Neil Thomas
TAKING STOCK
Everybody in the investment industry knows it happens. It’s share price manipulation, an activity that skirts the border of legality depending on its scale and intention.
But there’s little that can be done about it – many professional investors would rather nothing was done about it, regarding stock manipulation as just one more trading technique.
At its most innocent, buying and selling shares for no obvious reason is the result of ignorance. In these cases the financial broker or fund manager is not deliberately trying to manipulate prices, but rather following a misinformed strategy of chasing short-term performance. Problem is, how do you actually distinguish between foolish trades and someone who is deliberately switching a client’s money in and out of different shares simply to earn fees. There’s little doubt that what has become known as “churning” takes place on a large scale in the unit trust industry.
How else do you explain apparently buoyant sales over a quarter of around R30- billion when net inflows into unit trusts have actually reduced? At times it might be a genuine strategy, realigning a portfolio for better growth or constructing a defence strategy (churning typically increases in a bear market). But more often than not it’s trades executed for no reason other than generating income for the broker or management company.
Colin Woodin, executive director of the Association of Unit Trusts (AUT), points out quite correctly that, ultimately, anybody running a fund has a fiduciary duty to go in and out of the market if it’s in the client’s interests. But how do you distinguish the attempted real thing from the fraud?
At worst, an investor might fire their broker or change unit trust funds, and then not because of unnecessary trades but poor performance.
More insidious is window dressing, the practice of deliberately ramping up share prices towards the end of a quarter to improve returns. Woodin also points out that unit trusts unfairly bear the brunt of this criticism.
“We feel a bit sore that the unit trust industry is painted with this brush. It happens, but then just about anybody dealing in equities is affected.”
He’s right. The more serious, deliberate share price distortions are conducted elsewhere. Most notorious in this regard are futures traders, who start playing with share prices as the futures close out approaches (due again at the end of next week). It’s now simply accepted that volumes will increase significantly at the end of each futures close out.
But lots of other equity traders manipulate stock as well. Remember Greg Blank and Co’s now famous “park and ramp” strategy – holding shares being sought by a client and deliberately buying the stock to push up the price before selling on the original shares to the client.
And there are the short sellers, the scourge of former Liberty Life chair Donald Gordon. Liquid stocks like Liberty are thrown out into the market like fishing bait and bought back at a lower price, often forcing the particular share to trade in a narrow band.
But from April 1 next year a lot of this could change with the introduction of capital gains tax (CGT).
Probably without realising it, in his effort to widen the tax net Minister of Finance Trevor Manuel might be presenting the most effective deterrent to stock manipulation the local market has yet seen.
How the tax will be implemented and administered is still a fairly grey area, but from the beginning of April 2001 any capital profit on a share accruing after that date will be taxed, when the share is sold, on a quarter of the capital gain at an individual’s marginal tax rate. Or in the case of unit trusts at 30%, which works out to an effective tax rate on capital gains of 7,5%.
For individuals the tax will be fairly easy to track and administer, though there’s little doubt tax advisers will earn high fees trying to circumvent it over the next year. For unit trust funds it becomes far more complex, and the system used here could become such a deterrent to “techniques” like churning and window dressing that it forces them out of the industry.
Woodin says an attempt by the South African Revenue Service to force the unit trust industry to track gains on every individual share transaction would be a “systems nightmare”. Such a system, it seems, would just not be practical and too expensive to justify the amount of tax collected.
But it would almost certainly stop manipulation.
Pieter van Niekerk, MD of Old Mutual Unit Trusts, says he understands government is proposing a more simple system of just taxing a unit trust fund on its overall gain over a certain period, say every six months. Van Niekerk emphasises he is not sure whether nthis will be the nnsystem, but if it nnis then window nnndressing and nnnchurning will nprobably continue unabated.
What is certain though is that in future every equities trade will have to be more considered, with the emphasis moving to longer term holdings. And if CGT does act as an effective deterrent to manipulation, we will see for the first time the true extent of unnecessary trades, in declining volumes.