Regulation FOR Corporate Governance in Pakistan Capital Markets

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
ADB Project TA 3696-PAK "Regulation for Corp. Gov." 2
BUT WHAT IF:

FRAUD/DECEIT/LIES OPAQUENESS/LACK OF DISCLOSURE
UNTIMELY INCOMPLETE
CONFLICTS OF INTEREST SUBSTANDARD ACCOUNTING PRACTICES SINGULAR CONTROL LACK OF SHAREHOLDER RESPONSIBILITY NO REGULATION OR ENFORCEMENT
ADB Project TA 3696-PAK "Regulation for Corp. Gov."
Disclosure
RECOMMENDATION to Companies, Stock Exchanges, and SECP: Disclosure should be disclosedon web sites
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
Immediate disclosure of material information--Code

Buying or selling of companys 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.
WINNERS
GOOD PRACTICES
LOSERS
BAD PRACTICES
Shareholders
Stakeholders Management Directors Company Exchanges SECP Government/Economy
Shareholders
Stakeholders Management Directors Company Exchanges SECP Government/Economy
Immediate disclosure of material informationACT-UP Elements

Accurate Complete Timely UP-to-date
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
Disclosure and Other Recommendations

Board approves related party transactions Form Remuneration CommitteeNEDs Company must explain ANY noncompliance with Code Company, SE, and SECP to post on web sites the compliance statement and explanations for non-compliance
Disclosure Policy--Response to unusual market activity and clarification of rumors

Material or not material? Immediate Response Refute or confirm or clarify Research if necessary Registered person as source?
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 Whistleblowerstips from public and professionals
12
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
Shareholders (Customers) Complaints

Written complaint to company
Response?
At annual meetingheard? Satisfied? Complaint to Stock Exchange

Satisfactory response? Arbitration?
Complaint to SECP
Satisfactory response?
Court system remedy

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
Exchange Investigations: Sources of Customer Complaints

Determine Source:
Trading Practices Sales Practices Operational Written
Research history of Brokerage Firm

Note repeat complaints
Customer ComplaintsReview Documents in Firms Files

Customer files, new account information Account statements Commission reports Broker or trader files Advertising files Correspondence files Complaint files
Exchange Investigation Report

Gather evidence Copies rather than originals Document in report, facts and findings Resolvewrite to customer, or Refer to SECP, or Refer to Justice or Courts System
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
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
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?
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

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
CIS Guidelines and Practices

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
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
25
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 valuesdisclosure on non performing loans Reserve adequacy and loss development
Role and Need of Independent External Auditors(Code)

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
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?
28
Best Practices: Exchange Sanctions for NonCompliance of Listing Rules

Warning, non-public Public statement of facts Temporary halt of trading (issuers request) Temporary suspension of trading, with explanation to market Delisting, or cancellation of listing Fines against companies and/or directors Criminal sanctionsby SECP or Criminal Code Or...Black list/Defaulters Counter?
Continuous Disclosure Elements: ACT-UP

Accurate Complete Timely UP-to-date
30
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)
31
Regulatory Framework (cont.)

TopDown From Government Laws To SECP Regulations To Institutions Rules To Intermediaries Policies and Procedures To BoardsManagementsEmployees Codes and Practices To Individual actionsethics
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
Role of Chairman
Elected by Directors
Executive?
CEO?
Non-executive?
Presides over meetings of the Board Ensures minutes of meetings recorded
35
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
Role of NEDs
Transparency
Representation of minority shareholders?
Impartial checks and balances

No threat of job security
Majority on Audit and other committeesfor NBFIs

Board investment committee Remuneration committee
Role of Audit Committee

NEDs mostly Quarterly meetings Recommend to Board external auditors Determine measures to safeguard assets Review announcements prior to publication Oversight of quarterly, annual fincl statements Considers major findings of internal investigations and managements responses Monitors internal control system
External Auditors
KEYS:
Independent Board (Audit Committee) Oversight Understanding
External auditors work for the shareholders, not for management
Other conflicting services, e.g., consulting?
39
Roles, Duties, and Responsibilities of Directors

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
Significant Issues for Board Decisions and Review

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
Keys to Board Effectiveness:

Communications Information Expertise Experience Independence Effective senior management Recommendation: Board Manual
Supervisory Board
Split Board Board for operations of company Another board for shareholders rights and protections Specialized boards Interrelated ACT-Up Information
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?

