Stock Market crash of Bangladesh 2010

Reasons and Recommendation

 Stock Market crash of Bangladesh 2010

Abstract

The Capital Market of Bangladesh is passing tough times since December 2010 as high volatility
is eroding the capital of Thousands of Investors that might turn into social instability. This fall is
caused by many factors that I tried to identify and tried to link up between causal factors of
market crash and regulatory failure. Primary issue related problems was faulty listing methods
and IPO overpricing, few numbers of new listings, revaluating assets before company listing,
high premium in issuance of right share/Repeat IPO etc. while secondary market related
problems was stock splits and stock price manipulations through block trading, circular trading
and insider trading. Investor’s greed and irrational behavior played a big rule to make the stock
prices sky rocking as they were crazy to buy shares without judging the company fundamentals.
Shares of the companies with closed operations and big accumulated losses were rising
constantly due to investors high risk appetite that caused them to loss everything. Government
had already taken many steps (including SEC reforms) to stabilize the market but failed as
investors confidence is in the bottom level. Government and regulators should work together to
identify the main speculators and should brought under proper trial to bring investors back to the
market. Regulator should make reforms on Listing procedures and other faulty regulatory
frameworks to ensure transparency and efficiency in the capital market and also should bring
clear guidelines regarding Private Placements, Asset Revaluation, Insider Trading, Dealing with
Omnibus Accounts etc.

Keywords: Stock Market, regulatory bodies, syndicate, investors, Stock market Bubble, Liquidity
Manipulation, Omnibus Account.

Table of Content
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 Stock Market crash of Bangladesh 2010

Introduction

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 Stock Market crash of Bangladesh 2010

The indispensable part of an economy is Stock Market which acts as an intermediary for
movement of funds between surplus units and deficit units. It is a place to raise capital by means
of issuing share and hence transacting it on a regular basis among the participants. Thus, a share
is just like a commodity sold in the stock market through stock exchange. By purchasing shares
of a company an investor become the owner of that company up to the intrinsic value of his
shareholding and also become entitled to the profit or loss of the company proportionate to his
share.
In a market economy, the capital market plays a vital role in the efficient allocation of scarce
resources. Well functioning and developed capital markets augments the process of economic
development, efficiency welfare through different ways such as encourage savings, draw more
savers and users into the investment process, draw more institution into the intermediation
process, help mobilization of non financial resources, attract external resources, discipline sick
organization and investments organizing production of goods and services and creating
employment opportunities (Chowdhury, T.A., 2005). There is a saying that the stock market is
the pulse of the economy. In the developed western world, how the stock market is doing is not
only a matter for prime-time news bulletin but also a matter of public interest on an hourly-basis.
Keeping conspiracy theory aside, instability or extreme volatility of a capital market may suggest
weaknesses in the market. Further, this is an indicator of looming economic uncertainty (Monem,
R., 2011).
There is no doubt that a vibrant capital market is likely to support a robust economy but two
major catastrophes in the capital market of Bangladesh within one and half decades do not
indicate the existence of a vibrant market; rather these show a highly risky and unstable capital
market. The recent surge in the capital market has shaken the whole country as millions of
people became insolvent within a very short span of time. It was observed in 2010 that the DSE
(Dhaka Stock Exchange) general index was the highest ever which made it Asia’s top performer
after China (Islam, 2011), while the reverse scenario was scaring investors in the 1st quarter of
2011 as the lowest down ever in the index was observed during that period.
The present study is an endeavor to justify the present condition of the stock market identifying
the reasons of the catastrophe, to measure the impact of the surge and fall on the investors
simultaneously identifying their expectations from the regulatory bodies and to provide
recommendations to overcome the present conditions.

Objective of the study

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 Stock Market crash of Bangladesh 2010

The main objective of the study is to analyze the reasons and impact of the recent catastrophe in
the stock market in Bangladesh. To achieve the main objective, the study sets the following
specific objectives:
1. To depict the present scenario of the stock market and the recent catastrophe of the stock
market in Bangladesh
2. To find out the reasons of the recent catastrophe in the stock market in Bangladesh.
3. To provide some recommendations to overcome the present scenario of the stock market
in Bangladesh.

