Tuesday, 12 December 2017
Investments in listed securities and best practices to follow; practical guidance from a compliance
Investment in financial instruments has never been easier than today. With the sphere of new technology, an investor is able to invest not only in his or her own jurisdiction but also in other countries’ financial markets. The capital market is an attractive investment arena for many long-term and short-term investors regardless of the risk involved in listed securities. This is no different to the Sri Lankan context where investors invest through the Colombo Stock Exchange (CSE), the only stock exchange in the country. The capital market in Sri Lanka is regulated by the Securities & Exchange Commission of Sri Lanka (SEC) and its participants and activities are also subject to the rules of the CSE.
The CSE has its own rules applicable to the stockbroking companies (member firms). The nature of the many disputes between the investors and the member firms show that the investors tend to believe that the whole responsibility of their investment lies on the member firms through which they invest in and the responsibility for the financial soundness of the member firms lies with the SEC.
However, the investors have not only the rights but also the responsibilities in investing. The informed investors who are aware of their rights and responsibilities in investing are better able to prevent disputes with their broker firms and also reduce the risk of losing their investment portfolio due to fraudulent activities that can occur in the securities industry.
The following are some of the best practices that every investor needs to adhere to when investing in listed securities.
1. Understand that all investment involve risk and securities investment is no exception; rather securities investment is one of the more riskier categories of investments
Every investment carries some degree of risk and greater the potential for high returns (or earning) of an investment, the greater the risks as well. If you deposit your money in a licensed bank or a financial institution, depending on the tenure you still have to take the interest rate risk and inflation risk, however, the chance of you losing your capital is remote. When it comes to the securities investments, this completely changes; you may invest in listed stocks, debentures and unit trust funds. These investments involve varying degree of risks. For example, one of the main risks is market risk; that is the capital can erode in value if the price falls down and if you are forced to sell for less than what you purchased for. For example, Rule 7.1.3 of the CSE Stockbroker Rules requires that in the event the market value of the securities pledged by you falls by 25%, the member firm should inform you to meet the shortfall by the next market day. As per Rule 7.1.4, in the event you fail to meet the shortfall on the next market day, the member firm should immediately sell the securities which have been pledged by you, in order to ensure compliance with Rule 7.1.3. Such force selling along with the market risk factor can contribute to huge losses in your account.
This can happen very often and in any market due to numerous reasons. Likewise liquidity risk, political risk etc., are some of the other risks. Therefore, knowing that all investments involve risks and understanding whether you are willing to take some risk is one of the best practices in investing responsibly. Most of the capital market broker-client disputes that happen in the Sri Lankan context are due to the investors’ lack of understanding of the risks involved in their investments or the outcome of such risks. Some of the broker firms also do not encourage detailed discussions about the risk factors thinking that such discussions would scare the investor away. However, the CSE Stockbroker Rules requires all the brokers to include a risk disclosure statement to their client agreement/ account opening form. The minimum risk disclosure that is required to be included in the agreement is “the prices of securities fluctuate, sometimes drastically. The price of a security may move up or down, and may even become valueless. It is likely that losses may be incurred rather than profits made as a result of buying and selling securities”. Many investors may have seen the risk disclosure, however pay very little attention to that. If you want to understand the risks in your investments, you should carefully read and understand these risk disclosures, request your investment advisors to explain where it is not clear to you and ask questions and take independent advice if seems necessary.
2. Know your broker (KYB) firm and your investment advisor before opening an account
The broker firms play the role of a market intermediary and are regulated and licensed by the SEC. Information about the brokers licensed by the SEC including the names of broker firms, their contact details, website links and the CEO’s name and all the brokers licensed by the SEC is given on the CSE website. Ask about the broker firm’s client compliant history and whether there are outstanding court judgments etc. Doing some research about the broker firm and its investment advisors before you invest any money with them can certainly help you avoid problems as well as certain financial losses.
