Transcript Document

REGULATION
FOR
CORPORATE GOVERNANCE
IN PAKISTAN
CAPITAL MARKETS
eme
CONTEMPORARY
ECONOMICS
INTRODUCTION
CORPORATE GOVERNANCE:
 FAIRNESS
 TRANSPARENCY/DISCLOSURE
 ACCOUNTABILITY
Checks and Balances
Audits
1. Internal
2. External
 RESPONSIBILITY/DIRECTION
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BUT WHAT IF:
 FRAUD/DECEIT/LIES
 OPAQUENESS/LACK OF DISCLOSURE
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•
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



UNTIMELY
INCOMPLETE
CONFLICTS OF INTEREST
SUBSTANDARD ACCOUNTING PRACTICES
SINGULAR CONTROL
LACK OF SHAREHOLDER RESPONSIBILITY
NO REGULATION OR ENFORCEMENT
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Disclosure
RECOMMENDATION to
Companies,
Stock Exchanges,
and SECP:
Disclosure should be disclosed…on web sites
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Corporate Disclosure Policy—
Basic Shareholder Rights
Immediate disclosure of material information
Response to unusual market activity
Clarification of rumors
Dealings by directors
Note on “Interlocking Directorates”
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Immediate disclosure of material
information--Code
• Buying or selling of company’s shares, by
Director, CEO, or executive (xxvi)
– To Company Secretary within 4 days of transaction
– “Closed period”/Insider trading
• Results, business decisions, or news that may
materially effect market price
– To Exchange, review need for trading halts
– Before news to media; during non-trading hours
RECOMMENDATION: during non-trading hours; to
Exchanges BEFORE dissemination.
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WINNERS
LOSERS
GOOD PRACTICES
BAD PRACTICES
 Shareholders
 Shareholders
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Stakeholders
Management
Directors
Company
Exchanges
SECP
Government/Economy
Stakeholders
Management
Directors
Company
Exchanges
SECP
Government/Economy
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Immediate disclosure of material
information—ACT-UP Elements
• Accurate
• Complete
• Timely
• UP-to-date
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Other (Immediate) Disclosures
• Related Party Transactions
– Personal/Company Loans
– Personal/Company Purchases/sales
• Remuneration Package of Directors, Executives,
and CEO (in Annual Report)
– Including Stock options (off balance sheet)
– Severance pay, bonuses, service contracts
• Compliance with Code of Corp. Gov.
– Need to explain non-compliance
– Web site postings
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Disclosure and Other
Recommendations
• Board approves related party transactions
• Form Remuneration Committee…NEDs
• Company must explain ANY noncompliance with Code
• Company, SE, and SECP to post on web
sites the compliance statement and
explanations for non-compliance
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Disclosure Policy--Response to
unusual market activity and
clarification of rumors
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Material or not material?
Immediate Response
Refute or confirm or clarify
Research if necessary
Registered person as source?
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Continuous Disclosure Requirements
 Sufficient notice for shareholders meetings
 Pre-emptive rights
 Quarterly and annual accounts reporting
 Compliance with accounting standards
 Fixing of book closure dates
Whistleblowers…tips from public and professionals
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Continuous Disclosure (cont.)
• For Equitable Treatment of Shareholders
• To Protect Share(Stake/Policy)holders’
Rights
• At Annual Meetings
– Notices
– Voting
• In Annual Report
– Accounting practices
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Shareholders’ (Customers’)
Complaints
• Written complaint to company
– Response?
• At annual meeting…heard? Satisfied?
• Complaint to Stock Exchange
– Satisfactory response?
– Arbitration?
• Complaint to SECP
– Satisfactory response?
• Court system remedy
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Initiation of Customer Complaint
Investigations
• Company (Broker) compliance officer
• Written complaint with documentation
• Response from Company; accepted or rejected by
customer?
• If not accepted by customer, or resolved, Stock
Exchange should be contacted (same time as
SECP?)
