1. This Order shall dispose of the proceedings initiated through Show Cause Notice bearing No. 1(24)
SMD/MSRD/C&IW/2014-1 dated February 25, 2014 ("SCN") served to Karachi Stock Exchange Limited ("Respondent"). The Respondent was incorporated under the Companies Ordinance, 1984 and registered as Stock Exchange under Section 5 of the Securities and Exchange Ordinance, 1969 ("Ordinance") and was dernutualized under Section 6 of Stock Exchanges (Corporatization, Demutualization and Integration) Act, 2012.
2. Brief facts of the case are that Regulations Governing System Audit [Regulatory Compliance] ("System Audit Regulations") were promulgated under Sub-Section 1 of Section 34 of the Ordinance for conducting System Audit of the Brokers in order to ensure compliance with the requirements of the Ordinance; Securities and Exchange Rules, 1971; the Articles of Association of the Respondent; Brokers and Agents Registration Rules, 2001; Regulations of the Respondent and the directives issued by the Securities and Exchange Commission of Pakistan ("Commission") from time to time.
3. In pursuance of Clause 5.1 of System Audit Regulations, two ballots were held on July 31, 2012 ('Ballot No.17') and January 28, 2013 (`Ballot No. 18'). Clause 8.5 of System Audit Regulations requires that the Respondent shall forward the System Audit Reports ("Reports") along with counter comments of the Brokers and the Respondent on discrepancies/observations to the Commission within 45 days of submission of Reports. However, First Reports of non-compliant Brokers of Ballot No. 17 and Ballot No. 18 as submitted to the Commission did not contain views/counter views of the Respondent.
4. Moreover, enforcement actions in respect of Ballot No. 17 and Ballot No. 18 were taken based on Second Reports instead of First Reports in violation of the requirement as laid down under Clause 9.1 of System Audit Regulations. The First Reports of Ballot No. 17 were received from respective Auditors by the Respondent till October 2012; however, enforcement process was initiated by the Respondent from March 19, 2013 onwards. Moreover, perusal of the information revealed that the Respondent failed to take appropriate enforcement actions in a timely manner in respect of non- compliances reported in various Reports including Moosa Noor Mohammad Shahzada & Company (Private) Limited ("MNS") and B&B Securities (Private) Limited ("BBSL").
5. In light of above, the Commission served above referred SCN to the Respondent.
Hearing in the matter of aforesaid SCN was scheduled for March 11, 2014 at the Commission's Head Office in Islamabad. The Respondent vide letter dated March 6, 2014 requested for change in date of hearing. Acceding to the request of the Respondent, hearing in the matter was rescheduled to March 24, 2014 at the Commission's Head Office in Islamabad. However, the Respondent vide letter dated March 21, 2014 requested for another extension in the date of hearing and change of venue.
Acceding to request, hearing was rescheduled for April 8, 2014 at the Commission's Karachi Office.
