Market integrity and protecting investors

Eze Nwagbaraji
The common interest of Nigerians in a growing economy that produces jobs, improve our standard of living, protects individual savings, and encourage capital formation that is necessary to sustain economic growth is never in doubt.

Between 2003 and 2008, millions of us across urban and rural Nigeria embraced the call of the capital market. The rural market woman, the village farmer, and the professional urban dweller, all responded to the beckoning of a rejuvenated capitalist Nigeria. They poured in billions of hard earned Naira into the market in pursuit of profits and created an unparalleled capital formation opportunity in the country during this period.

The confidence exuded by these citizen investors raised the global profile of our economy and attracted considerable foreign investments into our local economy. Western Union (NYSE:WU) and Money Gram International (NYSE:MGI), two of the world’s largest processors of money wire transfers scrambled to make Nigeria one of the major hubs in their global presence.

The Securities and Exchange Commission (SEC), the Nigerian Stock Exchange (NSE) and other market regulatory authorities have exhibited gross ineptitude in advancing market integrity which is a necessary ingredient in sustaining a robust and growth oriented capital market.

The crisis riddled banking sector, the culture of corporate underhandedness, and the ongoing confusion between the SEC and the NSE raises the question of competence within these agencies that are supposed to be guardians and referees of our free market. The banking sector as monetary intermediaries come under the regulatory purview of the Central Bank of Nigeria (CBN), but as publicly traded corporations, the entities within the sector also come under the regulatory purview of the SEC and the NSE.

The SEC and the NSE also have primary responsibilities of monitoring and ensuring that those who come to the markets (corporations, states, and indeed the federal government) to raise money use such funds for the purposes stated. For example, States that come to the market to raise bonds for various “development” objectives secure approvals from the NSE before approaching the market for such bonds. Such approvals carry along with them the duty to monitor how such publicly raised funds are used.

Ensuring Market integrity is one of the three broad fundamental goals of the SEC. The other two fundamental goals are systemic safety and customer (investor) protection. Market Integrity is the duty to ensure that markets operate fairly and safely in other to encourage the widest possible confidence. Engendering the widest possible investor confidence is the primary component that leads to high levels of savings and investments.

Sound and efficient regulation of markets must look at issues such as integrity of price formation, the ability and or capacity of entities that approach the market or come to the market to raise funds to diligently utilize public funds for stated objectives.

Raising funds through the equity, bond, or commodity markets is not a gambling experiment. Investors put their trusts into the firms that come through these markets with the knowledge and belief that market regulatory agencies have the capacity and know how to weed out financial gamers and fraudulent institutions. The prevention of manipulative behaviors which deliberately attempt to scheme investors out of their funds or deliberate sharp practices by both corporate, sovereign or quasi-sovereign entities are antithetical to a sound regulatory regime.

The SEC must also provide sound legal basis for financial dealings and have adequate rules and laws within its books to protect market participants. All documents, laws, including insolvency laws, and codes, and generally accepted prudent systems of dealings, which are important to customer protection are fundamentally important in market integrity.

Over the next two decades, there would be an explosion in market activities among the top 50 world economies. Nigeria will most likely fall within this group. The United States, China, India, the United Kingdom, Japan, etc. have encouraged and intensified pressures on their market regulatory agencies to adopt best practices and in some cases encouraged well prepared local corporations to engage in dual listings of their equities in other countries. The New York Stock Exchange (NYSE), the National Association Securities Dealers Average Quotes (NASDAQ), the London Stock Exchange (LSE), etc. have all either gone public (becoming publicly traded corporations with millions of share holders), or have entered into definitive mergers or working arrangements with other foreign exchanges.

These market maneuvers are meant to give these institutions advantages that may not be readily available within their sovereign boundaries. They further encourage corporations to come to them in search of capital. To bolster investor confidence, the regulatory authorities in some of these countries have continued to pursue rigorous compliance regimes against all that come to them to raise capital.

