SEC
crisis and corporate dirty linen
By Professor Willie Mendis, Senior Professor of Town
and Country Planning, University of Moratuwa
With the advent of the liberalised economic culture in 1977, the
role of town planners in Sri Lanka diversified from being exclusive
regulators to that of `promoters' of development. The Urban Development
Authority Law No: 41 of 1978 pioneered this trend by empowering
the Urban Development Authority (UDA) "to promote integrated
planning and implementation of economic, social, and physical development
of areas designated for urban development".
The powers and
functions of the UDA allow it to enter into "joint ventures"
for the purpose of carrying out an approved development project.
It was complemented by the Board of Investment offering attractive
fiscal and other incentives to high-value investments in such projects.
Accordingly, it became imperative for town planners engaged in the
promotion of development to be woven into the web of intricacies
of the "capital market". Hence the `building blocks' needed
by them to promote urban investment were conceived in a model which
was formulated in the late 1970s which included the necessity to
develop the Colombo Stock Exchange as one of the `blocks'. Access
to inexpensive capital was possible through the stock market to
attract equity participation in high - value urban development projects.
On the other hand, the vulnerability of investors was also a concern.
Hence the need for a proper regulatory environment for protecting
investors in the capital markets.
Eventually,
stock market operations became familiar to the town planning community
in Sri Lanka. Furthermore, the significance of the daily performance
of share prices and of the All Share Price Index (ASPI) became useful
monitors for the planners to gauge the demand and supply for investment
in built-up space in urban areas. By this time the UDA had begun
several joint ventures in listed companies. In addition, it had
also entered the debt market with the issue of secured debentures
for select projects.
The settled
environment in the operation of the share market in Sri Lanka therefore
lulled investors, including the town planning community, into a
false sense of security and they returned to business as usual.
The bubble however burst with the shocking collapse of several corporate
giants in the USA. The revelations of what occurred at Enron, World
Com, etc., became traumatic when the downfall of these leaders of
Corporate America was associated with its accountants and auditors.
The accountants and auditors involved in the scandal comprised famous
names like Arthur Anderson, KPMG, and frontline brokerage houses
such as Goldman Sachs, Morgan Stanley, and Saloman Smith Barney.
Most recently the US SEC has decided to investigate the role of
the credit-rating firms for possible anti-competitive practices
in a field dominated by three big players, Moody's Investors Service,
Standard & Poor, and Fitch Ratings.
Their grading
of a company's creditworthiness influenced investor confidence in
such companies listed in the stock exchange. Consequently, the US
SEC is also looking into possible conflicts of interest stemming
from the fact that rating agencies are paid by listed companies
whose debt securities they evaluate. The investigation arose from
the Enron failure. The three big players had maintained high ratings
for Enron even as its stock price plummeted in late 2001.
Against such
a backdrop what triggered my interest was the action taken in the
US to restore investor confidence in its traumatised share market.
The action that created the biggest impression was the enactment
of the bi-partisan supported Investor Protection Law, also known
as the Sarbanes - Oxley Statute of 2002, named after its sponsors.
When I returned to Sri Lanka, I was amazed to find that our own
SEC was embroiled in a miniature version of the WorldCom-type saga.
The recent determination by the Attorney - General to frame charges
of insider - trading against the SEC Chairman and another leading
figure of Corporate Sri Lanka resurrected fears of a loss of investor
confidence in our share market. In such a context, I was able to
conceive the parallels of the incidents in the USA and in Sri Lanka
as shown in the accompanying chart.
The striking
similarities in the processes of the SEC crises between the two
nations suggest that the emergent situation in Corporate Sri Lanka
needs to be steadied before it snowballs to a point where investors
lose confidence in the market. This is critical if the country is
to move ahead to a share owning democracy where investors find that
fixed deposits or Treasury Bills are not as attractive investments
as dividends and capital gains earned from a transparent share market.