Methodology of the Study

We have used only secondary sources of data and they are

Secondary Source
The used secondary sources for the study are Books, investigation report, past research,
newspaper, journal, electronic publications and indices data of DSE and CSE

Limitations of the Study

The present study is a self funded work and therefore it was not possible to collect opinion of all
types of people relating to the stock market. It could be much more representative and
comprehensive, if opinion could be collected from other parts of the country

Previous research on this topic

Many studies are done around the world to find the reasons of stock market crash and linked
with regulatory issues. Recent economic crunch and stock market crash in US motivated
economists to conduct in-depth research on it. In Bangladesh many analysts expressed their view
regarding the capital market crash but no comprehensive research work is still done on it.
Government had formed an enquiry team headed by Mr. Ibrahim Khalid, former deputy
Governor of the Central Bank to make a probe into the recent activity and to identify the culprits
that submitted their report to the government. I am going to discuss the causes of recent Credit
Crisis of 2007-2009 and “Ibrahim Khalid stock probe report” regarding the stock market of
Bangladesh in this chapter

Stock Market and Crash

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 Stock Market crash of Bangladesh 2010

What is a stock market?

Fellowes (2008, p.29) described that stock market has same features like a normal mar-ket with
buyers, sellers and agreed price. He also added that there will be a middleman who guides
investor to deal offers of buying and selling shares in the stock market We usually find stock
exchange, regulatory organizations, investors, listed companies with securities, broker houses,
merchant banks, and other intermediary organizations in a stock market with co-operation of
central bank and government of the country.

What is a stock market crash?

“Stock market crash is a sharp and unexpected decline of stock market prices for a very short
period of time, usually accompanied with the decline of many other assets’ prices” mentioned by
stockmarketcrashes.net. It causes significant capital losses of investors and speculators. The
market participants become panicked which leads to more losses.

Reasons of Stock Market crash 2010

After the recent catastrophe of share market of Bangladesh, Government of Peoples Republic of
Bangladesh had formed a high powered committee in 2011 to investigate the issue and to give a
report to the government within two months. The committee was headed by the ex-deputy
governor of Bangladesh Bank, Mr. Khondokar Ibrahim Khaled and the committee was named
“Ibrahim Khaled share market probe committee”. The committee published a report that was
initially kept undisclosed to the general people but later on it was disclosed as investors groups
and civil society was creating pressure over the government for disclosing it. The committee
submitted a report consisting of the reasons for the crash and recommendations with couple of
case studies on 7th April, 2011. The report has identified a group of manipulators including key
officials, auditors, issuers, issue managers, brokers, individual investors and some other
stakeholders

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 Stock Market crash of Bangladesh 2010

Figure 1: DSE daily DGEN index of December, 2010

Figure 2: Daily DGEN index of January, 2011

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 Stock Market crash of Bangladesh 2010

According to the Investigation report (2011) of the probe committee, reasons for the stock
market crash are following:

1) Role of market regulators and their employees: The role of SEC to control & monitor
capital market, working in favor of manipulators, approving unethical proposal and
issuing wrong directives which lead to unexpected market conditions deteriorated the
image of SEC. Investigation report mentioned some names of corrupt employees of the
market regulators who were directly or indirectly responsible in the market manipulation.
There is a job overlapping between SEC and exchanges. Such as, DSE & SEC both
organizations have surveillance department for the same job but there is no co-ordination.
Listing committee of DSE & CSE examines listing application of company but SEC
doesn’t do it properly and approve it. Placement of Mutual fund & IPO at a price lower
than the market value has become a new method of bribery for powerful employees of
regulators. There is another accusation that these senior level employees received
placement by using other`s name which is very difficult to identify. The report admits
that SEC doesn’t have enough employees for example; qualified accountant, financial
analyst and researcher to control and monitor the market. Rahman&Moazzem (2011)
identified in their study that Dhaka stock exchange is becoming more volatile but the
regulators are unable to defend it. They also suggested increasing manpower and quality
of professionals in SEC.

2) Demutualization of Exchanges: There are both elected & nominated members in DSE
and CSE. Basically, elected members run the administration due to less interest &
relation of nominated members. As a result, the players of the capital market act as
controllers. Meanwhile, controllers are inactive during unethical activities due to conflict
of interest. In the investigation report it was said that different stake holders of capital
market and civil society support & demand for demutualization of exchanges. The
meaning of Demutualization is separating controlling functions from controller’s
functions, empowering controller and taking decisions without being motivated by the
market players.

