Shady securities transactions

AS A GOVERNMENT financial institution, Development Bank of the Philippines (DBP) is expected to be more scrupulous in complying with government rules and regulations.

Apparently, some DBP officials have a different mind-set on this matter.

A recent audit of the Commission on Audit showed that, from January to March 2014, DBP sold P14.3 billion worth of government securities to First Metro Investments Corp. then bought them back on the same day at the same selling price.

This transaction is described as a “wash sale” since there is no real change in ownership of the securities involved.

Depending on the nature of the securities, equity (stocks) or debt (bonds), the sale and repurchase is done either through the same broker or with a single counterparty, or both.

For shares of stocks, the simulation gives the impression they are being actively traded in the market and therefore worthy of consideration for investment.

In the case of banks authorized to engage in securities trading under their own name, like DBP, the transaction is sometimes done to “window dress” their books, e.g., to show increases in trading gains or volumes.

Cleverly presented, the growth can help boost the bank’s bottom line [at least on paper], especially during the monthly or quarterly financial review.

Common practice

Wash sales are prohibited by law because they are deceptive and manipulative. They distort the true value of the securities offered for sale to the public.

The person who buys or invests in “washed” securities is made to pay an amount that does not reflect the securities’ real market value. It’s like a con game where something is made to appear more valuable than what it truly is.

According to reports, citing inside information, wash sales are common practice in the banking industry and that regulators take a blind eye on them as long as they are “not big enough to be noticed.”

In other words, if the transaction can be buried deep in the books or capable of justification by some stretch of accounting or financial wizardry, the otherwise unauthorized transaction will not be scrutinized.

There is truth to this statement and it applies as well to securities traded in the stock market.

Wash sale is one of many ways by which unscrupulous stockbrokers manipulate the market to raise or lower the price of stocks, or give the appearance of trading to induce the unsuspecting investor into buying or selling certain stocks.

In spite of regulatory measures and advance warning systems in place, attempts at manipulation and deception in the stock market persist.

Regulation

If not for the eagle eyes of the Commission on Audit staff, the wash sales transactions at DBP would probably have gone unnoticed by government regulators.

This does not come as a surprise because transactions of this nature are not easy to spot unless they are too glaring to be overlooked (as in the case of the P717-million loss that resulted from DBP’s wash sales), or a party to the deal failed to get his share of the loot, or a conscience-stricken participant spills the beans.

Manipulative or deceptive securities transactions require good timing, and elaborate preparations. They have to appear normal and consistent with the regular flow of business. They should not arouse suspicion or trigger the activation of measures that would put a stop to the transaction or derail its consummation.

To prove the existence of the activity, it is necessary to look into, among others, the movement of the price of the securities over a certain period of time, the identity of the sellers or buyers of the securities, the party facilitating the deal, and the parties who stand to profit from it.

Government regulators are obliged to keep an eye on illegal activities, but with too much on their plate and limited staff the most they can do is conduct random checks on the companies under their watch, or be on the lookout for red flags that indicate something wrong is going on in the market.

It’s fortunate COA was around to uncover DBP’s wash sales transactions.

Prosecution

The people suspected to be behind this unlawful activity are not pipsqueaks or bumbling amateurs who were unaware of the serious consequences of their action.

They may have done it before and gotten away with it or, worse, even rewarded with a bonus for a “job well done.” This time, with a mistaken sense of hubris, they overreached and crossed the line of so-called common banking practice.

They were probably thinking that, in case they get caught, their superiors will take the cudgels for them, or, at best, sweep the problem under the rug until things blow over.

The worst that may happen is they will be prosecuted for violation of the Securities Regulation Code (SRC) or Anti-Graft and Corrupt Practices Law. And if they are, about eight to 10 years would pass before judgment, one way or the other, will be rendered on them.

It can be recalled that the first criminal conviction under the SRC happened in 2013 when a stockbroker named Francisco Borromeo was, after 10 years of investigation and trial, found guilty of seven counts of violation of that law, which included defrauding his clients of million pesos worth of investments.

He was meted the fantastic penalty of a fine of P2.1 million! No prison term at all. The government did not appeal the slap-on-the-wrist decision.

Remember the case filed against BW Resources Corp. for price manipulation in 2000, the scandal that that almost brought down the Philippine stock market?

Well, it’s still pending in court and only God knows when the case will be decided.

Barring any miracle in our justice system, the DBP securities mess will probably go through the same route.

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