Commemorative Lecture  


YBhg Dato’ Zarinah Anwar
Chairman, Securities Commission Malaysia

 at the

MICPA 49 th Anniversary
Commemorative Lecture  

24 January 2008
J W Marriott Hotel, Kuala Lumpur


YBhg Dato’ Nordin Baharuddin, President, MICPA

YBhg Dato’ Johan Mohammad Raslan, Vice President, MICPA, Chairman, Financial Reporting Foundation

Distinguished guests,

Ladies and Gentlemen,

Good afternoon.

Enhancing Confidence in the Capital Market

It is an honour to be addressing the members of MICPA at this 49 th Anniversary lunch. Yours is an august body whose members have a critical role to play in maintaining confidence in the capital market. I am pleased therefore that you have asked me to share some thoughts on this subject today.

As we all know from our personal experience in managing relationships, confidence is hard to create, requiring time, effort and consistently predictable and transparent behaviour. Yet it is so easy to lose, and once lost, so difficult to regain.

What is true of personal relationships is even more true of the Capital Market where two human emotions, greed and fear, can drive a large part of decision making. Neither is rational, making confidence much more fragile. Unpredictable external shocks, contagion effects, the herd mentality can all shatter confidence. It is precisely because of this fragility of confidence in the market, and the potentially devastating impact of unpredictable exogenous shocks, that we must spare no effort in ensuring that the market is built on unshakable foundations.

Investors in the securities market are vulnerable to many legal and ethical abuses and very expensive forms of corruption. The various scandals occurring within PLCs bear witness to this. These developments have provided useful lessons to us on the critical importance of transparency, emphasizing the need to pay serious attention to cases of accounting malpractices and outright frauds if there is to be confidence in the market.

Ladies and Gentlemen

Investor confidence in the integrity and fairness of the capital market as well as the ethical way in which it functions is key to the process of capital formation. Corporate failures and misconduct inevitably undermine such confidence leading to the departure of investors to jurisdictions where corporate governance standards are strong and their investments are safe.

For the Capital Market to thrive therefore and to attract capital it must be built to withstand shocks from outside and within; and this can only be achieved if it has firm foundations based on

  • Firstly, Self-discipline – the integrity and ethical values of top management in public listed companies which define the ‘tone at the top';

  • Secondly, Market discipline – where market participants must adhere to high standards of professionalism, and investors must assess the performance of companies and the conduct of the Board and management and reflect these in stock prices, bond spreads and credit ratings. Corporations that fail the test may well find it difficult to raise new capital.

  • Thirdly, Regulatory discipline to ensure that the framework of rules and regulations and enforcement efforts promote good corporate conduct and transparency, while at the same time avoiding excessive costs.

So as we can see a healthy and vibrant capital market is underpinned by a triangle of disciplines.

Let me take a few moments to discuss each of these.

Self-discipline is the bedrock upon which market confidence is built. Violations of securities laws are frequently the product of both individual failings and a deficient corporate culture. So companies must focus on individual values and on creating the right context. This can only be achieved through fundamentally honest, decent boards and top management who will not break the law and who will embed a culture that deters others from doing the same by regularly communicating a strong message of ethics to enforce and reinforce the standards set by the top management.

So the ‘tone at the top’ sets the example and parameters of acceptable behaviour. If the tone at the top is that “Anything goes, as long as we maintain the share price and meet analyst expectations”, then we must expect more spectacular disasters like Enron, WorldCom or Parmalat, and Transmile and Megan Media, in our own backyard. If the Chairman or CEO behaves in unprincipled ways, there is no doubt that employees will follow their example. Boards must remember that they are responsible for setting the parameters of acceptable behaviour and senior management must act as ethical role models for their employees. Otherwise the directors would have failed in one of their key duties.

