As Justice Ahmed Keerio announced the verdict inside a humid courtroom of the Sindh High Court last week, it marked an occasion that comes far too rarely: The Securities and Exchange Commission of Pakistan (SECP) had just won a case.
Victories enjoyed by the Securities and Exchange Commission of Pakistan (SECP) are few and far between when it comes to the capital markets. When they do end up getting a win in their column, it is a cause of celebration, even if the decision comes decades after the SECP first gives an order.
In Pakistan, the efficacy of the SECP is a major issue. The job of the SECP, for any reader that is unfamiliar, is to make sure that fairness and transparency is achieved in the capital markets like the stock exchange. You see capital markets work with certain sets of rules. Insider trading, bad faith deals, information exchange, and withholding material information are all white collar crimes that can unfairly disadvantage some investors. The idea is that the SECP keeps a check on such activities.
Unfortunately, even though the role is well defined, the track record of the regulator has been patchy to say the least when it comes to getting convictions in the courts of the country. The way it works is that when something suspicious comes up, the SECP carries out the relevant investigations and then pursues these cases to the full extent. They contact the people involved and try to get to the bottom of the matter. If they find wrongdoing they can issue orders against individuals or organisations involved.
While the procedures followed by the SECP have their own issue, a major obstacle in implementing these orders comes from the courts. If the SECP rules against someone, they can take the SECP to court for the decision. In most countries there are arbitration laws and procedures that make this process fast. In Pakistan, stay orders and judicial lag can drag them out for decades in some cases. On top of that, a lack of judges experienced in financial crimes can further delay an already painful process. But what went on in the recent case that the SECP has won? To understand the full story, we need to go back. [restrict level=1]
It takes ages
In 1997, a young man entered the bank branches of Habib Metropolitan Bank Limited (HMB). It is November in Karachi and the man has just been hired as a junior officer at the bank. As time went by, he was able to climb the organizational hierarchy ending up as the Assistant Vice President (AVP) handling the investments of the bank in 2014.
The job description of the new AVP was to be able to carry out the decision making on the equity investments that were being carried out by the bank.
For anyone that is unaware, a bank, like any other business, is set up to earn a profit. Where a cloth manufacturer might use cotton or raw materials to manufacture cloth and earn a profit, a bank has money as its raw material. Depositors give funds to the bank and earn interest on these deposits. The bank then has to use these funds in order to earn a return from these funds. The better the banker, the better the investments that he will make.
After investing these funds in different classes of assets, the bank will earn income or revenues on the investments that it has made. After paying back the return to the depositors, the amount left can be considered the profit being earned by the bank. This means that the higher the return the assets generate, the higher the profit. This leads to the bank investing in safe classes of assets like Government bonds which will yield a consistent return while bundling them with investments in the stock market which can lead to a higher but risky return.
This is the equity function of the bank which looks to invest in the best stocks which can yield a higher return for the bank. Zakir Hussain Somji was one of the individuals who was able to make the decision regarding which stocks or companies the bank could invest in. The power this position holds is huge as he has a large amount of funds owned by the bank which can be used to invest in.
That is why the SECP also exists. A bank has enough money that any investment or divestment they make in capital markets can spike or tank a stock. That means any person with prior information of what a bank is going to do has for all intents and purposes a crystal ball that can see the future. Theoretically they could buy stocks in a company right before their bank invests in it and make a killing from the raise in stock price that takes place after their investment. That is why the SECP keeps a check on the personal investments of individuals with access to this crystal ball. The case involving Somji has to do with something similar.
The offense
According to Criminal Complaint No. 29 of 2018, the SECP charged Somji with using his position and influence to make personal gains which disadvantaged the bank. The Complaint, filed in the Special Court (Offences in Banks) Sindh, stated that there was a breach of Section 128 of Securities Act 2015 which had been breached and had to be punished under section 159 of the Securities Act 2015.
Section 128 states that no person can indulge in insider trading and any contravention of its rule shall be considered an offence. The definition of insider trading covers a vast region as many different types of trading can be seen as being insider trading. Fundamentally, insider trading is supposed to encompass trading where an individual has information available with him that is not available to the whole market. Based on using this information, he can make an investment decision which will benefit him while the remaining market remains oblivious.
In order to prohibit insider trading, SECP defines it as any transaction that is conducted on information that is only available to a select group of people. This leads to asymmetric information being available in the market. The asymmetric nature means that the information is limited in terms of its availability and gives an unfair advantage that can be traded on and profit can be earned. Inside information is defined as any information that can have an impact on the price of the share that has not been made public. This is the asymmetric nature of such information. As certain portions of the investing public have the information, the SECP is allowed to investigate such activities which create an unfair advantage.
The SECP raised the charges against the accused and asked for punishment under section 159 of the Securities Act 2015 which would have meant a jail term of maximum 3 years and a fine of three times the gains earned by the individual.
