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In China's 'fixed' market, rule breakers are probed

Beijing says it is ready to stop major capital infusions into stocks, but that doesn't mean China is done intervening in its markets.

The Chinese government is reportedly cracking down on those who aren't following along with its plans to support equity prices. Stories from regional and international media suggest that traders, fund managers and journalists have been persecuted for running afoul of Beijing.

And these actions are meant to dissuade anyone from sending markets lower, said Patrick Chovanec, managing director and chief strategist at Silvercrest Asset Management. In fact, Beijing's probes of market participants may be one of its most successful interventions to date, he added.

China stocks
Jason Lee | Reuters

"The day that (stocks) turned around, it was the day that the public security ministry said they would be investigating," he said. "These are the guys who throw you in a hole for a long time."

Even if the Chinese authorities end up prosecuting only a few traders, doing so would likely instill enough fear to make every trader toe the line, Chovanec said. That effect is bolstered by nebulous charges like malicious selling—"the vaguer definition, the broader the message," he said.

"The fact is you're going to get arrested if they want to arrest you," Chovanec said. "The message is to everyone else: 'Watch your step.'"

But more probes may be on their way, as Chinese stocks continue to slide.

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"This has been the pattern throughout this stock market saga: That the government has come in with heavy boots on several occasions, trying to control the market," Jonathan Fenby, China director at Trusted Sources, told CNBC on Tuesday.

"We've had about 200 people who've been taken in for questioning or helping the authorities with the inquiries ... over the stock market gyrations over the last few weeks," he added. "Nobody quite knows what all this is about."

One such individual apparently is the China head of British hedge fund Man Group, Li Yifei, as a Monday report from Bloomberg suggested that she had been taken into custody by the local police as part of a probe into markets. Her husband, however, denied that claim to the Financial Times, simply saying that she attended a meeting with authorities. A spokeswoman for Man Group declined to comment.

The crackdown on those potentially moving markets lower also extends to journalists. On Monday, state television showed a confession from Wang Xiaolu, a reporter for financial magazine Caijing. In the broadcast, Wang admitted to a false report that "caused such a great damage to the country and stock investors."

"I shouldn't have sought to make a big splash just for the sake of sensationalism," he said on China Central Television.

Caijing said last week that its reporter had been detained for a story saying China's market regulator was considering ending interventions aimed at stabilizing share prices. That report was immediately denied, but the official Xinhua News Agency reported that Wang's story caused "abnormal fluctuations" in the market.

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"A statement aired by a state-run broadcaster, before the 'suspect' has ever appeared in court, shows the lengths to which the Xi Jinping government will go to intimidate journalists," Bob Dietz, Asia program coordinator at the Committee to Protect Journalists, said in a statement.

CPJ cited an anonymous Caijing journalist saying that there wasn't any problem with the article, but authorities want to find a "scapegoat for the stock market collapse."

Media outlets in China, as has been observed by many, have not reported much recently about the daily stock market swings—a notable change from the regular headlines when shares were rocketing higher earlier this year.

China has also emphasized that it is seeking out "malicious" sellers who were acting against the country's best interests. Funds have reportedly been required to explain their trading strategies to regulators on a periodic basis.

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Among those arrested for illegal market activities were four senior executives from China's largest brokerage, CITIC Securities, who confessed to insider trading, according to state media. A CITIC spokeswoman declined to comment on the matter.

Even if the impetus for the crackdown may be to boost equity prices, China's actions could end up being beneficial to the health of its markets.

"The Chinese stock market has been rife with insider trading, front running and all sorts of trading abuses for years," said Nicholas Lardy, senior fellow at the Peterson Institute for International Economics. "Going after these guys is a good sign."

Still, fears of Beijing's probes are affecting the Chinese investment community.

One manager at a major fund told Reuters that a friend, also an executive at a large fund, was recently summoned for a meeting with regulators, along with all other mutual funds that had engaged in short-selling activity.

"If I don't come back, look after my wife," his friend told him, handing the manager his home telephone number.

But some of those called in may actually just be offering advice. A source familiar with the Man Group situation, who asked not to be identified because of lack of authorization, said there is no evidence Li is being personally investigated for any wrongdoing—especially as the firm does not operate as a trader in China, and has no vehicle for shorting the markets there.

Although Beijing says it is cleaning up abuses in its markets, some suggest the recent probes are just another way of fixing its market—like it did with official interventions.

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"As soon as the market started acting in ways that the authorities didn't like, they came in with what's called the 'national team,' which spent hundreds of billions propping up the market, and this has created already a feeling that this is a fixed market—which is going to respond to what the authorities want rather than to what investors want," Fenby said.

Chinese authorities said last week they would stop with "national team" share purchases, but it remains unclear if there will be other means of propping up prices down the pipeline.

"My hypothesis is, although I can't prove it, that they are intervening a lot less now," Lardy said. "I'm hoping that this is implicitly a recognition that intervention in the first place was a mistake."

—Reuters and The Associated Press contributed to this report.