China’s Stock Markets Have Wild Side : Securities: Ineffective regulation and scandals involving gangs, murders and share price manipulation plague fledgling exchanges.

Since China decided to allow investing in stocks, many of its citizens have embraced the capitalist concept of share ownership with gusto.

Stocks are popular because Chinese save a large portion of their salaries, but bank interest rates are low and the country has no other investment opportunities.

However, the fledgling markets in Shanghai and Shenzhen have been plagued by ineffective regulation and a string of recent scandals involving gangs, murders and stock price manipulation.

The chaos in the markets provides strong ammunition for leftists in the Communist Party, who remain opposed to expanding the experiment, but there is growing evidence that practical problems of mismanagement, regulatory confusion and a circus-like atmosphere among buyers and sellers are now the main obstacles to expansion.

Yet, Beijing seems committed to rapid expansion despite the problems. More stocks are to be issued to foreigners despite go-slow warnings from officials who say the markets are still too disorganized for such sales to be rapidly expanded.

“We have come to realize that there is something wrong with our way of issuing and trading B shares (which are issued for foreign investors),” Wang Poming, vice president of the Stock Exchange Executive Council, said this spring in an interview with the official China Daily.

“It is time that we should stop and sit down to reflect a while before we issue too many (B shares) and hurt the markets as well as foreign investors,” Wang declared. “If we want to go international, we should have international standards.”

Officials in Shanghai, however, began pressing forward this month with issuance of stocks in 34 additional companies, of which 12 “will also issue additional B shares very soon,” the official New China News Agency reported. Prior to this expansion, the Shanghai exchange listed 15 firms.

The stock exchange in the special economic zone of Shenzhen, adjacent to Hong Kong, also has announced plans for large issues of new stocks, including both A shares for Chinese investors and B shares for foreigners, who must conduct deals with hard currency. The Shenzhen exchange lists 15 firms with A shares, of which six have also issued B shares.

While China’s stock markets have occasionally suffered declines, most Chinese investors are convinced that because the government wants its experiment with stock markets to succeed, the long-term trend can only be up.

At the same time, the government has hesitated to let prices rise enough to control demand. It has, however, gradually been reducing controls on stock price fluctuations and has now freed some stock prices.

The government also refuses to allow newly issued stock to be priced high enough to sharply reduce the number of interested investors.

As a result, determined would-be shareholders have produced chaotic scenes and long queues outside stock transaction offices both at the Shanghai and Shenzhen exchanges. Tens of thousands of hopeful investors lined up for applications to buy stocks in Xiamen in Fujian province recently, according to official reports, although the central government had yet to sanction the opening of a Xiamen exchange.

In Shenzhen, criminal gangs have begun organizing place-holding services in the stock market queues. Places in line that are held by gangsters or unemployed peasants are being sold to real investors, according to the state-controlled media.

Fights between gang rivals over queue positions have led to two murders in recent weeks and a subsequent crackdown involving the arrest of 461 accused gangsters, the Shenzhen Special Zone Daily reported.

Newspaper readers in Shanghai in recent weeks have been able to follow a tragicomic tale about trading in a company called Yanzhong Industrial, a manufacturing and trading firm.

First it was reported that the stock exchange service department of China New Technology Development Co., a member of the Shanghai exchange, had its trading rights suspended over allegations of stock price manipulation.

The firm was accused of causing share values of Yanzhong Industrial to jump 23 cents, to $38.95, by offering to buy four shares at $40 when the market price was $38.72, the Xinmin Evening News reported. This was seen as an attempt to unload stock on small investors at artificially inflated prices.

A few days later, Shanghai’s Liberation Daily reported that a man named Tang committed suicide after losing $1,172 on an investment in Yanzhong stock. Tang had bought 73 shares for $3,893 in early April, just before the market entered a rare but steep decline. Panic-stricken, he sold the stock on April 27 for $2,721.

Despondent, Tang told people that he was a fool and would be better off dead, and a few days later he hanged himself at home, the newspaper reported.

“It is not right to believe that socialist share holding leads automatically to big fortunes,” the Liberation Daily lectured its readers in an editorial on Tang’s death. “But many people believe this. Once the stock index falls, people can’t stand the economic loss.”

A few days later, Yanzhong was in the news again, in a murky tale of a private stock dealer named Wang Huiguo who was sentenced to four years’ imprisonment for trading “worthless shares” in the company.

In addition to official stock exchanges, where purchases and sales are formally registered, there exist in both Shanghai and Shenzhen unregulated black markets which also deal in the shares. Weak regulation of the official markets allows the shadowy unofficial markets to survive despite periodic crackdowns.

Wang was accused of “illegally” buying 168 “big shares” in Yanzhong early last year, then improperly having them split up into 840 “small shares,” according to a sketchy report in the official Legal Daily. He sold 510 of these shares through an acquaintance, but a falling market made it impossible to sell the remaining 330, the newspaper reported. The acquaintance returned the 330 shares to him, “telling Wang clearly they were worthless shares,” the newspaper said.

But Wang, rather than accepting his loss, tried to shift it elsewhere, the Legal Daily said.

He first sold the 330 shares for $2,471 to a man named Liu, who soon realized he had been duped. Liu demanded and received his money back.

Wang then sold the stock for $2,709 to a man named Xu. When Wang failed to show up to arrange for Xu to be formally registered as the shares’ new owner, Xu realized what had happened and went to the police, the newspaper said.

The fact that such incidents can occur reflects a lack of effective regulation of China’s stock markets. Standardized accounting procedures also are generally lacking in China, making trade in stocks here a highly uncertain proposition despite some analysts’ belief that there is a strong potential for profits.

Chinese investors generally display confidence, but there is an undercurrent of skittishness that could bring more volatility to the market in the future.

Processing of sell orders has been a bottleneck on the Shanghai exchange, where prices rose sharply through much of May. On June 1, a new annex designed to accept only sell orders was put into operation.

About 5,000 frightened small investors, believing the new facility was aimed at forcing down overheated prices, formed an uncontrolled crowd of sellers trying to shove their way to the counter, the Liberation Daily reported. Police, unable to establish order, were forced to close the annex down again within a few hours, the newspaper said.

Chen Yuan, deputy governor of the People’s Bank of China, insisted during a recent business luncheon with the American Chamber of Commerce in Hong Kong that the question of further developing stock markets is not a political one but rather one of bolstering their quality.

While Chen’s candor might be questioned by some, he undoubtedly is in a position to know, for he is the son of Chen Yun, the elderly former Politburo member who is the most powerful advocate of a slower pace to market-oriented reforms.

“We don’t want deteriorated quality (in the) stock exchanges, so we have to introduce international standards for accounting firms and accountants,” Chen Yuan told the U.S. businessmen.

With the search for workable procedures continuing, Yu Guogang, deputy general manager of the Shenzhen exchange, recently proposed another step for China: mutual funds.

The advantage of this, he suggested, is that fund managers could act on behalf of numerous private investors, thereby making transactions more orderly.

Chinese Stockmarket Soars

Since China began allowing foreigners to buy stock in February of this yeart, interest in China’s two emerging stock markets has skyrocketed.

Source: Credit Lyonnais; Chintung Research Institute