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July 22, 2006
Who is calling the shots in the stock market?
THE Finance and Revenue Committee of the National Assembly has once again brought into focus the stock market crash of March 2005. It recently held a meeting on the issue and also invited former chairman of the Securities and Exchange Commission (SECP) Dr Tariq Hassan to seek his views on the crisis that transpired during his tenure. Dr Hassan’s allegation of the finance ministry’s interference with the SECP’s work has enraged Musharraf regime’s financial managers, who initially issued instructions to charge-sheet the former chairman but then backed down and issued vague threats of stern action against all those responsible for the crash.
Prime Minister Shaukat Aziz and his close aides in the finance ministry continue to point fingers in all directions for the continuing volatility at Karachi Stock Exchange (KSE). Dr Salman Shah has stated that the government is awaiting a forensic investigation report on the March 2005 crisis in accordance with which market manipulators will be given exemplary punishment. Meanwhile, a team of US forensic investigators has arrived to help the SECP in its probe. The team includes forensic accountants, data mining consultants and fraud risk management specialists. What Dr Shah doesn’t realize is that neither he nor anyone else in the finance ministry has any legal authority to prosecute or punish someone for fraud or manipulation in the securities market.
Under the existing regulatory framework of Pakistan, the entire non-banking financial sector falls within the purview of the SECP, not the finance ministry. In fact, it is the ministry’s eagerness to treat the SECP as one of its appendages that has been the bane of independent regulation of the securities market in Pakistan and such a patronising attitude is evident even in the ministry’s latest statements denying interference in SECP’s work. The Aziz administration and its financial managers believe that they can win political battles by impugning the credibility of the apex regulator and the individuals at its helm. Hence, they are more interested in attributing the blame rather than finding solutions to the market’s malperformance.
What were the ‘revolutionary’ findings and recommendations of the Enquiry Report on the March 2005 crisis that could have addressed our securities market’s ailments if followed in letter and spirit? Why is it that the securities market confronted a new crisis in June 2006 even after the Aziz administration had done all it could to learn from the mistakes it committed in March 2005? If a more consensus-oriented SECP was meant to engender confidence among market players, why has the KSE continued to be fickle even after former SECP chairman was sacked and replaced by a more compliant industry insider? What can we expect of the much-awaited forensic investigation report on the 2005 stock crash?
Blaming individuals and rolling heads never solves any problem. The Enquiry Report of 2005 only reproduced conventional wisdom and banal solutions to reform the securities market, and any witch-hunt that might follow the forensic investigation report is expected to produce no solutions either. But this assessment is not meant to blame reports. Reports and investigations can only produce platitudes as finding solutions to develop a fair, transparent and efficient securities market requires no rocket science.
The solutions are simple and most market professionals are aware of them. Giving them effect is what is hard. If the Aziz administration is serious about effectively regulating the securities market, it needs to undertake structural reforms, legal reforms and policy changes. However, such reforms will hurt vested brokerage interests who have experienced an exponential growth in their wealth over the last decade and are now used to financial windfalls and not just paltry brokerage commissions. Reforming the securities market is the right thing to do, but doing it rightly doesn’t necessarily facilitate the political interests of the Musharaf-Aziz regime.
Pakistan has an extremely shallow securities market. While less than one-third of the 600 odd public listed companies are routinely traded, only a couple of dozen blue-chip stocks actually determine the size and health of the market. Besides, unlike developed countries where stock ownership is widely held (according to one survey in the US every fourth citizen is a stock-owner) and institutions control most of the big corporations, majority shareholdings in Pakistan are still controlled by wealthy individuals and families that do not frequently trade their shares for they are tightly held to retain control.
Such fundamentals reduce the size of free float in the securities market, enabling the bigger brokers with considerable liquidity to bend the laws of demand and supply in their favour and move the market up or down by injecting or withdrawing cash from the market. Such sudden lurches in the stock market also do not affect the more seasoned and wealthy players that have staying power and can wait for the artificially manipulated market to correct itself.
The casualty of such manipulation is the common man who trades on borrowed finances. With limited public information available with regard to performance of the listed companies and no research and analysis available to guide trading choices, the ordinary investor relies on his gut instinct and herd mentality while investing in the securities market. Thus, in times when the market has been engineered upward or downward, the listed value of a stock has little correlation with the financial performance of the company.
In simplistic terms, stock trade in Pakistan has striking gaming characteristics. It is like a big casino where the casino owners seldom lose and the ordinary gambler seldom wins (the KSE brokers being the casino owners in this case). The weakness in the structure of the stock market is then complicated by the weak regulatory structure. The stock exchanges in Pakistan are guarantee companies. While they are the frontline regulators of the securities markets, they are owned and administered by the members/brokers that they are supposed to regulate. These are elite gentlemen clubs that cannot be relied upon for self-regulation.
Matters are further complicated by the fact that the SECP as an apex-regulator is rendered toothless and incapable owing to legal limitations and pro-broker government policies. While volumes can be written on the legal limitations of the SECP, suffice it to point out that the SECP can only impose a fine of up to Rs100,000 on a regulated person found guilty of market abuse or manipulation. In order to affix criminal liability, it must prosecute individuals suspected of market fraud or manipulation. However, the burden of proof in any such prosecution is on the SECP and in the absence of any ability to carry out forensic investigations in-house or enter into plea bargains with the manipulators and in view of the inordinate delays that characterise our judicial system, the threat to prosecute hardly works as a deterrent.
The government sold out the credibility of the SECP as an independent regulator when it removed its former chairman on persuasion of the KSE brokers. And the policy of interfering with SECP’s statutory mandate has not changed since. It has been over nine months that the SECP has been functioning without the requisite number of commissioners. While the government has no legal authority to remove a serving commissioner without a cause, it can always appoint a new commissioner to act as chairman if there is a vacant slot. The government exercised the option against Dr Tariq Hassan and still seems to be keeping it open.
A dysfunctional stock exchange can cripple the drive to attract foreign direct investment, apart from continuing to hurt hundreds of thousands of ordinary investors. An effective exit through the stock market can be the only redeeming factor for prospective direct foreign investors in an undemocratic country marred by political instability. It took over a decade and a half to develop the State Bank of Pakistan as an effective banking regulator independent of the ruling regime, and the prize has been self-evident. The reward of investing in the independence and integrity of the SECP for Pakistan’s financial sector development would be as big, if not bigger, but unfortunately no one, including the SECP itself, seems to be fighting the battle for making the SECP independent.
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