CHAPTER I

METHODOLOGY

1.        This report has been prepared on the basis of information collected through the following sources:

i)        Trading records of KSE

ii)        Interviews of the current managements of KSE.

iii)        Views of the defaulted member of KSE

iv)        Report of the Ittrat Rizvi Enquiry Committee.

v)         Minutes of the meetings of the Board of Directors

vi)        Report of system Review Committee

vii)        Annual Reports 1995-2001

viii)        Record of CDC relating to brokers.

ix)         Other record / data made available by KSE.

1.1     The Committee held discussions with the following members of the KSE management team:

i)          Mr. Salim Chamdia, the Chairman

ii)         Mr. Noman Ahmed, the Managing Director

iii)         Mr.Yaqoob Memon, General Manager

iv)         Mr. Abdul Razzak Ali Muhammad, Manager Clearing House

1.2    The Committee also interviewed Mr. Shahid Ghaffar, the then Managing Director of KSE and Mr. Arif Habib, the then Chairman of KSE.

1.3     Mr. Hanif Moosa, the defaulted member of KSE was also heard on his own desire to speak on the Terms of Reference of the Enquiry Committee.

1.4    The Committee visited KSE several times to scrutinize the record and to meet the management team of KSE. While conducting investigation, the Committee also looked into the letters forwarded to it by SEC. The Committee held several meetings and discussions over telephone with the current management of KSE.

1.5    The Committee has devoted considerable time to analyze the information collected from various sources. The changes made in exposure rules from time to time, their implementation, the role of the Board of Directors of KSE and its management in respect thereof has also been studied in greater detail.

1.6     The outcome of the investigation has been comprehensively covered in the attached report.

2.        Whereas, the Enquiry Committee has made all-out efforts to examine all the issues in terms of the Terms of Reference, there could be a possibility that some of the non-compliances/lapses might have escaped the attention of the Enquiry Committee. The non-compliances/lapses reported in this report, therefore, may not be considered the only non-compliances/lapses.

CHAPTER II

1.      Regulations Governing Members Exposure and Losses: The Karachi Stock Exchange, with the approval of the Federal Government, enforced the “Regulation Governing Members’ Exposure” (the “Exposure Regulations”), reproduced at Annexure “B”, in January 1994 authorizing the Board of Directors of the Exchange to prescribe the “exposure limits” from time to time.

1.2     Under these regulations, “exposure” is defined as the amount of purchases and sales added together transacted by a member during a clearing period after allowing netting off the sales and purchases of common scripts. The “loss” is defined as amount payable by the member to the clearing-house due to difference in sales and purchase price or difference between transaction price and market price in case of outstanding transactions of any one or more scripts at any moment of time during a clearing period.

1.3     The Board of Directors of KSE amended the exposure limits and deposit payable thereon from time to time. A summary of all amendments is placed at Annexure “C”.

1.4     The KSE introduced future trading from July 05, 2001. The Regulations Governing Futures Contracts of The Karachi Stock Exchange (Guarantee) Limited came into force from September 19, 2001, with the approval of the Securities and Exchange Commission of Pakistan (the “SEC”). The said regulations prescribed the exposure limits in respect of future contracts. As future trading has commenced only recently, it is not covered in this report

2.      Members, Default and Procedure for Recovery of Losses Regulation. Members, Default and Procedure for Recovery of Losses Regulations (the “Default Regulations”) were enforced simultaneously with the Exposure Regulations. These regulations are placed at Annexure “D”. The Default Regulations lays down procedure to be followed in the event of default, squaring up of position, sale of assets, recovery and distribution of loss of a defaulter and payment of claims.   

CHAPTER III

1.      Management of Exposure and Losses Limits:

1.1    Clearing and Settlement Department.                Under the management set up of KSE, this Department is responsible for the management of all clearing and settlement functions, including the management of Exposure Limits. A Joint Secretary is the head of this Department, responsible for carrying out all the daily functions, including the supervision. According to the Organization Chart, he reports to Chief of Operations, who in turn reports to the Managing Director. The position of Chief of Operations has not been filled in, therefore, the Joint Secretary is directly reporting to the Managing Director.

1.2    Importance of management of exposure limits. The management of Exposure Limits is a very sensitive matter and vital to the smooth functioning of the KSE, particularly in a volatile market. The responsibility of the management is to keep a constant watch on the overall market situation and take remedial measures to avoid a situation, in which settlement becomes doubtful. The management is to keep market players on watch and keep on reviewing their position. Under all circumstances, the management has to pre-empt before an ugly situation arises. At any market place, safety of the Clearing House involved in trade settlement is always supreme. Any action by the management to ensure the smooth functioning of the Clearing House, if taken in accordance with the rules and after considering all the aspects is justified. The management has to act with great care and be total impartial. Any rash decision, arrived without proper evaluation can lead to crisis. It is also essential that market players, even if they are board members should not have any say in the management of exposure limits, as they have their own business interest. There is always a possibility that they can take undue advantage, if they have information of other members’ position. Not only that there should not be any involvement of market players in the management of clearing-house, it should clearly appear to be so. Please refer conflict of interest issue discussed in LSE report. 

1.3    Requirements for Good Governance at the Clearing and Settlement Department.   The essential elements of good management of this department and their responsibility can best be described as under:

a)      Requirement for staff: - High integrity, Knowledge of subject, sense of responsibility, duty of care, impartiality and capability to deal in crisis and take initiatives

b)     Requirement for record keeping: - Up to date and proper record to ensure monitoring of exposure and maintenance of deposits on daily basis and to keep track of actions taken in compliance of the rules and regulations.

c)     Requirement for information feed back: - From Bottom to top to keep the management fully and promptly informed about the clearing and settlement functions on daily basis.