3) Investment of bank in the capital market: In 2009 & 10 banks and financial
institutions invested huge amount of deposit money in the stock market. As a result share
prices sky rocketed until December 2010. When Bangladesh Bank restricted more than
10 percent investment of deposited money, increased CRR and SLR ratio, created
liquidity crisis and market crashed.

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4) Pre-IPO & IPO process: Investigation committee considered that due to Pre-IPO & IPO
manipulation share prices sky rocketed and that is the main reason for the share market
crash. Manipulators illegally & unethically created a Kerb market in Pre-IPO stage.
Without recommendation by the listing committee application for IPO was accepted.
SEC did not examine abnormal asset revaluation and indicative price. As a result in Pre-
IPO or IPO stage placement process and placement trade Kerb market overvalued share
prices. This eventually generated liquidity crisis in the capital market.

5) Uniform face value of share: During the meeting between investigation committee and
different stake holders of share market, a most important reason for abnormal climbing of
index was indicated to uniform face value of share at Taka 10. Splitting share does not
change revenue or asset of a company and should not affect the share price. But Small
investors showed their utmost inter-est to buy split share with their small investment and
consequently pushed the price up. Up to 62 listed companies split their shares in 2009 &
2010. So, it ab-normally increased liquidity of the market and brought notable change in
market capitalization. Investigation report shows that MC increased 655% of companies
those adopted share uniform and MC increased only 46% of those that did not adopt.
From July 2009 to December 2010 the role of total MC were 81.5% of companies which
adopted share uniform and only18.5% those that did not adopt.

6) Placement trade / Kerb market: Before issuing IPO, Issue manager or Issuer Company
sell shares to their nominated person and that is called Private placement or pre-IPO
placement. Private placement is risky because it doesn’t have accounting discloser. In the
developed countries there are some fixed rules but in Bangladesh SEC didn’t have proper
rules for it. As a result some manipulators used it as a tool of price manipulation.
Investigation committee found that in most of the cases placement was offered at less
than the IPO price. Though aim of public offering is participation of public but placement
doesn’t make sure it. Eight companies issued convertible preference share in 2009 & 10
in which average 69% went for placement. So, participation of the public was hindered
and that created placement trade or Kerb market. Some companies distributed 50-90
percent of their paid up capital in private placement. However, when a company raises
too much paid up capital through private placement, the number of free-floating shares
decreased. That’s why the difference between demand & supply push share prices up.
Moreover, non-listed companies created liquidity crisis as huge investment was stuck up
with these companies. Placement created new process of trading outside of the share

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market and that is illegal. By taking chance of placement many small companies raised
capital from illiterate and un-informed investors with their artificial financial reports.

7) Omnibus account: Investigation report found Omnibus accounts of ICB and merchant
banks as another major reason behind the stock market debacle. Every branch of
merchant bank operates only one omnibus account. There could be 3-10 thousands BO
Accounts under the omnibus account which are not under the surveillance of SEC. So,
information of individual accounts and its transaction are kept only with merchant banks.
As investigation reports shows that this kind of account made a lot of illegal transactions.
It publishes name of 30 big players including ICB for a lot of suspicious transactions and
says most manipulators traded from the omnibus accounts. It was also reported at least
Taka 2.5 billion has been traded from hidden or omnibus accounts.

8) Asset revaluation & Rumor: By taking chance of weak asset revaluation method
companies have overvalued their asset. In this process dishonest auditors generated
artificial audit reports. So, calculating of NAV on overvalued asset indicates wrong
signal. Some companies issued Bonus shares against unrealized gain of revalued asset
price which is a faulty accounting practice. There is rule to maintain provision against
“deferred tax” during asset revaluation to pay tax in future, but companies are not
following it. Investigation reports pointed some companies which got NAV more than
100% to 3,472% after asset revaluation.

9) Book building method: It’s a procedure of determining price of IPO at which it is

offered. The fair price is determined by the demand of a security from institutional
investors and their indicative price. The main aim of introducing this method in
Bangladesh stock market was to attract more firms for enlisting in the stock exchanges
through fair share pricing. However, it was found as an instrument of manipulating
market prices. Investigation report reveals that during the price discovery/bidding stage
investors manipulated share prices for placement with too high price. High price was
maintained only for the lock-in period and then investors offloaded their shares. As a
result they pulled out a lot of profit within a short period and after that the share price did
not increase. In this pro-cess corrupted Issuer and issue manager manipulated the price.

