsequently used the proceeds to make new investments.
NASD also found that Citigroup failed to maintain and enforce reasonable internal procedures and systems to prevent and detect the above abusive practices. In particular, the firm did not ensure compliance with the documentation requirements for the customers' eligibility.
I think this case was considered serious given the long period of violation (13 months), significant numbers (of brokers, customers & transanctions) involved and lack of monitoring.
Now I've realized claiming "disability" may not only cheat the government of money, but also the fund houses! I wonder whether these mutual fund companies had maintained a robust system in handling the waiver claims.
Tuesday, August 22, 2006
Elderly Investors
Elderly investors are always "protected subjects" from the eyes of regulators. Besides common mis-selling cases, they should also be protected from the "boiler room" type, fraudulent activities.
Yesterday US SEC filed an "emergency enforcement action" to halt an ongoing fraudulent offering of shares in a company called One Wall Street. SEC even sought temporary restraining orders to freeze the defendants' assets.
According to SEC, the defendants have obtained since 2003 over US$1.6 million from at least 64 investors, most of them are senior citizens who purchased the unregistered stock of One Wall Street.
The defendants made (verbally and in writing) the following false and misleading statements:
Investment fraud is a bit different from other scams. Generally the deceivers take advantage of old-aged persons' fear and sympathy, but investment fraudsters grasp their greed. It is easier to arrest the fraudsters than to educate the elderly investors that "wealth creation" is not a piece of cake!
Yesterday US SEC filed an "emergency enforcement action" to halt an ongoing fraudulent offering of shares in a company called One Wall Street. SEC even sought temporary restraining orders to freeze the defendants' assets.
According to SEC, the defendants have obtained since 2003 over US$1.6 million from at least 64 investors, most of them are senior citizens who purchased the unregistered stock of One Wall Street.
The defendants made (verbally and in writing) the following false and misleading statements:
- One Wall Street would soon conduct an IPO.
- E*TRADE was negotiating to merge with One Wall Street.
- One Wall Street would use the investment proceeds solely for business purposes.
Investment fraud is a bit different from other scams. Generally the deceivers take advantage of old-aged persons' fear and sympathy, but investment fraudsters grasp their greed. It is easier to arrest the fraudsters than to educate the elderly investors that "wealth creation" is not a piece of cake!
Monday, August 21, 2006
Beware of Your Titles
Everybody knows carrying on "regulated activities" defined under SFO without licence is illegal. But don't you know you would commit an offence even you do nothing but simply using certain titles in your name cards?
Under S114 of SFO prohibits, no one shall "hold himself out" to carry on a business of in a regulated activity without licence. S139 further prohibits the use of the following titles (specified in Schedule 6) for different types of regulated activity:
- Type 1 - "bond broker", "bond dealer", "securities dealer", "stock dealer", "stockbroker", "股票經紀", "債券交易商", "債券經紀", "證券交易商" and "證券經紀"
- Type 2 - "futures broker", "futures dealer", "期貨交易商" and "期貨經紀"
- Type 3 - "leveraged foreign exchange trader" and "槓桿式外匯交易商"
- Type 4 - "securities adviser", "securities consultant", "stock adviser", "股票顧問" and "證券顧問"
- Type 5 - "futures adviser", "futures consultant" and "期貨顧問"
- Type 6 - "corporate finance adviser", "corporate finance consultant" and "機構融資顧問"
- Type 7 - "automated trading service provider" and "自動化交易服務提供者"
- Type 8 - "margin lender", "securities margin financier" and "證券保證金融資人"
There is no prohibited title for Type 9, which appears that use of the title "asset manager" is not illegal. On the other hand, a title containing the term "trader" (e.g. bond trader) is not prohibited. The possible reason is that "trader" implies proprietary trading with professional counterparties, which is usually not regarded as a regulated activity. "Financial planner" is also not prohibited because its definition is too board to denote an adviser on specific product type.
Typically a person may violate S139 by using the above titles in his name cards or self-profile on a website before his licence is granted by SFC.
Friday, August 18, 2006
Unacceptable Sales Practices
Mis-selling cases for funds or structured products are common in HK but not so much for stocks. The reason is that the investors have too many channels to get tips on stocks. It is more difficult to prove that a person is misled by one particular broker to buy a stock. The following UK case about some unacceptable sales practices of a stockbroker is interesting.