1.4    Role of the Managing Director.       According to the Organization Chart of the KSE, the Joint Secretary – Clearing and Settlement Department supervises the functions of this Department, reporting to Chief of Operations, who in turn reports to the Managing Director. The Managing Director is a very busy person, attending to multifarious activities. However, considering the importance of this Department, he should have information feed back on bottom up basis. He should ensure that Clearing and Settlement is functioning smoothly. He should maintain frequent inter-action with the Department. As the position of Chief of Operations has not been filled in, the Joint Secretary is directly reporting to the Managing Director.  

CHAPTER IV

1.      Amendments in Members’ Exposure and Loss Limits and Deposit payable.            Introduction of Members’ Exposure and Loss limits and Deposit Payable thereon in August 1993 and subsequent amendments in the limits are described below.  Under Exposure Regulations, the Board of Directors of the Exchange has the authority to prescribe the limits from time to time. 

1.1    Period August 1993 to September 1998. The KSE Board first introduced the Exposure and Losses Limits and Deposit payable thereon on August 09, 1993. Initially when the Exposure Regulations were enforced, only slab rates were prescribed after allowing the free limit. For losses, 100% deposit was required after allowing a free limit. During this period, the changes that were brought mainly related to adjusting upwards or downwards (1) free “Exposure Limit”, (2) free “Loss Limit” and (3) rates of deposit. Although the justification for the changes made has not been recorded in the minutes, it seems that value of membership card has been kept in mind in setting free limits. As the value of card went up, the free limit was enhanced, on the assumption that if the member goes default, the sale of card and other assets would fetch enough amounts to settle claims against him. Similarly, when the value of card went down, the free limit was reduced. All the securities listed on the KSE were qualified as deposit. This system had many weaknesses, as securities listed on the KSE, including illiquid shares were accepted as deposit. Manipulation in share prices was, therefore, possible. 

1.2    Period September 1998 to November 1999.    These limits continued till September 09, 1998, when in the meeting of the Board of Directors held on August 06, 1998, it was decided to accept deposit in cash or in 301 “approved” shares with 10% margin. This was a major improvement from the then existing system and was clearly designed to protect the Clearing House of KSE.

1.3    Period November 1999 to April 2000. The Managing Director submitted a detailed paper, which was considered in the meeting of the Board of Directors held on November 08, 1999, in which three weaknesses of the system were outlined. These were (1) time (24 hours) for deposit of margin was high,  (2) “approved” list included illiquid shares and (3) members could have outstanding position in one share without any limit. The Managing Director proposed that approved list should contain only eighty-five top active shares. He did not specify the period of which turnover should be considered for making the list. He also proposed that the list should be divided into three categories of shares. “A“ category should have five top most active shares, “B” category next eight active shares and “C” category next seventy-two active shares. He proposed that deposit for exposure in excess of Rupees two hundred million should be accepted in category “A” shares. The Board approved the recommendations of the Managing Director and three categories of shares, which were prepared on the basis of turnover of the period from January 1999 to September 1999. The margin for categories “A”, “B” and “C” were fixed at 10, 15 and 20 percent. The Board authorized the Managing Director to delete a company from the list or change the margin, should the situation demand.

1.4    As the turnover is subject to fluctuation, the procedure for review of the list on a periodical basis should have been laid down, which was an omission.  The Joint Secretary Clearing and Settlement failed to implement the decision of the Board in respect of exposure above Rupees two hundred million and continued to accept all categories of shares as deposit for exposure and not just “A” category only, due to his own “misinterpretation”.  This error continued till this was noticed on April 19, 2000.

1.5    Period April 2000 to August 2000. An emergent meeting of the Board was called on April 26, 2000, which decided to revise the shares in approved categories. Around this time, the non-implementation, as mentioned in paragraph 1.4 above was also corrected. The Enquiry Committee is of the opinion that the decision taken in the meeting was neither justified nor needed. This is dealt in detail in chapter VI of this Report. In the same Board Meeting of April 26, 2000, a Committee was appointed to review the then existing system “comprehensively” and to make appropriate recommendations.

1.6    Period August 2000 onwards.          The Committee appointed by the Board, as mentioned in paragraph 1.5 above, with the background knowledge of the previous crisis and risk to the Clearing House, came up with a recommendation, which was accepted by the Board and enforced from August 07, 2000. KSE laid down the selection criteria for “approved” securities on the basis of “turnover” and “earning per share”, the basis on which shares would be placed in various categories and margin applicable for each category, with a cap on valuation, based on earning per share. In the opinion of this Enquiry Committee, the new system did address to important issues, like volatility in share prices, which hitherto had been the cause of concern. The new system also laid down a procedure for periodical review, which is now followed. However, no criteria were laid down for the slab rates for “Deposit Payable” and this was left at the discretion of the Board. In accordance with the procedure laid down, amendments in list of approved securities and some other amendments were made on October 4, 2000, November 14, 2000, January 18, 2001 and August 2, 2001.   

1.7    August 24, 2001.            The amendments made on August 24, 2001 related to slab rate. This was tabled under “any other item” in an emergent meeting. The Enquiry Committee is of the opinion that it is highly inappropriate that important matters like amendments in exposure limits and slab rates for deposits, which are vital for the integrity of the Clearing House are tabled under “any other item” and in “emergent meetings.”

