CAPITAL MARKET FRAUD
Kathmandu University School of Management
Submitted by:
Pratikchya Basnet (19303)
Submitted to:
Mr. Niranjan Phuyal
Behaviour Finance Professor
Date: 1/05/2020
Capital market is an integral part of a country’s economy and financial system. It is the major
source of long-term finance needed for operating corporate bodies in sustainable way. Such
funds are raised through issuance of securities (shares, debentures, bonds, mutual funds, etc) in
the primary and secondary market.
These markets have their own market mechanism and operate upon governance by respective
bodies. In Nepal, Securities Board of Nepal (SEBON) has been regulating the market under the
Securities Act 2007. The Securities Act is supplemented with a host of laws, regulations,
guidelines and byelaws that regulate the issuance and trade of various types or securities, as also
the activities of stock brokers and dealers. The Act incorporates the offenses, trial, punishments
and other necessary factors in the capital market.
Even with strict set of rules in the country, we can see a lot of anomalies in the market, in fact
increasing anomalies. There are several cases of fraudulent activities like insider trading, market
manipulation, fake trading and misrepresentation of information in the market. The governing
bodies are responsible for the regulation of such activities, punishing the offenders and maintain
safe and legal trading environment. However, that is not always the case. There has been large
number of fraudulent activities all over the world, even with strict governance.
Lets look at several cases of such activities, the first case from Japan Stock Exchange,
Hiromasa Ezoe was the chairman of Japanese human resources and classifieds company Recruit.
But before Recruit subsidiary company Cosmos went public in 1986, Hiromasa illegally allowed
high-profile figures, including top-ranking politicians, access to almost a million Cosmos shares.
When the company was then offered publicly, the value of the shares shot through the roof,
which translated into a huge amount of shady profit.
At first, only lesser officials admitted involvement in the scandal, but the resignations began to
snowball, including those of some of the most powerful men in the country. Soon, 155 people
had been implicated for their involvement in the insider-trading scheme, and many top officials
stepped down – among them the finance minister, Kiichi Miyazawa, and Prime Minister Noboru
Takeshita. Among the politicians involved in the scandal were Prime Minister Noboru Takeshita,
former Prime Minister Yasuhiro Nakasone, and Chief Cabinet Secretary Takao Fujinami. In
addition to members of the LDP government, leaders of the Komeito, Democratic Party of Japan,
and Japan Socialist Party were also found to be involved. As a result, Takeshita's cabinet was
forced to resign. The prime minister’s political secretary even committed suicide. Japan was
shaken to the core, and the stock market fell by 40 percent in 1990.
According to the court, Ezoe sold 53,000 pre-flotation Recruit Cosmos shares to lawmakers,
bureaucrats at the education and labor ministries, and executives of Nippon Telegraph and
Telephone Corp. He sold 10,000 Recruit Cosmos shares at about 3,000 yen per share, well below
market value, to then Chief Cabinet Secretary Takao Fujinami, and offered 3 million yen in cash
and checks plus 5,000 Recruit Cosmos shares to then New Komeito lawmaker Katsuya Ikeda.
The value of the shares shot up to 5,270 yen when they debuted on the market.
In December 1994, New Komeito lawmaker Katsuya Ikeda was found guilty of receiving 3
million yen in checks and cash as well as 5,000 pre-flotation Recruit Cosmos shares in exchange
for urging the government in a Diet committee to honor a gentleman’s agreement on job-hunting
seasons, a practice that benefited the parent company, Recruit Co. Ikeda was given a suspended
three-year prison term.
Takao Fujinami of the ruling Liberal Democratic Party was the other Diet member tried. In
October 1999, the Supreme Court finalized the guilty ruling on Fujinami, who was convicted of
accepting bribes in the form of 10,000 pre-flotation Recruit Cosmos shares in exchange for
political favors extended while he was chief Cabinet secretary under Prime Minister Yasuhiro
Nakasone.
In March 1992, Takashi Kato, a former administrative vice labor minister, was found guilty of
accepting 3,000 shares of Recruit Cosmos in exchange for attempts to exempt a job-information
magazine published by Recruit from government regulations.
In October 2002, the Supreme Court upheld the guilty verdict of Kunio Takaishi, a former vice
education minister. He was convicted of accepting 10,000 Recruit Cosmos shares in exchange
for favorably treating Recruit Co., including appointing an executive of the firm to an education
ministry panel. He was given a 4 1/2-year prison term, suspended for four years, and fined 22.7
million yen.
Hisashi Shinto, who led the privatization of Nippon Telegraph and Telephone Corp. in the mid-
1980s, was given a suspended prison sentence in 1990 for accepting Recruit Cosmos shares in
exchange for favorably treating Recruit Co. in its phone-line resale operations. Shinto, 92, died
of pneumonia in late January.
Hiromasa Ezoe’s trial lasted 13 years and only ended after he had signed interrogation records
that he insists were made up. The court noted that since quitting the executive post at Recruit,
Ezoe has engaged in philanthropic activities, including setting up a scholarship program with his
own money. Of the 12 people indicted in the trial, all except Ezoe had already been found guilty
and given suspended sentences. All the other rulings have been finalized. He was given a
suspended sentence as Ezoe, 66, has been “socially punished” since the case came to light in
1988 and therefore did not send him to prison.
This infamous scandal left a big mark in the Japan’s capital market.
