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CSE: Are the conditions right for pump and dump?

06 Feb 2021

The global pandemic is still not over and so is not the destruction it has been causing to the global economy. Even though the global economic output has recovered for a considerable extent now, as countries are increasingly adopting measures to live with the pandemic in society, the global economy has a very long way to go back to its pre-pandemic trends, as global financial institutions predict. This is mainly due to risks associated with global debt accumulation being exacerbated in the face of the pandemic. The Sri Lankan economy has been no exception. In January this year, the Central Bank of Sri Lanka (CBSL) downgraded the growth forecast for the year 2020 to a negative 3.9% from its earlier projected contraction of 1.7%, and stated that it expects the Sri Lankan economy to grow by 6% this year. The local economy too has been recovering to a certain extent; nevertheless, it is yet to reach the pre-pandemic levels. Amidst not-so-great global and local economic performance, the Colombo Stock Exchange (CSE) has risen to become the world’s second best-performing stock, as noted by Bloomberg. It has been breaking its own records achieved a decade ago. Last Monday (1), CSE recorded a 13-year high turnover of Rs. 23.7 billion. The benchmark All Share Price Index (ASPI) crossed 7,000 points on 6 January this year for the first time since 24 November 2015, closing the trading day at 7,036.76 points. The ASPI crossed the 7,000 mark for the first time on 1 October 2010 and reached its highest points level, recording 7,811.80 points on 14 February 2011. Meanwhile, days after, ASPI broke its own records as it reached its all-time high index tally on 18 January again, closing the 10th trading day of 2021 at 7922.66 points. In addition to this, CSE recorded two significant milestones on 13 January, with the market capitalisation reaching an all-time high value of Rs. 3.25 trillion and recording 52,559 trades, which is the highest number of trades recorded within a market day. The number of trades carried out on that day surpassed the previous record of 49,921 carried out on 18 August 2011. But this was all amidst sustained net foreign selling at CSE and we have talked about it enough for us to not talk about it here again.   Doubts cast by Opposition   In mid-January this year, in the midst of a record-breaking performance of the CSE, Samagi Jana Balawegaya (SJB) parliamentarian Eran Wickramaratne cast doubts over CSE’s recent performance, warning local investors to be careful of possible pumping and dumping in the stock market. Wickramaratne, who is also the former State Minister of Finance, during a press conference noted that we hear a lot of comments on the economy, “lots of nice stories and fairy tales”, but, in fact, people are being fooled by only focusing on the stock market. “When we hear the message of the share market – it was not only the message; we need to look at the messenger as well,” he added. He added that with the replacement of foreign investors with local investment, there seems to be a pattern similar to what was seen in 2011 and up to 2014, when there was corruption in the stock market. “People in high offices were involved in the racket, according to the forensic audit report. They had an opportunity to go before auditors and make their case, but they did not make their case due to reasons best known to them,” he stated. Meanwhile, Frontline Socialist Party (FSP) Education Secretary Pubudu Jagoda, during a press conference in early January, cast doubts over possible money laundering that might be taking place at CSE. Jagoda stated that the listing of companies in the CSE has soared dramatically in the recent past, while the Budget 2021 decided to provide a 50% tax concession for the years 2021/22 for companies listed before 31 December 2021 and maintain a corporate tax rate of 14% for the subsequent three years. “This might be an attempt to bring in all the black money of Sri Lankans into the country and pump it into the CSE in order to whitewash the money. This is possibly an attempt of money laundering,” Jagoda opined. SJB parliamentarian Dr. Harsha de Silva too made similar statements in early January during a press conference and warned of another pumping and dumping at CSE. “What is this old game? Shares of the companies that do not have a real value are being promoted by local investors while foreign investors are selling their stocks. Young investors with lack of experience and knowledge compete with each other to buy these promoted stocks. Then the CSE performance skyrockets, but as the time goes, prices of artificially pumped stocks will go down. The people who pumped those stocks might withdraw their profit and be long gone by then. Those young and small investors will take the hit,” Dr. de Silva noted. Meanwhile, on a further note, drawing a comparison between the possible pumping and dumping that could happen at the CSE and the pumping and dumping that took place from 2011-2013, Wickramaratne noted that improper activities took place at the CSE during the aforementioned period and the Central Bank decided to call for a forensic audit. He added that there were five major reports compiled in the aforementioned forensic audit.   