While China’s securities regulator has intensified efforts to crack down on rampant rat trading in recent years, industry figures say only jail terms in the most serious cases will serve as a deterrent.

Just last week, the Shanghai-based Oriental Morning Post reported that Zheng Tuo was being investigated by the China Securities Regulatory Commission (CSRC) for suspected rat trading during his time at Bank of Communications Schroders, which stretched from 2007 to 2009.

Now general manager of Shanghai Good Hope Equity Investment Management, Zheng had been a fund manager and deputy CIO of BoCom Schroders.

His old colleague and former BoCom Schroders CIO Li Xuli is reportedly also being investigated dating back to his time with the firm. Li subsequently joined private fund Chongyang Investment in 2009 but resigned in October this year.

And, in August, Xu Chunmao, deputy general manager of Lombarda China FMC and formerly the CIO of Everbright Pramerica, was also reported to be under investigation.

“This time, the CSRC seems very determined to crack down on rat trading among fund managers,” says Zhang Zibing, chief operations officer at Shanghai-based data provider Suntime Corporation. “ [The CSRC is] making a concerted effort to rebuild the image of the mutual-fund industry, which has been losing market share to private funds.”

The practice of rat trading is regarded as commonplace in China. It refers to malpractices whereby a licensed person takes advantage of a client's dealing instructions to place similar orders ahead of a client's orders for himself and his nominees (the rat orders). The rat orders disadvantage the client's orders in terms of time priority and consequently execution price.

Chen Jiwu, president of Shanghai Vstone Capital and formerly CIO of Fullgoal Fund Management, was quoted recently as saying: “In the mutual-fund industry, honestly it’s not easy to find someone who doesn’t own a rat account. Keeping tight-lipped is the rule of the game.”

For his part, Zhang suggests rat trading has become so widespread that some investors assume all mutual-fund managers engage in it.

The regulator began cracking down on the practice in 2007 when it imposed a permanent market ban on two fund managers -- Tang Jian at China International FMC and Wang Limin at Southern FMC-- who had used the accounts of affiliated people to trade shares. 

Last year, four fund managers – Zhang Ye of Rongtong FMC, Han Hang and Liu Hai of Great Wall FMC, and Tu Qiang of Invesco Great Wall FMC – were also found to have been involved in rat trading. They all had their securities qualifications scrapped, were asked to repay illegal profits and were fined between Rmb500,000 and Rmb4 million.

The National People’s Congress amended criminal law in February 2009 to include jail terms for rat trading. Those found guilty in serious cases can now be imprisoned for up to 10 years.

However, to date, no jail sentences have been handed out, although the CSRC has passed Han’s case to judicial authorities. The courts would set a precedent if they sent him to jail.

“We will not be able to see the power of the law until a person has been put in jail,” says Zhang, speaking generally about the industry. “Otherwise, the cost of violating the law is too low.”

At the same time as the CSRC has stepped up its scrutiny of rat trading, fund-management firms have tightened their internal oversight of staff, aware that any insider trading case will taint their reputation and hamper business.

One industry insider confirms that a fund-management firm has been unable to launch new products for almost a year as it awaited the conclusion of an insider trading investigation by the CSRC.

He notes that some firms now require staff to file a list of accounts owned by their relatives, while they also strictly monitor external communication channels, such as email, instant messenger and portable electronic devices.