We look at the structural incentive for corruption in membership admission to HKJC, and its small-circle voting system, highlighted by yesterday's arrest of 3 of the 200 Voting Members. If private clubs wish to avoid the reputational risk of corruption, then they should adopt tender-based admission systems to remove the incentive and capture full value for their members.

Mucking out the Jockey Club
18 November 2010

It's basic economics - if something is on offer for less than its fair value, then there will always be excess demand and people who attempt to capture the difference between the offer price and what buyers are willing to pay. Where there's muck, there's brass. So it comes as no surprise that once again, not one, but three of the Voting Members of the Jockey Club are under arrest on suspicion of soliciting or receiving bribes for nominating members to The Hong Kong Jockey Club (HKJC).

HKJC charges a fee for Racing Membership of HK$68k and Full Membership of $250k. This is far less than they are worth to some aspiring members, who are willing to pay a substantial premium to attain membership.

When cash is changing hands, it is perhaps not surprising that people sometimes get caught offering or receiving it. Far more subtle, however, is the non-cash form of advantage - the favour-trading and influence-peddling that inevitably goes on when there is value to be captured for admission to clubs. That's the underwater part of the iceberg that is never seen.

Removing the corruption incentive

If clubs are serious about avoiding the reputational damage caused by corruption, then they should change the way they admit members to remove the incentive for corruption. Each club has the capacity to handle a finite number of members. This number depends on how large the facilities are, and how often the members actually use them. The spare capacity is determined by the death or departure of members, an expansion of facilities, or a change in their utilisation. So a club can determine, perhaps on a quarterly basis, the number of new members it can admit.

There are two ways that clubs could remove the corruption incentive. The first method is to have fixed fees but a random ballot, without nomination, in which all applicants have an equal chance of winning. If the fixed fees are set above market value, then there would be fewer applicants than the quota of memberships, and every applicant would succeed. If the fixed fees are below market value, then some applicants would be unsuccessful, and would have to enter again. If there were any right to nominate people for the lucky draw, or to filter the applications on some subjective criteria, then that right would have value, which would reintroduce the corruption incentive. The lottery method is unlikely to appeal to most clubs, even one which runs HK's gambling monopoly, because it more obviously creates winners who pay less than fair value.

The second method is market-driven and allows the club to capture the full and fair value of its new memberships, rather than leaving value up for grabs. That means establishing what the fair value is, by way of a reverse tender. The club should invite sealed bids from individuals who wish to join. Each bidder would state the price they are willing to pay for membership, and enclose a deposit. The club would then accept bids in descending order of price until the quota of memberships is exhausted. In order to avoid "winner's curse", clubs can use a uniform price auction in which all the successful bids pay the same price as the lowest successful bid. There should be no subjective qualifications for admission. No nomination requirements, no requirement to be "the right sort of fellow". If there are any requirements at all, then they should be objective, such as not having a criminal record, if that is thought undesirable.

Some club members will recoil in horror at such an idea. They say that the "wrong sort" of person could then join a club. They say that their club, rather than the courts, should act as a filter on probity and quality of members of society. This notion is rather disproven by the fact that existing members of clubs are convicted of criminal offences from time to time, whether related to the club affairs or not. Indeed, having a membership admission system which invites corruption almost guarantees that from time to time, members will be caught and convicted of corruption. Perhaps what the opponents of reform are really saying is that they like the existing system because it gives them the ability to peddle their influence over membership for favours, and gives membership an air of exclusivity. Some may like the system for more personal reasons - they can nominate their adult children for membership (or if that is not allowed, then they can nominate the children of their fellow members in reciprocal arrangements).

There will always be some members who want to join a club not to use its facilities or for camaraderie but just to be able to say that they are members. It gives their friends and business colleagues the impression that they have been endorsed and vetted by society as fit and proper. Ironically these are the kind of members who may be most willing to offer an advantage or bribe to gain entry. But if entry was based purely on price, then that incentive would disappear, because membership would not prove that you had passed any vetting test, but simply that you had paid a fair price for membership. So in fact, the way to disincentivise status-seekers is to remove the vetting filter and let the market set prices.

