TABLE OF CONTENTS

Contents

Karachi Stock Exchange (Guarantee) Limited

Lahore Stock Exchange (Guarantee) Limited

Annexures

EXECUTIVE SUMMARY

There have been serious allegations regarding abrupt changes in exposure rules, management of exposure limits and non-compliance with the Exposure and Default Regulations by the Stock Exchanges during May 2000 crisis. The Enquiry Committee appointed by the Securities and Exchange Commission of Pakistan investigated these issues. The Executive Summary of the outcome of said investigation is as follows:

Karachi Stock Exchange      The investigation carried out by the Enquiry Committee constituted by the Securities and Exchange Commission of Pakistan in respect of Karachi Stock Exchange (Guarantee) Limited (the “KSE’) has revealed lapses in the management of exposure limits as well as unjustified changes in the exposure rules. The Committee has also observed non-compliance in the implementation of “Members’ Default and Procedure for Recovery of Losses Regulations.”

1.      Lapses in the management of exposure limits:  There were lapses in the management of exposure limits. The Board of Directors of KSE appointed a Review Committee, under the chairmanship of the then Vice Chairman. The Committee in its finding stated that Joint Secretary – Clearing and Settlement was primarily responsible for the lapses and recommended disciplinary action against him. The Committee also recommended the appointment of a Chief of Operations, a position in the Organization Chart, which was vacant in order to strengthen the Clearing and Settlement Department. The Committee further recommended that the “dead wood” be cleared “as soon as possible.” The Board of Directors of KSE accepted the recommendations of the Review Committee; however, the management took no practical measures and decided to close the matter. Please refer to pages 45 to 50 of the report.

2.      Changes in the exposure and loss limits and deposit payable there against.    The Committee reviewed all the changes made in the exposure and loss limits and deposit payable there against and its findings are as under:

2.1    The changes brought about in an emergency meeting of the Board of Directors held on April 26, 2000 were not justified. Please refer to pages 38 to 44 of the report. 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

2.2     The changes brought about in the emergency meeting of the Board of Directors held on August 24, 2001 were tabled under “any other item”. The Committee strongly feels that KSE may be specifically asked to desist from such practice. Please refer to pages 31 of the report.

2.3     The changes made in the exposure limits in respect of Fauji Fertilizer Company Limited in an emergency meeting of the Board of Directors held on April 26, 2000 were unjustified and not in accordance with the laid down criteria. Please refer to pages 72 to 74 of the report.

2.4     The changes in the exposure limits in respect of Adamjee Insurance Company Limited were in accordance with the laid down procedure. Please refer to page 63 to 64 of the report.

2.5     The changes in the margin of The Bank of Punjab were done on three occasions. The margin was increased from 10% to 25% after September 10, 1998 and before September 01, 1999.  KSE has stated that they do not have any record in this respect. Next, the change was made on September 01, 1999 by the management and the margin was increased from 25% to 50%. The reasons for this increase were high volatility of share prices without any change in the fundamentals. The management made the third increase on April 03, 2000, with effect from April 06, 2000 under the powers delegated by the Board of Directors. The Committee is of the opinion that there were good reasons for enhancing the margin requirements in respect of The Bank of Punjab, however, on the same basis, the margin requirements in respect of Dhan Fibres Limited should have been enhanced. This demonstrates that the management did not apply the said criteria across the board. This also raises doubt about the impartiality of the management while making decisions on such a serious issue. The Enquiry Committee has, however, noted that the third increase in the margin of the Bank of Punjab, was made by the Joint Secretary, Clearing and Settlement, with consultation of the Chairman during the absence of the then Managing Director, who was on a foreign visit accompanied by the General Manager of KSE. The Committee is of the opinion that neither the Joint Secretary nor the then Chairman was authorized to take this decision. It was incumbent on the Chairman to have convened the meeting of the Board of Directors of KSE, which was the only competent authority for taking the said decision. Please refer to pages 64 to 72 of the report.

3.      Members’ Default and Procedure for Recovery of Losses Regulations.         Only the underwritten shares of Mr. Hanif Moosa (the “defaulter”) were sold in the open market as per regulations. The shares of Adamjee Insurance Company Limited and The Bank of Punjab, which were not underwritten were not sold in the open market. The shares of Adamjee Insurance Company Limited were sold at a price of Rs. 55 per share as against shares of the same company sold/placed by Lahore Stock Exchange (Guarantee) Limited during May Crisis at an average price of Rs 70 per share.

3.1     KSE provided the particulars of clients to whom the shares of the defaulter were sold. This list did not tally with the computer-generated list provided to the Enquiry Committee by the IT Department of KSE.

