A fresh critique on the Securities and Exchange Commission Bill

It is time for the SEC Act to be empowered to heightened regulatory scrutiny. However, it should not contribute to undermining investor confidence and the operations of the SEC but should be a factor that fosters robust development of the capital market

• Freezing orders and travel bans in proposed SEC regulation 

Draconian and scary are two terms that automatically hit you when one peruses the SEC Bill that will be debated in Parliament and made law soon. 

The current Securities Exchange Commission Act came into force in 1987 and created the capital market regulatory body – the Securities and Exchange Commission of Sri Lanka (SEC). With the development of financial markets locally and globally, the market conditions have demanded a few amendments be made to facilitate market conduct. As new sophisticated and complex financial instruments become the “norm,” it is imperative for a paradigm shift in regulation to accommodate these complexities.

To accommodate the new market conditions, an Act with a complete overhaul is needed and hence the previous administration presented a bill to Parliament in 2017-’18. However, with the change of guard, a new bill was presented to Parliament on 4 August for debate and voting (‘SEC Bill’). However for some anomalous reason, potentially for the best of capital markets of Sri Lanka, this matter was not taken up. 

What I will try to elucidate in this article are some of the issues that need to be taken not with a pinch of salt, but with a grave amount of concern and seriousness. 

Regulating with the right balance 

As indicated by a former Director-General Dr. Aritta Wikramanayake, far too much discretion has been vested with the regulator which can eventually kill the market. He also went on to say that he would not wish to sit on any board as a director due to the stringent nature of this bill. 

Taking a cue from him, what one needs to understand is that while regulation is undoubtedly necessary and needs updating, we simply must ask ourselves if our market is mature enough and ready to absolve regulations that are inherently stringent and draconian. 

The current market is in a developing stage and therefore, must be regulated with the right balance. This means ensuring that issuers and investors are made comfortable and are at ease to enter a market and issue securities or trade with no inhibition that the regulation will be a dampener in their endeavour. 

In short, regulation should not try to take the risk out of the market. Rather, they should endeavour to regulate based on ‘disclosure-based regulation’ as opposed to ‘merit-based regulation’ strains of which are seen in the proposed regulation. It is recommended that one give serious thought to the below-mentioned clauses that would have an adverse impact at this stage of our market. 

It must be remembered that the market-friendly business magnate Ken Balendra during his term as the Chairman of the SEC and the then Director-General Dr. Dayanath Jayasuriya in early 2000 introduced meaningful steps to deregulate the market and the market reacted positively. 

Clause 80: Regulation of Unlisted Securities 

Public offers of companies that are not listed have been brought under regulation in this proposed bill. This will cause immense issues for regulation as currently, the SEC is regulating an estimated 280 listed companies which have proven itself to be an operose task, so one would justifiably wonder how it would do with the task of regulating a much larger number of public companies. 

Questions of an onerous task in conducting investigations and surveillance will be a concern. In the absence of a credible and proper price discovery mechanism could one do justice to an investigation? The regulator would need to have much more capacity than it has now if an unlisted market comes under its regulation, though public offers have not been defined properly, which undoubtedly would sprout numerous issues concerning regulation. 

Furthermore, the provision in the bill is too restrictive to non-listed businesses in the country with added costs and regulatory procedures. The SEC should not be a burden to non-listed entities as they do fall within the ambit of SEC regulation as in the present and its removal from the bill will avoid confusion. 

Clause 128 (4): Shifting of the Burden of Proof to the Investor

Instead of establishing the guilt by the SEC in respect of an offence, the burden of proof has been shifted to the investor. He or she needs to establish that an offence has not been committed. 

If the SEC, with all the expertise and dedicated resources, is yet unable to establish guilt concerning an offence, it is an unfair expectation for the investor to prove his innocence. This will also deter local and foreign investors from considering Sri Lanka for investments. The removal of this clause is justifiable. Let the SEC consider any enforcement action only when the SEC is satisfied that the required evidence is available to proceed with such enforcement action. 

Part V: Market Misconduct 

147. (1) A person who contravenes clauses 128, 129,130, 131, 132 or subclauses (2) and (3) of clause 137 commits an offence and shall be liable on conviction to a fine of not less than Rs. 10 million or to imprisonment for a term not exceeding 10 years or to both such fine and imprisonment. This bill does not provide for the compounding of offences. 

Ideally, the magnitude and the circumstance of the offence will have to be taken into consideration for justice to be meted. That privilege has been disregarded.

Clause 128 False trading, market rigging, and market manipulation. Clause 129 Stock market manipulations. Clause 130 False or misleading statements. Clause 131 Fraudulently inducing persons to deal securities. Clause 132. User manipulative and deceptive devices. Clause 137 Insider trading. 

 The need for compounding of offences 

The major offences including insider dealing will not fall under the ambit of compounding the offence by paying a fine and without the admissions of guilt. In securities offences and financial fraud, it is important to note that sanctions to be implemented must be practical and enforceable. Importantly, the offenders should be dealt with actions that will hurt them the most professionally, and that is imposing fines and penalties that will create a dent in their reputation. 

There is another school of thought that compounding should and must be permitted as a more practical approach to offending. Within our current legal system, to reach a finality of a criminal case from a Magistrate’s Court to a superior Court will take a good number of years. Testimony to that is a case filed by the SEC in1996 which is still awaiting an order from the Supreme Court. Hence compounding all offences as done currently is a way forward.

