THE year 2011 begins with a full-quorum Securities and Exchange Commission of Pakistan – first time in more than two years. Will this protect  investors and restore their confidence?

Investor confidence is the foundation of a well-functioning capital market. The brokers acquiring regulatory positions in the SECP have over the years thwarted the compliance of investor protection provisions of capital  market laws and have badly eroded investor confidence in the stock market.

Several provisions in the SECP Act 1997 require the SECP to maintain the confidence of investors in the securities markets by ensuring their adequate protection. It is mandated to take whatever action is necessary to enforce capital market laws and its Policy Board is required to oversee the performance of this regulatory body.

But the SECP has avoided to build genuine investor protection mechanisms in pursuance of these investor protection provisions and its board has not done anything to arrest the deteriorating performance.

To give the investors protection and effective remedies against market abuse, several jurisdictions have established independent tribunals to try capital market offences. When such a proposal came before the SECP board, for consideration in 2010, it was turned down for reasons which can be best appreciated after having a glimpse of the adjudication and prosecution system in vogue in the domestic capital market.

Currently, directors and commissioners of the security market division adjudge the market disputes at the original level.

An appellate bench of the SECP consisting of two commissioners hears appeals. Officials of thesecurity market division working under the influence of a broker turned regulator almost invariably charge the offending brokers under irrelevant provisions providing for much lenient punishment.

The offences committed in stock market have been made punishable under Sec 22 and 24 of the SE Ordinance, 1969 and Sec 28 of CDC Act, 1997. Sec 22 and 24 of the ordinance respectively provide for penalty of Rs50 million and imprisonment for three years. Sec 28 of the CDC Act provides for an imprisonment for five years.

The SECP charges the brokers punishable under above provisions usually under Rules 8 and 12 of the Brokers’ Registration Rules which provide for the penalty of suspension of broker’s brokerage licence or a penalty not exceeding rupees one hundred thousand. The SECP has traditionally imposed on offending brokers penalties from Rs25,000 to Rs50,000 and occasionally up to Rs100,000 which the brokers feel little pain in paying.

The state of prosecution for market offences is worse than adjudication. Currently, sessions courts which are overburdened with and have expertise in trials of offences under Pakistan Penal Code try the white collar crimes of securities market on the complaint of SECP.

In the first stance, the prosecution of a broker is a rare occurrence. When the SECP does rarely prosecute a broker, it prosecutes him half heartedly in a protracted trial proceedings. Even prosecution efforts does not bring the brokers any worries because it is invariably destined to result in acquittal.

The Policy Board turned down the proposal for the establishment of an  independent tribunal with an aim to save the powerful broker community from genuine accountability. With this policy decision, broker protection has been secured at the cost of shattering investor confidence.

Investor compensation on brokers’ defaults is another mechanism used to boost investor confidence. The global best practice in the developed markets of the US and Canada is to establish an investor protection fund. An independent corporate entity with its own board of directors manages such a fund. Sales proceeds of the assets of defaulter broker together with a contribution up to one million dollars per investor from investor protection fund makes good the investor’s losses.

Although an investor protection fund has been established by the KSE, it is within the exclusive control of brokers. In striking contrast with international best practice, the brokers impede investor compensation through the device of compensation per defaulter broker.

An amount of Rs10 million contributed from the fund reduces to an eyewash when it is distributed among thousands of clients of a defaulter broker. As the SECP’s conduct with regard to five defaulter brokers of market crash of 2008 shows, defaulters in the domestic market manage to dispose of their assets and run away from the country before investors get anything from this source.

Regulation 3 (b) of the KSE’s Investor Protection Fund Regulations envisages the current broker controlled fund as a temporary arrangement and alludes to the establishment of an Investor Protection Fund at a national level. However, the SECP has not given for years even the slightest consideration to this investor protection obligation.

The KSE brokers have elected five directors for the next year with the hope that they will fight for leverage and substitution of a broker chairman of the KSE for the currently SECP nominated chairman. The composition of elected directors shows that the faces which will actually engineer decision making in the SECP have chosen to use their weaponry in the background. Broker community is unable to realise that substitution of the KSE chairman means rolling back Asian Development Bank funded capital market reform on one hand and a manifest breach of Sec 34 (4)(5) of SE Ordinance on the other.

The problem of domestic bourses is being misdiagnosed.

Leverage is being prescribed as a panacea for market maladies. If leverage had been introduced a few months back, the foreign investors who are said to holding the key to market rise or collapse would have sensed the future risk and deserted the market leaving it free to suffer its traditional fate.

If the broker community wants a robust market, it will have to  ‘allow’ the regulator to establish Independent Tribunal for their genuine accountability and an Investor Protection Fund at national level for the investors’ genuine protection.