Investigation carried out
The case that was filed by the SECP revolved around the fact that the individual had carried out inside trading and used fraudulent practices which ended up making gains for him while it led to a loss to the bank. The investigation that was carried out used the KATS (Karachi Automated Trading System) data which records all the trading carried out in the stock exchange. From January 2014 to February 2016, the investigation team gathered the data that was related to the trading carried out.
The investigation was initiated after it was seen that trading activities being carried out were suspicious and there was a need to scrutinize the trade data in relation to that. Before trading was automated, brokers would gather in a trading pit and shout buy or sell orders at each other. The system was crude and basic, however, it allowed the traders to recognize who was trading with each other. With the inculcation of automated trading, this aspect went away as buyers and sellers had no knowledge who the counter party was. This led to trading being carried out on anonymous terms as the interface changed from faces to computer monitors.
With the advent of technology, it became virtually impossible to carry out trades between buyers and sellers on a consistent basis. This basic understanding was the reason that the activities of Somji were recognised as a breach. In a period of two years, the SECP saw that the bank and Somji’s personal account matched trades around 173 times. The chances of this happening are astronomically impossible.
The probability of the same accounts trading with each other was very low which showed that there was some influence of management being carried out to make this possible. This was already a breach of the code set out by the SECP. In addition to that, Habib Metro had also restricted its employees from carrying out trading in their personal accounts which was also being violated.
In terms of shares being traded, the investigation found out that out of 11,795,100 shares of different companies bought by Somji, around 1,230,900 were bought from Habib Metro which was more than 10% of purchases. On the other hand, Somji sold 11,836,600 shares of different companies from which 4,915,200 were sold to Habib Metro. This accounts for 41.52% of the shares sold.
Inside trading was being carried out by front running the bank. Bought from market and sold to HMB or bought from HMB and then sold in the market. The profit earned was around Rs 28 lakhs.
Front running and impact on the market
Even though the charges levelled by the SECP seem to be concerning inside trading, the sophistication level of the offence was much lower than the one that insider trading entails. When insider trading is mentioned, the picture that comes to mind is surreptitious information being exchanged in hush whispers that leads to trading being carried out. The inside trading that was being carried out was based on the sole element that Somji had a large amount of funds that he could use to invest. With such a large amount of finances, Somji could buy the shares of a company and lead to an increase in the share price by carrying out a buying in the specific share. Similarly, once he decided to sell his position, the fall in price could be substantial based on the value of trade that was to be carried out.
Having this power, the SECP claimed Somji started to use front running in order to make personal gains for himself. Before he would carry out a large purchase, he had the information that the buying was to be carried out. Using this information, he would buy the shares in his personal account beforehand. Once the share price would increase, he would either sell the shares to the bank or back into the market at a higher price.
Similarly, when he was about to sell the shares of the bank in the market, he would sell the shares in his personal account before the bank was going to do so. He would sell them at a higher price before the bank would and end up selling at a higher price. This all might seem like a victimless crime, however, he was actually breaching a fiduciary duty that he had. Rather than thinking of the bank first, he was looking to make a personal gain. Somji should have executed the trades for the bank first rather than trading for himself. As an officer of the bank, he was not only trading in violation of the policies but also earning personal gain.
The defense presents its own case
In response to the allegations made, the defense had certain arguments on their own part. First of all, they claimed that there was no money trail in relation to the Rs 28 lakhs that was being claimed by the prosecution. The prosecution had failed to substantiate the gain that was earned. The defense also contended that the account that was being used for trading was a joint account between Somji and Shayan Ahmed. While investigation was carried out against Somji, no such action was taken against Shayan Ahmed.
In the same line, the bank account that was used for trading was a joint account with Farhan Ahmed who was also not investigated by the SECP.
The defense also contended that the trading activities that were being carried out by the bank were being approved by Farhan Aslam who was the superior of Somji at the bank while the head of department, Intikhab Hussain, also gave the approvals while the SECP did not make any of these individuals part of the investigation. In response to the investigation, the accused was made the Area Compliance Officer and the bank did not fire him after the alleged offence came to light.
The court has its own word
After the case came in front of the court, it had to consider both sides of the arguments being made by the SECP and the accused. The court boiled down the whole case to four points. First of all, it tried to prove if Somji had the power to place the orders and did he earn gains from these trades? Secondly, it tried to see if any offence had been committed and lastly what the final decision of the case should be.
The court gave a detailed analysis in regards to the points that were in front of it.
The court admitted on record that the accused admitted he had the power to place the orders and also admitted that matching of orders on such a consistent basis was highly unlikely. Use of KATS meant that trading was supposed to be anonymous which was not being seen in this case. One of the witnesses of the case was the Chief Compliance Officer of Habib Metro who provided the trade data, disclosed the bank’s investments processes, the team responsible for the equity decision making and the process of decision making in the investments.
One of the persons named was the accused.
