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New Year resolutions for Sri Lanka's stock broking firms and state funds
04 Jan, 2013 07:06:21
By Ravi Abeysuriya, CFA

Jan 04, 2013 (LBO) - When it comes to investing in the stock market in Sri Lanka nowadays the chorus that has regrettably echoed has been Market manipulation and State owned Funds losing Billions of money by investing in the stock market.

Market manipulation or creating a “False Market’ or one of its more locally familiar tributaries ‘pump and dump’ has a long, eventful and storied history. From the Tulip Mania of the 1600s all the way to the recent US housing bubble that precipitated the global financial crisis, market manipulators have employed all-and-sundry tactics to skim the wallets of gullible investors.

Manipulated markets have come in all domains and dimensions. The Erie War of 1867 where Jay Gould a director of Erie Railroad Company converted debentures illegally and then bribed the legislators to make the conversion legal is one historical example.

The CEO of Enron, Jeff Skilling, who made use of accounting loopholes and misappropriated investments to keep billions in debt off the books and then coercing the reputed Accounting Firm, Arthur Anderson to play along, in addition to the great internet swindle where two UCLA students in 1999 drove the stock of a bankrupt printing company from 13 US cents to more than US $15 in two trading days, and booking over $350,000 in profits thereby demonstrating how the Internet has given a new dimension to the old game of stock market fraud, are all more recent but dramatic examples.

What happened to the Colombo Stock Market in 2011 and early 2012 has been distressing to those who had exposure to our stock market and to those who make a living from the industry. Although some have blamed SEC, CSE, retail investors, high net worth investors, state owned funds, politicians, the financial press and stockbrokers, all are culpable for the state of affairs today.

The damage is done and stock brokers have lost much of their good standing and public respect today. The investment profession stands at cross roads. Time has come for each and every one of us in this industry to take personal responsibility and act in an ethical manner to take our industry to a higher level. Now is the time for action to rebuild the confidence.

The painful truth is that investor trust in the investment industry has been diminished in recent years be it here in Sri Lanka or globally. Polls have shown that people mistrust financial advisors and believe most are greedy, dishonest and the game is rigged. The root cause of all these problems is a failure of self-control and short-sightedness. The erosion of values and morals of a few have made a whole industry suffer the consequences. People are tired of reading negative commentary in the newspapers about the stock market and certain investments made by state owned funds. The public will not see the good from the bad and the ugly.

Developing a relationship of trust is a foremost priority for finance professionals. They always need to put their client’s interests ahead of themselves and never let their personal interests and temptations get ahead of doing the right thing for their clients. The compliance records of the best advisors are virtually spotless. They have to be principled individuals and have demonstrated those principles from the beginning of their careers. They recognize that they are in their careers for the long term with great deal of patience and are willing to make less money initially to develop a long-term relationship of trust.

They know there is tremendous advantage in having satisfied clients, because satisfied clients provide referrals and are willing to bring more money in once the relationship of trust is established. When clients trust their advisor, they will follow their advisor’s guidance. A relationship built on trust takes time to earn, but once established, it’s priceless. At Heraymila, safeguarding our reputation is supreme, because it takes 20 years to build reputation and a minute to ruin it. Warren Buffett once said, "Lose money for the firm, I will be understanding; lose a shred of reputation for the firm, I will be ruthless"— a rule, he said, is generally applied at Berkshire.

The time has come for everyone in the industry to act and take personal ownership for restoring trust. Firstly, we need a bolder voice for professional ethics as there has never been a greater need to conform to a robust code of moral principles. Secondly, let us focus on financial activities that enable economic and social progress, rather than on finance as an end unto itself. Businesses exist thanks to a social contract granted in exchange for an expectation of professional services. In today’s atmosphere of mistrust, we must reconnect our profession with the public interest. Thirdly, let us extend our knowledge, our skills and our behaviours to wider communities within the field of finance. Leadership means sharing, teaching, and engaging. That means we mentor and inspire colleagues. It means we share and engage with peers, regulators, clients, and our service providers.

It is imperative that state owned institutional funds that manage public funds have proper governance structures by adapting globally accepted standards of best practice such as the “CFA Institute Asset Manager Code” Which specifically state that asset managers should:

1. Act in good faith the best interest of the beneficiaries of the funds whose livelihood after retirement largely depends on performance of these funds 2. Act with prudence and reasonable care.

3. Act with skill, competence, and diligence.

4. Maintain independence and objectivity by, among other actions, avoiding conflicts of interest, refraining from buying stocks at inflated prices, following orders from top management who have vested interests and refusing to take any kickbacks from service providers such as stockbrokers that could reasonably be expected to affect their independence (Financial press is full of acusations of how these funds are managed in Sri Lanka today).