3.2     According to the statement provided by KSE containing names of clients through whom shares of Mr. Hanif Moosa were sold, 1.351 million shares of Adamjee Insurance Company Limited were stated to have been sold through M/S Arif Habib Securities to M/S Crescent Investment Bank Limited. An enquiry, therefore, was made to Crescent Investment Bank Limited in this matter. The Crescent Investment Bank Limited has confirmed that they have purchased 2.750 million shares of Adamjee Insurance Company Limited from M/S Aqueel Karim Dhedhi Securities (Private) Limited (These are those shares, which were placed by Lahore Stock Exchange to square up the positions of its defaulting members) and 1.351 million shares of Adamjee Insurance Company Limited through M/S Arif Habib Securities. These 1.351 million shares were subsequently sold back by Crescent Investment Bank Limited to AHSL next day. No delivery of shares took place. A gain of Rupees 4.90 per share accrued to Crescent Investment Bank Limited in this deal. AHSL then immediately sold the shares to Mr. Bashir Ali Mohammad, Mr. Iqbal Ali Mohammad and Mr. Ghulam Ali Mohammad. The serial numbers of the statement of these transactions are very close and give rise to apprehensions about these transactions, which appear to have been made at the cost of Clearing House Protection Fund of KSE. Please refer to pages 75 of the report.

4.      Location of Clearing and Settlement Department.       The Clearing and Settlement Department 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 can go un-noticed.

5.        Conflict of Interest issue.        Attention is also invited to the LSE report (Page 92 to 93) regarding the serious issue of conflict of interest, which is equally applicable in the case of KSE.

Lahore Stock Exchange.             The investigation carried out by the Enquiry Committee constituted by the Securities and Exchange Commission of Pakistan in respect of Lahore Stock Exchange (Guarantee) Limited (the “LSE”) has revealed failure in the management of exposure limits and non-compliance in implementation of “Regulations Governing Members’ Exposure” and “Members’ Default and Procedure for Recovery of Losses Regulations.” The Enquiry Committee has also identified weaknesses of the system and inadequacy of internal control.

1.      Management of exposure limits.       There have been lapses in implementation of rules governing members’ exposure and loss limits and deposit payable thereon.  The Enquiry Committee has observed that exposures were calculated contrary to the rules and regulations exposing the Clearing House to a greater risk. Had there been proper management of exposure limits, the enormous losses suffered by the Exchange in May 2000 Crisis would have been averted. Please refer pages 118 to 136 of this report.

2.      Changes in exposure limits.       There were several occasions when the Management Committee of the Board of Directors have prescribed changes in the exposure and loss limits and deposit payable thereon in violation of the regulations. Moreover, the record does not provide any information on the decision-making process and rationale for making changes in the exposure and loss limits and deposits payable thereon. This issue has been dealt in detail in Chapter II (Pages 110 to 117) of this report.

3.      Punitive action taken by LSE for non-compliance in implementing Regulations Governing Members Exposures. The management of LSE has not taken any punitive action against persons responsible for the non-compliance in implementation of exposure limits. Please refer pages 144 to 146 of this report.

4.      Non-compliance in implementing Members’ Default and Procedure for Recovery of Losses Regulations.  LSE has not adhered to the Members’ Default and Procedure for Recovery of Losses Regulations in respect of its members suspended during May 2000 Crisis. The decision of the Board of directors of LSE not to follow the regulations appears to be motivated by the Badla (COT) providers, which include some of the members of the Board of Directors. As the aforesaid decision was made to save the Badla (COT) providers, therefore, it was incumbent on the directors who were Badla (COT) providers to comply with the provisions of Section 214 and 216 of the Companies Ordinance and Article 88 of Articles of Association of LSE pertaining to interested directors. It was, however, not done. Whereas, this decision has resulted in partial recovery from suspended members, LSE has assumed the liabilities of its members, which were in fact was the risk of the counter parties. Mr. Iftikhar Shafi has recently been declared defaulter. LSE must now strictly follow its regulations and determine scrip wise loss with a statement of transactions made with other members in those scripts. These losses shall be debited to the account of those members with whom the defaulter originally contracted such transactions and such members must pay the losses to Clearing House of LSE as required by the Default Regulations of LSE. Please refer Chapter IV (Pages 137 to 143) of this report.

