The term ‘Chinese wall’ has its origin in the Great Wall of China. That is an important point to remember. The financial sector uses the term to imply some kind of an iron curtain between conflicting roles of two departments within an organisation.
Online searches show the concept of ‘Chinese wall’ first came into being after the Great Depression of 1929, when the establishment wanted to separate the conflicting functions of banking and securities firms and enacted laws to this effect.
However, post-mortems of scams and crashes over the years have shown these walls often retain the defining characters of their Great Chinese ancestor. They are porous, intermittent and non-existent in many places. The advertised existence of such walls and regulations that require these have only helped instill a false confidence in the poor investor, often leading him into an abyss.
Two recent instances of blatant breaches of the so-called Chinese walls between the research and trading arms of broking companies have been noticed and reported by market-focused portal http://rakesh-jhunjhunwala.in. It calls itself a Fan Site in Rakesh Jhunjhunwala's name. “Rakesh Jhunjhunwala is not associated with us and is in no way aware, accountable or responsible for what is stated here,” it says in a disclaimer.
The portal has found these two analysts were shamelessly recommending certain stocks to their clients when their own employers, who had accumulated significant numbers of these stocks before such recommendations, were selling these stocks. Both stocks crashed subsequently, probably charring investments made by people who trusted the recommendations of these star analysts.
It has been a little over a year since the Securities and Exchange Board of India (Sebi) gazetted the Sebi (Research Analysts) Regulations, 2014. These regulations had given six months’ time for analysts to register themselves. That deadline expired in February.
An entire chapter was dedicated to ‘Management of Conflicts of Interest and Disclosure Requirements’. “Research analyst or research entity shall have in place appropriate mechanisms to ensure independence of its research activities from its other business activities,” says one of its earliest provisions. The chapter clearly requires the research entity to lay down internal policies to govern potential conflict situations and code of conduct to be followed by employees. It restricts trading by the analysts themselves in the stocks they recommend.
Whether such recommendation was either in the form of a report or through a “public appearance”, the analyst is bound to make disclosures about the financial interest of himself, his employers or both.
It is not clear whether or how such clear cut regulations were ignored by these two analysts. It is possible that these recommendations might have come in the six-month window given for registration. That might put them in a grey area between proven guilty and cloud of suspicion. Though the recommendations could have come earlier, market actions by associated entities happened as late as last quarter when the Analysts Regulations were firmly in force.
The Street grapevine is that investors have not been happy with the revelations and have been demanding answers and compensation from at least one of these brokerages, whose recommendations have caused deeper pain.
It was feared at the time of the drafting, how Sebi would ensure compliance of these regulations that sought to encompass a wide range of practitioners. Time has come for Sebi to show that it means business.
A reader comment on the Jhunjhunwala portal said: “Only Chinese wall is that of the joint selling hakka noodle near their (broker’s) office.” It would be good if all investors know that well in advance.
