Wednesday, December 19, 2012

The twin crisis - Prima donnas and robber barons

* Resolving the stock market crisis requires a firmer hand to the robber barons and putting prima donna brokers in their place

By Shamindra Kulamannage

Thieves and lunatics will always exist in the fringes. Their potential harm to society is usually kept under check by laws, regulations, civil society and an alert media. When these safeguards fall apart allowing thieves to ascend to the mainstream for even a little while, as happened in the case of the stock market in 2011 and early 2012, they usually extract a high price off organized society.

Hopefully that crisis is now behind Sri Lanka and greater vigilance will prevent a relapse. But repairing the damage and rebuilding the confidence are tasks that require a more comprehensive plan than any that have been articulated so far.

The last couple of years have been tragic for the retirement savings of responsible families who pay their taxes, service their mortgages, and labour to afford a better education and life for their children.

Their forced retirement savings managed by the Employees Provident Fund (EPF), where the Central Bank’s monetary board oversees investment, has lost multibillions in speculative stock market investments. For some it’s a double whammy, because their own portfolios – with large portions of speculative stocks of little fundamental value often purchased at the behest of crummy stockbrokers - have also taken a beating.

Stocks overtime give higher returns than do bonds; a fact also true in Sri Lanka. It makes perfect sense that some retirement savings of ordinary Sri Lankans be invested in stocks. A portfolio exclusively invested in government bonds here would struggle to provide an inflation beating return consistently. In rich countries most pension funds are invested in equities due to higher returns and the hedge against inflation they offer. Sri Lanka should be no exception.

The double whammy, of irresponsible EPF fund managers causing multi billion rupee losses to working class families, and the powerful mafia that desecrated the sanctity of transparency and fair play; has resulted in ordinary Sri Lankan investors now viewing the stock market with horror.

The stock markets image as a ‘den of thieves’, as explained by former SEC Chairman Tilak Karunaratne, should be a matter of grave concern for the regulator. Clearly then it isn’t a place where ‘securities can be issued and traded in an orderly and fair manner,’ as envisaged in the SEC act.

Besides the robber barons who set about exploiting investors gullibility, Sri Lanka’s market should also steer clear of stockbroker and sometimes regulator perpetuated myth, that direct stock market investment is for everyone. On the contrary stock markets are not places for amateurs.

SEC highlights the low direct participation in the stock market; that there are less than 50,000 active electronic depository (CDS) accounts. However that ignores the fact that millions of EPF members are also stock holders.

Markets are unpredictable beasts and most investors are unsophisticated or may not appreciate the complexities of individual stock picking. Instead they often get carried away with trading at the behest of brokers. A sift through stock market pornographic blogs – which are plentiful – to the large part exemplify how ignorant most individual investors are.

It’s a naive capitalist who will believe a stockbroker is a friend. Brokers move products based on volume and commission, and they will sell to an investor whatever can be sold. After all, stockbrokers allowed their clients to invest in a super ripe market where the price to earnings ratio was touching 30 times and the bubble was ready to pop. By failing to advice their clients to run for the door, brokers showed they were either utterly foolish or were exploiting the ignorance and blind trust their clients placed. It was probably a combination of the two, and neither boards well for individuals investing their savings in Sri Lankan stocks. Brokers take no responsibility for the carnage that followed and are now talking about the need to attract back individual investors to the market.

Not all stockbrokers are rouges. There are a number who are outside the industry association because it does not represent their views. Also a few other brokers, while being members of the association, have contrary views on what the priorities are for developing the stock market and increasing participation.

The stockmarket is a place for companies to raise capital. Its role shouldn’t be confused to mean the market somehow, can create wealth for everyone who invests. It can’t. However if listed companies thrive because the economy grows, the country is well governed, and laws and regulations are respected, then stock holders will thrive because higher profits may push up share prices.

Often this basic logic is forgotten when regulators and brokers promote the market as some get rich quick scheme.

