SECP's Regulation Relaxation Spree

The Securities and Exchange Commission of Pakistan (SECP) is on a relaxation spree, amending rules and regulations governing the markets. Almost on a weekly basis, it issues a statement that certain legal requirements have been ‘streamlined’, ‘revised’ or ‘relaxed’, in the ‘interest of the market.’

That may not be the case and what the relaxations actually mean for the ordinary investors, need to be examined.

Recently, the SECP has ‘revised’ the eligibility criteria for securities/shares qualifying for availability of margin financing.

Margin financing allows clients to buy securities on borrowed money, normally from their broker. It is another form of the infamous badla which was found to be the cause of the market crash of 2008. The market remained closed for nearly four months and thousands of investors lost their hard earned money at the hands of brokers who fled the country.

Margin financing was introduced in February this year by the SECP with a number of risk management restrictions which were claimed to be the features distinguishing margin financing from badla. These included cash margin requirements, selection criteria for securities for which margin financing can be obtained, lending and financing limits for brokers and financee, security etc., restriction on obtaining funds from individuals for purpose of providing finance to clients, etc.

The number of securities for margin financing was restricted, as allowing  trading in non-blue chip shares on borrowed money from the brokers, who also act as investment advisors, is considered to be risky for the market and the investors. Conversely, however, allowing such trading yields higher lending by brokers, as well as more volume in the market and naturally bigger commissions and profits for the brokers. Relaxation in the eligibility criteria by the SECP means the number of eligible securities are going to increase.

Another very important measure put in place through the Leveraged Markets Rules 2011 for protection of public interest was not to allow ordinary citizens/individuals to lend money to brokers for providing margin financing to their clients. Naturally, whereas lending by financial institutions and companies etc. is regulated under various laws and internal checks, policies and processes, no such framework exists for individuals.

The greedy instinct egged on by the brokers thus takes over and the market heads for the artificial bubbles created by excessive speculation and day trading. In a meeting with the KSE in July this year, SECP chairman agreed to look into the possibility of removing this restriction also. Thus it remains to be seen whose interest the SECP considers to be the ‘interest of the market’.

Another very important amendment being made by the SECP is in the Issue of Capital Rules, 1996. The amendments in the said rules were made and published in September 2010 by the SECP for eliciting public opinion when the last SECP chairman was still in office. These amendments were however not notified.

Interestingly, after passage of one year the same rules have been published last month again for eliciting public opinion with more amendments. And it is one of the amendments proposed this time around that is far-reaching.

Since the inception of the Capital Issue Rules, there has been a prohibition on issuance of shares by companies against goodwill. This prohibition was kept in place even in the amendments proposed in 2010. It is now proposed to be done away with.

Insiders understand that valuation of goodwill being an intangible asset requires difficult and sophisticated methods, and has a very high likelihood of being misused by the companies to issue shares without adequate consideration. It is the job of the corporate and securities regulator to ensure that the securities being offered to the public are correctly valued.

The amendment relating to goodwill is reported to have a background relating to floating of shares of a company disallowed by the SECP last year. The move has re-emerged with friendly top guys as regulators and former regulators becoming sponsors. The Securities Market Division of the SECP since last year has refused to give permission to this company to offer shares to the public that had been issued in violation of this prohibition.

The company, which is in the business of installing tracker devices in vehicles, was able to have Rs1.3 billion worth of shares issued by not disclosing to the High Court in a de-merger petition, the prohibition placed by the Capital Issue Rules. In addition, the SECP had even questioned the value of goodwill the company claimed it carries in the market and thus the number of shares which had been issued in lieu of such a goodwill.

After getting the shares issued, the company applied for SECP approval to offer these shares to the public. Public investors would therefore have no idea that the shares being bought by them are not backed by any tangible assets in the company..

Simply put, the company may not be worth what it claims to be. The Islamabad police  have questioned the very credibility of the tracker system and publicly asked car owners to adopt alternate security arrangements.

It is expected that once the prohibition on issuance of shares against goodwill is removed, a number of companies which currently are unable to recognise the value of the goodwill on their own books will head for similar schemes of mergers, de-mergers, transfer and sale of assets without any change in the beneficial ownership, hoodwinking the law and the accounting rules.

Insiders say that in mergers between unrelated parties, there is at least some check, as both companies make sure that the valuations are done properly and the swap ratios are calculated correctly. However, the real game happens where the mergers and de-mergers take place between companies within the same group.

The only independent authority left to check the valuations and swap ratios is the regulator who can protect public interest.

The SECP unfortunately has no capacity or even the desire to conduct proper valuations, especially in the cases of the powerful and mighty, and simply passes the buck and accepts the valuations of the auditors or the valuers appointed by the same companies. The losers in this game are, of course, the poor investors who are carried away with attractive prospects issued by companies with the SECP’s approval.

The opinions expressed in this write up are solely of the author and Accountancy may or may not agree with them.

Originally published in the Daily Dawn. Republished with permission.