I cannot overemphasise the importance of ethical business practices and the need for a moral compass by which to assess every strategic decision. Management must remember that companies are not just a nexus of legal contracts; they only flourish when the human relationships they are based on, are built on respect, equity and just rewards. Equally, it is wrong to expect that managers cannot be trusted to do the right thing, for if that is how they are treated and taught, then indeed they will live up to this cynicism, creating a self-fulfilling prophecy of amorality in business.

In today’s world, stakeholders expect companies to act responsibly: to make fit-for-purpose products at fair prices, to provide decent working conditions that show respect for employees, to follow good health and safety practices and to mitigate the environmental impact of the way business is done. Failure to perform in any one of these areas can undermine the sustainability of the company by destroying trust in the company and its commitment to do right by its stakeholders. When trust in a company is lost, it does not just affect that company’s share price; it has a knock-on effect on the market as whole because capital markets are built on trust.

Transparent, credible and timely reporting are therefore essential to build and maintain this trust in what the company is doing: trust by the regulator, trust by investors, trust by the employees, customers and suppliers, and increasingly important, trust by civil society. Violate this trust and you lose your ‘licence to operate’.

Directors and senior management can choose to adhere to high standards of corporate responsibility because they believe in doing the right thing or merely because they fear the consequences of failure and being caught. Business activities are hedged around with controls by regulators and increasingly by civil society questioning the business purpose. In both cases, a business culture that is based on a good code of ethics, providing clarity to all staff regarding what is acceptable and what is not, is less expensive for the company than one that is built out of fear of regulation.

Regulation is expensive; the cost to companies of the Sarbanes-Oxley legislation brought in to try to prevent recurrence of Enron is in the billions of dollars every year. Thus at the SC, we have moved towards instituting a principles based approach to regulation which encourages and fosters good business practices by enabling market participants to discover effective ways to meet a mandated principle and allows markets to operate and evolve without constraining it with overly burdensome regulation. But with greater reliance placed on principles, guidelines and codes of conduct instead of prescriptive rules, there is need for the board and senior management to take greater responsibility on how to meet their statutory obligations, and strengthen their risk management, compliance and internal audit functions. Senior management must rise above the rules based mentality that asks, “Is this legal?” instead of asking, “Is this right?” As Warren Buffett told his managers at Berkshire Hathaway, “The five most dangerous words in business may be ‘Everybody else is doing it'”. A company can only apply the criterion “Is it right?” rather than “Is it what everybody else is doing?” if the example comes from the Chairman and CEO who set the ‘tone at the top’. Good behaviour will be intrinsically strengthened through the practice of self regulation.

I would like to say a few words about the role of independent non-executive directors (INEDs) on the Board. They are the lynchpin of all corporate governance codes, which rely on them exercising their powers of challenge and review to ensure that sensible business decisions are being made. It is recognized everywhere in the world that the role of an INED is exceptionally difficult to do well. They do not have access to all the facts that the CEO has; they need to be masterly in the skills of being part of a team whilst at the same time being able to maintain the necessary independence of mind to challenge and criticize constructively without creating dysfunctional boards where CEOs feel they are not trusted. The obligation and liabilities of INEDs are enormous but too many INEDs in Malaysia are unaware of these liabilities.

There is no doubt that companies need strong independent Boards, and good corporate governance must start in the boardroom. ‘Independent’ in this context means independent of management and free from any business or other relationship that could interfere with the exercise of independent judgment or the ability to act in the interest of the stakeholders. However, it is important to recognise that whilst regulators are able to legislate the idea of independence based on proximity and relationship, we cannot regulate independence concerning the mindset. For example, when independent directors become beholden to the company or its current chief executive in ways too subtle to be captured in customary or legislative definitions of “independence”, these directors cease to be truly independent. This is when ethics play a crucial role, as a guide to proper and honest behaviour.

I realise we do not live in a perfect world, but think how much better it would be if boards were able to ensure that top management set the right ‘tone at the top’ in the first place so that government and society do not have to pick up the tab for putting right what should never have gone wrong.