6. The Respondent submitted its written response to the SCN vide letter dated March 17, 2014. The arguments put forward by the Respondent in its written response on the issues raised in the SCN are summarized below: a) Enforcement actions -- based on Second Reports instead of First Reports: System Audit Regulations need to be viewed as a whole for harmonious and consistent interpretation of various regulations. This regulation allows the Brokers to rectify any non- compliance identified in the Audit Report. Such rectification is then required to be confirmed by a Limited Scope Audit after a period of three months to ensure that the Brokers remain compliant during such period. It is therefore obvious that the disciplinary action can only be initiated if any non-compliant Broker remains so after the Audit Report and the non-compliances are also reported in the Limited Scope Audit Report. If the penal action is initiated and concluded without allowing the opportunity to the Broker to rectify the non-compliance, the provisions of Regulation 5.2 would be rendered a nullity. Reference to "Report" in Regulation does not change the aforesaid position. The basis for identification of non-compliance remains the Audit Report since the Limited Scope Audit Report is only required to confirm if the non-compliance has been rectified. The Limited Scope Audit Report itself does not contain the basis of the non-compliance and therefore the action is to be initiated on the basis of the Audit Report and for this reason Regulation 9J refers to the "Report" instead of the Limited Scope Audit Report. This, however, does not in manner imply that the actions against a Broker found to be non-compliant has to be initiated without allowing him an opportunity to such non-compliance as mandated by Regulation 5.2 b) Non-inclusion of views/counter views of the Respondent: Initial audit reports along with Brokers comments on the same were submitted to the Commission for Ballot 17 vide KSE's letter No. KSE/SECP -7907 dated November 2, 2012. However, regarding the comments of KSE on the same prior to their rectification, KSE vide letter no. KSE-908 dated February 26, 2013 explained that KSE shall be able to provide its comments after completing the enforcement actions. No further instructions in this regard were received from the Commission. Ballot 18 was held on January 28, 2013 and audit reports were received from respective auditors from March 27, 2013 to May 2, 2013. Exchange vide letter dated May 6, 2013 submitted Audit Reports of 31 Brokers to the Commission. c) Non-sharing of the Reports of Intermarket Securities Limited ("IML"); Invest Capital Markets Limited ("ICSL") and First National Equities Limited ("FNEL") on immediate basis by the Respondent: IML Initial audit report for IML under Ballot -- 17 was submitted to KSE on October 24, 2012, by the Auditor, Riaz Ahmed & Company. The report contained Broker's comments on the reported non- compliances. The same was forwarded to the Commission on November 2, 2012, vide above referred KSE's letter dated November 2, 2012. This IML initial audit report dated October 24, 2012 identified 15 non-compliances. The auditor after about three months submitted Limited Scope Audit Report and found that the Broker still had 14 out of 15 non-compliances reported earlier in the initial report, The Limited Scope Audit Report was submitted to KSE on January 14, 2013 which was also forwarded to the Commission on January 23, 2013 Hearing was held on March 29, 2013. During the hearing the CEO of the Broker responded on Limited Scope Audit Report as under: Limited Scope Audit Report point 1.2 -- pertained to obtaining the understanding of Broker's Client Order mechanism, The Broker's response was that all orders which were taken by phone were duly recorded however; due to unavailability of their activity log the auditors were unable to match specific order with recording of the telephone. The KATS record was requested and provided by Exchange to the Broker. The Broker also highlighted the fact that they used to send all confirmation to their clients on daily basis and their ledger balances are reconciled on regular basis, as such all order were fully match with all clients' orders. He pointed out, ''till to date we don 't have any investor's complaint regarding any issue related with order execution and account maintenance. Taking this into consideration the Broker was stated as compliant in this regard. FNEL Auditor vide its letter No. NZAJ/SYS-AUDIKHI/13/FNEE dated May 2, 2013 submitted its Audit Report on FNEL for the period from January 01, 2012 to December 31, 2012. KSE vide letter No. KSE/SECP-2324 dated May 6, 2013 submitted System Audit Reports of all 31 Brokers including FNEL to SECP. d) MNS -- Non-initiation of enforcement action in a timely manner: KSE did not fail to take timely action against MNS. The chronological summary of the events and actions taken by KSE in this regard is as follows: MNS was selected in ballot 17 on July 31, 2012. Audit was conducted by Naveed Zafar Ashfaq Jaffery & Cu, Chartered Accountants in August 2012. Internal audit compiled all initial reports of all non-compliant Brokers including MNS for ballot 17 and submitted the same to SECP vide letter dated November 2, 2012. Immediately after this the review of reported noncompliance and rectification process started by the Broker and the same was re-examined by the Auditor who submitted their final report to the Exchange on February 2, 2013. In accordance with Regulation 9,1 of the System Audit Regulations, and to take possible enforcement action against the company for un-rectified noncomplictnces disciplinary proceedings were initiated and hearing notice was issued to the company on March 19, 2013, the hearing was scheduled for March 22, 2013. The Broker through Nominee Director attended the hearing and informed that he has addressed all issues and has made his Brokerage house Ally compliant in line with the advice of the Auditor and he will be able to submit the NIC Building, 63-Jinnah Avenue, Blue Area, Islamabad.