Brokers here behave like a bunch of prima donnas; temperamental, takes as a right to use whatever means to earn money and seek privileged treatment as a right. They react with petulance when criticised by the media.

The gist for an individual investor is that unless the person knows what they are doing, which may involve volumes of research and training that it becomes an almost full-time activity, picking individual stocks is difficult. Of course stock in safe companies, where returns over the long term may lag those in mutual funds or government bonds, can be picked but investors may have greater expectations for their portfolios.

Corrupt stockbrokers may not want to let individual investors off their clutches but the more suitable option for unsophisticated investors – a category most individuals fall in to - are mutual funds or unit trusts as they are referred to here. The industry has done exceptionally well both during the market boom, before which they increased equity exposure, and the bust, before which they then reduced equity in their portfolio.

The mutual fund industry – which isn’t as influential as are the brokers here – has been overshadowed by the more boisterous stockbrokers to the utter misfortune of investors. For the SEC it’s perhaps time to shift a greater part of its attention towards mutual funds, as both an entry to the stock market, and also a safer and more suitable option for the long term. The more sophisticated and responsible brokering houses are also transforming themselves in to investment banks with a portfolio of products to attract investors. For individual investors the smarts of mutual fund managers is also protection from the robber barons that have bedeviled the Colombo market in the last two years.

There are a number of other steps the SEC, can and should take, to regain the confidence of investors that the Colombo Stock Exchange (CSE) isn’t a market that is rigged against them. Firstly, the bedrock of any plan must be the commitment by the SEC to swiftly and rigorously pursue any attempt to manipulate the market in the future. SEC’s former Chairman Karunaratne has made it clear that a small well connected mafia was manipulating the market. This should not be allowed to happen again.

Secondly, its contention that objective media reporting about the pathetic state of affairs will dent investor confidence is silly. It will not. However for the SEC to be seen as ineffective, will certainly damage the markets standing among investors here and overseas.

Thirdly, for the SEC to talk up the market is dangerous. Its new Chairman has made references to ‘many bargain buys available’ and lamented the markets fall this year to 5,000 points, implying somehow that stick prices should rise. This isn’t the first time in recent history that such statements have been made. SEC’s former Director General was often quoted saying market capitalization will top Rs3 trillion this year. When allowed to operate transparently and without manipulation markets are fully capable of determining the value of securities. The least qualified to determine stock prices are a bunch of paper pushing bureaucrats. It’s not the SEC’s job to worry about stock prices; its job is to ensure the process of price discovery is fair and transparent.

Fourthly, any apparent ties SEC commissioners, staff or its Chairman have with individuals who are being probed by SEC, and unusual price movements in companies in which they hold significant shares may spook investors. It’s only prudent that such relationships are unwound and full disclosure made in the interest of preserving the dignity and sanctity of their office.

At a media briefing recently the SEC chief pledged to fast track amendment to its act to bring it in line with international standards. Every SEC chief previously has lamented the agency’s inability to impose sanctions commensurate with the seriousness of the crime committed. It’s not clear if amendments now envisaged go far enough to give the SEC a bite as ferocious as its bark.

As the dust settles on the stock market fiasco and investors count the losses it would also be an opportune time for the SEC to evaluate its own standing in the capital market landscape. The recent press conference was significant for the blame apportionment and misdiagnosis of the challenge.

Clearly the regulator and market participants need a better handle on the priorities. As for the 10 point plan: this market has seen too many of those for it to be taken seriously.

Since market conditions are so overwhelmingly against manipulators, perhaps this offers the SEC the space to deftly reshuffle its priorities. Let’s hope the opportunity won’t be squandered.

(Courtesy: Echelon, Sri Lanka’s latest business magazine available for sale at Keells Supermarkets and bookshops. Echelon, published monthly, covers in-depth Sri Lanka’s most successful businesses, examining their winning strategies and profiling their leaders. It aims to set the benchmark for business reporting among magazines.)

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