Seminar on Due Diligence
29 August 1996 |   By : Dato' Dr. Mohd. Munir Abdul Majid, Chairman

Ladies and gentlemen,

Welcome to the fifth of our SIDC public seminars. You will recall that the first seminar on Call Warrants was held in December 1994, followed by one on Securities Lending in September 1995, then Infrastructure Project Companies listing in January 1996, and Islamic Capital Markets in March 1996. Indeed, this audit trail of seminars serves to remind us how far we have come in our efforts to advance the cause of our capital markets through a judicious balance of regulatory and development measures.

As Chairman of the Securities Commission, I am very conscious that the regulatory framework administered by the SC serves the investing community, and not the other way around. Laws and regulations should be framed with the end user in mind -- to provide legal certainty, and yet be practical.

This morning we are pleased to release our publication on due diligence practices, a subject of much discussion as market intermediaries come to terms with their roles and responsibilities in the disclosure based regulatory system introduced towards the end of last year. Recognizing that a body of industry practices has to be built up to enable the disclosure based system to thrive and prosper, we have worked hand in hand with industry in producing this publication on due diligence practices which we hope will be of use as a basis for further work and development.

Recent amendments to the Securities Commission Act, 1993 (SCA) have placed a higher standard of responsibility on promoters, directors and advisors in respect of their disclosures made to the Commission. Market participants should bear in mind that the disclosures they make is for the purpose of providing the investing public the information they reasonably need to evaluate the risks and returns of the securities offered to them.

Such disclosure should be timely, accurate and sufficient. They form the very bedrock of a disclosure based regulatory system. Indeed, the heaviest criminal penalties that exist today in our securities laws relate to non-disclosure.

By the same token, the defence in relation to disclosure is a due diligence defence. In essence, the ground that a defendant can stand on is that he has made reasonable inquiry, and as a result of that inquiry, he has the basis of his belief concerning the veracity of his disclosures. What I have just said is an abbreviation: I would urge all of you who have not read Section 32B of the SCA to read it in the original, as it forms a cornerstone of our regulatory structure.

A badly designed market regulatory structure can be compared to an American car of the '50's. It is big and flashy, bulky and heavy. It will get you from A to B, but be prepared to spend money on petrol if you are going to use it frequently. The regulatory framework which we are in the process of crafting for our capital market, is not such a car. We are designing a vehicle that will handle well, be fuel efficient, is safe and reliable and which meets the 90's standards of ergonomics and user friendliness.

A key to success in designing this new vehicle is to seek the contributions of those who will be actually driving it. The due diligence publication is a case in point. Merchant bankers, accountants, professional advisors and lawyers were directly involvement in the drafting this document alongside the SC . The consultative process was time consuming but absolutely essential. This publication is not rolled out of a bureaucratic assembly line, the product of some theoretical drafting exercise by people who never had to negotiate the traffic of the real world of commerce. It is the work of those who will have to make it work in the real world.

Building a workable regulatory framework is only the first step to laying a firm foundation for a credible and efficient market. I cannot but emphasize the importance of proper market behavior by market participants, like good drivers on the road. As the theme of this conference is on due diligence, permit me to reaffirm the importance of business, professional and personal ethics.

Malaysia is a culturally diverse society, but our religious beliefs, history and experience have taught us that fundamental ethical values like honesty, loyalty, integrity, fairplay and justice are vital in bringing about a stable and progressive society. Similarly, we must appreciate that the credibility of our capital market lies in its ability to weave moral and ethical standards into daily activities of professionals, be they lawyers, accountants, merchant bankers, stockbrokers, research analysts or fund managers. And in the pursuit of professional goals, we will often be confronted by moral and ethical dilemmas. The free market forces will present to us short term and personal gains which can sometimes obscure the long term integrity of our market. We may be so blinded by the rewards presented that we become quite unable to distinguish the good from the bad. Excuses can always be conjured up and justification made in order that the moral and ethical values are relegated to the background.

It is unethical practices such as market rigging, making false and misleading statements, illegal trading in securities, improper conduct by remisiers, insider trading and abuse of information obtained in official capacity, that could, if left unchecked, undermine the integrity of our markets. I am not saying that these practices are widespread - they are not. Nevertheless, we must be ever vigilant. How then do we protect our investors, and ensure market integrity ? In a nutshell, disclosure and credible enforcement.

