Seminar for Compliance and Best Sales Practices
5 May 1997 |   By : Dato' Dr. Mohd. Munir Abdul Majid, Chairman, Securities Commission, Malaysia

Ladies and gentlemen,

May I first welcome all of you to this Seminar on Compliance and Best Sales Practices organised by SIDC and subjecting yourselves to a rather heavy start to your week.

I must say when I was faced with the task of addressing this subject I expected that you would be neither compliant nor be on your best behaviour. But upon reflection, I surmised that if you were prepared to be here this morning then you would already possess a quintessential element to compliance and best sales - the sense of responsibility and accountability.

Many of you know too well the reasons behind the collapse of Barings and the 11-year deception practised by Daiwa Bank :

  • the failure or total breakdown in internal controls within a firm;
  • the neglect of senior management to play a pro-active role in the operational matters of the company particularly in areas of risk management;
  • the inadequate supervision of employees;
  • the lack of actual segregation between the different functions of an organisation and over-concentration of power in particular persons; and
  • the failure to implement the internal audit recommendations that there be a segregation between the trading and back room functions.

In many countries across the globe, regulators and market participants are reassessing how they should regulate and manage, and how to place more responsibilities on self-regulatory organisations to be in tandem with mature markets. The same is being done in this country.

As one of the reasons for regulating is investor protection, we consider compliance and best sales practices as one of the core issues.

Compliance and best sales practices essentially refer to a proper supervisory and competent system of internal controls within the firm to maintain the integrity of the firm's dealing practices, the safeguarding of assets and compliance with all relevant regulatory requirements.

What is the rationale for a good system of internal controls? Costs and risks that may ensue from non-compliance in terms of loss to the firm and its clients and also the damage to the good reputation of the firm, the latter of which is crucial to the continuous success of the firm. Although the benefits of compliance in monetary terms may not be easily quantified, the costs incurred by the firm in respect of the claims and proceedings which may be instituted by clients may be higher.

All of you are in some ways responsible for an on-going business concern which has among others the objective of not only making profits but also maintaining credibility and reputation for the business to survive. Others among us are enjoined to serve the interests of our stakeholders. It is through good corporate governance, compliance and best sales practices that credibility and protection of vested interests will be achieved and you will discover this as you listen to the various speakers during the course of today's seminar.

Corporate governance
In its Business Plan for the capital market, the Securities Commission has outlined a five-year plan spanning from 1996-2001 to move from a merit-based regulatory environment to one which is disclosure based. Central to the success of this transition is high standards of corporate governance (in addition to high standards of disclosure and due diligence).

The Companies Act 1965 and the securities and futures laws do have relevant provisions under which corporate governance obligations are to be discharged by directors and other officers of the company. These corporate governance procedures and obligations are also amplified in the KLSE Listing Requirements, the SC's Policies and Guidelines on Issue/Offer of Securities as well as the Malaysian Code on Take-overs and Mergers.

Taking into account the above rules and regulations, the system of corporate governance is essentially developed by each company to ensure that there is a balance between the interests of the shareholders who have entrusted their capital to the company and those of other constituents or stakeholders such an employees, suppliers, creditors, customers and the community in which they serve.

Let as now turn and look at the responsibilities of the key players in this system of compliance, best sales practices and corporate governance - the directors, the management and not forgetting the regulator' role. Ultimately however, it is the shareholders that benefit in the long run from these practices.

The role of directors and management
To promote a good internal control system, the Board of directors and the management should assume new roles in corporate governance. The Board ought to have a full understanding of all the risks involved in trading activities and should approve significant policies relating to the management of the trading risks throughout the firm having regard to the firm's business strategies.

The management needs to ensure a proper written supervisory system under the governance of an independent compliance functionary within the firm to monitor the activities of the employees. This is currently the requirement in the rules of the Kuala Lumpur Options and Financial Futures Exchange Bhd and the Malaysia Monetary Exchange Bhd.

It is important that management ensure that the organisational structure, reporting lines and functional responsibilities for all staff are clearly defined in writing, and that there is a proper segregation of tasks and delineation of responsibilities between the different departments and personnel, to avoid an over-concentration of powers or responsibilities on particular persons within the firm.

The importance of segregation was stressed in the Report of the Board of Banking Supervision - Inquiry into the Circumstances of the Collapse of Barings dated July 18, 1995 when it says, I quote -

"Perhaps the clearest lesson that emerges from the Barings collapse is that institutions must recognise the dangers of not segregating responsibility for 'front office' and 'back office' functions.............Management should also be wary of situations where it is apparent that only one individual is able to field all the key questions about a particular activity".

In managing the affairs of the company, it would be advantageous for management to have 'hands-on' involvement in the day-to day affairs and operational problems of the company and to institute a proper system of internal controls and to adequately follow-up on warning signals. It would also be good practice to strike the right balance between the matters of profitability and compliance and control issues. Issues of risk management may be worked on by formulating proper policies for trading activities such as limits and analysis and implementing the procedures to control the risk.