PABX: 051-9217091-94, Fax No. 051-9218595, Website: www.sec relevant documents and evidence to show his compliance in next two to three working days. His request was granted, the date of hearing was fixed as March 28 2013. But he failed to appear for the scheduled second hearing. On April 9, 2013, KSE received information that the Nominee Director and CEO were not in the city.
On the same day NCCPL vide their Notice dated April 9, 2013 suspended the Broker due to non- payment of their financial obligation to the clearing house. The absence of the Nominee director of the Company from the scene continued while KSE started receiving various investors' claims against MNS. Since the TREC holder was already suspended, no further enforcement action related to System Audit was possible and the matter was being dealt with at the board level. The KSE Board in its meeting held on July 25, 2013 resolved that TREC Certificate of MNS be forfeited with immediate effect. KSE has invited claims from all clients through Notice to market participants and via newspaper advertisement. KSE is in a process of selling the assets in its custody. Sale proceeds from these assets along with contribution from 'FF. KSE will settle the verified claims on pro rata basis. e) BBSL -- Non-initiation of proper enforcement action: B&B was selected for System Audit under Ballot 17 on July 31, 2012. The audit period was July 2011- June 2012_ M/s Haroon Zakaria was the auditor. The audit report was submitted to KSE on October 24, 2012, in which total of 11 non-compliances were reported. The report also contained Broker's comments.
This report was forwarded to the Commission on November 2, 2012, A limited scope review was conducted by the auditor and he submitted his final report to the Exchange on February 7, 2013. After the review it transpired that the Broker has rectified 9 deficiencies out of 11 non-compliances reported in the audit report. The same was forwarded to the Commission on February 18, 2013, The date of hearing was fixed as March 27, 2013. During the hearing, the Broker provided a copy of his clients' bank account statement showing a balance of Rs.. 900,000 representing clients' funds with the Broker as evidence that he is compliant of the requirement of segregation of clients' funds.
Only after verification of this, the Broker's status was stated as compliant in this regard, KSE has therefore taken appropriate action in accordance with the System Audit Regulations and any assertion contrary to the aforesaid is denied being incorrect 9 Non-initiation of enforcement action and subsequent declaration as compliant: First Capital Equities Limited (FCEL) The Broker was selected for system audit under Ballot 17 on July 31, 2012. The audit period for this audit was July 2011 to June 2012. M/s. Naveed Zafar Ashfaq Jaffery & Co was the auditor. The audit report was submitted to KSE on October 30, 2012 which contained one non-compliance relating to the "clients funds and securities not being used by the Broker for any purpose other than authorized by the clients in writing. The Limited Scope Audit Report was also forwarded to the Commission on January 23, 2013. On April 12 they provided a letter from the auditor M's. Naveed Zafar Ashfaq Jaffery & Co which states "FCEL is not using clients' funds for any purpose other than they are authorized by the client." Only after this, status of the Broker was stated as compliant in this respect. Gazipura Securities & Services (Private) Limited (GSL) The Broker was selected for system audit ballot 17, M/s. Naveed Zafar Ashfaq Jaffery & Co was the auditor, The report contained Brokers comments. The auditor conducted a limited review and submitted their final report to the Exchange on February 11, 2013, The same was forwarded to SECP on February 18, 2013. It still contained some non- compliance. The hearing date was fixed for March 25, 2013. During the hearing the Broker confirmed in writing that " No employee of our Brokerage house is allowed to trade on any stock exchange and in this respect the compliance officer of the Broker has already submitted list to NCCPL which is system generated and as such the same does not require to be reported separately.
