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It took just US$1.1 million worth of well-timed trades to knock down one of Asia’s top hedge funds.
A Hong Kong court on Wednesday (Jun 12) revealed how Simon Sadler’s Segantii Capital Management allegedly used insider information to sell shares of an apparel retailer ahead of an impending block trade seven years ago.
The details underscore how accusations of wrongdoing can be devastating for investment firms, even if they involve trades that are tiny relative to assets under management.
Segantii, which oversaw US$4.8 billion at the end of April, decided last month to shutter its hedge fund and return all its outside capital to investors, after the initial charges by Hong Kong authorities caused redemption requests to spike.
The Segantii case, which is being moved to a higher-level court in the Asian financial hub, is likely to delve into the inner workings of block trades – in which investment banks arrange sales of big chunks of shares off exchanges by connecting sellers with buyers. The next hearing has been scheduled for Jul 2.
The prosecution’s case mentioned in court on Wednesday centres around a block trade in Esprit Holdings.
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In June 2017, a large shareholder of the fashion chain was looking to sell out. The Hong Kong-listed company, which was valued at more than US$20 billion more than a decade ago, was well past its heyday after trying to revitalise sales of its name-branded apparel.
Esprit’s market capitalisation was about US$1.4 billion at the start of June that year, according to data compiled by Bloomberg. Lone Pine Capital, an American hedge fund firm, wanted to find buyers for its 10 per cent stake in the company.
It was just the kind of trade that Segantii was known for: a large block of shares was coming to market in Hong Kong, and investment banks needed to find buyers for them. The hedge fund was often the first port of call for bankers handling large public stock offerings and block trades when they needed to gauge demand for upcoming deals.
Sadler and former Segantii trader Daniel La Rocca received inside information about Esprit from Tony Psarianos, according to a court summons that was made public on Wednesday. Hong Kong’s Securities and Futures Commission (SFC) last month said it had started criminal proceedings against the two men and Segantii for insider dealing.
Psarianos, a veteran trader, worked at Bank of America’s Merrill Lynch division at the time, according to regulatory records. He has not been charged with wrongdoing.
Information about upcoming block trades is market moving, because stock prices typically fall if traders catch wind that a large sale is in the works.
Esprit shares were trading above HK$5 in the first half of June 2017. On or about Jun 14, Segantii sold 1.57 million shares that it already held at an average price of HK$5.25, according to the court summons.
The hedge fund also sold 132,000 shares short at an average price of HK$5.23. In short sales, investors typically sell borrowed shares with the intention of buying them back at a lower price and collecting a profit. Segantii’s trades were executed through its account with UBS Securities Asia, according to the court summons.
The next day, Lone Pine sold 195.64 million shares at an average price of HK$4.68 – nearly 11 per cent below the average price that Segantii sold the shares at. The US$117 million block trade only came to light about a week later in a stock exchange filing.
Esprit’s shares fell 29 per cent over six consecutive trading days, including the dates before and after the block trade, and never recovered to their levels before the deal. The court documents did not say how much profit Segantii earned from its Esprit trades.
On Wednesday, Sadler and La Rocca appeared in a Magistrates’ Court in Hong Kong to face the insider dealing charges. They were joined by Segantii’s chief executive officer Kurt Ersoy, who represented the firm, and the firm’s chief compliance officer, Niral Maru.
Segantii said last month that it intends to defend itself against the allegations. It declined to comment on Wednesday. Ersoy and Maru have not been accused of wrongdoing.
The men and their lawyers sat in a courtroom packed with spectators and Hong Kong residents who were charged with lesser offenses, such as operating unlicensed restaurants, breeding mosquitoes at a building site and failing to pay business registration fees, according to the court’s daily cause list.
La Rocca sat apart from his former colleagues and appeared tense, while Sadler and Ersoy were more at ease.
The defendants did not enter a plea, and a judge ruled that the Segantii case will be moved to a District Court that can mete out as much as seven years of jail time for individuals found guilty of insider dealing. Conviction rates are higher in District Court cases relative to those handled by Magistrates’ Courts, according to official data.
Financial regulators from the US to Asia have been turning up the heat on banks and investors involved in block trades, and warned them not to divulge material non-public information that could be used to give some clients a trading edge.
The exception is when potential buyers enter into agreements that prevent them from trading on the confidential information, a process known as wall-crossing.
Earlier this year, Morgan Stanley agreed to pay US$249 million to settle probes by the US Department of Justice and the Securities and Exchange Commission over how the bank handled confidential information ahead of block trades. It acknowledged that two employees tipped off clients to impending deals, which violated the firm’s policies.
In Hong Kong, the SFC last year launched a public consultation on proposed “market sounding” guidelines that would govern how banks and brokers can share information, when they are gauging investor demand for large stock sales. The final guidelines have yet to be published.
“Criminal prosecution has always been the priority” of the SFC, said Jimmy Chan, a partner at law firm Jingtian & Gongcheng and a former enforcement director at the Hong Kong regulator. He added that fines without jail time are less effective at deterring individuals from insider trading.
Chan said the Segantii case will be the highest-profile case of its kind since the conviction of Du Jun, a former Morgan Stanley managing director, who was sentenced to seven years in jail by a District Court in 2009 for insider dealing. That sentence was later reduced to six years. Bloomberg
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