Publicising the offenders will create reputational damage to the parties involved. In an evolved system, the punishments should not reflect the common reaction of i.e. jail time and other like limitations of liberty, rather offences such as the above should be met with a more progressive approach such as suspension, penalties, financial loss, and other reputational damage. White-collar crimes cannot be treated the same as quintessential criminal offences. 

 Clause 148: The Prosecutorial Discretion vested upon the Attorney General 

The prosecutorial discretion vested upon the SEC has been taken away in the new bill and such power has been vested upon the Attorney General. The said change has taken away the effectiveness and bargaining power of the SEC concerning any ‘Enforcement Action’ to be contemplated.

Further, it is the SEC who is in the possession of the technical knowhow and expertise to decide as to whether or not any enforcement action should be considered on suspected securities market-related irregularity and not the Attorney General. Once a decision is made by the SEC to prosecute any person regarding a suspected offence, the Attorney General could then proceed as per Clause 149 of the new SEC Bill. 

 Clause 151: Civil Remedies

The above clause has provided the right to aggrieved parties to claim damages (Civil Suit) from persons including the directors of public listed companies. Hence, this will discourage new companies seeking listing as well as existing and potential directors of listed entities. It is suggested to grant the restitution powers to the SEC rather than empowering agreed parties to institute actions in Court. 

 Clause 167 (1): Freezing of Assets 

New powers have been vested through SEC Bill upon the SEC to freeze assets of persons up to seven days and regularise such freeze through Courts. In other words, you are passing the baton on to the Judiciary to carry on extending an order issued by the regulator. This can certainly deter existing and potential investors as such power seems extremely draconian.

Further, it is inappropriate to issue a freezing order of assets of a person without properly ascertaining issues of such person which may otherwise adversely affect the livelihood of the affected party. 

Furthermore, if this power is in the wrong hands, it is open to be abused maliciously. In the event of any requirement that would arise to freeze assets of any person, let that be done through Courts as appropriate. 

 Clause 180(1) (n): Imposing a Travel Ban 

The SEC under this clause can make an application to the Court to impose a travel ban on any person who has contravened or is likely to contravene a provision of this Act. When such application is made ex parte, the Court will impose a travel ban and generally do so by impounding his or her passport. This clause includes subjective clauses “that there is a reasonable likelihood that any person has contravened or is likely to contravene a provision of this Act” which, in the wrong hands of a regulator, could be draconian. 

Although done through a Court some of these provisions are not very complimentary to the market. 

(a) restraining or requiring the cessation of the contravention; (b) restraining a person from dealing or trading in securities in respect of any class of securities mentioned in the order; (c) declaring a securities transaction to be void; (d) restraining the person from acquiring, disposing of or otherwise dealing with assets which the court is satisfied that such person is reasonably likely to acquire, dispose of or otherwise deal with; (e) directing a person to dispose of any securities that are specified in the order; (f) restraining the exercise of any voting or other rights attached to any securities that are specified in the order; (g) restraining a person from making available, offering for subscription or purchase or issuing an invitation to subscribe for or purchase or allotting any securities that are specified in the order; (h) appointing a receiver or liquidator over the property of a market intermediary or the property that is held by such person for or on behalf of another person whether on trust or otherwise; (i) vesting securities or such other property that is specified in the order in a trustee appointed by court; (j) requiring a person to do such act or comply with such directive where a person has refused or failed or is refusing or failing or is proposing to refuse or fail to do any act or comply with any directive that such person is required to do under this Act; (k) requiring that person or any other person who appears to have been knowingly involved in the contravention to take such steps as the court may direct to remedy it or to mitigate its effect including making restitution to any other person aggrieved by such contravention; (l) directing a person to do or refrain from doing a specified act for the purpose of securing compliance with any other order under this clause; (m) directing a person to comply with a directive that is issued by the Commission; (n) imposing a travel ban on any person who has contravened any provision of the Act; or (o) on any ancillary matter deemed to be desirable in consequence of the making of an order under any of the preceding provisions of this subclause. 

 Epilogue 

It is my humble opinion that it is time for the SEC Act to be empowered to heightened regulatory scrutiny. However, it should not contribute to undermining investor confidence and the operations of the SEC but should be a factor that fosters robust development of the capital market.

One should be mindful that if regulation is in the wrong hands it would be detrimental as more power to individual/s will lead to corruption. We should not get into situations where issues and personalities are mixed up. 

Needless to say, policy-based oversight which directs the functioning of an efficient, orderly, and well-regulated market, with improved transparency, integrity, governance and which assuage negative public sentiment is imperative to create an ecosystem where capital market players can transform the way they operate, making optimal decisions within a sound legal framework.

To achieve this, the SEC, CSE together with other stakeholders should attempt to move Sri Lanka with rigour towards achieving a status of being a ‘share owning democracy’.

 (The writer is an Attorney-at-Law, a Solicitor of the United Kingdom and Wales, a former Director General of the Securities and Exchange Commission of Sri Lanka, and a Senior Advisor of the Ministry of Finance. He is now a legal consultant practising in the area of financial markets.)

The writer can be reached via [email protected]