What is the Chinese Wall?

Chinese Wall (Chinese Wall) refers to the isolation between the investment banking department and the sales department or trading personnel to prevent the leakage of sensitive information and thus constitute insider trading. Decades ago, in order to restrict investment banks from using their information advantages and financial strength to publish distorted reports and analysis and research comments, they forced the investment bank's "research department to be independent." The term "ChineseWall" is used as its image title, which means that this separation must be as strong as the Great Wall of China.

Chinese Wall

The independence of the research department is sacred and inviolable. For two reasons: First, the Chinese Wall

Chinese Wall (Chinese Wall) is a proprietary term in securities regulations, similar to China's "internal firewall", which means that securities companies establish an effective internal control and isolation system to prevent mutual leakage of information from the research, investment and trading departments. Inducing internal transactions and market manipulation is one of the means to resolve the ubiquitous conflicts of interest in the securities market. The reason "Chinese Wall" is adopted means that this internal control and isolation is as strong as the Great Wall of China.

In securities practice, a conflict of interest refers to a situation where the self-interest of a securities broker, etc., conflicts with their fiduciary obligations to others, or where they have conflicting fiduciary obligations to two or more customers. At present, most securities companies set up research departments internally. The positive effect is that they can better play the synergistic benefits of research and support the primary and secondary market operations. Moreover, the company will give sufficient financial support, so the research department has no profit. Pressure, research is more objective and fair. But the Achilles heel of this model lies in the attempts of the investment banking and brokerage departments to influence the views of the research department. From the perspective of the internal institutional setup of major securities companies in the international financial market, the investment banking department of a securities company needs to face investment banking business such as underwriting by a listed company, while the research department is usually in the brokerage and sales department. Investor interest services. But the investor was a "weak majority" at this time, and the research department was a department within the securities company. When conflicts occurred between the protection of investors' interests and the obedience of high-level opinions of the securities company, the researchers were forced to be independent. Serving the interests of investors is not easy. At the same time, the information that the research department knows that is not public is often used by the investment bank of the securities firm. Therefore, a strict isolation system must be established between the research department and other business departments.

The China Wall has two functions: functions in securities business and functions in securities law. In the securities business, building a Chinese wall can prevent the inside information owned by the personnel of one department of the securities dealer from being misused by the personnel of another department. In the securities regulations, if the securities firm has a strict Chinese wall system, and the securities When a company is accused of engaging in insider trading or violating its fiduciary obligations to customers, the securities company may use the Chinese Wall system to defend it. The preventive function is now generally accepted, but the legal defense function is interpreted differently in different countries. Because in Anglo-American law, the relationship between securities dealers and clients is mainly adjusted by the agency system. There are two basic principles in agency law: the agent has an obligation to be honest and complete and loyal to me; meanwhile, the information obtained by the agent during the agency process is deemed to be my knowledge. Therefore, in principle, the inside information learned by the research department or the sales department should be regarded as the information obtained by the securities dealers. Any use of this internal information violates the fiduciary obligations of the securities firms to their customers. However, strictly following the rules of the agency law, although it is beneficial to protect the interests of customers, it will seriously damage the interests of brokers. In order to protect the integrity of the securities market, the British and American countries have, to varying degrees, made exceptions to the agency system and acknowledged the defense function of the Chinese Wall. In the United States, a series of insider trading laws passed by the Chinese Wall and federal courts have appeared simultaneously. In the well-known Merrill Lynch case in 1966, Merrill Lynch promised to establish a Chinese wall: prohibit any employee of the underwriting department from leaking information obtained from the company while discussing or negotiating the public or private issuance of a company's securities, and without Information made public to investors. However, except for the subordinates: senior management of the registry, personnel of the legal department, research department of the registry, and other co-underwriters of the underwriting syndicate. The purpose of the Securities and Exchange Commission's request for Merrill Lynch to establish a Chinese Wall between the underwriting department and other departments is to reduce or prevent the occurrence of internal transactions, but if insider trading has occurred, can the Chinese Wall be a reason for defense? No clear answer was given.

