Irrespective of whether employees of the corporate or private sector like it or not, or can afford it or not, a minimum contribution of 8% from their basic salary, made towards the Employees’ Provident Fund (EPF), is mandatory in Sri Lanka. The purpose of the Fund, identified as a retirement benefit for employees who do not belong to any other pension or provident fund, is to secure a better standard of living for employees at retirement. As such, in order to provide maximum retirement benefits, the fund engages in investment, specifically long-term investment. The EPF falls under the purview of the Central Bank of Sri Lanka (CBSL), which permits the investments made by the Fund. These investments include long-term Treasury bonds and bills, corporate debt, fixed deposits, and also equity. The relationship between the EPF and equity investment, however, has been not so pleasant; after a few years of unfavourable investments in the Colombo Stock Exchange (CSE), the EPF refrained from making any new investments there – that is, until last year. In 2019, the EPF began investing in equity once again. It is in this backdrop that market dealers are now inviting the EPF to invest in blue-chip company shares which were at their lowest levels after the market reopened on 11 May, following seven weeks of lockdown as a result of the Covid-19 pandemic. Accepting the invitation, according to market analysts, could result in the Fund incurring losses once again, similar to the 2012 “pump and dump” saga. The Sunday Morning Business this week is taking a look at the EPF’s entry into the market, how improper equity investment decisions prevented the EPF from investing, while also focusing on the Fund’s return to the market, and at possibilities of imprudent equity investment decisions. The Fund’s entry into equity investments The EPF was established under the EPF Act No. 15 of 1958 and is currently identified as the largest social security scheme in Sri Lanka with an asset base of Rs. 2.28 trillion at end-2018. The EPF began investing in the domestic equity market in 1998. However, at that point, its investment allocated to stock was negligible compared to over 97% of investments allocated in government securities. Other assets of the EPF including corporate debentures, commercial paper, call money, and repurchase agreements were trivial portions of the EPF’s assets. During this time period, restrictions imposed by the fund management ruled out possibilities of holding any international assets. According to research done by Japan’s National Graduate Institute for Policy Studies (GRIPS), from 1996 to 2003 and again in 2008, the total size of Sri Lanka’s EPF was larger than the market capitalisation of the CSE. For instance, in 2000, the EPF was 13.7% of GDP (Rs. 214.8 billion), while the market capitalisation of the CSE was 5.6% of GDP (Rs. 88.8 billion). During the year 2010, the equity portfolio of the Fund grew by Rs. 33.8 billion – from Rs. 9.8 billion in 2009 to Rs. 43.6 billion. In 2010, the Fund invested in fundamentally sound companies in the banking, finance, hotels and travels, manufacturing, construction, engineering, and other diversified sectors listed in CSE. The equity portfolio provided Rs. 1.6 billion revenue to the Fund by way of dividends and capital gains in 2010 compared with Rs. 348 million earned in 2009. In the year 2011, the price indices of the CSE declined after the upsurge in the previous two years. Nevertheless, the equity portfolio of the Fund consisted of both listed and unlisted equity and it grew by Rs. 34.6 billion from Rs. 43.7 billion in 2010 to Rs. 78.3 billion as at end-2011. The equity portfolio of the Fund was approximately 8% of the total portfolio as at the end of 2011.This consisted of an investment portfolio of Rs. 77.6 billion and a trading portfolio of Rs. 0.7 billion. Equity investments made by the EPF were deemed to be mostly beneficial up until 2011. Investigations over manipulation at CSE During the year 2012, a total number of 19 investigations were conducted by the Securities and Exchange Commission (SEC) into instances of suspected market misconduct, including market/price manipulation, insider dealing, front-running, etc. Controversies over manipulation at the CSE began to emerge in the third quarter of 2012. Pressure from high places in the Government was exerted on then SEC Chairman Thilak Karunaratne to resign from his position due to the investigations that were being conducted by the SEC into companies that were abusing the share market. Following his resignation, Dr. Nalaka Godahewa was appointed SEC Chairman. It should also be noted that Indrani Sugathadasa Weeratunga, wife of Lalith Weeratunga (current Principal Advisor to the President), served as the SEC Chairperson in 2011. Nevertheless, she tendered her resignation in December 2011 in order to “uphold her principles” amidst alleged market manipulations. Infamous pump and dump These manipulations included a practice called “pump and dump” – a scheme that attempts to boost the price of a stock through recommendations based on false, misleading, or greatly exaggerated statements. The perpetrators of this scheme already have an established position in the company’s stock and sell their positions after the hype has caused the share price to increase. It creates an artificial picture which masks the stock’s true value. The manipulators use this to their advantage