1.8    Decisions by the Board.           Whereas the Enquiry Committee is of the opinion that the Board of Directors have brought amendments in the “Exposure” limits and “Deposit” payable thereon in the larger interest of the Clearing House, it is necessary to point out that proper justifications were neither given nor criteria laid down in any working paper circulated to the directors. Moreover, justification was also not recorded in the minutes of the Board of Directors meetings for making the aforesaid changes. The two exceptions are amendments made in the (1) meeting of November 08, 1999, when the Managing Director submitted a paper for the consideration of the Board and (2) meeting of July 06, 2000, when the Board considered the recommendation of a committee appointed for this purpose. The Enquiry Committee is also of the opinion that the decisions taken in the meetings of April 26, 2000 and August 24, 2001 were extremely hasty and not taken after due consideration, deliberations and evaluation. It has been alleged that these changes of April 26, 2000 have been the root cause of the May 2000 Crisis. It is a fact that after implementation of these changes the KSE Index dropped from 1968.40 as on April 26, 2000 to 1399.30 as on June 09, 2000

1.9    Authority delegated to the Managing Director. The Governing Board of Director in their meeting held on November 08, 1999, authorized the Managing Director to delete any company from the list of approved securities or enhance its margin after giving reasonable notice. The Managing Director has exercised this authority even before the above delegation, in situation where immediate action was required. Amendments authorized by the Managing Director are given below:

a)      May 13, 1998.      Exemption Limit for Exposure reduced to Rupees Forty Million.

b)     September 01, 1999.     Margin on deposit of shares of Bank of Punjab enhanced to 50%.

c)     April 19, 2000.   Where “Losses” exceed Rupees Forty Million, only shares of “A” category to be accepted. The Board did not find this action on the part of Managing Director within delegated authority, but ratified his action in its meeting on April 26, 2000.

1.10  On April 03, 2000, margin on deposit of shares of Bank of Punjab was enhanced to 50%. This decision was taken by the Joint Secretary, Clearing House in consultation with the Chairman. For details please refer Chapter V.

1.11   It may be mentioned that in reply to the question from the Enquiry Committee, the present Managing Director stated that “Only the Governing Board of Directors of the Exchange is empowered to amend/ change the limits of Exposure/ Losses.” The Enquiry Committee concur with the opinion of the Managing Director that only the Board is authorized to prescribe changes in exposure rules.

1.12  Recommendation.          The delegation of authority to the Managing Director to delete any company from the list of approved securities or enhance its margins may be discontinued. As an upper limit has been placed on the shares prices, there appears to be no reasons for such delegation to the Managing Director. KSE may put in place a self-adjusting mechanism whereby such adjustment in the value of shares prices for the exposure purpose may be adjusted automatically to minimize the risk of the Clearing House.

CHAPTER V

1.      Whether the management of exposure and loss limits was bona fide?

1.1     This is the common knowledge and also dealt in the Report, dated August 2000 of the Enquiry Committee constituted by the SEC on June 17, 2000 to investigate in the affairs of Karachi and Lahore Stock Exchanges, that there were lapses in the management of Exposure Limits. The Board of Directors of KSE in their meeting held on June 09, 2000, appointed a Review Committee, headed by Mr. Saleem Chamdia, the then Vice Chairman and present Chairman to identify (1) weakness in the management of Exposure System and (2) person(s) responsible for the lapses.  The Committee submitted a report to the Board that there were two lapses.

1)     The purchases and sales were netted. This error was first noticed on May 30, 2000.

2)     Other than Category “A” shares were accepted, where exposure was exceeding Rupees 200 million. However, when deposit exceeded Rupees 200 million, only Category “A” shares were accepted for the excess amount. This error was noticed on April 19, 2000.

1.2     The Report of the Review Committee, dated September 01, 2000 is enclosed as Annexure “E”, together with minutes of the relevant meeting of the Board of Directors. The excerpts from the report of the said Committee on “Lapses”, are reproduced below:

“ a) There is a clear lapse of responsibility on the part of JS Clearing and Settlement in as much as he failed to discharge his duties and responsibilities diligently and adopted a routine clerical approach. Contrary to the requirement of his job description, he failed to review and recheck any procedure, which would have spotted the netting off of sales and purchases. Moreover, he misinterpreted a very clearly worded circular on exposure and did not even bother to consult his superiors before implementing his own version of the circular. Disciplinary action as per rules needs to be initiated against him.”

“ b) The Committee also noted the management failing in as much proper care was not exercised in implementing the computerized system that involved careful checking of test data. The Committee recommends that this aspect should be properly taken care off in future computerization of the Exchange. Although the responsibility of the “Exposure Program” was assigned to the Computer Committee in 1992 and 1993, there is no evidence to support that they fulfilled their responsibility, as there is no official computer committee minutes are available. The Committee recommends that in future record of the meeting Computer Committee (now renames as I.T. Committee) should be kept, including such matters as schedule, progress report, testing of data and discussions with computer consultants. There is a need of coordination between Computer Committee and Management, which would involve both the I.T. department and user department. The Committee recommends that the representatives of these departments should be on the Computer Committee.”     

1.3     The Board of Directors of KSE in its meeting held on October 03, 2000 decided to implement all the recommendations of the Review Committee. 

CHAPTER VI

1.      Whether the changes in the Exposure Limits and Deposit payable there against were bona fide.

1.1     The Board of Directors of the KSE, with the prior approval of the Federal Government enforced the Regulations Governing Members’ Exposure for the Karachi Stock Exchange (Guarantee) Limited. Under these Regulations, Exposure Limits have been prescribed as under:

(i)       If at any time during a clearing period, the Exposure of a Member exceeds the limit prescribed for this purpose, such Member shall deposit with the Clearing House the amount computed in accordance with the prescribed rates within twenty-four hours of demand.

(ii)    In case a Member sustains Loss during any particular period in excess of the limit prescribed for this purpose, such Member shall deposit with the Clearing House the amount of such loss within twenty-four hours of demand.

