Some salient features of the proposed Securities Exchange Act: Part I

In the early part of this year, the Legislature will consider the promulgation of the new Securities Exchange Act, which will provide the legal framework for the regulation and supervision of the capital market.

The original Securities Council Act 

It was 30 years ago, in 1987 when the first piece of legislation was introduced in the form of the ‘Securities Council’ Act No. 36 of 1987, which established the Securities Council and identified its objects as being (a) the creation and maintenance of a market in which securities can be issued and traded in an orderly and fair manner; (b) the protection of the financial interest of investors, (c) the operation of a compensation fund to protect investors; and (d) the regulation of the securities market and to ensure that professional standards are maintained in such market.

The powers, duties and functions of the Securities Council included to issue licenses to operate as stock exchanges and stock brokers; to give directions to a licensed stock exchange; to grant compensation to any investor who suffers pecuniary loss resulting from the failure of a licensed stock broker or a licensed stock dealer to meet his contractual obligations; to advise the Government on the development of the securities market; to suspend or cancel the listing of any securities or the trading of any given securities, for the protection of investors; to inquire into the business affairs of a licensed stock exchange, stock broker or stock dealer and public companies listed with a licensed stock exchange; to publish findings of malfeasance by any licensed stock broker or stock dealer or any public company listed with the licensed stock exchange; and to implement the policies and programmes of the Government with respect to the market in securities.

The Securities Council Act, also included provisions to deal with insider dealing/prohibitions pertaining to transactions made on the basis of unpublished price sensitive information.

Amendment in 1991

Several amendments were incorporated to the Securities Council Act in 1991, which included the change of name of the Council to the ‘Securities and Exchange Commission of Sri Lanka’, the introduction and regulation of Unit Trusts, enabling provisions for the regulation of takeovers and mergers, and several other provisions to strengthen the powers of the Commission in respect of supervision and enforcement. This included a widening of the supervisory jurisdiction of the Commission and also included new provisions for compounding of offences.

Amendment in 2003

In 2003, amendments were incorporated to the Act, which included the widening of the jurisdiction to market intermediaries, the creation of the Cess fund and the levy of Cess, and further strengthening of the regulatory framework in line with the experiential requirements and international best practice.

Amendment in 2009

A few further amendments were incorporated to the Act in 2009, which included a new power vested in the Commission to issue general or specific directives to listed public companies from time to time.

Need for a new act

From about 2007, the Securities and Exchange Commission, had made a policy decision that a new consolidated Securities Act was a requirement to provide a better and more efficacious framework in line with international best practice towards effectively regulating the capital market. During the first term of the present SEC Chairman Thilak Karunaratne, considerable work had gone into drafting a new Act, addressing the needs of the market, but, since his resignation in August 2012, the promulgation of the new Act did not see light.

It was after the appointment of the present Commission in the early part of 2015, which was once again chaired by Thilak Karunaratne, that this process was revived. The Commission appointed a Special Advisory Committee, under the Chairmanship of K. Kanag-Isvaran, PC to guide the process of drafting a new consolidated piece of legislation, and the formulation of the new Securities Exchange Act recommenced under the guidance of the Commission and the Special Advisory Committee, the culmination of which was the submission in November of the present Securities Exchange Bill to Parliament by the Prime Minister, who is also the Minister of National Policies and Economic Affairs under which Ministry the SEC comes.

During the process of drafting, the SEC requested IOSCO (International Organisation of Securities Commissions) to conduct a Country Review in Sri Lanka, in order to independently identify the gaps in the regulatory sphere, and this new piece of legislation, expected to be considered by Parliament shortly, addresses these gaps, and seeks to bring the legal framework on par with many areas of international best practice.

In fact, the IOSCO Secretary General Paul Andrews was quoted as saying “the Sri Lankan SEC showed courage which many other Regulators would not show, by allowing IOSCO to review Sri Lankan regulatory standards, and to advise on the areas which need improvement”. He also went on to state that “it shows commitment and shows strength of character. It’s good for business in Sri Lanka to have good regulations”.

