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Corruption and Weak Markets: The BW Resources Stock Market Scam CLARENCE PASCUAL AND JOSEPH LIM Introduction The BW Resources price manipulation scandal rocked the local stock market in 1999. The case provided the backdrop for one of the most dramatic moments in the impeachment trial of then President Joseph Estrada- the testimony of former Finance Secretary Edgardo Espiritu against his former boss. Its inclusion in the impeachment charges against Estrada signaled the growing importance of the stock market in our national life. It also showed that the stock market cannot be divorced from the larger social and political context. The stock exchange is the icon of a free market where prices are determined solely by the interaction of supply and demand and transactions are carried out on an arm's-length basis. But as the BW scandal indicated, market performance is only as good as the quality of institutions within and outside the market. (Lim, 2001) In this case, the interaction of anachronistic market institutions and political corruption in the context of a liberalized but poorly regulated market produced a crisis of unprecedented scale.
Pascual & lim From P2 at the start of 1999, the price of shares of stock of BW Resources Corp. (henceforth, BW) reached a high of P107 on October 11 of the same year. (Fig. 1) Acquired by Dante Tan, an Estrada crony, BW was hyped as a listing ve- hicle for Estrada's various business interests, particularly in gaming and property development. Massive trading in the stock overwhelmed a lethargic market. The average value of daily trades reached P3.1 billion in 1999, as compared with P2.7 billion in 1996 when emerging markets like the Philippines were at their peak. At the height of the bubble, trading in BW shares accounted for as much as half of total market turnover. Within a week after it peaked, the stock lost 60 percent of its value. By February 2000, it had dropped to P3 a share. 2,700 2,600 2,500 2,400 2,300 2,200 2,100 2,000 1,900 1,800 1,700 Figure 1. Price of BW Shares and the Phisix, 1999 (Source of basic data: Technistock) BW (rhs) 100 90 80 70 60 Ul 50 0 Ul Gl a. 40 30 20 10 The phenomenal rise and fall in the price of BW shares was a classic stock market bubble. But it was more than just a bubble: it was also a swindle of a scale unprecedented in the history of the exchange. Investigations by the Philippine Stock Exchange (PSE) and the Securities and Exchange Commission (SEC) revealed a grand scheme of market manipulation. It involved several Estrada cronies led by 110 PUBLIC POLICY
Corruption and Weak Markets: The BW Resources Stock Market Scam Tan, a close circle of friends and relatives and a group of influential brokers. Perpe- trated for the benefit of Estrada and the members of his family, it combined ele- ments of political corruption and financial fraud or market manipulation. This paper examines the role of political corruption in the scandal, the nature of institutions within the stock exchange and the state of market regulation. The BW scandai provides a fascinating study of how political corruption during the Estrada administration underwent significant transformation in both magnitude and scope. Gains acquired through traditional methods of political corruption- grants of franchises, government contracts and behest loans- were leveraged in the securities market for greater profit, albeit through fraud. The use of state-controlled fi- nancial institutions to abet this process marked another milestone in the history of corruption in the Philippines. What set the BW scam apart from the equally grand schemes of corruption during the Estrada administration was the combination of political corruption and financial fraud. But why is the Philippine stock market vulnerable to this new type of corruption? This paper argues that the answer may be found in the nature of insti- What set the BW scam apart from the equally grand schemes of corruption during the Estrada administration was the combination of political corruption and financial fraud. tutions within the stock exchange and in the poor regulatory framework that gov- erns the market. Ownership and control of the stock exchange by family-controlled houses, high ownership concentration among listed stocks, the influence of infor- mal networks and the absence of an independent, effective regulatory mechanism render the exchange vulnerable to corruption. These institutions work against a transparency of transactions and the fair price formation essential to the growth of capital markets. Weak market institutions and poor governance pose a serious challenge to de- regulation, liberalization and the growth of markets. Weak market institutions al- low a corrupt state to extend its 'grabbing hand' beyond its traditional spheres of influence either in the public sphere or at the interface of the public and private VOLUME V NUMBER 1 January-June 2001 111
Pascual & Lim spheres. In such a context, the growth of the market could imply greater volatility and risk of crisis. As the BW scam shows, the growth of the Philippine stock market as a result of capital account liberalization in the early 1990s magnified the risk of financial fraud and crisis. The reorganization of the exchange (two bourses were merged into a single exchange) and the opening up of the market to foreign players did not alter the structure of economic interests that underlay the market. Partly as a consequence, market regulation barely improved. The result was a greater risk of crisis as the potential gains from financial fraud increased even as market regulation remained poor. The discussion below is divided into three parts. The first part discusses the role of political corruption in the BW scam. The second part examines market ma- nipulation and identifies features of the stock exchange that render it vulnerable to financial corruption. The third part shows the failure of market regulation with respect to the BW case. It traces weak governance to the structure of interests in the stock exchange, weak regulatory capacity and the permeability of regulatory agen- cies to the influence of vested interests and political pressure. Political corruption: old and new The first element of the BW stock market scam -which received the most attention- is political corruption. The case showed the persistence of old forms of corruption and the emergence of new ones. The grant of franchises, govern- ment contracts and behest loans by state agencies (government-owned or- controlled corporations) are familiar tricks of the trade among the politically corrupt. Moreover, the nature of these privileges, the way they were approved, contested and confirmed betrayed the powerful hand of the President. What was new in the BW case was the capture of the stock market by the President and his cronies to leverage assets acquired through corruption for greater prof- its. Scams do not always have to begin as one. Tan's foray into stock trading could have been inspired by a legitimate business idea: to transform BW Resources (for- merly Greater Asia Resources Corp) into the gaming stock of the market. The vi- 112 PUBLIC POLICY