Chief Justice Asoka de Silva delivered the keynote address on ‘Financial Crime’ at Jesus College, Cambridge Symposium, recently. Following are excerpts:
Prof. Barry Ryder, ladies, and gentlemen, in the initial correspondence that the organisers of this very timely conference had with me, I was invited to dwell upon on any issue that I consider relevant to the promotion of integrity and probity in the financial and business sectors and in particular to control self dealing and conflicts of interest.
In the background of the recent financial crisis, it will be difficult to deliberate on these issues far too divorced from the crisis conditions. Therefore my presentation this morning will touch upon a few issues I deem important.
I will commence with reference to the financial crisis and talk about the intention of Sri Lanka to introduce a securitisation legal regime. I will also share with you a few recent instances where interventions of the appellate courts in the financial sector were sought by irate depositors and leave for your deliberations the impact of court interventions in financial markets. I will conclude emphasising upon the importance of a paradigm shift in our approach to corporate governance.
Ladies and gentlemen, much research has taken place during the last 18 months. In retrospect some have opined that the major causes of the financial meltdown include forgetting the lessons taught by the depression era and removing the firewall between banking and insurance in the early 1990s, almost zero regulation of (the now prohibited word) – Credit Default Swaps (CDS), allowing the financial institutions to measure their own risks, and the general trend towards deregulation.
For those of us from emerging economies, the direct impact of the financial crisis was felt only to the extent that we, succumbing to the insistence of some, allowed deregulated free movement of capital across borders.
With a background almost exclusively in public and judicial service, I propose to share with you my perspectives as the Chief Justice of an emerging economy which has just been released from the clutches of terrorism.
Integrity and probity in financial and business sectors can only be achieved through an integrated mechanism that brings together laws, ethics, corporate responsibility, and politics. But the problem is that in the real the world, dynamics within each of these do not at all times complement each other, as they should, but more often than not undermine.
It is this friction that leaves wide open chasms for those motivated by pure self interest to use and abuse the system to maximise their short term personal gains, whether it be investment bankers or money launderers.
If we are to analyse the correlations between the financial sector and legislatures, financial sector and policy makers, and even financial sector and academia, we may discover almost frightening trends.
Most financial dynamics we experience today have got the stamp of approval from the stakeholders who in the first instance were supposed to provide independent checks and balances. We may discover unhealthy correlations based on ideology, economic philosophy, national security, national interests, national economy, world trading regime, etc supported by expanding global markets and exponential developments in information technology.
I am sharing this angle with you to emphasise the enormity of the challenge we are facing with regard to insider dealing, conflict of interests, and self dealing in the financial sector. These malefactions are found throughout our economic and governance systems ranging from the behavioural psychology of market participants all the way to policy makers through the fabric of our institutional frameworks at national and global levels.
In emerging economies, the concentration of corporate power in the hands of a few is inevitable, making the problems more acute. Any action resulting in damages to the large business interests of the enterprises themselves is widely perceived as a luxury we can ill afford.
Let me now turn to a subject of which I have very little understanding; the concept of efficient market hypothesis; which was once explained to me in lay terms to mean that assets are always traded at the correct price due to the marvellous forces of supply and demand. I must confess that the momentary insights I gained on the rationale behind this hypothesis was lost when the now infamous securitised products started dominating the investment literature.
Sri Lanka was recently encouraged by one of our development partner organisations through a financial sector project to have in place a statute for securitisation. This, I believe, is part of a larger reforms programme. The analysis of the securitisation that took place as a precursor to the present financial crisis demonstrates an awful lack of transparency, informational asymmetry, demonstrable absence of good corporate governance practices, and sustainable leverage policies. A post facto conclusion is that the regulatory, institutional, and legal framework failed to address this situation.
It is in this background that the Securitisation Bill would be subject to debate and discussion if and when presented to the Parliament of Sri Lanka. The debate will hopefully centre around the recent events that the financial sector in Sri Lanka faced and the legislative and judicial response to the same.
Talking about the judicial response, the appellate courts of Sri Lanka are conferred just and equitable jurisdiction in matters of public law. In the 1980s Sri Lanka experienced a crisis in the finance business sector with many finance companies facing cash flow problems due to overreaching their leverage. Thereafter, closer to the Asian financial crisis in the late 1990s, Sri Lanka experienced the failure of one of its development banks.
During the last 18 months, the financial sector of the country was rudely awakened due to the failure of the credit card operations of a big conglomerate and the resulting contagion effect throughout the conglomerate which had branched out into banking, insurance, property, and even micro credit markets.
The 1980s crisis resulted in the Central Bank first trying to provide cash infusion and revive the failing institutions. By the late 1990s, the Central Bank took a different approach of attempting to isolate the failing institutions from the rest of the financial sector to prevent contagion effect.