Hoodless is a stockbroker specialising in Alternative Investment Market ("AIM", just like GEM in HK) of London Stock Exchange. FSA recently fined Hoodless £90,000 for unacceptable sales practices when selling shares in a company called Knowledge Technology Solution (KTS).
KTS is a technology and software solutions company traded on AIM, providing real time price information system called "QuoteTerminal" for market professionals. Hoodless signed a contract with KTS for supply of QuoteTerminal, and also bought some KTS shares as principal. Subsequently Hoodless sold KTS shares to its customers before KTS announced the signing of the supply contract.
It is unclear whether Hoodless' selling of KTS shares is insider dealing because the supply contract with a small broker may not be regarded as price sensitive information. But Hoodless was challenged by FSA for disclosing such non-public information to its customers as a "sales aid" when selling KTS shares.
In addition, Hoodless was found to have "pushed" customers to buy KTS shares when they were not ready to do so, or buy more shares than they appeared to want. In one instance, Hoodless' broker solicited a customer (a doctor) whilst he was at work in a hospital. The doctor said he did not want to make a decision until he could concentrate on studying the information about KTS after work. The broker dared to say: "You don't need to concentrate all you need to be able to do is say okay...that's fine."
If I don't indicate, you may think this is a HK case!
Hoodless is a stockbroker specialising in Alternative Investment Market ("AIM", just like GEM in HK) of London Stock Exchange. FSA recently fined Hoodless £90,000 for unacceptable sales practices when selling shares in a company called Knowledge Technology Solution (KTS).
KTS is a technology and software solutions company traded on AIM, providing real time price information system called "QuoteTerminal" for market professionals. Hoodless signed a contract with KTS for supply of QuoteTerminal, and also bought some KTS shares as principal. Subsequently Hoodless sold KTS shares to its customers before KTS announced the signing of the supply contract.
It is unclear whether Hoodless' selling of KTS shares is insider dealing because the supply contract with a small broker may not be regarded as price sensitive information. But Hoodless was challenged by FSA for disclosing such non-public information to its customers as a "sales aid" when selling KTS shares.
In addition, Hoodless was found to have "pushed" customers to buy KTS shares when they were not ready to do so, or buy more shares than they appeared to want. In one instance, Hoodless' broker solicited a customer (a doctor) whilst he was at work in a hospital. The doctor said he did not want to make a decision until he could concentrate on studying the information about KTS after work. The broker dared to say: "You don't need to concentrate all you need to be able to do is say okay...that's fine."
If I don't indicate, you may think this is a HK case!
Thursday, August 17, 2006
Dollar Cost Averaging
When banks are promoting monthly investment plans (MIP) of stocks or funds, they typically emphasize the advantage of "dollar cost averaging" (DCA). But their illustrations often give people a misleading impression that DCA is "cheaper".
Just sampling an illustration from a local bank's website:
- You contribute $1,000 monthly to a MIP for 6 months.
- The monthly unit prices during this period are $1.0, $0.9, $1.1, $0.9, $0.8 and $1.0
- Number of units bought in each month is equal to $1,000 divided by the monthly price.
- Total number of units bought during this period is 6,381.
- Weighted average cost of MIP is $6,000 / 6,381 = $0.94
- Average market price = $(1.0 + 0.9 + 1.1 + 0.9 + 0.8 +1.0) / 6 = $0.95
- So, you have got an impression that MIP lowers your average cost.
Mathematically, weighted average is always lower than simple average. But why should we compare MIP's weighted average cost with the simple average price? Such comparison is only meaningful for two investable strategies. MIP is of course investable: what you need to do is to pay $1,000 per month. But how about the strategy behind the simple average price?
Simple average price implies a strategy that every month you purchase the same number of units. For comparison with MIP, the total budget must also be $6,000. How do you know the number of units to be bought? This is only possible if you know the prices in the coming 6 months in advance! But are you the omniscient God?
Obviously the strategy behind simple average price is not investable, therefore comparing it with MIP's average cost is meaningless.
Wednesday, August 16, 2006
Investor Profiling (3/3)
DISC Profile for Investing
Type D investors like to take control of investments, thus may prefer stock investing to fund investing. As they are impatient and result-oriented, they tend to favor investment products which can generate short term returns. Given their confidence (or over-confidence), they don't easily listen to others' advice.
