The Securities and Exchange Commission of Pakistan last week released an ‘Investor Alert’ with reference to ‘research reports issued by regulated entities’ while making an investment decision.

The regulator has advised investors to ensure that the recommendations in the research report by a‘research entity’ ‘is based on reliable information with disclosed source and the valuation method in the report is stated along with key risk factors’.

Investors have been warned of risks associated with ‘making investment decisions based on hearsay, rumours and tips/advice disseminated by unregulated persons through various social media networks like Facebook, Twitter and Whatsapp.’

Despite the booming stock market, there is hardly an evidence to suggest that the number of investors has increased from 250,000-- the figure that has remained static since a long time. However a large number of small investors are known to take the long route of making investment through an account holder friend or acquaintance. It is mainly such investors with little means and even lesser investment acumen that fall for tips and rumours.


Many brokerage houses are unhappy with the rules: “These are too stringent and dissuade brokerages from preparing reports also for foreign clients,” said the head of an asset management firm


While regulators can pry upon research reports issued by stock brokerages or ‘regulated research entities’, it seems they are unable to crack down on ‘advisors’, ‘gurus’ and ‘investor groups’ that abound on social media, mainly Facebook.

In the recent run up to the euphoria over Pakistan’s reclassification to MSCI Emerging Market, from Frontier Market, big and powerful market participants who had been holding ‘junk’ stocks for years, managed to deliver them to the unsuspecting small investors who made a dash for these low-priced stocks in the hopes of making a killing. In pushing such small investors to ‘buy’, the ‘gurus’ made use of multiple those dubious tools: Facebook, rumours, their purported ‘insider information’ and misleading reports.

While regulators can scarcely be expected to prevail over the ‘un-regulated’ research reports, advise, and tips on the web, the SECP has tried to streamline the reporting rules for ‘regulated’ entities. In the autumn of last year, the chief regulator released the ‘Research Analysts Regulations, 2015’. These regulations provide a minimum professional qualification for a research analyst. They also tackle the issue of addressing actual or potential conflict of interest arising from trading in securities of a company on which research is conducted. The regulations also require analysts to have an adequate documentary basis for preparing a research report.

Valuation methods, that have a reasonable basis, have to be disclosed in the report used to determine the target price; and they have to be accompanied by disclosures concerning the risk that may impede the achievement of the price target. The law prescribes punishment for any brokerage and research analyst who contravenes any provision of the regulations.

Many brokerage houses are unhappy with the rules: ‘These are too stringent and dissuade brokerages from preparing reports also for foreign clients ‘, said a head of an asset management firm, who asked not to be named. Nonetheless, issuers of reports have been pressed to follow the rules. It is no longer enough for analysts to escape the blame for writing misleading research reports by putting a ‘disclaimer’ at the foot of the report.

Mainly after the episode of a research report by a major brokerage house, which was held by the FIA as a ‘criminal offence’ last year, leading to the arrest and incarceration of the CEO of the brokerage-investment house, sense has come to prevail. It is now common to notice ‘red flags’ at the bottom of the reports, to warn of events that could lead to the report going wrong.

Analysts are also generally loathe to put a ‘target price’ on a report of a particular company stock, lest they are held accountable for shares bought on the basis of such valuations; which may not work out as predicted.

Along with research reports, the heavy hand of the law has perhaps for the first time fallen on statutory auditors of listed companies. The SECP findings in one recent case suggested that the auditor had given an opinion on ‘fake and bogus accounts of a company’, which maintained two sets of books of accounts for the year ended June 30, 2011 showing wide variations in the total turnover and net profit.

But such a case is neither an isolated incident nor Pakistan specific; the practice is as old as the profession itself and is prevalent throughout the world. Yet, after the fall of giant US firms such as ‘Enron’ on misleading reports that put its auditor — one of the worlds big five — out of business, the profession has undergone severe self-regulation.

Yet, it is a company’s board of directors that prepare the accounts and pay the auditors their audit fee. Unless that changes it is difficult to see how auditors can be persuaded to issue a ‘qualified’ report as opposed to a ‘clean’ audit report, particularly where errant firms are multinational companies.

Published in Dawn, Business & Finance weekly, June 27th, 2016

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