to earn a profit, while investors who are unaware of the manipulation and who make decisions based on the available information, stand to lose, sometimes substantially, as a result of manipulation. In fact, manipulators count on this, often making a profit on the losses of others. This practice is illegal based on securities law and can lead to heavy fines. Some of the stocks that are reported to have benefited from this scheme were Ceylon Grain Elevators (CGE), Brown & Company PLC, Piramal Glass (Ceylon) Ltd., Galadari Hotels (Lanka) PLC, and Laugfs Gas PLC. What did EPF have to do with this? Reports alleged that the CBSL released funds from the EPF to encourage EPF investments into these “pump and dump” stocks. Releasing of EPF money into the private sector of the country was also facilitated by the long-pending requirement of the International Monetary Fund (IMF) with whom Sri Lanka has had 16 back-to-back financial arrangements. As a result, the EPF made billions in losses. The Fund incurred a loss of Rs. 700 million on an investment of Rs. 3 billion made in CGE equities. When the EPF invested in CGE, the share value was Rs. 250. The EPF also invested in a number of CGE shares when they were at Rs. 185 per share. Nevertheless, as the process of pumping was over and dealers began to sell their CGE shares, the price of a share dropped to a dramatic Rs. 55. Meanwhile, the EPF also made investments in Piramal Glass (Ceylon) Ltd.’s stocks in April 2012. The Fund purchased stocks at Rs. 6.20 per share, increasing its total shareholding in the company to 10%. And again, as the dumping of stocks began within one week of the EPF’s investments into Piramal Glass, the share prices went down by Rs. 5.20, causing a loss of Rs. 50 million to the Fund. The EPF’s poor investment decisions did not stop there as it purchased shares of Galadari Hotels (Lanka) PLC worth Rs. 23.7 million at a cost of Rs. 32.50 per share; the purchase was made from Nawaloka Hospitals and a few other parties, which ended up increasing the EPF’s stake by 13%. The trading price per share of Galadari Hotels soon came down to Rs. 13, once again causing the Fund to incur an additional loss of Rs. 500 million. The investment made by the EPF in Laugfs Gas PLC was another loss-making venture. Shares of Laugfs Gas were trading at a price of about Rs. 38 per share for about two months prior to the EPF’s purchase. The purchase was made in October 2012 and the EPF purchased shares worth Rs. 1 billion, when the price of a share was ranging from Rs. 48-51. Unfortunately, on the same day, a few hours after the purchase, the share price fell to Rs. 40, close to its original, Initial Public Officering (IPO) price at the. This resulted in an immediate loss of Rs. 300 million to the EPF. Thereafter, the EPF increased its shareholding in Laugfs Gas to 57.89 million ordinary shares holding a stake of 17.28% of the company followed by 18 million or 35% non-voting shares. The trading prices of Laugfs Gas Voting gradually fell to Rs. 22-23 per share whilst the Non-Voting price was Rs.14-15 per share, causing a loss of a sum in excess of Rs. 1.3 billion. In addition to these, the EPF incurred a loss of Rs. 1 billion as a result of an investment made in Lanka Orix Leasing Company. The losses the EPF incurred from equities did not stop there; the Fund also incurred Rs. 934 million in losses from investing in the shares of Brown & Company PLC, Rs. 933 million from Central Finance Company PLC, Rs. 655 million from DFCC Bank, Rs. 740 million from Vallibel One PLC, Rs. 572 million from Dialog Axiata PLC, Rs. 123 million from Richard Pieris & Company PLC, and about Rs. 420 million from Hatton National Bank (HNB) shares. It was revealed that the losses incurred by the EPF from investments made at the CSE amounted to Rs. 11.04 billion as of 20 June 2012 and that out of 65 companies in which investments were made, only 17 had recorded profits. In tandem with the decline in indices, market capitalisation in the CSE declined by 2% to Rs. 2.17 trillion by end-2012, from Rs. 2.21 trillion by end-2011. The equity portfolio of the Fund, which consists of both listed and unlisted equities, decreased by Rs. 16.7 billion, from Rs. 78.3 billion in 2011 to Rs. 59.2 billion in 2012, due to the sale of a part of the listed portfolio. Apart from the losses it made through investments made at the CSE, according to Verité Research, in 2010, the EPF, without due process, invested Rs. 500 million in SriLankan Airlines. As of 2016, this investment has been 100% impaired in the EPF books – that means it was valued at zero. “Another such example is the EPF’s investment of Rs. 5 billion in Canwill Holdings, for the controversial Hyatt Hotel project, in 2013. Both these investments have come under scrutiny in the Auditor General’s Report in 2016,” Verité noted. Court case filed against manipulation In August 2015, a lawsuit was filed by Attorney-at-Law Kelum Kumarasinghe against former CBSL Governor Ajith Nivard Cabraal for causing a loss of Rs. 12 billion to the EPF through the aforementioned investments made at the CSE. The second respondent of the case was former President (current Prime Minister) Mahinda Rajapaksa under whose purview the CBSL fell, and the offence was committed during Rajapaksa’s tenure. According to the complainant, when the Attorney General’s Department was consulted in 1995 with regard to the types of investments that could