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Wednesday, April 1, 2009
Slim chances

Unlisted securities are shares in public or private companies not Listed on an exchange licensed by the FSB or not included in the List of securities kept by an exchange. Trading in these securities takes place over the counter.

Legislative background
The Companies Act, 1973

The trading of unlisted securities is regulated in terms of the Companies Act, 1973, which is administered by the Department of Trade and Industry. All companies in South Africa must be registered with the Registrar of Companies and must comply with all the relevant provisions of the Companies Act. The Registrar of Companies has the power to investigate any contraventions of this Act.

The Securities Services Act, 2004 (SSA)

The objects of this Act are to:
• increase confidence in South African financial markets by requiring fair, efficient and transparent securities services which contribute to the maintenance of a stable financial market environment;
• promote the protection of regulated persons and clients;
• reduce systemic risk; and
• promote international competitiveness of securities services.

The Act regulates securities services, being services regarding the buying and selling of securities, the custody and administration of securities, the management of securities by a member of an exchange, and the clearing and settlement of transactions in listed securities.
The term ‘securities’ includes shares, stocks and depository receipts in public companies and other equivalent equities, notes, derivatives instruments, bonds, debentures, participatory interests in a collective investment scheme and instruments based on an index, but specifically excludes money market instruments (except regarding the custody and administration of securities).
The SSA regulates the trading of unlisted securities to some extent. Section 20 of the Act states that the Registrar of Securities Services may prohibit a person from buying or selling unlisted securities if such business defeats the objects of the Act. The Registrar may also impose conditions for the carrying on of such business or may prescribe conditions where specified types of unlisted securities may be bought or sold. This is a reactive approach compared to the regulation of listed securities as the FSB does not license such business up front.
Unlisted companies are entitled to facilitate the buying and selling of their own securities to investors. However, companies are not allowed to operate an exchange without being licensed by the FSB. The SSA defines an exchange as someone who constitutes, maintains and provides an infrastructure:
• for bringing together buyers and sellers of securities;
• for matching the orders for securities of multiple buyers and sellers; and
• whereby a matched order for securities constitutes a transaction.

Financial Advisory and Intermediary Services Act, 2002 (FAIS Act)

The FAIS Act regulates the rendering of financial advisory and intermediary services to clients. The Act’s main objectives are to protect the interests of consumers and to professionalise the financial services industry.
In terms of the FAIS Act nobody is allowed to render financial services regarding financial products as a regular feature of his or her business without being authorised as a financial services provider or appointed as a representative of an authorised provider.
Shares in a company other than a “share block company” as defined in the Share Blocks Control Act, 1 990, and any product issued by a foreign product supplier and marketed in South Africa which is similar to a “share in a company”, qualifies as a financial product. Therefore, the FAIS Act regulates the rendering of financial services to clients with respect to unlisted shares in public and private companies (local or foreign).
Consumers who wish to conduct financial services business with an institution or person are advised to check beforehand with the FSB whether such an institution or person is authorised to render financial services, or if the institution or person is appointed as a representative of an authorised financial services provider.

Risks of trading in unlisted securities
There are a number of risks investors should take into consideration before investing in unlisted securities. A few important ones are discussed below:

Lack of a regulatory framework

Investors do not enjoy the same protection by the SSA and the protection mechanisms provided by a licensed exchange, eg many deals are done by private placing companies which do not have to publish a prospectus.
Unlisted securities are issued by companies that either choose not to, or are unable to meet the stringent listing requirements of licensed exchanges. Unlisted securities are not subject to the same substantive requirements. Listed companies must meet minimum listing standards such as having minimum amounts of capital. Conversely, unlisted companies do not have to meet any minimum standards. Disclosure requirements for unlisted securities are less stringent compared to listed securities.
Since the market for unlisted securities is usually controlled by a single market maker, the securities are subject to price manipulation. The brokers on the inside can create false volume by trading among themselves, artificially raising the price on little volume. In the classic “pump and dump” scams, once they inflate the price, such brokers will dump their securities to unsuspecting investors. Such investors will find that once they buy these securities there are no other buyers, with the result that the price will plummet. The provisions of the SSA to take action against market abuse practices, such as insider trading, market manipulation and the publication of misleading statements, do not apply to the trading of unlisted securities.

Copyright © Insurance Times and Investments® Vol:22.4 1st April, 2009
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