(iii)  No member shall have outstanding transactions in his account of more than the prescribed percentage of the number of issued shares of a particular scrip in a particular clearing period.                                   

1.2     The Board of Directors of KSE is responsible for making changes in the Exposure Limits. The changes brought in from time to time, is summarized in Annexure “C” above. A detailed note on these amendments has been given in chapter IV, which may be referred. The changes made on November 08, 1999 and April 26, 2000 are discussed here. The three categories of shares approved on November 08, 1999 were, as under:

1.3     The KSE Board authorized the Managing Director to increase margin or remove companies from list any time after giving reasonable notice. It was further decided that no member would have outstanding transactions in his account of more than 20% of issued share capital of a company in a particular period.

1.4     During April 2000, three changes were introduced. Two changes were brought by management, under delegation of authority and third by the Board of Directors. These are as under:

1.5     The Chairman gave the following reason for calling the emergent meeting on April 26, 2000:

a)      Changes made by the management in the context of risk management. Chairman further stated that the decision of the management of April 16, 2000 was not strictly in accordance with power delegated. He further remarked, “such decision which affects the trading activity should have been taken after proper thought and deliberation.”

b)     Existing procedure was framed during last year and the present Board has not discussed or reviewed the procedure so far.

c)     When the procedure was implemented it was decided that the approved list of securities should be subject to review after every six months in order to update the list as well as to facilitate the members.

1.6    Our comments on the remarks of the Chairman for calling emergent Board Meeting are as under:

a)      The changes were made by the management on April 06 / 16, 2000. If the changes made by the management, as stated above in the table, were the cause of calling the emergent Board Meeting, the meeting should have been called much earlier. While commenting on the April 16 decision of management, the Chairman remarked, “such decision which affects the trading activity should have been taken after proper thought and deliberation.” While the remarks of the Chairman are commendable, the Board itself did not apply the thoughts and deliberation in approving the changes, as the decision was taken in the emergent meeting without a working paper having been submitted.

b)     The Board was in office for more than three months and if there was any need to discuss or review the risk management with the new Board, the meeting should have been called much earlier.

c)     No decision about timing of review was recorded in the minutes of November 08, 1999 nor it was mentioned in the KSE Notice, that the approved list of securities would be subject to review after every six months in order to update the list as well as to facilitate the members. However, even if a review of the list was felt necessary, a regular Board Meeting should have been called, as even the six months period since the last amendment was not over.

d)     The Chairman did not give any compelling reason for calling the emergent Board Meeting and taking important decision in a hush.  The Managing Director referred to the then “volatile” market conditions, which necessitated calling the emergent meeting. He did not elaborate. The tools were available with the Managing Director to deal with the volatility of market, which could pose threat to Clearing House.

1.7     The Enquiry Committee was not provided convincing justification for the changes. Previously five companies were in Category “A”. The reason for expanding to eight was not deliberated. Previously turnover of nine months (January, 1999 to September 30, 1999) was taken. A different time span (January 01, 2000 to April, 2000) was taken. With the revision of list under the three categories, the Board restored the 20% margin for The Bank of Punjab from 50% margin which was increased by the management in the absence of the Managing Director.  No reason for restoration of margin was recorded in the minutes. On April 03, 2000, the share of The Bank of Punjab was quoted at Rupees 48, whereas on April 26, 2000 when the margin was restored, it was quoted at Rupees 38.75.   Please also refer Chapter X regarding change in the margin of the Bank of Punjab on April 03, 2000, which was made effective from April 06, 2000.

1.8    As these matters can very easily be manipulated, there is a need that there should be consistency in the application of rules. If the consistency is not applied, these should be properly deliberated and reasons recorded. In the opinion of the Enquiry Committee, the decision taken at the Board meeting of April 26, 2000, were taken in haste and without proper discussion, deliberation and application of mind. In the same meeting, it was decided to appoint a Committee of the Directors to review the existing system comprehensively and recommend to the Board a revised procedure for consideration and approval. This Committee was appointed and it did come up with a recommendation, which was approved by the Board subsequently and implemented. The Enquiry Committee has not been able to understand as to why the changes were brought in the interim and as to how it was in the interest of the Clearing House. 

1.9    Recommendation.          The Enquiry Committee strongly feels, that amendment in Exposure/ Loss limit and slab rate for Deposit is too sensitive matter to be left solely at the discretion of the Board of Director, in which the majority of the members are market players. The decision of the Board of Directors should be made after obtaining comments of all stakeholders and subject to confirmation of SEC. A separate recommendation has been made elsewhere regarding the authority delegated to the Managing Director.

CHAPTER VII

1.      Punitive action taken by KSE for non-compliance in implementing Regulations Governing Members’ Exposure

1.1     After it was discovered that there was non-compliance in the implementing the “Regulations Governing Members’ Exposure”, KSE management decided to recover the additional deposit from its members.  The Enquiry Committee was informed that all the members, except the defaulted member deposited the additional securities. KSE Board was of the view that this was the fault of the management and members were not aware of the error in calculating “Exposure” and “Deposit.” This view is not convincing because of the reasons that the same rule was being fully complied by LSE.

1.2     As stated above in this Report, KSE Board of Directors appointed a Review Committee under the chairmanship of the then Vice Chairman (now Chairman) to identify person responsible for lapses. The Review Committee came to the conclusion that Joint Secretary Clearing and Settlement was primarily responsible for the wrong and suggested that disciplinary action be taken against him. The Board of Directors of KSE decided to implement the recommendations of the Review Committee.