be made by the EPF, then Attorney General Shibly Aziz had clarified that investing in shares was against the EPF Act. However, when the Department was consulted in 2002 during the tenure of Attorney General K.C. Kamalasabeyson in 2002, his opinion was that the EPF could invest in shares, although only that of listed blue-chip companies and not smaller companies. The complainant stated that as a result of the loss caused to the EPF, the rate of return from investments made by the EPF fell to 12% in 2011 from 15% the previous year, and the interest paid to members’ balances declined to 11.5% in 2011 from 12.5% in 2010. Is the re-entry premature? The EPF withdrew from the stock market following the controversial Bond Scam of 2015. The Sunday Morning Business in December last year first reported that the Forensic Audit (FA) reports related to the issuance of Treasury bonds and transactions of the EPF had uncovered a loss of at least Rs. 19 billion to the Treasury. Nevertheless, the EPF remained in the secondary market and made a return to the stock market in May 2019. According to Verité Research, the reasons provided by the CBSL for the EPF’s re-entry was to improve the financial returns to the EPF fund; and because the EPF’s lendable funds were expected to outstrip the Government’s demand for borrowing after 2020. Then CBSL Governor Dr. Indrajit Coomaraswamy stated that the Risk Management Department drafted investment guidelines for the EPF and added that investment operations would be published on the EPF website on a quarterly basis. According to Verité Research, as of September 2019, the EPF had a mark-to-market loss of Rs. 23 billion on its equity portfolio, with a purchase cost of Rs. 83 billion – that is equivalent to a 28% loss of the capital invested. The EPF posted a market loss of approximately Rs. 39.08 billion at the end of first quarter of 2020. So far, the EPF has invested Rs. 84.05 billion in 83 listed equities. As at the end of the first quarter of 2020, its market value reduced to Rs. 44.97 billion. Another pump and dump? By the end of 2019, the EPF’s investment portfolio consisted of just 3% in equity. Nevertheless, The Sunday Morning Business learnt that market dealers are now luring government institutions – mainly the EPF – to invest in blue-chip companies, which is believed to be a possible indication of another “pump and dump”. Following the opening of the CSE after almost seven weeks of countrywide lockdown, the share prices of blue-chip companies and almost all the banks too were at two-digit levels. The shares of the leading listed banks and premier blue-chip John Keells Holdings PLC (JKH) closed trading below the Rs. 100 mark on 12 May, for the first time since 2009. On the same day, Sampath Bank, which was the highest valued banking stock, closed at Rs. 99.90. According to seasoned market watchers, the last occasion all these stocks fell below the Rs. 100 mark was back in 2008 when the All Share Price Index (ASPI) crashed 41% following the Seylan Bank and Sakvithi scandals and the 2007/2008 global financial crisis. They hovered around those prices till around the time the war ended. As the prices of leading company shares reached their lowest levels in over a decade, market dealers began investing whopping amounts soon after the reopening of the CSE, gradually bringing the share prices of those companies almost close to their pre-lockdown levels within a short period of time. The dealers are now looking to sell these shares to the EPF. Several economists and market analysts are of the view that this “invitation” by market dealers is not being extended with sincere intention. Even though most of the blue chip companies managed to record a 60% growth for the past three months, we learnt that many of these companies are not recording a considerable performance like they used to, mainly due to the disruption caused by Covid-19. SEC not too worried Speaking to The Sunday Morning Business, SEC Chairman Viraj Dayaratne PC stated that the SEC welcomes investments from anyone, but as far as the investment decisions are concerned, the investment committees of the respective entities and those controlling the funds should do the due diligence themselves. “Whether all money should be invested in the capital market, and on which shares the investment should be made, are decisions that should be taken after doing due diligence. When an individual is going to invest, the particular individual should be mindful of their investment decision,” Dayaratne added. He further noted that the SEC would do its job properly, which includes regulating the market and building confidence amongst investors. Nevertheless, he added that if “pumping and dumping” is detected, the SEC would take stringent actions. Ensuring there is no repetition All our attempts to reach the CBSL for their comment on measures taken by them to ensure the EPF isn’t subjected to another “pump and dump” scheme proved futile. Nevertheless, the CBSL, under the previous Governor’s tenure, introduced security measures at the CSE including CCTV and voice recordings to ensure greater monitoring in terms of investments activities. Former CBSL Governor Dr. Coomaraswamy, during a press briefing following the comeback of the EPF in May 2019, stated that the CBSL decided to permit EPF investments only in a Monetary Board-approved “list of shares” which was finalised with the help of SEC and CSE.