Chinese walls need a leak test

By Shoeshine

Friday 25th October 2002

You know this country's investment banking industry is on its last legs when the merest suggestion it may have an independence problem provokes howls of outrage.

That was the reaction of Infinz, the merged body formed from the societies of investment analysts and corporate treasurers, to a vague and inconclusive six-paragraph mention of the subject in Corporate Transparency: Making Markets Work Better, the Institute of Chartered Accountants' (Icanz) exposure paper on regulation post-Enron.

Under the heading "options from greater disclosure to prohibiting investment bankers offering advice on share values," the institute noted a "possible problem" of advisors offering both merchant-banking services and advice on the value of companies to which those services are provided.

But it said merely it welcomed views on the subject.

Infinz's reaction was to tell the beancounters in pretty plain terms that the "problem" under consideration was auditors' independence, not analysts'.

Nonetheless, the Ministry of Economic Development is considering Securities Commission recommendations on the regime that governs investment advisers generally. As Icanz notes, it's unclear whether the review will extend to conflicts of interest within investment banks.

That there is a problem to consider is beyond argument.

New Zealand has yet to offer anything nearly as entertaining as the shenanigans of the big US investment banks and their humiliation following the April 2000 tech-wreck and subsequent corporate scandals.

Probably the best-known case is Merrill Lynch and its former celebrity tech-stock analyst, Henry Blodgett.

Blodgett, along with Morgan Stanley's Mary Meeker and a few others, achieved star status by tipping internet stocks such as Amazon.com in the days when you could float anything beginning with "e-" and see it trade at astronomical prices.

Blodgett's career took a turn for the worse early last year when New York State attorney general Eliot Spitzer filed legal action against Merrill Lynch, Blodgett, and a raft of other Thundering Herd analysts.

Spitzer alleged Merrill's stock recommendations were "biased and distorted in an attempt to secure and maintain lucrative contracts for investment banking services" in what he described as "a shocking betrayal of trust by one of Wall Street's most trusted names."

You might imagine this sort of stuff would be pretty hard to prove and would involve long drawn-out litigation.

But Spitzer had secured more than 30,000 Merrill internal emails. He had only to wave messages from analysts describing stocks they were tipping as "a piece of junk" and "a piece of s**t" and Merrill caved in, agreeing to pay the state $US100 million although, of course, without any admission of wrongdoing.

The issue of investment bank conflicts of interest down these parts warrants, as the Law Society submitted, further examination.

Take this year's Vertex float.

The IPO opened on June 10 with shares offered at $2.05. Even before the offer had closed various commentators had pointed out the profit forecasts were, to say the least, highly optimistic.

Vertex's lead manager and underwriter was JB Were, the country's biggest retail sharebroker.

Shortly after the float, Were's Vertex analyst rated the company a "buy" with a valuation of $2.68.

Only a few weeks later, on September 4, Vertex announced it was downgrading its profit forecasts dramatically due to the poor performance of its two "blue sky" units.

The market punished the stock severely, sending it to its current low of $1.14. Both the Market Surveillance Panel and the Securities Commission are investigating.

One of the arguments Infinz mounts against regulatory interest in investment banks is that professional investors are perfectly well aware of possible conflicts and take account of them. "A conflict that is acknowledged is a conflict that is controlled," the society reckons, arguing all that is needed is sufficient disclosure to bring retail investors into the loop.

But that didn't stop Alliance Capital surely a sophisticated, highly informed investor building up a 13.3% Vertex stake on behalf of Axa Asia-Pacific shortly before the company dropped its profit bombshell.

The society argues more convincingly that investment research is a high-cost loss-leader as analyst research is worthwhile only if it supports a firm's corporate finance arm and its client advisers.

Among pure sharebrokers with no significant investment banking business there is next to no meaningful company research. Were investment banks to be prohibited from providing research on any company they did business with it's possible no research would be done at all.

Hence Infinz's over-the-top reaction. With so many international banks having already pulled out and others tipped to follow, there are few enough jobs for the society's members as it is.

But surely it can't hurt to give the investment banks' Chinese walls a building inspection.

IT Capital shareholders fired up

IT Capital's dynamic duo, Maurice Bryham and David McKee-Wright, have been attracting a bit of attention from unwelcome quarters. Shoeshine understands the Securities Commission is pondering their sale last month of 8.75 million shares apiece to Taiwan's Glory Lake, raising $700,000.

At issue is what the duo knew at the time about funding problems at Conceptual Solutionz and the stage of negotiations to sell Terabyte.

Also of interest regarding the sales is an apparent breach of a condition of the Takeovers Panel's exemption notice allowing the duo to get more than 40% of IT Capital without making a code offer.

This has really annoyed some IT Capital shareholders. Watch this space.

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