1.3     In a letter addressed to a member of this Enquiry Committee, dated January 01, 2002, issued under the signature of the Managing Director, KSE confirmed, “appropriate disciplinary measures were taken following the order of the Board.” When asked to substantiate this statement another letter dated January 29, 2002 was received under the signature of the General Manager, who was Acting Managing Director stating that “the said officer was served with a show cause notice, dated November 21, 2000, asking his explanation for his negligence in implementation and monitoring of Exposure Regulations. The reply to the show cause notice dated November 22, 2000 received from the said officials was considered by the management and in view of the circumstances explained and apology tendered no further action was considered necessary.”

1.4     The two replies are contradictory. The Enquiry Committee reviewed the personal file of the said officer and observed as under:

1.5     A show cause notice was served to the said officer on November 21, 2000, six weeks after the Board Meeting in which decision to implement the recommendation of the Review Committee was taken. The charges were not properly framed. It was simply stated, “you have been negligent in your responsibility in the implementation and monitoring of Exposure Regulations.” The reply to this show cause, dated November 22, 2000 was evasive. Copies of relevant correspondence from the personal file of the said officer are attached as Annexure “F”. The main gist of the reply is as under:

1)     The computer did not calculate the exposure correctly.

2)     He was neither directly or indirectly involved in the preparation of the program

3)     The computer department generated the report and used to forward these to a section in the Clearing-House responsible for recovering of the deposits.

4)     Clearing house remained under the supervision of the computer department.

5)     The former Managing Director used to supervise and monitor the Exposure Regulations closely. As Managing Director, he was also supervising the I.T. Department.

6)     Neither he was involved in monitoring nor he was supervising the I.T department, except that whatever report he was getting were to be implemented.

7)     Despite this if there were any unintentional error or lapse of responsibility on his part, he requested forgiveness.

1.6     The Acting Managing Director after discussing with Joint Secretary – Human Resources filed the reply and the matter was closed. According to the reply of Joint Secretary - Clearing and Settlement, all the responsibility was placed on computer department, a section of Clearing House and the then Managing Director. According to him, he was not responsible, as his job was to implement “whatever” report he was getting.  The Enquiry Committee is of the opinion that decision of the Acting Managing Director “to take no further action in the matter”, was in violation of decision of the Board. If he had referred to the report of the Review Committee, it has been very clearly stated as under:

“There is a clear lapse of responsibility on the part of Joint Secretary Clearing and Settlement in as much as he failed to discharge his duties and responsibilities diligently and adopted a routine clerical approach. Contrary to the requirement of his job description, he failed to review and recheck any procedure, which would have spotted the netting off of sales and purchases. Moreover, he misinterpreted a very clearly worded circular on exposure and did not even bother to consult his superiors before implementing his own version of the circular. Disciplinary action as per rules needs to be initiated against him.”

1.7     Neither the show cause notice nor the reply covered any of these points.

1.8     This Enquiry Committee interviewed the said officer and found him not suitable for the post of Head of Clearing and Settlement Department, because of his evasive attitude and not being forthright. The Review Committee had also noted that there are “dead woods” in the Department and recommended that a Chief of Operations should be appointed to head this Department, who should then clear the “dead woods”. There must be a very strong lobby within the management or those having influence over management, who want to maintain the status quo in the Department, that despite decision by the Board, the matter was closed.

1.9    Recommendation.          The Enquiry Committee feels that the recommendation of the Review Committee must be implemented. If the Clearing and Settlement Department is to be managed independently, without being influenced by the market players, it is vital that a competent person should head it.

CHAPTER VIII

1.      Non-compliance in implementing the Members’ Default and Procedure for Recovery of losses Regulations. It is provided in the Default Regulations that all the outstanding positions of the suspended member will be squared up in open market. In reply to our query, if the position of Mr. Hanif Moosa was squared up in open market, the reply of KSE was evasive.

1.1     We give below extracts of our letter and KSE’s reply. We also give below our findings in the matter.

a.       Our letter dated February 15, 2002 requested the KSE to advise us about the mode of sale.

b.      KSE reply dated February 18, 2002 stated that the “shares were sold through an auction in the trading hall of the Exchange on June 01, 2000”.

c.      Our letter dated February 27, 2002 stated as under:  

“In paragraph 2 of your letter you have stated, “shares were sold through an auction in the trading hall of the exchange on June 01, 2000”. The notice number KSE/N-2088 dated June1, 2000 refers to auction of “shares which have already been underwritten”. Further in notice number KSE/N –2028 dated May 30, 2000, KSE has clarified that the underwriting commitments for all the shares, except The Bank of Punjab and Adamjee Insurance Company Limited have been obtained. Please explain as to how the shares of The Bank of Punjab and Adamjee Insurance Company Limited were sold and if the provisions of all relevant regulations governing members’ default and procedure of recovery of losses were complied with. We require the detailed statement of account of Mr. Hanif Moosa (defaulter).”

d.      In reply dated March 04, 2002, KSE did not make any comments on the above point raised by the Enquiry Committee

1.2     The Enquiry Committee has come to the conclusion that the shares of Adamjee Insurance Company Limited and The Bank of Punjab were not sold in the auction, but through private placement in violation of the provisions of Members Default and Procedure for Recovery of Losses Regulations.

1.3     It has been contended by Mr. Hanif Moosa that his outstanding positions (purchases and sales) were not squared up and no statement of the loss/profit was sent to him before declaring him defaulter. He has also alleged that some of the influential members had resorted to blank selling in the Bank of Punjab and Adamjee Insurance Company Limited before May 2000 Crisis.

1.4     Clause 2 of the Default Regulations provides as under:

1)                          If a member fails to pay the amount due from him under the Rules and Regulations of the Exchange over and above the prescribed amount, he shall be issued a notice requiring him to pay the amount or deposit shares. On failure to comply he will be suspended.

