The new capital market law will kindle investor confidence: SEC chief

Tough penalties for broadly defined market misconduct and auditor oversight are in, and compounding offences is tossed out of the new capital market law

Market misconduct; insider dealings; operating a stockbroking or market research firm without a license; and misleading investors to buy, hold or sell stocks will be offences attracting weighty fines, of up to Rs100 million, or up to three times the illegal profit made or loss avoided for insider trading, when the new SEC bill of 2017 becomes law. Some offences attract jail terms for up to a decade upon conviction.

The bill, a draft of which is available on the SEC’s website for public comment, sets the tone at the outset, spelling out the intention to ‘deal with market misconduct’.

A word search of the old (existing) versus the proposed law is telling: ‘Market misconduct’ is mentioned six times in the bill, and there are no references in the existing law. The words ‘insider’ and ‘insider trading’ appear over 20 times in the proposed new law, but only twice in the existing one. ‘Audit’ and ‘auditors’ are mentioned just six times in the existing law, but they appear 69 times in the bill.

Under the proposed law, the SEC can charge up to three times the gain or loss avoided on admission of guilt

Some stockbrokers, auditors and market intermediaries are concerned that the draft SEC law is draconian. Not only are penalties high, but the SEC will no longer compound offences for market misconduct. Compounding an offence entails paying a fine without admitting guilt.

But SEC Chairman Thilak Karunaratne insists that the proposed changes are relevant for the times. More importantly, the intention is to address a gaping trust deficit.

Market misconduct in proposed legislation includes false trading; market rigging; creating a false or misleading appearance of active trading; artificially raising, lowering or stabilizing stock prices; making untrue statements; and inducing others to invest in stocks.

“Anyone can invest in the capital market without fear of being played out, which was what happened to investors a few years ago. The proposed new Act will boost investor confidence,” Karunaratne says.

Amendments to the bill have included suggestions from public consultations, but its tone is unchanged. “We have sometimes given broad definitions so there’s little room for loopholes, but there are checks-and-balances in place,” he says.

Here are excerpts from the interview…

What is the reason for overhauling the SEC Act?
Karunratne: The proposed SEC Act will align our law with the most advanced jurisdictions in the region like India, Malaysia, Pakistan, Singapore and Thailand. In fact, our proposed law will be on par or slightly ahead of the laws in these counties. We didn’t look at the US because the market is too advanced.

The SEC’s regulatory role will be strengthened, ensuring a level playing field for local and foreign investors. They can invest in the capital market without fear of being played out, which was what happened some years ago. So, the proposed law will boost investor confidence.

There was an overwhelming need to update the antiquated SEC Act introduced in 1987. An attempt in 2004 didn’t progress beyond the drafting stage.

Then, during my first stint as SEC chairman, amendments were drafted in 2012 with World Bank technical assistance. Market misconduct was widespread at the time and some new investors lost their savings. The SEC couldn’t deal with this. Draft amendments were sent to the Treasury and the Committee on Public Enterprises (COPE), which was inquiring into the stock market’s decline due to rampant market malpractices.

I did not have the freedom to investigate these, so I resigned in 2012. The then Treasury Secretary, P B Jayasundera, appointed a committee to study the draft, and nothing happened afterwards. Unlike the first two attempts where changes to the SEC Act were drafted internally, we appointed a committee of lawyers, accountants and key SEC staff to study regional best practices in our third attempt at drafting new laws, after my reappointment as SEC chairman in 2015. Lawyer and 2007 Companies Act architect K Kanag-Isvaran chaired this committee, which included Laksiri Mendis who had experience drafting laws in Sri Lanka and several other countries as well.

Whistleblower protection is important and common in other jurisdictions

It also included two SEC commissioners Dilshani Wijayawardana and Marina Fernando, both lawyers; former KPMG Sri Lanka Head Rajan Asirwatham; Colombo Stock Exchange Chief Executive Rajeeva Bandaranaike; and the SEC’s Vajira Wijegunawardane (now its Director General), Ayanthi Abeyawickrama (Director Legal) and Suhadini Wickremasinghe (Legal).

A first draft of the proposed law was published online for comment. It has since changed because we’ve considered some proposals and concerns from public consultations.

A final draft was submitted to the Legal Draftsman’s Department before March 2017; from there on, it will be presented to parliament soon.

Previously, the SEC could compound offences without filing criminal action. Does the proposed law change this? Can you explain?
Karunaratne: Currently, allegations of violations are settled by paying a fine without admission of guilt. Under the proposed law, the SEC can charge up to three times the gain or loss avoided on admission of guilt.