As regards the Research report, the Broker affirmed that they do not circulate any research to anybody as they are execution Broker only. Only after the scrutiny and verification of the above, the Broker was declared as compliant.
Oriental Securities (Private) Limited (OSL) The Broker was selected under ballot 17. M/s. Riaz Ahmed Saqib Gohar & Co was the auditor. The report was submitted to KSE on October 31, 2012 which was forwarded to the Commission on November 2, 2012. The Limited Scope Audit Report was forwarded to the Commission on February 18, 2013 The date of hearing was fixed for March 26, 2013. Regarding KYC & CDD they informed that they had a policy in this regard as circulated by KSE and disseminated through its website. In view of the above, the Broker's status regarding reported non-compliances was stated as compliant.
Foundation Securities (Private) Limited fFSL) The Broker was selected for system audit under ballot 17. The audit was conducted by Mls. Nadir Javaid Maqsood Imran. A limited scope review was conducted by the Auditor and they submitted the Limited Scope Audit Report to KSE on January 22, 2013 which was forwarded to the Commission on January 23, 2013. The hearing was fixed for March 26, 2013. FSL submitted a letter during hearing from the auditor stating that we have received a copy of the agreement for securities trading through KSE Fix Gateway between KSE and FSL dated October 11, 2011 and received copies of monthly receipts according to KSE Regulations. In view of this, the Broker was stated as compliant. Alpha Adhi Securities (Private) Limited (ASL) The Broker was selected for system audit under ballot 17. The Auditor was MIs. Nasir Javiad Maqsood Imran. The report contained Brokers comment and the same was forwarded to SECP on November 2, 2012, The Limited Scope Audit Report was also forwarded to SECP on January 23, 2013. KSE therefore has proceeded properly and in accordance with the System Audit Regulations and have only declared Brokers compliant after being reasonably satisfied of the relevant facts and any assertion contrary to the aforesaid is denied being incorrect.
The Respondent with regard to declaration of non-compliant Brokers as compliant communicated that: As stated above, the audit reports contained total 76 non-compliances among 20 Brokers and after limited scope review this was reduced to 42 between 13 Brokers. Therefore, the enforcement action was initiated against 13 Brokers and after proper hearing and upon seeing sufficient evidences regarding Brokers' compliance with regulatory requirements the respective proceedings against 12 Brokers were disposed of. g) Non-initiation of enforcement action against non-complaint Brokers: Ballot No. 17: The contents of paragraph 15 of the Notice are denied being incorrect except for the reproduction of Regulation 5.2. This regulation allows the Brokers to rectify any non-compliance identified in the Audit Report.
Such rectcation is then required to be confirmed by a Limited Scope Audit after a period of three months to ensure that the Brokers remain compliant during such period. It is therefore, obvious that the disciplinary action can only be initiated if any non-compliant Broker remains so after the Audit Report and the non-compliances are also reported in the Limited Scope Audit report. If the action is initiated and concluded without allowing the opportunity to the Broker to rectify the non-compliance, the provision of Regulation 5.2 would be rendered a nullity. It has been amply demonstrated above that KSE has not merely relied upon assurances of Brokers and has taken appropriate proceedings where necessary. The Brokers have only been treated as compliant upon submission of sufficient evidence.
Ballot No. 18: The Limited Scope Audit Reports showed that IGI Finex Securities Limited and M.H.Securities (PA)
Limited were fully compliant. The exchange initiated disciplinary action and issued notices for hearing to Dattoo Securities (Private) Limited (Dattoo) and Moonaco Securities (Private) Limited ('Moonaco) on September 10, 2013. On September 23, 2013 Dattoo was issued an advice.