Investment advisors of the broker firm who are licensed by the SEC are permitted to deal with the clients on behalf of the broker firms. It is a requirement of the SEC that only the licensed investment advisors can deal with the broker firm’s clients and the trainees should be under the supervision of a senior licensed advisor. When an investor is looking for an investment advisor to work with, it is always good to request the broker firm the opportunity to meet with several investment advisors face to face to compare them before making any decision. Ask about the work experience of the Investment Advisor, any disciplinary actions against the investment advisor by the broker firm or the SEC or CSE. Generally the broker firms allocate investment advisors to their new clients based on their availability, portfolio size, clients investment objectives, communication needs etc. One of the negative practices in the industry is that many clients do not meet their investment advisor and only communicate with the investment advisor over the telephone or through emails and do not even see their investment advisor until a dispute happens. The investors have the right to decide on the investment advisor that they like to work with(subject to the availability of such investment advisor) and therefore, you should always know your broker firm and the investment advisor in the same manner in which member firms get to know your information through know Your Clients (KYC) practices.
3. Know your investment goals and communicate them to your investment advisor clearly
One of the most important requirements for an investor is to have a clear sense of his investment goals and the timelines attached to those goals. Whilst everyone wants to earn a better return, many investors want to achieve specific financial goals such as owning a house, sending children to foreign universities, or having a comfortable retirement plan. Generally, your investment advisor should ask you for these information in order to understand your profile including your risk appetite and your investment goals before they advise you on your investments. In many countries, the investment managers and investment advisors provide a detailed questionnaire to their clients to collect these information in addition to the information collected through discussions and meetings. For example; Client Assessment Form is a basic document which asks questions on investment goals, investment experience etc. The investor needs to provide accurate information in these forms and communicate their investment objectives and their risk tolerance levels clearly to their investment advisor. It is also important to update the investment advisor when there is a material change to the status of the investor. It is always good to ask for a copy of these forms, so that you know when to update the investment advisor.
4. Learn about your account, its features and related legal documents
What we have seen in the Sri Lankan capital market industry is that many investors do not like documentation part of the relationship. Very often they compare the brokers who request for less documents and tend to open account with such brokers. However, investors need to understand that knowing the nature of the account, features of it, the authority given to the broker and also the clauses of the related documents are similarly important in investing. More often clients misunderstand or do not know what they sign for. Reading the account opening form and learning of the features of your account is extremely important so that you know how to deal with your investment advisor and also the rights and responsibilities of you and your broker.
You need to know who has the authority to make investment decisions. You can have a discretionary or non-discretionary account. If you have a non-discretionary account, that means you have the full authority to make investment decisions with regard to your account. This also means that you are responsible for the decisions you make relating to your portfolio. As per the CSE Rules, the investment advisor should receive order instructions from you to carry out any transaction in your account. The broker firm should send to you a note confirming the purchase or sale of securities by the end of the trade day. Bought/sold note can also be received in electronic form if you have given your consent to the broker for such purposes. It is your responsibility to review those confirmation notes to see whether those transactions have been carried out in accordance with your instructions and to inform the Compliance Officer of the broker firm of any disagreements immediately.
If you have a discretionary account that means your investment advisor has the authority to effect transactions without your specific instructions or without consulting you in advance about the price, type, quantity or timing of each trade as long as trades are consistent with your stated investment objectives. Therefore it is important that you clearly state your investment objectives in your authorisation. The CSE Rules require that the broker firm receives prior written authorisation from the client to effect transactions without the client’s specific instructions.
As mentioned above, it is important to understand the features of a CDS account and how the CSE rules work. In particular, credit limits, conditions attached to extended credits, interest rates, and internet trading facility are some of the notable features you need to be aware of.
On the other hand, you need to know the effect of legal documents that you sign such as credit agreement, account opening form and online trading agreements etc. These are legally binding contracts that govern the terms and conditions of your account and your investments and will be the focus in any future disputes.
5. Learn about the fees and other cost charged to your account
It is important to know all the fees and expenses that you pay with regard to investments. In Sri Lanka the broker firms do not have much authority in this regard and the fee structure is mainly decided by the SEC other than the brokerage for debt instruments and over 100 million equity transactions which are negotiable among the parties subject to a minimum. With effect from 27 June 2017 the cost applicable for equity transactions up to 100 million is 1.12% and for the transactions cost for transactions over 100 million is applied on a step by step basis. As per the CSE Rules, if you fail to make payment for securities you purchase by 9.00 hours on the settlement date, which is T+3, your broker firm can at its absolute discretion recover interest commencing from the day after the settlement date up to the date of final settlement. This is however subject to maximum of 0.1% per day. In order to avoid surprises such as huge interest charged to your account, it is always better to understand the charges and take necessary action before it’s too late. Remember, Over T+3 credit almost always comes with a cost attached to it.
