Capital Market, Regulatory Lapses and Role of SEBON

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It is clearly evident that SEBON did not learn the lesson from CHCL case and allowed allotting the share of Upper Tamakoshi Hydropower Project Limited (UTHPL) to the employees of lender institutions like Employment Provident Fund (EPF).
--By Sabin Bikram Panta
In 2065 B.S., the Commission for the Investigation of Abuse of Authority (CIAA) warned Securities Board of Nepal (SEBON) for its decision to allow Chilime Hydropower Company Ltd’s (CHCL) to allot shares to employees’ and directors of Nepal Electricity Authority (NEA).  CIAA issued the warning after the CHCL shares were already listed on Nepal Stock Exchange Ltd (NEPSE) and trading on the company’s shares had already started.
On 2062-03-30, SEBON had decided to allow the company to issue shares to the company's staff members and directors under the condition that it should issue shares to general public too within six months of the allotment of the shares to the company staff. It was also mentioned in the prospectus that the allotted shares should be listed at NEPSE. In this process, shares of CHCL were allotted to NEA’s employees, ex-employees, directors and ex-directors. Against the instruction of SEBON and commitment of CHCL to issue shares to the general public within 2064-12-20, they issued shares to the public only on 2068-02-17 at premium price of Rs 408.36. Due to the inefficiency of SEBON to enforce its instruction and directives, only limited numbers of shares of CHCL were traded in the market leading to a severe shortfall of its supply. During this six years period, only those shares that were allotted to the employees of NEA were available for trade in the market. Due to the limited supply accompanied by huge demand, there was unnatural increase in the price of CHCL share – thereby benefitting the few shareholders who earned millions of rupees within a short period of time. 
That approval of allotment of shares of CHCL by SEBON was strictly against the norms of Initial Public Offering (IPO) and prudent practice of capital market. Interestingly and surprisingly, there were no lock-up conditions enforced by SEBON. Lock-up agreements prohibit company insiders—including employees, their friends and family, and venture capitalists—from selling their shares for a set period of time.  In other words, the shares are "locked up."  As a prudent rule, before a company goes public, the company and its underwriter typically enter into a lockup agreement to ensure that shares owned by these insiders don’t enter the public market too soon after the offering. U.S. and other country’s securities laws require a company using a lockup to disclose the terms in its registration documents, including its prospectus. Unfortunately, this too was overlooked by SEBON.  
It is clearly evident that SEBON did not learn lesson from CHCL case and allowed allotting the share of Upper Tamakoshi Hydropower Project Limited (UTHPL) to the employees of lender institutions like Employment Provident Fund (EPF). It is violation of fundamental principle of issuing shares to the public, violation of ethical standard and can be considered as a severe lapse in the policy level. There are two main implications of this decision. First, other financial institutions that provide loans to different hydropower companies or any company may have incentive to demand stock for their staff during the negotiating phase of loan approval. The likelihood of compromising on the prudent credit risk assessment will be high if that situation occurs. Second, general, and particularly small, investors will suffer as the number of shares allotted to them will be less as some of such shares are already sold to those privileged institution staff.  
There are cases of securities’ fraud and mismanagement in all areas of the investment world, and the IPO market is no exception. Cases of IPO market fraud and mismanagement occur in three levels. First; the policy level inefficiency occurs when regulating authorities violate basic principle and policies as in the case of CHCL and UTHPL. Even though allotting shares to the company employees is widely practiced and no one can argue against it, providing shares to the employees’ of lending institutions, on the basis of their status, is against the norms. In case of CHCL, the seriousness of the matter is not on the fact that it had allotted shares to its employees but rather in the way it was allotted and approved (even to ex-employees and ex-directors). This is a matter of extreme concern and is highly questionable. 
Second, the policy level inefficiency occurs when capital market regulator is not exercising its authority provided by the law. In case of Nepal, the Securities Law 2063 B.S, and other regulations have provided ample authorities to SEBON to regulate the capital market. So, the major concern is not the lack of authority but SEBON’s unwillingness or inefficiency to use and enforce proper rules and regulations. Nepal Rastra Bank (NRB) is a good example of as how a regulator can enforce its instructions and directives using its authority provided by the law. Unfortunately, this is not true in case of SEBON. Its failure to prevent insider trading in Nepal is one of the major constraints for a fair security market and overall development of capital market. The Security Law and regulations have provided ample powers to SEBON to investigate and persecute all Members of the Board of Directors, Company Secretary and Finance Manager/ Chief Financial Officer in the event of unusually high transactions before and after a crucial decision is taken by the Board of any listed company without announcement of the same to the public. Strict monitoring and vigilance by regulators is a must to prevent such unusual and insider trading. Unfortunately, SEBON and Nespe (as a front line regulator) are clearly weak to ensure both of these.  
Third and last, the companies which are going public, as well as the issue manager who represents them mislead the public about the true health of their business and regulators too fail to detect it. In some cases, regulators allow a company to raise capital even though the company's financial condition may be questionable. For example, SEBON allowed Arun Finance Ltd (AFL) to issue IPO @ Rs. 100, whereas the net worth of the company was far lower (around Rs. 42). Later, NRB declared AFL crisis-ridden, stating that the finance company is in the state of insolvency due to deteriorated financial situation. Given the current situation of AFL, investors have lost their wealth significantly. Therefore, investments in IPO stock are generally considered riskier than stocks that are traded in the secondary market. IPOs are unique stocks because they are newly issued. The companies that issue IPOs have not been traded previously on an exchange and are less thoroughly analyzed than those companies that have been traded for a long time. Therefore, it is believed that the lack of historical share price performance provides a buying opportunity. But on the other side of the coin, some analyst believed that because IPOs have not yet been analyzed and scrutinized by the market, they are considerably riskier than stocks that have a history of being analyzed. In case of Nepal, IPO is hugely popular and oversubscription is general phenomenon. Therefore, time has come to evaluate the current practice of issuing shares at fixed price (i.e. Rs. 100).   
Concerns about independence and ethical standard of IPO issues are often described as the clear ethical risks related to inefficiency, lack of long-term vision, conflicts of interest between professional service providers, issuing companies and regulators. SEBON needs to focus more on enforcing its regulations and instructions to protect the interest of investors as well as development of the capital market.
The writer is Assistant Professor, Kathmandu University School of Management.

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