October 23, 2017, 3:57 pm
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From fiduciary fraud to family feud

Underlying the recent controversies on unauthorized stock trading transactions within the capital markets are accusations of stockbroker fraud on one end and what might simply be a case of dirty linen laundering and family feud on another. Albeit combined into a singular aberration, the allegations of fraud are cast under an altogether different light -- the bedroom night lamp. Scandals hidden on account of shame. 

Unfortunately it is happening at a time when the market is surging, hitting historic highs and investor confidence in corporate returns are on steroids. Relative to the iffy, wishy-washy volatility in the political arenas where reckless political initiatives by congressmen may result in conflicts among the three branches of government as creeping authoritarianism wipes off unsteady capital market gains, the bravado of equity investors is commendable. The private sector has its thinking caps on and is snug even where congressmen struggle to sprout single brain cells from pork fat.

The stock market surge is indeed critical at this time.

More so given increasing uncertainty from a peso unexplainably weakening, aggregate prices rising, and weaker purchasing powers when new excise taxes kick in. As for registered foreign portfolio investments these are down by almost 50 percent relative to the more upbeat sentiments of local players who’ve been propping the market.

Unfortunately the issues on unauthorized stock transactions involve local investors. Allow us to briefly revisit the trading controversy’s details and the subsequent and timely reaction by the authorities.

Early last August preventive suspension was imposed on a securities broker for trading five accounts involving a total market value of over P2.6 billion. This was the result of a complaint filed a few days earlier by clients of the trading firm as they sought to prohibit further trading of their shares which they claimed were unauthorized. They likewise pleaded for the authorities to protect and preserve records pertaining to these transactions. 

Subsequently, they demanded that there be delivery of their shares of stocks and an official request was made for the appropriate agencies to take over the operations of the company doing the trading.

The authorities’ quick responses are commendable. The Securities and Exchange Commission (SEC) has since been on the ball and has instructed its Market Securities Regulation Department (MSRD) to investigate all allegations. Within a week of the suspension the MSRD issued a subpoena duces tecum, directing the suspended stock broker to immediately submit to the SEC relevant trading and financial data.

Three things were obviously in play. 

One is that shares were being traded without their owner’s knowledge as the latter needed a third party to stop the trading. Normally this is unnecessary.

Two, the records of the transactions needed to be preserved. This meant that the owners of the shares had no personal records of the trades.

Lastly, where the owners of the traded stocks needed to demand the delivery of the actual share certificates signifying ownership meant that the trades were not yet at that stage where certificates were printed.

These bring to fore the dangerous vulnerabilities associated with employing a stock broker inadequately controlled until it is too late. While the exchange authorities in this instance were quick to freeze transactions to mitigate the damage, these vulnerabilities remain.

Investors vest trust and consequently a lot of power in stock brokers where the exchange has little within its arsenal to verify and validate a trade as it happens in real time. When funds are placed in a broker’s hands for the latter to trade as they please given the ups and downs of stock movements within a day, sans specific controls and instructions from an investor on trading authorities, there is little an exchange can do.

The second vulnerability is that the documentation controls at the very instance of the trade are largely with the broker. This adds to a broker’s powers however vicarious the agency relationship is between the investor and his broker.

Lastly, the delivery of the actual stock certificates naturally involves a lag between the instance of the trade and the physical custodianship of the stock certificates by its owners. Such lead times and certificate-less transactions create risks.

The levels of trust between an investor and his chosen stock broker are immeasurable factors that would have either mitigated the risks and vulnerabilities in these areas, or in the specific case under scrutiny, worsened those risks.

As alarming as this scandal might be for the ordinary investor it has an upside that shows not simply the competence of our authorities but perhaps this is a rare and isolated case and may not be reflective of our exchanges. The victims of the alleged fraudulent transactions are related to the former president of the firm that traded the shares. This could very well be a simple case of a family feud unreflective of the Philippine stock market.
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