In addition, an effective internal audit function which is independent of the management would be well placed to exercise oversight of the internal controls and risk control systems and to highlight any discrepancies to the top management.

It would also be beneficial to the firm as a whole that the company's policies on its business and internal controls be properly implemented and disseminated within the firm.

Relating these precepts to the securities industry, market intermediaries ought to implement an effective system of internal controls and risk management and also play a reciprocal and interdependent role with the self-regulatory organisations for the purpose of investor protection.

In relation to this, it would be advantageous for market intermediaries to implement an internal system of "self-regulation" by instilling internal rules and procedures to promote high standards of business conduct. In this area, they would be in a better position to provide invaluable contribution by offering considerable expertise and capabilities with regard to their day-to-day market operations and practices.

The Regulator's Role
In Malaysia, all the exchanges are front line regulators and play an important function. In this capacity, they are responsible for the implementation and enforcement of their business rules, in conducting adequate surveillance of market activity and an on-going compliance program, auditing of their member firms, investigating infractions by them and imposing appropriate sanctions.

The Securities Commission as the oversight regulator oversees amendments to the business rules of the exchanges, the activities of the market intermediaries and performs regular market surveillance. In addition, the Commission licenses market intermediaries and their representatives, ensuring that only fit, qualified and competent persons are allowed to deal with investors.

In relation to the duty in ensuring that only fit and qualified persons are licensed, the Commission reviews the applications for licences. Now, let me touch a little on the licensing aspects. New applications if submitted with the complete documents will be approved by the Commission within one month. However, the Commission is in the position to process and approve licences within 2 weeks of submission, although I must emphasise that this can only happen on the basis of full and complete documentation. Similarly, fund manager's licences can be processed within ten weeks.

As at end of April 1997, the Commission has approved 78% of the new applications and 99% of the applications for renewals which typically are submitted six to eight weeks before expiry. The other applications are still in the various stages of processing which are mainly due to non-compliance with the conditions imposed by the Commission and due also to incomplete documentation submitted. In the context of compliance and due diligence, the Commission will satisfy itself that the applications meet with all the requirements and will not be hurried into issuing inappropriate approvals. We are absolutely on top of the situation in so far as the processing of the applications for the various licences are concerned.

In relation to the activities of the market intermediaries, the Commission has from time to time reiterated the importance of implementing proper standards of business conduct by market intermediaries for the purpose of prohibiting misleading sales practices, a high standard of disclosure to clients and proper segregation of clients' funds.

Compliance for Investor Protection

Ladies and Gentlemen,

Proper management controls and diligent management not only enhances the credibility and reputation of a firm but also protects the shareholders interests.

In their Report dated September 6 1995, the Inspectors appointed by the Minister of Finance, to investigate on the collapse of Barings concluded that the relevance of Compliance lies in the deterrence value that comes from the knowledge that some form of independent check is being implemented to ensure proper conduct of business.

The Report also concluded that the Baring Group could have averted collapse if initiatives such as the Asian Regional Treasurer as the "middle office" person had been effectively implemented.

The Commission proposes that an independent compliance function which has supervisory responsibility over trading and operational functions be entrenched within trading firms. It carries out supervisory responsibilities in ensuring compliance by the firm with all its internal controls and the relevant regulations and shall secure effective internal procedures and segregation of duties. The Compliance Officer should report directly to the Board of Directors. This requirement has been implemented in the derivatives markets and it is proposed that this procedure be implemented in the equity market as well.

Another compliance measure for the purpose of preventing the misuse of material non-public information ('inside information') is for market intermediaries to implement physical and procedural boundaries (known as "fire walls") to prevent the free flow and dissemination of information between different departments within an organisation. Inside information must be out of the reach of any person other than those who have been designated to work on the assignment.

In general, the "know your customer and product" rule needs to be taken into account by all market intermediaries to secure that in making recommendations to their clients, they employ diligence and thoroughness, have a reasonable basis supported by appropriate research and investigation.

Additionally, an integral component of compliance is also intended to ensure that personnel are equipped with sufficient training and exposure in relation to technical competency and knowledge of the products involved and compliance with all internal control procedures and the relevant rules and regulations.

We are pleased to say that the above compliance measures and best sales practices have been duly instilled in the derivative market and we are moving towards introducing the same standards in the equity market. Acknowledging the importance of these measures on the part of all parties will further ensure a fair, orderly and efficient market place and at the same time promote investor protection.

It is therefore timely that a seminar on this topic be held today to address this very important subject.

Thank you, ladies and gentelmen.
about the SC
The Securities Commission Malaysia (SC) was established on 1 March 1993 under the Securities Commission Act 1993 (SCA). We are a self-funded statutory body entrusted with the responsibility to regulate and develop the Malaysian capital market.

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