Apart from anything else, selling memberships for less than market value is a drain on a club's finances. Even though it is not run for profit, the relevant club will have to make up the income from monthly subscriptions and services to cover its costs. So selling memberships below market value is a cross-subsidy from existing members to new members. If a member joins a club purely for status and will not use the facilities, then other members should welcome that, because it allows the club to admit another member who will, and the club gets two fees, and two monthly subscriptions, for the price of one.

HKJC's structure makes it worse

While this lack of market pricing, and hence the corruption incentive, is common to many private clubs in Hong Kong, HKJC's own convoluted governance structure exacerbates it. Like most members' clubs, HKJC is a company limited by guarantee, and governed in accordance with its Memorandum and Articles of Association (M&A). HKJC's M&A allows for multiple categories of members. Its directors are known as Stewards. There cannot be more than 12 Stewards, each elected for a 3-year term. They must all be Voting Members, and they are elected only by Voting Members. There cannot be more than 200 Voting Members, and the Voting Members are elected by the Stewards.

This circular system is basically a club within a club. Only the 200 Voting Members can vote at general meetings, so all the other 13,000-odd "Full Members" are in fact not very full members - they have no voting rights and no say in who runs the Club or how it is run. You might say they are Half-full Members, or Half-empty Members, depending on your perspective. Racing Members, who have less access to facilities, are even further down the totem pole.

[UPDATED 19-Nov-2010 to use latest M&A] Not just any member can propose or second candidates for Racing Membership. Only those who are resident Honorary Stewards, Voting Members, or Honorary Voting Members can do so. The first category, Honorary Stewards, are former Stewards. Then there are the 200 Voting Members. The third category of nominators, Honorary Voting Members, has two sub-categories: Honorary Voting Members (O) and Honorary Voting Members (N). This is a legacy of change: anyone who became a Voting Member before 1-May-1975 can retain that status for life, but after the age of 70 they can voluntarily retire and become an Honorary Voting Member (O) and Life Member, thereby exempt from monthly subscriptions.

As there are never more than 200 Voting Members, 35 years later, there cannot be many left who were Voting Members before that date, and the survivors must be rather old. Further, if they chose to become Honorary Voting Member (O) after 12-Sep-1985 and have left Hong Kong, then they have lost their right to nominate new members. By contrast, anyone who became a Voting Member on or after 1-May-1975 must retire at 70 and become an Honorary Voting Member (N).

Despite the name "Honorary Voting Members", neither the (O) or (N) sub-types can vote in general meetings of HKJC. Perhaps, in the 1975 change, HKJC was intending to reduce the risk of senile demented retirees, and those who have lost their income, from taking bribes for nominations or votes or simply making bad decisions. Or perhaps they just wanted to make room for new Voting Members as the old ones were living too long. If anyone has the 1975 AGM minutes, we'd love to see them. Initially, Honorary Voting Members (N) were not allowed to nominate members. However, the right to nominate Racing Members was restored to Honorary Voting Members (N) by a change of the M&A on 26-Aug-2004. Since then, the Stewards may also elect Racing Members directly (without nomination) "through such other means as may from time to time be determined by the Stewards".

To become a Racing Member, you need two nominations. A sample of the application form is here. The procedure for promotion to Full Member is decided by the Stewards and not contained in the M&A. Currently, to be promoted to Full member, you need one nomination. A sample of the application form is here. It appears from that form that an Honorary Voting Member (O) but not an Honorary Voting Member (N) can sponsor a candidate. It is possible to go straight in as a Full Member by submitting both forms together.

Broadening the right to nominate members to all Full Members of the Club, giving them all voting rights, and allowing any member to be elected as a Steward, would eliminate the Voting Members' "club within a club" and make it more democratic, but would not eliminate the potential for corruption in membership entry. Instead, it would just shift the incentive. With over 13,000 potential nominators, the value of a nomination would be much lower, because the number of nominations would be higher. Instead, in the absence of a lottery or tender, there would still be a subjective selection process to decide which of the many applications are taken forward (only a few hundred per year), and that would still invite corruption.

Freedom of association

Of course, the HKJC and other clubs are private associations of members. Freedom of association is guaranteed by Article 27 of the Basic Law. So people are entitled to associate with each other by forming and operating clubs, and set whatever criteria they like, subjective or objective, to admit new members. However, all private clubs in Hong Kong should be asking themselves the same question - do we care about our reputation? If not, or not much, then we should carry on with our existing system, and accept the occasional reputational hit from a member who takes a bribe for nominating or promoting candidates. But if we want to remove that incentive, then we should move to a market-based membership system. Those who see the most value in membership will be those who bid highest for it.

