The forensic investigators have rejected most of the allegations levelled by the Task Force against the influential brokers/brokerage houses of the Karachi Stock Exchange (KSE).
The investigation report of Diligence reveal that the Task Force alleged that some of the brokers obtaining large naked short sale positions in Futures contracts were the same who manipulated market's steep decline, with reduction in lending to the regulated COT market.
Such activities could be violations of Section 17(a), and as such, the Task Force called for a further forensic investigation into these allegations, the report said.
"While examining these allegations, we noted that the amount of New COT was provided to the market during the first two weeks of March 2005 by the same thirteen brokers," the report said.
New COT provided by these brokers remained relatively stable through March 15 or, in some cases, actually increased. Consistent with our findings in Part I of this report, forensic investigates find no evidence to support the Task Force's allegations that brokers influential to the market and trading in significant naked short sale positions purposefully restricted COT lending to profit from their sales positions.
Diligence undertook several steps in response to the Task Force's request to examine the trading activities of brokers selling in the Futures market, namely: Identifying any instances of brokers in net sales positions in excess of the Rs 50 million threshold of Clause 3(b) in March 2005 Futures contracts, thus triggering a need for the broker to satisfy the KSE that the shares sold were indeed held or recently purchased by the broker as directed in Clause 3(b). For the brokers holding the largest net sales positions in March 2005 Futures contracts, comparing the broker's net sales positions to the shares reported held by the broker in its accounts at CDC. A short-fall in shares held of greater than Rs 50 million might be found to be a potential violation of Clause 3(b) and Section 17(a).
Quantifying and examining the lending of New COT for COT-eligible scrips by the market's more influential brokers for the period March 1 to March 18, 2005, to determine whether New COT for those scrips was reduced by these brokers, which could be a potential violation of Section 17(a).
Based on analysis, the forensic investigates found numerous incidents in which brokers, subject to additional factual and legal analysis, may be in significant violation of the securities regulations.
The foreign experts are not, however, of the opinion that the potential violations were an intentional and integral part of a larger scheme to inflate, and then crash the market, as alleged by the Task Force and others. Rather, these potential violations, if substantiated, are more likely to be individual isolated instances designed to take advantage of and to abuse regulatory loopholes and lack of oversight in order to profit from, at that time, overly optimistic sentiments in a highly volatile market, the report added.
On wash trades, the Task Force presented an analysis of "inter-trading" between several "top brokers." As a preliminary matter, it is unclear to Diligence why the Taskforce used a diagram of partial trades of scrip between different clients among different brokers as a graphical representation of large volumes of wash trades. Investors trading on the KSE must use a broker to effect a stock market transaction. That any number of brokers, particularly the larger ones, have a significant amount of trading activity between one another is not surprising, is not indicative of wash trading, and is, in fact, quite normal and expected. Moreover, certain trades between individual investors occur within the same broker is also to be expected, particularly within brokers that count thousands of investing clients.
Additionally, investigates find three significant flaws in the Task Force's analysis. First, the Task Force report highlighted the fact that for these seven brokers, there appeared to be a correlation in the amount of shares purchased and sold. This analysis was remiss in that it did not take into account the actual underlying clients involved in these trades.
Second, successfully executed wash trades serve the purpose of temporarily hyping the market and raising stock prices within a very short period time (measured in minutes). Therefore, wash trade analyses must be performed on an exceptionally granular level, preferably on a trade by trade basis. The experts believe that the analysis of summary trading data aggregated over a period of one month is not representative of individual client trading behaviour and cannot accurately identify potential wash trades.
Third, the absence of a universal identification coding system for investors renders it virtually impossible from using only KSE data to identify the same clients across different brokers. Without a universal identification coding system in place, to effectively and completely analyse wash trades within and across brokers in light of the limitations in the KSE data, one would need to review and compare the detailed back office trading data of each and every broker to accurately identify the underlying clients, as many investors have accounts at numerous brokers.
The implementation of Universal Identification Codes for clients in 2006 provided the SECP with statistics as to the number of accounts clients hold across different brokers. According to the data, 16 percent of investors, or 22,414 investors, maintained investment accounts at more than one broker. Sixty-eight investors held accounts at more than ten brokers.
The implementation of Universal Identification Codes for clients will alleviate this data limitation and greatly enhance the ability to track the same client trades across different brokers, the report said.