By Namini Wijedasa –

Namini Wijedasa

From one of the best performing capital markets in the world to one of its worst within two years-what the hell happened to the Colombo Stock Exchange?
It is Newtonian physics, says Thilak Karunarathne, chairman of the Securities and Exchange Commission (SEC), dryly: What goes up must come down.
“In 2009, there was euphoria in the country after the war and the market just took off,” Karunarathne explained, seated in his World Trade Centre office with its spectacular view of the ocean. “But some people made use of the opportunity to pump up some of the so-called penny stocks and made a lot of money on that. Actually, it was artificially pushed up.”
“So, when they say that the market went up by so many percentages in 2009 and 2010, and was the world’s best performing market, it isn’t saying very much about it,” he added, “because it wasn’t really (based on) the stocks or counters where the fundamentals were strong. They were mostly pump-and dump-stocks; mostly, not all.”

When the bubble burst

Naturally, the bubble didn’t last long. “I’m surprised it lasted for two-and-a-half years,” Karunarathne said.  This view might be strongly contested in some quarters. But it is not much different to the opinion held by Indrani Sugathadasa, Karunarathne’s predecessor at the SEC. The no-nonsense administrator resigned in December after insisting she “will not compromise on my principles”.
“There is a strong, powerful mafia which controls and manipulates the whole market,” Sugathadasa said last week, in an interview with this newspaper.  “There is no way for market forces to play without interference. The market can only be resurrected if we let the market forces to play and to let it adjust.”
What the mafia does, she said, is to manipulate the prices. “It was obvious, it was proved and SEC also had evidence,” she said. “Unfortunately, SEC could not take any action because of certain loopholes in the Act and some other reasons that I can’t explain to you.”
Although she is a retired officer of the Sri Lanka Administrative Service with 33 years of experience, Sugathadasa did not know much about the stock exchange when she was made SEC chairperson. “I walked into the SEC with only general knowledge of the capital market but I came out with a vast knowledge, not only about the fundamentals and concepts but about market manipulation and insider dealing,” she said.
While these malpractices did contribute towards an erosion of investor confidence, the slide of the Colombo Stock Exchange wasn’t exclusively due to insider trading or manipulation  Other factors played their part.

Still too expensive

“Externally, a crisis has left Europe with no money to invest anywhere,” Karunarathne pointed out. “Even the fund managers from Europe are now withdrawing their money and going back to their own countries or looking at better markets.  Our P/E (price to earnings) ratio is still hovering around 13. China is only six, Vietnam is five. And Arjuna Mahendra, who is based in Singapore and working in HSBC as its investment advisor, said a few months ago that they will look at Sri Lanka only when the P/E ratio is down to about eight.”
A higher P/E ratio means that investors are paying more for each unit of net income; the stock is more expensive compared to one with a lower P/E ratio. For most fund managers, the SEC chief said, “We are still overpriced”. But he didn’t agree with this contention because “there are very good buys at the moment into stocks where the fundamentals are strong but unfortunately the focus is not there”.
Among the internal factors dragging down the market are volatility of the rupee, weak economic parameters and “the reputation of the market not being properly regulated”. SEC is trying to change this, Karunarathne said-a move that was recently welcomed by the Ceylon Chamber of Commerce.
Sugathadasa recalled that, before 2009, “nobody took notice of the stock exchange”. “There were some blue chip companies and some highly sophisticated investors who traded in stocks but retailers did not see it as lucrative,” she said. When the market did start growing, however, prices were rising so high that they were “about to hit the ceiling”.
“Also, bank interest rates were going down so the market became attractive to middle class people,” she explained. “They thought this was the place to put all their money, their pensions, their EPF and everything. From what I learnt during my time at SEC, most of them just invested for the sake of it, to make a profit, without knowing the basic concepts of the stock market.”

