On December 10, 2008 Bernard Madoff’s massive Ponzi scheme was unravelled. The following day, FBI arrested Madoff and charged him with one count of securities fraud. On June 29, 2009, Madoff, the man who confessed to organising the largest fraud in the US history, was sentenced to 150 years in prison, the maximum allowed. Samuel D Waksal, founder and former CEO of the biopharmaceutical company ImClone Systems, which developed the drug Erbitux, was arrested on June 12, 2002 on insider trading charges. On October 15, he pleaded guilty to charges of securities fraud, bank fraud, obstruction of justice, and perjury. On June 10, 2003, Waksal was sentenced to seven years in prison.
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The Dhaka Stock Exchange all share price index, which was introduced on September 16, 1986 hovered at around 1,000 in June 1996, and reached 3,627 on November 16 the same year; and then moved further down to 484.44 in January 2000. At the market’s peak, shares were trading at an average of over 80 times of relevant earnings. One popular stock, Confidence Cement, sold for 1,060 times of 1996’s earnings, after a 1,400 percent increase in its price. Trading data shows that during this period, market capitalisation went up by 265 percent and the average daily turnover increased by over 1000 percent. As all bull runs eventually end in tears, the bubble was eventually burst: stock market prices dropped by close to 70 percent in end-April 1997 from the peak in November 16, 1996. Countless of investors lost their lifetime savings in the blink of an eye.
Graph: DSE All Share Price Index, 1995-1999
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On December 26, 1996 the Securities and Exchange Commission formed an enquiry committee to probe into the irregularities of stock market activities during July 1996 to November 1996. On March 27, 1997, the committee headed by the vice chancellor of Jahangirnagar University, submitted the report identifying a number of companies and some of the country’s biggest brokers apparently involved in market rigging. Based on the report, on April 2, 1997, the chief metropolitan magistrate court issued arrest warrants against 32 people in seven brokerage firms and eight listed companies. The SEC also filed 15 share scam cases in the High Court. The High Court, however, granted anticipatory bails to the accused along with nine others on April 6, 1997. Since then the government officials at the SEC have been unable to say anything about the status of the cases. Many say that the government is reluctant to pursue the case.
In 2002, SEC formed two separate committees comprising of officers of the regulatory body to carry out detailed investigation about the ‘unfinished task’ of the previous committee. SEC member K Iftikhar Ahmed was made convener of the two committees. However as anticipated, these two committees also failed to complete the ‘unfinished task’. However, financial market authorities should finish their ‘unfinished task’ by all means within the shortest possible time. Why?
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The irrational exuberance and its demise in 1996 occurred at the cost of thousands of investors who came to participate in the market for the first time having little or no knowledge of the market fundamentals. No one was held responsible for the scam and justice was denied to the victims. It’s been 14 years since the market was raped, still there is no sign that the victims would get justice even in near future. Delayed justice raises questions about SEC’s objective of saving interest of market investors.
Why do financial markets need special attention from relevant parties, e.g., legal system, government agencies, or even by other market participants? Presence of a market-oriented legal system determines the quantity and reliability of publicly available information. Researcher Rafael La Porta argues that strong legal protection would enable investors to act on disclosure, whereas weak protection hinders investors to rely on disclosure and future prospects, which makes disclosure less effective.
In a study on corporate governance, investor protection, and performance in the emerging markets, Leora Klapper and Inessa Love showed that firms in countries with weak legal systems disclose less information, which might be, as Rafael La Porta argued, due to the assumption of weak legal systems makes disclosure practices less effective. Besides, a well-developed legal framework enhances financial market liquidity. This is significant because lower liquidity costs have been shown to reduce a firm’s cost of capital and thus increases its market value.
A sophisticated financial market produce higher rates of economic growth. The extent of legal protection of investors in a country is an important determinant of development and growth of its financial markets. When laws don’t protect investors’ rights, development of financial markets is stunted. Weak investor protection increases the cost of external funds and cost of equity in particular. In countries where investors are poorly protected, firms issue less equity and stock markets are underdeveloped. Put differently, poor investor protection affects the supply of equity negatively. For instance, there are total 1,25,929 firms listed with the office of the Register of Joint Stock Companies and Firms in Bangladesh. Among those, 81,888 are private companies, 1417 are public companies, 125 are foreign companies, and 32,295 are partnership firms. However, only about 266 firms are listed on the Dhaka Stock Exchange (DSE). So, even to achieve a thriving and stable financial market, the authorities need to put the scammers behind the bar.
In 2007, according to Motley Fool Global Gains research report, in terms of stock return, Bangladesh stands first in the list with 134 percent return. China, Ukraine, Cote d’Ivorie and Nigeria come next in the list with 132 percent, 125 percent, 110 percent and 106 percent return respectively. Our bourses are making “record transactions” almost every week. Still many investors are reluctant to invest because of the memory of 1996. To some investing in the stock market is synonym to gambling. Hardly any major international investor committed any significant fund in any of our bourses. The stock market scam in 1996 is still a stain to domestic and international investors.
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As justice was denied in 1996, ‘manipulators’ are again trying to manipulate the market with different innovative ideas. Because of bureaucratic red tape and lack of resources within regulators, ‘manipulators’ adjust with the circumstance quickly than the regulators. To impede the ‘manipulators’ from exploiting markets, authorities need to adjust legal and judicial affairs. For instance, all financial market fraud should be considered as non-bailable crime.
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The 1996 debacle took place during Sheikh Hasina’s regime. The Awami League leadership cannot deny its responsibility as it has also played a significant role as a catalyst in inflating the market. For instance, former finance minister Shah ASM Kibria and Prime minister Sheikh Hasina herself claimed credit for the “outstanding” stock market performance. Awami League has additional responsibility to serve justice to those who lost their fortune in 1996 stock market scam.
AFM Mainul Ahsan is a PhD student of Economics department in Texas Tech University, USA