• RECOMMENDATION: SECP Brochure on web
site re: Customer Complaints and Resolutions
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Exchange Investigations: Sources of
Customer Complaints
• Determine Source:
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Trading Practices
Sales Practices
Operational
Written
• Research history of Brokerage Firm
– Note repeat complaints
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Customer Complaints…Review
Documents in Firm’s Files
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Customer files, new account information
Account statements
Commission reports
Broker or trader files
Advertising files
Correspondence files
Complaint files
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Exchange Investigation Report
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Gather evidence
Copies rather than originals
Document in report, facts and findings
Resolve…write to customer, or
Refer to SECP, or
Refer to Justice or Courts System
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Continuous Disclosure (cont.)
Need to Explain
• Financials
– Discrepancies or significant deviations in accounting
practices or results
– Lack of dividend declaration or payment
– Significant tax liabilities
• Shareholdings and Transactions
• Operations: Past and Future
– Significant risks, lawsuits
– Going concern
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Defects in Annual Reports
(Meetings)
• Shareholders’ meetings only once a year
• Information presented reaches investors too
late
• Management may only be required to
provide info on agenda points
• Only shareholders, not potential investors or
others, admitted to shareholder meetings
Therefore need for continuous disclosure
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Responsibility For Financial
Reporting and Compliance
• CEO and CFO must sign financial
statements
– Personal liability?
• Company Secretary to furnish compliance
certificate to registrar, along with list of
shareholders
– List of shareholders, public info?
– Web site?
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Regulatory Practices for
Continuous Disclosures
• SE/SECP monitoring of annual meetings
• Whistleblowers?
• Review of annual reports
– Capable?
• Reliance on auditors
– Trained
– Understanding of Capital Markets/Corp. Gov.?
• Investigations of discrepancies or significant notes
in annual reports
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CIS Disclosure Issues
• Is a CIS required to exercise voting rights?
• Who should make decisions about voting
and other rights attached to CIS?
• Should a CIS provide information to its
investors about how its rights as a
shareholder will be exercised?
– Questions above from IOSCO
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CIS Guidelines and Practices
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Act in best interests of CIS investors
Publish voting records
Disclose conflicts of interest
Vote according to investment objectives of
CIS
– Financial considerations
– Social objectives
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CIS Regulatory Techniques
• Require regular disclosure of individual company
holdings of CIS
• Prospectus disclosure of top holdings
• Limit CIS investing to a certain % in a company
• Prohibit CIS investing for control of a company
• Limits amount of CIS-group investing, again
relating to control
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Insurance Company Risk Disclosure
Issues
• Disclosures of exposure to financial risk and how
it is managed
• Market or trading risk, comparing risk to return
• Funding liquidity risk, including funding provided
by largest creditors
• Credit risk, nature of exposures, e.g., replacement
values…disclosure on non performing loans
• Reserve adequacy and loss development
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Role and Need of Independent
External Auditors(Code)
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Rating by ICAP
Compliant with Code of Ethics
Directors recommend appointment
No other services
Rotate auditors (or partner?) every 5 years
No prior affiliation or relation (2 years)
Partner to attend AGM
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Enforcement Actions on NonCompliant Disclosures
• Stock Exchanges or other intermediaries to
take enforcement action
• SECP to take enforcement action
• What actions?
– Imposition of sanctions or penalties
• publication of non-compliant companies and
sanctions administered?
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Best Practices:
Exchange Sanctions for NonCompliance of Listing Rules
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Warning, non-public
Public statement of facts
Temporary halt of trading (issuer’s request)
Temporary suspension of trading, with explanation
to market
Delisting, or cancellation of listing
Fines against companies and/or directors
Criminal sanctions…by SECP or Criminal Code
Or...‘Black list’/Defaulters’ Counter?
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Continuous Disclosure Elements:
ACT-UP
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Accurate
Complete
Timely
UP-to-date
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Corporate Governance Practice
Regulatory Framework
• Statutory laws and regulations
• Code of corporate governance
• Standards of best practices, e.g. a due diligence
guide or “Statement of Ethics and Business
Practices” (viii.a)
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Regulatory Framework (cont.)
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Top…Down
From Government Laws
To SECP Regulations
To Institutions’ Rules
To Intermediaries’ Policies and Procedures
To Boards’…Management’s…Employees’ Codes
and Practices
To Individual actions…ethics
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ETHICS
WHAT IS ETHICS?
