The stock market is preparing to make a major change in the payment for net proceeds of shares sales under a new system that links investors’bank accounts to their investment accounts. As capital market stakeholders conclude the plan for the full implementation of the Direct Cash Settlement (DCS) system, Capital Market Editor Taofik Salako examines the implications of the transition.
For nearly six decades, the stock market has traded under a stockbroker-mediated payment system. It appears simple and hassle-free. Every investor makes payment to his stockbroker for purchase of shares and conversely, the investor issues sale order to her stockbroker, who sells and remits the net proceeds of the shares sale to the investor, after removing the stockbroker’s commission and other regulatory charges.
The full fiduciary function rests on the stockbroker. It has held on for the 56 years of formal trading at the stock market, as the market moved from its humble beginning of 19 securities at the commencement of trading in 1961, a year after the establishment in 1960, to become a multi-trillion naira market with more than 240 securities and market capitalisation of more than N23 trillion.
The stockbroker-mediated system allows for flexibility and it brings into consideration the mutual understanding and trust developed over the years between the stockbroker and its client. While the stock market operates a T+3 cycle that settles each transaction in four days-trading day and three working days, investors have been known to order simultaneously immediate sale of stock and the immediate use of such net proceeds for purchase of another stock.
Investors have been known to demand and receive payments of shares sale ahead of the completion of the settlement cycle under special consideration that thrives on the mutuality between the stockbroker and its client. These are possible because investors, at times, also keep their proceeds with the stockbroker through delayed pick-up of cheques and shares deposit. It has been a mutually beneficial system with many informal flexibilities, known to the formal authorities in practice, yet unwritten. The most important rule to the market is that shares sale or buy must be on the order of the investor and payment must be made on his order, on demand.
A new payment system
But this is set to change. Under a new payment system known as Direct Cash Settlement (DCS), the stock market will transit from the current stockbroker-mediated payment system under which proceeds of shares sales are remitted to the stockbroker for onward remittance to the investor to a new system under which payment will be made directly to the investor’s account.
The DCS will become the mandatory payment process for the stock market as against the current stockbroker-mediated payment system. However, any investor may apply for specific or continuing remittance of his net proceeds to his stockbroker. While no specific date has been fixed for the mandatory conversion to DCS, a committee has been working to fine-tune arrangements for the launch of the new payment system.
With the DCS, all investors will have to provide their bank accounts to the Central Securities Clearing System (CSCS) Plc – the clearing and settlement gateway of the market, for direct remittance of the net proceeds of their transactions.
Under the rules for the DCS, stockbrokers are mandated to provide their clients’ bank account details to the CSCS, being the agent of the Exchange for the clearing and settlement of all securities traded on the Automated Trading System (ATS) of the Nigerian Stock Exchange (NSE). Settlement of each trade carried out on the ATS shall then be done by direct payment into the client’s account as provided to the CSCS. Any broker-dealer that fails to notify and provide the account details of an investor within three working days will be liable to a fine of N250, 000 in addition to any other penalty which the Exchange may impose.
As part of the new rules, where a client provides its broker-dealer firm with a written mandate to purchase securities with proceeds from the sale of other securities any payment attributable to the sale shall be made into the account of the broker-dealer firm provided the client gives its consent in that regard. Every broker-dealer is also expected to take all reasonable steps to ensure that all details of direct settlement originate from the actual client through confirmation of the client’s details in relations to particulars contained in the ‘Know Your Client’ (KYC) provisions.
“Any broker-dealer that trades in its client securities without receiving a mandate from its client or neglects to remit to its client the proceeds from trading in such client’s securities within three working days of receiving such, shall be liable for any penalties imposed under Article 148B for unauthorised sale of securities, in addition to any other penalty which the Exchange may impose,” the DCS rules stated. Besides, brokers are expected to improve their customer relations service and disclosures by being factual, plain and unambiguous in their presentations and agreements.
GTI Capital Limited Chief Operating Officer, Mr. Hassan Kehinde said the transition might be a good development, but it is a double-edged blade that needs to be carefully handled. He noted that while the DCS may enhance investors’ confidence and forestall fraud and diversion of sales proceeds, it may also impinge on liquidity and subject the market to a prolonged slowdown.
Foibles of the old order
The fervour for the transition to DCS has been strengthened in recent period with the incidence of unauthorised sale of client’s shares and diversion of proceeds of shares sale. Last July, the NSE revoked the operating license and imposed a fine of N582.37 million on a stockbroking firm-Bytofel Securities and Investment Limited, for allegedly engaging in fraudulent activities in the stock market. Bytofel Securities was expelled for engaging in “unauthorised sales of clients’ shares and misappropriation of clients’ funds”.
In another high-profile case last September, Nigeria’s apex capital market regulator, Securities and Exchange Commission (SEC), indicted Managing Director of Partnership Investment Company Plc and Partnership Securities Limited, Mr Victor Ogiemwonyi, for allegedly engaging in unauthorised sale of clients’ shares and diversion of sales proceeds among other infractions. Ogiemwonyi was banned from engaging in capital market activities and from holding directorship position in any public company in Nigeria. SEC also withdrew the operating licences of his companies.