When the witness was deposed, he stated that the accused confessed his guilt to the superiors, however, the confession could not be admitted into court as it was considered as being extra judicial in its nature.
When this witness was cross examined by the defense, he contended that the accused had been made the Area Compliance Officer by the bank, however, this was after the bank had carried out its own investigation and had terminated him in June of 2017. The investigation put the blame squarely on Somji which led to his termination in the equity department.
In regards to the defense’s contention that only Somji was investigated, phone recordings had been obtained which showed that only the accused was placing the orders on behalf of the bank. In regards to the trading account being joint in nature, the witness stated that all the trading activity was linked to the CNIC of the accused which meant only he was responsible for the trading being carried out in his personal account.
The fact that the bank and its compliance was accepting all the trades being carried out by Somji was due to the fact that he was only showing them the trades that were being carried out on behalf of the bank and his personal trades were not being disclosed. These trades were not even allowed to be carried out in the first place.
The defense never questioned the trade data that had been compiled which pointed towards the fact that it was correct and could not be contended.
The decision and punishment
After considering both sides of the argument, the court finally passed its judgement as it found Somji guilty of the breach that he had carried out. The court punished Somji under section 159 of the Securities Act 2015 which allowed him to be punished up to three years and fined for the offence. The court found Somji guilty of breaching Section 128 and handed down a fine of Rs 8,599,938 which was three times the gain that he had earned.
In terms of passing a jail sentence, the court felt that the case had been ongoing since 2017 and that the accused had suffered mental anguish due to the case. In light of this, he was given no jail time and only a monetary fine. Still, under section 162 of the Securities Act 2015, the court stated that it could recover the fine within seven days. If the fine had not been paid, the convicted could be remanded in jail till the amount had been paid.
As the court is dismissed and the convicted contemplates his fate and future, the decision can be considered a landmark decision for the capital markets of the country. The country has been marred by countless stock market meltdowns in the past which have seen the guilty not being punished and made an example out of. When Somji was carrying out these offences, there might have been hubris at play which allowed him to act in the way he did. The damage is that participants keep breaching the rules and are never punished while the public trust starts to decay. This can be considered a small notch of victory for the regulator as they have been able to get a conviction on its record. Hopefully this will be the first of many such cases going forward
On the heels of the judgment the Chairman of SECP, Mr Akif Saeed, stated that the judgment will boost investor confidence in Pakistan’s capital markets and, in turn, facilitate capital formation. He also expressed hope that the ruling will set a precedent for pending cases and ongoing inquiries into insider trading and market manipulation.
Everyone loses
A lot of this story has been details of the court case in question. Over here, we need to make a very important clarification: the case in question could be appealed further by the accused if he wants to prove his innocence. Of course, as the court noted, going through a seven year trial is a ridiculous and painful process. In Pakistan, the judicial system is so sluggish and mind boggling that going through the process is punishment enough, as the court has noted.
The figure given of Rs 28 lakhs is also not a very large one, and it took seven years to get to this decision. The courts are a pain both for the SECP and those accused. And this is a case that has been decided relatively quickly. Back in November 2024, the Islamabad High Court upheld an order of the SECP 24 years after it was first issued.
Read more: In 2000, the SECP passed an order. It took 24 years for the IHC to uphold it
This was a case that originated in 2000. In the 90s and the early 2000s, the capital markets of Pakistan were like the Wild West. There was little that existed in terms of rules and regulations and there was a blase attitude towards having a formalized manner of trading. Brokers were not mandated to ask the source of financing for the client, trading could be carried out without any sort of uniform account opening and custody of shares was mostly kept by the brokers rather than giving them over to the clients.
In order to place an order with the broker, the client would contact their agent and place a trade with them. These agents are people who have been hired by the brokerage house and act as a liaison between the company and the client. The client would contact the agent and ask them to place a trade. Any trust the client had in the brokerage house was based on his relationship with the agent and the agent would be the only point of contact. As the controls were not stringent, the agent could buy the shares for the client and place them in their own account rather than being mandated to deposit them in the client’s account. This is where the story of this case starts.
Much of this has changed since.
Accounts are only opened after a thorough Know Your Client (KYC) procedure has been carried out. Brokers need to record the orders being placed with them by the client and the shares of the clients are deposited with the Central Depository Company (CDC) once they are bought or sold. Any movement in these shares is communicated to the clients on that day and, in case they feel something untoward has happened, they can report this discrepancy to the relevant authorities.
While the SECP has caught up in some ways, our court system remains as paralysed as it was decades ago. An overflow of cases, a lack of technically trained judges and lawyers, and corrupt practices mean that neither the SECP, nor any defendant or complainant acting against them can look forward to anything but an arduous process. Without judicial reform, cases like this will continue to languish, and justice will be delivered late if it ever is. And we’re pretty sure there is a very famous saying about what it means when justice is delayed. [/restrict]
