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AA DDiisssseerrttaattiioonn iinn PPaarrttiiaall FFuullffiillmmeenntt ooff aa BBaacchheelloorr ooff LLaawwss ((LLLLBB)) DDeeggrreeee

NAME: REGISTRATION NUMBER: COURSE: YEAR OF STUDY: SUPERVISOR:

RWAKAKOOKO ALLAN FRANKLIN 97/U/4544/Eve LLB IV FOURTH YEAR 2000/2001 MR. KAGGWA

FACULTY OF LAW MAKERERE UNIVERSITY, KAMPALA June 2001

DEDICATION This dissertation is dedicated to my parents, Mr. and Mrs. Rwakakooko.

2

DECLARATION

I, Rwakakooko Allan Franklin declare that, to the best of my

knowledge, this thesis is authentic except where due

acknowledgement is made in the text. It does not include any

material for which any other university degree or diploma has been

awarded.

SIGNED: ………………………………………………………

RWAKAKOOKO ALLAN FRANKLIN

DATE: …………………………

SUPERVISOR: ………………………………………………

MR. MOSES KAGGWA

DATE: …………………………

3

ACKNOWLEDGEMENTS

I would first like to thank God without whom nothing is possible.

I would also like to extend my gratitude to a number of people whose help was very

valuable in this research.

I would like to thank my Supervisor, Mr. Moses Kaggwa for his meaningful assistance,

tireless guidance and patience.

I would also like to thank Mr. Swithin Munyantwali, Executive Director, International

Law Institute, Mr. Japheth Katto, Chief Executive Officer Capital Markets Authority, Mr.

Simon Rutega, Chief Executive Officer Uganda Securities Exchange, Ms. Christabel

Nankunda and Mr. Charles Mebeiha of Capital Markets Authority and Mr. Paul Mugaga

for their time and valuable information.

I would also like to thank my parents, Mr. E. K. Rwakakooko and Mrs. J. Rwakakooko,

my sisters, Judith, Jocelyn, Julianne, Elizabeth, Siima and brothers Davy, Enock and

“Denace” for their moral and material assistance. Special mention goes to Jeanne whose

literature, advice and encouragement has been priceless.

I would like to acknowledge my friends Eugene Karuhanga, Dunstan Kiwanuka, Abdul

Sami Eria, Harriet B. Magala, Florida Kabasinga, Bella Nyamutoka and Frank Ddamulira

whose interest in my research was very beneficial.

4

CONTENTS:

Lists of Statutes and Regulations List of Cases

Acronyms

Abstract Chapter One: History and Evolution of the Global Concept of

Investor Protection in Equity Markets: General Background Information

Statement of the Problem

Hypothesis

Objectives of the Study

Significance of the Study

Justification for the Study

Methodology

Literature Review

Scope of the Study

Definition of Some Concepts

Synopsis of the Study

Chapter Two: The Initial Public Offering (IPO): The Capital Markets

Authority’s Role in Regulating the Primary Market

Chapter Three: Post-IPO: Substantive and Regulatory Aspects of

the Secondary Market

Chapter Four: Constraints to Government Regulation: The Conflict

Between Laissiez Faire and Dirigisme and its effect on

Investor Protection:

Chapter Five: The Way Forward: Supporting Systems and

Recommendations for a Better Capital Markets Regime

Appendix A: The Regulatory Pyramid

Appendix B: The Legislative Pyramid

5

LISTS OF STATUTES AND REGULATIONS

1. Companies Act, 1964 Cap 85, Laws of Uganda

2. Capital Markets Authority Statute, 1996

3. The Capital Markets (Establishment of Stock Exchanges) Regulations

4. The Capital Markets (Licensing) Regulations

5. The Capital Markets (Prospectus Requirements) Regulations

6. The Capital Markets (Conduct of Business) Regulations

7. The Capital Markets (Advertisement) Regulations

8. The Capital Markets (Exempt Dealers) Regulations

9. The Capital Markets (Accounting and Financial Requirements) Regulations

10. The Capital Markets (Register of Interest in Securities) Regulations

11. Uganda Securities Exchange Listing Rules Manual

6

LIST OF CASES

1. Charles Hughes & Co., Inc. v. Securities And Exchange Commission

United States Court of Appeal Second Circuit, 1943 139 F.2d 434

2. Derry v Peek[1889] 14 App Cas 337

3. Hughes v. Securities Exchange Commission, United States Court of

Appeals, District of Columbia Circuit, 1949 174F.2d 969

4. New Brunswick and Canada Railway and Land Co. Ltd v

Muggeridge [1860] 30 Lj Ch 242

5. Peek V. Gurney (1873) L.R. 6 .L.377

6. Re Darby, ex p Brougham [1911] 1 KB 95

7

ACRONYMS

1. CMA Capital Markets Authority

2. USE Uganda Securities Exchange

3. IPO Initial Public Offering

4. RA Regulatory Agency

5. SRO Self Regulatory Organisation

6. BAT British American Tobacco (Uganda) Limited

7. UCL Uganda Clays Limited

8. EADB East African Development Bank

9. MTN Mobile Telecommunications Network

10. EMH Efficient Market Hypothesis

11. FDI Foreign Direct Investment

12. OTC Over the Counter Markets

13. UIA Uganda Investment Authority

14. NRM National Resistance Movement

15. GDP Gross Domestic Product

8

ABSTRACT

This thesis examines the legal and commercial implications of Government intervention

for investor protection in Uganda’s equity market. It begins by discussing the rationale of

the regulation and importance of investor protection in the development of equity

markets and capital markets as a whole.

The thesis further examines the operation of the Capital Markets Authority as the

regulatory agency and the distribution of regulatory responsibility among the regulatory

organs. The study takes a step-by-step tour of the primary and secondary markets and

examines the legislation related to the equities markets and its impact on investor

protection.

The study creates a link between capital market development and investor protection

and looks at the conflict between the regulated and free markets. It discusses

contradictions and constraints to market development and how they affect investor

protection. It also sets out supporting systems and gives recommendations for the

development of an efficient capital market, with emphasis on equities markets.

While this research is primarily concerned with Uganda’s equity markets, reference is

made to other markets to fill the gaps left by the new capital markets regime.

9

CHAPTER ONE:

History and Evolution of the Global Concept of Investor

Protection in Equity Markets:

General Background Information:

Government regulation of markets can be traced as far back as the era of Mercantilism

in Europe, which ran from the demise of feudalism until the beginning of the Industrial

revolution. In this period, countries regulated the market in order to create a favourable

balance of trade, accumulate gold and silver from other nations, and ultimately increase

the wealth and power of the state.

“This was the first modern alliance between big government and business”1

The Advent of classical liberalism in the eighteenth century and the works of scholars

like Adam Smith (1723- 1790) brought about an economic revolution. The paradigm of

Adam Smith contended that, by virtue of “the invisible hand” of capitalism, if individuals

pursue their selfish interests producing, buying and selling in a free, meaning

unregulated, market, then wealth is created and social welfare and prosperity grows.2

This he put in his book “The Wealth of Nations” thus: “It is not from the benevolence of

the butcher, the brewer, or the baker that we expect our dinner, but from their regard to

1 “Adam Smith and the New Paradigm- Economics and its Beginning” at http://krypton.mankato.msus.edu/~renner/eaib.htm 2 “Neoliberalism- A Short Course”- http://memebers.tripod.com/~PPLP/neoliberalism.html

10

their own interests. We address ourselves not to their humanity, but their self love.”3 The

economic system proposed by this new paradigm came to be represented by the French

term “laissez-faire”, translated to mean “let alone”. The liberalists advocated for the

removal of government control with competition remaining as the sole controlling force in

the market.4

The liberalist school of thought did not go without some criticism from a number of

nineteenth century economists and scholars who advocated for “dirigisme,” or

“government control.” These included the proponents of the teachings of Karl Marx,

Friedrich Engels, and John Maynard Keynes (1883- 1946). These scholars argued that

the liberalists, and the capitalism they had created from their teachings, “had sown the

seeds of their own destruction.”5 John Keynes wrote a book entitled “The End of

Laissez-Faire” warning about the evils of unregulated markets in 1926, three years

before the 1929-market crash and “Great Depression” in the United States of America.

It was believed that lack of transparency and market abuses caused that crisis.

Regulatory legislation was therefore passed to redress market failures, which occur

when the private marketplace fails to operate properly and in a competitive manner.

There are three main types of market failure, namely natural monopoly, externalities,

and asymmetrical information.6 Natural monopoly occurs as a result of unfair competition

and price fixing by companies with a large share of the market and this may lead to

exploitation. Externalities are costs “not properly accounted for in the prices which are

3 Adam Smith: An Inquiry into the Nature and Causes of the Wealth of Nations (1776) Book 1, Chapter 2. 4 This line of thought resurrected in the twentieth century capitalist era and neoliberalist scholars, Friedrich Hayek and Milton Freeman, even won the Nobel Prize. 5 “Capitalism, Marxism and Reformism- Neoliberalism- A Short Course”- http://memebers.tripod.com/~PPLP/neoliberalism.html

11

established in a competitive market.”7 Here a party outside the market may incur a cost

in that market, for instance, a company that wishes to cut its costs by dumping waste in

a nearby river may cause someone with no interest in that company to incur a cost from

the resultant pollution. Lastly, asymmetrical information occurs when the “insiders” or

promoters of share offerings withhold information that should be made public to

investors if that information does not serve their interests. The insiders can use this

informational advantage to exploit the investor.

Unlike the Mercantilist era, this new era of regulation was mainly aimed at protecting

investors. It has been said, that;

“An investor has the heart of a lamb, the feet of a cheetah, and the memory of an

elephant” 8.

This means that the investor usually makes decisions based on information given to him

by “insiders” in the market who have an informational advantage over him or her, making

him or her vulnerable and at a disadvantage in case of market failures.

Capital markets were developed with the aim of checking market failures. Investor

supremacy was highest on the agenda and legislation was passed in various countries

to regulate these markets.

6 Tim S. Campbell: Financial Institutions, Markets and Economic Activity (1982) McGraw Hill Inc. USA. Page 367 7 Ibid. 8 Ms. Candy Wekesa; “The Role of a Lawyer”- Capital Markets Journal, Volume 3, Number 2, April/ December 1999. Page 15

12

“Investors are not expected to be protected against normal market risks. But they do

need to be made aware of them in what are commonly referred to as ‘health warnings in

advertisements and prospectuses.”9

Investor protection was not a strong point in Uganda before the inception of the Capital

Markets Authority (hereafter called the CMA) and many investors did not get the benefit

of adequate disclosure.

The CMA was therefore established in 1996 to regulate and oversee the capital markets

industry in Uganda with the goal of promoting transparency and protecting the investor

from potential market failures that may arise from fraud. The CMA is a government

agency created by statute, with “broad powers ranging from rule-making to licensing to

enforcement actions.”10 The CMA is therefore the Uganda capital market’s primary

regulatory body.

Capital Markets in general have a number of goals. These can be divided into four

groups: National goals involve privatisation of national companies, strengthening

domestic companies, developing local ownership and attracting foreign investment.

Entrepreneurial goals involve capital formation, diversification of ownership risks and

alternative financing sources. Investor goals include efficient use of investment capital,

diversification, and liquidity. Finally, regulatory goals include consumer protection,

informational needs of the investor, allocative efficiency, and corporate governance.

9 Mbumba S. Kapumpa: “Investor Protection in the Zambian Securities Market”- Capital Markets Journal Vol. 4. No.1 January/ March, 2000. Page 10 10 Stuart R. Cohn and Fred Zake: Capital Market Development in Uganda, (1999) ILI- Uganda (Kampala) Page 7.

13

It would therefore be justifiable to say that if a culture of transparency is adopted in our

capital markets we will see increased investor confidence and a corresponding increase

in investment. This will ultimately boost capital utilisation and value and wealth creation,

which would be a positive step in the development of our economy.

The powers of the CMA are detailed in its parent statute as: “(i) The development of all

the aspects of the capital markets, with particular emphasis on the removal of

impediments to, and the creation of incentives for longer term investment, (ii) the

creation, maintenance, and regulation, through implementation of a system in which

participants are self regulatory to the maximum practicable of the market in which

securities can be issued and traded in an orderly, fair and efficient manner, (iii) the

protection of investor interests; and (iv) the operation of a compensation fund.”11 The

CMA is in charge of overseeing the participants in the market in what is termed, “the

regulatory pyramid”, which shall be discussed in detail in chapter two.

”The basic philosophy of regulation is to provide an environment where markets and

investments are allowed to grow on a sound long-term basis. The spill over effects of

this will be the capital markets contributing to the functioning of the economy and the

creation of wealth. Maintaining the integrity of markets and investor-confidence is

fundamental to the achievement of this goal…”12

11 Capital Markets Authority Statute, 1996. Section 6 12 Ms. Candy Wekesa: Legal and Regulatory Issues in Capital Markets. Paper presented at a seminar entitled “Development and Regulation of Securities and Capital Markets, May 15- 26, 2000 at ILI-Uganda. Page 23

14

Statement of the Problem:

A developed capital market is of great importance to the development of a country’s

economy. “The capital market has often been likened to the brains of an economy…and

are a ‘sine qua non for sustainable economic development.”13 The level of investment

and volume of funds involved in the market, however, greatly increase the possibility of

an economic crisis in case one part of the system defaults. Examples of economic

crises that occurred as a result of this are the American market crash and “Great

Depression” of 1929, and the capital outflow, devaluation and stagflation in Mexico and

East Asia in 1994 and 1997 respectively. In the conflict between regulation and

liberalization it has been contended thus:

“The adverse effects of capital market liberalization can easily overwhelm whatever

small benefits trade deregulation may bring.”14

The statement shows that the need for regulation is greater than the capitalist need for

unregulated “laissez-faire” or free trade even though the latter may bring about a

semblance of economic growth.

The principal aim of regulation is to promote transparency in the market and requiring full

disclosure by the issuers, or promoters of shares does this. This would limit the market

failure of asymmetrical information and the “insider” promoter using his informational

advantage to cheat the investor.

13 “Why Regulate in the First Place- The Securities Commission Business Plan” http://www.sc.com.my/html/publications/inhouse/businessplan/scbp_regulate.html

15

Uganda’s capital markets regime is rather new, having started in 1996. It therefore

remains to be seen how it will address the market failures that may exist in Uganda’s

securities market.

Hypothesis:

The study hypothesises that:

i. Capital markets are very important to countries. A developed capital market would

lead to better use of savings, capital formation, and value and wealth creation both

for individual investors and the state, and overall economic growth.

ii. Another hypothesis is that an efficient market is one in which prices of securities

reflect the impact of all the information publicly available concerning the future

prospects of the associated companies. This is what is referred to as the “Efficient

Market Hypothesis.”15 This highlights a conflict between the investor, who needs full

disclosure in order to make an informed decision, and the issuers and promoters of

shares who would like to release information only if it serves their interests. The

question, therefore, is: How much information is necessary? Proponents of this

hypothesis contend that the market price of a commodity “impounds all public

information and new information only becomes available at random,”16 therefore, the

actual value of a commodity takes a back seat to the bargaining power of the

participants in a market.

14 “Negative Effects of Trade and Capital Market Liberalization- Third World Network on Line”: http://www.twnside.org.sg/title/negat-cn.htm 15 SID MITTRA AND CHRIS GASSEN: Investment Analysis and Portfolio Management. Harcourt Brace Jovanovich, Inc. New York (1981). Page 6 16 Ibid

16

iii. The study further hypothesises that owing to the imbalance in bargaining power

between the investor and promoter, there is a need for government intervention to

protect the investor without, however, negatively affecting market development.