As Nigerians increasing look to the security markets to secure their future, save for university and college education for their children, generate income for retirements years, it is the duty of the market regulatory institutions to rise to the challenges of creating an enabling environment for robust market participation.

There are compelling examples from markets in some of the world’s advanced economies. The United States SEC for example, brought a civil fraud allegation against two of the country’s leading banking and investment firms. The US SEC this past summer dragged Goldman Sachs, the banking and investment advisory behemoth before a Federal Court alleging deceptive practices in the investment bank’s dealing with investors in its mortgage backed securities.

The Securities and Exchange Commission alleged that Goldman Sachs created a mortgage investment vehicle, called the Abacus 2007-AC-1, in February 2007 that contained mortgage bonds selected by a Goldman client, John Paulson, a top hedge fund manager.

According to the civil charges, Paulson selected the bonds believing they would lose value if the housing market collapsed. By betting against them, he stood to gain rich rewards. Indeed, he is believed to have made several billion dollars betting against the housing bubble in 2007.

The conflict of interest the SEC alleges stems from the fact that Goldman marketed and sold Abacus to its other clients as a good investment without revealing that its contents were handpicked by a client who believed those bonds would fail.

In settling the case, Goldman Sachs agreed to a fine of US $550 million. $300 million of this fine was paid to the United States and $250 million was paid to investors who lost money. In addition to the fine, Goldman Sachs also agreed to change the way it writes its marketing materials and to add additional training for its employees.

In the case against Citigroup, the US SEC on July 30, 2010 charged the banking conglomerate with misleading investors about the company’s exposure to subprime mortgage related assets. The SEC also charged the bank’s former Chief Financial Officer, Gary Crittenden and its head of Cross Marketing, Arthur Tildesley, Jr. for their roles in causing Citigroup to make the misleading statements in SEC filings.

According to the SEC charges, Citigroup as late as mid 2007, in the middle of a collapsing mortgage led global equities market, “boasted to its investors of its superior management skills in reducing its exposure to the subprime mortgage market.” The company advised its investors that it was exposed only to the tune of US $13 billion in subprime mortgages, when in fact the figures was close to US $50 billion.

As part of the litigation, Citigroup agreed to a penalty of $75 million, while its officers, Crittenden and Tildesley, Jr. were fined $100,000.00 and $80,000.00 respectively. Along with the fines, the company and the individuals received an Administrative Order from the SEC, approved by the Judge ordering them to cease and desist from causing violations of Section 13 (a) of the US Exchange Act and Exchange Act Rules 12 (b) – 20 and 13 (a) – 11. Prompting the Bob Khuzmi, US SEC Director of Enforcement Division to state “The rules of financial disclosure are simple. If you choose to speak, you must speak in full to investors, not in half truths.”

In its case against the State of New Jersey, the US SEC brought a civil fraud allegation against the State for failing to inform municipal bond investors that it was underfunding its largest pension plans. The SEC argued that New Jersey sold more than $26 billion in municipal bonds between 2001 and 2007 to raise money for its contributions to two state employee pension funds. The bond sale documents failed to disclose that the state could not make the contributions without raising taxes or cutting services.

The SEC and New Jersey reached an out of court settlement on August 18, 2010.
The laws that govern the securities industry is simple and straight forward. All investors, whether large institutional investors or private individuals must have access to certain basic facts about an investment prior to buying it and so long as such investors hold to the investment.

To achieve this, the SEC must require public companies to disclose meaningful financial and other information to the public. This provides a common pool of knowledge for all investors to use to judge for themselves whether to buy, sell, or hold a particular security. Only through the steady flow of timely, comprehensive, and accurate information can people make sound investment decisions.

The result of this information flow is a far more active, efficient, and transparent capital market that facilitates the capital formation so important to the Nigerian economy.

The SEC must also utilize the experience and skills of competently trained economists and financial market operatives, including those with skills in economic and prosecutorial abilities.

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