The Employees’ Provident Fund (EPF) has suffered close to Rs. 20 billion in losses from bond and equity market investments, with an additional Rs. 12 billion in foregone earnings, as a result of bypassing due process and investing in unlisted equity, according to a new report by Verité Research.
The report has calculated these losses and foregone earnings by analysing the findings of two forensic audit reports commissioned after a series of investigations into the infamous ‘bond scam’ of 2015.
The key findings of the report are: Bond market losses: The EPF incurred losses of Rs. 9,826 million (2002-2015) as a result of acquiring bonds at unfavourable prices.
Equity market losses: The EPF incurred losses of Rs. 9,859 million (1998-2017) from irregular investments in the equity (share) market, most of it a result of the ‘pumping-and-dumping’ of shares to the EPF.
Unaccounted equity losses: The EPF also incurred Rs. 12,382 million (2007-2017) as foregone earnings by investing in unlisted companies instead of Government securities, which provide fixed positive returns every year.
The full extent of the losses is not captured due to two serious limitations in the forensic audits. (i) The bond market audit only covers transactions up to February 2015, excluding losses that occurred in the aftermath of the ‘bond scam’ of February 2015 and (ii) The audits identify only the direct losses from transactions where there is documentable violation/an anomaly in the conduct of the transaction; the foregone earnings from such transactions are not reported by the audits
The EPF investments in the stock market returning less than 5% when the market index increased byover 100% is not identifiable as a loss in the forensic audit methodology. Only transactions that can be traced topump-and-dump schemes or are identified as violating the investment guidelines are identified as causing losses.
Such limitations significantly reduce the scope of what can be estimated on the losses incurred by the EPF – makingwhat has been enumerated by these forensic audits akin to the visible tip of the iceberg.
The majority of the EPF’s bond market losses, identified totalling LKR 8,973 million, stem from transactions in theprimary market where government securities are bought through direct placement from the Public Debt Department (PDD) of the Central Bank.
In this transaction method, the yield of the securities is fixed through an offer made by the PDD, unlike in auctions where the prices are determined through competitive bidding among multiple investors.
Theoffers can be public and the same for all market participants, but it has in the past also been private and differentto different market participants. This private offer arrangement is not transparent and prone to abuse.
The EPF is particularly vulnerable as the Central Bank that offers the debt through its PDD (as the agent of the government) can also be the buyer through its EPF department (as the custodian of the EPF). The standard practice for deciding the yield of a security sold through direct placement has been to base it on the weighted average market price of the previous auction. The forensic audit evaluates cases where the EPF faced losses from purchasing direct placements at off-market prices. See Box 1 for the forensic audit methodology in calculating the losses
