Securities market regulation and ethics

CONFIDENTIAL AND PROPRIETARYAny use of this material without specific permission of Candor is strictly prohibited

SECURITIES MARKET REGULATION AND ETHICS:HOW THE PROPOSED NEW SEC ACT WILL AFFECT YOU Ravi Abeysuriya, CFAGroup DirectorCandor Group

Capital Market Education and Training

Naomal Goonewardene, CFAPartnerNithya Partners

http://www.candor-holdings.com/

http://www.nithyapartners.com/who-we-are/naomal-goonewardena.php

Table of contents

1. Current status of the stock market2. Alleged reasons for current state of affairs3. Importance of trust & confidence4. Factors contributing to lack of trust5. The cost of failure of trust6. Actions needed to improve investor trust7. Importance of market integrity & ethics8. Self regulation9. IOSCO objectives and principles of securities

regulation10.Enforcement action thus far taken by SEC11.Objectives of the proposed new SEC Act12.Conclusion – vaccination to protect you

ASPI declined by 16% vs regional peers since Oct 2014

Oct-14Oct-

14Nov

-14Dec

-14Jan

-15Fe

b-15

Mar-15Apr-

15Apr-

15

May-15Jun

-15Jul

-15Aug

-15Se

p-15

Sep-1

5Oct-

15Nov

-15Dec

-15Jan

-16Fe

b-16

Mar-16Mar-

16Apr-

16

May-16Jun

-16Jul

-16Aug

-16Se

p-16

Sep-1

6Oct-

16Nov

-16Dec

-16Jan

-17Fe

b-17

Mar-17

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85

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105

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Sri Lanka - CSE Pakistan - KSE Vietnam - Ho ChiIndonesia - Jakarta Comps

Daily turnover levels have comedown by 62% (50 day moving average)

12/14

01/15

02/15

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2,000,000,000

4,000,000,000

6,000,000,000

8,000,000,000

10,000,000,000

12,000,000,000

14,000,000,000

0.02

200,000,000.02

400,000,000.02

600,000,000.02

800,000,000.02

1,000,000,000.02

1,200,000,000.02

1,400,000,000.02

1,600,000,000.02

1,800,000,000.02

TURNOVER SMA(50)

Stock Broker industry PBT declined by 112% (and Turnover by 76% in 6 years)

2010 2011 2012 2013 2014 2015 2016-2,000,000-1,000,000

01,000,0002,000,0003,000,0004,000,0005,000,0006,000,0007,000,0008,000,000

Some alleged reasons for current sate

• Auditors• Lack of Auditor independence and competence• Needs to be more effective watchdogs• Failure by listed company auditors to detect misleading financial information,

i.e. Accounting Shenanigans • CSE

• Lack of size and liquidity – not in the radar of Emerging Market Investors• Slow in implementing reforms

• Financial Press• Publishing negative stories about the capital market• Reproducing Co. press releases without being analytical and even distorting

the true financial performance• Government

• Lack of policy consistency & apathy with regard to the stock market• Confusing messages on implementation of Capital Gains Tax• Looming inflationary pressures and increasing interest rates• Contradictory views on economic policy by CBSL & MOF• Poor track record of policy implementing

Some alleged reasons for current sate Conti…• Investors

• Institutional investors not investing until completion of investigations• Related party transactions favoring majority shareholders• Market Manipulation & Pump & Dump by high net worth investors• Circumventing mandatory offers using loopholes in the SEC Act• Using un-listed holding companies to gain control of listed entities• Retail investors lack financial literacy - gambling rather than investing

• Listed Companies• Poor Corporate Governance Practices • Discriminating minority shareholders• Lack of timely disclosure allowing insiders to make money

• SEC• Too many stock broker licenses issued• Ongoing investigations of high net worth investors for pump & dump• Slow progress, no defined time lines in implementing pertinent reforms

• Market Intermediaries• IBs - Over pricing of IPOs, i.e. Soft Logic & Expo Lanka

IPO funds used for other purposes than originally declared• Fund Managers – Looking after their interest and not interest of members

who contribute the pension/provident funds • Stock Brokers - Spreading false rumors to induce trading, front running,

market manipulation, bribery & rebating

Domestic investor participation rate in the Sri Lankan stock market is one of the lowest

Source: Investor Protection, Equity Returns, and Financial Globalization, JOURNAL OF FINANCIAL AND QUANTITATIVE ANALYSIS

The industry has lost investor trust

We must restore “Trust” in our capital market

Factors contributing to lack of trust

The cost of failure of trust - miss out on the “The power of investing”

Firm level actions required to improve investor trust

Importance of market integrity

• Market integrity– extent to which a market operates in a manner that is, and is perceived to be, fair and orderly and where effective rules are in place and enforced by regulators so that confidence and participation in the market is fostered

• FELT – Fairness, Efficiency, Liquidity and Transparency (do I know what is going on in this market)

• Problems with information asymmetry – One party has more or better information than others – extreme case can lead to market failure. Issuers have an information monopoly thus the need for greater disclosure

• Negative network externalities and/or pecuniary externalities–problem of lemons – the bad drive out the good.