In one of the highpoints of the case against Ogiemwonyi, a former chief executive of Ecobank Transnational Incorporated (ETI) Plc, Mr Arnold Ekpe, an ally and client of Ogiemwonyi, had mandated his stockbroking firm, Partnership Securities Limited to sell his 96.08 million ordinary shares of ETI. Ogiemwonyi allegedly sold the shares but only remitted N300 million out of the total proceeds of N1.54 billion to Ekpe. The indictment of Ogiemwonyi changed the narration of unauthorised sales and diversion of proceeds from infractions of small-scale petty brokers to a larger scope of the market operators.
A fellow and former council member of the Chartered Institute of Stockbrokers (CIS), former council member of the Nigerian Stock Exchange (NSE), former president of the Association of Issuing Houses of Nigeria (AIHN), member of the Capital Market Masterplan Implementation Committee and member of the board of the NASD Plc among others, Ogiemwonyi was one of the leaders of the market during his time. His company-Partnership Investment Company Plc was one of the few stockbroking-originated investment companies that were listed on the NASD Plc-the alternative over-the-counter (OTC) securities exchange for listing of public limited liability companies that are not listed on the NSE.
In another landmark, SEC had recently, through the Economic and Financial Crimes Commission (EFCC) pursued and secured conviction of a stockbroker and former managing director of First Alstate Securities Limited, Mr Tajudeen Folaji, who was sentenced to seven years imprisonment by the Lagos State High Court over fraudulent sale of his client’s shares. The Lagos State High Court presided over by Justice Kudirat Jose found Folaji guilty of unauthorised sale of shares and stealing for fraudulently converting 31,886,200 shares of IPWA Plc valued at N331.3 million belonging to an investor on April 3, 2008. The court also has imposed a N20 million fine on First Alstate Securities Limited where he was the managing director and dealing clerk.
Besides, the court directed the EFCC to trace and liquidate properties belonging to the convict for restitution of the investor.
Authorities at the capital market have so far this year revoked the operating licenses and expelled some 90 stockbrokers for various reasons. Capital market regulators traditionally apply the highest punishment of expulsion and revocation of license to serious offences that could undermine investors’ confidence, including fraud and inability to meet major operating requirements for the function. There are two major factors fuelling infractions at the stock market-greed and illiquidity. Whichever way, investors bear the brunt.
“There are many structures put in place to safeguard investors and their investments. But we understand that the downtrend might be testing the honour of some few operators, my advice to members is to avoid sharp practices and operate with the highest level of professionalism, accountability, transparency and integrity. This would engender greater confidence and attract more investors to patronise the market,” President, Association of Stockbroking Houses of Nigeria (ASHON), Patrick Ezeagu, said.
But many have argued that infractions in the capital market are comparatively lower than other segment of the market, and these sharp practices are even on the decline. SEC indicated that level of infractions in the market has dropped by about 88 per cent over the past 18 months. The number of reported cases of infractions in the capital market had reduced from 291 in first quarter of last year to 36 in the third quarter of this year. The DCS will serve as a reinforcement for the market.
Automated ecosystem
Hassan said the timing and the benefits of the DCS must be weighed carefully against inadvertent negative impact on liquidity at the stock market. The extent and impact of free flow of funds through simultaneous trading must be studied to determine the possible fallout from the somewhat cumbersome process of filing for exceptions under the DCS. Ezeagu said while market operators and regulators have been working on effective compliance and enforcement at the market, the DCS may be one of the ways to forestall infractions.
“To investors, I strongly advise them to embrace the Direct Cash Settlement (DCS) which will enable sales proceed to settle into their bank accounts directly. They should not patronise quacks and always follow up on their mandates to their brokers to ensure quick and timely delivery on transactions,” Ezeagu said.
Association for the Advancement of Rights of Nigerian Shareholders (AARNS) President, Dr Faruk Umar, said the DCS will not only help to forestall incidence of unauthorised sale and diversion, but safeguard shareholders’ monies from confiscation by banks or other agencies in case of loan recovery or other enforcement action against a broker-dealer.
“The Direct Cash Settlement is a commendable initiative. We have lost money in the past through outright diversion or confiscation by bank; this should help to safeguard our money. It will also serves to authenticate ownership of shares since nobody can claim proceeds of share sale, unless through the direct cash settlement,” Umar said.
The DCS fits into the increasing automated and direct-dealing ecosystem at the capital market. Capital market regulators are aggressively implementing several other initiatives aimed at removing extraneous influences in the transaction. The electronic dividend payment system (e-dividend) will ensure that dividends are paid directly into shareholders’ bank accounts. This is in addition to the dematerialisation of all share certificates, which converts all shareholdings into automated deposits under the CSCS, and the related electronic offer (e-offer) and electronic allotment (e-allotment) that ensure that new supplementary shares are directly credited to the investors’ CSCS accounts. A shareholder, Adeleke Abayomi, however noted the need for a more intensive public enlightenment on the DCS and other initiatives, giving the low level of awareness about capital market issues. For investors and operators, the success of the DCS may be mutually beneficial, since investors’ confidence has positive correlation with attractiveness and participation in the market.