2)                          Upon suspension his outstanding position will be squared in the open market and he will be served a final notice of loss, so determined, calling upon him to pay the losses within a stipulated period. If he fails to comply, he will be declared defaulter.

3)                          Upon declaration of defaulter, a statement will be prepared by the Exchange of defaulters’ script-wise losses and statement of transaction by members in those scripts. The losses will be debited to those members with whom the defaulted member has transacted in those scripts and such members shall have to pay the losses to the Clearing House.

4)                          Such payment by members will be treated as claims against defaulter and settled with other claims in accordance with the General Rules and Regulation of the Exchange.

1.5           A statement given by Mr. Abdul Razzak Ali Mohammed, Joint Secretary – Clearing and Settlement of procedure followed is given at Annexure “F/1”.

Excerpts from the statement of Mr. Razzak Ali Mohammad

Mr. Abdul Razzak Ali Mohammed, Joint Secretary – Clearing and Settlement has further stated that no statement determining loss on squaring up position of Mr. Hanif Moosa on suspension was prepared and no notice was served on him to pay losses stipulated therein.

On specific question as to why Adamjee Insurance and BOP were not sold in open market, he only said that “notice attached regarding Adamjee, BOP.” 

On question whether Regulation 2(iii) & 2(iv) of Members’ Default and Procedure for Recovery of Losses Regulations were followed, the reply was that “it was not followed.”

1.6         A statement of Account of Mr. Mohammad Hanif Moosa is attached as Annexure “F/2”.

1.7         The Enquiry Committee reviewed the compliance/ non compliance of the Members’ Default and Procedure for Recovery of Losses Regulations from three aspects, as under:

1)              Whether the chronological order, as laid down in the Regulation were followed?

2)              Whether the Losses were allocated, as laid down in the Regulation and claims settled accordingly?

3)              Were the sale of assets of the defaulted member were transparent and in accordance with Regulation?

1.8                      Findings of the Enquiry Committee are as under:

a)         Upon suspension of Mr. Mohammad Hanif Moosa on May 30, 2000, his outstanding position was squared up in the open market. The statement of account of Mr. Mohammad Hanif Moosa is attached. The statement of sale of shares was attached as Annexure “G”. The shares of Mr. Hanif Moosa in deposit with the Exchange, with the exception shares of Adamjee Insurance and Bank of Punjab, were sold in the auction in the open market. Please refer to KSE notices, dated May 30, 2000 and June 1, 2000 at Annexure “G/1”. In respect of shares that were sold in the open auction, KSE Board of Directors had obtained underwriting commitment from the members, based on the market price of May 29, 2000. The price at which shares were underwritten was the floor price. The highest bid over and above this price was accepted.

b)     The details of sale of shares of Bank of Punjab and Adamjee Insurance (please refer to Annexure “G” of the Report), as provided by KSE is given below:

Bank of Punjab:

Adamjee Insurance:

c)        In respect of 1,351,000 shares of  Adamjee Insurance, stated to be sold by Arif Habib Securities Limited (AHSL) to Crescent Investment Bank Limited (Cres Bank), our comments are as under: 

1)     In a letter, dated March 22, 2002 to the Enquiry Committee, the Cres Bank did not confirm the transaction. (Annexure “G/2”)

2)     AHSL bill dated June 1, 2000 shows 1,351,500 shares of Adamjee Insurance sold to Cres Bank @ 55.10 per share.

3)     Vide letter, dated April 1, 2002, the Cres Bank confirmed the transaction. (Annexure “G/3”)

4)     In CDC account, 1,702,000 shares of Adamjee were moved to the account of Salim Chamdia from the account of Hanif Moosa on the instruction of K.S.E, Managing Director. Out of these 1,351,000 shares were moved to AHSL account.

5)     From AHSL, the shares were not moved to Cres Bank account, but to the account of Messrs Bashir Alimohammed, Iqbal Alimohammed, and Ghulam Alimohammed.

6)     Mr. Arif Habib appeared before the Enquiry Committee and stated that the very next day Cres Bank sold the shares. He provided the sale statement issued to Cres Bank for the same number of shares. There was no movement of these shares in Cres Bank account in CDC from AHSL account.  Cres Bank made a gain in the transaction, as under:

Date	Transaction	Rate (Rs.)
1.6.2000	Sold to Cres Bank	55.10
2.6.2000	Purchased  from Cres Bank	60.00
	Gain	4.90

7)           The shares were then sold on 2.6.2000 to Bashir Alimohammed, Iqbal Alimohammed, and Ghulam Alimohammed @ Rs. 60.30 per share. Mr. Arif Habib provided the purchase statement issued to the client.

d)                   The statements of transactions issued by AHSL to Crescent Bank, Mr. Bashir Alimohammed, Mr. Iqbal Alimohammed, and Mr. Ghulam Alimohammed are attached as Annexure G/4. The serial numbers of these statements are as under:

e)                                   The CDC account of Mr. Salim Chamdia, AHSL and Cres Bank  are attached as Annexure “IG/5”. 

f)                                    Apparently Cres Bank made a gain of Rupees 4.90 per share. AHSL were instrumental in this deal, which appears to have been made at the cost of the Clearing House Protection Fund of the Karachi Stock Exchange.

1.9     The Enquiry Committee is of the opinion that Members’ Default and Procedure for Recovery of Losses Regulations were not followed by KSE while declaring Mr. Hanif Moosa as defaulter, squaring up of his positions and sale of its assets.

CHAPTER IX

1.      Member(s) through whom the shares kept as exposure margin and the outstanding position of Mr. Hanif Moosa were disposed off and the respective clients with whom such transactions were made.

1.1     Statements showing shares sold on account of Mr. Mohammad Hanif Moosa are placed at Annexure “G” and “H”, as provided by the KSE management and KSE - I.T. Department respectively. Please also refer Chapter VIII for details.