There is a need to strike a balance between market regulation and the maintenance

of the freedom of trade17.

iv. Finally, the study hypothesises that investor protection leads to an increase in

investor confidence and a rise in levels of investment. This will ultimately lead to

individual, market, and national economic growth and development.

Objectives of the Study:

This research paper aims at examining the state of market regulation in Uganda with

emphasis on investor protection. It studies, the operation of the primary and secondary

markets, outlines the problems that investors face, shows the action that regulatory

bodies like the CMA have taken, and finally gives recommendations for the

strengthening of the new market regulation system in Uganda. This system of regulation

would, in turn, boost investor confidence, increase investment, and ultimately lead to

economic growth. This shows therefore that regulation is very crucial for economic

development and should be discussed.

The research paper shows the need for investor protection based on the principle of

investor supremacy. It further shows the dangers that investors face in the securities

market and problems the regulatory agencies like the CMA face in rule making,

licensing, and enforcement in the securities market.

17 Guaranteed in article 40 of the 1995 Constitution of the Republic of Uganda

17

The study makes a critical assessment of the laws governing investment and market

regulation in Uganda, with emphasis on investor protection. It also attempts to show the

dangers that may arise from lack of clarity, as well as contradictions in the applicable

law, particularly the jurisdictional conflict between the Companies Act and the

Capital Markets Authority Statute.

The research paper makes a comparative study of the pre- CMA share offer, by

Greenland Group of Companies and the post-CMA initial public offerings by Uganda

Clays Limited and British American Tobacco Limited in a series of case studies. These

case studies show, in the Ugandan context, the problems that would arise if there were

no adequate disclosure and due diligence in share offers, and thus, the need to regulate

the market.

The paper finally makes recommendations for the regulation of the market, restoration of

investor confidence, and consolidation of the securities market in Uganda. This would

ultimately lead to a better investment climate in Uganda and a corresponding economic

gain.

Significance of the Study:

i) “Many studies have been done to examine the performance of emerging capital

markets in developing countries. However, many of these studies focus on the

emerging capital markets of Southeast Asia, Latin America, and the Caribbean.

Sub-Saharan Africa, and Uganda in particular, has not received the attention that the

18

Southeast Asia and Latin American countries have received in the academic

literature.”18 To the international entrepreneurs, this study aims at placing the Sub-

Saharan stock market on the map. Many companies see emerging markets as a

good source of capital and "the lion markets of Africa are now developing in such a

way that investors interested in emerging markets can no longer ignore them.” 19

ii) For the policy makers, this study raises the following policy research questions: (a)

What are the linkages between capital market development and economic

development? (b) How much protection should an investor be accorded? (c) What

is the rationale for investor protection and government intervention in Uganda’s

equity markets? (d) To what extent has the existence of a regulated equity market

improved the prospects of raising long-tem capital and protecting investors? (e) How

is the onus and power of regulation shared among the various regulatory organs? (f)

What is the effect of legal and administrative regulation of the equities market on

investor protection? The study is timely because it deals with these, and other

related questions raised by policy makers and individuals concerning investor

protection in equities markets, as well as capital market performance and regulation

in Uganda. A systematic investigation of the research questions has led to the

formulation of policy recommendations aimed at developing efficient capital markets

in Uganda. These policy recommendations may be used by the policy makers and

various donor agencies concerned with the development of the equity, and capital

markets generally in Uganda.

iii) For the investor, the study focuses on rights issues and shows regulation as a tool

for promoting the economic rights of investors. The focus on investor protection

18 Sam Q. Ziorklui: Capital Market Development and Growth in Sub-Saharan Africa: The Case of Tanzania, African Economic Policy Discussion Paper Number 79 February 2001. Page 2

19

highlights the need for a more public-oriented capital market regime and shows the

progress made, as well as the shortcomings of the current regulatory regime.

iv) The equity market in Uganda has been a useful tool in the ongoing public enterprise

reform and divestiture programme, with the Government of Uganda divesting its

shares in British American Tobacco Limited and Uganda Clays Limited. The

workings of the regulatory structure of the CMA are therefor worthy of discussion, as

the sale of shares in these companies to the public will affect investors, the economy

and the nation at large.

v) Though the capital market regime is rather new in Uganda, having only started in

1996, and the market is still in its infant stages with only two equities listed on the

Uganda securities exchange, the evolution of a securities market marks a turning

point in the country’s development. For companies, this indicates a shift from the

traditional method of raising finance through high interest loans, to the cheaper, more

abundant equity method. Equity markets therefore lead to easier access to capital

for entrepreneurs, better corporate governance, investor confidence, an incentive for

public savings and better resource utilisation. This will, in turn lead to increased

output, more wealth created and overall economic growth. It is therefore necessary

to create a forum to discuss this contemporary subject and it’s impact on the

entrepreneur, investor, market, and the economy at large.

vi) With the advent of globalisation, the need for a capital market to promote foreign

investment and keep up with other developing and developed countries has

necessitated the evolution of a regulated capital market in Uganda. This study is

aimed at provoking discussions about the performance and prospects of Uganda’s

capital market regime vis-à-vis other regional and global markets.

19 Per Kenneth Mwenda in “Securities Regulation And Emerging Markets: Legal And Institutional Issues For Southern And Eastern Africa” Murdoch University Electronic Journal Of Law Issn 1321-8247 Volume

20

vii) Apart from this study being an academic requirement in partial fulfilment of my

degree, it aims at tracking a new economic era in Uganda and studying a capital

markets regime that will shape the economic future of Uganda.

Justification for the Study:

The state of investment in Uganda before the advent of the CMA put emphasis on the

positive capital market theory which stressed the “is” rather than the “ought” which was

stressed by the normative capital markets theory. This investment regime had the

characteristics of a “laissez-faire” market, without strict government regulation especially

as far as disclosure requirements were concerned. This regime was manifested in the

share offer of Greenland Group of Companies, where the investors did not have

adequate information and as a result, did not make informed investment decisions. The

birth of the CMA was therefore necessary to address the lacuna in market regulation in

Uganda and as a result, increase investor confidence and volume of investment in

Uganda, with an aim of fostering economic growth and development.

The CMA has been in force for only four years and the volume of transactions in the

securities exchange is still rather low. This infant regime should therefore be studied

with an element of projection into the future.

The CMA is at the top of the regulatory pyramid in Uganda’s capital market and it gets its

power from the Capital Markets Statute of 1996. However, the CMA conflicts with the

Registrar General’s Office, where registration statements are filed. The Registrar

7 Number 1 (March, 2000) Page 1.

21

General gets his authority from the Companies Act, which does not have rules of

regulation as strict as those of the Capital Markets Authority Statute.

Methodology:

In compiling data for this research paper and testing the hypothesis a number of

methods were employed:

A comparative study of legislation governing capital market regulation shows some

conflict especially between the Companies Act and the Capital Markets Authority Statute

and the antecedent regulations. There is a need to study the legislation and make

resolutions with regard to the aspects of regulation and enforcement in the laws of

Uganda.

Libraries will be used to review published literature, information from conferences,

textbooks, newspaper articles and case law. Furthermore, Internet research is a source

of a wide range of documents that are very useful and informative.

It is necessary to conduct field trips to widen the research base and have a more

grounded approach. Interviews with officers from the CMA, Uganda Securities

Exchange, the Registrar-General’s office, and various brokerage firms like MBEA

Brokerage Service (Uganda) Limited will enrich my research by giving me more accurate

and exhaustive information. These offices are also a source of a lot of published

material that would come in handy in my research.

22

The aforementioned methods of research were advantageous in that:

Reading through records, reports, textbooks, and related publications exposed the

researcher to a wide range of literature, which showed the history and jurisprudence as

well as the advances in capital markets regulations. The articles of jurisprudence

showed the historical basis and a greater insight into investment and capital markets.

The study of legislation showed the loopholes and areas in the regulatory legislation that

are silent and need to be addressed.

Interviews and newspaper articles give the Ugandan context and help reconcile the

Ugandan situation with the global scenario.

The problems outlined are accompanied by recommendations that suggest ways to

improve the situation of investors in Uganda.

Literature Review:

This review seeks to examine the existing literature about the conditions affecting the

development and regulation of the Ugandan security market in general, and equity

market in particular.

The capital market plays an important part in economic development of any country. It is

therefore important to define the concept of investment. SID MITTRA AND CHRIS

GASSEN: in ”Investment Analysis and Portfolio Management “ define investment as the

23

commitment of a given sum of money at the present time in the expectation of receiving

a larger sum in the future.

The history and development of capital markets has been characterised by a struggle

between two antagonistic forces, usually referred to as “Laissez-Faire” and “Dirigisme”

or liberalism and interventionism respectively. From the beginning of the Industrial

Revolution in the nineteenth century, until the Great American Depression in 1929 the

market was inclined more to the liberalist side. The proponents of “Laissez-Faire”

followed the teaching of scholars like Adam Smith (1729- 1790) and David Ricardo

(1772- 1823).

ADAM SMITH, in An Inquiry into the Nature and Causes of the Wealth of Nations20

advocated for the market to be guided only by forces of competition and self-interest,

writing: “It is not from the benevolence of the butcher, the brewer, or the baker that we

expect our dinner, but from their regard to their own interests. We address ourselves not

to their humanity, but their self-love.” However, he does consider the possibility of abuse

of this market system and in the same book, writes: “Consumption is the sole end and

purpose of production and the interest of the producer ought to be attended to only in as

far as it may be necessary for promoting that of the consumer.”21 Adam Smith’s work

shows the development of the investment climate along with the development of

capitalism in the eighteenth century. However, his work was limited as the level of trade

was still very low at that time and the market was not as sophisticated as it is now. His

work does not deal with the Ugandan capital markets situation and is generally used as

a foundation for the study of the need for regulation.

20 Adam Smith: “The Wealth of Nations,” Op.Cit, Book 1, Chapter 2. 21 Adam Smit: “The Wealth of Nations” Op.cit. Book 4, Chapter 8.

24

The work of DAVID RICARDO was similar to Adam Smith’s and he asserted, in “The

Principles of Political Economy and Taxation (1817) that the free market is “the best

allocation of resources” and “the market is always right,” advocating that the poor were

to blame for market imperfections. Like Adam Smith’s work, his writings provide a

historical perspective in the development of capital markets, but can not be used in an

analysis of contemporary capital markets.

The liberalists were opposed by proponents of “Dirigisme”, or government control. Many

nineteenth century scholars criticised “Laissez-Faire” markets and they included Karl

Marx, Friedrich Engels, and John Maynard Keynes (1883- 1946)

KARL MARX and FRIEDRICH ENGELS in “The Communist Manifesto” studied the

labour relations in portraying an imbalance in bargaining power. They contended that

“Wealth is created in blood, sweat and tears” but this is not always equal to value, which

is a factor of haggling and bargaining. In “Das Capital: a Critique of Political Economy

Volume II, Edited by Friedrich Engels, they contended that the free market created a

two-tier community with a wealthy bourgeoisie minority and a relatively poorer proletariat

majority, creating a class struggle. However, Marx concentrated mainly on labour

relations and did not emphasise investment and capital markets. This could be

because, like Adam Smith and other eighteenth and nineteenth century scholars, he

lived in a time when the market was not as sophisticated as it is now, and therefore his

work can not give an accurate portrayal of the state of the market today.

JOHN MAYNARD KEYNES (1883- 1946) wrote about the dangers of free markets in his

book “The End of Laissez-Faire”, in 1926 and three years later in 1929, the American

25

stock market crashed due to market failure and lack of due diligence and transparency.

His twentieth-century writings draw a clearer picture of the market, and are probably

more relevant to the public sector driven market in Uganda than the work of the

eighteenth and nineteenth century scholars. His work was, however limited to the

American economy and his writing, also has mostly historical value to the study of

Uganda’s equity market.

TIM S. CAMPBELL, in “Financial Institutions, Markets and Economic Activity”, describes

the ingredients of market failure as “natural monopoly, externality, and asymmetrical

information”22 and explains the need for government regulation. This is further

emphasised by RUMU SARKAR in “Development Law and International Finance”23

contends; “the state assumes the role in mitigating the harshness of capitalism…plays a

central role in deciding what safety nets to provide.”24 Their work has great descriptive

value, but, provides a perspective outside Uganda, and does not adequately cover the

emerging markets.

Uganda’s capital markets are governed by the CMA, which gets its authority from the

CAPITAL MARKETS AUTHORITY STATUTE, 1996. We also have Part III of the

COMPANIES ACT OF UGANDA, 196425 that deals with capital market activity.

Furthermore, there are a number of regulations promulgated under the Capital Markets

Authority Statute governing various aspects of the market. These include:

The Capital Markets (Establishment of Stock Exchanges) Regulations

The Capital Markets (Licensing) Regulations

22 Page 367. 23 International Economic Law Series; Kluwer Law International (1999), London 24 Page 39. 25 Cap 85, Laws of Uganda,

26

The Capital Markets (Prospectus Requirements) Regulations

The Capital Markets (Conduct of Business) Regulations

The Capital Markets (Advertisement) Regulations

The Capital Markets (Exempt Dealers) Regulations

The Capital Markets (Accounting and Financial Requirements) Regulations

The Capital Markets (Register of Interest in Securities) Regulations

The legislature gives the CMA legitimacy and power to carry out its duty. This power is

supplemented by the rules of the stock exchange, also called the Self Regulatory

Organs (SRO), which may include the memorandum and articles of association of a

company. The licensees in a market may also issue codes of conduct and procedure

manuals to govern their operation and these may act to regulate the capital market. It

should be noted, however, that the Capital Markets Authority Statute is the main law

governing capital markets operation in Uganda and these rules must not be contrary to

it. There has been a little conflict between the Companies Act and the Capital Markets

Authority Statute and the numerous laws and regulations may prove tedious to the

simple investor, thereby diminishing their informational and regulatory value, but the

detail is important to maintain the high market standards of transparency.

The capital market in Uganda can be described as an emerging, rudimentary market.

STUART R. COHN and FRED ZAKE, in “Capital Market Development in Uganda”

explain in detail the operation of the market in Uganda, discussing its role in

privatisation, regulatory role and power. It also extensively looks at the relevant laws

governing capital markets in Uganda. This book is a contemporary study, which gives

insight on the market operation in Uganda and is very valuable for a study of Uganda’s

capital markets regime.

27

Material from a seminar entitled; “Development and Regulation of Securities and Capital

Markets”26 conducted by Professor Stuart Cohn, gave exhaustive material on the capital

markets regime in Uganda, especially in relation to other more developed markets. A

paper entitled “Legal and Regulatory Issues in Capital Markets” by Ms. Candy Wekesa

presented at the above mentioned seminar explained the regulatory structure of the

capital markets regime in Uganda. This material is very detailed and valuable to my

study, but the capital market is very dynamic and the information may soon become

outdated.

Further information on capital markets in Uganda can be found in the “Capital Markets

Journals” which are produced quarterly by the CMA and are very up to date and

informative. Other informative CMA publications include “General Information and

Guidelines for Issue of Securities”, a simplified pamphlet. These may be supplemented

with Internet research.

Scope of the Study:

The purpose of this study is to critically analyse the role of the CMA in regulating capital

markets in Uganda with particular emphasis on investor protection.

The study places Uganda in the global market and gives a comparative analysis of

market regulation in Uganda and other more developed markets in Africa, Europe, and

North America.

26 May 15- 26, 2000 at the International Law Institute- Uganda (Kampala)

28

A review of the history and jurisprudence of capital markets serves to show the evolution

of regulation of investment. A comparative study of pre and post- CMA investment

regimes will illustrate and justify regulation of the market further.