Type I investors are generally talkative and willing to share with others their investment interests and experiences. They like to study market trend and collect hot tips on stocks to avoid losing profit-making opportunities. As a result, they tend to switch between investments frequently.
Type S investors are risk adverse, favoring investments with steady returns and regular investment plans. They usually hesitate when making investment decisions and thus may lose some good opportunities. They tend to follow the majority and listen to experts' advice.
Type C investors are typically supporter of value investing. They like to gather adequate information and do their homework before making independent investment decisions.
If you are a salesman, how do you think about these 4 types of investors?
Obviously Types I & S investors create a higher mis-selling risk because they are vulnerable to advice. But Type I are even riskier as they make decisions quickly without doing much homework and so more likely blame you for mis-advising.
On the other hand, Types D & C investors are more autonomous. They seldom take advice, so your mis-selling risk is lower. But they are more concerned for the accuracy of product information provided by you. As they are less sensitive to people relationship, they won't hesitate to make a formal complaint against your mistakes.
If you make use of DISC Profile, you can manage the client relationship and the mis-selling risk better.
Type D investors like to take control of investments, thus may prefer stock investing to fund investing. As they are impatient and result-oriented, they tend to favor investment products which can generate short term returns. Given their confidence (or over-confidence), they don't easily listen to others' advice.
Type I investors are generally talkative and willing to share with others their investment interests and experiences. They like to study market trend and collect hot tips on stocks to avoid losing profit-making opportunities. As a result, they tend to switch between investments frequently.
Type S investors are risk adverse, favoring investments with steady returns and regular investment plans. They usually hesitate when making investment decisions and thus may lose some good opportunities. They tend to follow the majority and listen to experts' advice.
Type C investors are typically supporter of value investing. They like to gather adequate information and do their homework before making independent investment decisions.
If you are a salesman, how do you think about these 4 types of investors?
Obviously Types I & S investors create a higher mis-selling risk because they are vulnerable to advice. But Type I are even riskier as they make decisions quickly without doing much homework and so more likely blame you for mis-advising.
On the other hand, Types D & C investors are more autonomous. They seldom take advice, so your mis-selling risk is lower. But they are more concerned for the accuracy of product information provided by you. As they are less sensitive to people relationship, they won't hesitate to make a formal complaint against your mistakes.
If you make use of DISC Profile, you can manage the client relationship and the mis-selling risk better.
Tuesday, August 15, 2006
Investor Profiling (2/3)
Features of DISC Profile Types
If you have a strong tendency of Type D, you are strong-willed, decisive and directive. You are result-oriented and less concerned about people.
If you have a strong tendency of Type I, you are enthusiastic, energetic and expressive. You are people-oriented and eager for others' recognition.
If you have a strong tendency of Type S, you are stable, cooperative and sympathetic. You are more concerned with people but keeping low profile.
If you have a strong tendency of Type C, you are objective, analytical and systematic. You are more concerned with accuracy and quality, thus cautious about making decisions.
The above are general descriptions of different types. Actually you may identify one's type by simply looking at their faces and/or chatting with them for a few minutes. But of course there are some people who do not expose a strong tendency towards any type.
In next blog, I will talk about how people of different types behave as an investor.
If you have a strong tendency of Type D, you are strong-willed, decisive and directive. You are result-oriented and less concerned about people.
If you have a strong tendency of Type I, you are enthusiastic, energetic and expressive. You are people-oriented and eager for others' recognition.
If you have a strong tendency of Type S, you are stable, cooperative and sympathetic. You are more concerned with people but keeping low profile.
If you have a strong tendency of Type C, you are objective, analytical and systematic. You are more concerned with accuracy and quality, thus cautious about making decisions.
The above are general descriptions of different types. Actually you may identify one's type by simply looking at their faces and/or chatting with them for a few minutes. But of course there are some people who do not expose a strong tendency towards any type.
In next blog, I will talk about how people of different types behave as an investor.
Monday, August 14, 2006
Investor Profiling (1/3)
As required by SFC, firms should ensure suitability when making investment recommendation or solicitation to their clients. A pre-requisite for suitability assessment is "investor profiling". That means, you understand the clients' investment objectives, investment experiences, financial situation, risk tolerance, etc. before you promote any product / service to them.