Corporate Governance Structure
Role of chairman, chief executive officer, non
executive directors and audit committees
Roles, duties, and responsibilities of directors
Related party transactions
Insider trading
Prompt and adequate disclosures
Fair treatment of minority shareholders
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Role of Chairman
• Elected by Directors
– Executive?
• CEO?
– Non-executive?
• Presides over meetings of the Board
• Ensures minutes of meetings recorded
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Role of CEO
• Chairman? Director?
• Appointed and remunerated by Board of
Directors
• Appoints CFO, Company Secretary, and
head of Internal Audit
• Runs the day to day business of Company
• Disclose good and bad developments
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Role of NEDs
• Transparency
– Representation of minority shareholders?
• Impartial checks and balances
– No threat of job security
• Majority on Audit and other
committees…for NBFIs
– Board investment committee
– Remuneration committee
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Role of Audit Committee
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NEDs mostly
Quarterly meetings
Recommend to Board external auditors
Determine measures to safeguard assets
Review announcements prior to publication
Oversight of quarterly, annual finc’l statements
Considers major findings of internal investigations
and management’s responses
• Monitors internal control system
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External Auditors
• KEYS:
– Independent
– Board (Audit Committee) Oversight
– Understanding
• External auditors work for the shareholders, not for
management
– Other conflicting services, e.g., consulting?
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Roles, Duties, and
Responsibilities of Directors
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“Direct” company in meeting its goals
Independent? NED? Broker-related?
Annual Statement of Ethics and Practices
Appoints and monitors management
Disclosure of information to shareholders
Review control issues of Audit Committee
Appoints external auditors
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Significant Issues for Board
Decisions and Review
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Annual and long term business plans
Budgeting
Internal reports, including cases of fraud
Internal and external audits and financials
Joint venture or distributor agreements
Material regulatory review notices
Significant liability claims or judgments
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Keys to Board Effectiveness:
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Communications
Information
Expertise
Experience
Independence
Effective senior management
Recommendation: Board Manual
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Supervisory Board
• Split Board
• Board for operations of company
• Another board for shareholders rights and
protections
• Specialized boards
• Interrelated
• ACT-Up Information
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Related Party Transactions
• Transactions with/for company subsidiaries,
directors, executives
• May be legitimate or
– At ‘higher than market’ rates or prices, or
– At ‘lower than market’ rates or prices
• Disclosure
• Approvals needed? By Board?
Shareholders?
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Related Party Indicators
• Borrowing or lending on an interest-free basis or at a rate
of interest significantly above or below market rates
prevailing at the time of the transaction.
• Selling real estate at a price that differs significantly from
its appraised value.
• Exchanging property for similar property in a nonmonetary transaction.
• Making loans with no scheduled terms for when or how
the funds will be repaid.
• Purchase of assets at greater than fair market value
• Loans at less than market interest rates
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Determining the Existence of
Related Parties (Auditing
Procedures)
• Evaluate the company's procedures for
identifying and properly accounting for
related party transactions.
• Request from appropriate management
personnel the names of all related parties
and inquire whether there were any
transactions with these parties during the
period.
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Identifying Transactions With
Related Parties
1. (SECP or SE to) Provide audit personnel
performing segments of the audit or
auditing and reporting separately on the
accounts of related components of the
reporting entity with the names of known
related parties so that they may become
aware of transactions with such parties
during their audits.
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Identifying (continued)
2. Review the minutes of meetings of the
board of directors and executive or
operating committees for information
about material transactions authorized or
discussed at their meetings.
3. Review conflict-of-interests statements
obtained by the company from its
management.
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Identifying (continued)
4. Review the extent and nature of business
transacted with major customers, suppliers,
borrowers, and lenders for indications of
previously undisclosed relationships.
5. Review accounting records for large, unusual, or
nonrecurring transactions or balances, paying
particular attention to transactions recognized at
or near the end of the reporting period.
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Examining Identified Related Party
Transactions
1. Obtain an understanding of the business purpose
of the transaction.
2. Examine invoices, executed copies of
agreements, contracts, and other pertinent
documents, such as receiving reports and
shipping documents.