A study of the contemporary legislation governing regulation of capital markets shows

the advances in investor protection and shows how the law can be reformed to serve the

interests of investor sovereignty better. The study will further show the inadequacies in

regulation and enforcement as well as the role of different regulatory bodies. This

research also shows the laws of Uganda, which are applicable to capital markets and

how these laws will help in investor protection.

Lastly, recommendations will be put forth in the Ugandan, and the global context,

suggesting legal and extra-legal ways of promoting investor sovereignty, protection, and

confidence through market regulation.

Definition of Some Concepts:

Before tackling this research, it is necessary to define a few key terms for easier

comprehension of the paper.

29

SID MITTRA AND CHRIS GASSEN: in ”Investment Analysis and Portfolio Management“

defines investment as the commitment of a given sum of money at the present time in

the expectation of receiving a larger sum in the future.27

A market can be defined as a situation where two or more people meet to express their

choices with regard to financial assets and the market is the place or mechanism where

the said assets are exchanged28. Markets assume different classes based on the type

of traded instrument and degree of regulation. The less regulated markets are known as

the “Over the Counter” Markets (OTC), while formal stock exchanges are vigorously

regulated.29 The market determines the value of the asset, thereby creating wealth and

income to participants in case the market value of the said asset appreciates. A

financial asset is a future claim on some future income, while wealth can be defined as a

right to an income stream, which an asset is expected to generate.

According to the CMA publication entitled: “General Information And Guidelines For

Issue Of Securities – July, 1999”, capital markets are “sophisticated markets where the

products for sale include equity or debt securities issued by government or corporate

bodies, and units in collective investment schemes and these securities include shares,

stock, bonds, debentures, notes, rights, warrants, options of futures in respect of shares,

bonds or debentures.”

27 Chapter 1 page 4. 28 Tim S. Campbell: Financial Institutions, Markets and Economic Activity (1982) McGraw Hill Inc. USA. Page 14. 29 Leo Kibirango: Securities Markets: A Reliable and Credible Source of Low Cost Capital: Capital Markets Journal: Vol. 4, Jan/ Mar, 2000, Page 36

30

The two major forms of securities are equity and debt. Equity securities are

investments, which “become part of the permanent capital of a company”30 and they

usually take the form of stock in the company. The investor, in effect, buys a part of the

company but has neither a claim to repayment of the principal, nor payment from profits.

The equity holder mainly makes a profit from secondary trading on the stock market.

Equities are a good source of low cost capital to the entrepreneurs, but the risk levels

are high for the investors.

Debt securities occur when a lender gives money to the company “on the promise that

both the principal and interest will be paid.”31 They may be in the form of treasury bills,

bonds and fee notes, and are more risky to the entrepreneur and less risky to the

investor than equity securities.

The capital market can be divided into two distinct sections, namely the primary and

secondary markets. According to TIM S. CAMPBELL in his book “Financial Institutions,

Markets, and Economic Activity”32 the primary market is the market where new securities

are issued to obtain new funds. This is done by way of an Initial Public Offering (IPO)

where the public are invited to buy shares in an enterprise that is going public for the first

time.

The secondary market on the other hand “comprises the market for outstanding financial

assets”33 This, according to “General Information and Guidelines for Issue of Securities

– July, 1999” is a facility where securities initially acquired from the primary market are

subsequently traded.

30 Stuart R. Cohn/ Fred Zake: Capital Market Development in Uganda: Op.Cit. Page 20 31 Ibid, Page 22 32 Tim S. Campbell: Financial Institutions, Markets and Economic Activity (1982) McGraw Hill Inc. USA. page 150

31

The main participants in a capital market include sellers or promoters of securities and

other financial instruments who seek to obtain money from the sale of the shares on the

one hand, and potential purchasers who are willing to invest in the offered securities.

The market also has investment advisors, accountants, lawyers, underwriters, broker-

dealers and broker representatives and the regulatory organs that are collectively

instrumental in facilitating the transactions in a securities exchange.

A broker is one who buys or sells securities as agent for a customer while a dealer is

one who buys or sells securities for its own account34. Brokers give their clients

investment advice for which they charge commissions, while dealers try to buy shares

cheaper than they sell them, thereby making a profit. While the “Ancien Régime” made

a distinction between the two it became clear over time that this was impracticable and

firms of ”market makers”35 acted as both broker and dealer.36 It is more common now to

have the dual-purpose broker-dealer firms. Broker representatives, commonly referred

to as “stockbrokers“, are employees in the broker-dealer firms and deal directly with

individual customers.

33 Ibid 34 Stuart R. Cohn/ Fred Zake: Capital Market Development in Uganda: Ibid. Page 3 35 Also known as broker-dealer firms. 36 Bernard Grey: “Beginners’ Guide to Investment:” Investors Chronicle; Century Business (London, 1991) Pages 28, 29 and 31

32

Synopsis of the Study:

CHAPTER ONE:

This is the introductory chapter. It introduces the global concept of equity and capital

markets and gives a historical background of the study. It further analyses the

jurisprudence and state of affairs that led to the need for regulation in the first place. It

states the problem that the research paper wishes to address and gives a hypothesis for

the study, thereby showing the scope, objectives and significance of the research.

Lastly, it lays down the methodology used, and defines some of the terms used in the

study.

CHAPTER TWO:

This chapter deals with the legal and administrative duty and powers of the CMA with

regard to regulation of primary markets. It studies the Companies Act37 and the Capital

Markets Authority Statute and its antecedent regulations from which the CMA, as the

regulatory agency gets the authority to register, license, oversee companies and enforce

standards of adequate disclosure and due diligence during the Initial Public Offering

(IPO) of new issues. The IPOs of Uganda Clays Limited and British American Tobacco

(Uganda) Limited are used for illustration.

CHAPTER THREE:

37 1964, Cap 85, Laws of Uganda, Part III

33

This chapter studies the CMA’s role in the secondary market and its legal and regulatory

duties and powers with regard to the Self-Regulatory Organization (SRO) also known as

the stock exchange. The chapter further studies the Capital Markets Authority Statute

and its antecedent regulations as well as the SRO rules and regulations and licensees’

code of conduct and procedures manuals, which govern the secondary market. The

chapter studies the effectiveness of the continuous disclosure process and operation of

the compensation fund in the pursuit of a transparent and efficient secondary market, all

in the interest of investor protection.

CHAPTER FOUR:

This chapter deals with the status of the equity market regime in Uganda. It studies the

conflicts between laissez faire and dirigisme, and its effect on investor protection and the

development of an efficient equity market in Uganda. It further studies the constraints to

the operations of the public sector driven capital market regulatory structure in Uganda

and their effect on investor protection.

CHAPTER FIVE:

This is the conclusive chapter and it puts forward recommendations based on the

observations drawn from the research. It shows the link between investor confidence

and capital market development and stipulates the “supporting systems” of the CMA

which are, in essence, legal and extra-legal reforms that need to be made to improve the

investment climate, and consequently, the market regime in Uganda. These reforms are

in line with empowering the investor and generally fostering investor supremacy. Issues

like investor education, creation of a “modern” commercial law regime, developing the

supply side of the market, market incentives, promoting savings, corporate governance,

34

capacity building and improving the macro and micro economic conditions of the market

are assessed in the context of investor protection.

35

Chapter Two: The Initial Public Offering (IPO): The Capital Markets Authority’s

Role in Regulating the Primary Market

Uganda’s capital market is divided into the primary and secondary market. When a

company makes a decision to go public, the new issues of shares are sold to the public

in the primary market in what is called the initial public offer.38 Subsequent transactions

of these shares are done in the secondary market. This chapter examines government

intervention for investor protection and other regulatory considerations in an IPO of

equities in the primary market.

The capital markets regime in Uganda is public sector driven with the Government

deliberately setting up the necessary regulatory structure to create and maintain a

transparent and efficient market in which the interests of the investor are paramount and

can be protected.

Uganda employs the “cocktail approach” of regulation, combining oversight, and self-

regulation. This it does by using a “Regulatory Pyramid.”39 This method is effective, in

that, it apportions the onus of regulation, supervision, and enforcement fairly among the

market institutions, namely, “the Regulatory Agency, the Self Regulatory Organisation40,

38 Hereinafter referred to as the IPO. 39 Ms. Candy Wekesa: Legal and Regulatory Issues in Capital Markets. Paper presented at a seminar entitled “Development and Regulation of Securities and Capital Markets, May 15- 26, 2000 at ILI-Uganda, Page 1. Also see Appendix A on page 81. 40 Herein after referred to as the SRO

36

that is, the Stock Exchange and Member Associations, and the licensed firms

themselves.”41

The Capital Markets Authority is the Regulatory Authority, and, being at the top of the

regulatory pyramid oversees the SRO and the licensees in both the primary and

secondary markets. This regulatory body derives its existence and power from

Parliament42 and as a product of legislation its powers and duties are clearly stipulated in

the enabling Statute to avoid misunderstanding.

The Regulatory Agency is empowered by both the Companies Act43, and the more

recent Capital Markets Authority Statute44 and its antecedent regulations, to carry out its

role of protecting the investor from any market failures and ensuring that the market is

fair, efficient, and transparent. These functions and powers are discussed in section 6 of

the statute45 and extend to licensing market operators, regulating and supervising

market practices and compensating investors for losses.

The first duty of the CMA is developing all aspects of the market, removing impediments

and creating incentives for longer-term investment46. In furtherance of this goal, it is

empowered to advise the Minister on matters relating to the development and operation

of capital markets47.

41 Ibid 42 through the Capital Markets Authority Statute, 1996 43 1964, Cap 85, Laws of Uganda 44 1996 45 Capital Markets Authority Statute, 1996, Section 6 46 Ibid. Section 6 (1)(a) 47 Ibid. Section 6(2)(a)

37

The second duty of the CMA is to create, maintain and regulate the market and

implement a system where the market is self-regulatory as far as possible48. In carrying

out these functions, the statute gives the CMA jurisdiction in registering, licensing,

authorising or regulating stock exchanges, investment advisers, registrars, securities

brokers or dealers and their agents. The CMA also has the duty of maintaining

surveillance over securities to ensure orderly, fair and equitable dealings in securities

with a view to maintaining proper standards of conduct and professionalism in the

securities business49.

The duty to protect the investor is perhaps the most important function of the CMA50. In

pursuing this goal, the CMA is empowered to formulate principles for the guidance of the

securities industry51 and monitor the solvency of licence holders and take measures to

protect the interests of customers where the solvency of any license holder is in doubt52.

The CMA is charged with performing the functions conferred on it by section 43 of the

Companies Act53, which deals with registration of the prospectus. This empowers the

CMA to set the disclosure standards during an IPO. The CMA is further empowered to

adopt measures to minimise and supervise any conflict of interest that may arise for

brokers or dealers and protect the integrity of the securities market against any abuses

arising from any unfair advantage the issuer might use to the investor’s detriment. This

would ultimately create the necessary environment for orderly growth and development

of the capital market.

48 Ibid. Section 6(1)(b) 49 Ibid. Section 6(2)(c) 50 Ibid. Section 6(1)(c) 51 Ibid. Section 6(2)(d) 52 Ibid. Section 6(2)(e) 53 Ibid. Section 6(2)(i).

38

The practice of insider trading is one of the most common offences in the primary

market. This involves the use of confidential material information by company officers,

directors, employees and other insiders to buy or sell shares from or to an unsuspecting

public54. This asymmetrical information could take the form of material information about

the company, which is withheld from the public that would lead to the appreciation or

depreciation of the share price of the equities. These insiders use this unfair

informational advantage to influence the price of securities to the detriment of the

prospective investors. Insider trading is contrary to the requirement that the market be

transparent and efficient and is therefore prohibited by law55.

The CMA is finally empowered to intervene in case the investors incur losses and this it

does by establishing an investor compensation fund56. This shows the supremacy of the

investor and the need to protect him or her from any loss as a result of market

imperfection.

From the, above, we see the extent of Government intervention57 in the securities

markets to ensure a fair and efficient market and promote investor protection. This

shows that capital market regulation and investor protection are now a priority of the

government.

In order to detect, deter and penalise partiality of market structures, informational

equivocation, and unfair market practices, the regulator has the task of approving stock

54 Stuart R. Cohn and Fred Zake: Capital Market Development In Uganda: A joint Publication of ILI Uganda and ILI Washington, 1999 Page 173 55 Capital Markets Authority Statute, 1996, Section 89 56 Ibid. Sections 6(1)(d) and 82 of the CMA Statute, 1996

39

exchange and system operators, and making listing and other rules to give the investor

fair access to market facilities and information. The regulator further ensures that the

information given is relevant, timely, and widespread, especially with regard to market

prices in a bid to make the market efficient. This pre- and post-trade information should

be available to the public to let investors know if and when they can deal. These three

values are closely linked to investor protection and promote market integrity, investor

confidence, and a corresponding individual, market, and national gain.

In an IPO, there are a number of steps that a company must take before it can be listed.

The first step is the company’s decision to go public. A company that wishes to get low-

cost capital for expansion or divest its interest in the company may offer its shares or

debentures to the public58, who seek diversified investment opportunities, fewer

business risks and a chance to own part of the company. According to the Companies

Act, any reference to the offering of shares or debentures to the public is seen as:

“…including a reference to offering them to any section of the public, whether

selected as members or debenture-holders of the company concerned or as clients of

the person issuing the prospectus…”59

This offer may not be seen as public if it is properly construed as:

“…not being calculated to result, directly or indirectly, in the shares or debentures

becoming available for subscription for purchase by persons other than those receiving

the offer or invitation, or otherwise as being a domestic concern of the persons making

and receiving it…”60

57 Ibid. Section 5 (4) The Minister has discretion in appointing members of the CMA 58 The Companies Act, 1964, s. 40(3)(b) 59 ibid s. 57(1) 60 ibid s. 57(2)

40

Along with the benefits of this stage of the IPO, the issuer of shares must also consider

the burdens of registering the company in deciding whether the company has the

financial or managerial capacity to go public. The company then executes formal

resolutions to convert from a private enterprise to a public one, and lodges it in the

companies’ registry.

The CMA, in order to ensure investor protection, regulates the public offer of shares and

sets the qualifications for a public offer. Before a company can go public, it must meet

certain requirements set out by the Uganda Securities Exchange. A two-tier system has

been created to encourage both large and small companies to list on the stock exchange

and ensure broad market participation for both the investor and issuer.

In tier one, the company must have a minimum paid up capital of 500 million shillings

and must offer for sale to the public, shares valued by the company’s auditors at the time

of application at not less than 500 million shillings for equities61. The CMA also

prescribes a listing fee of 0.1 percent of the value of the securities being listed but not

less than five hundred thousand shillings and not more than ten million shillings. Any

additional listing will attract a fee of 0.05 percent, but not more than two hundred and fifty

thousand shillings and not more than five million shillings. The USE also charges an

additional annual listing fee of 0.025 percent of the market capitalisation of the listed

securities. The company must have audited accounts for the past five years.

The second tier requires the company to have a minimum paid up capital of 250 million

shillings and must issue or offer shares to the public whose value as determined by the

61 or 150 million shillings for debt securities.

41

auditors at the time of application at 150 million shillings for equities.62 The initial listing

fee is 0.05 percent of the issue value of the shares to be listed subject to a minimum of

250,000 shillings and a maximum of 5,000,000 shillings. An additional annual listing fee

is 0.025 percent of the market capitalisation of the listed securities. The company must

have audited accounts for the past five years.63

The next step is the assembling of the team who will work with the company’s directors

and managers. This team comprises “the sponsoring broker, the underwriter64, the

financial adviser or merchant bank65, the legal counsel66, the reporting accountants and

auditors67, the publicity firm and advertisers68, the independent registrar or transfer

agent69, and special experts depending on the nature of the issuer’s business70”.71

These experts will be charged with making the offer as efficient and transparent as

possible in order to ensure that the companies business is in order and prospective

investor is given enough information before purchasing the securities, which is the

principal consideration in a public offering.