In the 1973 Slade v. Shearson case, the Securities and Exchange Commission provided a brief opinion to the Second Circuit. The Securities and Exchange Commission points out that the case involves two important principles: no significant inside information should be used in the securities market; and brokers must treat customers fairly. The Securities and Exchange Commission argues that securities dealers should not recommend to clients to buy or sell certain types of securities based on inside information obtained by the investment banking department or the underwriting department. The recommendations made by the broker should have sufficient and reasonable reasons. Although the Securities and Exchange Commission encourages the establishment of the Chinese Wall system, it is also reluctant to admit that it is not presumed that the inside information known to the investment banking department is known to the securities firm because the securities firm has a Chinese wall. To ensure that securities dealers fulfill their fiduciary obligations, the Securities and Exchange Commission requires securities dealers to establish "restricted directories." Securities dealers are not allowed to make recommendations on the securities on the restricted list, nor can they accept any discretionary financial management. Although the Chinese Wall has become an important means of preventing insider trading, the Securities and Exchange Commission has not clearly identified the legal function of the Chinese Wall.

In 1980, the United States formulated Rule 14e-3, which for the first time allowed securities dealers to defend the allegations under Rule 14e-3 on the basis of the already established Chinese Wall. In other words, the agency law is still the main principle for adjusting the relationship between brokers and customers. However, under the exceptions stipulated in this rule, the China Wall can only be an exception to the agency rules, and the securities firms do not need to bear corresponding responsibilities. Such an exception is: when a securities firm makes an investment decision, its specific executor does not know that the information on which it is based is non-public, and the securities firm has internally formulated corresponding policies and procedures to prevent the above specific decisions People get this information. In 1988, the United States passed the "Insider Dealing and Securities Fraud Enforcement Act", which stipulates that securities dealers have special monitoring obligations to prevent staff from conducting insider trading. Therefore, the securities firm is obliged to formulate and implement specific procedures to reasonably prevent the misuse of material non-public information. If the securities firm neither knows nor acts recklessly, and has fulfilled its monitoring responsibilities, then it will be exempt from insider civil liability. Recently, the US Securities and Exchange Commission adopted new rules to restrict securities company analysts. The main starting point is to strengthen the "China Wall" system of business and research departments. The specific contents of the rules include: (1) Prohibiting analysts from providing biased investments The bank's positive report; (2) Within 40 days of the initial issuance of the stock by the investment bank, its analyst shall not provide an assessment of the stock. No evaluation of stocks issued for the second time within 10 days; (3) Restricting analysts and investment banking departments from exchanging opinions on evaluation reports; (4) Except for composite mutual funds, restricting analysts to trade their own initial evaluation of the industry (5) Analysts must not buy or sell their own stocks 30 days before and 5 days after submitting the evaluation report; (6) Forbid analysts from selling stocks that they have recently recommended; (7) Investment banks should announce Stock rating standards and history.

In short, the United States tends to use more of the Chinese Wall as an internal constraint mechanism to strengthen internal control and management; however, the United States does not seem to want the Chinese Wall to be a defence for breach of fiduciary obligations, and only admits certain exceptions: Allegations of insider trading, if the securities company has established a sound isolation system, then the securities company can not bear the corresponding civil liability.

The scope of application of the Chinese Wall system in the United Kingdom is much broader than that in the United States, and it relies heavily on the Chinese Wall to protect securities firms from adverse legal consequences that may result from conflicts of interest. The 1988 Rules on Investment Practices prepared by the Securities and Investment Bureau stipulated that the China Wall is applicable to insider trading occasions, and it can also oppose other rules.

First, according to the regulations of the Securities and Investment Bureau, unless the securities dealer takes into account the facts about the investment vehicle and the client's other investment vehicles and the situation of the client, there should be reasonable reasons to believe that an investment is suitable for the client. However, if the specific decision maker does not know the existence of such facts and makes an unreasonable decision due to the existence of the Chinese Wall, it can be considered that the securities firm has fulfilled the rule.

Second, securities dealers are not allowed to recommend to their clients investments that are not easily realizable, unless they have clearly informed the client about the situation in advance. However, if the isolation of the Chinese Wall makes the person who specifically recommends the securities unaware of whether the securities firm owns such securities, it can be regarded as no recommendation.

Third, if the securities dealer does not fully complete the client's instructions, or decides to complete a transaction for the client's disposable account, the securities dealer cannot self-operate on the same securities, or complete the transaction on the same securities for subsequent instructions. However, if the Chinese Wall blocks the transmission of information, it does not violate the principle of time-based centralized bidding for floor trading.

Fourth, when a securities dealer recommends an investment instrument to a client, it should disclose the long or short position of the investment instrument to the client. If the existence of the Chinese Wall makes specific decision makers unaware of the existence of positions, then the securities firm is deemed to have fulfilled its disclosure obligations.