False pretences

December 02, 2019

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Last week, the Securities and Exchange Commission of Pakistan (SECP) launched a crackdown on half a dozen companies that are registered as private limited entities.

The crackdown took place after the apex regulator got wind of their business activities that ranged from those outside the scope of their memorandum and articles of association to those that were outright illegal.

These activities included the leasing of vehicles, properties and home appliances as well as investment and financing schemes that sought deposits from the public while promising attractive returns.

The SECP has initiated proceedings to wind up these companies. Earlier, the chief regulator took similar action against other errant registered companies.

But many people may have already been robbed of their money. So does the action mean closing the stable door after the horse has bolted? Is it not incumbent upon the regulator to thoroughly assess the promoters and their businesses before enrolling them as registered companies?

An official at the SECP said that thousands of companies ask to be registered every month, which took the number of registered companies to 104,030 by September. The regulator scrutinises their memorandum and articles of association to ascertain that they do not include any activity forbidden.

Fraudulent companies use their SECP registration to beguile the public into believing that their activities are within the ambit of the law

But the trouble is that fraudulent companies use their SECP registration to beguile the public into believing that their activities are within the ambit of the law. “We take swift action when illegal activities undertaken by (registered) companies come to our notice,” the SECP official said.

Corporate lawyer Sakib Majeed said the blame for a registered company carrying out activities not mentioned in its memorandum should not lie with the SECP. It is difficult for the SECP to pre-empt such unlawful activities by monitoring thousands of registered companies in view of the dearth of staff and resources, he added.

Supreme Court advocate Dr Tariq Hasan, who has served as SECP chairman, said the procedure for setting up a financing company is different from that for an ordinary firm. The former can operate only after obtaining a no-objection certificate, incorporating the company and receiving a licence to operate as a financing entity.

“Such companies are more vigilantly monitored by the SECP,” he affirmed. Companies that operate outside the scope of activities mentioned in their memorandum were acting ultra vires.

The Companies Act 2017 specifies the guidelines to draw up the object clause in the memorandum of association. It says that after mentioning the “principal line of business of the company” — which can be anything legal such as the manufacturing or sale of textiles — the firm has to ensure that “nothing empowers the company to undertake or indulge, directly or indirectly, in the business of a banking company, non-banking finance company (mutual fund, leasing, investment company, investment adviser, real estate investment trust, housing finance company, venture capital company, discounting services, microfinance or microcredit business), insurance business, modaraba management company, stock brokerage business, foreign exchange, real estate business, providing services of security guards or any unlawful operation”.

After every action against fraudulent companies, the SECP reminds the public to be cautious as “merely registering an entity as a private or public limited company with the SECP does not authorise a company, sponsors and directors to conduct the business of leasing, modaraba, or take funds from the public on a profit-sharing basis and to provide returns”.

All such activities can only be conducted after getting an appropriate licence from the SECP. “(The) general public is advised in their own interest to conduct due diligence before entering into any transaction of leasing or investing funds with companies that the company is duly authorised/licensed by the SECP/SBP to conduct such business,” the regulator warns.

Yet companies are sometimes detected for carrying out multi-level marketing, lottery business and, most commonly, pyramid or Ponzi schemes. Until recently when regulatory officials took some steps to improve enforcement and compliance at the Pakistan Stock Exchange (PSX), unsuspecting small investors would often fall prey to brokers or their accomplices who lured them into a Ponzi scheme by promising huge returns.

A source at the PSX said that such episodes became extinct after persistent efforts that went into investor awareness campaigns. But he did admit that there was no way to tell if such activities were still being surreptitiously taking place in some small brokerage houses.

He said the exchange looked into the audited accounts of brokerage houses but it was still possible for them to hoodwink the regulator by keeping more than one set of books. In the past, too often brokers collected billions of rupees from shareholders and fled.

The classic big-fraud case of stockbroker Munir Ladha of Eastern Capital — who decamped with bagfuls of money entrusted to him for share purchases by small, voiceless shareholders — went unnoticed as the man was never apprehended. The modus operandi for such brokers at the time was to sell investors’ shares, usually in a crisis-ridden market, take the money and run.

The exchange has now closed that loophole by means of client-asset segregation — shares belonging to clients and their broker are segregated and a fortnightly statement is submitted to the bourse for scrutiny.

But a market guru said that investors’ campaign and stringent crackdowns on fraudulent companies could all fall by the wayside until men learn to control greed. As Chinese philosopher Lao Tzu said: “There is no greater guilt than discontent and there is no greater disaster than greed.”

Published in Dawn, The Business and Finance Weekly, December 2nd, 2019