The Appellate Bench of the Securities and Exchange Commission of Pakistan (SECP) has declared that the Karachi Stock Exchange (KSE) has demonstrated its ability to diligently perform functions and duties towards protection of investors with the exception of not being able to comply with System Audit Regulations.
According to a SECP's new Appellate Bench order issued by Tahir Mahmood Commissioner CLD and Fida Hussain Samoo Commissioner Insurance, it is established that there was no malafide; and the KSE fully intended to comply with the System Audit Regulations and contravention of regulation 8 of the System Audit Regulations seemed unintentional on the facts of the case which did not have any adverse impact on the interests of the investors.
Therefore, the SECP bench has set aside the Impugned order of the SECP Market Supervision and Regulation Department. The order is in appeal Nos. 26, 27 and 28 of 2014 filed under section 33 of the Securities and Exchange Commission of Pakistan Act, 1997 (SECP Act) against the order (Impugned Order) dated 23/05/14 passed by the SECP's department.
The brief facts of the case are that KSE was incorporated under the Companies Ordinance, 1984 and registered as Stock Exchange under section 5 of the Securities and Exchange Ordinance, 1969 (the Ordinance) and was demutualized under section 6 of Stock Exchanges (Corporatization, Demutualization and Integration) Act, 2012. The Regulations Governing System Audit (Regulatory Compliance) of the Brokers of the Karachi Stock Exchange Governing System Audit (System Audit Regulations) were promulgated under sub-section 1 of section 34 of the Ordinance for conducting System Audit of the Brokers in order to ensure compliance with the requirements of the Ordinance; Securities and Exchange Rules, 1971; the Articles of Association of KSE; Brokers and Agents Registration Rules, 200 I; Regulations of KSE and the directives issued by the Commission from time to time. Clause 8.5 of System Audit Regulations requires that the KSE shall forward the System Audit Reports (Reports) along with its views and counter comments of the brokers to the Commission within 45 days of submission of Reports.
A Show Cause Notice dated 25/02114 was served on the Appellants (KSE) under section 7 read with section 22 of the Ordinance. The Appellants submitted their written response to the SCN vide letter dated 17/03/14. Hearing on the matter was held on 08/04/14. The SECP head of department Market Supervision and Registration Department held that KSE, being a frontline regulator, is required to vigilantly monitor and oversee the process of system audit of brokers by the auditors and enforce it firmly for the protection of investors' interest and to ensure the safety and fairness of the market. It was evident that the KSE failed to ensure that appropriate enforcement actions were initiated by KSE in a timely manner against non-compliant brokers as required under the regulatory framework. It was the responsibility of the Managing Director and Deputy Managing Director to ensure that the KSE performs its functions in an objective and just manner as it has to set an example for the intermediaries related to its business, enhance the confidence of investing public and promote healthy development of the securities market.
The KSE has argued that in a vast majority of cases the incidents of non-compliances were rectified. Further, the period for which the SCN was served was a transitory period due to demutualization and corporatization of the exchange and KSE has also been taking a remedial as well as a disciplinary action against the non-compliant brokers from time to time. The department has argued the KSE must not only ensure that the non-compliance is rectified but take action where provided by the law.
The Appellate Bench is of the view that the KSE has been taking disciplinary action against non-compliant brokers from time to time. Regulation 5.2 of the System Audit Regulations provides that, "If the Report contains any non-compliances, the Broker shall rectify the same immediately and such Broker shall be subject to limited scope audit in the following year to confirm that such Broker is now compliant of those particular non compliances ..." In the instant case, appropriate action was taken and the acts of non-compliance were reported to the Commission. Further, the bench agrees with the Appellants that as mandated by Regulation 5.2 the System Audit Regulations, no penal action can be taken without allowing the broker an opportunity to rectify such non-compliance and an action can only be taken if it is reported that the acts of non-compliance are not rectified in the Limited Scope Audit. Regulation 8.5 of the System Audit provides that, "The Exchange shall forward to the Commission copies of the reports of the brokers audited, along with the views, counter views and comments of the Brokers and the Exchange on the discrepancies/observations, within 45 days of submission of the Reports". The KSE has stated that the reports were submitted but the reason for the delay for the submission of its own comments and comments of the brokers on the identified non-compliances was due to an enforcement or a disciplinary action being taken against the said Brokers and their awaited outcome.
Article 170 of the AOA of KSE provides that, "The Exchange and its directors and employees of the stock exchange shall strictly adhere to Articles, all applicability rules, regulations and any other securities market laws in discharging their functions, duties and responsibilities." The Respondent has not been able to establish how the Appellant No 2 as Managing Director and Appellant No 3 as Deputy Managing Director have failed in their responsibilities towards ensuring compliance level among Brokers and violated Article 170 of the AOA of KSE.
The bench is of the view that the Appellants (KSE) have demonstrated their ability to diligently perform their functions and duties towards the protection of investors with the exception of not being able to comply with Regulation 8.5 of the System Audit Regulations for reasons cited above; therefore, the imposition of penalty on Appellant No 2 and Appellant No 3 could not be justified.
It is established on the facts of the instant case that there was no malafide; the KSE fully intended to comply with the System Audit Regulations and contravention of Regulation 8.5 of System Audit Regulations seemed unintentional on the facts of the case which did not have any adverse impact on interests of the investors, SECP Appellate Bench added.
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