ASIC reports on managing conflicts in capital raisings and equity market cleanliness

ASIC findings relating to managing conflicts in capital raisings

What you need to know

• ASIC has released its findings on the handling of material, non-public information (MNPI) and the management of conflicts of interest in the context of sell-side research and corporate advisory activities which have implications for capital raising processes.
• ASIC intends to undertake industry consultation regarding the role and appropriateness of "investor education" research as it considers proposed guidance to ensure good research practices are followed.
• ASIC is also undertaking a review of the practices used by firms to market IPOs to investors and other institutions including the use of social media and other platforms.

On 9 August 2016, ASIC released Report 486 Sell-side research and corporate advisory: Confidential information and conflicts (REP 486).

The proper handling of MNPI and the management of conflicts by research analysts and corporate advisory teams are seen by ASIC as critical to the promotion of market integrity and efficiency and ensuring investor confidence in our markets.

ASIC's review has been undertaken in the context of similar concerns about these issues having resulted in a number of regulatory reforms in the United States and Hong Kong. Those jurisdictions have opted for a more prescriptive approach to these issues rather than the principles based approach taken in Australia. The United Kingdom is also looking at the capital raising process including research and corporate advisory.

The report sets out ASIC's findings from its review of the compliance and risk frameworks of the firms involved in the Newcrest matter, its inquiry into the circumstances surrounding debt research published on the privatisation of NSW infrastructure, its review of the policies and procedures of large and mid-size firms and an examination of four market transactions being a large IPO (with a market capitalisation above $500 million), a small IPO (with a market capitalisation below $500million), a placement and a sizeable block trade. Large firms are investment banks mostly with an offshore parent who typically advise on transactions over $100 million. Mid-size firms are usually domestically owned and operated and typically advise on transactions of less than $100 million.

ASIC found that most firms had policies and procedures for handling MNPI and managing conflicts but the implementation and supervision of these policies was varied and in some instances appropriate policies and procedures were not in place or were being ignored. ASIC observed more issues with the practices of mid-size firms than large firms. Please see our Financial Services Update on ASIC's findings more generally.

This update focuses on ASIC's findings and recommendations specifically in the context of capital raisings.

Key ASIC concerns for capital raising processes

The key concerns identified by ASIC in the context of capital raisings related to the management of conflicts. These are set out below.

Pressure for favourable research

• The expectation of after-market support (including research coverage) is an important factor in companies awarding capital raising mandates.
• Policies of some large firms permit corporate advisory staff to advise corporate issuers that while they cannot commit to provide research if awarded a mandate, it is nevertheless firm policy to provide research on entities that the firm has raised capital for.
• Mandate letters for capital raisings managed by mid-sized firms included an obligation to initiate research coverage following completion of the transaction.
• Firms providing drafts of research including "investor education" research that included valuation information and opinions to their corporate advisory team and the corporate issuer before publication.

Research involvement in pitching for or marketing capital raisings

• Research analyst involvement in IPO pitches including providing valuation opinions and attending pitch meetings with or immediately after their corporate advisory teams.
• An implicit or explicit promise to corporate issuers that research coverage will be provided.
• Common for research analysts to be involved in marketing transactions their firms are advising on through the preparation of "investor education" research and to meet with investors in both domestic and international roadshows (with expenses reimbursed by the corporate issuer).
• Firms with key roles in IPOs generally initiate research coverage with a recommendation of "buy" or above.
• Investors who have received "investor education" research appear to be advantaged over other potential investors because they are given an indication of the research analyst's approach to valuation and an indicative valuation range.
• There were instances of research analysts passing on feedback from investors (obtained through the "investor education" process) to their corporate advisory team to use in pre-bookbuild pricing deliberations. Institutional investors that participated in the "investor education" meetings and provided feedback may receive priority or favourable treatment in the eventual share allocation process.
• Although the large firms had a blackout period following IPOs where no research recommendation could be released following the listing, a number of the mid-sized firms did not.

