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Tuesday, 1 November 2016 00:02 - - {{hitsCtrl.values.hits}}
By Legal Eye
I was extremely surprised to read the news item regarding the decision of the Monetary Board to pay the stakeholders of the ‘The Entrust Securities PLC’ by the Central Bank.
The relevant press release of the Central Bank in this regard is quoted below for expediency.
As announced to the public on 10.10.2016, the Monetary Board at its meeting held on 14.10.2016 considered resolution issues pertaining to a number of non-bank financial institutions in the context of relevant legal provisions in the interest of protecting the public trust in the financial system. Accordingly, the Monetary Board approved a resolution mechanism for repayment of depositors of three finance companies and legitimate investors in government securities-linked investments in Entrust Securities PLC.
The three finance companies are The Standard Credit Finance Ltd., City Finance Corporation Ltd. and Central Investments and Finance PLC. All three companies got into a chronic financial position in 2008 and 2009 due to fraud and mismanagement of funds and, therefore, these companies did not have assets to pay off deposits. All restructuring efforts made by the Central Bank, from time to time, could not produce envisaged results as those who managed these companies failed to arrange an infusion of new capital. As a result, these companies became insolvent and were out of business since then.
The Entrust Securities PLC, a company with a primary dealer license to trade government securities, got into a chronic liquidity and insolvency crisis during latter part of 2015 as a result of fraudulent use of funds placed by customers for investment in government securities. The Central Bank on January 4, 2016 suspended the Board of Directors of the Entrust and vested its operations in the National Saving Bank to protect the investors.
The Monetary Board reviewed the lack of progress so far and took cognisance of the fact that there was no further room to revive these companies to enable them to repay depositors and investors in the foreseeable future. Given the long-delay involved so far, the Monetary Board approved the company resolution plans submitted by the Department of Supervision of Non-banking Financial Institutions to repay deposits and investments annually commencing from 2017 over a reasonable period of time with a fair interest rate during this repayment period.
In the case of the three finance companies, repayment will cover Rs. 4,868 m of nearly 11,878 depositors. In the case of the Entrust, investments secured with government securities amounting to Rs. 3,100 m belonging to 107 investors will be settled in the coming weeks. In respect of unsecured investments in the Entrust amounting to Rs. 8,508 m belonging to 24 individuals and entities, government securities will be allocated and be repaid under the repayment plan to be implemented with the managing support of the Seylan Bank PLC. The Central Bank will complete the required administrative procedures and communicate details to all those depositors and investors. Once the repayment plan is legally finalised, those companies will be dealt with through applicable laws for liquidation. The Monetary Board is of the view that this is the only option that now remains as there are no assets in these companies and no investors have been willing to revive these companies and repay above depositors and investors.
As part of the resolution plans, the Central Bank will set up a new Enforcement Division in the Department of Supervision of Non-bank Financial Institutions to institute legal action against Directors and managers who have been responsible for the fraud and misappropriation of funds and to make every effort to recover such funds from them. In the case of the Entrust, the law enforcement authorities, in association with the Central Bank, have already initiated legal actions. The Enforcement Division will also introduce a routine procedure to take legal action against parties who have committed similar fraudulent practices in existing companies, in the event such instances are detected by the examination staff. Further, action will be taken to address lapses in the Central Bank and to strengthen regulatory and supervisory mechanisms on a priority basis to ensure the safety and soundness of existing institutions.
However, it is important to stress that the regulation and supervision do not mean a guarantee for each and every deposit and investment made by the public in banks and financial institutions. Those who make such deposits and investments and those who undertake businesses based on these funds are primarily responsible for their business decisions regarding prudent management of their funds. In fact, almost all funds placed in the above distressed companies have been mobilised through unauthorised financial products. Even large depositors and investors have been negligent in not undertaking the normal due diligence on risks and return, despite being sufficiently knowledgeable and skilful to do so. The responsibility of the Central Bank is only to provide an external safeguard through regulation and supervision to the extent permitted in law while facilitating institutions to carry on their businesses essential for the economy and general public in a safe and sound manner in a stable financial system.
Therefore, all those who are stakeholders to these resolution plans are kindly requested to co-operate with the Central Bank in order to end this long-standing issue in the public interest. In the event of non-cooperation, the Central Bank will have no option but to reluctantly permit these companies to be wound up under the law.
In the case of the three Finance Companies referred to in the above press release, there is provision in S 67 of Finance Business Act No. 2011 quoted below for easy reference, which make provisions for the Central Bank to pay monies to failed Finance Companies in the circumstances set out in of the said Act.