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
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.
Determining the Existence of Related Parties (Auditing Procedures)
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.
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.
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.
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.
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.
51
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
Indicators (continued)
7. Sale of securities 8. Sales without substance 9. Unusual, material transactions, particularly close to quarter or year-end
53
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?
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?
55
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
Insider Trading
Material information Non-public Insider use or passed on Significant gains Trading in securities or derivatives prior to public news or announcements
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
Company Policy and Procedures to Deter Insider Trading

General Company Policy, pre- and post- trading
Report intent to trade Report trade Arrangement with Depository Material Non-public
Determination by Company if info:

Prohibit or report trades

How Companies Can Restrict Access to Material, Non-Public (i.e., Confidential) Information
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.
Companies Restricted Access (continued)

Visitors should not be permitted to wander through the Companys 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.
Fair Treatment of Minority Shareholders

Ownership structure Transparency of ownership Concentration and influence of ownership Shareholder Meetings Ownership rights Equitable treatment of shareholders of same class
Self Dealing Issues

Trading ahead or frontrunning Cherry picking; Preferential allocations Best price or execution Wash trades Marking the close Churning Misappropriation of funds/securities
Investigation Techniques
Review documents
Internal External
Interview
Harmed parties or whistleblowers Suspected violators Supervisors
Report facts and findings

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
Investigation and Enforcement

Enforcement Objectives
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
Basic Elements of Enforcement Program
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.
Reasons that Investigations Should be Private and Non-public

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 inquiriesall to be referred to supervisors or the delegated press relations personto develop a standard response to press inquiries regarding ongoing investigations
Investigations: Criteria and policy considerations
Allocation of resourcesown staff? Outside auditors or inspectors? Nature of conductwith intent to harm? Unintentional? Size of harm or losses to investors and markets Supervisor and management involvement and ongoing oversight
Develop Theory of the Case

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 othersnote, this theory may change during investigations)
Develop Investigative Plan

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
Issuer and Company Documents
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
Decision to Initiate Proceedings or to Close the Investigation

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
Publicity Considerations
Issue press release after public proceedings initiated Announce enforcement proceedings on (SE/SECP) website
74
Basis for Appropriate Sanctions

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
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 auditorsrather than rotation of partner
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
77
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
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
Council of Institutional Investors

All directors should be elected annually via confidential ballots counted by independent tabulators Audit, nominating, and compensation committeesindependent directors A corporation should disclose information necessary for shareholders to determine whether each director qualifies as independent
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
And Finally...
Disseminate information Educate Instill ethical behavior Partner and transformation
82
CASE STUDY
How Leeson Broke BaringsIssues:
Employee actions and profits (?) Management and supervision activities Accounting and audits practices Board disclosures and (non-) actions Regulatory (non-) actions Ultimate shareholder questions
Leesen/Barings: Role Play

Split into Individual Smaller Groups comprised of:
Board of Directors Shareholders CEO/Management Regulator (i.e., Exchange or Commission) Audit Committee/auditors
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
85
Leesen/Barings: General Questions (continued)

4. Describe some mistakes or fatal errors in judgment made by:
Management and Supervision of Barings Internal Audit CEO Operations (i.e., Back Office) Board of Directors Shareholders Stakeholders (i.e., creditors, debtors, employees)
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
87
Leeson/Barings Case Study

Leesen Keys:
Resultant losses; bad decisions Did not arbitrage; huge positions Hid losses Dual roles as trader/bookkeeper
88
Leesen/Barings Case Study

Management and supervision
Checks and balances; reviews Customer positions Trader positions Questions Reports and reporting
89

Accounting and Audit Practices
Actions of internal auditors Findings of external auditors Audit or Risk Committee practices
90

Board disclosures and actions
Questions on losses Questions on profits Disclosure to shareholders
91

Regulatory actions
Position limits Inquiries Report reviews Hedging Capital considerations
92

Shareholder actions and questions
Risks Disclosure Strategies Remuneration
93
Leesen/Barings Case Study: 13 (Shareholder) Questions

1. What is the companys philosophy towards financial risks? 2. Do (supervisory) board members understand the financial instruments the company uses or owns (particularly derivatives)? 3. Who formulates the firms 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?
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?
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?