On September 23, 2013 a penalty of Rs. 100,000 was imposed on Moonaco with directions to rectij5, all non-compliances by October 8, 2013. However, after hearing of his appeal against imposition of penalty, KSE Management Committee on December 23, 2013 upheld the appeal and reversed the enforcement action in favour of Moonaco h) Non-submission of Limited Scope Audit Reports to the Commission within prescribed time of 15 days of conclusion of the same: KSE has previously also explained to the Commission that the Limited Scope Audit Report is to be forwarded after conclusion of the same and this is concluded when the disciplinary procedure is concluded. The disciplinary procedure was concluded on September 10, 2013 and the reports were submitted on September 25, 2013 Accordingly there is no delay in providing these reports. i) The approaches and procedures adopted by the Respondent in taking enforcement actions against non-complaint Brokers: KSE has been proceeding properly and diligently and have accepted compliances based on the Auditors reports or other reliable evidence. The Commission has never asked for evidence of independent verification of this evidence nor has questioned the quality of such evidence before this Show Cause Notice, The Commission, despite ample powers to take independent inspection or action, has not proceeded on any occasion against any of the Brokers on the basis of the Audit Reports of Ballot 17 and 18.
7. The Respondent further in the written response stated that: "KSE as noted above has kept the Commission updated with all developments and all matters raised in the Show Cause Notice have been discussed in various meetings held with the Commission as reflected in the minutes of such meetings, as well as through various correspondence with the Commission KSE had been given the understanding that the Commission did not require any further actions in regard to these issues. Regulation 9.4 of the System Audit Regulations empowers the Commission to take action against a broker if the Commission is of the view that KSE has neglected or failed to take action in accordance with the System Audit Regulations. To the best of KSE's knowledge no action has been ever initiated by the Commission under Regulation 9.4."
8. Hearing in the matter of aforesaid SCN was held on April 8, 2014. Mr. Nadeem Naqvi -- Managing Director; Mr. Shafqat All -- Chief Regulatory Officer and Mr. Haroon Askari -- Deputy Managing Director attended the hearing on behalf of the Respondent ("Representatives"). The assertions made by the Representatives of the Respondent during the course of hearing are summarized below: a) The Representatives affirmed that there was no intent of the Respondent to circumvent any regulations as it always endeavored to abide by the regulatory regime. The Representatives further added that the period for which SCN has been served was a transitory period due to demutualization and corporatization of the exchange. They explained that changes were being carried out in the governance structure of exchange and the management responsibilities were being segregated into commercial and regulatory functions during this period. The Representatives added that these changes were undertaken with a clear vision of improving the governance of the stock exchanges in Pakistan. b) The Representatives of the Respondent explained that due to some confusion and misunderstanding, enforcement actions against non-complaint Brokers were not initiated on the basis of First Reports and assured that in future enforcement actions will he initiated on the basis of Reports of non-compliant Brokers. They apprised that Ballot No. 17 was held immediately after the promulgation of the revised System Audit Regulations wherein major changes were carried out in audit process and the scope was enhanced, as a result of which the Respondent faced some operational issues which have now been rectified, c) The Representatives informed that the Respondent has created a separate department specifically for the monitoring of the system audit and as of now, immediate enforcement actions are being taken on the basis of the Reports. They further stated that affairs of Ballot No. 19 are now proceeding satisfactorily and compliance level by the Brokers has also been increased. The Representatives emphasized that the purpose of system audit is to increase the compliance level among Brokers and not to penalize them. d) With regard to non-compliances identified in the Report of FNEL, the Representatives apprised that it has almost paid all penalties and complied with the directives issued by the Respondent.
They further added that there is a need to prioritize the issues according to their seriousness and at present major one is segregation of client's assets and that should be our prime focus. e) The Representatives of the Respondent were enquired about the discrepancies identified in the financial statements of BBSL as of June 30 2012; non-initiation of enforcement action on the basis of Report of BBSL and subsequent declaration of BBSL as compliant. They assured that the requisite information will be provided to the Commission shortly.
The Respondent concluded that there was no malafide or willful negligence of the procedures, there might be some instances of omissions which would primarily be due to this transition phase but would have not been otherwise. The Representatives assured that the Respondent hold the Commission in the highest respect and esteem and laud its endeavours towards improving and developing the exchange specifically and capital market's in particular.
