Last week, The World Bank published a report entitled “A New State of Mind: Greater Transparency and Accountability in the Middle East and North Africa.”
A main premise of the report, the link for which is at the end of this article, is that “poor governance, and, in particular, the lack of government transparency and accountability, is at the root of the region’s development failings—including low growth, exclusion of the most disadvantaged and women, and overuse of such precious natural resources as land and water.”
When put in a legal context, “transparency” becomes “disclosure.” And, depending on which context disclosure is being applied in, we get different manifestations of it.
For public shareholding companies listed on stock markets, there are rules and regulations that require accurate, timely, and complete disclosures. Nowadays, capital markets cannot function and thrive without this.
External auditors play a critical role in safeguarding proper disclosure of listed companies. To paraphrase Captain Ramsey in the movie Crimson Tide, external auditors constitute the front line and the last line of defense as far as investors and shareholders are concerned. How external auditors are licensed, accredited, and monitored is critical to safeguarding shareholder interests and maintaining investor confidence, particularly in markets where legal recourse is not readily available - which is the case in many Middle East and North Africa markets.
Listed companies typically engage in two types of legally required disclosures: routine regular disclosures, such as those pertaining to quarterly, semi-annual and annual results; and, immediate disclosures of information related to events that may have a material impact on the share price, such as a fire in a production facility or the gain or loss of a major contract to sell products, or an acquisition.
An area that receives little attention in the Middle East and North Africa markets is related to “related party transactions.” A listed company may have legitimate reasons to, say, purchase goods and services from another company that happens to be related to a board member, a major shareholder, or a member of its senior management.
However, such transactions need to be conducted on an “arm’s length” basis, making sure of the quality of goods purchased and that the price paid is a fair market price, without unfair markups. A related party transaction should also be disclosed to the market, along with the rationale for entering into it. Several international organizations, including the OECD, have issued recommended best practices that can be followed in such circumstances.
An acquisition of a related company by a listed company at a price that includes a high markup of goodwill needs also to be fully explained and disclosed to shareholders.
Monitoring proper disclosure by listed companies is the responsibility of the capital market regulator. The capital market regulator has three main functions: enforcement of the securities law and related regulations; market reform - updating existing rules and addressing market deformities; and, market development - introducing new financial products, for example.
The ability of the capital market regulator to enforce disclosure is paramount. Otherwise, investor confidence in listed companies will be lost, leading to dwindling liquidity and a migration away by investors and companies from the afflicted stock market to greener pastures. The days of investor and company “capture” by national exchanges are gone.
This “ability” of the regulator has two main aspects to it: top notch knowhow of the intricacies of capital markets, and freedom from political interference. The ability of the capital market regulator to recruit, retain, and remunerate qualified talent is critical. Political freedom for the regulator means financial independence, with its allocations enshrined in successive government budgets, and a reporting line to the highest political authority in the land - not to cabinet minister, for example.
The regulator cannot take part of the trading or depository fees that accrue to exchanges and depositories to finance its operations - a clear regulatory conflict of interest that will lead to a loss of investor confidence.
It may seem, at first sight, a forgone conclusion that taking care of one’s capital market is good for on’e economy. After all, the national capital market, with the stock market at its core, plays an important role in facilitating access to finance for small, medium, and large enterprises and corporations, which use funds raised to undertake capital investments that lead to economic growth and create jobs - much relevant points for the fast growing populations of the Middle East and North Africa region.
But that is now always the case. And, as The World Bank report implies, the ability of the capital market regulator in some countries of this region to enforce proper disclosure rules and regulations requires a shift in the enforcement matrix. And in such circumstances, the “state” has to provide the political cover and support to the entities undertaking enforcement actions.