Government stood firm by its ‘surveillance’   Issuing a statement in mid-January, the Securities and Exchange Commission (SEC) stated that in order to ensure the integrity of the market and to protect the large number of investors in the face of the surge in the daily number of transactions, the regulatory and supervisory framework of the SEC has been strengthened by enhancing the capability and capacity of its Supervision and Surveillance Divisions. “Given the increased level of market activity, the CSE has taken measures to heighten the level of regulatory supervision, market surveillance, and monitoring of risk. The CSE has been proactively taking such measures in the past and will continue to do so,” the statement added. Entirely ruling out possible pumping and dumping, the Sri Lankan Government firmly noted that pumping and dumping is mostly associated with penny stocks. But what are penny stocks?   Penny stocks   According to investopedia, a penny stock typically refers to the stock of a small company that trades for less than $ 5 per share. In the past, penny stocks were considered any stock that traded for less than $ 1 per share. The US Securities and Exchange Commission has modified the definition to include all shares trading below $ 5. “Penny stocks are usually associated with small companies and trade infrequently meaning they have a lack of liquidity or ready buyers in the marketplace. As a result, investors may find it difficult to sell stock since there may not be any buyers at that time. Because of the low liquidity, investors might have difficulty finding a price that accurately reflects the market,” investopedia adds.   Is every stock at CSE a penny stock?   As the new definition of penny stocks include any shares that are trading for less than $ 5 per share, which is a Sri Lanka rupee equivalent of Rs. 965, almost all the shares that are being traded at CSE go into the category of penny stocks, including that of John Keells Holdings (JKH), Sampath Bank PLC, and Expolanka PLC. After the market reopened for trading in May last year after a prolonged closure of seven weeks amidst an islandwide lockdown to control the further spread of the virus, fundamentally sound stocks gained significantly from their two-digit share price levels. These stocks which belong to the “penny stocks” category grew by 100-200% or by even a higher percentage right after CSE opened for trading in May. For example, banking stocks were trading well below the Rs. 100 mark in mid-May last year for the first time since 2009. JKH was at some point Rs. 94.10, which last Wednesday (3) was Rs. 159. Sampath Bank was at Rs. 99.90 in mid-May, which last week was around the levels of Rs. 179. Sri Lanka’s largest private commercial bank, Commercial Bank of Ceylon PLC, was trading at Rs. 55 in mid-May, but was trading at Rs. 93.30 last Wednesday. As the aforementioned stocks, along with many stocks, have gained significantly since then, it raises a question whether they were pumped as, by definition and according to what government sources said, all of them belong to the “penny stocks” category. In which case, Sri Lanka might need to come up with its own definition for penny stocks where it classifies, for example, shares that trade below Rs. 50 as penny stocks which will filter out fundamentally strong stocks and help both traders and the regulator to clearly identify penny stocks at CSE, as currently there is vagueness surrounding the local definition of penny stocks. There is also ambiguity around identifying penny stocks during a subdivision of shares. According to Jonathan Lea Network, a group of business solicitors, sometimes referred to as a “stock split” by those more familiar with US legal terminology, the subdivision of share capital refers to the process whereby a company that has shares of one nominal value decides to split those shares into shares of a smaller nominal value. For example, if a company has one share issued with a nominal value of £ 0.20, it could subdivide this share into two shares with a nominal value of £ 0.10 each.   Pump and dump on the way?   