{{Under Rule 8 read with Rule 12 of the Brokers and Agents Registration Rules, 2001 (the "Brokers Rules") and Section 28 of the Central Depositories Act, 1997 (the "CDC Act")}}
1. This Order shall dispose of the proceedings initiated through Show Cause Notice SMDSOUTHISCN/114107 dated August 03, 2007 {;'Show Cause Notice") issued to DJM Securities (Pvt.) Limited (the "Respondent") for violation of Rule 8, Rule 12 and Clause A5 of the code of conduct contained in the Third Schedule to the Brokers Rules by the Securities and Exchange Commission of Pakistan (the "Commission").
2. Basic facts of the case are that the Respondent is a member of the Karachi Stock Exchange (Guarantee) Limited (the "Exchange") and is registered with the Commission under the Brokers Rules. An enquiry was initiated by the Commission in exercise of its powers under Section 21 of the Securities and Exchange Ordinance, 1969 ("1969 Ordinance") and Ford Rhodes Sidat Hyder & Co.
(`the Enquiry Officer") was appointed as the Enquiry Office; under the above mentioned section inter atia: a) to enquire into the dealings, business or any transaction by the Respondent during the period from April 1, 2006 to June 15, 2006 (`the Review Period"); b) to identify any and all the acts or omissions constituting the violation of the 1969 Ordinance and the Rules made thereunder; and c) to identify violations of any other applicable laws, including but not limited to the Brokers Rules and Regulations for Short Selling under Ready Market, 2002 ("2002 Regulations") and The Central Depository Company of Pakistan Limited Regulations ("CDC Regulations") read with the CDC Act.
3. The findings of the Enquiry Officer revealed several instances of potential non compliances with applicable laws and regulations. A copy of the Enquiry Officer's report was sent to the Respondent under cover of a letter dated May 7, 2007 which required the Respondent to provide explanations on the observations of the Enquiry Officer together with supporting documents.
4. After perusal of the Respondent's replies to the above mentioned letter, which did not adequately explain the position, a Show Cause Notice was issued to the Respondent under Rule 8 of the Brokers Rules and under section 28 of the CDC Act. stating that the Respondent has prima facie contravened Rule 12 of the Brokers Rules read with Clause A5 of the code of conduct contained in the Third Schedule to the Brokers Rules and requirements of the CDC Act and Regulations. Rule 12 of the Brokers Rule and clause A5 of the code of conduct are reproduced as under: Rule 12- " A broker holding a certificate of registration under this rules shall abide by the code of conduct specified in the Third Schedule"
Clause A5 of the code of conduct-"A broker shall abide by all the provisions of the Act and the rules. regulations issued by the Commission and the stock exchange from time to time as may be applicable to them"
5. The Respondent was called upon to show cause in writing within seven days and appear before the Executive Director (SMD-South) on October 11, 2007 for a hearing, to be attended either in person and/or through an authorized representative.
6. The hearing was held on October 11, 2007 which was attended by Mr. Dawood Jan Muhammad, the Representative of the Respondent, who submitted a written reply and argued the case.
7. A summary of the contentions that were raised by the Respondent in the wntten submission / during the hearing and findings / conclusion of the Commission on the same are as follows:
8. Blank Sales 8.1 In terms of Regulation 4 of the 2002 Regulations, 2002, blank sales are not permissible.
The findings of the Enquiry Officer revealed 25 instances of blank sales during the Review Period, 81 The Respondent made the following submissions on this Issue ("Issue No. I"): The Respondent contended that the blank sales as identified by the Enquiry Officer were made by 5 clients of the Respondent who may have pre-existing interest in the form of holding in their CDC sub accounts maintained with other brokerage houses, CDC investor account or as security against margin financing or some other form of borrowing with one or the other banks. The Respondent contended that considering the heavy volumes of trades it is impossible to verify before each sale. whether the client has pre-existing interest. The Respondent also stressed upon the need for changes in the 2002 Regulations in light of the developments and changes in the functioning of capital markets specially after the blocking of CFS held securities, 8.3 I have considered the submissions of the Respondent and am of the view that a brokerage house is required to abide by all the provisions of the relevant laws as well as the rules, regulations issued by the Commission and the stock exchange from time to time as may be applicable to it.
For this purpose a brokerage house must establish a sound system of internal controls corresponding to the size of its business and appoint sufficient personnel with appropriate professional knowledge and experience to prevent any violation of laws and regulations. Heavy volumes of trades cannot be an excuse for not abiding by the applicable laws and regulations.
8.4 Considering the above facts and the contentions of the Respondent, it is established that on 25 occasions blank sales have been made in violation of Regulation 4 of the 2002 Regulations. In terms of Rule 8 of the Brokers Rules, more particularly sub rule (ii), sub rule (iii) and sub rule {iv) thereof, where the Commission is of the opinion that a broker has inter alia failed to comply with any requirements of the Securities & Exchange Commission of Pakistan Act, 1997 p1997 At or the 1969 Ordinance or of any rules or direction made or given thereunder and/ or has contravened the rules and regulations of the Exchange and/or has failed to follow any requirement of the code of conduct laid down in the Third Schedule, it may in the public interest, take action under Rule 8(a) or
(b) of the Brokers Rules.