I believe that a principles based regime is more likely to make people pay attention to doing the right thing rather than focusing on legalistic box ticking and therefore is more conducive to setting the right “tone at the top”. I also recognize, however, that it means trusting senior management to have the right values and the right processes in place and that is why I place so much emphasis on self-discipline as the bedrock on which confidence in the capital market is built.

Ladies and gentlemen,

I would now like to turn to the second discipline, namely market discipline. This is where, as accountants and auditors, you have a key role to play as external enforcers of good corporate governance. We all recognise that information is fundamental to the capital market. However, we also know that raw information is not much help without high quality accounts prepared according to recognised accounting standards and audited or verified according to generally accepted auditing standards. It follows that the quality of corporate governance is only as good as the quality of information available to the market. We have seen with the recent debacles how large corporations have failed where good information and checks and balances in accounting and audit are absent. It is therefore the role of the accounting profession to make sure that the process of data collection and verification are robust, that the numbers are right, and that the exercise of judgment in interpreting those numbers is not clouded by ill intentions.

But accountants have a much bigger role to play in enhancing confidence in the market. Increasingly you are being asked to help management understand risks and to embed effective enterprise risk management systems that permeate the entire fabric of the organisation.

As a result you have been moving steadily from record keepers of the past to providers of early warning indicators and ‘red flags’ that should help directors make informed judgments about the risks they face with enough notice to be able to take corrective action.

Unfortunately over the past year there have been a number of events that have damaged the credibility of the profession here in Malaysia, with a knock on effect on the reputation of the entire Malaysian capital market. I cannot over-emphasize therefore the importance of ensuring that effective market discipline is brought to bear, to carry out your work with integrity and to act to prevent harm.

I would like to say a few words about the role of a critical segment of stakeholders which is fundamental in ensuring effective market discipline, the investors, and in particular, the institutional investors. The price signals and credit ratings I mentioned earlier are just one aspect of market discipline. These must be supported by shareholder activism. Institutional investors in particular have the ability, and indeed, the responsibility to bring management to task for failure to manage and govern properly. The development of a mature and activist shareholding population is a major challenge for Malaysia. Minority and institutional shareholders in Malaysia (indeed in most of Asia) are generally passive, preferring exit over voice. In contrast, the evolution of corporate governance in the Anglo-American world has seen the rise of private pension funds and large institutional investors which exert a powerful influence to ensure appropriate corporate conduct. Organisations like CalPERS for example ensure that companies do right by their shareholders and have well-formulated strategies.

I must mention the role of the MSWG who have been doing a creditable job in demanding that minority shareholders be properly treated. But retail investors typically do not have the power nor the expertise to make changes in company strategy or management. This is a role that must be undertaken by the institutional investors. Our institutional shareholders however are perhaps a little more wary of using their powers to raise company performance than they should be, but over time this must change and institutional shareholders must use their influence to discipline errant management.

Ladies and gentlemen,

Finally let me say a few words on regulatory discipline

It is worth remembering that laws are used when internal controls or mores that provide for an orderly and just system have lost their effect. When ethical expectations are not met, society calls upon legal remedies, which, unlike appeals to morality, can impose sanctions and penalise undesirable behaviour. Thus when ethics fails, what deters manipulation and other forms of capital market fraud is effective enforcement. The SC strives to provide clear, accessible and timely information regarding the institutional arrangements for the regulation, supervision, and the oversight of the capital market to all market participants. Regulations however come at a cost, so the propensity to over-react in times of crisis by supplying yet more regulations to minimise future failures need to be managed. Indeed the SC adopts the philosophy of no more regulation than necessary.

As the regulator, the SC is committed to protecting investors and developing a vibrant capital market that is a preferred destination for investors’ funds.

We do this in three ways: first through continuous review and updating of the framework of regulations; second through effective supervision, surveillance and enforcement; and third through education of investors and market participants alike.

