CHARTERED INSTITUTE OF
STOCKBROKERS
ANSWERS
Examination Paper 2.4
Ethics and Professional Standards
Law relating to Securities and Investments
Regulations of Securities and Corporate Finance
Professional Examination
September 2011
Level 2
1
SECTION A: MULTI CHOICE QUESTIONS
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
C
C
D
C
B
C
B
B
D
B
D
C
D
A
D
16
17
18
19
20
21
22
23
24
25
26
27
28
29
30
C
B
C
D
C
C
B
D
A
B
C
D
D
B
B
31
32
33
34
35
36
37
38
39
40
C
A
D
B
B
D
C
A
C
A
(60 marks)
SECTION B: SHORT ANSWER QUESTIONS
Question 2 – Ethics and Professional Standards
The following ethical issues are of concern:
i.
Failure of Audu and Michael to report the wrongdoing of Nancy to CIS, NSE and
SEC.
ii.
Audu made recommendations to his client on the basis of non public information.
iii.
Audu made investment recommendations to his client without sound investment
analysis.
(2 marks for any 2 well-explained points= 4 marks)
Question 3 – Law Relating to Securities and Investments
i.
Prohibition on a company from acquiring its own shares or those of its holding
company except under certain conditions (CAMA 1990 Sections 160 to 162).
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ii.
Prohibition on a company from giving financial assistance to purchasers of its
shares or those of its holding company (CAMA, Section 159(2)).
iii.
Dividend rule, which defines distributable profit in such a way as to prevent
unlawful return of capital to members. (CAMA, Section 381).
(1 mark each = 3 marks)
Question 4 – Regulations of Securities and Corporate Finance
i.
Establishment of Investors protection fund by Investment and Securities Act,
2007.
ii.
Registration of all securities to the public by SEC.
iii.
Strict monitoring of the content of prospectus for public issues.
iv.
Requirement for prompt reporting and transparency by quoted companies.
v.
Adjudicating mechanisms in the capital market – including CIS Investigating &
Disciplinary Tribunal, and Administrative Proceeding Committee of SEC.
(1 mark each = 3 marks)
SECTION C: COMPULSORY QUESTIONS
Question 5 – Ethics and Professional Standards
The question was generally concerned with the identification of a series of breaches in
the brokerage, research and corporate finance operations within a securities firm.
(5a)
Practices which should have generated concerns with regard to the quality of the control
infrastructure maintained by the firm would include:
i.
ii.
iii.
iv.
v.
vi.
vii.
viii.
ix.
x.
Head of Research reporting directly to head of Brokerage.
Absence of any formal organizational chart which suggests ineffective
demarcation of functions and responsibilities within the firm more generally.
Broking tem attending weekly research team meetings.
Research payments tied to brokerage use.
Provision of privileged information to separate sets of clients.
Failure to maintain effective separation between brokerage and research
personnel.
Failure to complete training of staff in corporate finance before being allowed to
conduct controlled functions.
Absence of effective oversight over trainee staff.
Conflicts of interest in taking consultancy services form a client without the
knowledge of the firm.
Failure to maintain effective demarcation between corporate finance and research
and broking teams.
(2 marks each for any 4 well- explained points = 8 marks)
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(5b)
The following revisions should be considered to the control systems maintained within
the firm:
i.
Research should report to a senior manager outside brokerage.
ii.
The organizational structure of the firm should be reviewed to ensure that all
relevant operations functioned effectively and independently where necessary
with a revised organizational chart being provided to all personnel.
iii.
The broking team should not be required to attend research meetings although
they may be entitled to see the final reports produced the following week.
iv.
Remuneration packages should be reviewed within research and across the firm
more generally.
v.
The extent and nature of any preferential treatment given to clients should be
reviewed.
vi.
Effective separation (Chinese walls) should be maintained between brokerage and
research at all times.
vii.
The training of junior members of staff should be reviewed with personnel not
being entitled to carry on any specific control function until they are appropriately
qualified.
viii.
Head of corporate finance should not handle consultancy services for a client of
the firm personally while handling an IPO for the firm at the same time in light of
the clear conflicts of interest that could arise.
ix.
The effective separation (Chinese walls) should be maintained between corporate
finance and the other core sections within the firm with all personnel being made
aware of the firm's policy with regard to the management of conflicts of interest.
(1 mark each for 5 points = 5 marks)
(5 c )
Failure to maintain appropriate management and control systems could lead to
breach of the following provisions:
i.
Many of the core provisions within SEC rule and NSE articles may have been
breached. This includes provisions on prohibition of insider trading, compliance
function, and supervision & internal control.
ii.
A number of core provisions within the CIS Code and Standards may have been
breached including duties to employer, responsibility of supervisor, prevention
and disclosure of conflict of interest, trading with insider information, professional
competence and fair dealing with clients.
iii.
Also several
have been
preferential
trading with
provisions of the Code of Conduct for Capital Market Operators may
breached, including prohibition of discrimination and giving of
treatment to some customers, avoidance of conflict of interest,
insider information and duty to employer.
(5 marks)
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Consequences of the breaches
The regulators may exercise any of their enforcement powers against the firm including:
i.
ii.
iii.
iv.
v.
vi.
vii.
Fines.
Suspension.
Withdrawal of practicing license.
Public censure.
Expulsion.
Revocation of registration of authorized clerks or accredited representatives.
Compensation may separately be available with clients also having a right of
complaint.
(Any 5 points = 5 marks)
(Total 18 marks)
Question 6 – Law Relating to Securities and Investments
This question requires a consideration of the ways in which the law, both common law
and perhaps more importantly statute law, protects the interests of minority
shareholders in companies.
