Exempt Principal Trader

Recently the Takerovers and Mergers Panel has reported a decision relating to Lehman Brothers Asia Ltd, which cast some light on the issues of Chinese Walls.

From April 2008, Lehman worked specifically on a proposal which would result in the privatization of CITIC International Financial Holdings Ltd ("CIFH") (183.hk) listed on SEHK. On 3 Jun 2008, CIFH announced that it had received a proposal from Gloryshare Investment Ltd, a wholly-owned subsidiary of the CITIC group, regarding the proposed privatization. It envisaged that Banco Bilbao Vizcaya Argentaria S.A. ("BBVA"), presently a substantial shareholder of CIFH, would increase its shareholding in CIFH from 15% to 30%, the balance being held by Gloryshare or members of its group.

By 10 Jun 2008 Lehman was formally retained by Gloryshare as its adviser and on that date Glorysky and CIFH jointly announced the terms of the privatization proposal. In summary, members of CIFH will receive, in consideration for the cancellation of their shares, one "H" share of China CITIC Bank Corporation Ltd ("CNCB") (998.hk) and HK$1.46 in cash for every share in CIFH. In anticipation of resumption of trading on the following day, the Lehman group instituted a restriction on all proprietary trading, but not agency trading, in the shares in CIFH and CNCB.

However, on 11 Jun 2008 the Lehman group:

• purchased 31,000 shares in CIFH for the purpose of rebalancing a hedge against existing swaps with a client on the MSCI HK Index;
• purchased 179,000 shares in CIFH for the purpose of unwinding a short position resulting from OTC sales to clients; and
• purchased 72,000 shares in CIFH for the purpose of executing a "Lehman Performance Swap" for a client through its direct market access (DMA) system.

On 13 Jun 2008 the Lehman group purchased a further 41,000 shares in CIFH for the purpose of covering a short position created as a result of a client facilitation trade. HK$6.27 was the highest price paid by the Lehman group for purchases of shares in CIFH during the offer period. When the Compliance and Control divisions of the Lehman group were aware of these purchases, they immediately informed SFC.

Under the Takeovers Code, the Lehman group is treated as a person "acting in concert". The Code places strict disciplines on a financial adviser to an offeror in respect of in shares of the offeree. In the case of a securities exchange offer, purchases made by the Lehman group above the offer price will result in that offer being accompanied by a full cash alternative at the highest price paid. This would increase the cash element of the offer from HK$2.6 bn to between HK$10.92 bn and HK$11.16 bn!

Nevertheless, the Code recognizes that for a multi-service financial group the disciplines it imposes on a financial adviser and its group may have an impact on other activities which are unrelated to the provision of advice to an offeror. Therefore the Code contains provisions for exemptions for principal traders. But the Lehman group failed to apply for the exempt principal trader status.

The Panel finally decided to exercise its discretion to waive the requirement for a cash alternative for the following reasons:

• the size of the purchases were very small relative to the size of the offer and the total volume of shares in CIFH traded;
• the purchases had a negligible impact on public shareholders;
• the imposition of the cash alternative requirement would have a substantial and adverse impact on Gloryshare who had no knowledge of the purchases; and
• the remedy would be disproportionate to the scale of the purchases if the primary obligation for the offer fall on the Lehman group.

If the Panel did not give a leeway to this case, then I think the Lehman group would get into great trouble!