The third step is the performance of the due diligence process. This is a process where

the company ensures that the information it intends to put in the prospectus is not

misleading and the company’s interests are clearly stated and the team member’s

62 and 80 million shillings for debt securities. 63 Nafula Awori: “Demystifying the Decision to go Public: What does it do for the Company”: The Capital Markets Journal, Volume 3 No. 1. January/ March 1999, page 6. 64 both regulated by the regulatory agency 65 regulated by the Central Bank 66 regulated by the Uganda Law Society 67 regulated by the ICPAU 68 indirectly regulated by the Advertising regulations 69 regulated by the registrar guidelines, which are still being formulated in Uganda. 70 Indirectly regulated by the prospectus regulations. 71 Source: Ms. Candy Wekesa: Legal and Regulatory Issues in Capital Markets: A paper presented at a seminar entitled “Development and Regulation of Securities and Capital Markets,” May 15-26, 2000 at ILI-Uganda; Page, 13

42

contributions are compiled in accordance with the prospectus regulations. This process

in effect gives the prospective investor constructive notice about the company and the

purchase of shares is an arms length transaction. The investor should therefore have all

the necessary information to limit his risk.

The fourth step is the preparation of a prospectus, also regulated by the prospectus

regulations. The prospectus must cater for the unsophisticated investor in a “plain

English disclosure standard”72 in the cover page, summary, and risk factor parts of the

prospectus. The prospectus is the basis of the adequate disclosure standards in an

IPO, which shall be discussed in detail later on in this chapter.

After the preparation of the prospectus, the publicity firm must inform the public of the

company’s decision to go public through advertising, road shows and meetings with

potential individual and institutional investors in accordance with the advertising

regulations. The offer should be seen by a large number of people to qualify as a public

offer.

The next step is the execution of an underwriting agreement where the lead or

sponsoring broker or a syndicate of brokers undertakes to minimise the issuer’s risk by

either buying all the shares and reselling them to the investors73 or buying any left-over

securities after the offer is closed. In Uganda, the underwriting agreements are

reviewed and regulated by the CMA. At this stage the performance and value of the

company can be gauged and the underwriter and company price the shares of the

company. The pricing of the shares, while determining how much money the company

72 Ibid 73 This is called the firm commitment underwriting

43

will make, can have an effect both in the primary, and secondary market and subsequent

performance of the shares must be taken into consideration. This price should be the

main consideration before the purchase of shares by the prospective investors.

After distribution of the prospectus to the public, the “offer period” begins. In this period

prospective investors apply for shares in the company. This period runs until the

company’s receiving institutions stop receiving applications for shares. The opening and

closing dates and times must be clearly stated in the prospectus, per the prospectus

requirement regulations74. The allotment process follows the end of the offer period.

Here, the successful applicants get share certificates and unsuccessful ones get their

money back. The date of announcing the allotment policy must also be stated in the

prospectus.

The last stage of the IPO is the listing stage, where, after the regulatory agency

approves the company’s prospectus, the sponsoring broker applies to the stock

exchange to have the newly issues shares listed.

The main regulatory consideration in the primary market is adequate disclosure and it is

the duty of the regulatory agency to set the standard of disclosure. These standards

play a major role in investor protection and market regulation. It is important to note,

however, that they are not aimed at ensuring that the investment is totally free of normal

market risks, but that the investor is made aware of the risk before he commits his

money.

74 for example, page 1 of the Uganda Clays Limited prospectus gives the offer period as four weeks, from 12:00 PM on Monday 11 October, 1999 to 3:00 PM on Friday 5 November, 1999

44

Over and above the duty to prevent loss to the investor, the regulator has the duty of

setting up a compensation fund to reduce the impact of any loss to the investor in the

event of market failure75.

In an equity market, the main vehicle for disclosure is the prospectus, which has been

described as:

”…any prospectus, notice circular, advertisement, or other invitation, offering to the

public for subscription or purchase any shares or debentures of a company and includes

any document which, save to the extent that it offers securities for consideration other

than cash, is otherwise a prospectus.”76

The prospectus is further defined as “a document that seeks “full and adequate

disclosure” by giving all “material information” to assist the prospective investor make an

informed decision… an illustration of the “long arm of the regulator”, which fishes out or

causes the fishing out of all information, positive or negative, about the Issuer in order to

meet the disclosure standards prescribed under the law.”77

The prospectus is the main source of information for the prospective investor and, in

Uganda; this is where we first see the regulatory authority of the CMA over the issuer of

securities. It is mandatory to issue a prospectus in any application for shares in or

debentures of a company78. Considering that information is very crucial in investment

75 This is a legal duty per Sections 6 and 82 of the Capital Markets Authority Statute, 1996 76 Companies Act, S. 2 it should be noted that the Companies Act uses the word “prospectus” in the definition and this makes the section vague. 77 Ms. Candy Wekesa: “Prospectus: Protection or Puzzle?” The Capital Markets Journal, Vol. 4, No. 3, July/ September, 2000, Page 26. 78 The Companies Act, 1964, s. 40 (3)

45

and is the focus of market regulation79, it is necessary to set clear disclosure standards.

A weak prospectus will mislead investors, make continuous disclosure reporting harder,

and jeopardise the work of the regulatory agency, thereby discrediting the entire market.

The common law principle governing the standard of disclosure in a prospectus was

dealt with in New Brunswick and Canada Rly and Land Co. Ltd v Muggeridge80, where

Kindersley, VC said;

“Those who issue prospectuses…are bound to state everything with strict and

scrupulous accuracy and not only abstain from stating as fact that which is not so, but to

omit no one fact within their knowledge the existence of which might in any degree affect

the nature, or extent, or quality of the privileges and advantages which the prospectus

holds out as inducements to take shares.”

The prospectus must therefore comply with the disclosure standards set in the

schedules of the Companies Act81 and the Capital Markets (Prospectus Requirements)

Regulations, 199682. These provisions give the matters to be stated in the prospectus

before a company can get listed.

The prospectus must have a caution note on the first page of the prospectus stating that

the prospectus has been submitted to the CMA for approval and the Registrar of

Companies for registration. The caution note must also state that the securities on offer

have not been approved or disapproved by the authority and the prospective

shareholder should carefully consider the matters set forth under the caption “risk

79 This was the basis of the Efficient Market Hypothesis (EMH) per SID MITTRA AND CHRIS GASSEN: in ”Investment Analysis and Portfolio Management “Op.Cit, Page 6-7 80 [1860] 30 Lj Ch 242 81 Sections 32, 40, 41, 379, 380, 382 and parts I, II and III of the Third Schedule

46

factors”.83 This is aimed at informing the prospective investor of the business risk

involved.

The prospectus must have the purpose of the issue. The purpose of the issue of shares

in Uganda Clays Limited was to implement the Government’s decision to divest its

holding to the public84, enhance the image and status of the company and foster the

growth of the housing sector and capital markets in Uganda.85

The prospectus should spell out the rights of the different classes of holders of

securities86. These rights extend to “dividends, capital, pre-emptive rights to subscribe

to new issues of shares, redemption (where applicable), voting rights, and the creation

or issue of further shares of equal priority with the shares.” This is important because it

clearly sets out the extent of the shareholder’s rights and may influence a prospective

investor in his decision to buy shares.

The prospectus must have a statement on the legal status and affairs of the issuer. This

includes a brief history of the initial organisation, including the form and name under

which the initial organisation took place. This statement must contain information on the

history, titles, contracts, licences, consents, litigation, and any other information pertinent

to the company that might influence the investor’s decision to buy shares.87

82 See S. 4 and part I and II of the Schedule 83 Matters to be Stated on the First Page of the Prospectus; Part I of the schedule to the Capital Markets (Prospectus Requirements) Regulations, 1996 84 UCL is listed in class 4 of the Public Enterprise Reform and Divestiture Statute, 1993 85 “Key Information and Background:” Uganda Clays Limited Prospectus (1999). Page 7 86 Per paragraph 2(a) of part II of the schedule to the Prospectus Requirement Regulations and paragraph 17 of part I of the third schedule to the Companies Act, 1964 87Ibid. Paragraph 2 (c) of Part II of the Schedule

47

There should be information relating to executive officers, directors or nominees for the

position of director, giving details of their business experience, whether they have been

involved in a petition of bankruptcy or criminal proceedings that “permanently or

temporarily prohibited him or her from acting as an investment adviser or a director or

employee of a broker or dealer, director or employee of any financial institution or

engaging in any type of business practice or activity. This information may influence

prospective investors who might suffer loss in the even of fraud or mismanagement by

the director or executive.88 The directors’ interests in the company must also be stated

since they are trustees of the investors’ money and conflict of interests may affect the

shareholders. This information extends to the director’s shareholding, any acquisition or

disposal of the issuer’s share capital by the director within a one-year period prior to the

public distribution and any contracts or options to purchase securities of the issuing

company or any holding or subsidiary company.89 There should also be information on

the lead and sponsoring brokers, financial advisors, registrars, auditors, and lawyers,

receiving bankers, underwriters, public relations firms and any other professional

advisors of the issue.

The prospectus must contain audited financial statements for five or three years

depending on whether the issue is in tier one or two.90 This should inform the

prospective investor of the issuer’s capital or debt. The prospectus must give

information on the loan and debt profile of the issuing company and to this effect; there

88 In the English case of Re Darby, ex. p Brougham [1911] 1 KB 95, where two discharged bankrupts, previously convicted of fraud incorporated a company and did not disclose this to prospective investors; the “corporate veil” was lifted to make them liable upon the company’s liquidation. 89 Prospectus Requirement Regulations, S.2 (d) (iii) to (vii) and paragraphs 3 and 16 of part I of the third schedule of the Companies Act. 90 Ibid. See footnote 30

48

should be information on the company’s bankers91. The prospectus should also have

information on the dates of and parties to all material contracts not entered into in the

ordinary course of business two years before the issue of the prospectus92. An

accountant’s report must cover the financial statements and include a review of the

unaudited statements where applicable.

There should be information regarding the company’s authorised share capital and

details of land and fixed assets of the issuer. This may include and is not limited to

authorised share capital, amount paid up, location, area or tenure of the factories and

fixed assets, and particulars of primary plant and equipment93. This should be

accompanied by a valuation report with respect to the value of the property. There

should also be a statement regarding the intended and transient use of net proceeds of

the company.94

In line with the caution note and the performance of the due diligence process, the

prospectus must have a section labelled “risk factors” dealing with risks on new

ventures, construction, licensing, regulation, competition, taxation, dependence on a key

personality, taxation, level of indebtedness, dilution and unexpectedness of dividends.

This information acts as a warning to the investors that there are business risks that they

should consider when making their investment decisions.

Finally, in pursuance of the “plain English standard” there should be a summary of the

matters to be stated in the prospectus for clarity and easier use by the prospective

91 Prospectus Requirement Regulations. (b) 92 Ibid. (i) 93 Ibid. (h) 94 Ibid. (k)

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investor. This information gives protection to both the company and the investor. While

it gives the investor all the material information necessary for making an informed

investment decision, it relieves the company of any liability in case of unforeseen

financial loss to the investor95.

In addition to the information in the prospectus the company must furnish the investors

with copies of the memorandum and articles of association, authorising regulations,

agreements with professionals, trustee agreements and a contract with the guarantor in

case of debt securities. The Prospectus Regulations96 further empower the CMA to

seek further information and documentation in a particular case or class of cases that

might be to the investors’ benefit.97

This strict disclosure standard limits market failures, promotes transparency and

credibility of the market thereby making it more favourable to investors.

The rationale for government regulation of the primary market can be clearly seen by

looking at the effects of an IPO on the market participants. The main reason for

floatation of shares by any company is the need to raise capital. Equity markets provide

a cheaper, more abundant alternative to the traditional methods of raising finance

through high-interest loans. In this case, the company sells a portion of its shares to the

public for money, which it will need for expansion. Businesses under state control98 can

be floated in a privatisation exercise, which is aimed at separating Government from

95 Mbumba S. Kapumpa, Supra, footnote 9. The principle of caveat emptor is qualified here and the investor is deemed to have constructive notice if the issuer acts in good faith. 96 Regulation 5 (1) 97In the Uganda Clays Limited IPO for instance, the CMA sought a report on the company’s environmental policy to minimize the negative effects of the clay mining, as well as a geological survey on the life expectancy of the clay reserves, which are the main raw material of the company. 98 The Government of Uganda has sold its shareholding in both Uganda Clays Limited and British American Tobacco (Uganda) Limited to the public on the stock exchange.

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business in order to increase public participation and improve the management of the

privatised companies. The floatation of a company may indicate a move away from the

traditional family business operation that is very common in Uganda and this may lead to

better management and growth of these companies.

The primary market has many benefits for the issuer, investor, market, and economy in

general. The benefits of floatation for a company are not limited to capital realisation

and improvement in management. When the company gets listed its shares become

liquid and can be converted to cash quicker than shares in a private company. This

would help the entrepreneur diversify his investment and minimise risk. The liquidity

may also lead to establishment of employee benefit programmes to encourage

employee investment in the company. This would lead to better quality of work, as the

employees would now own a share of the company.

A company that meets the disclosure requirements for getting listed is regarded as

having high standards of corporate governance and this will boost the company image.

The company would further benefit from shareholder support through the shareholders

identifying with and buying the company’s product and even providing extra capital

should the need arise.

In a share offer, the investor diversifies his investment opportunities and utilises his or

her savings better. This may also lower his or her investment risk through an “eggs in

more than one basket”99 approach.

51

The offer of new issues to the public may, on the other hand have its disadvantages.

The disclosure requirements are a big source of discord among the entrepreneurs who

find that exposing all the weaknesses of the company might kill the selling element of the

company and ultimately lead to losses. The entrepreneurs further fear that competitors

could use the information to the company’s detriment. This is common in Uganda where

the standards of corporate governance leave a lot to be desired. To add to their

discontent, the high cost of going public has discouraged many entrepreneurs. The

team of professionals required for an IPO is seen as an added cost rather than a factor

in getting capital.

Many entrepreneurs fear the loss of control that might occur as a result of an IPO. The

development of the equity market will be contingent on a change from the traditional

“build-own-operate” family business corporate structures and lack of corporate

governance common in Uganda’s commercial organisation and this might not augur well

with the directors of such companies.

The opportunity to own a part of a company is an incentive to savings mobilization as a

result of the development of the supply side of the securities market. With more equity

and debt securities being traded, the stock market will get depth and width, which lead to

lower investment risks, greater competition, and better products on the market.

Ultimately, the developed market through increased investment and public participation

in the market will boost the national economy. Strong business units will evolve and

there will be lower costs of capital as financial institutions compete with capital markets.

Ultimately, higher savings and returns on investment as a result of market development

99 Ms. Candy Wekesa: Legal and Regulatory Issues in Capital Markets: A paper presented at a seminar entitled “Development and Regulation of Securities and Capital Markets,” May 15-26, 2000 at ILI-Uganda;

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will lead to wealth creation and sustainable growth and economic development. These

benefits are, however dependent on investor confidence, which determines the levels of

investment and growth of the market. Protection of the investor is therefore a necessary

requirement for the development of capital markets.

In furtherance of their common goal of investor protection the CMA Statute100 and

Companies Act101 contain both civil and criminal penalty provisions against unlawful

practices in an IPO. These provisions set out the liabilities of the issuers with regard to

the IPO and are necessary to enforce the rights of the subscribers, who are usually at a

disadvantage compared to the issuers of securities.