3. Determine whether the transaction has been
approved by the board of directors or other
appropriate officials.
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Examining (continued)
4. Confirm transaction amount and terms,
including guarantees and other significant
data, with the other party or parties to the
transaction.
5. Inspect evidence in possession of the other
party or parties to the transaction.
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Potential Related Party Indicators
1. Agreements under which one party pays
expenses on behalf of another party
2. Circular arrangements between related parties
3. Engaging in business deals (such as leases) at
more or less than market value
4. Identification of an unidentified related party
5. Inadequate disclosures
6. Payments for services at inflated prices
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Indicators (continued)
7. Sale of securities
8. Sales without substance
9. Unusual, material transactions,
particularly close to quarter or year-end
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Sample Related Party
Questionnaire
1. Have you or any related party of yours had
any interest, direct or indirect, in any
sales, purchases, transfers, leasing
arrangements or guarantees or other
transactions since [Beginning of period of
audit] to which the company [Or specify
and pension, retirement, savings or
similar plan provided by the client] was,
or is to be, a party?
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Questionnaire (continued)
2. Do you or any related party of yours have
any interest, direct or indirect, in any
pending or incomplete sales, purchases,
transfers, leasing arrangements,
guarantees or other transactions to which
the company is, or is to be, a party?
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Questionnaire (continued)
3. Have you or any related party of yours been
indebted to the company at any time since
[Beginning of period of audit]? Please exclude
amounts due for purchases on usual trade
terms and for ordinary travel and expense
advances.
The answers to the foregoing questions are correct
to the best of my knowledge and belief
DATE
SIGNATURE
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Insider Trading
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Material information
Non-public
Insider use or passed on
Significant gains
Trading in securities or derivatives prior to
public news or announcements
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Insider Trading
Detection Techniques
• Surveillance of unusual trading activity,
either by price movement or share volume
– By Exchange
– By SECP
• Review “insider” activity prior to public
news
• Again, unusual (‘outside-of-pattern’)
activity
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Company Policy and Procedures to
Deter Insider Trading
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General Company Policy, pre- and post- trading
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Determination by Company if info:
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Report intent to trade
Report trade
Arrangement with Depository
Material
Non-public
Prohibit or report trades
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How Companies Can Restrict
Access to Material, Non-Public (i.e.,
Confidential) Information
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Files containing information should be sealed,
and have restricted access
Telephone conversations or meetings discussing
confidential information should be conducted in
private whenever possible
Confidential information should be
communicated to others on a need-to-know basis
only, e.g., if information is needed to perform
duties.
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Companies Restricted Access
(continued)
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Visitors should not be permitted to wander
through the Company’s offices and should be
escorted to and from the reception area.
Secretaries and receptionists should generally
avoid responding to inquiries from outsiders.
In appropriate cases, code names should be used
in confidential documents being prepared or
used within the office.
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Fair Treatment of Minority
Shareholders
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Ownership structure
Transparency of ownership
Concentration and influence of ownership
Shareholder Meetings
Ownership rights
Equitable treatment of shareholders of same
class
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Self Dealing Issues
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Trading ahead or “frontrunning”
Cherry picking; Preferential allocations
Best price or execution
Wash trades
Marking the close
Churning
Misappropriation of funds/securities
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Investigation Techniques
• Review documents
– Internal
– External
• Interview
– Harmed parties or whistleblowers
– Suspected violators
– Supervisors
• Report facts and findings
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Initiation of Investigations
• Trading irregularities discovered through
surveillance
• A customer complaint filed against a member
• A member complaint against another member
• Financial or other reports or calculations that are
inaccurate, or even not filed on time
• Discovery of alleged trader or sales practice
violations
• Prior problems or violations with follow-up
inspections
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Investigation and Enforcement
•
Enforcement Objectives
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Protect shareholders/policy holders
Promote investor confidence
Encourage broad and active participation in
the market by all investors
Punish wrongdoers/level playing field
Remedy ‘harm’ to investors
Deter (prevent) illegal conduct
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Basic Elements of Enforcement
Program
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Investigate possible violations of the securities
laws vigorously but fairly
Recommend and implement enforcement
proceedings where warranted
Remedy harm to investors
Punish wrongdoers and impose sanctions that
correspond to misconduct
Refer matters to other authorities (i.e., justice
minister) for follow-up action as appropriate.