Typically firms are using a questionnaire to collect the above information and then classify the clients into different categories. For instance, if you are classified as a sophisticated investor, the salesmen can sell a high risk product to you. This profiling process can help reduce the so-called "mis-selling risk".
Such a system is good but not perfect, because it doesn't take into account one important factor: investor's behavioral pattern. Have you encountered some investors who keep asking questions but never making decisions? This is a behavioral pattern affecting both your sales performance and mis-selling risk.
How can salesmen understand clients' behavioral pattern better? There are some well-known models designed by psychologists. A very famous and useful one is called DISC Profile. In this series of blogs, I will explain how this model may be used to profile an investor.
DISC Profile sets out a standard questionnaire which has been done by millions of people and thus it can provide consistent results to predict one's behavioral pattern. This model classify people into 4 types and explain for their differences. Even without using the questionnaire, you can ascertain your type by asking yourself the following 2 questions:
Typically firms are using a questionnaire to collect the above information and then classify the clients into different categories. For instance, if you are classified as a sophisticated investor, the salesmen can sell a high risk product to you. This profiling process can help reduce the so-called "mis-selling risk".
Such a system is good but not perfect, because it doesn't take into account one important factor: investor's behavioral pattern. Have you encountered some investors who keep asking questions but never making decisions? This is a behavioral pattern affecting both your sales performance and mis-selling risk.
How can salesmen understand clients' behavioral pattern better? There are some well-known models designed by psychologists. A very famous and useful one is called DISC Profile. In this series of blogs, I will explain how this model may be used to profile an investor.
DISC Profile sets out a standard questionnaire which has been done by millions of people and thus it can provide consistent results to predict one's behavioral pattern. This model classify people into 4 types and explain for their differences. Even without using the questionnaire, you can ascertain your type by asking yourself the following 2 questions:
- I generally perceive the environment as (a) unfavorable or (b) favorable.
- I generally believe I am (a) more powerful or (b) less powerful than the environment.
Then...
- If you choose (a) for both questions, your type is Dominance.
- If you choose 1(b) and 2(a), your type is Influence.
- If you choose (b) for both questions, your type is Steadiness.
- If you choose 1(a) and 2(b), your type is Conscientiousness.
I'll explain the salient features of each type in next blog.
Fake Websites
The HK financial regulators often alert us to those fake websites. People may think the best way to verify the alleged website of a financial institution is to check with the relevant regulator's website. But can we fully trust on this channel?
Once a time I located this website from SFC's online public register: www.broking.hsbc.com You can figure out which financial group this website refers to. But when I clicked on this website, an error message was displayed!
Then I tried www.broking.hsbc.com.hk and this time I was routed to the homepage of "HSBC Broking Services (Asia) Limited". The website states that this company is incorporated in HKSAR and it provides brokerage and dealing services in equities, bonds, foreign exchange, futures and options, precious metals and derivatives to retail, corporate customers and financial intermediaries.
However, when I checked again with SFC's online public register, the company "HSBC Broking Services (Asia) Limited" was not found! Instead, I can only find another company of a similar name: "HSBC Broking Securities (Asia) Limited".
Who can tell me what's wrong?
Once a time I located this website from SFC's online public register: www.broking.hsbc.com You can figure out which financial group this website refers to. But when I clicked on this website, an error message was displayed!
Then I tried www.broking.hsbc.com.hk and this time I was routed to the homepage of "HSBC Broking Services (Asia) Limited". The website states that this company is incorporated in HKSAR and it provides brokerage and dealing services in equities, bonds, foreign exchange, futures and options, precious metals and derivatives to retail, corporate customers and financial intermediaries.
However, when I checked again with SFC's online public register, the company "HSBC Broking Services (Asia) Limited" was not found! Instead, I can only find another company of a similar name: "HSBC Broking Securities (Asia) Limited".
Who can tell me what's wrong?
Friday, August 11, 2006
Market Abuse
This is a recent case in the UK. FSA fined hedge fund manager GLG Partners LP (GLG) and its former managing director Philippe Jabre £750,000 each for market abuse and breaching FSA principles. This is the largest fine the FSA has issued against an individual.
According to FSA's report, Jabre was "wall crossed" on 11 February 2003 by Goldman Sachs International (GSI) as a pre-marketing exercise of a new issue of convertible preference shares in Sumitomo Mitsui Financial Group Inc (SMFG). Jabre was given confidential information and agreed to be restricted from dealing SMFG securities until the issue was announced.
