Scaling Chinese walls


The Securities and Exchange Commission of Pakistan (SECP) has issued rules for research analysts that make it mandatory for issuance of a licence to a researcher and has asked brokerage firms to have a disclaimer and declare outright – interest of its company directors in shares of a company being researched, while advising their customers (investors).

These rules have been debated for over a decade and half and SECP has done well to finally draft rules making them stringent by creating a Chinese wall. However, such disclaimers can at best be a legal cover; how SECP implements these rules is more important.

After all, the other apex regulator – State Bank of Pakistan – also requires a Chinese wall between owners and management of banks. However, SBP has found it increasingly difficult particularly when an owner has the political clout and relevant connections to implement its regulations and rules uniformly. We are afraid SECP will face similar difficulties in implementation of new rules that it has issued as there are at best 10 to 15 brokerage firms with research wings.

Further, the investor class in our country is ‘penny wise and pound foolish’. They suffer from a herd mentality and follow the big boys who they think have ‘inside information’ about a company and their researchers have spent time and money looking into a particular stock. These investors want free advice and come running to the exchange or SECP when faced with a loss.

Further, now investment advice is readily available on social media ie Facebook, WhatsApp, Twitter, etc. The rules issued by the Apex Regulator (SECP) are silent and do not cover the social media. The frontline regulator (Karachi Stock Exchange) has recently been forced to issue an advisory to investors and market participants to be cautious while making investment decisions.

The ground reality needs to be considered when making rules and regulations. Investors recently have been on a hunt for ‘penny stocks’ of illiquid companies and could end up burning their fingers. Both KSE and SECP need to share the blame when they approve a discount mechanism for registration and a lower membership fee on the pretext of broad-basing the bourses and taking them out of the clutches of a few big firms.

Banks are also active in registering brokerage firms for their investment decisions. And, banks like to register those brokerage houses which are willing to negotiate and give them a lower rate (commission charged). Let us face the facts: we are a country of free loaders who are willing to pay peanuts for services rendered.

There is a saying: “When you pay peanuts – you get monkeys”. Investors need to spend some of their hard-earned money to obtain proper research. SECP investor rules require the names of researchers to be listed. Investors also need to register directly with ‘CDC’ to avoid misuse of their accounts by brokerage firms. Crying over spilt milk should not become the norm. Disclaimers and up-front disclosures by research houses constitute a positive development. But it is also essential for the Board of Directors to have proper oversight of their staff which is also sometimes involved in ‘front running’.

The investment industry in this country does not have the structure to fully comply with SECP rules. Only fear of an investigation or audit will compel them to implement SECP rules and ensure integrity in licensed research. Or else, it would be business as usual.

Banks with investment arms need to take the lead and pay proper emoluments (fee) for quality research. All kinds of discounts being offered to attract more business as a norm should be shunned and a proper fee structure drawn.

SECP and KSE only become active when the equities market in their opinion overheats. Regulators need to look at causes and not allay fears for the sake of legal coverage. Paid research needs to be seen as an ancillary business of brokerage firms and banks. Stringent rules alone will not work unless there is inner belief to be more transparent and avoid saving money for personal gains. Investors too need to judge independently and be willing to pay for quality service.