9. I have heard the arguments presented by the Representatives of the Respondent at length during the hearing. Additionally, I have perused the available record and the written response filed by the Respondent. Accordingly, my findings on the arguments and assertions made by the Respondent and the Representatives to the issues raised in the SCN are as follows: a) With regard to Regulation 5.2 of the System Audit Regulations, it is noted that the Respondent misinterpreted the time of Limited Scope Audit. Regulation 5.2 of the System Audit Regulations states that: "If the Report contains any non-compliance(s), the Broker shall rectify thethe same immediately and such Broker shall be subject to limited scope audit in the following year to confirm that such Broker is now compliant of those particular non-compliances where the Auditor found such Broker non-compliant. The period for limited scope audit shall not be less than 3 months ensuring the discrepancies identified in the Report are rectified and the Broker has remained compliant during the said period. The limited scope audit may be conducted by the Exchange itself which shall not alter or affect the Broker's normal selection process or timing through random balloting. The Exchange shall also provide a copy of such report of limited scope audit to the Commission within 15 days of conclusion of the same".
It is clear from the review of the Regulation 5.2 that Broker shall be subject to Limited Scope Audit in the following year covering three months' period and not immediately after the submission of Reports within three months. in this regard, the Respondent's stance cannot be accepted.
Regulation 5.2 envisages two rectification processes to be initiated. One is the immediate rectification of non-compliance followed by Limited Scope Audit in the following year to ensure that recalcitrant broker is compliant with the Regulations. This process of rectification, however, does not stall the enforcement action provided in the Regulation 9. The provision of Limited Scope Audit is to provide an exception to audit process prescribed in the Regulation 5.1 i.e. random balloting and be construed to provide respite to a noncompliant broker. The Regulations cannot be attributed such a meaning whereby its provisions are rendered redundant. The clear language and intent of rules and regulations cannot be subservient to perverse interpretation. On the contrary the penal provisions are to be construed strictly. b) With regard to non-sharing of the Reports of non-compliant Brokers i.e. IML, ICML and FNEL, the Respondent in its written stance asserted that it shared the Reports with the Commission. However, the Respondent ignored the fact that these Brokers were having material and serious nature of non-compliances, the Respondent was required to immediately share the Reports along with its own comments and the comments of the Brokers on the identified non-compliances to the Commission, which it failed to do so However, admittedly they failed to share their views and counter views which were sin qua non of the reporting procedure enunciated in the Regulation 8.5, reproduced hereunder for ease of reference: "The Exchange shall forward to the Commission copies of the Reports of the Brokers audited, along with the views, counter views and comments of the Brokers and the Exchange on the discrepancies/observations, within 45 days of submission of the Reports. Provided that, f the Report highlights any material noncompliance by the Broker, such Report shall be immediately forwarded to the Commission. "
The Reports submitted were deficient in material particulars as per scheme of System Audit Regulations and without essential prerequisites, stalling any punitive action thereto. c) With regard to the enforcement actions against the specific Brokers, which mainly include BBSL, MNS, IML, FNEL and ICSL, the Respondent in its written response and the Representatives during the course of hearing communicated that it initiated the disciplinary process on the basis of Limited Scope Audit Report, whereas, Regulation 9.1 of the System Audit Regulations requires the Respondent to initiate disciplinary proceedings on the basis of Reports of the non-compliant Brokers, which states that: "If the Report identifies any non-compliance(s) including that of the Articles, Rules, Regulations and directives/noticesIcirculars/ guidelines of. the Commission, Exchange etc., the Exchange may, after giving the Broker an opportunity of being heard and considering the severity and materiality of the non-compliances, take appropriate enforcement action including issuing warnings, imposing fines, suspension of membership rights with the approval of the Board etc. The Exchange may by order, direct the broker to pay a fine amounting to not less than Rs. 10,000/- but not exceeding Rs.
