DEPOSING before the National Asssembly Standing Committee inquiring into the stock market fiasco, Chairman SECP tacitly accepted his inability to discipline the country’s stock broker community.

The revelation is disturbing because it appears that the regulators were driven by disruptive market forces instead of controlling them. The requisite regulatory framework and supervisory apparatus was lacking.

For the Chairman SECP, the occasion turned into a day of reckoning because, in spite of the defence he put up, NA Standing Committee members accused SECP of failing to take timely action to prevent the stock market meltdown.

There is more than a grain of truth in the allegation because, beginning September 12, 2004, trend of stock prices foretold the coming catastrophe. By November 6, KSE-100 index had fallen by 900 points. What followed were a much bigger boom, and many times more crippling bust.

The SECP move to discontinue Group Account facility (a haven for anonymous accounts and a major source of market abuse, according to SECP), by March 31 was too little too late.

What the SECP didn’t pursue as vigorously as it should have done was the move to de-mutualise the stock exchanges to neutralize the power their broker-owners continue to exercise. By its own admission, it is this group that the SECP finds itself unable to control. What need to be investigated are the reasons for SECP’s failure in implementing this fundamental market reform.

The SECP chairman observes that “the immense control wielded by a small number of market players will not only result in the subversion of capital market reforms but will keep the market hostage to excessive volatility and manipulation. This will destabilize the market and its ripple effect felt throughout the economy”. And “If opposition to the reform process is allowed to continue, Pakistan’s chances of emerging as a leading capital market which can compete with other international markets would be lost forever.” The assertions are shocking.

These fears should be the focus of the NA Standing Committee. Rumour has it that earlier this year, some political big wigs were eager to know when the KSE-100 index would cross 12,000 points. Given this background, Standing Committee’s rejection of the report of the Taskforce appointed to investigate the stock market meltdown, should not surprise anyone.

The accusation that the report didn’t name names and the demand for another investigation (to be completed, miraculously, in 15 days) reflects the sincerity of the legislators in dealing with complex issues, such as regulatory reform.

The Standing Committee overlooked that, at the outset, the Task Force report points to lack of time and resources at its disposal to investigate this enormously complicated affair. It is therefore not a weakness of the report that it doesn’t level specific accusations. Hurling unsubstantiated accusations would have been a serious indiscretion, which the Taskforce avoided very sensibly.

The Task Force report pinpoints government agencies and specific officials, possible connivance of the management of PSEs (prices of whose shares fluctuated wildly) in market manipulation, brokers who may have manipulated stock prices, the roles of the management and Board of Directors of the KSE, and recommends specific areas for in-depth investigation to fix responsibility based on credible evidence of wrongdoing. Aren’t these pointers enough? For those who can see, these are enough to initiate action (by individual and by institution) provided those who are to initiate action, want to do so.

Many flayed the report for not being specific about manipulators. The move was aimed at discrediting the Task Force report because implementing it could lead to the black sheep being uncovered.

As the regulator, it was for the SECP to investigate the areas pinpointed by the Task Force, fix responsibility for misconduct, and make the culprits pay. According to Chairman SECP, it is being done and some brokerages may face disciplinary action.

Under the circumstances, the Standing Committee should have allowed SECP to continue its probe along lines suggested by the Taskforce, and back the SECP unreservedly rather than fault its investigative process. What SECP needs is parliamentary support in legislating preventive laws.

The reports that KSE members are trying for a rapprochement with SECP is not a good development because it could lead to a compromise and sustain the hold of the brokerage houses over the stock exchanges. If it is the result of behind the scene activities of legislators, it is most regrettable. This is the time to act against the bad elements within the ranks of stock brokers, not reach unhealthy compromises with them.

The Standing Committee is well within its rights to call an explanation from the SECP about the forces that led to the stock market meltdown. That, however, doesn’t absolve any big wig, especially legislators, of their failure to shake the managements of both SECP and KSE in early 2005. Was it not the responsibility of the legislators to ask how on earth could stock prices suddenly rise by an average of almost 250 points a day in March 2005?

The NA Standing Committee overlooked the fact that SECP’s lethargy (the Committee’s accusation), was not the only factor that led to the tragedy. Foundation of the catastrophe was laid the day banks were permitted to trade in equities. The belief that banks would keep their investments within regulatory limits was over optimistic.

Bank regulators should know that on reporting dates banks limit their exposures within regulatory parameters but during the period ending on the reporting date profit-crazy bankers far exceed the regulatory limits.

Between September 12 and November 6, 2004 the bubble (first of the current series) burst as banks unwound their holdings to confine their equity investments to 30 per cent of their own equities (the regulatory limit set to take effect from January 1, 2005).

The 18.9 per cent fall in KSE-100 index was largely the result of banks cutting their positions by just 4 per cent of its peak of Rs44 billion. The fall, warned the head of a large bank, could have been steeper had banks not been “supportive” of the stock market. In markets like Pakistan that lack depth, banks with enormous liquidity, will continue to shake the stock markets.

Hardcore proof of banks’ manipulating stock prices is provided by their published accounts. Some banks earned the better part of their profit (70 per cent in one case) from stock trading, not banking activities. But why blame them?

With excess liquidity, artificially lowered interest rates, venues for earning from banking activities drying up and the freedom to trade in equities, they did what seemed logical – manipulate stock prices and trade at prices that maximized their profit. None care about small investors and corporate social responsibility under a blatant capitalist regime, which is what Pakistan is going through since 2002.

All this does not augur too well for market liberalization, which is priority number one of the Prime Minister. Those in the corridors of power may indirectly have influenced the regulators to adopt a dangerously soft approach to regulation. Should that be the case, what happened in the financial markets would not surprise anyone.

It is important that regulators realize that their shortcomings or misplaced priorities can spell doom. The tip of the iceberg is now clearly visible.