Not just a private club

The HKJC is not just a private club though. It is entrusted with HK's gambling monopoly, which makes it a tax-farming vehicle of the HK Government. Although most of the punters' losses ($21.1bn last year) are paid to Government as betting and lottery duty, HKJC is also is allowed to keep some of the revenue on the understanding that they will spend some of it on things that the Government would otherwise pay for directly, such as health, education and welfare projects. So that makes HKJC an off-balance sheet spending vehicle of the Government too, putting some of the welfare budget beyond the supervision of the Legislative Council. In the financial statements for the year to 30-Jun-2010, you can see that about $14.3bn goes to betting and lottery duties and the Lotteries Fund (a welfare fund run by Government), and about $1.5bn to the Jockey Club Charities Trust, the trustees of which are the Stewards of HKJC.

HKJC also keeps a fair chunk for itself - it has accumulated $21.4bn of long-term investments and $7.1bn of cash and short-term bond investments. The Trust also spends slowly, and has $17.7bn of reserves, shown in its own financial statements.

All this allows HKJC to dress itself up as a charity organisation rather than a gambling monopoly, although the Government could just as easily raise the betting duty by $1.5bn instead, and spend the money centrally, leaving the HKJC without the charity fig leaf to cover its naked monopoly status. It would be far better if the Government would liberalise the gambling sector by allowing betting exchanges and licensing bookmakers, as other modern economies do, and taxing their profits. Give consumers more choice, and competition would squeeze out a lot of triad-run illegal bookmakers, reducing crime. HKJC could still run its racetracks and a reasonable statutory levy on horse-race betting profits could be established, so that the betting exchanges and bookmakers pay their fair share of the costs of running the races.

The details of the monopoly problem are beyond the scope of this article, but the essential point here is that HKJC, above all other private clubs, has an additional public interest reason for removing the corruption incentive from its membership system, so long as it retains its monopoly, tax-farming and welfare role.

Third time?

If the Voting Members arrested yesterday are charged and convicted, then they won't be the first, or even the second. It is becoming increasingly incredible for HKJC to brush these problems off and claim that its integrity is intact, without addressing the root of the problem through changes in its membership system.

In 1998 Mr Abdulla Tyeb Chiba, then 82 and a HKJC member since 1938, was convicted of receiving part of a $400k sum paid in 1996 by Mr Liu Sun Ming to a middle man, Ricky Lee Wing Chiu. Mr Liu, who was not charged, thought the money he paid Mr Lee was the membership fee, the court was told. According to the prosecution, Mr Lee then contacted Mr Lin Sun Fook, a caretaker of the building in which Mr Chiba lived, and the caretaker, who was not charged, paid $150k to Mr Chiba and $10k to another Voting Member, Mr Bhawandas Murjani, who was not charged either. Mr Chiba received an 8-month jail term suspended for 18 months and a fine of $20k, and Mr Lee was given a 6-month sentence suspended for 18 months. In comments to the SCMP at the time, ICAC chief investigator John Shanahan put the black-market rate for membership nominations at between $700k and $1m, and said that he believed 20-30 voting members were "doing this on a regular basis".

More recently, John Terence Hung, SBS, JP, was convicted on 25-Jun-2009 of accepting a total of $450k in bribes from a middleman, Joseph Loong Shun Ming (or Joseph Loong Sai Cheong, depending on your newspaper), in return for proposing that Racing Member Joanne Wong Pui be promoted to Full Member. Ms Wong had given $800k to Mr Loong, the court was told. Mr Hung was jailed for 2 years and ordered to pay $350k to the Jockey Club. Neither Mr Loong nor Ms Wong were charged.

Mr Hung was charged on the same day as 3 other persons:

It's about time that HKJC admitted that it has a structural problem embedded in its governance structure. If they don't want repeated scandals of this nature, eating away at the club's reputation, then they should reform the admission mechanism and the voting structure. Meanwhile, other clubs should take note and consider how much their own reputation matters, and whether the right to pick and choose their membership is worth the risk.

© Webb-site.com, 2010

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