200,000/- per instance of non-compliance, in addition to the specific penalty/enforcement action as provided in the relevant law, rules and regulations."
The Respondent by not initiating the proceedings on the basis of Reports failed to initiate timely and proper enforcement actions. Moreover, the Respondents' stance that Ballot No. 17 was held immediately after amendments in the System Audit Regulations, does not absolve the Respondent from its responsibility of proper compliance and enforceability of the applicable regulatory framework. d) The Respondent in its written response, while explaining its stance about declaring non- compliant Brokers as compliant, stated that the requisite information was provided to the Respondent during the course of hearing by the Brokers. Here, it is pertinent to mention that all the evidences on the basis of which Respondent has declared the non-compliant Brokers as compliant; pertains to the same period for which the said Brokers were declared as non-compliant by the respective system auditors. This leads to two of the following possibilities: The said information was not provided by the Brokers to the respective auditors in a timely manner or; The Brokers were non-compliant during the period and subsequently made the requisite changes to make itself compliant and submitted the evidence of the same to the KSE.
In either of the above referred possibilities; the Brokers' status is non-compliant and the Respondent should have enquired the Brokers in this aspect and ensured that all the non- compliances were addressed properly in conformity with the true spirit of the regulatory framework. e) The Respondent while accepting that IML, BBSL and FCEL were non-compliant initiated disciplinary proceeding against these Brokers. The Respondent in its written response, with particular reference to segregation of clients' assets and maintenance of books of accounts, communicated that 1ML provided copy of the bank account and a letter from their Auditor M/s. Rahman Sarfraz Rahim lqbal Rafiq certifying that MIL has opened separate bank account. RBA was declared as compliant on the basis of its statement that the current liabilities as of March 26, 2013 are Rs. 850,000 and it has placed an amount of Rs. 900,000 in the bank account tagged or clients' money. FCEL was declared compliant on the basis of auditors' statement submitted to the Respondent that FCEL is not using clients ' funds for any purpose other than they are authorized by the client. the above referred instances, the Respondent declared the Brokers as compliant on the basis of either a simple letter from respective auditor or copy of the bank statement (tagged as clients'), which cannot be adequately considered as confirmation of the maintenance of segregation of clients' assets by the Brokers. The Respondent should have enquired specific reconciliation as of a date to ensure that the Broker is maintaining segregation of clients' assets. In cases of noncompliant Brokers specifically regarding segregation of clients' assets, it was the responsibility of the Respondent to ensure that the requirement was complied with and enforced in letter and spirit. f) With regard to the Respondent's stance that the purpose of the System Audit Regulations is to increase compliance level among the Brokers and not to penalize them, such a perverse interpretation of a penal provision cannot be appreciated. The Regulations were made to safeguard the interest of investors and infuse confidence in the market. If the delinquent broker is not to be penalized than such a toothless Regulation would not have served any purpose. The very object of clear cut and unambiguous language of Regulations 9 under the heading "Enforcement" was to ensure compliance and penalty was prescribed to punish non-compliant broker Be that as it may, the stance of the Respondent is also negated from its actions in the case of FNEL, to whom the Respondent has penalized time and again is still a non-compliant Broker (as communicated by the Respondent). It is imperative that the Respondent should have strong mechanism in place to handle such instances as the Brokers are custodian of the investors' money and the Respondent is responsible to ensure that investors' assets are not mishandled by the Brokers in any form. g) With regard to MNS, non-compliances were identified in the Report submitted to the Respondent in August 2012 and the Respondent initiated disciplinary proceeding in March 2013 (almost after 7 months). The Respondent's laid back attitude in the matter of non-compliances identified in the Report of MNS led to the default of the Broker and non-settlement of number of investors' claims.
Had the Respondent initiated timely enforcement action, the suspension of the Broker could have been avoided and may have resulted in less damage to the investors. The inaction of the Respondent cannot be condoned on flimsy grounds or innovative meaning attributing to plain and simple language of the System Audit Regulations of which Respondent miserably failed to comply and enforce.