The following is a brief analysis pertaining to several important provisions of this new Bill:

The proposed new Securities Exchange Act 

The Constitution of the commission, objects and powers

The long title of the proposed new Securities Exchange Act provides that it is “An Act to establish the Securities and Exchange Commission of Sri Lanka; to Regulate Market Institutions, Public Offers of Securities, Market Intermediaries; to deal with Market Misconduct; and to meet the challenges encountered by Securities Markets in an effective and efficient manner..”, and seeks to seamlessly consolidate the several aspects which must come within a Law that would regulate a capital market.

The Objects of the proposed Act are (a) to establish the Securities and Exchange Commission of Sri Lanka for the creation and maintenance of a fair, efficient and transparent securities market; (b) to protect the interests of investors both local and foreign; (c) to ensure the maintenance of high professional standards in the provision of services under this Act; and (d) to mitigate systemic risks in the financial system.

The Objects have not been substantially revised, except for the inclusion of the object of the mitigation of systemic risk in the financial system, which is vital, and was implicit under the old Act as well. Protection of investors is still a paramount consideration over other competing interests such as competition and capital formation, which have been given parallel importance in jurisdictions such as the US.

The Commission largely comprises of the same, except for the replacement of the President of the Institute of Chartered Accountants of Sri Lanka, with a Fellow Member of the Institute of Chartered Accountants of Sri Lanka who is not engaged in Auditing as nominated by its Council. This was to eliminate any conflicts of interest that could arise from an Auditor, who provides professional services to listed market Regulatees becoming part of the Commission, and also in view of the fact that under this proposed Act, Auditors have certain obligations. 

The term of office of every appointed or nominated Commission Member is for three years and is limited to a maximum period of two successive terms of office, which is an important provision from a governance standpoint.

Conflicts of interest

A further safeguard to ensure the independence of the Commission has been included whereby the Minister, when appointing Commissioners must have regard not only to that person’s integrity and standing, but also the likelihood of any conflict between the interests of the Commission and any interest which that person has or represents.

Powers of the commission

The powers of the Commission include, (a) to advise the Government on the development of the securities market and to assist in the effective implementation of the policies; (b) to encourage and promote the development of securities markets in Sri Lanka; (c) to give general or specific directives to any person or persons including market institutions, market intermediaries, registered persons, clearing members, trading participants, depository participants, issuers, investors or recognised market operators; (d) to give general or specific directives to supplementary services providers of market institutions, market intermediaries or listed pubic companies from time to time; (e) to grant a licence to a body corporate to operate as a market institution and ensure its proper conduct; (f) to grant a licence to any person to operate as a market intermediary and ensure its proper conduct; (g) to register a person advising clients on sale or purchase of securities for and on behalf of a market intermediary as a registered person and to regulate their conduct in the discharge of their duties; (h) to issue general or specific directives to listed public companies or listed foreign entities from time to time; (i) to issue specific directives to any person to prevent the imminent infringement of this Act, regulations or rules and to restrain infringement; (j) to regulate the listing and trading of securities in an exchange; (k) to regulate the issuance of securities; (l) to prohibit or suspend the listing of any securities or to delist the listed securities or to take such steps as the Commission considers necessary for the protection of investors; (m) to regulate a takeover or merger of a listed public company or any matter connected therewith; (n) to inquire and conduct investigations into any activity of a market institution, market intermediary, a registered person, a listed public company or a listed foreign entity; and (o) to conduct investigations into any alleged violation or contravention of the provisions of this Act or any regulation, rule, or directive.

The director general and staff

The Director General under the new Act will come under the direct purview of the Commission, and shall be appointed and also removed by the Commission.

The Staff of the Commission shall also be appointed by the Commission, and their terms of service and remuneration shall be determined by the Commission. These are further provisions which strengthen the independence of the Commission.

Markets and market institutions

Part II of the Act under the heading “Markets and Market Institutions”, contains the provisions pertaining to Exchanges, Clearing Houses and Central Depositories.

Exchanges

Chapter 1 of Part II which deals with Exchanges (which is defined to mean a stock exchange or a derivatives exchange licensed under this Act) among other things, sets out the threshold requirements to become an Exchange which gives paramount importance to governance and investor protection, the duties of an Exchange including to ensure an orderly and fair market in securities that are traded through its facilities, to act in the public interest having particular regard to the need for the protection of investors, and other administrative and operational requirements.

