By Clarence Rambharat Thursday, October 9 2008

The remarkable amount of US taxpayers’ funds already used to shore up the global financial markets will give embattled Hindu Credit Union (HCU) investors more than a glimmer of hope that the Minister of Finance of Trinidad and Tobago may consider stepping in to fill the $400 million black hole which auditor Ernst and Young has found in the HCU’s books.

From a lawyer’s perspective, there is little doubt that the State can be held accountable for at least part of the HCU’s debacle (discussed in this column on July 31, 2008), especially when it involves an institution like a credit union.

I say “an institution like a credit union” because, by and large, the membership of credit unions would not be expected to understand the details of the operations of the institutions and in many cases members may not possess the basic skills to challenge the financial statements of these institutions.

Of course, it is something the Prime Minister as Minister of Finance had recognised, and he articulated and the Central Bank implemented a policy to provide Financial Literacy Training for citizens.

It is arguable that in circumstances where credit union members and other investors may not have readily understood the risks inherent in investing in an entity which, as has been explained before, conducted many business activities with investors’ money outside of the Credit Union structure, the Commissioner of Cooperatives was, arguably, under a duty to provide the oversight and also take steps to curtail the risks involved, at the appropriate time.

At a minimum, the Commissioner may have been under a duty to advise members and investors of the precarious position the credit union was finding itself over a period of time, since it was only the Commissioner who had the full knowledge of the extent of the claims against the credit union and the extent of its delinquency in its dealings with members and investors.

Moreover, when you are talking about credit unions, insurance companies and publicly listed companies, the public is not expected to have the intimate knowledge of the way these entities operate, and often it is left for the Commissioner of Cooperatives, the Supervisor of Insurance and the Securities and Exchange Commission (SEC) to provide, respectively, both oversight and advice to the public on matters which are inimical to the public’s interest and to investor confidence in the financial system.

Two things will be uppermost in the minds of the public in this HCU issue, against the background of what is happening in the global financial markets.

The first question is of course what took the Commissioner so long to take the action the office eventually took? The second question is why was the HCU along with perhaps other credit unions allowed to operate outside of the well established credit union body and the Credit Union Stabilisation Fund, without the public being made aware of these facts and the risks which go with them?

In the US, the current meltdown is being blamed in part by the sub prime lending crisis (discussed in this column on August 17, 2008) and the bursting of the speculators’ and short sellers’ bubble.

Again, like the HCU, the regulators were quick to point out the causes, but in no way acknowledged that action might have been taken much sooner.

When crude oil prices moved quickly past US$100 per barrel, and up to US $150, industry analysts were pointing out the absence of demand pressure or sellers shortfalls and warned about the prevalence of speculators who were betting on oil futures and pushing prices up with their betting power and without physical ownership of a single barrel of oil.

In the same way, while short selling has been described by many business writers as having a legitimate place in the stock market, a US Securities and Exchange Commission (SEC) statement, released in the wake of the temporary ban on short selling in mid-September 2008, stated that “unbridled short-selling is contributing to the recent, sudden price declines in the securities of financial institutions unrelated to true price valuations and financial institutions are particularly vulnerable to the crisis of confidence and panic selling.” (Star Tribune, September 19, 2008).

What then is short selling?

Short selling, according to investopedia.com, is the selling of a stock that the seller doesn’t own. Basically, in the US environment, where there is a high degree of volatility, especially in certain types of stock like banking, energy and pharmaceuticals, investors would wish to take advantage of this volatility, even when they do not actually own the particular stock.

To do so when an investor wishes to short sell a stock, a broker will lend it to the investor.

Investopedia.com explains that the stock will come from the brokerage’s own inventory, from another one of the firm’s customers, or from another brokerage firm.

The shares — assuming its 5,000 are sold at the prevailing price — assuming it’s $50 a share — and the proceeds, $250,000, are credited to the seller’s account.

Of course, at some time the investor/seller must buy back the 5000 shares and return them to the broker.

If the price drops below $50 then the investor/seller can buy back the 5,000 shares at the lower price, return the 5,000 shares to the broker and profit the difference.

On the other side, if the price rises above $50, then the investor/seller has to buy the 5,000 shares back at the higher price and incur a loss on the transaction.

Certainly, over mainly short sales over many shares, the investor/short seller will hedge and smoothen the losses/gains.

In a bid to shore up investor confidence in the face of the spiralling market crisis, the US SEC temporarily banned all short-selling in the shares of 799 financial companies. The Taipei Times reported on September 21 2008, that US officials have been denouncing hedge funds and other short sellers they say have swarmed over the limp bodies of venerable investment banks and other big companies.

The Times added that New York Attorney General Andrew Cuomo likened them to “looters after a hurricane,” and his office was said to be investigating a possible conspiracy among short-sellers to spread negative rumours to pound companies’ stock prices down.

Both the HCU issues locally and the US meltdown globally point to the need for strict and independent oversight, if investor confidence is to be part of the financial markets. Added to that is the critical role of updated legislation to identify and deal with the wrongdoers.

Part of that must certainly be the swift and penetrative power of the regulator to identify and ring-fence the personal assets of directors and officers before it’s too late.



Clarence Rambharat is the past Chairman of the Employers’ Consultative Association.

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