(1) Where the Director is satisfied, after examination by himself, or by any officer of the Central Bank or any other person, authorised on that behalf by the Director, of the affairs of any finance company, or upon information received from the finance company that it would be in the interest of depositors to provide temporary financial accommodation to such finance company, the Director shall report accordingly to the Board and the Board may grant a loan or advance to a commercial bank from the Medium and Long Term Credit Fund established under section 88E of the Monetary Law Act (Chapter 422), for the purpose of lending to such finance company on such terms and conditions as may be determined by the Board.
(2) The provisions of section 88A to 88E of the Monetary Law Act shall, mutatis mutandis, apply to any loan or advance granted to a commercial bank under the provisions of subsection (1).
(3) The Board may guarantee loans, advances or other accommodation granted to a finance company by credit institutions operating in Sri Lanka.
(4) In this section “credit institution” means:
(a) any bank licensed under the Banking Act, No. 30 of 1988;
(b) any finance company licensed under this Act;
(c) any agency or institution acting on behalf of the government (whether established by any written law or otherwise) which grants loans and advances or makes investments or accepts deposits from the public;
(d) any other person declared by the Minister in charge of the subject of Finance, by Order published in the Gazette, to be a banking institution for the purposes of Monetary Law Act (Chapter 422); and Providing temporary financial assistance & guarantees by the Board. 78 Finance Business Act, No. 42 of 2011
(e) any such society registered under the Co-operative Societies Law, No 5 of 1972.
However, there is no provision in the Monetary Law Act which establishes and sets out the powers and duties of the Monetary Board and the Central Bank to provide the funds ripped off by a devious Primary Dealer.
The role of the Primary Dealer is to facilitate the sale of the Government Securities in compliance with the laws, regulations, directions, guidelines or codes of conduct applicable to it the Primary Dealer rules of Lanka Secure (which is the Central Depository Settlement System of the Central Bank for Scripless Securities) for this purpose. The Central Bank is authorised to punitive action to contravene such laws, regulations, directions, guidelines or codes of conduct or acts in a manner detrimental to the interest of the Primary Dealer system or to the national economy.
An extract of the newspaper article by W.A. Wijewardena, a former Deputy Governor of the Central Bank published in the Daily Financial Times of 24 October 2016, reproduced below explicitly explains the implications of the flawed decision of the Monetary Board.
Solving Entrust issue without legal provisions
The primary dealer, Entrust Securities, has reportedly defrauded investors who have paid that company to buy government securities on their behalf. The amount involved has been estimated at Rs. 12 billion. The Bank has proposed to lend Rs. 8 billion to a Special Purpose Vehicle managed by Seylan Bank to enable the manager to accumulate interest for eight years by investing the same in a government security and pay the investors out of the interest income so earned.
SPV is required to return the original Rs. 8 billion to the Bank at the end of the eight-year period. This lending is against the Monetary Law Act or MLA which has authorised the Monetary Board to lend only to commercial banks and NSB for meeting liquidity shortfalls against the collateral of prescribed securities, only for a period at the maximum of nine months. This restriction has been introduced to prevent the Board from lending to others causing inflation, on the one hand, and leading to frauds, on the other.
Hence, the Board is exposed to possible criminal liability charges in the future. In this scenario, it is advisable that the Monetary Board re-examine this proposal before its implementation.
It is exceedingly strange that the Monetary Board of the Central Bank, which has quite boastfully in Part II page 88 and 89 in the Annual Report of 2014 as well as pages 86 and 87 in the Annual Report of 2015 records of the actions taken by the Central Bank to regulate and supervise Primary Dealers has failed in the protection of the Investors of the Government securities by institutions such as the Electricity Board, funds of Departments of the Central Bank as well as the general public.
For instance in the Annual Reports of the year 2014 of the Central Bank of Sri Lanka it is stated that “continued regulation and supervision of Primary Dealers in Government Securities (PDs) in 2014, in terms of the Local Treasury Bills Ordinance and the Registered Stock and Securities Ordinance, with a view of ensuring stability of the PD system and the safety of investors in Government Securities.” The headings of the actions taken are supposed to be as follows:
With all these supervisory actions taken, the Public Debt Department appears to have failed to detect the fraud committed by the mismatch of the Government securities purchased and sold. Hence, there appears to be a need for the identification of the accountability.
More surprisingly the Magistrate has granted bail to the Directors of the company, the Entrust Securities PLC on the basis that they have not committed an offence under Sections 5(3) and 8(3) of the Public Property Act and Section 386 of the Penal Code.
Yet, the proposed bail out of Entrust Securities PLC would be a burden to the public.
Therefore, the President should be apprised of this situation so that Central Bank funds would not be used for purposes not authorised by law, even in the larger interests of financial stability, as a result of the managed bankruptcy of a Primary Dealer due to fraudulent transactions and not as a result of normal business downturns.
