Here are three theories for explaining Hong Kong’s penny stock crash

Mainland Chinese investors were the biggest losers when dozens of Hong Kong’s penny stocks plunged, some losing as much as 90 per cent of their value, on June 27.

Three theories stand out to explain the crash.

First a little premble: 90 per cent of these penny stocks belong to an Enigma Network of 50 interconnected issues, mapped out in May by gadfly investor David Webb.

A professional trader, let’s call him Fun Gor, controls the network. He’s been having financial troubles, ever since trading in Lerado Financial Group Co. was suspended on June 6 pending a regulatory investigation.

The first and the most colourful theory says the crash was an ambush by enemies, of which Fun Gor has no shortage. There are the TV starlets who lost their shirts on his investment tips, his fellow traders whose sweethearts had made the wrong punt, and regulatory officials who were forced into a corner to conduct an industry-wide crackdown because of his recklessness. Even Webb himself had his 2.3 per cent investment wiped out by a major rights issue.

The second and more tantalising theory says that the regulators want Fun Gor’s fingers burnt, because he’d been way too arrogant in his recklessness.

His stocks kept breaking price records, to the extent that an umbrella maker with a 2015 net income of HK25 million could have a market capitalisation of close to HK$50 billion. His boys didn’t so much fight the regulators with the best lawyers, as simply shutting their doors, or making a prolonged stay on the mainland.

However, given Fun Gor’s tight control on the stocks, and therefore the lack of available shares for dumping, he and his party were shielded from the ambush.

That brings us to the third theory: Fun Gor orchestrated, or at least contributed to, the crash by dumping the stocks himself. Cash is king when the tide is changing.

In fact, he didn’t mind his finger prints seen. Six members of the Enigma Network dumped their holdings in the umbrella maker China Jicheng Holdings, Luen Wong Group Holdings and Major Holdings, as did two securities firms linked to him. Their sale accounted for more than 15 per cent of Jicheng’s volume on the day.

The changing tide has mainly to do with his source of funding - pyramid schemes linked to penny stocks in Hong Kong that were sold to mainland Chinese investors.

Ever since the A share market fiasco in the summer of 2015, market manipulators have been luring mainlanders with promises like this: “Invest US$30,000 in an asset pack linked to Hong Kong stocks and bring in two others to invest the same sum. You get the script of 2,000 shares in one of the stocks on top of 30 times return. Real stocks. No scam. Your money will be used to manage the stock’s market value, with HK$0.05 share price increase every month, guaranteed. An investment that will only go up,”said the Facebook page of one such scheme.

It smells fishy. Yet, to mainland punters, the gift of share scripts, the link to a Hong Kong brokerage plus the online video promotion by a popular singer were promising.

The scheme was so popular that GF Securities barred employees from directing investors to the scheme, and subsequently issued a press release rejecting any links to it.

This is just one among many similar Ponzi schemes. The money raised was spent in supporting the share price, bringing in more victims.

Everyone was having a good time until local regulators tightened their grip on new issuers and mainland regulators were alerted to the scams.

The Ponzi scheme no longer works, and a crash was a mere matter of time.

For Fun Gor, the exit price was not great, but it didn’t hurt either. After all, the stock plummeted 90 per cent, after having rallied 15 to 20 times.

He didn’t lose his grip on the Enigma Network, and neither was there any sign of a panic sale nor a margin call. The shares of most Enigma members deposited in the central securities clearing system hasn’t increased, reflecting there’d been no change in the shares pledged. The top 40 holdings of his securities firms remain unchanged, except for two.

So far the only losers out of this game, who’re left feeling the pain and anger, are the mainland Chinese victims of his Ponzi scheme. And their regulators.

The problem is the spiral has already been started. When the regulators act, there’s only one direction for penny stocks to go.

Shirley Yam