The CMA Statute prescribes civil and criminal sanctions in the form of fines,

imprisonment and compensation for contravention of the rules set out in part IX of the

CMA Statute. These criminal sanctions are also provided for non-compliance with the

disclosure requirements set out Section 40 and the third schedule to the Companies Act.

This non-disclosure shall lie against a director if he fails to show that the error was not

deliberate or he was unaware of it. This is based on the principle that the directors act

as trustees to the shareholders and must act in good faith. In allegations of fraud or

negligence against directors or promoters of a company the onus of proof lies on the

subscriber.

Page 7 100 Part IX of the CMA Statute lists various market offences and section 90 lists the criminal and civil liabilities for the offences named in sections 83 to 89 of the statute.101 the Companies Act 1964, Sections 45 and 46

53

Individuals can be fined up to ten million shillings, imprisonment up to five years or

both.102 Companies, on the other hand can be fined up to twelve million shillings. Over

and above the remedy of fines or imprisonment is the requirement that compensation be

paid to the aggrieved party by a person convicted of an offence under part IX of the

statute.103 The rationale for this is the recognition of the duty of care held by the issuers

of securities104 and fraudulent or negligent breach of this duty will require the party in the

wrong to make good the losses sustained by the person claiming the compensation.105

An investor’s rights with regard to the prospectus are absolute and cannot be waived.

Section 40 of the Companies Act makes the issue of a prospectus mandatory and

Section 40(2) makes it clear that contractual waiver cannot avoid prospectus violations.

This provision operates to prevent instances where, owing to the superior bargaining

power of the issuer, the investor may be induced to waive his rights to his detriment.

Section 41 of the Companies Act preserves any common law remedies that the investor

may seek. These remedies may include damages for misrepresentation, rescission and

actions for negligence.

The common-law remedy of damages for misrepresentation in a prospectus is based on

the belief that “those who advertise a prospectus know that it will be relied on

indiscriminately by investors who apply on allotment and those who buy on the

102 Ibid. Section 90(1)(a) 103 Ibid. Section 90 (2) 104 This is based on the principle set out by Kindersley, VC in New Brunswick and Canada Rly and Land Co. Ltd v Muggeridge 105 the Companies Act 1964. Section 90(3)

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market.”106 As seen in the case of Peek v. Gurney107 if a false statement was made in

the prospectus and it was the intention of the issuers to have it acted upon an investor

that acts upon such misrepresentation to his detriment is entitled to damages108. This

was extended to cover the subscriber’s loss as a result of negligent misstatements in the

prospectus.109 However, as was seen in Derry v. Peek110, if the directors make the

misrepresentation in the honest belief that it is true they will not be liable for

misrepresentation. This Companies Act provides a defence for an honest mistake of

fact that may make what may be strictly construed as a misrepresentation

exculpatory.111 This defence does not extend to mistakes of law.

In the alternative, if the statement in the prospectus is untrue and misleading, but not

fraudulent, the aggrieved subscriber may seek to rescind the contract and have the

register of members rectified.112 Proof that the prospectus contained a

misrepresentation in respect of a material matter intended to be acted upon and the

company is liable would entitle the aggrieved subscriber to repayment of the initial

investment he made in the company.

The common law provision for damages for misrepresentation is concretised in section

85 of the CMA Statute that prohibits making false or misleading statements to induce a

person to buy or sell securities. Liability with regard to these statements lies with the

issuer if they are made fraudulently or recklessly to the investor’s detriment.

106 D. J. Bakibinga: Company Law in Uganda. Professional Books Publishers & Consultants Ltd- Kampala (1997). Page101 107 (1873)L.R. 6 H.L.377 This remedy is restricted to the actual allottee of the shares and not the subsequent purchasers of the shares. 108 This is further illustrated in section 87 of the Capital Markets Authority Statute, 1996 109 this remedy is given in Section 45 of the Companies Act, 1964110 [1889] 14 App Cas 337 111 Section 40(4)(b)

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The Companies Act prescribes a number of monetary fines for irregular allotment under

Section 51 and reporting violations under Section 54. Section 45 entitles a subscriber

who has suffered loss as a result of misrepresentation to a claim of compensation

against the director or person named as director in the prospectus. This liability may

extend to experts under Section 42 of the act.

The statute prohibits false trading and market rigging. This offence takes the form of

creating a false or misleading appearance of active trading with respect to market or

price for the securities.113 It may also involve purchase or sale of securities with no

change of beneficiary mainly leading to fluctuation of the price of the securities114. If it is

shown that the issuer wilfully created a false or misleading appearance of trading in

securities trading he commits an offence. The statute further prohibits transactions that

are tantamount to share price manipulation with intent “to induce other persons to sell,

purchase, or subscribe for securities of the body corporate or related body corporate.”115

The CMAs mission statement to “promote and facilitate the development of an orderly,

fair and efficient capital market in Uganda116” points to the state’s goal of increasing

investor confidence. This increased confidence will ultimately lead to increased

investment, market growth and economic development. Investor protection is perhaps

the main consideration from which all the other goals stem and it is in the state’s best

interests to safeguard the investors’ rights, which would otherwise be violated by

unscrupulous issuers of securities.

112 Section 118 of the Companies Act. 113 Capital Markets Authority Statute, 1996, Section 83(1) 114 Ibid. Section 83 (2) 115 Ibid. Section 84

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Chapter Three:

The CMA Post-IPO: Substantive and Regulatory Aspects of the

Secondary Market117:

This chapter seeks to study the regulatory role the CMA plays in the secondary market.

This role is in line with the obligation given to it by the CMA Statute to create, maintain

and regulate the market and make it as self-regulatory as possible118. This is the source

of the CMA’s mission statement, which is:

“…To promote and facilitate the development of an orderly, fair and efficient capital

market in Uganda”119.

This CMA has the task of “removing impediments to, and the creation of incentives for

longer term investment in productive enterprise”120 and it can achieve this by increasing

investor confidence through “protection of investor interests.”121 The aspects of

regulation involve licensing and supervising market participants, imposing sanctions on

participants who violate the securities regulations, and as a last resort, compensating

aggrieved investors for their loss122.

116 CMA Uganda: Annual Report & Accounts 1998/ 1999. Page 2 117 We see in Candy Wekesa’s article entitled Legal and Regulatory Issues in Capital Markets. Op.Cit, Page 15 that the secondary market is synonymous with the Stock Exchange 118 Capital Markets Authority Statute, S.6(1)(b) 119 Capital Markets Authority Annual Report and Accounts, 1998/ 1999, page 2. 120 Capital Markets Authority Statute, S.6(1)(a) 121 Ibid, S.6(1)(c) 122 Ibid, Sections 82(1) and 6(1)(d) deals with the investor compensation fund

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As we discussed in the previous chapters, securities can be categorised into equity and

debt.123 Debt securities are a good source of short-term capital to the entrepreneur.

Here, a lender gives money to the company “on the promise that both the principal and

interest will be paid”124 regardless of whether the company makes profits or not. The

lender’s claim is to repayment of the debt and therefore he or she has a lower level of

risk than the borrower. These securities are more common in Uganda where the capital

markets regime is still in its infancy and reliance on banks and other financial institutions

is still high. This is further confounded by the predominance of small family businesses

that cannot meet the listing requirements in the IPO.

Equities are a good source of long term, low cost capital to the entrepreneurs. The

primary forms of equity are ordinary and preferred shares. Unlike debt securities, when

an investor buys equity he is actually buying a share in the ownership of the company

and owns a proportion of the company’s assets. However, he has neither a claim to

repayment of the principal, nor payment from profits. The risk levels are therefore high

for the shareholders who only get paid their dividends at the discretion of the directors.

This is the case particularly with the ordinary shareholders who have the lowest priority

claims. Preferred shares carry a fixed dividend rate and are entitled to payment of

dividends before the ordinary shareholders. The equity holder mainly makes a profit

from secondary trading on the stock market.125

The secondary market refers to subsequent trading in already issued shares. This

trading occurs at the stock exchange and is regulated by the self-regulatory organisation

123 See the definition of securities in Chapter One, page 20 124 Stuart R. Cohn/ Fred Zake: Capital Market Development in Uganda, Op.Cit, Page 22 125 For example, an investor who bought shares in BAT at one thousand shillings per share during its IPO can now sell them at one thousand two hundred shillings per share, thereby making a twenty percent profit.

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in line with the “cocktail approach” to equity market regulation adopted by the

Government of Uganda126. Uganda’s secondary market is in the Uganda Securities

Exchange127, which was established by the CMA128 to act as the SRO in the Regulatory

Pyramid.129 Companies have their IPO of their shares through the CMA as the primary

market but all subsequent transactions are carried out in the secondary market.

The stock market is not unlike an ordinary market and the commodities traded are

already issued shares. Trading is conducted on the USE trading floor under a

continuous open outcry trading system. The trading floor is, however, restricted to

broker-dealer members of the stock exchange and their representatives. The aim of this

restriction is to ensure order in the stock market with the broker-dealers130 acting as

agents for the investors.

The secondary market acts as an exit or entry mechanism for the shareholders who wish

to dispose of their shares after the IPO, or investors who wish to purchase already

issued shares. The entry and exit mechanism simplifies investment and makes the

market liquid. The secondary market can also act as an indicator of the company’s and

the country’s general economic performance. Furthermore, the market provides a price

discovery mechanism when offers and bids match on the trading board.

The SRO, under the supervision of the Regulatory Authority oversees the operation of

the secondary market. The secondary market is for the most part self-regulatory, and

126 See the discussion on the “Regulatory Pyramid” in Candy Wekesa’s article entitled Legal and Regulatory Issues in Capital Markets. Op.Cit, Page 1 127 Incorporated as a Company limited by guarantee in May, 1997 by the CMA. 128 Under Part III of the Capital Markets Authority Statute 129 See appendix A and the discussion on the “Regulatory Pyramid” in Candy Wekesa’s article entitled Legal and Regulatory Issues in Capital Markets. Op.Cit, Page 1

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governed by the forces of demand and supply. Any appreciation in the value of the

shares held by the equity holder leads to a profit when the shares are disposed of in

secondary market transactions. These transactions usually do not change the

company’s capitalisation implying that the benefit or loss from an appreciation or

depreciation of the share value of a company’s stock will fall squarely on the

shareholder’s shoulders. This is contingent, however, on the need to protect the

investor from market imperfections that may arise in the secondary market131.

Investor protection is the major regulatory consideration in the secondary market, and

the capital markets in general. The focus of regulation in the secondary market is on

protecting investors in the secondary market from losses from an unfair disadvantage

that may arise in the market. This may be done by preventing a conflict of interest on

the part of licensees in the stock market from adversely affecting the investor, as well as

ensuring that the participants in the secondary markets conform to the continuous

disclosure requirements. This protection is tied down to information in line with the

“efficient market hypothesis”132. The market must ensure that price sensitive information

is brought out into the open and the market operates as transparently as possible to

enable the investor make an informed investment decision.

The CMA Statute empowers the CMA to make subsidiary legislation to achieve its

objectives.133

130 See the definition of brokers, dealers and broker-dealer firms in Chapter One, Page 22 131 See the functions of the CMA in The Capital Markets Authority Statute, 1996, S.6(1)(c) 132 Sid Mittra and Chris Gassen: ”Investment Analysis and Portfolio Management “ Op. Cit. See also, Chapter One, page 7 133 The Capital Markets Authority Statute, 1996, S. 102

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An orderly market can be attained through legislation governing the operation of broker-

dealers and the participants on the trading floor. To protect the investors, the legislation

is intended to make transactions on the trading floor more transparent, effective and free

of conflict.

In order for the market to be fair, the legislation must adequately deal with prohibiting

market malpractices arising from an unfair advantage the company may have over the

investor, usually to the investor’s detriment, and ensuring that the price is a product of

demand, supply and information.

The legislation attempts to create an efficient market by making legislation governing

trading, clearing, delivery and settlement in the stock exchange. It should prevent undue

restriction of trade by allowing the buyer freedom to transact and get valuable

consideration for his shares and this will boost investor confidence.

The CMA protects the investors in the secondary market by regulating the SRO and

Licensees who, with the CMA make up the regulatory pyramid. This regulation extends

to licensing, overseeing and censuring the market participants with the goal of investor

protection.

The first regulatory duty of the CMA is to license the securities exchange, thereby

forming the secondary market. The CMA Statute gives the requirements for establishing

and running a securities exchange in Uganda134 and the Establishment of Stock

134 The Capital Markets Authority Statute, 1996, Part III. In the case of Uganda, it is the Uganda Securities Exchange (USE).

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Exchange Regulations135 sets out conditions for approval of a stock exchange in

Uganda. The stock exchange must engage solely in business for securities136 in order to

avoid conflict of interest. The stock exchange must also have a permanent

establishment and establish a trading floor for efficient operation of the exchange.137

Finally, the exchange must establish a system of compensation. This compensation is

aimed at mitigating any pecuniary losses the investors might incur as a result of failure

on the part of the broker-dealers to meet their contractual obligations.138

The USE was licensed in 1997 and is the only licensed SRO in Uganda’s capital market.

The stock exchange’s mission statement is

“To develop and manage the most efficient, transparent Securities Market that matches

the best international standards and promote a partnership with the general public,

foreign investors, employees, the Government and other stakeholders in the

development of Uganda’s Capital Markets industry.”139

The securities exchange is required to create a trading system that protects investors

and is open to the public. The USE is a creature of legislation and derives its existence

from the CMA statute140. It makes rules that govern the secondary market but these

rules are subject to review and approval by the CMA as the regulatory agency. This

means that the SRO is subject to the CMA’s control, thereby showing the government’s

regulatory role in the secondary market. Over and above licensing the securities

135 Part IV of the Capital Markets (Establishment of Stock Exchange) Regulations made under Section 102 of the CMA Statute deals with approval of the stock exchange. 136 Ibid, regulation 12 137 Ibid, regulation 12(d) and (e) 138 Ibid, regulation 12(f) 139 USE: About the Uganda Securities Exchange Capital Markets Authority/ USAID (2000)

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exchange, the CMA is empowered to supervise secondary market operations and

ensure that the market is orderly, fair and efficient. The SRO aims at creating a free

market where forces of demand and supply are the main consideration but there still

exists an element of dirigisme in the secondary market.

The SRO’s autonomy is limited by the need for investor protection and in this vein it

must be accountable to the regulatory agency. The securities exchange is required to

furnish the CMA with returns as well as reports in case of disciplinary action taken

against any member of the exchange.141

The regulatory agency plays an appellate role in the operations of the SRO. The CMA is

empowered to review decisions made by the exchange and has jurisdiction to hear

appeals against such decisions.142

The CMA has powers to license, supervise and censure broker-dealers with the goal of

investor protection and minimisation of risk in the relationship between the investor and

the broker-dealer. A broker that purports to act as a principal rather than an agent and

puts himself in a position of trust and confidence with his customer has a duty of care to

the customer143. This risk depends on the level of reliance the investor has on the

broker’s advice and whether the broker has disclosed all the material information

necessary to enable the investor make an informed decision.

140 The Capital Markets Authority Statute, 1996, Part III 141 Ibid S.27(1) and (2) 142 Ibid S.2 (3)(4) and (5) 143 This was the principal in Hughes v. Securities Exchange Commission, United States Court of Appeals, District of Columbia Circuit, 1949 174F.2d 969

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There are three types of investors. The first category comprises those who know what

they want and conduct their own research and simply give the brokers purchase and

sale orders regarding the securities. The second group has investors who have a rough

idea of what they want but need the broker’s advice before investing. The last category

comprises investors who do not know what they want and rely on the broker’s expertise

in order to make an investment decision144. It is mainly the third category of investor to

whom the broker has a duty of care based on the investor’s reliance on his advice145.