In fact, there is specific provision which imposes a duty on a Director of an Exchange to act at all times in the public interest having particular regard to the need to protect investors.

There is also new provision, which enables the listing of securities of an Exchange, on such Exchange, which would become immediately relevant when the demutualisation of the Colombo Stock Exchange takes effect.

Clearing houses

Chapter 2 deals with the regulation of Clearing Houses for the purposes of clearing and settlement and among other things, sets out the threshold requirements to be licensed as a Clearing Facility, provisions pertaining to regulation and supervision of the clearing house and its members, establishment and administration of a settlement guarantee fund etc.

Further provisions include prioritisation of default proceedings of a Clearing House in the distribution of assets, and other ancillary powers to facilitate clearing operations.

With the promulgation of the Act, the legal provisions will be in place for the setting up of a Central Counterparty which would engage in the clearing and settlement of trades, thereby minimising / spreading the risk of non-settlement.

Central Depository

Under the proposed Act, there is also a separate Chapter for the regulation of Central Depositories. Under the present operative Act, the Central Depository Systems (Pvt.) Limited (CDS) has been registered under generic provisions. 

General provisions pertaining to markets and market institutions

There are also general provisions applicable to Market Institutions, including requirement for Rules to be approved by the Commission, need for approval to hold more than 5% of the voting rights, and other governance measures including the power vested in the Commission to make preliminary orders, fit and proper rules/criteria for Directors, etc.

Responsibilities of auditors – market institutions

Another important provision which has been included, is found at section 69 of the proposed Bill, which imposes an obligation on an Auditor of a Market Institution to inform the respective Board of Directors, with a copy to the Commission, in instances where; (a) any matter which, in his opinion, adversely affects or may adversely affect the financial position of the market institution, to a material extent; (b) any matter which, in his opinion, constitutes or may constitute a breach of any provision of this Act, regulations, rules or directives made thereunder or an offence involving fraud or dishonesty affecting the financial stability of the market institution to a material extent; or (c) any irregularity that has or may have a material effect on the accounts of the market institution, including any irregularity that adversely affects or may adversely affect, the funds or property of investors in securities.

Issue of securities

Part III of the Act pertains to (a) the regulation of the issue of securities; (b) the disclosure of financial information by listed public companies; (c) the requirements for Auditors to disclose financial irregularities; (d) to license market intermediaries and to register their representatives and (e) to protect clients. 

Trade in securities

The Chapter on Trade in securities categorically stipulates that a corporate entity listed or unlisted shall not make a public offer of securities either directly or through a third party by way of a prospectus or similar document, unless approved by the Commission, and thereby extends the regulation of the SEC to all public offers of securities to raise funds. Section 81 provides that where it appears to the Commission that a listed public company has contravened or failed to comply with any provision of the Act, regulations, rules or directives or has furnished the Commission with information that is false, inaccurate or misleading, the Commission may issue a directive to the listed public company (a) to cease and desist from any contravention of this Act, regulations, rules or directives made thereunder; (b) to do or refrain from doing any matter as specified under this Act, regulations, rules or directives made thereunder; or (c) to carry out any other matter that the Commission considers necessary in the exercise of its powers under this Act, regulations, rules or directives made thereunder. It is also a punishable offence for a listed company to submit false information to any market institution.

The Commission will also be empowered to issue ‘Stop Orders’ or ‘Interim Orders’ where there is imminent violation of the stipulated requirements. 

There is also a requirement that Directors and Chief Executive Officers of listed Public Companies must comply with the fit and proper criteria specified by the Commission or by the Rules of the Exchange.

(To be continued)

The writer is an Attorney-at-Law with a wide practice in the areas of Public Law and Corporate Consultancy. He is a Fellow Member of the Chartered Institute of Management Accountants (CIMA – UK), and an Alumnus of both the Faculty of Law of the University of Colombo 

and the Harvard Kennedy School of Government, Executive Education. He is a Commissioner 

of the Securities and Exchange 

Commission of Sri Lanka. Disclaimer: The views expressed herein do not necessarily reflect the views of the SEC.)