It is particularly relevant, if as recently reported private sector
pension funds are to be set up where prospective applicants will
have the discretion of investing in a fund of their choice which
will give them the maximum yield. The issue of investor confidence
becomes pivotal in avoiding what happened to the retirement funds
of Enron employees in the USA.
In the above
context, it is pertinent to quote from a recently published newspaper
article : "Our local corporate scene has still to see anything
like the exposure of the scandals in the USA. It is not that all's
well with our corporate sector. Far from it. It's just that the
network of friends among the CEOs, directors and auditors are very
powerful. They all come from a small class of men who have gone
to the same schools and hobnob at the same clubs. The poor investors
and depositors in banks are left high and dry when the crunch comes
as seen in the unfolding Pramuka Bank drama.”
The situation
has been compounded by the reported details of the alleged conflicts
of interest of some SEC Commissioners in relation to the current
crisis, as reported in The Sunday Times FT.
In these circumstances,
the challenge is not to fear the worst but to face it. Consequently,
it will be alright to air corporate dirty linen in public, even
if it means losing face, if the business community wants to clean
up its standards and practices. Professionalism alone cannot be
expected to bring about this change. Moral values are essential
whether it is capitalism, socialism, or any other `ism'. Society
needs to ensure and safeguard the same by the protective net of
an Investor Protection Law to deter those who are so greedy that
they have no qualms about robbing other people's money.
The recently
reported allegation by the former Chairman of the Ceylon Chamber
of Commerce that our business community was corrupt, unethical,
and not transparent, adds fuel to the fire. It therefore becomes
incumbent on the government to bolster confidence, as recently stated
by the Minister of Finance. Sri Lankans would like to see all-party
agreement on this issue, as was manifest when the SEC Amendment
Act was unanimously passed by Parliament on 28 January 2003.
As the nation
progresses towards increased private sector-led economic transformation
in a very liberal business environment, it is important citizen
participation through share trading can be done in a fair and orderly
manner.
The opinion
expressed by the Minister of Finance in Parliament when it was debating
the SEC Amendment Bill, that "this transformation has highlighted
the need for further amendments to the SEC Act to facilitate market
development in a properly regulated environment", is a step
in the right direction. It is however uncertain whether the Amendment
Act alone will suffice to promote investor confidence, as the Minister
has also conceded that excessive regulation is unproductive.
The shock waves
of the present SEC crisis has already inspired a group of concerned
citizens to initiate the formation of an Association styled as CITIRIGHTS
under the Companies Act, with several allied objects, including
the following:
- To protect
shareholders in public and private companies.
- To undertake
litigation in the interest of the shareholder.
- To provide
legal aid to shareholders.
- To encourage,
support, create an awareness and stimulate the dissemination of
knowledge relevant to stock market activities.
- To encourage
the study, research and investigation of stock market activities,
and to promote by lawful means the creation and growth of a vibrant
share owning society.
- To make
representations at forums, meetings and to relevant authorities
with regard to matters concerning any problems faced by stock
market investors and make investors aware of their rights and
duties as shareholders of companies.
This type of initiative by the investor community will hopefully
deter greed and exploitation in the share market.
It will also
convey to the accounting industry and its professional institutes
that oversight bodies are growing in the formal and informal sectors
to inspire confidence in investors that their investments are safer
than before.
Yet, we need
to acknowledge that in the real world of business, bad apples do
surface from time to time in any profession. The time may therefore
be opportune for all political parties represented in Parliament
to unite in the passage of an Investor Protection Law with powers
to require the SEC to establish an Accounting Oversight Panel which
would obligate public companies to make available the right disclosures
and also to monitor same in enabling investors to take informed
decisions. The punitive punishments for violations will however
represent only one side of the coin. It is most likely that investors
will not have much faith in long drawn processes of litigation.
In all probability
neither will the offenders be much concerned as can be seen from
the following quote in a recently published article on what a US
prisoner named Alfred Porro, a corporate lawyer, recalled of his
painful downfall: "for those who manage to hold on to their
money, prison can just be a place to mark time. A guy who has ripped
off millions of dollars isn't worried about going to jail.
