Heed the warnings

The citizens of Troy paid a high price because its leaders didn’t heed Cassandra’s warnings. Retail stock market investors here face a similar predicament

By Shamindra Kulamannage.

Published on October 02, 2012 with No Comments

Trojan-Horse

Cassandra – the best looking of the Trojan King’s daughters – tried to persuade her father that it was a bad idea to haul in a wooden horse left at the city gates, apparently by the Greek army which had just ended a decade long siege on the city. Her pleadings were ignored by the relieved Trojans keen to celebrate the city’s victory, and the after party lasted late in to the night.

Tired and intoxicated they were asleep or passed out when elite Greek soldiers hiding in the horse’s belly opened the city gates to the Greek army that had slipped back in, under the cover of darkness. Troy’s capture in many ways resembles the capitulation of the securities regulator here to the robber barons and its inability to protect investors, or the Cassandras’, from their clutches.

An unregulated market is a jungle and not a level playing field. But it appears the Sri Lankan capital market crisis is far worse than mere weak or indifferent regulatory action. There are two reasons why the crisis here is perhaps more complicated and far more worrying. Firstly it is possible for a regulatory agency to be dominated by the industry they oversee. Secondly it is also possible for regulation to be designed and implemented to defend the interest of a favored few. Economists generally refer to such a predicament as regulatory capture and it appears powerful and well connected sections have done just that to the securities regulator here – the SEC.

Investors are helpless, like was Trojan princess Cassandra, against the influence and might of powerful individuals. But the capital market system that has evolved the world over doesn’t expect investors to fend for themselves. It is a regulator’s job to ensure these individuals investing their savings and portfolio funds, which invest people’s future retirement benefits, have the benefit of a level playing field. Foreign investors of course have the option to shift their portfolios elsewhere when they feel a market is rigged against them, as they did last year when outflows were at record levels. Sri Lankan citizens and companies, unfortunately, are prevented by capital controls from seeking a fairer market or better valuations overseas. So ones seeking exposure to equity in their portfolio have no choice but brave the elements here.

There are enough credible voices including that of former SEC Chairman Tilak Karunaratne, who had a ringside view of goings on because he had access to SEC’s state of the art market surveillance system, who say price manipulation is rampant. Karunaratne, has yet provided the best account of how the system was being forced off the rails, when he describes the market as one ‘dominated by a mafia’ and ‘a den of thieves’.

Against tremendous odds, the SEC under Karunaratne and his predecessor Indrani Sugathadasa fought assiduously against a corrupt mafia because there was far more than personal honor at stake. The island’s securities regulator – its employees and commissioners – had realized they were the only thing standing between greedy robber barons and their plundering the savings and future pension receipts of investors and office workers.

There is a clear line between ambition and greed – which certainly aren’t illegal – and corruption. Transparency International defines corruption as the abuse of public office for private gain. The challenge facing the stock market regulator is to be part of the solution by not aligning itself or seeming to do, with the foul nexus of market manipulators and becoming the source of the problem.

Firstly the SEC should with renewed rigor pursue investigations against market manipulators. The agency’s new Chairman says investigations will continue while identifying that small investors need to be attracted to the market. Clearly the two aims aren’t mutually exclusive. Small investors will come, either directly or through mutual funds, if SEC though its actions gain their confidence; that the market is not rigged against them. If market manipulation is rife then surely SEC should file action in court against those individuals, if it wishes to encourage retail investors and mutual funds that channel small investor money.

However a recent shakeup at the top of the agency, which sidelined its Acting Director General, has become a cause of concern for investors. Leadership changes are delicate matters and are not things to be done in haste. SEC should be particularly cautious because, investors, whom it wishes to attract by improving market credibility, may fear hasty changes are designed to protect powerful incumbents in the market. The Trojan leadership let down their guard and abandoned caution, despite warnings from the people they were protecting. Abandoning vigilance will extract a high price, especially from the defenseless population, the Cassandras’.

Secondly an update to the SEC Act to grant the agency independence from government and impose penalties commensurate with the seriousness of crimes is something its commissioners should continue to pursue. They will be up against proactive lobbyists, often powerful individuals with vested interests, wishing to shape policy to their advantage and seek special favors. Such lobbying is corruptive of democracy as opposed to legislation debated by the public at large, and less likely to be captured by vested interests. SEC’s position on why its Act needs an update is clear and its new leadership should publicly recommit itself to its perusal, another important step to rebuild market credibility that is in tatters.

Thirdly there shouldn’t be conflicts of interest, real or perceived, between senior SEC officials and the market participants they regulate. There are no clear rules here but at certain points it becomes clear the line had been crossed. When for instance, a staff member, commissioner or SEC Chairman owns stock in a company in which the share price has shown unusual volatility and an astronomical rise, it is a red flag. Clearly the options are to exit such positions or if that’s not legally possible or the individual is unwilling, then to maintain the credibility of a national institution by not accepting SEC office.

Direct commercial relationships with firms and individuals the SEC has opened investigations in to or has sought information from in pursuance of an investigation, is also a red flag. It’s prudent and in the interest of regaining market credibility that such commercial relationships be unwound, and full disclosure made.

Market credibility is a delicate issue and shouldn’t be carelessly handled. It may be damaged further for no other reason than investors having lost faith in the regulators ability to play by and police the rules.

When the Greeks were sacking Troy, Cassandra, whose warnings about the wooden horse were ignored, was raped and taken as a war prize. She would be eventually killed when the Greek army returned home.

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