Just fourth months after the head of China's securities regulator publicly took aim at listed firms that have been offering "generous" bonus shares to their shareholders, one of the targeted firms is now under investigation, signalling the regulator's increasing crackdown on stock speculation.
East Group, a power supply manufacturer based in south China's Guangdong Province, announced late on Thursday that the firm and its chairman He Simo have been under investigation by the China Securities Regulatory Commission (CSRC) over suspicion of breaching financial regulations on information disclosures.
In early April, Liu Shiyu, the chairman of the CSRC, called certain companies' offers of 30-for-10 bonus issues "unprecedented", noting that such practices should be put under close watch. Nine listed companies unveiled such plans in 2016, including East Group.
A 30-for-10 bonus issue entitles an existing shareholder to receive 30 shares at zero cost for every 10 shares they held before the issuance. A shareholder with 1,000 shares for example would receive 3,000 bonus shares for free and their total holding would increase to 4,000 shares.
In principle, increasing the number of outstanding shares should decrease the stock price, making the stock more affordable for retail investors.
However, in China stock prices have seen a surge following announcements of bonus share plans, as retail/individual investors viewed them as a sign of major shareholders' confidence in a near future growth of earnings.
Therefore, bonus issues have increasingly been exploited by some Chinese companies, particularly smaller ones, as a way to ramp up stock prices for major shareholders' speculative trading.
How unique is the Chinese stock market?
The unusual market reaction to bonus issues highlights how different the Chinese stock market, which was established in the early 1990s, is from others.
Unlike many of the world's stock markets, most trading activities on the Chinese stock market are made by individual retail investors, rather than institutional investors.
About 85 percent of trades are retail investors, according to Reuters.
China has approximately 100 million retail investors, according to the CSRC, who trade more often than foreign investors. Eighty-one percent said they trade at least once a month, according to a survey by State Street.
That is alarming considering that another survey found that more than two-thirds of the most recent batch of new investors did not even graduate from high school.
"Remember during the dot-com boom when everyone from the taxi driver to your grandmother was investing and making money? People quitting their jobs to be day traders?" an American working for an international bank in Shanghai has told CNBC. "That is exactly what it is like in China. I have staff that quit their jobs to do day trading."
Moreover, China's stock market tends not to correlate with other world markets, and about two percent of Chinese shares are owned by foreigners.
China's battle against manipulative speculation
The uniqueness of the immature stock market poses regulatory challenges. The CSRC has been particularly worried about stock market volatility since the stock rout of 2015 wiped out five trillion U.S. dollars in a few weeks.
The securities watchdog has introduced increasingly tough measures to crack down on financial speculation and short sellers, including banning large shareholders from selling, outlawing forms of short-selling and chasing down individuals for manipulating the markets.
Liu Shiyu, a banking veteran, was named the head of the securities regulator early last year, quickly earning a reputation for being tough on manipulative activities, while encouraging value investing.
Instead of bonus shares, Liu encouraged listed companies to pay cash dividends as real returns to investors, calling those unwilling to pay as "iron roosters".