Compliance versus ethics

Why ethics matters

• Investment professionals manage other people’s money• Capital markets are information driven• A viable market hardly gets under way in the absence of

investor confidence & trust• Adherence to ethical practices instill investor trust in

markets & development and sustainability of the market • Investors will be reassured only if investment

professionals act with the their clients’ best interests in mind

• Actions by a few unscrupulous individuals have had a terrible toll on investors’ trust

• Trust is hard earned and easily lost

Self regulation

Some countries have abandoned self-regulatory organizations (SROs) altogether, others are actively exploring the benefits offered by a system that provides a “front-line” regulator, such as an SRO.

National Securities Dealers Association (NASD) in USA is one of the first registered SROs since 1938

Several countries have SRO models: i.e. Brazil, Canada, China, Colombia, India, Japan, Malaysia, Philippines, Romania, Thailand, Turkey

Emerging markets are more likely to use the SRO model to oversee and police their own members

Advantages of self regulation

• Technical and Hands-on Expertise– SROs better understand technical & practical aspects

of market regulation• Flexibility

– SRO have greater ability to adapt to new innovations & developments

• Greater Acceptance of Rules– SRO members elect their directors and participate in

rulemaking; may cause greater willingness to comply with rules

• Cost Savings to Government– More than 100 market intermediaries of varying

complexity– Over 300 registered investment advisors

Disadvantages of self regulation

• Conflicts of Interest - make money AND serve the public interest?– Securities exchanges are both business ventures and

regulatory bodies; may not enforce rules if detrimental to business

– demutualization creates additional conflict regarding profit motive of a shareholder-owned SRO

• Antitrust Implications– Members of an SRO are collectively regulating their

own behavior; danger of collusive behavior that hurts clients

• Due Process Concerns– Members regulated by individuals exercising a form of

governmental power, may not follow a due process that would apply if the government were the disciplinary body

New paradigm for self governance

• Enhance current SRO system• Strengthen CSBA governance, enhance disclosure and

reporting requirements• Enhance SEC´s ability to regulate CSBA members market

trading activity• Peer Review - Get practitioners involved in fostering an ethical

culture and championing ethical behavior in investment markets

• Mandated SRO internal restructuring• Increase CSBA regulatory independence, e.g., by requiring all

Members to regulate their members’ market operations• Adopting principles-based regulation to replace detailed

prescriptions that add to compliance costs but not to stability or efficiency

• Practitioners know all the tricks in financial crimes, so involve them in the drafting of rules and regulations

IOSCO objectives and principles of securities regulation - 38

1. Protection of Investors2. Ensuring that markets are fair, efficient and

transparent3. Reducing systemic risk

Protection of investors

1. From misleading, manipulative or fraudulent practices: market manipulation, mis-selling, insider trading, money laundering, front running and misuse of client assets

2. Ensuring full disclosure of information material to investors’ decision, a key part being accounting and financial forecast information

3. Ensuring only qualified persons are allowed as intermediaries by a system of prior authorization

4. Exercising adequate supervision over intermediaries5. Enforcing the rules effectively

Ensuring fair, efficient and transparent markets

1. Ensuring prior authorization of marker operators2. Ensuring fair competition in the operation of markets3. Ensuring timely and widespread dissemination of

trading information and that such information is fully reflected in the securities prices

4. Ensuring transparency of all trading information

Reducing systemic risk to the financial system

1. Reduce the risk of failure of intermediaries2. Knowing at all times the risks undertaken by

firms and ensuring that they have adequate systems to manage risks

3. Ensuring that there are workable procedures to isolate single failures from contaminating the whole financial system

Enforcement action thus far taken by SEC

• Insider Dealing– Offences against 17 individuals pertaining to 7 cases.

• Market/Price Manipulation– Offences against 17 individuals and 1 entity

• Front Running– offence against 1 individual

• Failure to Disclose Material Information– Offence against 20 individuals and 2 entities

• Provision of False/Misleading Information– Offences against 3 individuals

• Submission of False Financial Information– Offences against 2 individuals

• Violating M&A Code– Offence against 1 person.

http://www.sec.gov.lk/?page_id=4791&lang=en







The new SEC Act will help regain Investor trust & confidence

• Provide full and fair disclosure of all securities (listed & unlisted) sold

• Regulation of the exchange, central counter party and of over-the-counter market

• Facilitate the introduction of new financial products i.e. Short Selling, Derivatives, ETF, REITS

• Promote financial literacy• Protection of consumers of financial services• Reduction of financial crime through effective

surveillance and enforcement action against unauthorized activities of auditors, listed company directors, market intermediaries and all investment practitioners

Opportunity to establish a facility to check out the integrity of RIAs & Market Intermediaries

http://brokercheck.finra.org/

Conclusion

• Develop long term relationship of trust• Always put your client’s interests ahead of you and never

let your personal interests and temptations get ahead of doing the right thing for your clients

• Have a unblemished compliance record• Satisfied clients will put more money & provide referrals

once the relationship of trust is established• Relationship built on trust takes time to earn, but once

established, it’s priceless• Safeguard your reputation - because it takes 20 years to

build reputation and a minute to ruin it

Securities market regulation and ethics

Economy & Finance

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