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

ISSUES (continued) 5. Lack of supervisiondisclosurecorp. 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
CASE STUDY
Sprint and Coca Cola
Shareholder rights Disclosure Dual roles of auditors Shareholder actions Results
99
CASE STUDY
Insider Trading, Martha and ImClone
Sale before public news Stock decline Friend of CEO Stop/loss order?
100

Regulation FOR Corporate Governance in Pakistan Capital Markets

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Regulation FOR Corporate Governance in Pakistan Capital Markets

Uploaded by

Copyright:

Available Formats

REGULATION FOR CORPORATE GOVERNANCE IN PAKISTAN CAPITAL MARKETS

BUT WHAT IF:

ADB Project TA 3696-PAK "Regulation for Corp. Gov."

Corporate Disclosure Policy Basic Shareholder Rights

ADB Project TA 3696-PAK "Regulation for Corp. Gov."

Immediate disclosure of material information--Code

ADB Project TA 3696-PAK "Regulation for Corp. Gov."

Immediate disclosure of material informationACT-UP Elements

ADB Project TA 3696-PAK "Regulation for Corp. Gov."

Other (Immediate) Disclosures

Remuneration Package of Directors, Executives, and CEO (in Annual Report)

Compliance with Code of Corp. Gov.

Disclosure and Other Recommendations

Disclosure Policy--Response to unusual market activity and clarification of rumors

Continuous Disclosure Requirements

ADB Project TA 3696-PAK "Regulation for Corp. Gov."

Continuous Disclosure (cont.)

Shareholders (Customers) Complaints

At annual meetingheard? Satisfied? Complaint to Stock Exchange

Court system remedy

Initiation of Customer Complaint Investigations

Exchange Investigations: Sources of Customer Complaints

Research history of Brokerage Firm

Customer ComplaintsReview Documents in Firms Files

Exchange Investigation Report

Continuous Disclosure (cont.) Need to Explain

Shareholdings and Transactions Operations: Past and Future

Defects in Annual Reports (Meetings)

Responsibility For Financial Reporting and Compliance

Regulatory Practices for Continuous Disclosures

Investigations of discrepancies or significant notes in annual reports

CIS Disclosure Issues

CIS Guidelines and Practices

CIS Regulatory Techniques

ADB Project TA 3696-PAK "Regulation for Corp. Gov."

Insurance Company Risk Disclosure Issues

Role and Need of Independent External Auditors(Code)

Enforcement Actions on NonCompliant Disclosures

ADB Project TA 3696-PAK "Regulation for Corp. Gov."

Best Practices: Exchange Sanctions for NonCompliance of Listing Rules

Continuous Disclosure Elements: ACT-UP

ADB Project TA 3696-PAK "Regulation for Corp. Gov."

Corporate Governance Practice

ADB Project TA 3696-PAK "Regulation for Corp. Gov."

Regulatory Framework (cont.)

Corporate Governance Structure

Presides over meetings of the Board Ensures minutes of meetings recorded

ADB Project TA 3696-PAK "Regulation for Corp. Gov."

Impartial checks and balances

Majority on Audit and other committeesfor NBFIs

Role of Audit Committee

Other conflicting services, e.g., consulting?

ADB Project TA 3696-PAK "Regulation for Corp. Gov."

Roles, Duties, and Responsibilities of Directors

Significant Issues for Board Decisions and Review

Keys to Board Effectiveness:

Related Party Transactions

Disclosure Approvals needed? By Board? Shareholders?

Related Party Indicators

Determining the Existence of Related Parties (Auditing Procedures)

Identifying Transactions With Related Parties

Examining Identified Related Party Transactions

ADB Project TA 3696-PAK "Regulation for Corp. Gov."