6. Keep records, monitor your account and if there is a problem with your account report immediately in writing
The broker firms are required to maintain proper records of all their clients and investments, however, it is important that you maintain your own copy of your investment related documents such as a copy of the account opening form, credit agreement, letters granting discretionary authority to your investment advisor, trade confirmations and other important correspondence with the broker firm. As you make investments and trade in your account, you should receive trade confirmation for each trade which should include the transaction details required by the CSE Rules. If you are a debtor, you should also receive your monthly account statement by the 7th day of the following month. Reviewing all your transactions promptly enable you to monitor your account for any unauthorised activity. It is also important to know that the investment advisors should act in the best interest of the clients and they are prohibited from trading excessively in their clients’ accounts. If you notice any unauthorised transaction, excessive trading or an error in your account, you need to inform the Compliance Officer of your broker firm immediately and the communication should be in writing. This will help you to minimise the possible financial losses to your account and also to settle disputes if any in a timely manner. The CSE Rules require any complaint first be referred to the Compliance Officer of the broker firm, in writing, within a period of three months from the date of transactions and this time restriction is only waived by the CSE under exceptional circumstances.
7. Understand your investments and ask questions
Investment advisors who advise you on your investments may be experts in trading securities, however, you also need to understand such investment advice and investments in your account. You have the right to ask questions about the financial product that you invest in, the risks involved, why the product is right for you, how the investment works etc. until you are certain that you fully understand the investment. This will help you to invest wisely and avoid disputes with your investment advisor and the broker firm.
Remember your investment is your responsibility too – after all it’s your hard earned money at stake.
(The writer is a capital market compliance professional with over 10 years of combined experience in commercial law and compliance in the financial services industry. She is an Attorney-at-Law and the Head of Compliance of a reputed investment banking group in Sri Lanka. Anusha’s local and foreign employments and professional affiliations include reputed Sri Lankan financial services groups, US Securities and Exchange Commission (Office of Compliance Inspections & Examinations) and State Street Global Advisors, US Anusha has a LL.B Second Class Honours (Upper) Degree from the University of Colombo, LL.M in Commercial Law from the University of Melbourne, Australia and a Fellowship in Finance and Banking from the University of Boston, USA.)
www.ft.lk
However, the investors have not only the rights but also the responsibilities in investing. The informed investors who are aware of their rights and responsibilities in investing are better able to prevent disputes with their broker firms and also reduce the risk of losing their investment portfolio due to fraudulent activities that can occur in the securities industry.
The following are some of the best practices that every investor needs to adhere to when investing in listed securities.
1. Understand that all investment involve risk and securities investment is no exception; rather securities investment is one of the more riskier categories of investments
Every investment carries some degree of risk and greater the potential for high returns (or earning) of an investment, the greater the risks as well. If you deposit your money in a licensed bank or a financial institution, depending on the tenure you still have to take the interest rate risk and inflation risk, however, the chance of you losing your capital is remote. When it comes to the securities investments, this completely changes; you may invest in listed stocks, debentures and unit trust funds. These investments involve varying degree of risks. For example, one of the main risks is market risk; that is the capital can erode in value if the price falls down and if you are forced to sell for less than what you purchased for. For example, Rule 7.1.3 of the CSE Stockbroker Rules requires that in the event the market value of the securities pledged by you falls by 25%, the member firm should inform you to meet the shortfall by the next market day. As per Rule 7.1.4, in the event you fail to meet the shortfall on the next market day, the member firm should immediately sell the securities which have been pledged by you, in order to ensure compliance with Rule 7.1.3. Such force selling along with the market risk factor can contribute to huge losses in your account.