Timely, accurate and adequate disclosure by public companies will improve the level of transparency and efficiency in the allocative function of our market. We are now embarking upon a disclosure based route. Directors and officers of listed companies are required to disclose relevant, adequate and timely information to the markets to enable investors to make informed decisions. Disclosure is the cornerstone of a mature market. Disclosure requirements are detailed in chapter 6 of the Policies and Guidelines on the Issue/Offer of securities. Corporate disclosures are required but not limited to the issuing of a prospectus in fund raising by a company. Equally important and significant are the periodic disclosures, including half year and annual reports and continuous disclosure requirements. Public companies are, in fact required to maintain high standards of disclosure on a continuous basis for investors to make informed decisions. Directors may choose to comply with the minimum requirements of the law, or adopt a more liberal approach in giving detailed and useful information to shareholders.

Timeliness is also an important factor. Good corporate governance practices would seek to release immediately information which may have a material effect on both the activity and share prices of the company. So much for disclosure.

Credible enforcement speaks to an effective system of justice which exists to punish wrongdoers. Self regulatory organizations and professional bodies have powers of sanctions for improper disclosures and unethical behaviour by their members. Proper surveillance procedures, including vetting of prospectuses by the SC are in place to check and verify information disclosed in prospectus and corporate announcements. Market participants therefore have incentives, both positive and negative, to avoid making damaging disclosures to maintain their own integrity.

What does this mean for market participants? What should they do, when the body of due diligence practices is still being developed? In attempting to answer the question, we cannot be encyclopaedic. The range of securities offered is so wide that no single prescription can fit all cases. However, the following pointers may be useful.

A set of due diligence procedures and practices - a proper system and process - has to be established and carried out with due skill, care and conduct, with reasonable investigations and enquires made in verifying information submitted to the SC, corporate announcements and prospectuses and shareholder circulars. Having laid down the system, there must also be adequate supervision to ensure that its procedures are carried out.

In the process of setting up due diligence procedures, checklists are often used. Indeed, I am told that the Association of Merchant Banks is working on a due diligence checklist as a general guide for its members. Directors and advisors would love to have a checklist of obligations so that they can tick the box and rest comfortably at night. At initial stage of development, such checklists are essential to provide some guidance of the requirements, and act as check of completeness. However, blind adherence to checklists, in the long term, could encourage an attitude of form over substance. Due diligence is not about ticking boxes only. Means must not be confused with ends. Due diligence procedures should be used to build a good prospectus, not to offer a good defence.

A word of caution to those involved regarding the costs and benefits of conducting due diligence. The operative word is REASONABLE. The costs of the whole due diligence process should not lose sight of the amount of funds raised. The extent of due diligence required would therefore depend on the circumstances, the size of the company and complexity of the company's operations. Finally, disclosure of information and due diligence processes are aimed at protecting investors. It must be clear what we are protecting them from fraud and non-disclosure most certainly, but not from their cupidity and their ignorance. Investors must be constantly reminded that we have a free market system which allows them to make their own investment decisions, to choose investments suitable for their risk/return profile, at the right time, and in the right amounts. Even as disclosure based regulations are being introduced, investors must be educated to be responsible for their own investment making decisions, and to seek professional advice if they cannot fully comprehend the disclosures that are being made.

Let me close with a story about the English channel. In June 1982 a group of British and French civil servants submitted to their respective governments a report favouring the establishment of a tunnel across the English channel. This concept was not new. In 1802 Napoleon proposed the idea to the British statesman, Charles Fox, but due to the subsequent hostilities between the two nations, the idea was not realized. Fifty years later, Queen Victoria, who suffered from sea sickness, consented to a rail tunnel, only to receive objections from Lord Palmerston, the then British Prime Minister, on the grounds that.... " we will shorten a distance which we already find too short." In some jurisdictions, regulators and regulatees tend to share some of the hostilities of the Anglo-French relations in the past. In Malaysia, we consider these hostilities to be quaintly Victorian. Indeed, we must redouble our efforts at shortening the distance between purveyors of securities and buyers of securities, and build bridges and tunnels between all market participants, regulators included, as we move towards the disclosure based environment.

Lastly, a word of thanks to today's speakers and panelists who have come from far and wide for making time to share with us their expert views and experiences on due diligence. I trust that you will all have a fruitful and beneficial seminar.
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