Previous records of manipulations in the name of pump and dump   During the year 2012, a total of 19 investigations were conducted by the SEC into instances of suspected market misconduct, including market/price manipulation, insider dealing, and frontrunning. Controversies over manipulation at CSE began to emerge in the third quarter of 2012. Pressure from high places in the government was exerted on then SEC Chairman Thilak Karunaratne to resign from his position due to the investigations that were being conducted by the SEC into companies that were abusing the share market. Following his resignation, Dr. Nalaka Godahewa was appointed SEC Chairman. It should also be noted that Indrani Sugathadasa Weeratunga, wife of Lalith Weeratunga (current Principal Advisor to the President), served as the SEC Chairperson in 2011. Nevertheless, she tendered her resignation in December 2011 in order to “uphold her principles” amidst alleged market manipulations.   Infamous pump and dump   These manipulations included a practice called “pump and dump” – a scheme that attempts to boost the price of a stock through recommendations based on false, misleading, or greatly exaggerated statements. The perpetrators of this scheme already have an established position in the company’s stock and sell their positions after the hype has caused the share price to increase. It creates an artificial picture which masks the stock’s true value. The manipulators use this to their advantage to earn a profit, while investors who are unaware of the manipulation make decisions based on the available information stand to lose, sometimes substantially, as a result of manipulation. In fact, manipulators count on this, often making a profit on the losses of others. This practice is illegal based on securities law and can lead to heavy fines. Some of the stocks that are reported to have benefited from this scheme were Ceylon Grain Elevators (CGE), Brown & Company PLC, Piramal Glass (Ceylon) Ltd., Galadari Hotels (Lanka) PLC, and Laugfs Gas PLC.   EPF’s entry    Reports alleged that the CBSL released funds from the Employees’ Provident Fund (EPF) to encourage EPF investments into these “pump and dump” stocks. Releasing EPF money into the private sector of the country was also facilitated by the long-pending requirement of the International Monetary Fund (IMF), with whom Sri Lanka has had 16 back-to-back financial arrangements. As a result, the EPF made billions in losses. The Fund incurred a loss of Rs. 700 million on an investment of Rs. 3 billion made in CGE equities. When the EPF invested in CGE, the share value was Rs. 250. The EPF also invested in a number of CGE shares when they were at Rs. 185 per share. Nevertheless, as the process of pumping was over and dealers began to sell their CGE shares, the price of a share dropped to a dramatic Rs. 55. Meanwhile, the EPF also made investments in Piramal Glass’s stocks in April 2012. The Fund purchased stocks at Rs. 6.20 per share, increasing its total shareholding in the company to 10%. And again, as the dumping of stocks began within one week of EPF’s investments into Piramal Glass, the share prices went down by Rs. 5.20, causing a loss of Rs. 50 million to the Fund. The EPF’s poor investment decisions did not stop there, as it purchased shares of Galadari Hotels worth Rs. 23.7 million at a cost of Rs. 32.50 per share; the purchase was made from Nawaloka Hospitals and a few other parties, which ended up increasing EPF’s stake by 13%. The trading price per share of Galadari Hotels soon came down to Rs. 13, once again causing the Fund to incur an additional loss of Rs. 500 million. The investment made by the EPF in Laugfs Gas was another loss-making venture. Shares of Laugfs Gas were trading at a price of about Rs. 38 per share for about two months prior to EPF’s purchase. The purchase was made in October 2012 and the EPF purchased shares worth Rs. 1 billion when the price of a share was ranging from Rs. 48-51. Unfortunately, on the same day, a few hours after the purchase, the share price fell to Rs. 40, close to its original, initial public offering (IPO) price. This resulted in an immediate loss of Rs. 300 million to the EPF. Thereafter, the EPF increased its shareholding in Laugfs Gas to 57.89 million ordinary shares, holding a stake of 17.28% of the company, followed by 18 million or 35% non-voting shares. The trading prices of Laugfs Gas Voting gradually fell to Rs. 22-23 per share whilst the Non-Voting price was Rs.14-15 per share, causing a loss of a sum in excess of Rs. 1.3 billion. In addition to these, the EPF incurred a loss of Rs. 1 billion as a result of an investment made in Lanka Orix Leasing Company (LOLC). The losses the EPF incurred from equities did not stop there; the Fund also incurred Rs. 934 million in losses