Boards look to independents to resolve takeover conflicts

By Nick Stride

Friday 17th September 2004

A sharebroker's investment banking arm wins the mandate to defend a company against a hostile takeover bid. Almost immediately, its equity analyst finds reasons to hike the target company's valuation.

A broker acts as lead manager in a listing and stuffs its clients' accounts full of the shares. Within a matter of weeks, the company downgrades its profit forecast and the shares fall to almost half the issue price.

It sounds like Wall Street pre-Enron. But both are well-known examples of shenanigans right here within the last two years.

New Zealand investment banks have at least escaped the lawsuits and huge settlements US firms have endured. In the past two years US brokers have paid more than $US4 billion in fines and settlements for underwriting and research practices, and Citigroup has set aside $US6.7 billion for further claims.

But although little has been said publicly about investment banking conflicts of interest, New Zealand regulators such as the Securities Commission have been collecting examples and are watching the reforms proposed by their counterparts in the US and Australia.

Possibly of even greater significance for the banks is evidence the boards of listed companies themselves are beginning to order their affairs differently.

A good recent example is the sale of British Airways' 18.2% stake in Qantas. BA retained independent adviser Caliburn to run the process.

Caliburn asked five banks to make an offer for the shares and unconditionally underwrite the sale, effectively auctioning them to the highest bidder and making the bank take the entire risk of the secondary sale.

In New Zealand the rapid growth of independents such as Cameron & Co, which advises boards involved in mergers and acquisitions work or responding to takeover offers, suggests local boards are also putting a greater value on independence.

One conflict is between the interests of the bank and those of its investor clients, who are supplied with research and recommendations by analysts the bank employs.

It can go both ways. Notorious US cases have involved analysts recommending to investors floats of companies they consider to be rubbish because their investment banking department is handling the float.

The other way round, a bank that is both selling an initial public offering to its own investor client base and deciding how the issue will be priced and allocated can have an incentive to favour its investors.

The book-build method investment banks use to set pricing is a "black box" process that isn't transparent to the issuer's management, which has to trust the bank to run the process in such a way as to maximise the price.

But the bank has an incentive to keep its investors a regular source of income sweet.

Corporate finance theory says both parties should be satisfied with a 10% premium in first-day trading but the average in the US is 15% or more.

In the US the response from the New York Stock Exchange and the National Association of Securities Dealers has been to propose that companies be required to establish a "pricing committee" to oversee share issues.

At least one member will have to be independent of management, and the committee must be informed about all indications of interest the lead managers receive and about all allocations.

New Zealand investment banks might have something to learn from the experience of their Australian counterparts.

In a speech about ethics in sharebroking given in May, the Australian Stock Exchange's chief integrity officer, Karen Hamilton, suggested best practice guidelines for analyst independence had met resistance, if not downright hostility, from the industry.

Legislation is now making its way through the Australian Parliament.

Said Ms Hamilton: "Regrettably it has been a missed opportunity for the industry to lead rather than follow the debate."

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