Brokers carry out a dual function of advising the investor and purchasing shares on his

or her behalf. This brings up a conflict of interest and there is a need to protect the

investor at all times. It is therefore the CMA’s duty to oversee the operation of the

broker-dealers to prevent unfair treatment of the investor.

To this end, the CMA has made subsidiary legislation.146 Licensing of broker-dealer

firms is dealt with by the Licensing Regulations.147 These regulations prescribe

application fees to be paid by the broker-dealer firms and the form of application.148 A

deposit subject to the acceptance or rejection of the application must accompany the

application.149 This deposit will be refunded if the application is rejected or nullified150,

and invested by the CMA if the application is accepted151. The CMA grants the

application if it is satisfied that the broker-dealer firm has met the licensing requirements

144 Mr. Murigu: How do you Make Money on a Stock Exchange? The Capital Markets Journal; Vol.2, No.4 Oct/ Dec, 1998, page15 145 The Capital Markets (Conduct of Business) Regulations, 1996, regulation 9 146 this power is derived from the Capital Markets Authority Statute, 1996 Section 102(i) 147 The Capital Markets (Licensing) Regulations, 1996 148 Ibid, Part II 149 Ibid, S.10 150 Ibid, S 11 151 Ibid, S. 12

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under the regulations. The broker-dealer must be informed of the acceptance or

rejection of his or her application within forty-five days. 152

A license is not transferable and the broker-dealer firm must always keep the CMA

informed of any changes in the company’s administration.153 The broker dealer must

only carry out business in accordance with his or her licence154 and this license must be

displayed at the firm’s official place of business155.

The broker-dealer firm is required to maintain a minimum capital of fifteen million

shillings156 and where the financial operations of the firm indicate a necessitous state,

which could put the broker- dealer’s clients in a precarious position, the CMA will revoke

the broker-dealer’s licence157.

The Conduct of Business Regulations158 deals with conflicts of interest that may arise as

a result of the dual capacity of the broker-dealer firms. The regulations ensure that the

licensee does not hold himself out to be independent when he or she is not, and state

the extent of any interest in the matter, if any.159 The regulations further prohibit the

broker-dealer from advising or dealing on behalf of his or her client unless his or her

interest in the matter is disclosed and will not adversely affect the customer’s

interests.160 Inducements that may conflict with the broker-dealer’s duty to his or her

152 Ibid S.13. An exception can be seen where further information is required under S.31 of the CMA Statute, 1996 153 Ibid S.15(a), (b), (c) and (d) 154 Ibid S.15(e) 155 Ibid S.19(1) 156 Ibid S.16(1) 157 Ibid S.15(2) 158 The Capital Markets (Conduct of Business) Regulations, 1996 159 The Capital Markets (Conduct of Business) Regulations, S.3 160 Ibid regulation 4

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customers are expressly prohibited161 and the broker-dealer is precluded from

misinforming or hiding information from his or her clients in any advertisement162. An

example of this is the “shingle theory” which stipulates ”the essential objective of

securities legislation is to protect those who do not know market conditions from the

overreachings of those who do”.163 The sanctions for these offences range from fines to

revocation of the broker’s license.

The Register of Interests in Securities Regulations164 also deals with the brokers and

dealers operating on a client’s or their own behalf. The broker-dealer is required to

maintain a register of securities in which he or she has an interest in the form prescribed

in the schedule to the regulations.165 The interests in question must be entered or

changed within seven days of the acquisition or disposal or change in interest of the

securities.166

The Advertisement Regulations167 give restrictions and conditions for issuing securities

advertisements. The regulations lay down who can issue securities advertisements168.

They further require the person making the advertisement to disclose his particulars169

and the form the advertisement must take in order to meet the requirements of the

regulations.170

161 Ibid, regulation 5 162 Ibid, regulations 6 and 10 163 This principle was set by Clark, J. in Charles Hughes & Co., Inc. v. Securities And Exchange Commission United States Court of Appeal Second Circuit, 1943 139 F.2d 434 164 The Capital Markets (Register of Interests in Securities) Regulations, 1996 165 Ibid regulation 3 and Forms A and B of the Schedule 166 Ibid regulations 4 and 5 167 The Capital Markets (Advertisements) Regulations, 1996 168 Ibid regulation 3 169 Ibid regulation 4 170 Ibid regulation 5, read with the schedule to the regulations

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Regulation with regard to a company’s entry into the stock market is dealt with in the IPO

and this role is therefore not a premise of the SRO. The company, however, has a duty

to existing shareholders and prospective purchasers of shares in the secondary market

to ensure that the transaction will be orderly, fair and efficient.

The CMA is currently developing continuous disclosure requirements that impose an

obligation to companies to provide material information about their financial and

organisational structures. This is based on the efficient market hypothesis, which gives

information prominence in the market.

Like the primary market, the importance of information cannot be understated. The

continual flow of information is necessary to give the investors in the secondary market a

chance to make an informed decision lest they consider investing in the secondary

market a gamble they cannot afford to risk.

Information is also necessary to prevent market failures and abusive trading practices

that may lead to the investor incurring a loss due to an unfair informational advantage

the company insiders may have over him or her.

Disclosure requirements must be both accurate and timely. While it is agreed that the

company cannot operate in a goldfish bowl, it is imperative that companies disclose all

the material information. This information is what a reasonable investor would consider

important in making an investment decision. While the question of what constitutes

materiality of information, especially with regard to future, still uncertain developments in

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the company is a grey area it is clear that the higher the importance, the more the

materiality favours disclosure, however uncertain the development is.171

Information disclosure may affect the share price of the securities. If the share price is

falling, the uninformed shareholders might not have an opportunity to avoid losses. On

the other hand, the share value might rise and the uninformed shareholders might sell

off their shares and thereby incur a loss. It is therefore necessary ensure that the

disclosure is timely and investors are not adversely affected by any delays in disclosure.

The SRO is empowered to prepare a listing rules manual, which stipulates the

obligations of companies listed on the stock exchange to “make prompt and full public

disclosure of material developments in their affairs.”172 Material information that must be

communicated within twenty-four hours of making a decision can be found in the section

of the Manual dealing with “Continuous Listing Requirements and Letter of

Undertaking.”173 The information includes details on shareholders’ status and rights with

regard to dividends or other distribution, company meetings and voting.

There must be a declaration of the board on dividends and information backing up

variations from earlier dividends, if any, including failure to recommend or declare a

dividend. 174

171 Stuart Cohn and Fred Zake: Capital Market Development in Uganda; Ibid. Page 141 172 Uganda Securities Exchange Listing Rules Manual S.10.1 173 Ibid. Appendix 4 174 Stuart Cohn and Fred Zake, Op. Cit.

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Information on company meetings with regard to venue, date and time must also be

given. This should also include any resolutions put forward in the meeting and whether

they were passed.

Administrative changes in the company must be disclosed. These include changes in

the registered office, directors and proposed changes in the memorandum or articles of

association of the company. There must also be detailed information in case of a

change in substantial shareholdings.175 Substantial shareholding is construed as

controlling fifteen percent of the voting power or power to influence the majority of the

board and this would give the holder an advantage over other shareholders.

In case the company or one of its subsidiaries winds up, information thereof must be

furnished to the USE. This includes information on winding up applications filed with a

court by the company or its subsidiary and any subsequent appointment of a receiver or

liquidator.

Information on share acquisition or disposal that affects the company structure must be

included. This information is extended to embrace sale of more than ten percent of the

company’s net assets.

The Listing Rules Manual has a general provision requiring disclosure of “major change

of business policy or operations.”176 The company information may be instrumental in

the investor’s decision to purchase shares and should therefore be given serious

175 USE Listing Rules Manual S. 2.33. 176 Ibid. Appendix 4, Item 1(15)

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consideration. Any shortcomings in the company following these rules may lead to

disciplinary or punitive action being taken by the SRO.

The manual specifies six disclosure policies 177. The first is the requirement of

immediate public disclosure of information in a company. This involves a company

being obliged to communicate a resolution of its board of directors that “could be price

sensitive” to the USE. This information must be given within one hour through

telephone, telefax, telex, hand delivered mail, or electronic mail.

The second requirement is that the information that the company gives to the USE must

be concurrently disclosed to the public. This could be done through newspaper articles,

radio announcements or other means in the public media.

The company must respond as promptly as possible to rumours, whether true or false,

that may affect trading in the company’s securities. An illustration of this was seen in an

article in “The Monitor Newspaper” of November 4, 1999 entitled “Uganda Clays is a

Good Deal” where Mr. Andrew Owiny178 responded to an article in the Sunday Monitor of

October 31 by Joseph Sserwadda entitled “Uganda Clays Sale Raw Deal” and dispelled

any rumours that the share valuation method used in the Uganda Clays Limited IPO was

flawed. This rumour would have affected secondary trading of the securities.

The company must look into unusual market activity and either correct it or if there is no

explanation for the activity, inform the public of its failure to account for the state of

affairs and add that there is no undisclosed material information.

177 Ibid. S.10.2 178 Executive Director MBEA Brokerage Services, lead brokers in the Uganda Clays IPO.

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The Listing Rules Manual prohibits excessive disclosure that would mislead investors or

cause unwarranted price movements and activities in the company’s securities.179 This

is a continuation to the disclosure requirement in the IPO and it gives a duty of care to

the directors based on the fact that investors in the secondary market may rely on the

information they give and any misrepresentation could be to the investors’ detriment.

Appendix five of the Listing Rules prescribes the “moral Code” and companies dealing in

securities must follow this provision.180 Directors’ transactions are limited and it must

first be shown that a director acted in good faith before his transaction can be deemed

valid.

The Listing Rules Manual supplements the rule against insider trading in the CMA

Statute181. The manual however is not as strict in its prohibition and says insiders

“should not trade” on the basis of confidential material information and should abstain

from trading for at least two weeks to allow the information to reach the public.182 The

Manual further gives guidelines as to when directors may buy and sell shares in their

companies183 and this is aimed at preventing the danger the investors face from

asymmetrical information and insider trading.

179 See the USE Listing Rules Manual Ibid S. 10.2(5) 180 Ibid. The listing Application, S.7.0 cited in S. Cohn and Fred Zake: Capital Market Development in Uganda. 181 CMA Statute S.89 182 The USE Listing Rules Manual S.10.2(6) 183Ibid, Appendix 5

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Over and above the prompt disclosure rule, companies are required to file periodic

reports with the USE.184 These are categorised into half yearly, preliminary year-end

and annual reports. The Half yearly reports must be filed with the USE not later than

three months after the close of the first six months of the financial year. The company

must also file preliminary year-end reports not later than three months after the end of

the financial year. The third and most important category is the annual report, which

must be given to the USE and shareholders not later than six moths after the end of the

financial year. This is slightly different from the annual report requirement under the

Companies Act185 that gives the time frame as forty-two days after the annual general

meeting.

From the above argument we see that subsequent disclosure requirements for

companies are crucial in enforcing investors’ rights and promoting investor confidence in

the secondary market and capital market in general. This investor confidence is

considered a major ingredient for capital market development. Insufficient public

disclosure may be counterproductive to the companies, which seek to use the secondary

market as a source of capital.

The licensing and regulation of the other members of the regulatory pyramid by the

Regulatory Agency is supplemented by a punitive role where the CMA may penalize

perpetrators of disclosure violations in the secondary market. The general antifraud

provision can be found in section 88 of the CMA Statute. This provision makes it

criminal for any person to employ a device, scheme or artifice, act or make an untrue

statement with intent to defraud in security transactions. This provision applies to all

184 Ibid. Appendix 4, Item 2 185 Cap 85 Law of Uganda, 1964. These requirements are in sections 125 and 127 and the Fifth Schedule.

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people who have a duty of care to the shareholders and are in a position to make

statements that can be relied on.186

The prohibition on insider trading in both the primary and secondary markets also covers

instances of “tipping” which occurs when an insider gives confidential information to third

parties for their use, thereby giving them an unfair advantage over other investors.187

Tipping is an offence if the insider passes the confidential information directly to the

“tippee” with the intention that the information be used.188 The tippee will only be liable if

he or she got the information directly from the insider, knew, or should reasonably know

that the insider is not permitted to use the information in question and the information

gathered is used to trade in securities and gain an unfair advantage.

The CMA Statute prohibits market manipulation, which is regarded as illegal activity by

insiders to alter the prices of securities upwards or downwards. Market manipulation

has a number of components that are expressly prohibited.

False trading practices involve creating a false impression that shares have a higher

demand or value than they really do usually through a series of transactions.189

Stock market manipulation involves multiple transactions that raise or lower stock prices

to induce the public to purchase or sell shares.190

186 The definition of an insider can be found in S. 89(8) of the Capital Markets Authority Statute, 1996 187 Capital Markets Authority Statute, 1996, S.89(4) 188 Ibid. S.89(2)(ii) 189 Ibid S.83(2) 190 Ibid S.84

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Fraudulent inducement to trade involves making an untrue statement either deliberately

or recklessly with the effect of price manipulation or inducing the public to transact in

securities.191 This inducement extends to deliberate or reckless concealment of facts or

publishing information that is known to be false and is aimed at price manipulation in the

market.192

It is an offence for a person to make a statement that a company’s share price may fall

because of the company’s violation of securities regulations. This statement must not be

made in good faith and the person should have colluded with the company or expects to

receive consideration for his statement.193

The USE as the SRO is empowered to assist the CMA in performing its functions and

duties194. The provision also further empowers the USE to suspend or expel any broker

or representative from the trading floor for malpractice.195 Details and particulars of the

disciplinary action taken by the USE must be reported to the CMA within a week.196

The CMA plays a punitive role and section 90 of the statute prescribes for punishments

for wilful or reckless violation of the duty of care by the company or individual. The fines

range from a maximum of ten million shillings or five years imprisonment for an

individual197, to a maximum of ten million shillings for a body corporate.198 The convicted

offender is also liable to compensate the aggrieved investor for any losses incurred as a

191 Ibid S.85 192 Ibid S.86 193 Ibid S.87 194Ibid, S.27(1) 195 The Exchange Rules, Op.cit. Rule 2.4(9) 196 The Capital Markets Authority Statute, 1996 S.27(2) 197 Ibid, S.90(1)(a) 198 Ibid, S.90(1)(b)

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result of his, or his agent’s unlawful actions199 and this compensation is the amount the

investor sustained in the loss.200 The court is further empowered to determine the extent

of an offender’s liability with regard to harm occasioned to the market as a whole201 and

any damages levied where the harmed people cannot be determined go to the

compensation fund.202

Regulations under the CMA Statute also prescribe sanctions. The Conduct of Business

Regulations for example provides for a fine of up to four million shillings for a licensee

who does not comply with its requirements without reasonable excuse.203 If this is a

continuing offence the fine may be revised by up to 100,000 for each day of the

offence.204

The USE and CMA are empowered to investigate the conduct of licensees to determine

whether there are any improprieties.205 These investigations could lead to injunctions

and actions in mandamus206 or temporary or permanent loss of license.207 These

decisions vary with the severity of the offence and are in the CMA’s jurisdiction. The

CMA Statute also provides for an appeal avenue against the CMA’s decision.208

As a last resort, the CMA is required to set up a compensation fund to mitigate the

losses the investor might suffer as a result of a licensed broker or dealer’s failure to meet

199 Ibid, S.90(2) 200 Ibid, S.9(3) 201 Ibid, S.90(4) 202 Ibid, S. 90(5) 203 Item 32. 204 S. Cohn/ F. Zake: Capital Markets Development in Uganda, Op.Cit. 205 Capital Markets Authority Statute, Ss. 20-21 and the Exchange Rules Rule 10.23(8) 206 Capital Markets Authority Statute, S.99 207 Ibid, S.45 208 Ibid, S.47

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a contractual duty.209 The sources of the funds include general contributions, initial

deposits paid by licensees,210 ill-gotten wealth where the beneficiaries are

unidentifiable,211 interest and profit from investing the fund, reimbursement from bodies

for whom fund payments have been made and other approved sources.212 The fund

could operate to help the investor avoid litigation and directly recover from the CMA, who

in turn, would seek to recover from the violating broker-dealer. The CMA however is

required by statute to go through judicial process to recover the money213 unless the

broker-dealer and the CMA reach an out-of-court settlement.