from investing in the shares of Brown & Company, Rs. 933 million from Central Finance Company PLC, Rs. 655 million from DFCC Bank, Rs. 740 million from Vallibel One PLC, Rs. 572 million from Dialog Axiata PLC, Rs. 123 million from Richard Pieris & Company PLC, and about Rs. 420 million from Hatton National Bank (HNB) shares. It was revealed that the losses incurred by the EPF from investments made at the CSE amounted to Rs. 11.04 billion as of 20 June 2012 and that out of 65 companies in which investments were made, only 17 had recorded profits. In tandem with the decline in indices, market capitalisation in the CSE declined by 2% to Rs. 2.17 trillion by end-2012, from Rs. 2.21 trillion by end-2011. The equity portfolio of the Fund, which consists of both listed and unlisted equities, decreased by Rs. 16.7 billion, from Rs. 78.3 billion in 2011 to Rs. 59.2 billion in 2012, due to the sale of a part of the listed portfolio. Apart from the losses it made through investments made at the CSE, according to Verité Research, in 2010, the EPF, without due process, invested Rs. 500 million in SriLankan Airlines. As of 2016, this investment has been 100% impaired in the EPF books – which means it was valued at zero. “Another such example is the EPF’s investment of Rs. 5 billion in Canwill Holdings, for the controversial Hyatt Hotel project, in 2013. Both these investments have come under scrutiny in the Auditor General’s Report in 2016,” Verité noted.   Another pump and dump in the making?    Following the opening of the CSE after almost seven weeks of countrywide lockdown, the share prices of blue-chip companies and almost all the banks too were at two-digit levels. The shares of the leading listed banks and premier blue-chip JKH closed trading below the Rs. 100 mark on 12 May for the first time since 2009. On the same day, Sampath Bank, which was the highest-valued banking stock, closed at Rs. 99.90. According to seasoned market watchers, the last occasion all these stocks fell below the Rs. 100 mark was back in 2008 when the ASPI crashed 41% following the Seylan Bank and Sakvithi scandals as well as the 2007/08 global financial crisis. They hovered around those prices till around the time the war ended. As the prices of leading company shares reached their lowest levels in over a decade, market dealers began investing whopping amounts soon after the reopening of the CSE, gradually bringing the share prices of those companies almost close to their pre-lockdown levels within a short period of time. The dealers are now looking to sell these shares to the EPF. Several economists and market analysts are of the view that this “invitation” by market dealers is not being extended with sincere intention. Even though most of the blue-chip companies managed to record a 60% growth for the past three months, we learnt that many of these companies are not recording a considerable performance like they used to, mainly due to the disruption caused by Covid-19. However, it was recently noted that the EPF has taken steps to sell off the investments it made in six companies at the CSE. Accordingly, in the last quarter ended 31 December 2020, the Fund has fully sold its investments in ACL Plastics, Balangoda Plantation Company, Chemanex, Expolanka Holdings, Malwatta Plantation Company, and Seylan Developments. Furthermore, the fund has also taken measures to sell 250,906 shares in Durdans Hospitals; 1,750,609 shares in Dipped Products PLC; 2,387,818 shares in Hayleys PLC; and 2,751 shares in Nawaloka Hospitals. As at 30 September 2020, the Fund had invested in 81 shares of listed companies, ending as at 31 December 2020 as 74 companies. The Fund has invested a total of Rs. 83.46 billion and as at 31 December 2020, the total market value of these is Rs. 70.80 billion.   It is up to investors to avoid a pump and dump   Speaking to The Sunday Morning Business last year, SEC Chairman Viraj Dayaratne PC stated that the SEC welcomes investments from anyone, but as far as the investment decisions are concerned, the investment committees of the respective entities and those controlling the funds should do the due diligence themselves. “Whether all money should be invested in the capital market and on which shares the investment should be made are decisions that should be taken after doing due diligence. When an individual is going to invest, the particular individual should be mindful of their investment decision,” Dayaratne added. He further noted that the SEC would do its job properly, which includes regulating the market and building confidence amongst investors. Nevertheless, he added that if pumping and dumping is detected, the SEC would take stringent actions.

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