Party Poopers

IPOs aren't half the fun they once were now that bankers and analysts can't mix.

Ironically, it was at a posh meal on Nantucket this summer that Ralph Castner, CFO of sporting goods retailer Cabela’s Inc., saw a vivid example of how much tougher life has become for investment bankers.

Wachovia Securities, which served as co-manager of Sidney, Nebraska-based Cabela’s 2004 initial public offering, had invited Castner and several other major clients to an annual event it sponsors on the island. Castner arrived at a dinner one evening to find investment bankers and sell-side analysts wearing color-coded name tags — a fact that struck him as odd until he noticed the team of compliance officers roaming the party.

In a setting tailor-made for deal-making, he recalls, “there was a group of people at the party to make sure the investment bankers and the sell-side guys were never talking to me at the same time.”

The chummy world of investment banking hasn’t been the same since New York State Attorney General Eliot Spitzer exposed widespread conflicts of interest and pervasive unfair trading back in 2002. Spitzer’s investigation proved that the compensation of sell-side equity analysts was tied to their ability to pull in big IPO clients, giving them an incentive to hype mediocre stocks. It also showed that investment bankers were attracting new clients by promising CEOs preferential treatment in the allocation of shares in valuable IPOs.

The revelations eventually caused 10 major investment banks to agree to the so-called global settlement in 2003, which obliged them to pay sizable fines, bar analysts and investment bankers from collaborating, and make IPO allocations more fair. Investment banks were thus deprived of their two best tools for attracting potential IPO clients — a particularly hard blow, coming as it did just as the IPO market went into the doldrums, from which it is only now beginning to recover.

“How banks sell themselves and try to gain underwriting business is what has really changed,” says David Fisher, CFO of Chicago-based online options and stock broker OptionsXpress Holdings Inc. Fisher, who helped take OptionsXpress public in January, also has experience in the pre-Spitzer era, having been CFO of Prism Financial when it went public in 1999.

“Before Spitzer, they would lead with their analyst, and a primary selling point was analyst coverage,” says Fisher. “Now, investment bankers need to try to differentiate themselves. The problem is that they all do the same thing. If you are sitting there in a pitch meeting and going through five or six different bulge-bracket firms, they can all do the job. They can all get you a meeting with Fidelity or Putnam.”

Lost in the Crowd

To the extent that investment banking services have been commoditized, it’s not easy for specific banks to stand out in the crowd. Assuming that most have relationships with key investors in the IPO candidate’s field, a major selling point is the bank’s distribution network — which suggests a competitive advantage for large institutions that have networks of retail brokers.

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