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Reasons that Investigations Should
be Private and Non-public
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Preserve integrity of the investigation
Protects the reputation of innocent market
participants and others
Ensures that securities, funds, or documents are not
removed beyond the jurisdiction of the regulator
Preserves the “element of surprise”
Press inquiries…all to be referred to supervisors or
the delegated press relations person…to develop a
standard response to press inquiries regarding ongoing investigations
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Investigations: Criteria and policy
considerations
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Allocation of resources…own staff?
Outside auditors or inspectors?
Nature of conduct…with intent to
harm? Unintentional?
Size of harm or losses to investors and
markets
Supervisor and management
involvement and ongoing oversight
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Develop Theory of the Case
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•
Possible motives for conduct
Benefits and relationships to promoter,
trader, or others (e.g., family members
or business associates, relationship of
trader to company, broker or
others…note, this theory may change
during investigations)
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Develop Investigative Plan
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Define scope and objectives of investigation
Identify issuers, promoters, traders, and time
period
Investigation should seek to develop facts and
evidence to support each element of an
alleged violation
Many cases are largely based on
circumstantial evidence
Identify necessary documents and witnesses
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Issuer and Company Documents
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Periodic reports, offering circulars,
prospectuses, and other disclosure
Press releases and promotional materials
Documents related to Board of Directors and
other meetings, including meeting minutes,
agendas, lists of attendees
Notes or summaries of meetings and
telephone conversations
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Decision to Initiate Proceedings or to
Close the Investigation
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Criteria and policy considerations
Allocation of resources
Impact on investors and the market
Other
Preparation of recommendation
Supervisor and management oversight
Criminal and other accompanying
proceedings
Possible settlement
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Publicity Considerations
• Issue press release after public
proceedings initiated
• Announce enforcement proceedings on
(SE/SECP) website
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Basis for Appropriate Sanctions
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Statutory authority
Policy considerations
Seriousness of misconduct
Nature of misconduct
Repetitive or continuous
Single instance
Amount of monetary damage
Likelihood of future misconduct
Previous violations
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Caution
• Over regulation may cause great expense in
time, money, and personnel
• Public companies consider ‘privatizing’
• Private companies to seek private financing
• Stress general ethics and conduct
• Costs to accomplish
– Rotation of auditors…rather than rotation of
partner
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Recent International Laws and
Reports
• Sarbanes-Oxley Act of 2002 (US)
• Higgs Report, January 2003 (UK)
• Council of Institutional Investors 2002 (US
Pension Funds)
• IOSCO Technical Committee Report,
October 2002
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Sarbanes-Oxley Act
• Prohibits most company loans to directors
and executives
• CEO and CFO now criminally liable for
financial misstatements
• Real time reporting (within 2 days)
• Whistleblower protections
• Public Company Accounting Oversight
Board
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Higgs Report
• Chairman and CEO separate individuals
• At least 50% of Board, NEDs
• Board evaluated by Board Review
Committee
• At least one member of Audit Committee to
have recent and relevant experience
• Disallowing ex-CEOs as Chairmen
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Council of Institutional Investors
• All directors should be elected annually via
confidential ballots counted by independent
tabulators
• Audit, nominating, and compensation
committees…independent directors
• A corporation should disclose information
necessary for shareholders to determine whether
each director qualifies as independent
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IOSCO Technical Committee
Statement of principles to guide securities
regulators requiring:
• Transparency and disclosure by listed
entities,
• Independence of external auditors, and
• Need for public oversight of the audit
function
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And Finally...
•
•
•
•
Disseminate information
Educate
Instill ethical behavior
Partner and transformation
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CASE STUDY
How Leeson Broke Barings…Issues:
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–
–
Employee actions and profits (?)
Management and supervision activities
Accounting and audits practices
Board disclosures and (non-) actions
Regulatory (non-) actions
Ultimate shareholder questions
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"Regulation for Corp. Gov."