However, Jabre breached this restriction by short selling around $16 million of SMFG ordinary shares on 12-14 February 2003. When the new issue was announced on 17 February 2003, he made a substantial profit for the GLG Market Neutral Fund.
The following facts are also remarkable:
According to FSA's report, Jabre was "wall crossed" on 11 February 2003 by Goldman Sachs International (GSI) as a pre-marketing exercise of a new issue of convertible preference shares in Sumitomo Mitsui Financial Group Inc (SMFG). Jabre was given confidential information and agreed to be restricted from dealing SMFG securities until the issue was announced.
However, Jabre breached this restriction by short selling around $16 million of SMFG ordinary shares on 12-14 February 2003. When the new issue was announced on 17 February 2003, he made a substantial profit for the GLG Market Neutral Fund.
The following facts are also remarkable:
- Before Jabre was informed by GSI of the information on the perspective issue, he had already maintained a trading strategy of borrowing and short selling the shares of SMFG.
- "Wall crossing" was formally agreed between Jabre and GSI salesman during their communications. Jabre clearly accepted the restriction so that he could not trade the name of SMFG at all, even just for following his "existing trading pattern".
- There are no tape recordings of conversations between Jabre and GSI saleman on 11 February 2003. FSA has considered other materials such as internal GSI emails and transcripts of interviews.
- Jabre failed to consult GLG's Compliance Department on this wall-crossing issue.
FSA considers this guy is a prominent figure in the hedge fund industry. Obviously it was perceived he understood the rule but still decided to take the regulatory risk. £750,000 is quite a huge penalty at individual level.
Monitoring of wall-crossing activities between a fund manager and an outside investment banker is also a challenge to compliance officers.
Thursday, August 10, 2006
IP & SSA Services
SFC is now under fire after the consecutive collapses of 3 brokers in recent months. Every time it reminded the investors to open the Investor Participant Account (IP) or Stock Segregated Account (SSA) for "self-protection". Unfortunately, retail investors do not favor on such services. According to the findings of media, the investors are generally concerned with delay in order execution and stock transfer fees by using the services.
This week SFC issued a circular to remind the brokers that they should heighten their clients' awareness of the IP and SSA services. This is fine but subsequently SFC uses such kind of "threatening" tone:
"The Commission will not look favourably upon those brokers who either refuse to provide interested clients with the related information on the IP and SSA services, or who actively or tacitly discourage clients from availing themselves of such services."
It seems that IP or SSA services have never been popular (even launched for so many years) is due to brokers' deterrence! Any facts to support this conjecture? Have investors been surveyed why they don't use the IP or SSA services? I can't find such study in either the Retail Investor Survey 2005 or the Stock Investor Survey (June 2006) published by SFC.
Perhaps somebody has attempted to conceal the failed service marketing by finding a scapegoat.
This week SFC issued a circular to remind the brokers that they should heighten their clients' awareness of the IP and SSA services. This is fine but subsequently SFC uses such kind of "threatening" tone:
"The Commission will not look favourably upon those brokers who either refuse to provide interested clients with the related information on the IP and SSA services, or who actively or tacitly discourage clients from availing themselves of such services."
It seems that IP or SSA services have never been popular (even launched for so many years) is due to brokers' deterrence! Any facts to support this conjecture? Have investors been surveyed why they don't use the IP or SSA services? I can't find such study in either the Retail Investor Survey 2005 or the Stock Investor Survey (June 2006) published by SFC.
Perhaps somebody has attempted to conceal the failed service marketing by finding a scapegoat.
Wednesday, August 09, 2006
7 Deadly Sins of Investing (7/7)
Sin #7 - Sloth
Sloth means laziness. That means, you are too lazy to do your homework before investing. I am afraid this is the most common fault of investors. If you are not so slothful, the harm caused by other 6 sins (even all committed by you) would be undermined...
Conclusion
The best way of investor protection is that every investor knows how to protect himself. Of course there are many investment traps in the market, but who is deciding to jump into them? You are suffering from one or more of the 7 sins, then others can take advantage of them.
With self-awareness of your weaknesses, you are in a better position to reduce your investment mistakes.
Sloth means laziness. That means, you are too lazy to do your homework before investing. I am afraid this is the most common fault of investors. If you are not so slothful, the harm caused by other 6 sins (even all committed by you) would be undermined...