209 Ibid, Sections 82(1) and 6(1)(d) show the duty of the CMA to set up the fund. 210 For example, Part II of the Capital Market Authority (Licensing) Regulations, 1996 211 Capital Markets Authority Statute, S.90(5) 212 Stuart Cohn and Fred Zake: Capital Market Development in Uganda, Op.Cit. 213 Capital Markets Authority Statute, S.22

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Chapter Four:

Constraints to Government Regulation: The Conflict Between

Laissiez Faire and Dirigisme and its effect on Investor

Protection:

The capital markets regime in Uganda can at best be described as “infant.” This infancy

is reflected in the fact that the CMA and USE have only recently been established under

the Capital Markets Authority Statute. This chapter is aimed at analysing inadequacies

in Uganda’s market regulatory structure and the conflicts that undermine the CMAs

regulatory role. It further analyses contradictions between capital market regulation and

the need for development of a free market and their effect on investor protection in

Uganda.

The CMA has the contradictory duties of developing and regulating the market. This can

be seen by comparing their duty to protect the investor214 with the obligation of

implementing a system where the market is as self-regulatory as possible215 and

developing all aspects of the market and removing impediments to or creating incentives

for long-term investment216. We see dialectical materialism being manifested in the

Government employing a “cocktail approach” of oversight in the primary market and self-

regulation in the secondary market in trying to find a synthesis between the laissez-faire

214 Capital Markets Authority Statute, 1996. Section 6(1)(e) 215 Ibid, Section 6(1)(b) 216 Ibid, Section 6(1)(a)

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based positive theory as the thesis217 and the dirigisme-based normative theory as the

antithesis.218 This emphasises the conflict between the need for regulation based on the

supremacy of the investor, and the need to develop a free market fuelled by the forces of

demand and supply. The question that follows therefore is how much regulation should

the equity market have without negatively affecting the market?

As we saw in the previous chapters, the primary justification for dirigisme is the need to

protect the investor from market failures219. Their investment decisions are usually

based on second-hand information from better-informed insiders in the market and they

risk losing their investment if they do not fully understand the modus operandi of the

market. The Government220 therefore has the onus of preventing the insider from

unfairly using any informational advantage he may have to the vulnerable investor’s

detriment. This is done through regulation of the market with emphasis on disclosure

requirements and ensuring that there is no breach of the insiders’ duty of care to the

investor as a result of a conflict of interest. However, public ignorance or apathy, with

regard to the operation of the CMA, is a fundamental limitation to investor protection and

general capital market development.

Many entrepreneurs consider dirigisme not only unnecessary, but a restraint of trade

and a violation of their economic rights.221 The opponents of dirigisme believe that

Government intervention leads to perfect competition, which is “…a stationary situation

217 This involves the liberal common law norms of “caveat emptor” and non-interference by the Government, which favour entrepreneurs. 218 This equitable principle of fair play stresses Government intervention for investor protection 219 Capital Markets Authority Statute 1996. Section 6(1)(c) 220 through the CMA as a Regulatory Agency 221 The Constitution of the Republic of Uganda, 1995, Article 40(2) confers the right to practice a profession and carry on any lawful occupation, trade or business.

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in which all competitive activity has ceased…”222 They further dismiss the cocktail

approach of regulation, contending that laissez faire is a substitute for dirigisme and they

cannot function in the same economy.

“…The belief in the superiority of the free market over centrally controlled economies

and …the need for political guidance and Government decision making makes as much

sense as being half-pregnant…”223

Only two equities have been listed on the stock exchange224 and the volume of trade is

still very low. This raises the issue of jurisdiction of the regulatory authority. The CMA

has more control over public companies than private ones and focuses on establishing

public confidence through investor protection. Despite the benefits of getting listed,

many companies are reluctant to get listed and the level of compliance by the private

sector is still quite low. Until the market is well developed and companies bring

themselves within the CMA’s jurisdiction by meeting the listing requirements,

shareholders in a private company will not be afforded the protection that accrues as a

result of the company getting listed.

Uganda’s private sector is largely made up of small private enterprises with rudimentary

management structures. They mainly take the form of family businesses and their

directors and shareholders are usually one and the same. The owners of these

companies fear the loss of control in the form of voting power and management that

222 Gerard Jackson “Competition, Telecommunications and Ignorant Columnists”: The New Australian, No. 81, July 6-12, 1999. citing Milton Hayek 223 Ibid. Mr Jackson tries to dismiss “political guidance” as being contrary to free trade. 224 Uganda Clays Limited in 1999 and British American Tobacco Limited in 2000

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goes with listing the company225. It therefore follows that the founders’ mentality that a

company they put time, money and effort into would be taken over by shareholders is a

serious impediment to companies going public. This notion, however, becomes more

illusory as the company grows and the owner will find that the capital raised from selling

equities is adequate compensated for the loss of control.226

The adequate disclosure requirements in an IPO present a conflict between the need for

privacy for the company and its owners vis-à-vis the strict disclosure requirements set by

the CMA for listed companies. The term “transparency” implies that the company will be

“akin to living in a goldfish bowl”227 implying that public companies have disclosure

obligations that are not shared by private companies. As a result, many entrepreneurs

do not take kindly to the idea of exposing all the company and it’s directors’ “dirty linen”

in order to meet the adequate disclosure requirements. These disclosure requirements

make disclosure of any material information that would affect the company before and

after listing mandatory. The entrepreneurs fear that the strict initial and subsequent

disclosure requirements will negatively affect the public company’s share price by

making public any problems that the company might have and the market failure of

asymmetric information is still rife in private companies today.228 It should be noted

however that this fear, though real, is fast becoming illusory. Private companies cannot

grow in an informational vacuum.229 Banks creditors and business partners continuously

seek information about their histories, financial position and prospects and management

225 Nafula Awori: “Demistyfying the Decision to go Public: What does it Really Do for the Company?” Capital Markets Journal Volume 3, No. 1 January/ March, 1999, Page 7 226 S. Cohn and F. Zake: Capital Market Development in Uganda, Supra, Pages 93- 94 227 S. Cohn and F. Zake: Capital Market Development in Uganda, Supra, Page 92 228 This is a global problem. According to the CNN programme “Money Line with Lou Dobbs” on June 26,2001 companies in the USA have been accused of not reporting money paid as terminal benefits for laid off workers in a bid to make their companies financial position look more attractive to investors. 229 S. Cohn and F. Zake: Capital Market Development in Uganda, Supra

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structure in a bid to find out exactly whom they are dealing with. The Companies Act230

also requires the company to file annual returns with financial information similar to that

in a prospectus.

Taking into account the lack of a good corporate governance culture in Uganda, most

entrepreneurs look at the disclosure of financial statements and tax reports with

trepidation. They fear that disclosure may lead to civil and criminal liability. It is not

disputed that most of the companies in Uganda’s corporate sector have a poor taxpaying

reputation and many entrepreneurs fear that their initial and continuous disclosures

requirements in the capital market can lead to Government action against them for

underpayment or even non-payment of tax.231

The costs incurred in an IPO are an obstacle to companies’ participation in the stock

market. Up front costs incurred in paying the attorneys, accountants and consultant

involved in the IPO in addition to subsequent costs in preparation of periodic reports are

daunting to the entrepreneurs. In addition, many companies in Uganda are small and

cannot meet the capital requirements necessary for the IPO.

Uganda’s commercial legislation namely Companies Act232 and the CMA Statute and its

antecedent regulations, which are the major legislative instruments governing the capital

market, have been criticised as being too complex and hard to understand.233 Overlap

and contradictions especially in the provisions governing the securities market cause

230 Section 125 231 S. Cohn and F. Zake: Capital Market Development in Uganda, Supra, Page 92 232 1964, Cap 85, Laws of Uganda 233 The Companies Act in particular has been criticised as being antiquated and not catering for contemporary needs. It was derived from the UK Companies Act of 1948 and while the UK Act was amended the 1964 Companies Act has more or less remained intact.

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uncertainty with regard to jurisdiction of the respective laws thereby alluding to their

inadequacy. The duplicity and uncertainty in the law has been seen as a major source

of injustice, especially for the investor who seeks to rely on the legislation to enforce his

rights.234 This uncertainty could be because the law has been adopted in a vacuum since

there is no history of capital markets trading and it is based on laws governing other,

more developed markets. This signifies that the regulatory mechanism in the market is

still largely untested and based on western models.

In establishing the CMA, the Government recognised the need to represent all the

stakeholders’ interests and encourage them to participate in the decision-making

process. The CMA Statute235 prescribes a twelve-member authority representing the

interests of both the private and public sector.

The Minister of Finance appoints six members from the private sector to look after the

interests of private companies. The composition of the board is intended to represent a

wide range of people and institutions affected by capital markets in Uganda and provide

an avenue for the business community to voice their opinions and ensure that their

interests are kept paramount by giving them a say in the development of a law that might

affect their businesses. Currently, the privates sector institutions represented in the

CMA are: The Institute of Certified public Accountants, Uganda Law Society, Uganda

National Chamber of Commerce, Uganda Manufacturers Association, Insurance Institute

of Uganda and Uganda Bankers Association.236 These key institutions are instrumental

234 An example of this duplicity is the repetition of the third schedule to the Companies Act, 1964 in the Capital Markets (Prospectus Requirements) Regulations, 1996. 235 Section 5 236 Source: CMA Annual Report and Accounts 1998/ 1999

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in promoting the interests of the private businesses, which make up a large part of the

commercial sector in Uganda.

However, the question that arises is whether these "core stakeholders" represent the

entire business community in Uganda. The high standards required by the CMA might

alienate it from the business community and this might lead to companies not

appreciating the benefits of getting listed.

The prospectus, which has been described as the “long arm” of the regulator that seeks

“full and adequate disclosure” of all “material information” to assist the prospective

investor make an “informed decision”237 may defeat its purpose if the prospective

investor cannot comprehend the prospectus’ contents. The prospectus has a

“presentation puzzle” and is “styled in English with a host of technical jargon for a

population whose literacy rate is 62%.”238 The prospectus serves to give prospective

investors constructive notice of the company’s affairs and if the investor does not

understand the prospectus’ contents his chances of maintaining an action against an

insider if he incurs a loss are limited by “caveat emptor.”239 The CMA therefore faces a

daunting task of ensuring that companies disclose all material facts about their

companies, while attaining simplicity in the prospectus.

Many writers have understated the importance of disclosure requirements to the

investor. The most notable critic of the disclosure requirements was George Benston240,

237 Ms. Candy Wekesa: Prospectus: Protection or Puzzle; Capital Markets Authority Journal, Volume 4 Number 3 July/September, 2000. Page 26. 238 Ibid 239 Or “buyer beware” 240 George J. Benston: “Required Disclosure and the Stock Market: An Evaluation of the Stock Exchange Act of 1934,” American Economic Review, 63 (March 1973)., Pp. 132-155

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who contended that detailed reports are more useful to the trained analyst than the

ordinary stockholder.

“The analyst then passes on his information to his clients, or in any event, trades on the

information, thereby bringing its effect to the market. But does it get there by means of

the financial reports required?"241

The test is whether the disclosure leads to observable and significant changes in the

prices of securities to which that information relates. A negative answer would therefore

undermine disclosure requirements, which form the basis of investor protection.

A broker-dealer’s dual role of advising the investor and dealing on the stock market may

present a problem with regard to the broker-dealer’s interest in the transaction. When

the broker-dealer takes on a greater role than that of a middleman, he acts as both

agent and principal and might use any informational advantage he might get as a result

of his insider role in the market to the investor’s detriment.242

Market manipulation as a result of asymmetric information is still a problem in many

capital markets. These problems are mainly associated with the shortcomings in

criminalisation of insider trading. The enforcement of the “disclose or abstain” rule243

that prevents insiders from trading in securities if they have information not readily

available to the public is difficult if the disclosure is made to a third party. It is hard to

241 Ibid. 242 In Hughes v. Securities Exchange Commission, United States Court of Appeals, District of Columbia Circuit, 1949 174F.2d 969 it was held that a broker dealer’s informational advantage his position of trust with the investor gives him a duty of care to the investor. 243 Set in Hughes v. Securities Exchange Commission, Ibid.

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prove that inside information has been divulged to a third party and this makes the de

facto situation very different from the de jure with regard to preventing.

There are a number of extra-legal problems the capital markets face in protecting the

investor and promoting capital markets in Uganda. In Uganda the supply side still

leaves a lot to be desired. This means that there are fewer companies meeting the

listing requirements and there is very little competition. Investors wishing to “hedge”

their risks by diversifying their investments, will not have many options and this may lead

to the market failure of monopoly, which puts all their eggs in one basket. Meanwhile

the small companies that comprise the bigger part of Uganda’s corporate sector still rely

on debt securities as a source of capital and the competition puts a strain on capital

market development.

Uganda faces a shortage of professionals like lawyers and accountants who are familiar

with capital markets and who would help in facilitating capital market regulation. A

shortage of skilled personnel might lead to insufficient disclosure before and subsequent

to the IPO, thereby undermining investor protection by exposing the prospective investor

to a higher level of risk.

The investor compensation fund is established under the Capital Markets Authority

Statute244 as a source of compensation for an investor who suffers financial loss due to

market failures. It was meant to be an alternative to litigation, which can be expensive

and burdensome to the investor. The fund gets its resources from contributions,

licensees’ initial deposits,245 ill-gotten wealth where the beneficiaries are

244 Capital Markets Authority Statute, Sections 6(1)(d) and 82 245 Capital Markets Authority (Licensing) Regulations, 1996. Part II

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unascertainable,246 reimbursements and interest or profit from reinvesting the fund.

However, the immaturity of Uganda’s capital market limits the operation of the investor

compensation fund. Unless and until the market develops, the fund will not have enough

money to compensate the investor.

The Government has a duty to provide a suitable environment for the growth of the

capital market.247 However, Government policies have been criticised for not giving

incentives to promote private sector participation in the equities market and generally

discouraging the development of the capital markets industry. In particular, many blame

Uganda’s tax regime and cite the fact that the expenses incurred by a company during

its IPO are non-tax deductible248 as a major hindrance to companies’ participation in the

equities market.

The suitable environment can be extended to include a secure setting for investment,

which would encourage people to invest in long term projects. The Government must

therefore ensure that there is a good political climate by preventing internal discord and

civil strife, which would serve to discourage investors from participating in Uganda’s

equity and capital market. In pursuing this objective, the NRM Government has, since

1986, liberalised the economy and promoted the public sector by pursuing an aggressive

investment drive through the Uganda Investment Authority.

Through the “big push” initiative249 and the privatisation drive, particularly the divestiture

of its holdings in Uganda Clays Limited and British American Tobacco (Uganda) limited,

246 Capital Markets Authority Statute, 1996. Section 90 247 Ibid. Section 6(1)(e) 248 Section 31 of the Income Tax Act, 1997. 249 This involves attracting foreign investment by the CMA and UIA.

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the Government has played a big role in the development of Uganda’s capital market.