They have millions
of dollars put aside. They are on vacation." Hence, it is pertinent
to note that a recent publication on `Codes of Conduct for CFOs
and others' states that the Investor Protection Law in the USA requires
relevant companies to disclose whether or not they have adopted
a code of ethics for their principal accounting officer, and if
not, why not. The rationale for the latter being that 'rebalancing
the various elements of corporate governance is only part of the
solution, and that attitudes and behaviour have to change as well,
not just at the top of an organisation, but throughout'. The central
aim of the latter being to change the corporate culture and values
for the better.
Fortunately,
the Institute of Chartered Accountants of Sri Lanka, the premier
national professional accountancy body in the country, has itself
launched a competition for the award of the Best Corporate Governance
disclosures for companies listed in the Colombo Stock Exchange with
the aim of helping to build investor confidence at a time when post-Enron
concerns still continue to linger.
Meanwhile,
the lessons of the current breakdown in public confidence needs
to go beyond the accounting and auditing profession to others, including
town planners. The latter in particular could be equally vulnerable
as its members promote development which eventually becomes linked
to the axis of Investment - CSE - SEC. Hence all professions in
this axis need to contribute collectively to good governance, whether
in the public or private sector. Each of its professional institutes
must therefore scrutinise its own governance.
The public trust
in them was placed in their respective Acts of Incorporation. In
the bigger picture, the private sector which has been termed as
the `engine of growth', needs a paradigm shift in building investor
confidence. Public sector reforms as envisaged in Regaining Sri
Lanka must necessarily accompany it with equal seriousness.
At stake is
the social, economic, and political stability of the country. It
may have been the reason which prompted a leading US Senator, Trent
Lott, to state as follows, at the time Harvey Pitt resigned under
pressure as Chairman of the US SEC:
"The SEC
Chairman must be someone that has the confidence of the American
people, the markets and both sides philosophically and politically".
In these circumstances, when there is now an opportunity arising
from our current SEC crisis, where all stakeholders seem united
in building investor confidence, it is appropriate to introduce
an Investor Protection Law. This is as important for the economy
as the peace process is for political stability.
Parallels in SEC crises in the US and Sri Lanka
- Harvey Pitt,
SEC Chairman, resigned under pressure in November 2002 on ethical
grounds after allegations that he was 'soft' on the accounting
industry.
- Michael Mack,
SEC Chairman, resigned under pressure in January 2003 due to alleged
charges of insider trading.
- US media
alleges that the SEC was sweeping its problems under the carpet.
- Sri Lanka
media alleges that the SEC was sweeping its problems under the
carpet.
- Arthur Anderson,
auditors of Enron, faulted for not reporting the true health of
Enron Corp. Also, accounting firm KPMG sued by SEC for alleged
securities fraud. *Sri Lanka Accounting and Auditing Standards
Monitoring Board launches investigation into whether KPMG Ford
Rhodes Thornton, auditors of Pramuka Bank, had carried out the
audit according to Sri Lanka Accounting Standards.
- Alleged
pressure from the accounting industry on Harvey Pitt, SEC Chairman,
wherein he was unable to tell the SEC that his nominee to the
Accounting Oversight Panel had chaired an audit committee of a
company embroiled in an accounting scandal. *Alleged conflict
of interest of the President, Institute of Chartered Accountants
of Sri Lanka, being a Commissioner of the SEC, due to his reported
reaction to a recent SLAASMB announcement that some audit firms
had not complied with accounting standards, by stating that the
auditors should be exonerated from any negligence as compliance
depended on materiality.
- According
to the SEC Corporate Finance Division, the review by the SEC of
the financial statements of a substantial majority of the Fortune
500 companies, have raised questions. Furthermore, in the second
quarter 2002, 48 of them practised reporting rules that departed
from nationally recognized standards.
The SEC has reviewed 100 annual reports and accounts of listed
companies, and found that 50 companies had not complied with the
relevant rules and regulations.
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