Barbarians breach the gates

The resignation of the second SEC Chairperson, clearly shows that challenges to capital market regulation run deep

By Shamindra Kulamannage.

Published on September 17, 2012 with No Comments


Its splendor and grandeur wasn’t the price for the Vandals, Goths and Huns who came to conquer Rome. The barbarians instead were intent on destroying the magnificence, looting the wealth and debasing its system of government. Constant vigilance was the price of freedom for Rome and despite its massive resources the empire was often under threat of attack.

Sri Lankan’s stock market has been under a similar siege by barbarians threatening to tear apart its credibility, loot investors and decimate its system of governance. It’s not the first time the regulator – which ensures a level playing field – has had to defend the system from the brute force of barbarians intent on gaming it. However Tilak Karunaratne, the second stockmarket regulator to quit in the last nine months, was unable to hold the barbarians at the gate.

Regulators have tougher jobs here because in addition to ensuring fair play in the market they have to fend off or manage the influence on regulatory actions from the appointing authority. The SEC Chairman and commissioners are appointed by the government, a major weakness in the law here, as it impedes their ability to act independent of the appointing authority. Former SEC Chairman Karunaratne refused to heed calls to ‘go slow’ on market manipulation investigations and he claims ‘people who appointed him asked him to leave’.

There are a number of arguments being circulated by those pressuring the regulator to back off. The first is that the SEC’s overzealous regulations have paralyzed both confidence and legitimate market activity. Secondly that colluding to corner an illiquid stock to force up its price is a legitimate trading activity and thirdly that SEC should be discussing with stakeholders the challenges to find solutions instead of acting on its own.

All three arguments conveniently ignore reality and lack merit. Fortunately for investors the SEC chiefs don’t live in utopia. They perhaps have realized that – because the agency lacks independence and teeth – filing criminal action against blatant and powerful market manipulators even when evidence is overwhelming would result in a standoff with government, a situation best avoided. Crooks after all often have friends in high places. So the agency did the next best thing, introducing curbs on credit and price movements. Few disagree that stock prices are best left for markets to determine. However that would leave the regulator no option but to prosecute wrongdoers risking political recrimination. Perhaps SEC realizes it lacks the independence to prevail in such a standoff.

For years the agency’s demand for independence and an update to its law has been conveniently ignored. The maximum fine it can impose by compounding an offence is a mere Rs10 million even if the action has resulted in multi-billion rupee profits. Successful enforcement is not just catching crooks it’s also about the imposition of penalties commensurate with the crime.

Secondly the regulator’s critics argue that cornering an illiquid stock isn’t illegal. It certainly isn’t. But to manipulate prices, front run and collude to drive up a stock price is an offense and often these activities take place in the guise of simply trading. Asymmetric information is indeed a fact of life but acting on such information in the stock market is insider trading. It reduces market efficiency, diminishes confidence, and spooks both individual investors and portfolio managers – who often invest pension funds and retirement benefits – from entering a market they fear is rigged. It’s SEC’s duty to ensure fairness by prosecuting insider trading.

Thirdly it’s now argued the regulator should work in consultation with stakeholders and reconcile differences.  SEC has a track record of seeking public comment on contemplated capital market policy change. However in limiting credit and daily price movements it indeed didn’t consult stakeholders. Perhaps it should have given them adequate pre warning about the impending changes on credit and clamped down sooner on runaway credit. However in reality the SEC was tackling crimes in the capital market in the only roundabout way it could. It’s now amply clear how influential the people they were up against are who have managed to remove a second Chairman in quick succession. For skeptics who insist highly leveraged traders are merely just that, its proof.

The way forward they also say is for reconciliation. In other words there is no need for a criminal justice system, laws or regulations. Criminals can now opt for reconciliation to avoid justice. The whole idea is laughable. Criminals don’t belong around a reconciliation table, they belong in jail.


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