In normal circumstances, the minority has no grounds to complain, even though the
effect of majority rule may place them in a situation they do not agree with. Even where
the minority shareholders suspect that some wrong has been done to the company, it is
not normally open to them to take action. This situation is encapsulated in what is
known as the rule in Foss v Harbottle (1843), in which case individual members were not
permitted to institute proceedings against the directors of their company. It was held
that, if any wrong had been committed, it had been committed against the company,
and it was for the company acting through the majority to decide to take action.
Problems may arise, however, where the majority uses their power in such a way as
either to benefit themselves or cause a detriment to the minority shareholders. In the
light of such a possibility, the law has intervened to offer protection to minority
shareholders.
The source of the protection may be considered in these areas:
At common law it has long been established that those controlling the majority of shares
are not to be allowed to use their position of control to perpetrate what is known as a
fraud on the minority. In such circumstances, the individual shareholder will be able to
take legal action in order to remedy their situation. In Clemens v Clemens Bros Ltd
(1976), equitable principles were deployed to prevent a majority shareholder from using
her voting power in such a way as to affect the rights of a minority shareholder. The
rejected proposal was to increase the company’s share capital to an extent that would
have reduced the minority shareholder’s holding to below 25%.
(6a)
The Companies and Allied Matters Act 1990 (section 300) provides remedies for minority
shareholders. Thus in circumstances where the minority shareholders disagree with the
actions of the majority, but without that action amounting to fraud on the minority, an
alternative is to petition the court to have the company wound up.
Based on the above provisions, it would appear that Lawal has a number of causes for
action to protect his situation as a minority shareholder.
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(6b)
At common law, Jubril and Kanu by transferring some of the company’s assets to a
separate company owned by them both, have clearly perpetrated a fraud on the minority
(Menier v Hooper’s Telegraph Works) and Lawal can take action to recover the property
in the name of the company.
(6c)
Following Clemens v Clemens it would appear that the majority should not be allowed to
use their majority voting power to increase the capital of the company in such a way as
to destroy Lawal’s negative power to prevent the passing of special and extraordinary
resolutions. The right of the majority cannot be fettered, but a minority may petition for
dissolution. Therefore, Lawal could petition to have the company wound up on the
grounds that it is just and equitable to do so. On the basis of Re Bird Precision Bellows
Ltd, Lawal would appear to have a legitimate expectation to be included in the
management of the company. Lawal is entitled under the rules of preemption to a part of
the shares.
(6d)
Following Re Sam Weller and Sons Ltd (1990), it would seem that the failure to pay
dividends would also amount to unfairly prejudicial conduct. Consequently, Lawal could
expect the court to order that the other two at a fair valuation, buy out his shareholding.
A shareholder cannot compel a company to declare a dividend as such; Lawal may only
seek for an equitable remedy that his shares be bought at a fair price.
(14 marks)
Question 7 – Regulations of Securities and Corporate Finance
(7a)
i.
ii.
iii.
iv.
v.
vi.
It is likely that most of the dividend warrants are stale and they need to be
revalidated.
Mike would need to contact the Registrar concerned by personal visit, or go
through his stockbroker.
He would be required to identify himself as the rightful owner. He needs to
provide a valid means of identification such as Drivers Licence, International
Passport or National I.D Card.
The dividend warrants would then be verified and revalidated by the respective
Registrars.
In the case of dividend warrants that have been lost or destroyed, he would be
required to complete an indemnity form for the Registrar to issue a duplicate.
Mike may be required to provide bankers confirmation of signature in any of
these cases if his signature is irregular.
There is a restriction on the dividends Mike could claim. After 12 years, unclaimed
dividends become statute-barred and forfeited; therefore Mike risks forfeiting those
dividends that had been declared over 12 years ago.
(6 marks)
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(7b)
i.
Mike would need to first open a stock account with a stock broking firm by the
following procedures:
•
•
•
•
He completes relevant account opening forms (CSCS shareholder’s particulars
form (Form CSCS-R005) ), and submits required documents to register with a
Stockbroker.
He fills a transfer form and submits shares certificates along with other
documents above to Stockbroker.
Stock broker issues script receipt for the certificate.
Stockbroker forwards shares certificates plus completed CSCS certificate
deposit form (CDF) and other documents to the Registrar for processing
ii.
The Registrars verify his shares certificates and thereafter forwarded to CSCS for
onward processing.
iii.
The CSCS assigns a clearing house number (CHN) to Mike. An investor’s stock
account number is automatically generated for him in the custody of the Stock
broker in the CSCS system. Mike’s full personal details and stock position are
captured in the shareholder’s account in the custody of the stockbroker.
iv.
The shares in the depository can now be used as security for borrowing. First,
the bank would demand current CSCS statement of shareholding from Mike.
v.
The bank would confirm statement from CSCS on payment of N100 fees (letter of
authority from borrower is required for this).
vi.
A memorandum, jointly signed by the bank and Mike, would be prepared
requesting CSCS to place a lien on specific quantity of stock(s).
vii.
The following procedure would have to be complied with:
•
Undated authority letter to sell from borrower to lender in case of default
•
Joint memorandum to be registered at the stamp duty office or sworn to on
oath in court
•
Lender should not disburse until a confirmation of lien by CSCS is received
•
The Stock broking firm may be required to confirm and/or consent to the lien
agreement and to confirm the title of the stated stock(s)
•
viii.
ix.
Draw-down date and duration of lien should be clearly stated
CSCS moves stock to reserve lien account with the interest of lender noted.
Only the lender should advise CSCS to remove the lien when due. Stocks are then
moved back to the account of the original stock-broking firm
(12 marks)
(Total 18 marks)
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