Getting To Know the Chinese Wall

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There have been recent discussions concerning the protection of investors and the key focus here has been on the fundamental issue known to us as “conflict of interest”, this issue has substantially affected practitioners in the financial service industry. The incorporation of the Chinese Wall could be seen as an approach to avoid any form of conflict.

However, sometimes in the ambiguous world of investment management, professionals will often lead investors to question whether or not these multi-service organizations could be free of conflict.

As a result, many firms are now expected to institute a “Chinese Wall” in their organization to prevent any sensitive information that could leak between divisions or departments allowing access to confidential information.

A “Chinese Wall” is basically a virtual barrier designed to prevent information from moving within the departments or divisions in the financial firm that could either benefit or jeopardize the trader.

Let’s make this simple, for instance, ABC asset manager purchases a considerable amount of shares in SABMiller at R165 per share. The asset manager then begins to negotiate the buy out with the securities arm. The securities arm then spreads the information around to its clients that there will be buyers coming in soon to make a purchase that can support the price.

Soon after the word has been spread, the asset manager then buys the SAB shares. An analyst at the ABC research proposes in a report that the share is worth R200, the price then rockets.

A series of such events obviously raises some question about ‘conflict’, since the firm would have clearly benefited from various sides.

The JSE advises investors in its guidelines for insider trading, “Many organizations that trade in shares, for instance investment banks, are also involved as advisers to companies during corporate actions.’Chinese walls’ should be imposed to avoid the possibility that price-sensitive information becomes available to the trading divisions.”

Organizations are usually required to have a physical barrier between the staff and the documents/information that can cause one party to gain an advantage over the other parties that are involved.

Should employees be moved from one department to another, they are then expected to sign a confidentiality agreement that prevents them from ever disclosing any information they may come across, while being in the other department.

Firms also need to employ the use of compliance officers, who need to keep a track of all the trading activities of both the fund managers and the brokers, thus to ensure that the firm’s own traders will not be benefiting from any information.

To ensure transparency in the process, traders working in a stock brokerage need to obtain permission from their compliance officer before trading on their accounts.

Although most financial regulatory bodies and exchanges around the world have opted for establishing the use of “Chinese walls” within their organizations, many outsiders believe that it hasn’t proved to be effective enough to control share-price manipulation and insider trading.

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