CHAPTER X

1.      Reasons for changes made in the “Regulations Governing Members’ Exposure” in respect of shares of Adamjee Insurance Company Limited, The Bank of Punjab and Fauji Fertilizer Company Limited.

2.      Adamjee Insurance Company Limited

2.1     The placement of Adamjee Insurance Company Limited in list of approved securities was in accordance with the laid down criteria, based on turnover and from July 2000 on the basis of turnover and EPS.

3.      The Bank of Punjab

3.1     Inclusion of The Bank of Punjab in various categories can be justified on the basis of criteria laid down, uniformly applied.

3.2     With regard to the change in margin introduced by the management of KSE, our comments are as under:

(a)     Date not known - Margin increased from 10% to 25%: No record of this change is available with KSE.

(b)     September 01, 1999 - Margin increased from 25% to 50%: Share price volatility was the main reason. Share price increased to Rupees 43.50, without any change in fundamentals. The Enquiry Committee is of the opinion that the management decision to enhance the margin was justified.    

(c)     November 08, 1999 - Margin reduced to 20%, as applicable to “C” category: Action of the Board of Directors appears to be justified as share price came down to Rupees 19.10 and there was no need to maintain 50% margin. 

(d)       April 06, 2000:    KSE informed the Enquiry Committee that enhancement of the margin of The Bank of Punjab to 50% on April 06, 2000 was necessitated in view of the volatile market condition and more particularly abnormal increase in its share price and the deposit of major portion of the shares under exposure by a single member. The KSE further informed that this was a timely action and any delay would have exposed the Clearing House to higher risk. However, with the implementation of the revised list of approved securities with effect from May 01, 2000, the margin was reduced to 20%. The major reason stated for enhancing the margin in respect of The Bank of Punjab were inter alia (a) the share price, which was at Rs. 16.50 on June 01, 1999 increased to Rs. 56 on April 03, 2000 without any changes in the fundamentals (b) out of the total number of shares pledged by the members with Clearing House against exposure, 60% was pledged by a single member (Mr. Mohammad Hanif Moosa). While the Enquiry Committee is generally in agreement with KSE management in this respect, it has been noticed that this change was made by the Joint Secretary, Clearing and Settlement Department in consultation with the then Chairman when the then Managing Director was on foreign tour. In this regard, the Enquiry Committee has come to know that the then Managing Director as well as the General Manager of the KSE were on foreign tour during the period April 01 2000 (Saturday), to April 10, 2000. During their absence, the Managing Director had delegated the “day today work” of the Clearing and Settlement Department to Mr. A. Razzak Ali Mohammed, Joint Secretary - Clearing and Settlement Department and of remaining departments to Mr. Farooq Sharif, Joint Secretary - Company Affairs. Copy of the internal office memo is attached as Annexure “H/1”. The Joint Secretary - Clearing and Settlement Department enhanced the margin of Bank of Punjab on April 03, 2000 (Monday), immediately the next working day after the Managing Director had left on foreign assignment, after consulting the Chairman. Please refer to Annexure “H/2”. The Joint Secretary did not consult the Managing Director prior to his departure about the possibility or need for change in the margin of Bank of Punjab. He also did not consult Mr. Farooq Sharif, who was authorized to look after day-to-day work of the KSE to ascertain or clarify his legal authority before taking the said decision. The findings of the Enquiry Committee in this respect are as under:

a)         The Board of Directors in the meeting held on November 08, 1999 resolved “the management can delete any company or change the margin of any company any time after giving reasonable notice.”

b)        According to the clause 54© of the Article of Association of KSE, “the Managing Director has the executive powers to run, superintend and effectuate the day to day operation, administration and general management of the exchange”. Further he is authorized to “implement decisions and directions of the Board”.

c)        Under Articles clause 54(d), in the absence of the Managing Director “his powers and functions may be delegated or entrusted to the General Manager by the Board”.   

d)        It has already been stated that the Board of Directors is empowered to change the limit of exposure/ losses. The Board of Directors does not have the power of delegation under the Regulations Governing Members Exposure.

e)        The Managing Director had instructed the Joint Secretary – Clearing and Settlement to “look after the day today work” of the Clearing and Settlement Department and to coordinate with the Chairman.

f)         Neither the Managing Director nor the Board of Directors delegated any authority to the Joint Secretary – Clearing and Settlement to amend/change the exposure limit/ margin. His action is without any legal authority. A proper course would have been to call the meeting of the Board of Directors.

g)        The share price of BOP was already at a high level, not justified by the intrinsic value even before the departure of the Managing Director and the Joint Secretary could have consulted with the Managing Director and if necessary sought his orders before his leaving. However, in defense of Joint Secretary, it can be said that on April 03, 2000, the share price further increased, which may have prompted him to enhance the margin. Please refer to Annexure “H/3” showing movement of share price of Bank of Punjab from March – May 2000. The Enquiry Committee does not question the reason for increase in margin. However, it does question the authority of the Joint Secretary and also that the decision was not across the board.

h)        The Chairman should have called the meeting of the Board of Directors, which is the only competent authority to take such a decision or at least he should have advised the Joint Secretary - Clearing and Settlement to clarify his own legal authority from the legal department/ legal adviser. He could also have advised the Joint Secretary - Clearing and Settlement to check the position of other listed companies, as the Bank of Punjab was not the only company whose share price had moved up. 