Most of the affected were average depositors. With the failure of the institutions, the depositors turned to the Court for remedy. Most actions were public law remedies where quite innovatively the causes of action were crafted against the regulator, the Central Bank, on the basis that the failure of the regulator amounted to a violation of the Constitutionally-guaranteed right of equal protection of the law.
For instance, in 1995 the Supreme Court1 was called upon to adjudicate on the issue whether the decision of the regulator to wind up the company was done in good faith. The facts of the case were of course in favour of the regulator and in any event the Court did not want to step into the shoes of the regulator, but limited its role to judging if due process had been followed.
In 2003, the Court of Appeal went a step further and issued writs of certiorari and mandamus in response to an application by the Depositors of Pramuka Development Bank, on the ground that the Regulator should have considered several of the options that had been put forward jointly by depositors to revive the bank, prior to issuing the winding up order2.
Going a step further, in 2010 we saw a number of cases filed in different courts due to the inability of an investment company to allow the depositors to withdraw their money. The directors were arrested and were in custody until recently. The allegations before Court include mismanagement and even criminal misappropriation.
The discernible trend is towards seeking more (not less) intervention of court to assess, evaluate, and rule on the day to day running of the corporations and the activities of the respective Boards of Directors, on one side and to review regulatory action on the other. The just and equity jurisdiction dictates the Courts to go beyond the strict contractual relationships that financial sector firms have with their customers. Too much judicial intervention could result in higher compliance costs and reactive regulatory forbearance.
How does all this relate to self dealing? Ex post measures found in the traditional Court remedies will only provide a deterrent to situations which need ex ante and real time interventions. Even if deterrence is a potent tool, the cyclical nature of mini and major financial crisis demonstrate that given a choice between “hard cash” as against “hard labour,” the former has a bigger appeal to the investment banker.
The Wall Street Journal, on 2009 Christmas Eve, reported of the judiciary’s battle to stem the rising tide of foreclosures by punishing mortgage companies for paperwork mistakes and alleged mistreatment of borrowers by wiping away borrowers’ mortgage debt, invalidating foreclosure sales and even barring some foreclosures outright.
In the same article Todd Zywicki, a law professor at George Mason University, posed the question whether judges are changing the rules in the middle of the game... just because there is a financial crisis.
The capital market hypothesis I referred to earlier certainly does not encourage the intervention of courts into capital markets. Should the Courts intervene with its baggage of laws of evidence, procedures, and principles of sentencing, to pierce the corporate veil and be the “big brother” to monitor the companies, their share holders and Boards of Directors? Or to what extent should the Courts expand its just and equity jurisdiction, especially during times of crisis, when large numbers of the public are left worse off, irrespective of the degree of their complicity?
Traditional wisdom advices us to “keep away from lawyers and doctors”. The wisdom of this truism holds true for the financial sector: “keep away from Courts”.
I think we need to see the financial sector not for its own sake, but in the context of its role in economic growth and social justice. We have to revisit the concept of the firm from this paradigm shift and reengage at all levels, critically assessing the legal design, economic, social and political environment, and most importantly internal leadership; converting corporate social responsibility from a management fad to an enforceable set of principles and guidelines complemented with an operational mechanism for self regulations in the first instance.
Ladies and gentlemen, another aspect of the capital market hypothesis that I was told about is that price movement of the asset will take place only if there is an external “shock” to the system. Naïve as I am to this branch of economics, I do not see why an external “shock” cannot be provided for by the combined force of politics, policy, media, and judiciary providing inclusivity, sustainability, transparency, and accountability.
This I think is an opportune moment to refer to legislation of UK passed in 2000 which brought about a regime to stimulate ethical investment forcing decisions being made on environmental, ethical, and social criteria than mere financial numbers. I will conclude by leaving with you a few basic thoughts.
I think we have an opportunity for a paradigm shift and looking at applying the concepts such as trusteeship to governance of companies than only relying on the familiar game of cat and mouse to find and prosecute offenders for insider and self dealing. Trusteeship introduces a positive incentive appealing to the emotional interest in all of us to be a part of an organisation or a system that can boast of ethical branding and profits.
Paradigm shifts are not new to the financial industry. For instance let’s consider the amount of investments in green technologies and alternative energy sources due to pressure to “go green”. Some venture capitalists are leading the way in earth friendly investments. If there is a combination of political will and professional skill, I am, ladies and gentlemen, certain that such a paradigm shift in fighting insider dealing or self dealing is possible.
I thank you for your patient hearing and wish you all success in your deliberations.
1 Dawson Silva’s case reported in 1995 1 SLR 344
2 Reported in 2003 3 SLR 68