For years, African Stock Exchange officials and Capital Markets regulators have been courted by U.K. and U.S. securities officials. They are invited to and attend annual conferences in London and D.C. to learn how developed markets are managed and regulated-all that is about to change. Since the global financial crisis-and given the rampant fraud discovered in New York, London and Europe- how can developed markets now lecture emerging markets on how to effectively manage and regulate an exchange? Will Aid ever more be tied to the adoption of transplanted laws that clearly do not function in a way that protects investors-at least from fraud-no matter what continent they operate on? Too often the world focuses on what is wrong with Africa. Fraud happens on exchanges worldwide. All regulators need to minimise or eliminate fraud in order to allow a stock exchange to function as an effective mechanism for growth. Moreover, African commercial law clearly does not need to replicate the West-both are flawed. As the global financial community considers the efficacy of global securities regulation, the African exchanges must be included in that dialogue. It may be that progress lies in recognizing the challenges all exchange face and learning, together, how to regulate accordingly.
Nyaga Stockbrokers was put under receivership by the Capital Markets Authority of Kenya (CMA) in March of 2008 after a discovered fraud. Statutory managers were appointed to assist with the resolution of business at the firm. The CMA conducted a forensic audit and plans to make public the report after further consultation with the Government. 3 Additionally, there was evidence of Nairobi Stock Exchange board members who also served in management positions at Nyaga. 4 The alleged fraud involved the creation of ghost client accounts with the Central Depository System, allowing brokers to hide the movement of funds as well as brokers trading in clients accounts without their permission. 5 It is possible that Kenyan CMA action, closing the brokerage firm, was in the interest of market stability as the broker held large numbers of accounts and shares. 6 There was however, criticism that the regulator did not respond to complaints about Nyaga as early as 2007. In addition, this activity occurred during the post-election troubles as well as the Safaricom IPO which may have has an influence on the decision to act quickly and decisively. The political and economic events surrounding the fraud at Nyaga are diverse but there are similarities with the Madoff type of fraud, the involvement of market insiders and client account manipulation.
Bernie Madoff used his long-term relationship with the financial community in New York to gain the confidence of investors. They invested with him and he never invested a dime of theirs. This went on for years. He printed reports of trades and statements of profits that never existed. There were no safeguards that would indicate to the US securities regulators that something was amiss. There were no audits conducted that could have revealed the bogus reports or unlawful trading in accounts. This was because Madoff held his accounts under his firm not as a broker-dealer, heavily regulated and subject to multiple audits, but as an investment advisory firm. Investment advisory firms or hedge funds are less regulated in the states. This regulatory black hole with respect to hedge funds has been the subject of much of the US Congressional review of regulators actions before the financial crisis. 7 In addition to the Madoff firm, officials are also prosecuting firms and individuals who fed their clients money to Madoff for civil fraud. 8 This is the unique aspect about the Madoff scheme-there was a tight knit community of investors invited to invest as well as large groups unaware that they were invested with Madoff. 9 This sophisticated network did not exist in Nairobi.
Both regulators in our tale of fraud failed. Investor confidence is necessary for markets to grow and this confidence is undermined by fraud; eroding the ability of exchanges to provide opportunities for economic growth not dependent on aid. Capital markets regulation involves rules, regulation and guidance for financial services professionals who sell stock to investors. The main purpose of regulation is to ensure that markets are run fairly and without fraud. Exchanges are a symbol that the country is open for business and attractive for investors. Many African nations that have exchanges have benefited economically from their exchanges without dependency on aid. 10 Stock exchanges open economic doors that aid and donors cannot. The IMF predicts that the poorest countries will need $25 billion (USD) in aid this year. 11 If there were funds available for aid, much of it now will be spent on domestic economic support. It may be possible that economies with available money to invest will need to consider more seriously alternatives to the formerly more reliable developed markets. That is always the hope- that markets in Africa will look attractive for more direct investment. 12 Before that happens however, investors must feel confident which is always a problem in economies subject to unexpected political changes and surrounded by economic uncertainty which many Sub-Saharan economies are. Investor confidence needs to be restored before markets look reliable enough to invest in from outside. This is true on any continent.
The recent economic crisis has made it clear that our financial fates are closely linked. Fraud, similarly transacted, was discovered in one of the oldest and heavily regulated markets in the developed world and in a much younger, emerging market of the developing world. Can this be reduced to a simple failure to regulate? Perhaps, but what these events really demonstrate, is that fraud is endemic to stock markets universally. It also demonstrates that the developed regulatory agencies of the US, or the UK for that matter, have more in common with emerging exchanges than they might care to admit. As things move forward in Kenya and the US in terms of regulation and our understanding of how markets work and how we would like them to work, the developed world must acquire a new attitude. Ideally, this attitude will reflect respect for the difficulties all financial markets face and the realisation that in our integrated global reality all voices deserve to be heard not because they have earned some right, but because this is the only true way to move forward together.
1 We have not been able to acquire first hand confirmation of the specific transactions that led to the demise of the brokerage firms. We have also not been able to get a copy of the PriceWaterhouseCoopers (PWC) forensic auditors report on Nyaga brokers.
2 http://www.sec.gov/news/press/2008/2008-293.htm
5 http://www.bdafrica.com/index.php?option=com_content&task=view&id=5819&Itemid=5812. Brokerage firms have accounts at the Central Depositories. Central Depositories ‘clear stocks’ which is how they reconcile shares against funds held within accounts.
7 Testimony of Mary Shapiro, head of the SEC before the Senate Committee on Banking, Housing and Urban Affairs. http://www.sec.gov/news/testimony/2009/ts032609mls.htm
8 The State of New York, filed a complaint against J. Ezra Merkin and Gabriel Capital Corporation for funnelling $2 billion of clients assets to Madoffs firm. Merkin allegedly collected over $45million in fees for directing charitable organisations, universities and individual investors to Madoff.The complaint does not allege that Merkin knew Madoff was running a Ponzi scheme
10 See the Botswana Stock Exchange. http://www.bse.co.bw/
11 WSJonline, 3 March 2009, last accessed 3/5/09
12 http://www.uaeinteract.com/docs/TAQA_to_invest_US$2.5_billion_in_Morocco_and_Tunisia/35005.htm. Adu Dhabi Energy firm to invest in Tunisia and Morocco.
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