|
Matching & Cheating
Many investors in the Nepali stock market don’t know that they are being cheated by brokers who use a relatively unknown technique called “Matching.” The investors cheated by this method are normally those who occasionally buy or sell shares, not the regular ones who are active almost every day in the market.
When the same broker has both orders of buying and selling the securities of the same company, he is allowed by the existing regulations of the Nepal Stock Exchange (NEPSE) to “match” these orders and execute the transaction. Though this system facilitates the transaction and make the sellers and buyers of the securities happy as the seller gets the cash for his shares and the buyer gets the shares he wanted, the broker can manipulate the transaction in favour of one of his clients at the cost of the other. At the same time, he may also increase his commission earning at the cost of the investors by following another stock exchange technique called “splitting the transaction.” Matching and splitting are the most prevalent mode of securities transaction in Nepal . According to the Securities Board Nepal (SEBON), the regulator of the country’s stock market, about 65% of the total transactions in the NEPSE are executed through matching.
Here is the explanation of how the investors are cheated by matching:
In Nepal , most of the orders to the brokers are made without mentioning the price preferred by the investor. A study by this scribe (published in A Journal of Management and Development Review, January-April 2004) has reported that 62 percent of the buying and selling orders received by the brokers have no desired price mentioned. In technical jargon, it is called “market order”, which in normal parlance can be translated into “open order.” The broker is free to buy and sell such securities at a price he thinks fit.
When a broker has such orders, he can, according to the existing regulations, make one of his clients buy the stock from the other at a price he thinks fit. He does not need to participate in the competitive bidding process at the NEPSE floor. Though this is allowed only when there is no other bidder at the NEPSE floor for the same stock, the chances of such other bids are very rare in NEPSE because of the small volume of transactions. That is why NEPSE every week reports that the transaction could not take place in many stocks, as there were quotes either only on the buying side or only on the selling side of these stocks.
As per the principles of stock exchange, a broker should try to execute the selling order for the maximum possible price and the buying order at the minimum price. This is possible only through the bidding process. But if they are allowed matching, there is a conflict of interest and possible moral hazard on the broker’s part. The broker uses this opportunity for his own gain or to give more benefit to one of his two clients. The client with whom the broker has closer relations will benefit and the other will be cheated. For example, if the broker is closer to the client who is selling his stock, the broker will match the stock at a maximum possible price, thus benefiting the selling client at the cost of the buying client. Similarly, if he is closer to the buying client, he will match the stock at the minimum possible price, thus benefiting the buyer at the cost of the selling client.
Though NEPSE has fixed a range of prices within which the subsequent transactions should take place, it has not stopped the brokers to benefit by matching at the cost of the investors.
For example, there is no such price range fixed for the transaction that takes place on ex-dividend or ex-rights day. On March 30, 2005, four brokers matched the shares of the World Merchant Banking and Finance Company Ltd. at Rs. 102 and Rs. 103 while the same stock was bought and sold at Rs. 135 per unit before the book closure for the AGM and the company did not announce distribution of dividends or right shares which would have justified so drastic reduction in its share price. The same stock was sold for Rs. 118 on April 4, 2005 . The investors who sold these shares on March 30 were clearly losers and those who bought them were winners, and it was due to the brokers’ manipulation.
Of course, the broker will get lower commission when he sells the stocks at a lower price because the commission rate is calculated on the business volume. There is, however, another method available through which he can increase his commission earning. This is called “splitting the transaction.” If the transaction volume is below Rs. 25,000 the broker gets a commission at the rate of 1.5 percent of the transaction, and if the volume is higher the commission rate goes down. Thus while matching, the brokers split the transactions into several lots of Rs. 25,000 or less so that they earn 1.5 percent commission from the entire transaction. Again, the loser is the investor, though in this case it is the selling broker who has to pay the commission.
NEPSE has no motivation to control this because the main source of revenue is 25 percent of the commission earned by the brokers. Therefore higher the commission earned by the broker, higher the earning of NEPSE.
That is not all. There is still one more method followed by brokers to benefit from this regulatory environment. Though a broker is strictly prohibited from buying and selling stocks under his own name, he can do so under the name of his friends or relatives. So he can benefit by matching the shares held in his friend’s name by selling them to an occasional client at a higher price. Or he can match the shares of the occasional client at lower price to buy them in his “friend’s” name. Thus it can be argued that this facility of matching rather encourages the brokers to be involved in buying and selling shares themselves, under fictitious names, by violating professional ethic.
Matching is also helping market manipulators to increase the price of their selected stock by matching small quantities of shares at a higher price and thus misleading the naïve investors who would be tempted to buy large quantity of shares at the artificially increased price from the same manipulators.
It is not that the authorities are not aware of this problem. Feeling the insufficiency of the existing regulations to control the misuse of the matching facility, SEBON had sometime ago issued a list of directives in this regard. But NEPSE refused to implement the directives because the requirements fixed by the directives would increase the workload of the floor staff.
If matching is totally banned, the government may lose some revenue as the total transaction in stocks may be reduced and its impact will not only be on capital gain tax but also on the tax earning from the commission earned by the brokers. But the question is whether the cheating of the general investors should be allowed to continue. Thus it calls for a proper regulatory framework so that the investors are not cheated while the brokers also get a fair commission for their service even by pursuing their profession honestly.
|
