12: Raising Long-Term Financing
12-2a CONFLICTS OF INTEREST FACING INVESTMENT BANKS
The institutional arrangements for selling securities to the public, as described above, confront investment
banks with potential conflicts of interest. Banks are providing advice and underwriting services to
companies that want to issue securities. On the one hand, issuing firms want to obtain the highest
possible price for their shares. But they also want favourable coverage from their investment banks’
research analysts, who produce reports that are intended to advise clients on whether securities are fairly
priced. Investors, on the other hand, want to purchase securities at the lowest price possible, but they
also value dispassionate, unbiased advice from analysts. Investment bankers must therefore walk a thin
line, in terms of both ethics and economics, when attempting to please their constituents. Firms issuing
securities are wise to bear this in mind. Investment bankers deal with investors, particularly institutional
investors such as mutual funds, on a repeated basis. They must approach this group each time they
bring a new offering to market. In contrast, over the life of a firm, there is just one IPO and perhaps a
few SEOs.
Banks struggle with these conflict-of-interest problems; instead, they must price new security
issues to strike a balance between the revenue maximisation goal of the issuing firms and the profit
maximisation objective of their investing clients. Of course, lawmakers and regulators recognise that the
investment banking business is susceptible to conflict-of-interest problems, and so there is an extensive
set of rules that impose constraints on how securities may be sold. The Facebook IPO debacle (discussed
in Chapter 20) provides an example of these issues. As a result of litigation in relation to the Facebook
IPO, Nasdaq OMX Group agreed to settle a class-action lawsuit for US$26.5 million, in addition to a
penalty of US$10 million paid to the US Securities and Exchange Commission.^2 The lead investment
bankers behind the IPO, Morgan Stanley, were also fined US$5 million for their part in allowing
investment bankers to influence the activities of investment research analysts, who were supposed to
provide independent research about the equity issue.
Now we turn to a brief overview of the legal environment surrounding security issues.
12-2b LEGAL RULES GOVERNING PUBLIC SECURITY SALES
The basis for the regulation of the sale of securities is the concept of full disclosure, which means that
issuers must reveal all relevant information concerning the company selling the securities and the
securities themselves to potential investors.
Given the emphasis that securities law places on disclosure, it is not surprising that investment
banks are required to perform due diligence examinations of potential security issuers. This means that
they must search out all relevant information about an issuer before selling securities to the public.
Investors can sue underwriters if they do not perform adequate due diligence; of course, in such cases
the underwriter’s reputation suffers as well. The fact that investment banks are willing to underwrite an
issue provides valuable certification that the issuing company is in fact disclosing all material information.
In Australia, financial markets are regulated by the Corporations Act 2001, which is administered
by the Australian Securities and Investments Commission (ASIC) under the Australian Securities
and Investments Commission Act 2001. Companies choosing to raise funds in Australia need to
follow the various rules and regulations set out by ASIC, and these are available on the ASIC website
(http://www.asic.gov.au). The principal disclosure document for all public security offerings is the
2 ‘NASDAQ to settle Facebook IPO lawsuit for $26.5 million’. Reuters, 23 April 2015. http://www.reuters.com/article/us-nasdaq-omx-facebook-
litigation-idUSKBN0NE1FD20150423. Accessed 15 December 2015.
full disclosure
Requires issuers to reveal
all relevant information
concerning the company
selling the securities and
the securities themselves to
potential investors
due diligence
Examination of potential
security issuers in which
investment banks are legally
required to search out
and disclose all relevant
information about an issuer
before selling securities to
the public
certification
Assurance that the issuing
company is in fact disclosing
all material information
Tim Jenkinson, Oxford
University
‘There are basically
three ways of doing an
IPO.’
See the entire interview on
the CourseMate website.
COURSEMATE
SMART VIDEO
Source: Cengage Learning