The Securities and Exchange Commission of Pakistan (SECP), to make share trading more transparent and to curb systematic risk, has decided to prohibit stockbrokers to transact business from fellow brokerage houses from October 10, 2005.
"It has been observed that brokers route their businesses through other brokerage houses, within the same Exchange. Such intra-Exchange trading between brokers allows trades to be carried out beyond the capital adequacy limit of a broker (trade initiating broker),' a notice of the Exchange issued on Saturday said.
The notification further said: "This poses systemic risk to the market and is in stark contrast with the international best practices. For a broker to trade through other brokerage house at the cost of brokerage commission (payable to the broker executing these trades) does not make any commercial sense. Furthermore, such trading practice can be used to 'pump and dump' shares with the intention of influencing prices in the market.
"Therefore, for the purpose of investor protection, market transparency, and promoting fair and efficient market practices, it is hereby directed that brokers shall not trade through other brokerage houses within the same Exchange with effect from October 10, 2005."
A leading expert said that broker's definition is to buy and sell shares on behalf of clients, but it has been observed that several brokers, in order to keep intact their capital adequacy limit laid down by Karachi Stock Exchange, route their dealings with other stockbrokers, which is against the definition and international practices.
Moreover, in the past some of the stockbrokers, to manipulate share prices of some particular scrip, had either jacked up the prices artificially through selling shares to fellow broker, which enticed small investors that there was some inside information about the particular company and started placing orders.
The report prepared by Task Force released last month said that any investigation of KSE was handicapped by a number of structural flaws that hide the identity of persons undertaking transactions. This had been facilitated by brokers dealing through other brokers with the clear intention of covering their tracks as symbolised by the existence of 'dhobi' brokers.
In addition, the brokers do not declare whether their trade represents a transaction on their own account or on behalf of a client.
The report stated: "The other factors that have plagued this investigation were potential insider trading and the liberal existence of 'Benami' and group accounts. These factors make the KSE an opaque market and, consequently, a haven for manipulators."
At another place, the report said that "risks also lie in the opaque domain of the exchanges where those transacting can design manipulations behind the screens of group accounts, Benami accounts and 'dhobi' brokers".
The report mentioned the ability of brokers to undertake excessive day trading and 'wash sales'. That, the report said, was possible because of policy, procedurals and systemic flaws. "The analysis of stock market data helped identify a number of potential cases of market abuse where players had undertaken 'wash trades' either for the same client or a series of common clients across brokers to 'pump' the market. Analysis shows that the brokers and their clients largely dealt with each other in groups or sub-groups at both broker and client level," said the report.
It pointed out that there were no limits on the level of day trading by a broker, due mainly to the lack of pre-trade verification systems and other capital adequacy measures. This weakness, coupled with an almost out of control use of 'wash trades' either directly by a broker's client or through the use of two or more brokerages in violation of the rules, facilitated market manipulation.
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