No getting away with manipulating share prices

The announcement by the Financial Sector Conduct Authority (FSCA) that it has fined an asset manager and his stockbroker a total of R5.5 million for trying to rig prices on the JSE – in an effort to profit from huge exposure to the same shares in the futures market – makes for interesting reading due to the huge amounts invested in two small companies.

At the time of the transgression in 2008, Trinity Asset Management bought single stock futures contracts to the equivalent of R225 million worth of shares in the two companies. The exposure to ConvergeNet, a small IT company, amounted to some R200 million and exposure to the even smaller Sallies in the mining sector came to R25 million.

Unfortunately, the shares didn’t go up and deliver large profits as the buyers obviously hoped for. Price data from 2008 shows they were very volatile. The investors were in for a wild ride, especially in the case of ConvergeNet.

Rapid decline

Not only did ConvergeNet’s share price experience large swings, hindsight shows that the trend was definitely down. The share declined rapidly from a high of above R13 in February 2008 to a low of less than R8 per share in December.

A report of the investigation by the FSCA and an old report of investigations by the Directorate of Market Abuse flagged suspicious transactions in ConvergeNet shares between November 2008 and March 2009, and in Sallies between July and December 2008.

The FSCA investigation found that Quinton George, CEO of Trinity Asset Management at the time, and Justin Fletcher, a share dealer at Imara SP Reid, manipulated the share prices of ConvergeNet and Sallies during November and December, to avoid posting additional margin to their loss-making positions in the futures market.

Deception

According to the FSCA report, George and Fletcher “used manipulative, improper, false or deceptive trading practices to create deceptive appearance of trading activity or an artificial price in respect of ConvergeNet Holdings and Sallies Limited”.

“In November and December 2008, many of Trinity’s clients, as well as ConvergeNet’s black economic empowerment structures, were invested in ConvergeNet and Sallies single stock futures (SSF). Due to the decline of the ConvergeNet and Sallies share prices, the SSF contracts attracted a variation margin. Variation margin payments were payable daily.

“In order to avoid paying significant amounts in variation margin for the SSF positions held by Trinity’s clients, Mr George employed a strategy where he gave instructions to his trader, Mr Fletcher, near the close of the market with the sole purpose of inflating the closing share prices of ConvergeNet and Sallies,” says the FSCA in its report.

The effect of the inflated closing prices meant that Trinity avoided or reduced the additional margins that would had to have been paid – by as much as R19 million on some days.

The mechanics of the futures market allow investors, speculators or fund managers looking to temporarily hedge an investment to buy exposure to a share, index, commodity or currency without paying in full. Derivatives based on shares, such as SSF or contracts-for-difference (CFDs), require an initial margin of only 10% to 20% of the value of the transaction, depending on the perceived risk of the particular share.

Daily adjustments

Every position is valued at the end of the day based on the price of the underlying instrument, in this case the prices of ConvergeNet and Sallies shares. This process of mark-to-market values the whole position, and every participant’s account is adjusted accordingly.

The winners can withdraw their profits to their bank accounts without closing the position, while the losers must either close the position or deposit more margin, or both.

Trinity’s position of R200 million in ConvergeNet would have required an initial margin of around R20 million and that of Sallies around R2.5 million. Any change in either share price influences the margin balance.

The leverage in the derivatives markets works wonders, as long as the share goes the right way.

An increase of just 5% in ConvergeNet’s share price – say from R8 to R8.40 – would have yielded a profit of a tidy R10 million on the R200 million deal, or a cool 50% return on the capital invested.

Margin call

Unfortunately, the opposite is also true. Any decline in the share price leads to a loss and the dreaded margin call the next morning to top up the balance.

A decline of only 10% in the price of ConvergeNet would have depleted the initial margin of R20 million and Trinity would’ve had to deposit another R20 million, immediately.

The R19 million the FSCA refers to in its charges would have been the result of a relatively small change in share prices.

The FSCA says in its report that evidence showed that George’s instructions were explicit of his intention (to support the share prices) and were specific that shares should be purchased at or near the close of the market at higher prices.

In essence, only a few shares need to trade to fix a higher closing price, which is possible in instances where the share trades infrequently or only small volumes trade.

Fines

The FSCA imposed an administrative penalty of R4 million on George, saying that it had considered the seriousness of the misconduct.

Fletcher was fined R1.5 million. At the time, he was a dealer at stockbroker Imara SP Reid.

The FSCA noted that share price manipulation and its impact on the integrity of our financial markets is a very serious matter.

“Further, the authority took into account, as an aggravating factor, that Mr Fletcher, as a qualified market participant, was the gatekeeper who has been trained and was expected to ensure that he prevents any orders that are intended to diminish the integrity of our financial markets from being executed,” according to the FSCA.

“It was clear from the context of the instructions that the intention behind the instructions was to create an artificial closing share price.”

The FSCA noted further that South African financial markets, as emerging markets, require integrity to attract global investors and foster investor confidence. “Any conduct that compromises the level of integrity of our financial markets needs to be deterred by imposing significant penalties,” it concluded.

More than 10 years later

Moneyweb had to ask the FSCA why it took nearly 12 years to investigate and castigate the wrongdoers if market integrity is so important.

“The matter was only reported to the FSCA by a whistleblower many years after the event had taken place,” says Brandon Topham, divisional executive of investigations and enforcement at the FSCA. “It then took considerable time to retrieve the necessary vital evidence before the investigation could proceed.

“It must be reiterated that the enforcement process is gradual in nature, particularly when the negotiation of settlements is involved,” he adds.

Topham says it involves a lot of correspondence and must provide those under investigation with an opportunity to give their inputs and consult legal professionals. It is seen as essential to provide enough time in order to comply with the constitutionally-provided protection against administrative actions and penalties.

“The FSCA follows the administrative process and can issue administrative penalties,” says Topham. “However, decisions made by the authority can be challenged through the tribunal and then the court system.”

A director of ConvergeNet, Hanno van Dyk, was also investigated and fined R750 000 some 10 years later for price manipulation of the company’s share during December 2008.

Now, 12 years after the flurry of trades, and with the investigations finalised and fines issued, none of the companies is still in existence.

Sallies was delisted from the JSE on the first trading day of 2013 and ConvergeNet sold most of its IT interests during a restructuring in July 2013.

Van Dyk acquired Sizwe IT Group from ConvergeNet in 2013 for R110 million. In 2018, Ayo technology acquired an interest of 55% in Sizwe for R165 million. ConvergeNet morphed into an asset manager, Stellar Capital Management.

Twist in the tale

Trinity Asset Management disappeared, but not without another interesting tale.

Trinity took a knock of R4.6 million when a creditor refused to repay a loan of more than R3 million plus interest. The dispute ended in the Supreme Court of Appeal after several court appearances and ended with a surprise ruling.

The creditor, Grindstone Investments, borrowed R3 million from Trinity in 2007 to buy a property. The loan agreement stated that the debt was repayable within 30 days after Trinity issued a demand for the repayment, which was delivered to Grindstone in 2013.

The final judgment by the court created a furore in legal circles with its ruling in favour of Grindstone – that the debt had prescribed by 2013. The ruling stated that the wording in the agreement for payment on demand referred to the date when the agreement was signed and that the debt became payable in 2007.

By 2013, more than three years later, the debt had prescribed. The ruling has an effect on similar agreements and is also relevant in cases of inter-company loans, according to several law firms that studied the ruling.