- you analyze the stock's merits and defects before you follow others to invest
- you spend some time to listen to others' opinions even you need to save your face
- you regularly review your investing decisions in light of changing market conditions
- you prepare for the worst if your greedy deal ends in disaster
- you find out what is the root problem of your investments
- you calculate the full costs of over-trading
Conclusion
The best way of investor protection is that every investor knows how to protect himself. Of course there are many investment traps in the market, but who is deciding to jump into them? You are suffering from one or more of the 7 sins, then others can take advantage of them.
With self-awareness of your weaknesses, you are in a better position to reduce your investment mistakes.
7 Deadly Sins of Investing (6/7)
Sin #6 - Gluttony
Researches have justified that in the long run over-trading would lessen your investment returns, but people continue to suffer from the sin of gluttony. When HK people are eating a buffet, they like to put a large variety of food on the dish. When they are investing, they have a pattern of switching between stocks and trading too frequently.
Don't you have sufficient knowledge and time to analyze so many stocks? You don't care because you rely on "financial actors" who appear to understand all companies well. You are impatient with any good fundamental stock which fails to give you a quick profit. You choose to be a speculator even you don't have the capability of a professional trader. You have also forgotten to calculate the transaction costs behind your active trading.
No matter how unwise you are, your brokers / advisers would always support your trading decisions because they earn the commissions from your transactions. Getting rid of over-trading may just as hard as quitting smoking!
Researches have justified that in the long run over-trading would lessen your investment returns, but people continue to suffer from the sin of gluttony. When HK people are eating a buffet, they like to put a large variety of food on the dish. When they are investing, they have a pattern of switching between stocks and trading too frequently.
Don't you have sufficient knowledge and time to analyze so many stocks? You don't care because you rely on "financial actors" who appear to understand all companies well. You are impatient with any good fundamental stock which fails to give you a quick profit. You choose to be a speculator even you don't have the capability of a professional trader. You have also forgotten to calculate the transaction costs behind your active trading.
No matter how unwise you are, your brokers / advisers would always support your trading decisions because they earn the commissions from your transactions. Getting rid of over-trading may just as hard as quitting smoking!
7 Deadly Sins of Investing (5/7)
Sin #5 - Anger
Anger is an emotion. It is not a sin by itself. The real devil is your attribution of anger to the wrong subject. For example, in the incident of the collapsed broker Wing Yip, a victim claimed that he would no longer buy stocks if SFC has not enhanced the investor protection. I empathize with his misfortune but I can't understand why his anger with Wing Yip / SFC would trigger his decision of leaving the market. Obviously, he was beating the straw man.
You may have some bad investment experiences. But don't generalize a conclusion that all investments are scams or all investment advisers are thieves. Make it clear exactly what you are angry at. Apart from blaming others, you can take up your "responsibility" (= response-ability) before making investment decisions.
Anger is an emotion. It is not a sin by itself. The real devil is your attribution of anger to the wrong subject. For example, in the incident of the collapsed broker Wing Yip, a victim claimed that he would no longer buy stocks if SFC has not enhanced the investor protection. I empathize with his misfortune but I can't understand why his anger with Wing Yip / SFC would trigger his decision of leaving the market. Obviously, he was beating the straw man.
You may have some bad investment experiences. But don't generalize a conclusion that all investments are scams or all investment advisers are thieves. Make it clear exactly what you are angry at. Apart from blaming others, you can take up your "responsibility" (= response-ability) before making investment decisions.
7 Deadly Sins of Investing (4/7)
Sin #4 - Greed
More people agree that greed is a sin, but less people admit that they are greedy. Instead they would say they are just "ambitious" or "aspiring". They want to earn a huge profit in a short period of time by making a big deal. But how can you differentiate ambition from greed? Usually you only know you are actually greedy (or over-ambitious) after you have paid for a heavy lesson!
The fundamental problem of greed is: being unrealistic. Is it realistic for you to fully believe in the so-called "insider information" heard from your neighbor and put your full stakes on a stock? Is it realistic for you to believe that you are the smartest or luckiest guy at this moment? The answer is too obvious.
Okay, even you insist that you are just ambitious, let me give you a final advice - Be very cautious when borrowing to invest or speculate. Remember how people died in the past 10 years.