I would like to take examples of fraud speculations in Nepal as well,
Kalika Laghubitta has been speculated to be involved in insider trading. The company has
recently notified NEPSE about its 75% right share issuance. The company has stated that the
meeting of BOD regarding the right issuance took place on Jan 2, 2019, but the time of the
meeting has not been mentioned in the notice. Also, despite the meeting being conducted on Jan
2nd, the notice found its way to NEPSE only on Jan 3 rd. If we see the performance of the shares of
KMCDB in secondary market, it had been phenomenal for Jan 1 st and 2nd. The company has
been the top gaining company for these two days hitting the positive circuit. The company has
also recorded turnover of Rs 81.32 lakh during Jan 2nd’s trading period. It should also be noted
that the price of KMCDB was Rs 754 on Mangsir 27, 2075 while its LTP for yesterday stands at
Rs 1,104. The price has increased by 46% within 14 trading days.
In another example of fake trading, NEPSE has forwarded a letter to Securities Board of Nepal
(SEBON) urging it to take action against two broker companies for their alleged involvement in
the fake certificate scandal that came to light. A report submitted by a probe committee formed
to look into the fake certificate scam had found Agrawal Securities (broker 6) and Shrihari
Securities (broker 56) guilty of involving in the scam. The fake certificate scandal came to light
after a promoter of G & G Investment Company was arrested last month. The promoters of the
company had traded 13,500 unit shares of Chilime Hydropower Company between one another.
They had also taken out loans by pledging those shares as collateral. The promoters of G & G
Investment had taken out a loan of Rs 64,20,000 from Siddhartha Development Bank and
another loan of Rs 59,27,000 from United Finance by pledging the fake shares of Chilime
Hydropower. The shares were sold under the names of Shristi Kafle, Sona Dahal, Ramhari
Acharya and bought in the name of Govinda Ghimire. The bank and finance companies had
agreed to provide the loans after Agrawal Securities pledged to stand as a guarantor. Later,
Agrawal securities itself paid back the loan amount to the issuing companies.
In recent time, the price of Salt trading corporation is rising continuously. The stock price which
was Rs 500 in the beginning of current FY soared to Rs 2,005 on Sunday, January 5. As the end
of the second quarter is nearing, the stock price has jumped by Rs 1,500. The continuous rise of
the stock price has made the investors suspicious of its transaction. The investors are suspecting
‘pump and dump’ practice in the stock. The perpetrators of ‘pump and dump’ usually already
have bulk stocks purchased at low price. Once the price reaches the highest point, they sell their
stock at a higher price and rake maximum profit.
Another significant observation in the Nepalese market is the price anomalies before/ after the
important decision announcements from respective companies. SEBON has been unable to flag
down the rampant insider trading in stock trading at present. The price movement prior to
dividend announcement of the listed companies or before they announce merger plans indicates
information leakages but the regulator has so far been turning a blind eye to it.
We can see a number of cases like these in Nepal, but we can also see that there are minimal
actions taken against the guilty party or minimal investigation done in these cases. It is very
important for governing authorities to take necessary actions in these cases and enforce the laws
as per Securities Act. These kinds of fraudulent activities create fear among potential investors
and create negative mindset among people. Since the securities market of Nepal is young and in
a growing phase, it is high time to set the culture and environment of the market. If the governing
bodies are able to control the illegal activities now, and enforce the law, then large of number of
potential investors can be attracted. NEPSE as well as SEBON should try to address the issue as
soon as possible while the companies also need to develop independent behavior and help to
maintain transparency in the stock market.
The market can be efficient only when the information dissemination is effective i.e. if all
investors have access to information at the same time. The time lag between those who get prior
information benefit more because of it at the expense of other non-informed investors. The
Nepali capital market is struggling to gather larger investor pool and such insider trading
instances rips the new investors' faith. If they can't make their investment decisions with full
information, then their investment is at risk and so are all the other small investors. The examples
given above represent just the tip of the iceberg, and if authorities don't take any action soon then
we might as well just surrender our investments and pull out from the market.
‘In order to prevent insider trading, Nepal should first define who is an insider. In China, when
an executive quits, he or she is no longer an insider. In the UK, any person having information
from within the company in question is considered an insider. In India, even family members are
defined as insiders. Only when an insider has been clearly defined can actions against insider
trading be implemented. It is the regulatory body who has to monitor what is happening. Insider
trading is widespread in Nepal, and the board needs to spend time and resources to prevent it.
This will make share trading outside the capital city fair and trustworthy, otherwise new and
small investors and those from outside the Valley will always feel that they are being cheated,
and that the share market is not a fair and honest market.’ Dwaipayan Regmi on Kathmandu
Post, April 10, 2018.
I believe that the legal provisions in Nepal is very good given its infancy stage, however what is
lacking is the enforcement of these law. The governing bodies do not seem eager to control the
fraudulent activities in the market and are being ineffective in doing their parts. The speculations
in insider trading have been rising more than ever and we can still see no actions from the parts
of NEPSE and SEBON. These bodies need to be very observant of the irregularities in the
market and take strict and prompt actions. The small size of the trading market makes its hard to
observe and recognize market anomalies from regular market mechanism but they could set up a
separate party or team for observing such activities. The volatility of the Nepalese market is
another factor that makes it hard to recognise the irregularities in the market, so a specialized
team is extremely important.
It is extremely important for the governing bodies to manage and hire experts in the area, who
are financial literates, to the least, as employees. Unavailability of resources could be another
factor contributing to slow and delayed case investigations or actions taken in the cases, so
appeal to provide the resources from the concerned authorities should be done as well.
Defining the existing law in a more specific way will also help curb the problem. As discussed
earlier, defining the factors in insider trading in more specific ways will help identify the cases
with much ease.
Board members of the companies are themselves involved in share trading in the name of
relatives and confidants. SEBON should end the practice through conducting investigation and
taking proper action against them. Thus, these are some of the measures that governing bodies
and concerned authorities can take.
