At 11:05 August 16, 2013, due to error of its ETF strategy transactions system, Everbright Securities mistakenly placed a massive RMB 23.4 billion worth of purchase orders for 180 ETF, of which RMB 7.27 billion were concluded, causing CSI300 Index, Shanghai Composite Index and other major indices and many heavyweight stocks to experience short-lived yet violent fluctuations. This incident, the first extreme case caused by erroneous trading software since the establishment of China’s capital markets, has caused significant adverse impact on the securities and futures markets.
Following the incident, the CSRC and the exchanges responded immediately, launching an emergency investigation on Everbright Securities. Considering the novel nature of the case, the Commission, on the basis of in-depth investigation, called in external experts for advice. As of now, the CSRC has finished the investigation and reached a conclusion regarding the case, and is now releasing the preliminary notification for administrative punishment. In the next step, it will issue the official decision on penalties.
I. Unlawful Acts
1) Everbright Securities converted and sold ETF funds and sold short index futures contracts after the abnormal trading incident and before the lawful disclosure of information.
After the abnormal trading incident, Everbright Securities started selling short IF1309 index futures contracts (sold short 235 contracts by market close at noon) pursuant to the brokerage firm’s rule in the Administrative Provisions of the Department of Strategy Transactions providing that 「in the case of abnormal trading caused by system errors, hedging transactions should be conducted」 and reported relevant information to the department manager Yang Jianbo. At the same time, Everbright Securities got calls from the SSE inquiring about the situation and started internal verification.
Around 11:20, manager of the Financial Planning Department Shen Shiguang inquired Yang Jianbo about the situation and then reported to president Xu Haoming about the possible correlation between the abnormal index surge and the operation of the Strategy Transactions Department.
Around 11:59, without much knowledge of the situation and its cause, board secretary Mei Jian made a rash denial when being confronted by the reporter about the 「RMB 7 billion glitch in the proprietary trading at Everbright」. At 12:47, this misleading information was released and quoted by major portal sites.
At 13:00, Everbright was suspended from trading due to significant event. At 14:22, through statutory procedures for disclosure, Everbright Securities publicly announced that 「there were some errors in its own arbitrage system when the Strategy Transactions Department was conducting proprietary business activities in the morning」. Prior to the disclosure of such information, between 11:40 and 12:40, Xu Haoming, Yang Chizhong (assistant president in charge of Strategy Transactions Department), Shen Shiguang and Yang Jianbo had an emergency meeting and decided to sell short index futures contracts and convert and sell ETF for hedging purposes. Yang Jianbo was designated to execute the plan. Between 13:00 and 14:22, Everbright sold short 6420 IF1309 and IF1312 index futures contracts, making a profit of RMB 74.14 million.
At the same time, the brokerage firm converted and sold 263 million 180ETF, 689 million 50ETF, avoiding a loss of RMB 13.07 million. The aforementioned two transactions generated a total of RMB 87.21 million in profit and loss avoidance. After 14:22, Everbright continued to sell short IF1309 index futures contracts (with 750 new SK contracts and 200 new BPK contracts).
2) Everbright Securities lacks effective internal control and management. The abnormal trading incident can be attributed to the flawed design of its arbitrage system for proprietary business.
According to the investigation, the strategy transaction system used by the Strategy Transactions Department of Everbright Securities for proprietary business consists of order generation and order execution functions, and both have serious flaws in program design. One particular problem is that under the ETF arbitrage module of the order generation system, the 「replace order」 function (used for resubmission of orders that were not concluded) has a flaw in design, whereby the 「write the function of individual stocks」 was mistakenly written as 「write the function of a basket of ETF stocks」. In addition, in the order execution system, the default stock purchase price for market order was mistakenly set as 「0」. Therefore, the system was unable to check whether market orders exceed the credit limit of the account.