8.5 In light of the above i.e, the fact that the Respondent made blank sales, the Respondent has violated the 2002 Regulations thereby attracting sub rule (iii) of the Brokers Rule and has also failed to comply with Clause A5 of the code of conduct contained in the Third Schedule to the Brokers Rules, thereby attracting sub rule (iv) of the Brokers Rule. Accordingly, a penalty of Rs.25,000 (Rupees Twenty Five Thousand) is hereby imposed on the Respondent under Rule 8 (b) of the Brokers Rules,
9. Missing Account Opening Forms 9.1 In terms of Regulation 74 of the General Rules & Regulations of Karachi Stock Exchange (Guarantee) Limited ("KSE Regulations") it is provided that: "The Members of the Exchange shall adopt the Standardized Account Opening Form, attached as Form-I to these Regulations, for their new Account Holders with immediate effect and for the existing operating accounts, the same shall be brought into conformity with Standardized Account Opening Form effective from March 31, 2004".
9.2 Findings of the Enquiry Officer revealed that the Account Opening Forms of certain customers were not available with the Respondent.
9.3 The Respondent made the following submission on this Issue ("Issue No 2"): The Respondent contended that it provided the Enquiry Officer all account opening forms pertaining to individual clients. The Respondent also undertook to provide copies of all the forms again to the Commission. The Respondent pleaded that the Institutional clients do not generally provide account opening forms and asked the Commission to intervene and direct the Institutions to submit the forms.
9.4 I have considered the contentions of the Respondent and am of the view that it is the obligation of a brokerage house to abide by all the relevant laws and regulations which require it to obtain duly filled account opening forms of each and every client before opening its account. In the absence of an account opening form the account should not be opened at all. If this approach is followed the Institutional clients will inevitably submit the account opening forms in order to be able to trade.
9.5 However, considering the fact that non-submission of account opening forms by institutional clients is an industry-wide problem which is faced by all the brokers and that majority of account opening forms pertaining to the individual clients were submitted by the Respondent, I am inclined, on this occasion, to take a lenient view in the matter and will not take any punitive action under Rule 8 of the Brokers Rules. As such. I believe a 'caution' In this instance to the Respondent would suffice and I would further direct the Respondent to ensure that no individual or Institution is admitted as a client unless it submits a duly filled account opening form and that the Respondent should clearly direct all of its existing clients to immediately submit duly filled account opening forms.
10. Book entry securities of various clients kept in the CDC House account 10.1 in terms of CDC Regulation 2.11.1, the term "House Account" is defined as: 'An account maintained on the CDS by an account holder for recording book entry securities beneficially owned by the account holder'.
10.2 Findings of the Enquiry Officer revealed that the Respondent had a practice of keeping shares placed by clients as margin against trading in its House Account in violation of the CDC Regulations.
10.3 The Respondent made the following submissions on this Issue ("Issue No. 3"): The Respondent contended that as a matter of practice, those individual clients who conduct leverage trading have their shares placed in the CDC House account for the purpose of using the same as margin. The Respondent claimed that if these shares are placed in an investor sub- account, it creates a third party interest and the Respondent would not have access to the same, According to the Respondent, these shares are used to offset daily losses and determination of mark to market ratio. The Respondent further contended that Banks, DFIs and other financial institutions as a policy do not accept third party interest for pledge of shares and the shares of these customers are pledged for obtaining finance. The Respondent further claimed that the procedures suggested in the rules will only result in litigation and the Respondent will never be able to recover losses from its clients. The Respondent suggested that the Commission should devise a method whereby it could undertake to make good the losses of clients of the brokerage houses.
10.4 I have considered the contentions of the Respondent and the issues raised therein which are addressed below: CDC accounts are opened to establish the title and beneficial ownership of the shares and keeping the shares of clients in the CDC House account as margin is a serious violation of the CDC Act, as it results in the change in the beneficial ownership of the shares. A brokerage house must design and implement a proper risk management system which allows it to prevent and recover losses from its clients without violating any laws and regulations. Further, the practice of pledging the shares of clients with financial institutions is also not acceptable and in order to provide financing to the customers, CFS and margin financing could be utilized.
10.5 Considering the above mentioned facts, it is established that the Respondent has violated CDC Regulation 2.11,1.
10.6 In terms of Section 28 read with Section 3 of the CDC Act, it is provided that the Commission can impose a penalty for contravention or an attempt to contravene any provision of the CDC Act or CDC Regulations.
10,7 Since by keeping the book entry securities of different clients in its CDC House account. the Respondent has violated CDC Regulation 2.11.1, I am of the view that a penalty of Rs.25,000 {Rupees Twenty Five Thousand) be imposed on the Respondent.
