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Insider trading: it’s most significant type of conflict of interests: SECP

ISLAMABAD: The Securities and Exchange Commission of Pakistan (SECP) has considered 'insider trading' as most significant type of conflict of interests, along with market manipulative practices, such as 'wash trades', 'circular trading', and pump and dump strategies at stock exchanges.

According to the final report of the Emerging Markets Committee (EMC) of International Organisation of Securities Commission's (IOSCO), titled 'Efficient Regulation of Conflicts of Interest Facing Market Intermediaries', released by the SECP on Monday, Pakistan considers insider trading the most significant type of market ma-nipulative practices.

Next were churning and other issues such as unauthorised trans-fer/misuse of clients' securities, blank selling, not keeping client's assets segregated from brokers' assets, non-maintenance of prop-er record of transactions, failure to furnish net capital balance cer-tificate.

Front-running was also an issue of concern in this jurisdiction. Each type of conflict of interests is mostly regulated by the Securities and Exchange Ordinance (SEO 1969), Regulations for Proprietary Trading, Code of Conduct for Trading by Employees of Brokerage Houses, and Broker and Agents Registration Rules.

The sanctions imposed on churning was the severest rating on a scale of one to five, and other sanctions imposed on the rest of the activities were rated two, the report said. The Brokers and Agents Registration Rules state through its Code of Conduct that broker should treat the clients in a fair manner, clearly defining the role of the broker (principal/agent), ensuring clients that there is no conflict of interest between him and the client.

However, in the event of such an issue, he shall inform the client accordingly and shall not take advantage of the situation. Regula-tions for Proprietary Trading requires that a broker disclose to his customer placing an order in a particular security, while accepting such order, whether he intends to or carrying out proprietary trading in that security on that particular day.

In Pakistan, Securities and Exchange Ordinance 1969 (SEO) strictly prohibits insider trading, which encompasses front-running, by specifically defining 'insider' and 'inside' information, and the per-son found responsible for breach is liable to a fine, cancellation of registration, bar on services etc, depending on the nature of such defaulting persons occupation/involvement. Regulations for Pro-prietary Trading and Code of Conduct for Brokers forming part of the Brokers and Agents Registration Rules also provide measures for curtailing front-running.

The report said that the draft Securities Act includes various other provisions that extensively cover conflict of interest issues that may arise for such regulated persons when operating in the secur-ities market/onducting business with their clients, issuers and other market intermediaries. In addition, the demutualisation of the stock exchanges is expected to improve the efficiency of the stock exchanges by segregating the commercial and regulatory functions and is thus expected to bring greater balance among interests of different stakeholders.

Nevertheless, the SECP in order to complement review of the overall financial regulatory architecture, is currently undertaking a comprehensive review of the entire regulatory framework for the capital markets for ensuring greater harmony and consistency and addressing any gaps in investor protection, it said.

It said that more than half of the jurisdictions surveyed regulate this conflict using government rules and laws. Mostly jurisdictions use general disciplinary actions to deal with non-compliance. In Pakistan, quoting an expert in the prospectus to invite subscription needs to be done with care. The Companies Ordinance 1984 stipulates that a market intermediary must ensure the expert is independent from the company and prior consent must be ob-tained from the expert where the issue of a prospectus contains a statement by him.

In Pakistan Collective Investment Scheme (CIS) operation cannot be performed concurrently with brokerage services, and only sale and distribution of CIS units are allowed. Sri Lanka is not exposed to conflict of interests between CIS operation and other financial services as they do not allow CIS operators to act as market inter-mediaries.

The report said that most of the responding jurisdictions under-stand the importance of regulating conflicts of interest and have legislative proposals or regulatory considerations under way to improve current regulations on conflicts of interest in order to prevent conflicts from occurring due to the business conduct of market intermediaries.

In Pakistan, there are various on-going actions to improve the market system and regulatory framework as well as to amend laws in order to enhance the investor protection system and prevent potential conflicts of interests involving market intermediaries.

Referring to Pakistan, it said that the brokers, dealers and broker-age houses can undertake only sale/distribution of CIS units. A non-banking finance company (NBFC) can undertake asset management and investment advisory services. An asset management services company (AMC) cannot provide any of the corporate finance services. An NBFC can engage in brokerage services only through a separate affiliated entity. An investment finance company, licensed as an NBFC corporate finance services under NBFCs and Notified Entities Regulations 2008.

It said that a corporate brokerage house in Pakistan can be ap-pointed as 'Book Runner' in case of Book Building for an IPO, whe-reas a corporate brokerage house can be appointed as Lead Man-ager by the Issuer/ Offeror. The Brokers and Investment Finance Companies (IFC) may act as adviser and arranger for Merger and Acquisition of Companies.

Further, an entity that fulfils the prerequisites laid down in the Balloters, Underwriters and Transfer Agents Rules, 2001 may act as an underwriter. Accordingly, brokers and IFC's that fulfil the said requirements can also act as underwriters to an issue.

In Pakistan, the Code of Conduct that applies to registered brokers defines malpractices, execution of orders, breach of trust, business and commission, fairness to clients, and investment advice as potential areas of conflict of interest. The Code of Conduct for brokers states the fiduciary obligation through clauses addressing integrity, exercise of due skill and care, malpractices, execution of orders, breach of trust, business and commission, fairness to clients, and investment advice. In addition, Non Banking Finance Companies and Notified Entities Regulations outline fiduciary duties of asset management companies.

The brokers registered to the SECP are required to nominate a 'compliance officer' responsible for ensuring implementation and compliance with relevant regulatory framework. The Non Banking Finance Companies and Notified Entities Regulations 2008 specifi-cally provide the conditions for important component of internal controls. Lastly, the NBFC regulations prohibit companies' key ex-ecutives from holding concurrent offices within the organisation.

In case of the NBFC, there are annual onsite inspections and regu-lar offsite inspections of entities to check their financial condition and compliance with the regulatory framework. About the conflicts of interests that may arise between asset management services and other securities businesses/services, the report said that two jurisdictions including Pakistan and Sri Lanka have no risk of conflicts of interests with respect to this issue due to local laws or financial market conditions. In Pakistan, market intermediaries are not allowed to concurrently perform CIS operations and brokerage services, the report added.