Good and fair regulation doesn’t impede success in Colombo’s stock market but provides a framework for a level playing field, according to governance NGO, Transparency International Sri Lanka (TISL). “If we understand regulation to be simply that, then perhaps those who push for less market regulation are only attempting to cover up their tracks,” it said in a ‘position paper’ on manipulation in the Sri Lankan stock market.
TISL said while a stock market is expected to present a level playing field to all investors, many investors trading in the Colombo Stock Exchange (CSE) have encountered hurdles to trading, coming from both major private investors and errant government elements.
“These hurdles refer to various methods of market manipulation, such as insider trading and ‘pump-and-dump’ tactics that artificially jostle share prices towards the benefit of a handful of individuals. The distortion of the structure of the market through these market manipulations seem to go unpunished as investigations are halted or fade away from public interest rapidly, ensuring that the perpetrators of these white collar crimes go unpunished,” it said.
TISL said the responsibility for maintaining a level playing field falls on the Securities and Exchange Commission (SEC) and the investors themselves. “Directors, stock brokers and capitalists no longer play within the rules of the game and while ‘greed is good’ in investing, it should be exercised within parameters applicable equally to all market players,” the governance agency noted.
The report said that civil society organizations (CSOs) need to educate the public on the rules of the game and raise public awareness on the consequences of a corrupt stock exchange. “It falls upon the SEC to resist politically-motivated impediments to investigation and efficiently regulate the market while prosecuting the perpetrators of white collar crimes. Additionally, it falls upon the SEC to educate the government on the purpose and effects of regulation, as it is currently seen as a negative influence in market economics. It falls upon the media to pursue alleged white collar criminals and expose their misdeeds in the public light, and to also raise public knowledge on the workings of the CSE and the links between good governance and good corporate practices,” the report noted.
Market manipulation, the report added, refers to the deliberate interference in the free and fair operations of a financial market. The aim of manipulation is to paint a false picture of the market, misleading investors and analysts, it said.The CSE has been plagued by a barrage of market manipulations in the recent past, the report said referring to investments by the Employees’ Provident Fund (EPF). It said the EPF bought an 8% stake in Laugfs Gas PLC for Rs.1.6 billion, pushing share prices up to between Rs.38-41 per share. However, through this inflation of share prices, the stock was sold at Rs.51 per share before coming down to Rs.40 that same day.
As at 4th July 2012, the share price of Laugfs Gas PLC is Rs.19, amounting to a loss of Rs.1.4 billion (in value) to the EPF. “It is clear that the brokers involved made a massive profit by artificially inflating share prices. This example highlights another problem, which is the misuse of public funds,” the report noted saying that the manipulation described above is but one example of a myriad of ‘pump-and-dump’ rackets witnessed on the trading floor. It involves the overvaluing of shares so that stock holders are able to sell their shares at an artificially inflated price.
This however comes at the expense of another party; in the example above the ‘loser’ is the pool of EPF funds.Another example of public funds being used in a pump-and-dump transaction is that of the EPF purchasing stock in Galadari Hotels (Lanka) 2010. The EPF purchased 23.7 million shares in the company, at Rs.32.50 a share. The value of these shares, as at July 2012, is at Rs.11 per share, which amounts to a loss of Rs.500 million. The previous owner of the share, Nawaloka Hospitals, was reported to have been ‘relieved’ to have gotten rid of the ‘burden’ of the loss making Galadari Hotels (Lanka). “It is convenient that a loss making company was transferred from private stock holders to an institution that deals with public funds,” the report said.
Insider trading is another form of market manipulation. It is the “unfair use of trading by those within privileged access (‘insiders’) to information that has not been disclosed by a company to the public (‘undisclosed information’) and which information would, if made public, have an impact on price of securities of that company.”TISL said that although conflicts of interest might not be a form of market manipulation, it is worth exploring the role they play in the erosion of fairness and transparency on the trading floor.
A scandal in the recent past is that of the National Savings Bank (NSB) purchase of The Finance Company (TFC). 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 which heavily involved Taprobane Securities.
“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’,” the report noted.
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 rogue political elements at play,” it said.
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, TISL said.
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.
Market manipulation allegations, whether proven or false, deter investors from entering the trading floor and impede foreign direct investment in the country, TISL said. 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.40 billion. “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,” the report said.
“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,” it said.
The SEC has been unable to curb market manipulation, TISL noted and referred to its leader leadership changes that seem to allude to a corrupt stock market. In December 2011, chairperson of the SEC, Indrani Sugathadasa, resigned in order to “uphold her principles”. Her resignation could be chalked up to attempts to regulate more efficiently being shot down by the Brokers Association of the Colombo Stock Exchange.
“The Association met with President Rajapaksa in order to convey their concerns over regulation in the credit market. We see here that the brokers are able to sway the highest political order in the land in order to get their way,” it said.
TISL noted that there seems to be a Sri Lankan misconception that regulation inhibits the workings of a stock market, creating constraints to brokers.“This conception might be true, if brokers would rather be free to carry out nefarious activities than be subject to a system of checks and balances! The point of regulation is to create barriers to those who would subvert the level playing field and prosecute those who ‘are foolish to flaunt it and get caught’,” it said.
It noted that the SEC seems to be unable to carry out its duties, let alone prosecute the perpetrators. “It is thus clear that the SEC ought to pipe up and do more than sit complacent with entities such as the Brokers’ Association undermining their regulatory capacity. A more hands-on approach is required, one that investigates and fully prosecutes individuals accused of white collar crimes. The SEC Act is sufficient to regulate the market; however, the resources and infrastructure to prosecute perpetrators and regulate the market need to be built up to the point where the issue of white collar crime becomes something that is severely looked down upon in the public sphere,” the report said.
TISL said that “regulation is not aimed at people; it is supposed to be fair and transparent, giving investors rules to be followed by all involved on the trading floor. It should be free from political interference and should not be undermined by errant financiers”.
The judiciary must also be armed with the legal tools required to prosecute white collar criminals, it said.
CSOs have a large part to play in public awareness of white collar crimes, TISL said, adding that is clear that the Sri Lankan public has very little understanding of how financial markets work. “Given this gap in the knowledge base, those who do know the rules are able to manipulate them to gain personal advantage, or to even work in tandem with others in order to fix the market in their favour.”