This is done to avoid long-drawn-out court cases. Once a penalty is paid, with the admission of guilt, the SEC cannot later seek court action. All records of the matter will not be accepted by any court.

Criminal proceedings will be filed at the magistrate courts for serious violations such as market misconduct, or otherwise, it will be civil action heard by the Commercial High Court.

The SEC will no longer be able to compound market misconduct and can file action in court. If convicted by courts, violators will be fined a minimum Rs10 million or up to three times the gain or loss avoided, and/or jailed for up to 10 years.

Market misconduct includes false trading; market rigging; creating a false or misleading appearance of active trading; artificially raising, lowering or stabilising stock prices; making untrue statements; and inducing others to invest in stocks.

The draft Act says having access to ‘intensions or likely intentions of a person’ can constitute as insider information. Isn’t that vague?
Karunaratne: Offences have been defined broadly so they don’t leave room for loopholes. The SEC is subject to judicial review if someone feels ‘likely intention’ is too vague. However, when we take action against insider trading, it will be backed by proof that someone benefited from information or knowledge that was not public at the time.

The SEC will be able to investigate transactions going back six years. Is the SEC going after past offences?
● Karunarante: We are already doing this. There is no time bar.

The bill suggests that the SEC will have the power to investigate market misconduct arising from what Sri Lankan listed companies do here and abroad, as well as what companies listed outside Sri Lanka do here and abroad. Isn’t this too broad a focus?
● Karunaratne: We’re only regulating securities listed and traded in Sri Lanka. If what companies do here or outside the country will have a material impact on investors, then we will investigate them.

The regulator is responsible for monitoring activity in that specific jurisdiction. We can look into what a Sri Lankan listed company does outside the country or what a foreign company listed here does. SEC Sri Lanka is a member of the International Organisation of Securities Commissions, and there is an arrangement for cross-border regulator collaboration. By introducing a multi-currency board, we will enable foreign companies to list here. These companies will come here for a secondary listing, so we will depend on their primary regulator for monitoring what goes on in their home countries.

The bill includes several provisions to protect whistleblowers, but there are concerns that these could be abused by disgruntled employees. Do you agree?
● Karunaratne: Whistleblower protection is important and common in other jurisdictions. Anybody can misuse a law, but we have said that the information must lead to successful enforcement action. This will deter frivolous claims and not impair companies. If at all, it will only waste our time.

The president of CA Sri Lanka, the country’s accounting body, is an ex-officio SEC board appointee, but the proposed new law removes this appointment. Why is this?
● Karunratne: We’ve reached a compromise. The president of CA Sri Lanka will not be an ex-officio appointee to the SEC board. However, the accounting body will be able to nominate an accountant who is not an auditor to the board instead.

The proposed law will bring in auditor oversight as in other countries, so we cannot have auditors on the  board

We agree that CA Sri Lanka has done much to move the profession with the times. Nowhere in the world does the accounting body have an ex-officio seat on the regulator board. The proposed law will bring in auditor oversight as in other countries, so we cannot have auditors on the board. Audit firms will be classified as supplementary services. There are other services they can provide such as valuations.

Also, for example, if a listed company retains the services of a corporate financial advisor, because it directly impacts a listed firm, the SEC will have jurisdiction over them. Audit firms will assist the regulator in monitoring listed companies and market intermediaries. The SEC will have the right to issue directives and seek clarifications from them. Auditors give an opinion whether financial statements give a true and fair view of a company’s financial position. This is their primary role.

However, the proposed new law will require auditors of listed companies and market intermediaries to report irregularities they uncover in their work to the SEC, which may also ask them to provide additional information?
● Kurnaratne: This isn’t something new. The existing law requires this. But there will be a reporting structure in place.

Auditors must first bring irregularities to the notice of a company’s audit committee. If nothing changes in two weeks, the auditors have to reach out to the company’s board. Yet again, if no material change occurs in two weeks, they have to bring it to the SEC.

Auditors are already regulated, so why is SEC oversight necessary now?
● Karunaratne: We’re adopting capital market best practices from elsewhere. Public auditors are regulated by the Sri Lanka Accounting and Auditing Standards Board (SLAASMB), which reports irregularities to CA Sri Lanka; but this arrangement isn’t good enough. However, we will not force auditors to report directly to the SEC, but amend the law eventually requiring them to do so. This needs to happen when the market matures.

The SEC will get the power to call for information from anyone to aid its investigations and can delegate external auditors to do the same. How can companies protect privileged or confidential information if third parties have access to their books?
● Karunaratne: Again, this is an authority we already possess. The proposed law only introduces civil and administrative action against violations. Currently, the SEC can only instigate criminal action against violations, which is harder to prove. The new law will allow the SEC to file civil action at the Commercial High Court or take administrative measures. If someone wants to raise privilege or confidentiality, they will have to seek judicial intervention.