More people agree that greed is a sin, but less people admit that they are greedy. Instead they would say they are just "ambitious" or "aspiring". They want to earn a huge profit in a short period of time by making a big deal. But how can you differentiate ambition from greed? Usually you only know you are actually greedy (or over-ambitious) after you have paid for a heavy lesson!
The fundamental problem of greed is: being unrealistic. Is it realistic for you to fully believe in the so-called "insider information" heard from your neighbor and put your full stakes on a stock? Is it realistic for you to believe that you are the smartest or luckiest guy at this moment? The answer is too obvious.
Okay, even you insist that you are just ambitious, let me give you a final advice - Be very cautious when borrowing to invest or speculate. Remember how people died in the past 10 years.
7 Deadly Sins of Investing (3/7)
Sin #3 - Lust
Still remember this investment motto: "Don't fall in love with a stock"? If you are addicted to a company, an economic sector or a particular trading strategy, you may suffer from the sin of lust.
Before its collapse, many US investors were lusting for Enron by putting most of their stakes on it. Yes, you may have a very brilliant record of investing in a company, but it doesn't imply this company would never fail. The market conditions could change to make your past successful ways no longer valid. If you feel like "betraying a friend" when you consider downsizing your holding of a stock, you are in danger of losing all in one game.
What can you do before you know too late your lust is wrong? My suggestion is: diversification. Even you are a great optimist of the property sector, you may still diversify at least a portion of your portfolio to other sectors. Thinking of alternatives is the best way to cope with changes.
Still remember this investment motto: "Don't fall in love with a stock"? If you are addicted to a company, an economic sector or a particular trading strategy, you may suffer from the sin of lust.
Before its collapse, many US investors were lusting for Enron by putting most of their stakes on it. Yes, you may have a very brilliant record of investing in a company, but it doesn't imply this company would never fail. The market conditions could change to make your past successful ways no longer valid. If you feel like "betraying a friend" when you consider downsizing your holding of a stock, you are in danger of losing all in one game.
What can you do before you know too late your lust is wrong? My suggestion is: diversification. Even you are a great optimist of the property sector, you may still diversify at least a portion of your portfolio to other sectors. Thinking of alternatives is the best way to cope with changes.
7 Deadly Sins of Investing (2/7)
Sin #2 - Pride
Is confidence good? Yes. But over-confidence is another sin - pride. If your confidence in making an investment decision is well supported by your research, you can stick to your choice even the market does not favor on it at a moment. Otherwise, you may suffer from pride which makes you hard to admit, and correct, your mistakes.
There are so many people picking up the wrong stocks. Having witnessed strong negative news and price plunge, they refuse to cut loss but buy even more to dilute the average cost. As a result, they lose more.
The problem is: How can you differentiate confidence from pride? I suggest the "sunshine test". Ask yourself a question - Are you willing to convince your friends and peers what you are doing? If yes, just do it. If you find they can't defeat your grounds, it is more likely you are confident rather than prideful.
Is confidence good? Yes. But over-confidence is another sin - pride. If your confidence in making an investment decision is well supported by your research, you can stick to your choice even the market does not favor on it at a moment. Otherwise, you may suffer from pride which makes you hard to admit, and correct, your mistakes.
There are so many people picking up the wrong stocks. Having witnessed strong negative news and price plunge, they refuse to cut loss but buy even more to dilute the average cost. As a result, they lose more.
The problem is: How can you differentiate confidence from pride? I suggest the "sunshine test". Ask yourself a question - Are you willing to convince your friends and peers what you are doing? If yes, just do it. If you find they can't defeat your grounds, it is more likely you are confident rather than prideful.
7 Deadly Sins of Investing (1/7)
SFC is always talking about investor education. But is it effective? Yes or not. In terms of knowledge, HK investors are getting more acquainted with various investment products. But in terms of self-understanding of their bad investment habits, they are still lagging behind.
In recent decades the research on behavioral finance has released many findings on so-called "irrational behaviors". For example, HK investors viewed the stock split of Manulife (945) as a "positive" signal and made a buy.
But what is the "mindset" behind these irrational behaviors? Investor psychology is the relevant topic of study. I recently read a book titled "The 7 Seven Sins of Investing", which identified 7 kinds of "blind spot" of investors, namely, envy, pride, lust, greed, anger, gluttony and sloth.
Based on my observations of others and personal experiences, I find these 7 sins are quite influential and prevailing. In this series of blogs, I would like to introduce them one by one.