We have introduced important changes to the regulatory framework , each targeted at a key constituency of the capital market:

  • We have revised and updated the Code of Corporate Governance to strengthen the role of INEDs in general and of the Audit Committee in particular. The revised code requires all public listed companies to carry out their own internal audits. The reporting line for internal auditors has been clarified with the board being held accountable for ensuring an effective internal audit process. The Audit Committee has been strengthened with its members being non-executive and the majority INEDs as well. All members must be financially literate and the Chair should be a qualified accountant, who is held accountable for continuous engagement with the company Chairman, CEO, CFO and head of internal audit as well as the external auditors;

  • We have also set in motion the establishment of the Accounting Oversight Board (PCAOB), targeted at the accounting profession, to reinforce the message that this community must not fail to exercise its duty of utmost care in the preparation of the numbers and reports upon which everything else rests;

We have adopted a new approach to enforcement.

Effective enforcement is critical and we continue to invest in our own capability to enforce the rules we set, to manage risks and to handle public complaints. We have at the same time modified our approach by increasingly employing civil and administrative remedies in addition to criminal prosecution to achieve swift and fair resolution.

The scope of financial and corporate surveillance has been widened as has the spectrum of actions we take against misconduct, ranging from directing companies to re-issue their accounts, suspending auditors, to prosecuting company officials. As a result perpetrators are being punished. In 2007 we adopted pre-emptive measures to freeze assets, disgorge ill-gotten gains and make restitution, although we will continue vigorous criminal prosecutions wherever appropriate.

We are providing targeted educational support

If market participants are to fulfil their roles in enhancing confidence in the capital market, they must be properly qualified and educated to understand what these roles demand from them. To this end, we

  • Introduced the Industry Transformation Initiative for all capital market licensees. This is a revolutionary curriculum based programme designed to equip remisiers and dealer representatives with skills needed to move from being order takers to trusted advisers;

  • Introduced a twice yearly Institutional Investors Programme designed to raise awareness of leading edge practices in developed capital markets with regard to shareholder engagement to raise the performance standards of the companies in which institutions have invested;

  • Are developing a range of programmes designed to help directors carry out their duties more effectively, targeted specifically at the INEDs. These programmes are being designed to reflect the different stages of evolution and sophistication of public listed companies, recognizing that a ‘one size fits all’ approach is not the best way to help INEDs.

Ladies and gentlemen,

I said earlier that the SC has begun to institute a principles based approach to regulation. However, this also means that the responsibility for maintaining and building confidence in the market is shared between business leaders, market participants and the regulator.

This means that boards must ensure the right ‘tone at the top’, and that the CEO role models the appropriate standards of behaviour, continuously promoting the message that they are committed to an ethical perspective, that the reason for doing something is because it’s the right thing to do. We have to create a pervading corporate culture that inculcates and encourages integrity and ethical conduct in business as much as entrepreneurship. However, the task of doing so should not be left solely to the regulators. Our focus is on ensuring that there is a level playing field through the imposition of codes of conduct and regulations to prevent and deter market abuse when ethics has failed.

Ethical behaviour cannot be legislated, but it can be reinforced and rewarded; we can shine the spotlight on unethical behaviour and fraudulent practices and that is the role of market discipline. This is where you, the membership of MICPA, have an essential and inescapable responsibility to exercise the utmost care in ensuring that the damaging and embarrassing failures of 2007 are not repeated.

As the regulator, the SC will provide the regulatory discipline to support and strengthen self-discipline and market discipline. We will provide the market with the appropriate framework of laws and enforcement. We will take all necessary steps to ensure that malfeasance does not pay, prosecuting perpetrators either in the criminal or in the civil courts.

The initiative to inculcate integrity and ethical considerations should be taken on by all market participants be it at the macro or the micro level. Companies must promote a system, which aligns profit-making activity with one’s ethics.

Captains of industry must demonstrate ethical leadership through example and ensure that ethics permeates the environment to such an extent that it becomes the culture, an ethical culture.

The world is changing in ways that the ethical choice is the practical choice. Ethics today is not only about doing the right thing and feeling good – it is also about staying in business.

Paulson, Henry M., “Competitiveness of US Capital Markets”, November 2006