Since the Strategy Transactions Department was never included in the brokerage firm’s risk control system, it lacked effective management on technological system and trading control. Upon request of the traders of the department, the ETF arbitrage module of the order generation system was developed and tested by one sole programmer. Developed between June and July, 2013, the strategy transaction system was first used for real trading on July 29, merely 15 days before the abnormal trading incident on August 16. Prior to the incident, the 「replace order」 function was never used, causing the serious program error to be left unnoticed.
On the morning of August 16, 2013, traders conducted three batches of 180ETF arbitrage transactions for redemption, with the first two batches successfully executed. At 11:02, traders started the third batch. At 11:05:08, traders wanted to use 「replace order」 function to repeat the order of the 24 stocks, which were not successfully traded, of the 171 heavyweight stocks included in the purchase order in the third batch. After being consulted, the programmer pressed the 「replace order」 button as a demonstration, triggering the severely flawed program. The replaced purchase order of 24 individual stocks was executed as a purchase order of 「24 baskets of ETF stocks」 and was submitted to the order execution system.
Of the faulty purchase order, RMB 23.4 billion worth of order were verified and entered the SSE system waiting to be traded. It was not until the transaction of some orders was concluded and returned to the order execution system and the account balance showed as negative, did the verification of available fund limit in the order execution system start to function.
Of the RMB 23.4 billion market orders that entered the SSE system, RMB 7.27 billion was actually traded and the rest RMB 16.13 billion was automatically cancelled by the SSE trading system in accordance with the rule of 「concluding the trading of the best five orders and canceling the rest」.
II. The Finding of Unlawful Actions
Although the abnormal trading incident of Everbright Securities was caused by flawed design of the trading system of securities brokerage institution, it did reveal some major problems of the brokerage firm in internal control, risk management and compliance. Following the incident, when considering hedging measures and position adjustment to lower potential clearing risks, Everbright and relevant individuals adopted wrong solutions, committing multiple violations of laws and regulations such as insider trading, information misleading and violations of internal control management rules of the securities firm.
The Everbright incident not only has heavily impacted the business and finance of the brokerage firm, but also directly affected the normal order of securities markets and caused violent stock price fluctuation, influencing investors』 decisions in the investment in heavyweight stock, ETF and stock index futures and constituting insider information of the securities and futures markets as stipulated in Section 75 of the Securities Law and Section 82 of the Regulation on the Administration of Futures Trading. Before the public announcement at 14:22, Everbright was aware of the real cause for the abnormal market fluctuation while the public remained uninformed. Against this background, Everbright should have stopped trading and chosen reasonable measures to avoid risks after the insider information was announced.
However, the brokerage firm started offsetting transactions before the lawful disclosure of insider information, blatantly violating the fair trading principle. Based on the aforementioned fact, the CSRC, pursuant to law, determined that Everbright’s coverting and selling 50ETF and 180ETF and selling short IF1309 and IF1312 index futures contracts between 13:00 (following the decision of the senior management of the brokerage firm) and 14:22 on August 16 constitute insider trading as stated in Section 202 of the Securities Law and Section 70 of the Regulation on the Administration of Futures Trading. Xu Haoming was the main person directly in charge and Yang Chizhong, Shen Shiguang and Yang Jianbo were other persons directly responsible.
Following the incident, Everbright’s board secretary Mei Jian was uninformed about the cause of the violent market fluctuation. Yet as someone directly responsible for information disclosure of a listed company and a practitioner at a securities firm, given the lack of information disclosure and the considerable speculations regarding the incident, Mei Jian, without coordinating the performance of the obligation of information disclosure by the internal and external interested parties and verifying facts, released personal speculations to the public, which were then extensively quoted by the media. Mei Jian’s rash comments exacerbated market fluctuation and severely misled investors, violating the second paragraph of Section 78 of the Securities Law, which prohibits practitioners of securities firm from giving misleading information in securities trading.