Sin #1 - Envy
You focus on successes of others. Think about if you have such experience - when you heard from your good friend he made a small fortune by picking up a small-cap, how do you feel? A bit down, right? If yes, this is envy. If yes, then what would you do? You are tempted by yourself to replicate his success by buying the same stock. But at that time your purchase price must be much higher than your friend's, and most likely you will buy at the "historical high".
Could you eliminate your envy? I think it's difficult, if not impossible. Envy is a deep-rooted human nature. What you can do is keeping aware of it and try to minimize its influence on your investment decisions.
My suggestions for you to balance your envy are:
In recent decades the research on behavioral finance has released many findings on so-called "irrational behaviors". For example, HK investors viewed the stock split of Manulife (945) as a "positive" signal and made a buy.
But what is the "mindset" behind these irrational behaviors? Investor psychology is the relevant topic of study. I recently read a book titled "The 7 Seven Sins of Investing", which identified 7 kinds of "blind spot" of investors, namely, envy, pride, lust, greed, anger, gluttony and sloth.
Based on my observations of others and personal experiences, I find these 7 sins are quite influential and prevailing. In this series of blogs, I would like to introduce them one by one.
Sin #1 - Envy
You focus on successes of others. Think about if you have such experience - when you heard from your good friend he made a small fortune by picking up a small-cap, how do you feel? A bit down, right? If yes, this is envy. If yes, then what would you do? You are tempted by yourself to replicate his success by buying the same stock. But at that time your purchase price must be much higher than your friend's, and most likely you will buy at the "historical high".
Could you eliminate your envy? I think it's difficult, if not impossible. Envy is a deep-rooted human nature. What you can do is keeping aware of it and try to minimize its influence on your investment decisions.
My suggestions for you to balance your envy are:
- Don't just focus on others' successful outcomes, but also their processes (e.g. homework done for stock picking)
- Pay attention also to others' unsuccessful experiences
Small is beautiful?
Within a few months a total of 3 small brokers have collapsed with misappropriation of client assets. Such incidents even happened during the current economic conditions. What's wrong?
Somebody commented that SFC should prohibit repledging of margin clients' securities. This is overshooting. In Wing Yip's case, all clients were cash account clients, but the owner simply stole their securities.
The beauty of small brokers is the personalized services (including "stock tipping"), but the clients are bearing the risk of theft of their assets. The ideal solution proposed by SFC is of course the opening of IP account or segregated account with statement service. But investors dislike such inconvenient arrangement. This is funny - you trust on somebody who is not so trustworthy, and then you blame the regulator for not protecting you!
Family-based or small brokers carry their own values. Why don't they concentrate on providing their niche services and "outsource" their back office functions to a centrally managed company? This independent company (formed by a union of small brokers) can afford appointing qualified compliance officers or auditors to monitor its operations. As a result, small brokers could lower their operational risk, then recovering the public confidence. This may even be a cost-saving proposal.
If the internal control problem of small brokers is not resolved, I can't believe that Wing Yip's owner is the last "bad guy".
Somebody commented that SFC should prohibit repledging of margin clients' securities. This is overshooting. In Wing Yip's case, all clients were cash account clients, but the owner simply stole their securities.
The beauty of small brokers is the personalized services (including "stock tipping"), but the clients are bearing the risk of theft of their assets. The ideal solution proposed by SFC is of course the opening of IP account or segregated account with statement service. But investors dislike such inconvenient arrangement. This is funny - you trust on somebody who is not so trustworthy, and then you blame the regulator for not protecting you!
Family-based or small brokers carry their own values. Why don't they concentrate on providing their niche services and "outsource" their back office functions to a centrally managed company? This independent company (formed by a union of small brokers) can afford appointing qualified compliance officers or auditors to monitor its operations. As a result, small brokers could lower their operational risk, then recovering the public confidence. This may even be a cost-saving proposal.
If the internal control problem of small brokers is not resolved, I can't believe that Wing Yip's owner is the last "bad guy".
Opening
Having worked in the compliance field for more than 10 years, I eventually decided to create a personal blog for this profession. I do this not because I am knowledgeable. The opposite is true - there are too many interesting regulatory issues to explore. Publish or perish - I want to keep myself abreast of the times by means of writing.
Subscribe to:
Posts (Atom)