A DIRECTIVE issued by the Securities and Exchange Commission of Pakistan (SECP) on November 29 requiring the stock exchanges to elect a non-broker director as chairman was received with the expected response from the various stakeholders.

The Islamabad and Lahore stock exchanges, eager to strengthen their identities ahead of merger and demutualization plans accepted the directive. The voices of power at the Karachi share market donned their well-worn rebel robes and lit a fire.

The financial media fuelled it with customary blindness, shunning altogether an attempt to analyze the merits or demerits of the directive. And the officials of the SECP responded with defensive, almost angry explanations.

What’s all the fuss about? Let’s take a few steps back. Since capital market reform began in 1997 under an Asian Development Bank-sponsored loan, several measures have been implemented in an effort to modernize the share markets and improve governance and investor protection.

Almost all of these — notably principal steps like the launch of automated trade, the introduction of independent management and the reduction of the size of the board with the inclusion of outside directors—were met with loud resistance from elements within the broker community that had been unaccustomed to sharing power or opening up for inspection.

Even more recent reform plans (for merger and demutualization) were initially resisted with great gusto even though when demutualization plans were first announced, the majority of brokers were unable even to define the term. Meanwhile, the newly reformed SECP has, over the years, handled reform through either barbaric, unwarranted aggression or wavering, uncertain directives. Sometimes the approach used work, more often it caused chaos. But the regulator seemed unable to strike the right balance.

Is timing an issue? To begin with, the regulator let it be known to the exchanges through two reports—the experts report on the March 2005 crisis and the demutualization report—that an outside chairman is the way to go prior to demutualization.

Hence, brokers who now object to a dilution of power should have been well-prepared. And those aiming to become the next chairman should have realized the course was changing.

Second, by issuing the directive on November 29, the SECP allowed the present chairman to complete his term and implement the change in the next term. However, since the SECP should by now be well-acquainted with the outbursts from the broker community, they would have done far better had they issued the directive in September or even earlier with the provision that the rules would apply to the board being elected for the term beginning January 2006. That would have given the brokers enough time to digest the news if they chose to ignore the two reports.

And it would have stamped out the ability of some brokers to use the weak argument of legal complications that they have now desperately latched on to.

Sadly, it is usually a certain class of brokers that is largely responsible for the unnecessary conflict. There are five distinct classes of brokers at the exchange. One is the group of old, seasoned brokers who have been in business for years, are professionals to the core armed with a wealth of knowledge and experience and uninterested in politics or power.

Close to them is a smaller group of corporate brokerages who are involved in expanding their corporate client base and have contributed to improving research and modernizing the business.

The third is the majority—of small and medium-sized brokers—who do their business the same way they have for years, are unaware of global changes and trends and have little say in the matters of the exchange. They are the ones who are exploited by those in the next category.

The fourth group is the power brokers, a hand full of extremely wealthy, politically well-connected, brokers who have grown their businesses into mammoth empires over the last few years and who remain voices that are heard. They’re commonly known as the big boys. They’re also the ones donning the rebel robes and fighting to monopolize all the power and decision-making.

And the fifth category is of younger, educated brokers who have come into the business with family money and stars in their eyes, eager to make it into the big boys club. They’re the ones who celebrated when their names were included with the big boys in the brokerages fined for insider trading and wash trades earlier in the year. And this is why ethics and the lack of self-regulation among certain categories of brokers continues to be a major problem.

For example, rather than revolting the way some brokers have, why could the objecting lot at the KSE not take cue from the SECP reports and smartly prepare for the change by getting together and looking for an outside chairman who would best represent all interests, including their own?

After all, the rules say the board will elect the chairman and there are five broker votes on the board unlike other exchanges such as Malaysia where the chairman is selected by the government. Moreover, since brokers have (albeit reluctantly) accepted demutualization, why could they not readily agree to switch to an independent chairman even prior to demutualization? This would, after all, only serve to ease the transition, help identify stumbling blocks in the process and improve the image of the exchange and of brokers.

The SECP should also realize that their capacity building remains poor and they are far from the number and quality of experts they need to have the self- image they currently have. They should also realize that there is a wealth of experience and information among the senior brokers which can be galvanized to improve and smoothen the reform process. That is where the consultation should come in.

But the brokers also need to realize that consultation is a bonus they should appreciate and that this process will not and should not be stretched to the point of negotiation, bargaining and mutual agreement. That the SECP has often let things degenerate to that level is disappointing and undermines their own ability to implement reform.

Let’s start with the obvious: the conflict of interest inherent in a broker running his own brokerage business and governing the board of the exchange.

While a board with outside members and independent management has helped lessen this problem, it is far from over. Indeed, in many ways, a broker-chairman has undermined the other reform measures by creating a force that easily overruns independent management which has been unable to function completely effectively as a result.

Moreover, even if a broker chairman favours reform, he is often unable to vocally support it and thus help the process since peer pressure from broker colleagues becomes insurmountable.

Similarly, the same issue can prevent a broker-chairman from taking or supporting action against a colleague in the interest of investor protection. And finally, it has become obvious that an independent chairman is international best practice.

True, many international practices cannot be forced onto local conditions without adaptation but must nonetheless be studied and considered. There must, after all, be solid reasons why exchanges such as those in Australia, Singapore, Hong Kong and others have non-broker chairmen.

So the question then is, what are brokers at the KSE so worried about? Culturally, it may be a shame to see the colourful annual stock exchange elections fade away. But then that process has already lost its charm since the introduction of the new board.

Brokers should be happy to be left to do business and grow their trade and leave the running of the exchange to others. If they are prepared to do business fairly, reform will only foster competition, not hurt it. Perhaps the resistant brokers should think about that.

Meantime, the SECP should do some thinking of their own. A directive issued early in the year to be implemented now would have been smarter. And now, they must think carefully about the division between the roles of the chairman and the CEO. So far, the distinction they’ve made has not worked well with power struggles being on uneven footing.

Moreover, simply the introduction of “independent” voices is not enough. The SECP must be able to ensure those voices are technically sound and courageous enough to handle independence. And then the SECP must be able to give them the independence to use. That has not yet happened with the SECP’s independent directors. And if the independent chairman meets the same fate, the effort will have failed altogether.