“Unpopular” restrictions

The prices of some stocks were shooting up so dramatically (and clearly not on the basis of fundamentals) that the commission was forced to step in. First, it introduced a 10 percent ‘price band’ to control price manipulations on weak stocks and to maintain stability in the stock market.
“I remember the main reason was that the share prices of one or two companies, very famous to play in or manipulate the market, went from nine rupees to 100 rupees overnight!” Sugathadasa recounted. “A lot of people asked us how that happened. They said this stock was not fundamentally strong at all. Even when I joined, investigations were going on against a certain group of companies over non-declaration of accurate information.”
Meanwhile, certain “new entrants” to the market had started trading heavily in the stock market. There were allegations of market manipulation.  “Therefore, the commission had to come in,” Sugathadasa said.
The price band, however, was heavily criticized. The SEC soon followed that with another temporary measure-credit restrictions. “We did this because prices were going up, and up, disproportionately,” she said. “Even the newspapers were giving out warning signals. The brokers came and told us, requested us in writing, to please restrict the credit because ordinary people didn’t know what was happening and they kept on buying and buying.”
“They would come to the market in the morning, sometimes without a cent in the pocket,” Sugathadasa explained. “They would trade on credit, sell whatever they buy the same day and go home with at least Rs. 50,000 in the pocket. Nothing wrong with that but little did they know that if something happened they would not be able to sell what was there.”
And something did happen. By the latter part of 2011, the curve changed. “We thought it had adjusted itself due to market forces but suddenly everyone started blaming the SEC for having restricted credit.”
The SEC then relaxed the credit restriction but saw no improvement. Why? “Because that was not the reason for the fall of the market,” Sugathadasa claimed. “This only proved it.”

Get more capital in

Sugathadasa and Karunarathne cited similar reasons for the downfall of the Colombo bourse-for instance, the economic situation in the country, the devaluation of the rupee and high bank interest rates. People now prefer to put money into high interest fixed deposits.
“There is now a loss of confidence in the market among foreigners and locals,” Sugathadasa emphasized. “One reason is people saw that the market is highly manipulated and that there were a couple of insider dealings. The genuine investors and minority investors got scared and don’t want to come into the market because they are not sure of the investments.”
While the government took many steps to promote foreign direct investment, the money didn’t come. “Foreigners lost confidence,” Sugathadasa said. “The chairperson of SEC changing all the time is also a reason.” Karunarathne is the third chairperson in less than four years. Finally, there is still no clearing corporation in Sri Lanka to bear and manage risk.
Asked why the “mafia” was silent now, Karunarathne guessed that they might have “siphoned out the cream of it and gone into other ventures, some of them burning their fingers in doing so”.
And asked how the stock market could be revived, he stressed that there must be a fresh inflow of money, predominantly from abroad because “that kind of capital is not available locally”. SEC is now taking various measures to stimulate this. “You need to get in at least 10 to 15 billion rupees initially and add about 100 billion rupees within a year or so to get the market up,” he calculated.
“People who raised money through IPOs (initial public offerings) have gone and dumped them in many ventures, for instance hotels,” Karunarathne said. “That has taken a lot of money out.”
Last years, 42 billion rupees came out of the market by way of IPOs and there was a 19 billion rupee outflow of foreign capital. “Where are we going to get this money?” he asked. “Of course, there are the big pension funds. Now there is a controversy about EPF (Employee’s Provident Fund) investing; but if EPF is investing wisely and prudently and in a calculated manner, I think they should come into the bourse.”

-Ex SEC Chairperson

Determined to bring regulation

Indrani Sugathadasa tried, and failed due to various reasons. But now her successor at the Securities and Exchange Commission, Thilak Karunarathne, is determined to regulate the market and to create a level playing field.

