Laws for protecting small investors
The Punjab government’s cooperatives and finance departments whose job it was to regulate these societies were unable or unwilling to prevent these societies from violating their charter and acting as investment companies rather than as cooperative societies. Later on, thousands of these small investors had to run from pillar to post for a decade to retrieve some crumbs of their lost funds.
Emboldened by the plunder in Punjab in this manner, and realizing how unprotected the investors are, others turned their attention to Karachi in the second half of 1980s. Marketing the same wares under a new label of ‘finance companies’, thousands of small investors again lost their savings in the scandals of the finance companies. This time it happened under another watchdog— the State Bank of Pakistan whose duty it was to stop these ‘finance companies’ from conducting banking operations without submitting themselves to SBP’s banking regulations and requirements.
And now the crash of the capital markets last March gobbled up billions of the savings made by thousands of investors under the watchful eye of another set of regulatory organizations— the stock exchanges and the Securities and Exchange Commission.
The regularity with which such scams keep recurring has damaged the already fragile investor confidence in our capital markets and has done no service to the image of the country- here as well as abroad.
There is a common thread running through these recurring scandals that have left the small investors totally unprotected. Various patchwork of attempts at redressing investor grievances through executive orders have not proved of much help because these keep missing the real target.
Without going into any blame game that has been flying around, the stock market crash can be seen from three perspectives: policy, regulatory and operational. For the purposes of this discussion, we will restrict ourselves to the legal and regulatory aspects of the crash.
Before we take up the issue of securities laws and regulations, it is necessary to underline the fact that the stock price movements do not fully reflect the true state of even the corporate finance of a company, much less its total performance. Therefore, it was disingenuous for some responsible people in the government to attribute this to the rising stock price movements, the non-existent quality of reflecting the economic performance of the whole country.! That this hype by high officials handicapped the regulators in terms of timely and effective action as KSE 100 index was ballooning beyond 8000 points is no consolation to thousands of investors who saw their savings melt away in the month of March.
Stock exchanges are self-regulatory organization (SROs) under the securities laws of the countries. They are required to create their code of conduct within the guidelines of the principal regulator and enforce these on their members on its behalf- in this case the SECP. Which does not mean that SEC itself is absolved of the responsibility of ensuring compliance with the securities laws and regulations through its own systems of monitoring and enforcement over these SROs.
Since money-making is why people play the market in the first place or not for any welfare purposes, market players are not likely to miss opportunities for profiting from every short term movement of the stocks. No wonder, one of them was still trying to lure more investors, just one day before the crash, by claiming that “only a superman could stop the KSE issue rising to 12000”.
The responsibility for protecting the investors against market manipulations falls squarely on regulators. That is exactly why the securities laws and regulations exist as do the regulators, whose very raison d’etre lies in creating a regulatory environment to fulfil two fundamental responsibilities—- the integrity of capital markets and equal protection of investors.
Our practice, whenever investors have been taken for a ride, has, however been to rely on some general laws, executive orders or corporate laws to address investor complaints. No wonder, these have not worked. Our securities laws and regulations which are specifically meant for this purpose, have on the other hand, remained outdated, neglected, inadequate, and ineffective in ensuring the integrity of the markets and ‘investor protection’.
The corporate laws all over the world are oriented towards the management side of the enterprise and rightly so. A corporate law framework exists to assist the management in the smooth running of the business and affairs of the companies. Even in the investment industry, the corporate law would look after the management side of the investment business and not the investor side of the business. Since the corporate laws are not meant to protect the interests of the investors, every developed market economy in the world relies on developed securities laws for this purpose.
Our securities laws (Ordinance 1969 along with its subsequent minor amendments) have remained outdated and out of sync with many developments in the securities industries over the years. These are vague or even silent on the important areas of securities including ‘investor protection’, equal treatment of all investors, disclosure requirements of all material facts and such others critical issues.
Incidentally, the SEC of Pakistan should also come out of the shadows of its predecessor - the Corporate Law Authority- and instead of still marketing all its activities under corporate laws as it now does on its website, it should, like all securities commissions, focus on the securities laws and regulations of the country which have been neglected and work towards enhancing their scope and effectiveness.
The central concern of all securities laws is ‘investor protection”. In order to achieve this objective, the SECs are required to enforce two cardinal conditions in the capital markets: (1) ‘Equal treatment’ of all investors and (2) ‘Disclosure’ of all material facts for the information of all players to make ‘informed investment decisions’. Failure to do so creates opaque and manipulative markets where the risk to investors, especially small investors- is extremely high.
As a matter of fact, as the daily turnover of shares at KSE crossed the one billion mark and market capitalization was nearing Rs3 trillion, it should have caused sleepless nights to the regulators seriously committed to enforcing these cardinal conditions in the market.
That our regulators have not been able to develop investor confidence in our capital markets is evident from the fact that for many years, the investor base has remained narrow— about one million— despite tens of millions of shares offloaded through the years of privatization of state enterprises. This lack of faith is also evident from the small number of companies listed on the stock exchanges.
The recent market crash should serve as a wake-up call for Pakistan to update its outdated and inadequate securities laws, curb abusive practices, enhance investor protection and help people to become good savers and investors in the economy.
It is good that Public Accounts Committee of the National Assembly is holding hearings into the recent crash of the stock markets. It should use the upcoming report of the task force on the subject for further deliberations. In the light of these, the PAC should finalize its recommendations in the shape of a draft bill to be submitted to the parliament to amend and update the securities laws, improve integrity of the capital markets and increase investor protection.
Only such reforms in the securities laws that strike a fair balance between the risks of investors and the responsibilities of those who take other peoples’ money in the name of ‘investment’ will restore investor confidence and turn our stock exchanges into instruments for capital formation and industrialization of the country.
Email: smshah@alum.mit.edu