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10) Serial and artificial trading: Some manipulators created artificial active trading
environment among themselves through bulk transaction and increased share prices.
Moreover serial trading and price manipulation by many buy-sell orders through different
accounts and broker houses which overheated the market.

11) Issue of Right and preference share: Right Share is issued at a discount price to
existing shareholders. SEC took 4/5 months to take the decision of right issue proposal
which is mysterious. Meanwhile companies inform the market about Right issuance and
increased the share price. Moreover, issuance of Right share increase number of share
which should decrease share price but it did not happen. Investing in Preference share is
safe to get a fixed percentage of profit. To make the share attractive companies keep an
opportunity to convert it and in that case it is called Convertible Preference Share.
Companies issued preference share for only 2-3 months even for 1 month which is not
common in other countries. The faults with convertible preference share were its time
period (short), convertible process and private placement. Investigation committee found
that SEC did not have proper guidelines for Right and Preference Share issuance.

12) Suspicious transaction of top players: Investigation report reveals some names of
individual and institutional investors as top buyers and sellers during abnormal increase
and decrease of index in different time periods. The transactions of these investors were
suspicious and affected the market heavily and liable for abnormal rise and fall.

13) Block placement: There was a lot of suspicious block trading of mutual funds. Some
investors got enormous amount of placement time to time.

14) Direct listing: With the approval of SEC few companies have been directly listed in the
stock exchange. These companies come to the market with inflated share prices.
Investigation report mentioned that indicative prices of these companies were determined
even 58 times more than EPS and 9 times of NAV. Though share prices of these types of
directly listed companies have been artificially determined, but SEC or exchanges did not
investigate the reason of abnormal price.

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Recommendation

We suggest following recommendations for stronger capital market in Bangladesh in line of our
analysis.

1. Demutualization of Stock Exchanges

Stock Exchanges of Bangladesh are controlled by its members under the supervision of SEC. But
such control creates conflicts of interests in the market. In India, Bombay Stock Exchange was
demutualized under the pressure of Government. Bangladesh should follow the same. Peoples
heading the DSE are highly debated for his rule in market manipulation (Ibrahim Khalid Report).
According to the report “conflict of Interest” made the body almost inactive on its rule.
Government should force Exchanges to be demutualized. In this regard, government can take the
help of any donor agency (World Bank or Asian Development Bank) to develop necessary
infrastructure.

2. Strengthening the Market Surveillance Systems

To strengthen the SEC’s operations and governance, (i) a real-time market surveillance system
should be installed, and (ii) capacity building will be provided to improve monitoring,
supervision, and enforcement capacity of the SEC. The SEC surveillance system should
complement the stock exchanges’ own market surveillance activities and ensure that the
exchanges are performing their regulatory functions well. The stock exchanges should establish a
regulatory review committee to support the implementation of surveillance systems and to
prevent vested interests of the exchanges’ members from encroaching on the exchanges’
regulatory functions. The committee will be composed of representatives from the legal and
accounting professions, who will be independent of members of the exchanges, and an SEC
representative who will participate as an observer. The committee will be responsible for
establishing policy and direction in applying the regulations of the exchanges; reviewing existing
regulations, regulatory practices, and procedures of the exchanges; and providing views on new
regulations and recommending appropriate regulations. The two stock exchanges can form an
inter-market surveillance unit, to share and discuss matters of mutual concern and to share
information.

3. Ensuring Integrity and Efficiency of SEC Members and Staffs

Staff of SEC, CSE, and DSE will be trained in modern market surveillance and enforcement
techniques to enable them to be more effective at detecting trading irregularities and market
abuses. The training will include examination of evidence and analysis of trading accounts of

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brokerage firms. In addition, staff will be trained not to contaminate evidence obtained from the
surveillance system that could later be used in prosecuting a matter in the courts.

4. Co-ordination between SEC and Stock Exchanges

From the analysis and Investigation report we found lack of coordination and inconsistencies
between the functions of SEC and Stock Exchanges. Esp. in case of Company listing and
surveillance, Coordination is highly important. To combat future debacle both SEC and stock
exchanges should work closely.

