SECP needs help

The Securities and Exchange Commission of Pakistan sent its inspectors to the Karachi and Lahore Stock Exchanges on Friday morning, to ascertain whether the recent sharp decline in the stock index was due to manipulation by some brokers.
At the same time, SECP issued a public warning to the brokers that it views "blank selling; short selling beyond permitted limits, misuse of CFS financed shares, ie not keeping them in separate CDC accounts; and wash trades designed to drive down prices," as unscrupulous.
A fifteen-member teams (probably led by the Chairman Razi Khan) has been constituted "to find the truth". And, SECP has also advised the brokers to review their positions and if they voluntarily rectify the malpractices by Friday, June 9, it would take a lenient view. SECP's Friday move not only deserves to be appreciated but also supported by all those who want capital formation to flourish in a investment starved underdeveloped nation. Domestic investment is sorely needed for employment generation and improving the quality of life of the masses.
The cynics are, of course, likely to just shake their heads in disbelief. They do not have the confidence in the regulator's ability to bring to book the manipulators who take the investors for a ride with regularity.
Some people even suspect a linkage between the so-called 'manipulators' and the 'powerful decision makers.' It is also felt that compared to the other financial regulator ie the State Bank of Pakistan, the capital market regulator, SECP's proximity with Islamabad instead of the regulatees in the commercial hub of Karachi, impairs its ability to make swift and timely moves. The distance has also slowed down its capacity building, ie, induction of suitable hands and vigorous training of the staff.
As a result, SECP it does not have the aggressive attitude that is required from a regulator. Unlike it is with the banks, the fear of the regulator is missing in the hearts of exchange/brokers.
In April 2005, former SECP Chairman Tariq Hasan realised his shortcomings. He, therefore, sought outside help for investigation into the March settlement crises. Task Forces are not a substitute for proper surveillance and timely action.
It is the first time that the SECP has constituted an in-house investigation team. They need help. Assistance from abroad is not likely to be of much effect. The last time, SECP appointed an outsider - an Australian Consultant - he was not familiar with our ground realities. SECP's decision to hold hearings on "wash trades" of 500 shares, identified by him turned the institution into a laughing stock for the brokers community. Not a single member has been found guilty in any case thus far. Will the new investigation not end the same way?
The Securities and Exchange Commission Ordinance 1969 empowers the regulator to institute criminal proceedings against persons engaged in fraudulent activity (manipulative practices now under investigation).
It provides for a three-year jail term along with half a million rupee penalty. The law alone can not be a deterrent unless some high and mighty ones found guilty of white collar crime are punished. That is why the jail terms recently awarded to Enron big wigs in the US, have given added strength to the country's capitalist system.
SECP's offer now to brokers to voluntarily correct their wrong doings amounts to an amnesty. It will be viewed as a weakness and reluctance implement the law and seek punishment. It is better to accept one's weakness instead of issuing unimplementable warnings. For, words need to be backed with action and results.
The KSE index has fallen (from 11019 on May 24th to 9775 last Thursday) by 1244 points.
When the index goes up, the reasoning from the pundits is expectations of good earnings from listed companies. But when the index plummets it is attributed to bad news in the media, or manipulation, or infighting among big brokers etc. Rising inflation, hike in interest rates, fall in investment and lower expectations of earnings are rarely mentioned. What is surprising is that before the SECP it was the duty of the front line regulator, KSE to investigate reports of short selling. The rules require mention of account number at the time of trade by brokers. No mention of account means proprietary trading on brokers' own account.
The payment trail, whether by cash or cheque or authorised transfer, needs to be backed with ownership of shares by the seller. The Central Depository Company (CDC) can verify if the shares were with the seller-client/broker at the time of sale. Since brokers also act as financiers through the CFS system for clients, creating a proper audit trail, is a little difficult but not impossible. The CDC and CFS record has to match. Transfer from CFS can only be for the purpose of bank borrowing. All the answers lie in the trading record at the exchange.
The real issue is the calibre of SECP's investigators. Usually their educational background, training and experience was limited to the taxpaying world. They lack the knowledge and expertise of how the non-tax paying grey area accounting and settlement takes place.
Even the tax hounds of CBR realise this. Therefore, CBR collects direct taxes (withholding) in an indirect collection mode. Sometimes one needs to set a thief to catch a thief. Instead of groping in the dark, SECP needs to offer a pardon and hefty reward to 'whistle-blowers' who can help them catch the culprits. All law enforcing agencies seek help to gain information, from outside their fold, offering millions in rewards. SECP needs to do the same.