III. Administrative Punishments and Administrative Supervision and Market Bans
Taking into account the immense adverse impact of the abnormal trading incident of Everbright Securities on securities and futures markets as well as the significant loss suffered by the public, especially small and medium investors, based on the principle of strict enforcement and accountability investigation, pursuant to Sections 150, 202, 207 and 233 of the Securities Law, Section 70 of the Regulation on the Supervision and Administration of Securities firms, Sections 70 and 78 of the Regulation on the Administration of Futures Trading and the Provisions on Banning of Access to the Securities Markets, the CSRC will impose the following administrative punishments and administrative supervision and market bans on Everbright Securities and relevant responsible individuals in accordance with statutory procedures:
1) The unlawful gains of RMB 87214278.08 of Everbright Securities will be disgorged and a fine equal to five times of its unlawful gains will be imposed. The total of the amounts disgorged and fined is RMB 523285668.48.
2) Xu Haoming, Yang Chizhong, Shen Shiguang and Yang Jianbo respectively will be given an official warning, fined RMB 600,000 and banned from the securities markets for life, and will be banned from the futures markets.
3) Mei Jian will be ordered to make corrections and fined RMB 200,000.
4) Everbright Securities shall shut down its proprietary business (excluding fixed income business). A suspension on approving proposals for new businesses will also be placed. Everbright Securities will be ordered to rectify its problems, take disciplinary action against responsible individuals and report the result of such measures to the CSRC.
The CSRC’s administrative and legal actions against the insider trading case of Everbright Securities in compliance with the law sends a clear signal that the Commission will show no leniency when it comes to any violations and is determined to prohibit improper trading and safeguard market justice. Meanwhile, the Commission did take into account the specific background of Everbright’s insider trading and the brokerage firm’s intent to hedge risks and adjust positions so as to lower potential trading and clearing risks. Everbright’s case, unlike other insider trading cases, is an unprecedented and a novel case in China’s securities and futures markets that involves cross-market trading. Therefore, based on in-depth investigation and careful consultation from relevant administrations and experts, the CSRC finds such administrative and legal actions against Everbright Securities to be appropriate.
Right after the incident, Everbright Securities was suspected of market manipulation. After in-depth investigation, evidence collection and thorough consultations, the CSRC believes that, although the violent market fluctuation was technically caused by the massive amount of transactions by Everbright, the root cause was a system with flawed technological design. The investigation found no evidence of the brokerage firm and relevant individuals organizing, planning or facilitating the incident. Pursuant to the Securities Law, the Regulation on the Administration of Futures Trading and the Commission’s enforcement practice, abnormal fluctuation in securities and futures price and trading volume caused by unexpected incidents does not constitute market manipulation.
IV. Investor Compensation
The 3rd paragraph of Section 76 of the Securities Law stipulates that in the case of insider trading causing losses of investors, the insider shall assume compensation in compliance with the law. Investors who have suffered losses due to Everbright’s insider trading may file a civil suit and demand compensation.
In recent years, securities and futures industry remained market-based, real economy-oriented and client-centered, demonstrating further improvement in industry innovation and positive development. However, securities and futures industry should attach great importance to the problems exposed by the incident, learning from the mistakes and effectively reinforcing internal risk control, in order to prevent similar incidents from happening again. Securities and futures firms should place its focus on the management of novel trading methods, quantitative trading software and IT system, ensuring risk surveillance and control.
Regarding innovative business, relevant institutions should strike a balance between the efficiency and security of transactions, making full use of new technology while preventing any potential systemic risks. Securities and futures exchanges should further enhance line management and improve relevant rules and contingency plans, in order to safeguard sound and stable market operation.
The CSRC has already set up special force to focus on the improvement of regulatory rules and adopt effective measures to boost stable market operation and prevent systemic risks. Drawing from positive experiences from overseas markets, securities and futures regulatory system should also be in line with the current market reality in China, balancing sound and stable market operation and higher market efficiency; equal attention should be paid to improving market supervision and encouraging market innovation; technological prevention should be enhanced along with market-based development and effective legal framework; market supervision should be fostered to ensure market transparency, fairness and justice and protect the lawful rights and interests of investors, especially small and medium investors, facilitating sound and stable development of capital markets.