5. Bank Finance in Capital Market

Commercial Banks relies heavily on capital market by investing directly and indirectly (Margin
Loans) that creates high risk on depositor’s money. So Regulators should impose restriction on
investment on Capital market by Banks. In India, Banks can invest a certain portion of their
owner’s equity/capital (not deposit) to capital market but in Bangladesh Banks can invest 10% of
their total liability that is not rational at all. Such huge investment by banks pushes only the
demand side and creates bubble to the market as supply side response is very low in Bangladesh.
SO, regulators should set new limit on the basis of Shareholders equity and should monitor this
very strictly.

6. Introduction of Asset Revaluations Policy

In my analysis, I showed how companies revalued their fixed assets to manipulate stock price
that caused distortion in the market and ultimately caused huge sufferings for Investors. In
Bangladesh there is no certified surveyors in Bangladesh and also don’t have any Chartered
surveyor Institute. So, their jobs could not be reliable and that’s why regulators should establish
clear guideline for Asset revaluation. Chartered Accountant (CA) firms can play a rule to revalue
asset until Chartered surveyor Institute. But CA firm that conduct asset revaluation should not
audit the company account. Also companies should take SEC nod before disclosing the asset
revaluation result and SEC should check the result with due diligence.

7. Consistency in Regulation

From the analysis made in this report, I found various inconsistencies in the SEC regulations.
SEC notification came only when the market rises continuously for many days that do not reflect
good regulation. The Bangladeshi stock market needs to move towards a market based system of
regulation for capital market activities and SEC should act proactively instead of its reactive
response. SEC does not measure the costs and benefits of its rapidly changing
guidelines/regulations. SEC and GOB should have long term visions regarding market and
should make cost-benefit analysis before making any rule/law as it affect investor’s return.
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Regulatory parity and consistency between all institutions and participants conducting related
capital market activities has to be ensured at all times.

8. Supply of adequate securities

Supply side response during last two years was very poor relative to sky rocking demand of
securities that helped to inflate the price of almost every share traded in Dhaka and Chittagong
stock exchanges. Government initiated to offload more securities of government owned
enterprises several times to meet unanticipated demands of the market but finally it has failed to
offload these securities. Government should take measures to bring good companies (both local
and MNCs) by allowing easy access and good IPO price to promote the market. Other regulators
like (Bangladesh Bank, Bangladesh Telecom Regulatory Authority, Registrar of Joint Stock
companies and Ministries) can also take measures to enlist new companies to the market to
enhance the depth of it.

9. Transparency in listing procedure

As listing methods (Book Building methods and direct listing) played a vicious rule to damage
the stability of the market; major change should be brought to make it acceptable and
transparent. In this regard, SEC should promote only Fixed Price method as it lack less
opportunity to manipulate the offer price. SEC can also use due diligence to fix the offer price
under this method.
For Book Building Method, price bidder Eligible Institutional Investors (EIIs) should deposit at
least 10% of the value of the securities that they are interested to buy. Such deposit will make
them more careful and help them to make better analysis to quote any price. Lock-in period
should be fixed to at least 180 days at short lock-in (21 days) help them to speculate them more
to get higher returns. Institutes and persons behind the book building scam should be under trial
and steps should be taken to the confiscate their ill-gotten wealth. Peoples of Regulatory bodies
who allowed such offences also should be brought under proper trial. Direct listing method
should not be allowed as it is very to manipulate under this method.

10. Serial Trading and Manipulation

As there are many evidences that some investors and institutions were involved in the serial
trading and insider trading to manipulate the price of individual stocks under regulatory supports.
Manipulative trading under Omnibus accounts should be fully investigated and peoples and
institutions under the hidden accounts should be identified and also should bring under trial if
any irregularity is found.

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Conclusion

As an important part of the economy of the country, well-functioning of the capital market is a
must for the industrialization process of a un-industrialized country like Bangladesh but un-
stability in the same may negatively affect the total financial system. Therefore, all related
corners including Government, Regulatory bodies, Listed Companies, Brokerage houses,
institutional investors, and retail investors should act rationally to maintain the stability in the
capital market for the greater interest of the country.

Reference

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2. Ali, M. A. (2011). The view of general investors towards Bangladesh Bank’s strategy
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