11) With regard to BBSL, the Representatives of the Respondent agreed to provide the requisite information to substantiate the basis due to which enforcement action was not initiated against the Broker. However, subsequent to the hearing the Respondent wrote number of letters to BBSL and enquired about the information and the noncompliances by the Broker. Here, it is pertinent to note that the above referred conduct of the Respondent showed that BBSL was non-compliant and was falsely declared as compliant by the Respondent. Accordingly, the Respondent failed to take appropriate action in a timely manner in the matter of BBSL. i) With regard to the Respondent's stance that the Commission was aware of all the happenings at the exchange and could have initiated disciplinary proceedings against the non-compliant Brokers under System Audit Regulations does not absolve the Respondent from performance of its responsibilities in a diligent manner. The Commission being Apex Regulator is envisaged with all the powers and can initiate disciplinary proceedings, as and when required. However, the Commission is not expected to involve in the micromanagement of the day to day affairs and functions of the exchange including the system audit process. Furthermore, the Respondent being the primary recipient of the Reports containing non-compliances of the Brokers is required to initiate enforcement actions against the non-compliant Brokers and ensure compliance with the System Audit Regulations. The Respondent is expected to take ownership of the responsibilities assigned under the regulatory framework and cannot shift its responsibilities towards others. In this regard, it is also clarified that on the persistence of the Commission two meetings were held with Respondent's team to discuss procedures applied by it to ascertain compliance status of regulations; however, no understanding was ever given to the Respondent that Commission did not require any further actions with regard to the issue.
10. It is pertinent to mention here that the spirit of System Audit Regulations is to uphold the integrity of stock market and safeguard the interest of investors while putting in place effective checks and balances to deter, detect and rectify instances of non-compliances. Moreover, the System Audit Regulations have been promulgated to strengthen risk management; monitoring and oversight of the market intermediaries with applicable regulatory framework which also includes conformity with the requirements of effective Know Your Customer and Customer Due Diligence policies at the Broker level and formulation of framework to reinforce requirements of the Anti-Money Laundering Act.
11. I am of the view that regulations are rendered ineffective if not followed in letter and spirit. The KSE, being Frontline Regulator, is required to vigilantly monitor and oversee the process of system audit of Brokers by the Auditors, properly follow the regulations and enforce it firmly for the protection of investors' interest and to ensure the safety and fairness of the market. The System Audit Regulations, if properly enforced, shall increase the compliance level among the Brokers, in particular aspect of the Risk Management which cover the capital adequacy requirements and segregation of clients' assets. The Representatives of the Respondent, during the course of hearing, agreed that enforceability of the segregation of clients' assets is the need of the hour and would be of greater value to protect assets of the investors' and strengthening of the capital markets' integrity and credibility.
12. After a detailed and thorough perusal of the facts, evidence/information available on record, contentions and averments made by the Representatives of the Respondent during the course of the hearing, it is evident that with regard to the instances highlighted in the SCN, the Respondent failed to take appropriate enforcement actions against non-complaint Brokers as required under the regulatory framework. It is very important that a stock exchange must function in an objective and just manner as it has to set an example for the intermediaries related to its business, enhance the confidence of investing public and promote healthy development of the securities market,
13. Having considered the facts and circumstances described in the above paragraphs and my observations/findings in the matter, I am of the considered view that the Respondent has deviated from the requirements as laid down in the System Audit Regulations and is negligent in the discharge of its duties and obligations. Therefore, in exercise of powers conferred under sub- section (c) of Section 22 of the Ordinance, I hereby impose a penalty of Rs. 1,000,000/- (Rupees One Million Only) on the Respondent.
14. The matter is disposed of in the above manner. This Order is issued without prejudice to any other action that the Commission may initiate against the Respondent in accordance with the law on matter subsequently investigated or otherwise brought to the knowledge of the Commission.