3.3        The Enquiry Committee is of the view that:

a)                  There were good reasons for enhancing the margin requirement in respect of the Bank of Punjab, however, on the same basis the margin requirement in respect of Dhan Fibre should have been enhanced. In the case of Dhan Fibres Limited, the share price increase, as well as position of shares pledged with one broker (M/S AKD Securities (Pvt.) Limited) was higher than Bank of Punjab, yet similar action was not taken in case of Dhan Fibres Limited. The action of the management was, therefore, not across the board.

b)                 The Joint Secretary was not authorized to enhance the margin of Bank of Punjab on his own authority.

c)                 The Chairman should have convened the meeting of the Board Directors to consider the issue of enhancement of the margin of Bank of Punjab.

3.4     The above point has been further illustrated in the following table:

3.5     The Enquiry Committee further enquired from KSE, as to why Dhan Fibres Limited was not given similar treatment, as The Bank of Punjab. In response, it was stated that 310% price increase of Dhan Fibres was on merit, due to reported merger with Dewan Salman Fibre Limited. With the swap ratio of 3:1, the share price of Rupees 17 for Dhan Fibres Limited could hardly be called on merit or a cheap entry into Dewan Salman Fibre Limited. We quote from a news item from daily Dawn, dated July 20, 2000:

“The news was greeted by the market with a mixed response. While the share in the Dewan Salman gained 50 paisa to close the day at Rupees 28.60 with trading seen in 7.3 million shares, the Dhan Fibre stock shed 70 paisa to end at Rupees 9.85 with business in 12.2 million shares”.

This is exactly the reverse of KSE’s explanation given to the Enquiry Committee. This clearly indicates that the management had not applied the criteria across the board. No plausible reasons have been given to the Enquiry Committee in this respect.

4.      Fauji Fertilizer Company Limited:

4.1    In the opinion of the Enquiry Committee, the decision of the Board on April 26, 2000 to place the company to Category “B” was not justified, because of following reasons:

i)                   The decision was taken in an emergency Board Meeting, without presenting any working paper to the directors.

ii)                The criteria for placing companies in “A”, “B” and “C” categories was changed without assigning any reason, as under:

iii)              Due to expansion of category “A” list, FFC Jordan Fertilizer Company Limited, Dhan Fibres Limited and Ibrahim Fibres Limited were included in the said list. Had the list been expanded to nine, Fauji Fertilizer Company Limited would have been included in the list as well. Please refer Annexure “J”

iv)               Dhan Fibres Limited had benefited in more than one way from the decision of the Board of Directors. Firstly, it was not treated at par with Bank of Punjab in increasing margin. Secondly, it was placed in category “A” by changing the “period of which turnover” was considered and expanding the category “A” list. These maneuvers almost coincided with the timing of correction of error by the Clearing and Settlement Department regarding acceptance of only category “A” shares for exposure above Rupees 200 million. Previously, it mattered little, whether shares are in category “A”, “B” or “C”, as Clearing and Settlement Department was accepting all shares. 

v)                  A Committee of Directors was formed to look into the criteria and come up with the suggestion. It is not understood, as to urgency for not waiting for the Committee recommendations and making the changes in the interim.

CHAPTER XI

1.      Significant changes made in the “Regulations Governing Members’ Exposure” during the last five years.

1.1    No change as such was made in Regulations. However, changes were made in “Exposure” or “Loss” Limits of members and Deposit payable thereon.

1.2     The Enquiry Committee has listed all the changes since August 1993. Significant changes during last five years (1996 to 2001) are listed on the next page:

1.3     Significance of these changes are briefly discussed below:

August 06, 1998: KSE decided to introduce the concept of “approved security” for the purpose of Deposit under the Regulation. 10% margin was introduced, if Deposit is not in cash. This was a good decision to protect the Clearing House and first step to make it liquid.

November 08 1999: As a further improvement to August 06, decision, the shares were categorized on the basis of liquidity and the margin was also graduated at 10%, 15% and 20%.

April 03, 2000: Increase in margin for The Bank of Punjab. A good move to protect the Clearing House, but other share(s) should also have been included. See comments under The Bank of Punjab in Chapter X.

April 26, 2000: Amendment to November 08, 1999. Decision was not justified. Enquiry Committee has already commented in this respect.

July 06, 2000: A comprehensive system evolved, which takes into consideration the turnover, as well as earnings (fundamentals of the company). The cap on valuation of the shares on the basis of 15x EPS introduced, so that manipulators cannot take advantage of very high price, which otherwise cannot be justified. Margin introduced on graduated basis. System of half yearly review introduced, so that management can revise the list on the basis of turnover and EPS, in a routine manner.

CHAPTER XII

RECOMMENDATION

1)           Management of Exposure Limits:  KSE must strengthen the Clearing and Settlement Department and take necessary steps including implementation of the recommendation of Review Committee.

2)           The powers of the Board of Directors to prescribe changes in Exposure/Loss limit and slab rates for deposit payable there against:         This is very sensitive matter to be left solely at the discretion of the Board of Director, in which the majority of the members are market players. It is recommended that the decision of the Board should be made after obtaining comments of all stakeholders and subject to confirmation of SEC.  

3)           Delegation of authority to the Managing Director: The delegation of authority to the Managing Director to delete any company from the list of approved securities or enhance its margin may be discontinued. As an upper limit has been placed on the shares price, there appears to be no reason for continuance of such delegation to the Managing Director.

4)           Location of Clearing and Settlement Department. The Clearing and Settlement Department of K.S.E. is located in the old building away from the limelight. The contact of the staff of the Department with the members of the Exchange or their staff cannot be ruled out and such contacts will go unnoticed. The Department processes very sensitive information, which should not be available to market players. The correct location of this very sensitive department should be in the main building under the watchful eyes of the top management, ensuring the inaccessibility or no contact of the market players. It is recommended that the Clearing and Settlement Department be brought to the main building on the same floor where the office of the Managing Director is located.