Have faith in SEC
* Transparency International (SL) urges government, calling for tough action on white collar crimes in stock marketJuly 30, 2012, 12:00 pm
Transparency International Sri Lanka (TISL) in a special report titled ‘Manipulation in the Sri Lankan Stock Market’ has urged authorities to come down hard on market malpractice, asking the government to have faith in the Securities and Exchange Commission (SEC) of Sri Lanka.
The SEC has come under severe pressure in recent months as influential groups try to derail investigations into criminal market malpractice that had plagued the Colombo Stock Exchange.
"Currently, the CSE is a vulnerable institution, illiquid and exposed to the whims of a few high value investors. The once bright outlook presented to investors in mid-2009 has now turned to a market rife with scandal and corruption," the TISL said.
The TISL report looks at how market malpractices occur, calling it white collar crime, where even public monies in the EPF and ETF have been victim of such activities.
"The government should reinvigorate its faith in the SEC as an efficient regulatory body and gain a deep insight into the beneficial effects of effective regulation in the stock market. The government should not cave into the demands of high net-worth investors and must understand the highly illiquid nature of the stock market as it stands right now," the TISL report said.
"The SEC must develop a strong stance on white collar crime, resisting both political interference and independent interference (from bodies such as the Brokers’ Association). Through the CSE’s reduction wing, public awareness must be raised on the overstepping of major investors and the effects of market manipulation.
"The SEC must also raise awareness on the ability of the SEC Act, that it is a legal document to be followed by investors that provides a level playing field. In this same vein, awareness of the various possible avenues of market manipulation must be made. This public awareness will instil a sense of what is acceptable and what is not on the trading floor.
"Civil Society Organisation must conduct public awareness campaigns on the misuse public funds in the stock exchange, how the stock market works in an elementary form and how white collar crime affects more than just ‘rich people’.
"The need for a change in perception is stronger now more than ever. As mentioned earlier, public perception on white collar crime must be changed; the public must understand that the implications and consequences of market manipulation effect the overall wellbeing of the economy and this, the public themselves suffer," the TISL said.
"A scandal in the recent past is that of the National Savings Bank (NSB) purchase of The Finance Company (TFC). In a nutshell, this scandal is concerned with the purchase of 13% of TFC by NSB for Rs.49.74 a share, whereas typical share prices were at Rs.3 0.7 Following public disclosure of this deal, President Mahinda Rajapaksa halted payment and ordered Secretary to the Treasury, Dr. P.B. Jayasundera to initiate an investigation into the deal. The 13% of TFC shares were to be purchased from two of the company’s directors, Dinal Wijemanne, CEO of Taprobane Securities, and Raynor De Silva, ABC Radio Managing Director. It came to light that there is a conflict of interest at hand; Taprobane Securities was the firm that authorized the purchase of these shares and the director of the company was the individual selling these shares. The SEC has stated that they are investigating Taprobane Securities for insider dealing, front running and conflict of interest violations even though an internal investigation into the incident is yet to be undertaken."
"It is hard to pinpoint the exact cause of market manipulation; it could be greed in the mind of the controlling interest or senior ranking director or it could very well be poor corporate governance. As Warren Buffet once said, ‘Earnings can be pliable as putty when a charlatan heads the company reporting them’. A Sri Lankan example of this is the case of Watawala Plantations. Recently the directors stripped the company of its marketing division with no prior consultation with the shareholders. Arbitrary decisions made without the consultation and consent of the stock owners points towards serious concerns over the transparency and good corporate practices of the directors. This section was sold for Rs.741mn when the company’s true value stood between Rs.2.5-3bn. In this case, it is hard to see who gains from manipulating the market, yet it is easy to see how poor corporate governance leads to slights on the trading floor.
"The question of who is involved with market manipulation is somewhat complex in its dimensions. As we can see from the examples cited in this document, the perpetrators are high ranking executives and stock brokers. The misuse of public funds seems to allude to the fact that there could be rouge political elements at play," TISL said.
"It is a common misconception that white collar crime involves the rich stealing from the rich. However, in Sri Lanka this is not the case. As seen in, the NSB scandal, the savings of the Sri Lankan people were plundered in order to artificially inflate stock prices. This callous use of public finance has obvious repercussions; a poor investment, merely set in motion to paint a false picture of a company’s value, yields a poor return in the long run, hemorrhaging money rather than appreciating the value of the initial investment. This erosion of value will put the NSB in hot water as bank patrons realize their money has been squandered in this investment process."
"Another consequence of market manipulation is shareholder fatigue. This is a phenomenon that occurs when minority shareholders do not receive dividends on their preferred stock." As company directors become tied up in the profit reaping on their manipulations, their companies usually suffer under long term over valuation of stock. As in the case of Watawala Plantations, ordinary shareholders are denied the right to exercise control over their company. Market economics dictate a divorce between company ownership and control, yet ordinary shareholders are presented with voting rights (whereas preferred stock holders typically do not receive voting rights) to steer the direction of their company."
"Market manipulation allegations, whether proven or false, deter investors from entering the trading floor and impede foreign direct investment in the country. When the Sri Lankan civil war ended in 2009, the country seemed to have a bright economic future, with great foreign interest in investment opportunities." In the previous year, Sri Lanka had witnessed massive investment from Malaysia and India, giving analysts the ability to predict good tidings for the Sri Lankan economy. However, the Central Bank of Sri Lankan (CBSL) mentioned in a 2009 report that foreign direct investment in Sri Lanka was inadequate. Yet, by 2011, it seemed that Sri Lanka was far from the tiger economy status it had been bestowed in 2009. The bubble burst in 2011, with the all share price index reporting an all-time low of 3.S% negative earnings and a total loss of Rs.141bn in October 2011.
"A bubble occurs when share prices are inflated to levels higher than their real value, usually through the dissemination of false performance rumors by brokers and a myriad of other market manipulations and investor speculation. The article cited for this claim also goes on to mention how brokers have a heavy hand to play in the creation of a bubble, as they gain on the commission received from brokering stock transactions. It also mentions a group of high net worth individuals who prop up the market through the purchase of illiquid stock (also known as penny stocks).
"The stock market crash of 2011 persists today, with a year-to-debt ratio of 20% reported in May 2012, which amounts to a loss of Rs.40bn. 18 We can now clearly see how brokers and investors play a crucial role in preventing a bubble from forming yet, in the Sri Lankan context, this responsibility is rarely carried out. We also see how one market manipulation can lead to a variety of unintended negative effects, i.e. over-valuation of stocks leading to a stock market bubble and subsequently, a crash.
"In addition to the effects pointed out above, it is critical that we understand the erosion of confidence in the CSE, the irreparable damage done to once credible institutions such as the NSB and, ultimately, the unfortunate deterrence of investment in the Sri Lankan economy. Currently, the CSE is a vulnerable institution, illiquid and exposed to the whims of a few high value investors. The once bright outlook presented to investors in mid-2009 has now turned to a market rife with scandal and corruption," the TISL report said.
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