This can happen very often and in any market due to numerous reasons. Likewise liquidity risk, political risk etc., are some of the other risks. Therefore, knowing that all investments involve risks and understanding whether you are willing to take some risk is one of the best practices in investing responsibly. Most of the capital market broker-client disputes that happen in the Sri Lankan context are due to the investors’ lack of understanding of the risks involved in their investments or the outcome of such risks. Some of the broker firms also do not encourage detailed discussions about the risk factors thinking that such discussions would scare the investor away. However, the CSE Stockbroker Rules requires all the brokers to include a risk disclosure statement to their client agreement/ account opening form. The minimum risk disclosure that is required to be included in the agreement is “the prices of securities fluctuate, sometimes drastically. The price of a security may move up or down, and may even become valueless. It is likely that losses may be incurred rather than profits made as a result of buying and selling securities”. Many investors may have seen the risk disclosure, however pay very little attention to that. If you want to understand the risks in your investments, you should carefully read and understand these risk disclosures, request your investment advisors to explain where it is not clear to you and ask questions and take independent advice if seems necessary.
2. Know your broker (KYB) firm and your investment advisor before opening an account
The broker firms play the role of a market intermediary and are regulated and licensed by the SEC. Information about the brokers licensed by the SEC including the names of broker firms, their contact details, website links and the CEO’s name and all the brokers licensed by the SEC is given on the CSE website. Ask about the broker firm’s client compliant history and whether there are outstanding court judgments etc. Doing some research about the broker firm and its investment advisors before you invest any money with them can certainly help you avoid problems as well as certain financial losses.
Investment advisors of the broker firm who are licensed by the SEC are permitted to deal with the clients on behalf of the broker firms. It is a requirement of the SEC that only the licensed investment advisors can deal with the broker firm’s clients and the trainees should be under the supervision of a senior licensed advisor. When an investor is looking for an investment advisor to work with, it is always good to request the broker firm the opportunity to meet with several investment advisors face to face to compare them before making any decision. Ask about the work experience of the Investment Advisor, any disciplinary actions against the investment advisor by the broker firm or the SEC or CSE. Generally the broker firms allocate investment advisors to their new clients based on their availability, portfolio size, clients investment objectives, communication needs etc. One of the negative practices in the industry is that many clients do not meet their investment advisor and only communicate with the investment advisor over the telephone or through emails and do not even see their investment advisor until a dispute happens. The investors have the right to decide on the investment advisor that they like to work with(subject to the availability of such investment advisor) and therefore, you should always know your broker firm and the investment advisor in the same manner in which member firms get to know your information through know Your Clients (KYC) practices.
3. Know your investment goals and communicate them to your investment advisor clearly
One of the most important requirements for an investor is to have a clear sense of his investment goals and the timelines attached to those goals. Whilst everyone wants to earn a better return, many investors want to achieve specific financial goals such as owning a house, sending children to foreign universities, or having a comfortable retirement plan. Generally, your investment advisor should ask you for these information in order to understand your profile including your risk appetite and your investment goals before they advise you on your investments. In many countries, the investment managers and investment advisors provide a detailed questionnaire to their clients to collect these information in addition to the information collected through discussions and meetings. For example; Client Assessment Form is a basic document which asks questions on investment goals, investment experience etc. The investor needs to provide accurate information in these forms and communicate their investment objectives and their risk tolerance levels clearly to their investment advisor. It is also important to update the investment advisor when there is a material change to the status of the investor. It is always good to ask for a copy of these forms, so that you know when to update the investment advisor.
4. Learn about your account, its features and related legal documents
What we have seen in the Sri Lankan capital market industry is that many investors do not like documentation part of the relationship. Very often they compare the brokers who request for less documents and tend to open account with such brokers. However, investors need to understand that knowing the nature of the account, features of it, the authority given to the broker and also the clauses of the related documents are similarly important in investing. More often clients misunderstand or do not know what they sign for. Reading the account opening form and learning of the features of your account is extremely important so that you know how to deal with your investment advisor and also the rights and responsibilities of you and your broker.
You need to know who has the authority to make investment decisions. You can have a discretionary or non-discretionary account. If you have a non-discretionary account, that means you have the full authority to make investment decisions with regard to your account. This also means that you are responsible for the decisions you make relating to your portfolio. As per the CSE Rules, the investment advisor should receive order instructions from you to carry out any transaction in your account. The broker firm should send to you a note confirming the purchase or sale of securities by the end of the trade day. Bought/sold note can also be received in electronic form if you have given your consent to the broker for such purposes. It is your responsibility to review those confirmation notes to see whether those transactions have been carried out in accordance with your instructions and to inform the Compliance Officer of the broker firm of any disagreements immediately.
