Competitive, up to a Point
Lawyers say it would be hard to argue that an investment bank has a legal conflict of interest when representing an underwriting client, or that it has any formal fiduciary duty to that client (see “Legal Liability: Little to None” at the end of this article). Still, its role as a go-between for issuers and investors is a legitimate concern.
“The investment bank is clearly in the position of having two customers at the same time in the same transaction,” says attorney Daniel Berick, a partner at Squire, Sanders & Dempsey. “It’s got a product it wants to sell to its buy-side customers, and it’s also going to get a fee for arranging that sale from the issuer.”
Corporations, Berick suggests, can easily lose sight of the bank’s dual allegiance. “They’re spending an awful lot of time in conference rooms with lawyers and their investment bankers working on either structuring a transaction or preparing an offering for the market,” he notes. “I think it’s human nature to assume, well, these guys are our guys, like our lawyers are our guys.”
But they’re not. Their role is more like that of a real estate agent selling someone’s house on commission. Both agent and seller gain from a higher sale price, but their interests are not wholly aligned. The homeowner may want to hold out for the highest possible price no matter how long it takes, for example, while the agent may want a quick sale to generate a higher return on his investment of time and marketing dollars.
Competition helps keep banks focused on the issuers’ needs, of course, but only to a point. And that point, Pritchard argues, is reached when the banks have finished drafting their pitch books and the client has chosen its lead underwriter.
“The first part of the process is extremely competitive,” says Pritchard, who before launching Aequitas was co-head of equity capital markets for CIBC World Markets in New York. “An enormous amount of thinking and analysis goes into the creation of those pitch books, which reflect the best ideas the banks have for you as an issuer: how they suggest you do things, how the market looks, how your offering might break down between institutional and retail investors, why they are the best bank to represent your deal in the market. But often, as soon as that process is done and the corporate client selects an investment bank, the competitive dynamics of the process fall away — in most cases, almost entirely.”
Daniels, formerly co-head of U.S. investment banking for Barclays Capital in New York, agrees. “Once the banks get the underwriting mandate from the client, many are often focused on supporting their investor clients who pay the day-to-day bills,” he says.
It’s worth noting that no one interviewed for this article ascribes any dishonorable intent to investment banks. “Obviously, they have a lot of reputation capital at risk in terms of doing a good job for both sets of customers,” Berick notes. “They’re trying to arrange a transaction between buyer and seller; that’s what they do. Their special sauce is coming up with what they would call the market-clearing price — the transaction that meets, as closely as possible, the issuer’s needs and can get good execution on the sell side.”