5.      Punitive action taken by LSE for non-compliance in implementing Members’ Default and Procedure for Recovery of Losses Regulations.      No punitive action was taken because the Board of Directors itself has decided not to follow the Members’ Default and Procedure for Recovery of Losses Regulations. In the opinion of the Enquiry Committee, it was done to avoid losses, which otherwise had to be borne by the members of LSE including members of the Board of Directors / Badla  (COT) providers. Contrary to the regulations in force, the Board of Directors has decided to Fund the shortfall of the Clearings from the Members Contribution Fund, Investors Protection Fund and loans from financial institutions. This has resulted in substantial losses to the LSE including financial charges on loans in addition to loss of opportunity cost on the funds used from Members Contribution Funds and Investor Protection Funds. For detail, please refer page 146 of this report.

6.      Level of competence of the Clearing and Settlement Staff.      The Clearing and Settlement staff fell short of the competence needed for the office. The Enquiry Committee has also observed lack of co-ordination among the different departments of LSE. Please refer pages 147 to 148 of this report for further details.

7.      Compliance with the instructions of members to square up their respective positions.     Mr. Iftikhar Shafi has agitated that his instruction to square up his position was not complied with by LSE. In this respect, the only letter produced to the Enquiry Committee is dated May 30, 2000. LSE has denied having received any such instructions. According to LSE, Mr. Iftikhar Shafi was never stopped from reducing his outstanding position from his own terminal before suspension of his trading rights on June 01, 2000. While agreeing to the point of view of LSE, the Enquiry Committee has observed that it was the responsibility of the Board of Directors and the management of LSE to promptly squared up the positions of its members who failed to make payment to the Clearing House. LSE has pointed out practical difficulties in squaring up the huge positions of its members suspended during May 2000 Crisis. Consequently, the shares of suspended members were placed with institutions. This issue has been examined in detail on pages 149 to 153 of this report.

Recommendations.        The recommendations of the Enquiry Committee are placed at Pages 154 to 160 of this report.

ACKNOWLEDGEMENT

The Enquiry Committee acknowledges the assistance received from the Managing Directors of Karachi and Lahore Stock Exchanges and their management teams in providing the information and documents needed for the investigation. The Enquiry Committee also expresses its appreciation for the co-operation and courtesy extended by all concerned at Karachi and Lahore Stock Exchanges.

BACKGROUND AND INVESTIGATION

1.         Appointment of the Enquiry Committee. The Securities and Exchange Commission of Pakistan (SECP), vide its Order No. F 1 (22) DS – III/ 2001, dated August 28, 2001 appointed an Enquiry Committee comprising of Mr. Habib ur Rahman, Chief Executive Officer, ABAMCO Limited and Mr. Rashid Sadiq, Executive Director, Securities and Exchange Commission of Pakistan. Terms of Reference of the Enquiry Committee are attached as Annexure “A”.

 2.         Objective of the Investigation.          The enquiry relates to the management of exposure limit and compliance of the regulations governing members’ default and procedure for recovery of losses at the Karachi Stock Exchange (Guarantee) Limited (the “KSE”) and the Lahore Stock Exchange (Guarantee) Limited (the “LSE”). In accordance with the term of reference, the Enquiry Committee covered two broad areas, as under:

2.1       Regulations Governing Members’ Exposure.       There have been serious allegations regarding management of exposure limits and abrupt changes in the exposure rules by KSE. The objective of the enquiry was to find out, (1) if the management of the exposure limits by the Clearance and Settlement Department has been according to the rules and (2) if the changes made from time to time in the exposure limit and deposit payable there against have been bona fide. The Enquiry Committee made a detailed study to find out the method adopted to manage the exposure limit and whether the management has maintained neutrality and fair play with all the market players. The Enquiry Committee has also gone into the reasons for bringing changes in exposure limits and deposits and evaluated, if justification existed for the changes and were brought after proper consideration and deliberation on all the issues involved. The thrust of our enquiry is to evaluate, if the principle of good governance has been followed by KSE and LSE.

2.2       Members’ Default and Procedure for Recovery of Losses Regulations.        The objective of the enquiry was to find out, if the provisions of the regulations have been followed and the outstanding positions and assets of the defaulter member(s) were squared up/disposed off in a proper manner in the open market in the best interest of the Clearing House and other concerned.

2.3       Period covered in the Enquiry.         In respect of paragraph 2.1 above, the enquiry covers the period since the introduction of the Regulations Governing Members’ Exposures at KSE and LSE.  Only trading under the Ready Counters has been covered. Since the future trading has only recently commenced, enquiry on Future Trading was not considered necessary. As to Members’ Default and Procedure for Recovery of Losses Regulations, the enquiry has only covered the May 2000 Crisis. There were several other defaults before May 2000 Crisis, however, the same have not been covered in the Enquiry Report.  

2.4    Enquiry Report.               The Enquiry Report consists of two parts. Part one relates to the KSE and part two to the LSE.