5. Abide by all applicable laws, rules, and regulations, including the terms of the scheme documents.

6. Deal fairly, objectively, and impartially with all participants and beneficiaries.

7. Take actions that are consistent with the established mission of the fund and the policies that support that mission.

8. Review on a regular basis the efficiency and effectiveness of the fund’s success in meeting its goals, including assessing the performance and actions of scheme service providers, such as investment managers, consultants, and actuaries.

9. Maintain confidentiality of scheme, participant, and beneficiary information.

10. Communicate the performance of the funds with participants, beneficiaries, and supervisory authorities in a timely, accurate, and transparent manner. (Information such as the year on year performance of the part of the state owned fund invested on the stock market benched marked against ASPI would help alleviate a lot of criticism about their investment practices).

A collection of 50 things investment professionals can all do called “the Integrity List” to help restore trust in the industry has been developed by the CFA Institute. Forty of those relevant to Stock Broking Companies and investment advisers in Sri Lanka are itemized in the table.

If all Stock Broking firms and investment advisors use them as part of their professional practice, advocate them at their firm, regaining the trust and confidence of our investors in Sri Lanka will not be too far-away. I leave you with a quote from Mahatma Gandhi: “If you want to change the world, you must begin with yourself. You must first become the change that you want to see in the world”.

Ravi Abeysuriya is Chief Executive Officer at Heraymila Securities Ltd., a subsidiary of Heraymila Investments Ltd. (HIL) UAE. HIL directly manages over 290 million dollars of private and public investments on behalf of Abdulaziz Al Mashal’s family office

40 tangible steps that stock broking companies and investment advisers in Sri Lanka can do to restore confidence and trust in our stock market

1. The Colombo Stock Brokers Association commit to a code of ethics and professional conduct with an independent structure to enforce the Code and Standards on its members
2. Require training on ethical decision-making for yourself and your firm.
3. Place the client’s interests before your own.
4. Name and shame unethical behaviuor.
5. Recommend products with transparent returns, costs, and risks.
6. Help clients focus on risk as much as they do on performance.
7. Disclose your educational achievements and how you improve professional competence.
8. Strive for a conflict of interest free business model.
9. Advocate for stronger regulations that protect investors.
10. Act with integrity 24/7 – not just at the office.
11. Encourage young professionals to have the courage to disagree.
12. Keep client fees fair.
13. Be transparent with clients when something goes wrong.
14. Actively disclose all compensation arrangements to clients.
15. Lead by example with your firm and colleagues.
16. Write articles and speak publicly about ethics.
17. Act with fairness and prudence with every decision.
18. Present analysis based on facts and client needs.
19. Always be honest with clients.
20. Never overlook unethical behaviour because you’re better served by ignorance.
21. Never offer kickbacks or engage in misleading sales promotions to win business.
22. Vocally demand that your firm does what is right for clients.
23. Tip the balance between competing interests in favour of clients.
24. Disseminate transparent, accurate and timely information.
25. Be clear about situational influences in your environment.
26. Make investment recommendations based on strong analysis not on rumours.
27. Elevate the importance of integrity in the hiring process.
28. Disclose information in ways even novice investors can understand.
29. Maintain regular contact with clients.
30. Openly share bad news with all who are affected.
31. Understand client requirements and listen to clients’ concerns and fears.
32. Promote the concept of earning money rather than making money.
33. Create an ethical work culture that allows constructive criticism.
34. Bring an ethical dimension to discussions of business strategy.
35. Remind your staff that reputations are hard earned and easily lost.
36. Take responsibility for the actions of your team.
37. Help financial journalists to report the true position of companies you follow.
38. Refuse to associate with anyone who takes advantage of clients.
39. Bring to justice those who take part in irresponsible and illegal activities.
40. Recommend companies with fair practices and good corporate governance.

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READER COMMENT(S)
8. Analyst_2 Jan 28
While i agree that its tough to rely on management guidence, i think RA and majority of the stock broker analysts didnt emphasise enough on the fact that there was a large number of pre-IPO investors who had held share at nearly half the IPO-price.

Also, if i remember correctly, this IPO was promoted by a company which had a stake in EXPO as well didnt they? Didnt the same thing happened with Softlogic?

In my personal opinion, relaying heavily on management guidence to set up a forecast in itself has some major flaws. I believe RA's company focuses on fundamental cash flow analysis and focus on value investing.