However, the number of equities being traded on the Uganda Securities Exchange is still

very low and this might negatively affect the development of the market. The

Government’s decision to look for strategic investors for the majority of the companies it

is privatising250 further undermines the development of the capital markets industry in

Uganda.

From the above analysis, one can be justified in contending that while it is not disputed

that dirigisme is necessary for investor protection, it only flourishes in a developed

capital market and Uganda’s market is far from developed. Evaluating the CMA's

performance today would be premature since it is too early to say whether a large

number of private companies will be listed on the stock exchange. However, the infancy

of the market and low volume of trade means that until the market achieves this growth

the CMA will play a limited role in investor protection in Uganda’s commercial sector.

250 For example, instead of privatising Uganda commercial Bank on the stock exchange, Government sought strategic investors and this has been very controversial.

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Chapter Five:

The Way Forward: Supporting Systems and Recommendations

for a Better Capital Markets Regime:

“The basic philosophy of regulation is to provide an environment where markets and

investments are encouraged to grow on a sound long-term basis… Maintaining the

integrity of the markets and investor confidence is fundamental to the achievement of

this goal.”251

This chapter examines the supporting systems necessary for the development of a

regulatory framework in Uganda’s capital market. This is a discussion of the legal and

extra-legal steps that should be taken to ensure that capital markets grow in line with the

goal of investor protection.

The global rise to prominence of capital markets shows the change in the public’s

perceptions with regard to the role of the state in business. The state was traditionally

seen as a provider, entrepreneur, regulator, and administrator of justice. It was

generally responsible for providing public services, redistributing wealth, and mitigating

the harshness of capitalism.252 In many developing countries, including Uganda, the

state was seen as the sole entrepreneur and even took deliberate steps to nationalise

and take responsibility for industry. An example is Dr. Milton Obote’s “Move to the

251 Ms. Candy Wekesa: Legal and Regulatory Issues in Capital Markets. Paper presented at a seminar entitled “Development and Regulation of Securities and Capital Markets, May 15- 26, 2000 at ILI-Uganda. Page 23

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Left”253 and particularly the “Nakivubo Pronouncements” of May 1, 1970, which placed

over sixty percent ownership of all means of production in the hands of the

Government.254 The recent liberalisation and divestiture of state enterprises in Uganda

and other African states shows that the state is moving away from the traditional role of

economic production to the more appropriate regulatory role in the economy.

Though the concept of capital markets is new to Uganda, having only begun in 1996 with

the enactment of the Capital Markets Authority Statute it is believed that it will bring

about a revolution ushering in new era in her commercial sector. The Government has

implemented policies focusing on “promoting private sector development …

strengthening public private sector partnership and abolition of state monopolies in

utilities such as electricity and telecommunications.”255 It therefore follows that with the

growth of the private sector and public participation in industry the provision of

appropriate measures of security for investors is necessary not only as a human rights

issue, but also to encourage investment both at the local and international level. These

policies are expected to result in overall economic growth and development.

Public perceptions of the market are influential to the development of capital markets. A

negative perception of the market not only discourages prospective investors, but could

also lead to people already in the market pulling out. Without active, unremitting public

support and participation, the market will wane from the lack of products and liquidity.

The CMA‘s primary focus is on building investor confidence through regulation.

252 Rumu Sarkar: Development Law and International Finance. Supra. Page 39 253 This policy was contained in the “Common Man’s Charter” of 1969. 254 Phares Mutibwa: Uganda Since Independence: A Story of Unfulfilled Hopes. Fountain Publishers- Kampala (1992). Page 70 255 H.E. Y.K. Museveni: “Uganda: Making Institutions Support Private Sector Growth.” Final Report; September 25, 2000. Page v

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Development of the market is contingent upon a number of supporting systems that

directly or indirectly affect capital market regime. Without these systems no regulatory

framework can exist and the regulatory institutions would be rendered inert.

Public awareness is a fundamental supporting system to the development of an efficient

equities market. As long as the public remains ignorant of what capital markets have to

offer, the markets will lack liquidity and continually lag behind due to the lack of

investment. The CMA increased public awareness through road shows and seminars

during the IPOs of Uganda Clays Limited and British American Tobacco (Uganda)

limited. With the support of the Austrian development agency, it also published a

number of informative brochures and leaflets256 and set up a website,257 which act as

sources of information about investment and the securities market in Uganda. To

supplement this, the Government should implement and finance a policy to inculcate

capital markets related subjects in secondary schools and tertiary institutions’

programmes of study.

Apart from training the general public, there should be an effort to improve the quality of

supporting professionals like lawyers and accountants who help in preparing a company

for its IPO. Their professional input is essential in the implementation of the due

diligence and adequate disclosure requirements prior to and after the IPO which are the

main tools of investor protection. The Government should concentrate on capacity

building to facilitate the operation of the equities and capital markets. This training

256 Simon Rutega: ”Events at the Uganda Securities Exchange” Capital Markets Journal, Vol. 4, no. 4, October/ January, 2001 257 www.ugandacapitalmarkets.co.ug. The CMA shares this website with the USE and Uganda Investment Authority

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should be extended to the media to increase their comprehension and reporting on

market issues.

There is a need to provide compliant laws to support market development. In Uganda,

the Companies Act258 is the main legislative document for regulation of the commercial

sector. This fifty year-old Act was derived from the 1948 British Companies Act, which

was drafted largely with large public companies in mind. 259 Since most of the

companies in Uganda are small private enterprises, Uganda’s Companies Act has been

deemed obsolete and condemned for not meeting the market participants’ needs. The

Government of Uganda through the Uganda Law Reform Commission is in the process

of implementing the Commercial Justice Reform Programme, which involves enacting a

new, more compliant Companies Act260. A new Companies Bill was proposed on

September 28, 1998261 based on the “core company law" approach. This approach

recommends that the Companies act slimmed down and simplified to cater for

contemporary business needs.262 The Law Reform Commission is pursuing these

recommendations and has commissioned attorneys and legal consultants263 to look into

the reform of the law of companies, joint ventures, co-operatives and partnerships in

Uganda. A stronger legal regime would provide better legal and regulatory provisions

than the current one under the 1964 Companies Act. The CMA is currently in the

process of preparing proposals for the amendment of sections 2, 40, 42, 43, 380, 381

258 1964, Cap 85 Laws of Uganda 259 Clare Manuel: Consultative Draft Paper on Key Draft Proposals for Reform of the Companies Act. Commercial Justice Reform Project, September 28, 1998. Page 2 260 This was based on recommendations from Reid and Priest, a US law firm commissioned by the Government in 1998, which prepared a background paper with over forty draft law proposals 261 This proposal was drawn up by Ms. Clare Manuel, a consultant with the Commercial Justice Reform Project 262 Clare Manuel: Consultative Draft Paper on Key Draft Proposals for Reform of the Companies Act. Op. Cit Page 2 263 This research is being carried out by attorneys and legal consultants at the Central Law Offices in Kampala.

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and 382 of the Companies Act, which mainly deal with disclosure requirements and the

registrar’s powers with regard to an IPO.

The “core company law approach” is also recommended to streamline the administrative

functions of the various regulatory organs and prevent a conflict in jurisdiction in the

capital market. Under the Capital Markets Authority Statute, the Registrar of Companies

or a person deputed by him or her in writing represents the Companies Registry on the

CMA board.264 This indicates a merger of the pre-existing, and the current regulatory

structure and is aimed at preventing conflict between the two institutions, which would

only serve to make the market less efficient.

With the advent of globalisation and regionalism there is a need to harmonise our laws

with those of our trading partners. This is more so with regard to Uganda’s participation

in regional economic groupings like the East African Community and Common Market

for Eastern and Southern Africa. The establishment of the East African Securities

Regulatory Authority is aimed at realising economies of scale, market growth and

increased liquidity in the member countries’ markets.265 This regional initiative is aimed

at deepening the region’s market further and attaining general capital market

development. The cross listing of East African Breweries on the Uganda Securities

Exchange in the first quarter of 2001 gave Ugandans an opportunity to benefit from

investing in an foreign company. Regional groupings can therefore act as supporting

systems and this state of affairs is fast becoming a norm of international economic

relations.

264 Ibid. section 5 (3)(e)

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The need to promote savings and exploit our resources more efficiently is a primary

supporting system to capital market development. Savings are a major source of capital

for the investor and symbolise demand for the equities. They would be more accessible

if the banking and pension sectors were strengthened. Uganda’s banking sector took a

nosedive in 1999 when a number of banks were closed due to mismanagement. The

highlight of this crisis was the closure of Greenland Bank on April 1, 1999. This eroded

public confidence in the banking sector and negatively affected the supporting system of

savings mobilisation. It is hoped that with the development of a strong banking system

the volume of investment will increase and lead to capital markets development.

The Government should strive to achieve a wide retail investment base along with a

strong institutional investment base. This will provide stability to the issuer and security

for the investor. This objective could be attained through collective investment schemes,

which encourage open-ended investment and broader public participation in equity

transactions. The Collective Investment Schemes Bill was tabled before Parliament and

approved in the first quarter of 2000.266 The schemes will further facilitate savings

mobilisation and bring the market closer to individual investors who could not afford to

invest earlier.

The Government should focus on promoting private sector participation in the equities

market and adopt economic policies that are more investor-friendly. The USE is currently

considering establishing an IPO trust fund that companies can access to cover their

professional and administrative costs. This is aimed at promoting listing through

265 Japheth Katto: “Capital Markets Authority Third Quarter Review”: Capital Markets Journal, Vol. 4 No.3 July/ September, 2000 266 Mr. Japheth Katto, CEO USE: “Review of the Activities at the Capital Markets Authority.” The Capital Markets Journal: Volume 4, No.2 April/June 2000, Page 4.

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offsetting the initial listing costs in an IPO.267 Incentives like tax exemptions favour

investment and make the market more competitive and attractive. An example of this is

the announcement by the Minister of Finance that transfers of shares listed on the

Uganda Securities Exchange will be exempt from stamp duty.268 These incentives could

facilitate the practice of “hedging” investment options, which the investors use to reduce

investment risks. This would boost investor confidence, which is essential to market

development.

The Government must support the regulatory enforcement mechanism. The CMA has

adopted a "merit review" standard where the regulatory agency allows the offer to go on

regardless of the risks as long as the company meets the disclosure requirements. The

CMA does not guarantee investors protection against normal market risks but ensures

that they are made aware of the risks involved in what are commonly referred to as

‘health warnings in advertisements and prospectuses.”269 This will ensure that the

market is fair and encourage investment. It is believed that the investor compensation

fund will act as a mitigating force, compensating the investors if they incur losses due to

market imperfections.

The supply side of the market must be improved if we want to achieve the desired levels

of growth. In addition to providing an exit mechanism for the Government in the

divestiture of its interests in Uganda Clays Limited and British American Tobacco

(Uganda) limited, the CMA has its eye on other companies in which the Government has

interests that it intends to divest. These include Kinyara Sugar Works, Uganda

267 Ms. Nafula Awori: “Demystifying the Decision to go Public: What does it do for the Company”: The Capital Markets Journal, Volume 3 No. 1. January/ March 1999, page 7. 268 Ibid.

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Commercial Bank, Bank of Baroda, Stanbic Bank, Barclays Bank and Uganda Telecom

Limited270. The involvement of the CMA in the privatisation process shows the

confidence the Government has in the capital markets and is intended to motivate

private sector corporations and investors to utilise the equities market as a source of

capital and an avenue for investment.

The importance of corporate governance as a supporting system cannot be understated.

Considering the predominance of family business corporate structures in Uganda it is

essential to stress professionalism and good corporate governance in the administration

of these companies. Companies that do not meet the CMA’s corporate governance

requirements do not qualify to trade on the stock market. The need for depth and an

increase in the volume of trade through companies participating in the equities market

therefore necessitates meeting these requirements.

A viable capital market can only exist where the Government plays an active extra-legal

role in assuring security and a good investment climate. Any political upheaval would be

detrimental to capital market development since it would discourage long-term

investment. The Government’s relative improvement in national security and

concentration on improving her economy through pursuing an aggressive investment

promotion drive has encouraged foreign direct investment that brings depth to the

market. The Government could also promote investment by facilitating the regulatory

organisations. Computerising the USE, for instance would increase efficiency in the

market and boost investor confidence.

269 Mbumba S. Kapumpa: “Investor Protection in the Zambian Securities Market”- Capital Markets Journal Vol. 4. No.1 January/ March, 2000, Page 15 270 Mr. Japheth Katto, CEO USE: “Review of the Activities at the Capital Markets Authority.” The Capital Markets Journal: Volume 4, No.2 April/June 2000, Page 4.

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There are three main beliefs that justify the formation and development of an equity

market in Uganda. The first is that there is no scarcity of resources to invest in

“productive, transparent and well-managed enterprise.”271 The second is that the

development of an equity market is a long-term affair and the capital market regime in

Uganda is, indeed, a going concern. The third is that many medium sized businesses in

Uganda are family owned and financed “through high cost debt”272 and an alternative

source of capital must be sought. The capital market in Uganda is fast growing and it is

justifiable to say that investor protection and market development are complimentary

factors and a market cannot have one without the other. This interdependence makes

capital markets and particularly equities markets complex operations dependent on

many contingencies for survival.

The Government has already started implementing reform policies to strengthen the

CMA and has boosted the equities market through its public enterprise reform and

divestiture programme. However, It is not sufficient for the Government to set up the

institutions and pass appropriate legislation then leave the rest to the privatisation unit.

It is not possible to judge the performance of the market based on divestiture of state

enterprises and it still remains to be seen whether Uganda’s equities market will be

successful in the private sector. One can only infer from looking at market success and

prominence in other countries like the United States of America that capital markets are

viable avenues for investment and a major contributor to economic development.

271 Mr. Simon Rutega: Events at the Uganda Securities Exchange: Capital Markets Journal, Vol. 4, No. 1, January/ March, 2000, Page 4 272 Ibid

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In conclusion, the development of an efficient capital market requires alliances between

the state and private interests. A developed capital market is of benefit to investors,

entrepreneurs and the economy as a whole. The benefits include:

“(a) mobilization of long-term savings for long-tenured investments, (b) providing risk

capital (equity) to entrepreneurs, (c) broadening ownership of firms, and (d) improving

the efficiency of resource allocation through competitive pricing.”273

The investor is the lifeblood of the capital markets industry and the supremacy of his

interests is the major basis for regulation of equity and capital markets. The state must

ensure that it develops public confidence in the market and this will lead to better

resource utilisation, easier access to capital, promotion of industry, wealth creation and

general economic growth and development.

273 Sam Q. Ziorklui, Howard University: Capital Market Development and Growth in Sub-Saharan Africa: The Case of Tanzania: African Economic Policy Discussion Paper Number 79, February 2001

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APPENDIX A:

THE REGULATORY PYRAMID274

THE REGULATORY AGENCY

THE SELF REGULATORY AGENCY

LICENSEES (Compliance Departments and Personnel)

274 Source: Ms. Candy Wekesa: Legal and Regulatory Issues in Capital Markets- “Objectives of the Presentation”: Paper presented at a seminar entitled “Development and Regulation of Securities and Capital Markets, May 15- 26, 2000 at ILI-Uganda, page 3

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APPENDIX B:

THE PYRAMID OF LEGISLATION275

PARENT LAW

SRO CONSTITUTION

SRO RULES AND REGULATIONS

LICENSEES CODES OF CONDUCT AND PROCEDURE MANUALS

275 Source: Ms. Candy Wekesa: Legal and Regulatory Issues in Capital Markets. Paper presented at a seminar entitled “Development and Regulation of Securities and Capital Markets, May 15- 26, 2000 at ILI-Uganda, page 6.

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