11. Order Register 11,1 In terms of Rule 4(1) of the Securities and Exchange Rules 1971 ("1971 Rules"), it is provided that: "All orders to buy or sell securities which a member may receive shall be entered. in the chronological order, in a register to be maintained by him in a form which shows the name and address of the person who placed the order, name and number of the securities to be bought or sold, the nature of transaction and the limitation, if any, as to the price of the securities or the period for which the order is to be valid."
11.2 Findings of the Enquiry Officer revealed that the register as mentioned above was not maintained by the Respondent during the Review Period, 11.3 The Respondent made the following submission on this Issue ("Issue No. 4"): The Respondent contended that the register as provided above was not possible to maintain due to practical difficulties and all orders executed are recorded in a computerized system.
11.4 I have considered the contentions of the Respondent and am of the view that the computerized record of orders executed as maintained by the Respondent is not a substitute for the Order Register as required under the Rule 4(1) of the 1971 Rules, since these reports only record those orders that are placed by a brokerage house into KATS and not the orders received from the clients.
11.5 However, the Commission is cognizant of the practical difficulties associated with the maintenance of such an Order Register manually and in order to facilitate the brokerage houses in meeting the requirements of the said rule, the KSE is developing a system which will be provided in due course. However, it is noted with disappointment that the brokerage houses and exchanges were not able to keep pace with evolution in technology and significant increase in trading activities whereby a system should have been developed to enable simultaneous recording of orders received from clients and their incorporation in a database to generate the order register as required under the requirements of the Rule 4(1) of the 1971 Rules.
11.6 Considering the above mentioned facts I am inclined, on this occasion, to take a lenient view in the matter and will not take any punitive action under Rule 8 of the Brokers Rules. As such I believe a 'caution' in this instance to the Respondent would suffice and I would further direct the Respondent to ensure that full compliance is made of all the Regulations in future for avoiding any punitive action under the law.
12. Order Confirmation 12.1 In terms of Rule 4 (4) of the 1971 Rules, which provides that: "A member executing an order of a customer shall, within twenty four hours of the execution of the order, transmit to the customer a confirmation which shall include the following information, namely:- i. date on which the order is executed ii. name and number of the securities: iii, nature of transaction (spot, ready or forward and also whether bought or sold); iv, price; v. commission, if the member is acting as a broker; vi. whether the order is executed for the members own account or from the market."
12.2 Findings of the Enquiry Officer revealed that confirmations of orders executed were not provided to the clients on a regular basis despite the above legal requirement.
12.3 The Respondent made the following submission on this Issue ("Issue No. F): The Respondent contended that it has a practice of providing order confirmation to the institutional clients through fax/ delivery and to individual clients through courier service, However, it is not practical to maintain record of all order confirmations sent.
12.4 Considering the above mentioned facts I am inclined to take a lenient view and no punitive action is required under Rule 8 of the Brokers Rule. However, I would direct the Respondent to take measures to maintain evidences of dispatch of order confirmations in order to demonstrate compliance with the above mentioned rule.
13, CDC Balance statements 13.1 In terms of Regulation 6.2A.1 of the CDC Regulations, it is provided that: `Every Participant shah send by the 10th day of every month to all Sub- Account Holders maintaining Sub-Accounts under the control of such Participant Holding Balance statements showing the number of every Book-entry Security entered in every such Sub-Account as of the end of the preceding month, Such Holding Balance statements shall be generated from the CDS and shall be sent to the Sub-Account Holders in the manner set out in Regulation 2.6.4."
13.2 Findings of the Enquiry Officer revealed that the Respondent did not have a practice to send the CDC Balance statements to all of its customers by the of each month as required under the CDC Regulations and where the CDC Balance statements were sent, the same were not generated from the CDS, instead the statement was sent on the Respondent's own format, 13.3 The Respondent made the following submission on this Issue ("Issue No. 6): The Respondent submitted that CDC Balance statements are provided to its clients upon request and are also sent to all of its clients on half yearly basis 13.4 have considered the contentions of the Respondent and am of the view that sending the CDC Balance Statements on a half yearly basis or providing the same upon request does not fulfill the requirements of CDC Regulations, which require that the Balance statements must be sent by the 10th of each moth to all the clients. However, acknowledging the practical difficulties in sending the CDC balance statements to all of the clients of the Respondent, including the dormant accounts, I am inclined, on this occasion, to take a lenient view in the matter and will not take any punitive action under Rule 8 of the Brokers Rules. As such, I believe a caution' in this instance to the Respondent would suffice and I would further direct the Respondent to ensure that full compliance is made of all the rules and regulations in future for avoiding any punitive action under the law.
14. In view of what has been discussed above, I am of the considered view that no punitive action is necessary in relation to Issues No. 2, 4, 5 and 6 and a simple caution will suffice in case of Issues No. 2, 4 and 6. As regards Issue No, 1 and 3, as stated above, penalties of Rs. 25.000 (Rupees Twenty Five Thousand) for each issue are imposed. which should be deposited with the Commission nol later than fifteen (15) days from the date of receipt of this Order.