Modelling and forecasting companies isnt rocket science, its a matter of understanding the long term sustainability of a company and seeing if the company can maintain or grow their intrinsic value in the way Graham and Buffet pointed out. Like Buffet bluntly say, "only invest in a company that you fully understand". Look at Coca-cola - same formulae has been in existance for a centuary now. In this case, what i gather is the analyst didnt understand the entity... simple!

If you look at any global fund, the emphasis is given to the sustainability of the investment philosophy and not to the ability of any analyst. Thats why major investors dont depend on sell-side research. And like "Niro" rightly pointed out - the 'alignment of interest"... Any thoughts on the performance of the funds managed by Heraymila? If you look at any big fund, im sure their performance is shown.

The day an investor learns the proper fundamentals and discipline themselves, the brokers will end up being a homogenous bunch doing the same basic job (of executing a deal). And the markets will work more efficiently and we will actually make a sensible return.

7. Lasantha Jan 10
The comments here has gone on writer's research on Expo IPO. However, point remains whether we as investment community value a through research? Do we go for the brokers who provide us with the best research instead who give best insider information and deals by the market movers?

Are we ready to pay implicitly for research? There is no market for non marketable products. Still ther are people who try to make a change. The writer should be evaluated in respect of his efforts to do something diffrent in a society that doesn't value it. Somebody has to change it.

Expo could be one particular example. But, fact remains that none of the reports has predicted at least close estimates. So, it's not a problem of judgement, we just do it for doing. There is no point of accusing the writer for a problem of the industry. Lets understand and demand it as investors. Choose only brokers who emphasize on research based recommendation. Investors should be organized and keep pressure on brokers to excercize careful analysis & informed judgements.

6. Koheda Yanne Jan 07
I say, dont shoot the messenger. Those of you who attack the writer should also take up issue with management with a tougher line because as RA rightly points out the analysts are somewhat reliant on management to make these forecasts. I would yet find fault with broking houses for painting a rosier picture that even those who believe fairies would find hard to accept. RA should accept that his firm is also gullible and party to such flimsy analysis. However, beyond that I find RA is an ethical person.

I also have a bone to grind on not just the Expo IPO but also several others such as the Raigam Wayamba which had artificially boosted it's performance in the year before the IPO. If you check their Prospectus and the subsequent annual reports you would note the annualised turnover(prospectus was for 15 months) is not even 1/2 of this post-IPO. Who audit these companies? All are big 4 firms.

Do they ever adjust for cut-off? They manipulate stock/ debtor balances to report earnings favourable prior to IPO's. Some of these newer IPO's are also notorious for pilfering profits through unlisted related entities. Who would question these? The Sri Lankan financial reporting is so weak and also fraught with errors & ommissions I wonder why no one questions the management and auditors much more often.

5. zumba Jan 06
This confession makes it clear that brokers write reports without their own understanding or research on the company or industry.
4. bean investor Jan 05
Do companies give brokers their forecasts to write reports ????
3. Niro Jan 05
No matter how you slice and dice ethical practices, it is always a small group of people (insiders with contacts) who reap the benefits.

Can Mr. Abeysuriya disclose how many shares of Expo did he by for his own account while peddling the 'buy' recommendation. How many shares are you holding now which you bought at 14?

My gut feeling is, you bought none and holding none!

Never trust a investment adviser proclaiming to be a saint peddling CFA guidelines !!

2. Ravi Abeysuriya Jan 04
ۥ We rely heavily on management guidance for forecasts which we assume is based on their, forward, confirmed order books for revenues and management expertise in controlling expenses in-line with historic trends.

• However, macro events, specific issues with clients or inability of the management team to properly forecast are factors based on continued engagement with the management teams after they become public.

• In the case of an IPO, our methodology is to take a haircut in revenue and net profit estimates from the company forecast. We are compelled to do so because at the time of the IPO we are not at liberty to determine whether the management’s historical earnings estimates were within proximity to the actual achieved by the company.

• The filters we apply when a new company goes public through an IPO is always stringent. However, it’s important to note that the forecasting ability of the management will come to the fore only after we have on-going coverage of the stock.

In the case of EXPO

• While we had managed to conservatively estimate FY’11 numbers, the guidance for FY’12 and eventual performance took us by surprise just like every other research forecast. We hope this answers your criticism.

If you send your email address we will send you a detailed explanation.

1. analyst Jan 04
Unfortunately the writers company gave a massive recommendation to EXPO during the IPO which was over-priced at Rs 14. The price is now Rs 7. Good to practice what you preach! It's disappointing that LBO entertains these!