The bill is proposing that the SEC draw up qualification criteria for listed company directors and chief executives. Isn’t this something best left to businesses to decide and not the regulator?
● Karunaratne: We’ve removed that proposal. The SEC will insist on directors being fit and proper to hold office.

The bill has included a criminal defamation clause carrying a Rs1 million fine and six-month imprisonment for ‘making remarks or publishing statements with a view to bring disrepute or defame the reputation’ of anyone in the SEC. Isn’t this draconian?
● Karunaratne: Criminal defamation is no longer in our legal system, so we’ve removed that. We will have to deal with misinformation through civil courts or administrative action.

The proposed law uses subjective words detailing the grounds on which market intermediaries will be refused a license or even appointment of directors. For example, the draft says a license will be refused if the SEC has reason to believe it ‘may’ not be able to act in the best interest of clients’ or if there are circumstances that are ‘likely’ to lead to improper conduct, or reflect discredit, or will not carry on the business efficiently, honestly and fairly. Why can’t the law be definite and clear on what grounds licenses and director appointments can be refused?
● Karunaratne: There is always an element of subjectivity in regulating and decision making. We’re still open to judicial review, so anybody aggrieved can seek court redress. We’re tightening regulations, but the checks-and-balances are the inherent judicial power. Anyone can file a write application to question the SEC’s decisions.

Following public consultations, we made some changes to the draft, but its overall mandate to protect investors and give them confidence in the capital market remains intact.

No matter how hard you try to eliminate prejudices, laws are always subjective, and it’s up to courts to decide.

The bill suggests that market intermediaries will not be permitted to offer investment advice without reasonable basis. How do you judge this, especially when share prices don’t always reflect a company’s earnings and growth potential? When the stock price falls despite a company’s earnings growth, will anyone recommending that stock get into trouble?
● Karunaratne: Any recommendation must have a reasonable basis. We have excluded accredited investors; these are people and institutions with large pools of funds sophisticated enough to understand risks. This rule intends to protect retail investors. The SEC received many complaints from people who lost their life savings because they were fooled into buying certain stocks.

At the moment, the SEC has jurisdiction of listed securities, but we are concerned about the unlisted market

Anyone giving investment advice must be able to prove a reasonable basis for those decisions and must show that they have warned their clients about risks, and that markets tend to go up as well as down; but market intermediaries must prove that they exercised due diligence before advising anybody about investing.

We can impose administrative sanctions like freezing accounts and institute legal action against individuals or firms operating any business as a market intermediary. We’ve come across people and firms functioning as stockbrokers and offering investment advice. If we prosecute such offenders, the penalty can be as high as Rs50 million and several years in jail if courts find them guilty.

Is there an appeals process for those aggrieved by the SEC’s rulings, such as penalties or refusal to license a market intermediary?
● Karunaratne: The SEC, like any public body, is open judicial review of its decision. It would be superfluous for us to enable an appeals process when it is already there. In certain cases, a market institution can appeal to the minister.

The SEC will also regulate non-listed companies’ securities. Is there a need for this?
● Karunaratne: At the moment, the SEC has jurisdiction of listed securities, but we are concerned about the unlisted market. There is a big market out there accessing public funds for capital. Regulators elsewhere have oversight of these, which are called over-the-counter (OTC) transactions.The proposed law mandates the SEC to regulate public offers. This is important to fulfill the SEC’s mandate of protecting public investments. There is also a development aspect to this. We’re encouraging the establishment of visible OTC trading platforms. They will be subject to disclosure rules and other guidelines. Other jurisdictions have far stricter rules for OTCs, but we aren’t taking that route.

When do you expect the bill to become law?
● Karunaratne: The draft is with the Legal Draftsman. We don’t expect many changes because we had an experienced former Legal Draftsman on the committee, but it needs to be translated into Sinhala and Tamil, which will take some time. Hopefully, it will become law by June 2017. It will take time for the market to absorb everything, but the new law will lead to a better regulated market and create a level playing field for everyone.

Enacting this Act was one of the conditions for the $250 million loan from the Asian Development Bank. What can you tell us about this arrangement?
● Karunaratne: The ADB loan is for the government. It has nothing to do with the SEC, which isn’t receiving any of the money. The loan, I think, was granted on two conditions: enacting this Act and once the demutualization of the Colombo Stock Exchange is finalised. That’s all I know.