“The SEC is not a thug in the street but we are tough…in the sense that we don’t want unwanted things happening,” the chairman said.
Karunarathne said that the contention that the Sri Lankan capital market was overregulated was a “myth”. “We are one of the least regulated markets,” he reiterated. “Overregulation is a myth and a canard.”
“The thing is that some of these guys, the so-called mafia, want the freedom of the wild ass here so that they can do anything they want,” he said. “That is why they say we are over regulating but in actual fact we are not. The SEC Act which came into force 25 years ago has many weaknesses.”
Like cops-and-robbers, the SEC was always trying to catch up with the robbers, he noted. “All regulatory authorities are like that,” he admitted. “People who want to manipulate and do insider trading will always be one step ahead.”
Karunarathne said SEC was drafting amendments to bring the Act in line with those in more mature markets, in order to reduce various acts of manipulation in the broadest sense of the word.  “Obviously, we are controlling to some extent, or trying to control, all of the nefarious activities conducted by this group,” he continued. “For them we are over regulating.”
The SEC chief confirmed that, while there is so far no criminal prosecution, there are investigations going on into the activities of brokers and other parties “but nothing is concluded yet”. “What is wrong with filing action against a wrongdoer?” he asked, when it was pointed out that the commission is accused of creating a fear psychosis. “If they have not done anything wrong, then there is nothing to fear. Simply because a few people are worried about it, we can’t stop sending letters. They keep on feeding this kind of nonsensical stuff to people who are not very conversant with what’s going on.”
He was referring to letters sent out to clients seeking clarification on certain stock market transactions. Karunarathne said most of the incriminating files had been mothballed when he took over. “I went back to the commission and said, while I’m not a dictator, how can we revive things if the regulator is not doing his job.”
Asked whether he was trying to “catch some big guys and put them in jail,” he replied: “It is not so. Why are they worried? We are not trying to put anybody in jail but to see in place a properly regulated and vibrant capital market where the Johnnies who came late are not controlling the whole thing. They all came in after 2009 and now call themselves ‘high net worth investors’. (LAKBIMAnEWS sent questions via email to one of these investors but he did not reply).
Outspoken UNP parliamentarian and economist, Harsha de Silva, said the problem at the Colombo bourse was a complex one. “It is not just one of people front-running in the stock market, although that is also taking place,” he mused. “There is much more than that.”
The question, he said, was whether SEC had done enough to ensure that the Colombo stock exchange had created a fair and equitable marketplace for people to trade in. He urged the SEC to strike a balance where regulation was concerned. Right now, some areas were overregulated while others were underregulated.
“An instance of underregulation is how the alleged pump-and-dump allegations have either not been investigated sufficiently or are not perceived to have been investigated sufficiently,” he said. “If there are so many allegations, how come there wasn’t single a prosecution?”
“Something has happened in the market now,” he asserted. “There is at least a slowdown in the amount of these types of frauds taking place. You don’t hear as many complaints. We take credit that our speaking out has brought some sort of pressure either directly or indirectly leading to a slowdown of this daylight robbery.”
Last year, SEC said several players were identified of having violated or committed some form of securities fraud, “but not even those names were divulged,” he said. “We in fact said why don’t you name and shame them.”
For the moment, however, there is no naming or shaming in the public arena. But there is plenty being said in private.

The flip side

On the one hand, the SEC says there is a “mafia” or widespread price manipulation. On the flip side, sources pointed out that “speculating buying and manipulation” also happens in other countries. “Markets are such that when you see a stock moving up, people start buying it and the price starts going up more and more,” said one confidential source.

The market is very small and over-regulated. And, like everything else in Sri Lanka, there is no consistency. The SEC once brought in a price band but it was a formula not used in any other country. “You can’t use something that is not tested,” this source said. “Then they shifted to a new IT platform without doing trial runs. There were so many bugs in it that with one share you could push the price up. Then they also introduced credit limitations.”

“Another thing is that certain people, like the secretary treasury and SEC chairman are going around saying people are making money from the SEC,” the source continued. “Why kill the market if people are making money? It doesn’t make sense.”

Now there is talk of fear psychosis. The SEC has sent notice of summons to various persons, including a powerful government politician, to record information about the purchase of certain stock. The letter states that failure to comply would result on criminal action. “They are killing the market by creating such a lot of fear,” the source said. “And the market if freefalling now because of all these factors including a lot of it from the economy. And whatever the SEC is doing is also not helping.”

The SEC was making it a criminal act to invest in the stock market. “In that case, shut down the Colombo stock exchange,” the source asserted.

It is thought that people within SEC “have an issue because they can’t play the market.” “Certain personal agendas are being followed,” claimed the source. For instance, the government politician who received five letters from SEC reportedly has a close relative in the commission that does not get along with him.

It is also felt that the SEC was going “overboard” with some people because of irrational animosity towards them. “They didn’t have to take Harry Jayawardene or Nirj Deva into custody,” said the source. “They could have issued a warning without taking some drastic measures.”

This is all because some people having been saying, “We have to catch some big fellows and put them in jail”.

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