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Leesen/Barings: Role Play
Split into Individual Smaller Groups
comprised of:
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–
–
–
–
Board of Directors
Shareholders
CEO/Management
Regulator (i.e., Exchange or Commission)
Audit Committee/auditors
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"Regulation for Corp. Gov."
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Leesen/Barings:
General Questions
1. Choose 1 person, group, or body as the
main cause of Barings going down
2. Why was the position not detected or
investigated?
3. Describe some types of Risk associated
with this situation
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"Regulation for Corp. Gov."
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Leesen/Barings:
General Questions (continued)
4. Describe some mistakes or fatal errors in
judgment made by:
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–
–
–
–
–
–
Management and Supervision of Barings
Internal Audit
CEO
Operations (i.e., Back Office)
Board of Directors
Shareholders
Stakeholders (i.e., creditors, debtors, employees)
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Leesen/Barings:
Individual Group Questions
1.
2.
3.
4.
5.
6.
What went wrong, and why?
What corporate governance principles or practices
were NOT applied by (or for) your group?
What corporate governance principles and practices
should have been applied?
What the regulators could have/should have done?
Complete the sentence describing the ‘Lessons
Learned by Leeson Broking Barings’:
“This could have been prevented if ………………”
ADB Project TA 3696-PAK
"Regulation for Corp. Gov."
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Leeson/Barings Case Study
• Leesen Keys:
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–
Resultant losses; bad decisions
Did not arbitrage; huge positions
Hid losses
Dual roles as trader/bookkeeper
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"Regulation for Corp. Gov."
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Leesen/Barings Case Study
• Management and supervision
–
–
–
–
–
Checks and balances; reviews
Customer positions
Trader positions
Questions
Reports and reporting
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"Regulation for Corp. Gov."
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Leesen/Barings Case Study
• Accounting and Audit Practices
– Actions of internal auditors
– Findings of external auditors
– Audit or Risk Committee practices
ADB Project TA 3696-PAK
"Regulation for Corp. Gov."
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Leesen/Barings Case Study
• Board disclosures and actions
– Questions on losses
– Questions on profits
– Disclosure to shareholders
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"Regulation for Corp. Gov."
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Leesen/Barings Case Study
• Regulatory actions
–
–
–
–
–
Position limits
Inquiries
Report reviews
Hedging
Capital considerations
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"Regulation for Corp. Gov."
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Leesen/Barings Case Study
• Shareholder actions and questions
–
–
–
–
Risks
Disclosure
Strategies
Remuneration
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Leesen/Barings Case Study:
13 (Shareholder) Questions
1. What is the company’s philosophy towards
financial risks?
2. Do (supervisory) board members understand
the financial instruments the company uses or
owns (particularly derivatives)?
3. Who formulates the firm’s guidelines and
policies on the use of financial instruments?
4. Has the board approved these policies?
5. How can the board foster a risk management
culture within the firm?
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13 Questions (continued)
6. How does the board ensure the integrity of
the risk management system?
7. Is there a separation of duties between those
who generate financial risks and those who
manage and control these risks?
8. What type of financial instruments may the
firm use?
9. How are these financial instruments valued?
10. Is there a (position/value) limit in place?
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13 Questions (continued)
11. What are the major risks resulting from
financial instruments?
12. Are senior managers and the board of
directors kept abreast of the financial
exposures facing the company at any one
time?
13. As a shareholder, how much information on
the financial risks of the company can I
reasonably expect?
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Leesen/Barings Case Study
ISSUES:
1. Segregation of front and back-office
2. Senior management involvement
3. Adequate capital
4. Poor control procedures
 Credit risk
 Market risk
 No limits
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Leesen/Barings Case Study
ISSUES (continued)
5. Lack of supervision…disclosure…corp. gov.
Conclusions:
• Management assumed positions hedged, rather
than checking or supervising
• No attention to profitable account
• Management/board entered new businesses
without ensuring adequate support and control
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CASE STUDY
• Sprint and Coca Cola
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Shareholder rights
Disclosure
Dual roles of auditors
Shareholder actions
Results
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"Regulation for Corp. Gov."
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CASE STUDY
•
Insider Trading, Martha and ImClone
Sale before public news
Stock decline
Friend of CEO
Stop/loss order?
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