If you have a discretionary account that means your investment advisor has the authority to effect transactions without your specific instructions or without consulting you in advance about the price, type, quantity or timing of each trade as long as trades are consistent with your stated investment objectives. Therefore it is important that you clearly state your investment objectives in your authorisation. The CSE Rules require that the broker firm receives prior written authorisation from the client to effect transactions without the client’s specific instructions.
As mentioned above, it is important to understand the features of a CDS account and how the CSE rules work. In particular, credit limits, conditions attached to extended credits, interest rates, and internet trading facility are some of the notable features you need to be aware of.
On the other hand, you need to know the effect of legal documents that you sign such as credit agreement, account opening form and online trading agreements etc. These are legally binding contracts that govern the terms and conditions of your account and your investments and will be the focus in any future disputes.
5. Learn about the fees and other cost charged to your account
It is important to know all the fees and expenses that you pay with regard to investments. In Sri Lanka the broker firms do not have much authority in this regard and the fee structure is mainly decided by the SEC other than the brokerage for debt instruments and over 100 million equity transactions which are negotiable among the parties subject to a minimum. With effect from 27 June 2017 the cost applicable for equity transactions up to 100 million is 1.12% and for the transactions cost for transactions over 100 million is applied on a step by step basis. As per the CSE Rules, if you fail to make payment for securities you purchase by 9.00 hours on the settlement date, which is T+3, your broker firm can at its absolute discretion recover interest commencing from the day after the settlement date up to the date of final settlement. This is however subject to maximum of 0.1% per day. In order to avoid surprises such as huge interest charged to your account, it is always better to understand the charges and take necessary action before it’s too late. Remember, Over T+3 credit almost always comes with a cost attached to it.
6. Keep records, monitor your account and if there is a problem with your account report immediately in writing
The broker firms are required to maintain proper records of all their clients and investments, however, it is important that you maintain your own copy of your investment related documents such as a copy of the account opening form, credit agreement, letters granting discretionary authority to your investment advisor, trade confirmations and other important correspondence with the broker firm. As you make investments and trade in your account, you should receive trade confirmation for each trade which should include the transaction details required by the CSE Rules. If you are a debtor, you should also receive your monthly account statement by the 7th day of the following month. Reviewing all your transactions promptly enable you to monitor your account for any unauthorised activity. It is also important to know that the investment advisors should act in the best interest of the clients and they are prohibited from trading excessively in their clients’ accounts. If you notice any unauthorised transaction, excessive trading or an error in your account, you need to inform the Compliance Officer of your broker firm immediately and the communication should be in writing. This will help you to minimise the possible financial losses to your account and also to settle disputes if any in a timely manner. The CSE Rules require any complaint first be referred to the Compliance Officer of the broker firm, in writing, within a period of three months from the date of transactions and this time restriction is only waived by the CSE under exceptional circumstances.
7. Understand your investments and ask questions
Investment advisors who advise you on your investments may be experts in trading securities, however, you also need to understand such investment advice and investments in your account. You have the right to ask questions about the financial product that you invest in, the risks involved, why the product is right for you, how the investment works etc. until you are certain that you fully understand the investment. This will help you to invest wisely and avoid disputes with your investment advisor and the broker firm.
Remember your investment is your responsibility too – after all it’s your hard earned money at stake.
(The writer is a capital market compliance professional with over 10 years of combined experience in commercial law and compliance in the financial services industry. She is an Attorney-at-Law and the Head of Compliance of a reputed investment banking group in Sri Lanka. Anusha’s local and foreign employments and professional affiliations include reputed Sri Lankan financial services groups, US Securities and Exchange Commission (Office of Compliance Inspections & Examinations) and State Street Global Advisors, US Anusha has a LL.B Second Class Honours (Upper) Degree from the University of Colombo, LL.M in Commercial Law from the University of Melbourne, Australia and a Fellowship in Finance and Banking from the University of Boston, USA.)
www.ft.lk
Quote for the day
“You need to divorce your mind from the crowd. The herd mentality causes all these IQ’s to become paralyzed. I don’t think investors are now acting more intelligently, despite the intelligence. Smart doesn’t always equal rational. To be a successful investor you must divorce yourself from the fears and greed of the people around you, although it is almost impossible.” - Warren Buffett
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