Joint Lead Manager research

• Research analysts usually meet to receive a joint briefing from the corporate issuers and corporate advisory staff may be present.
• ASIC undertook an analysis of the price targets included in a range of IPO transactions from January 3014 to December 2015 and did not observe a noticeable difference between connected and non-connected research but the sample of non-connected research was low.
• ASIC also looked at the IPO of Medibank Private where there was a larger number of non-connected research reports. In this case the average price target for connected research was around 10% higher than for non-connected research.
• Corporate advisory teams of the JLMs engaged in an IPO agreed to a common approach on how to value the corporate issuer and then some sought to influence their respective research analysts to adopt this approach.
• There was an instance of financial forecasts in "investor education" research that went beyond the forecast period to be included in the prospectus.

Disclosure of conflicts

• One large firm repeatedly failed to disclose conflicting advisory mandates.

Prospective financial information

• Although the prospectus for an IPO did not include prospective financial information, the lead manager released a research report shortly after listing that contained prospective financial information which was then released on the website and ASX.

Share allocations

• Most firms have allocation policies which are used as guidelines and subject to the discretion of the firm.
• For institutional investors, larger allocations being provided to the firm's most valuable clients.
• Differential treatment based on classification e.g. hedge funds suffer larger scale backs.
• Instances of larger allocations in an IPO being offered to investors in exchange for a commitment to engage in after-market buying in the corporate issuer.
• An instance of a sizeable allocation in an IPO being offered to senior management and directors of companies that the firm managing the IPO was seeking to secure corporate business from in the future.
• Instances of investor bids being scaled back in favour of principal or staff allocations.
• An instance of potentially misleading information provided to potential investors on the bookbuild for a secondary sale about the level of demand.

Principal and staff trading

• High levels of staff trading among the majority of mid-sized firms (but not large firms) where staff were allowed to participate in capital raisings they were managing.
• There is a range of minimum hold periods for staff trading. For capital raising transactions this was typically 30 days although there were instances of 15 days and some mid-sized firms had no minimum hold period.

Structure of research

• Common for mid-sized firms to have poor internal structures and reporting lines that may make it difficult to adequately manage conflicts e.g. research analysts reporting to the CEO who is often involved in decisions about research coverage or corporate advisory work.
• Instances with mid-sized firms where research reports were authored by the corporate advisory team that advised the company on a capital raising or corporate advisory work.
• Instances of remuneration structures which took into account research analyst involvement in marketing corporate transactions or being rewarded for seeking capital raising mandates.

Better practices recommended by ASIC to manage conflicts in capital raisings

Research coverage

• The involvement of research analysts in pitching for corporate advisory mandates should be restricted.
• Firms should not commit to provide research coverage (either explicitly or implicitly) for an issuer where the firm is currently mandated or seeking a mandate.
• Decisions regarding research coverage should be made by the research team and not subject to influence from other parts of the firm or from corporate issuers or their advisers.
• Draft research reports for an IPO should only be provided for fact checking and should not contain financial forecasts, valuation information, price targets, recommendations, or information which is not included in the prospectus.
• There should be prominent, specific and meaningful disclosure in the report of any material interest the firm has in the capital raising and the firm's relationship with the corporate issuer and any services the firm provides the corporate issuer.
• "Investor education" research should not include information that is not in the prospectus or not otherwise publicly available or tipping-off potential investors about the price target to be contained in subsequent initiating research.
• There should be appropriate blackout periods around capital raising transactions the firm is involved in.

JLM research

• Prevent research analysts from discussing their approach to valuation or indicative valuation ranges with their corporate advisory team, the corporate issuer or its advisers or with other JLM research analysts.
• Invite non connected research analysts to pre listing company briefings to ensure that research analysts are similarly informed and reduce the risk of selective briefings.

Share allocations

• Firms should implement a policy of how shares are allocated in capital raising transactions.
• Corporate issuers are encouraged to understand or be involved in the allocation process.
• Client interests should be placed ahead of staff interests.
• Investors should not be provided with larger allocations on the understanding they will place buy orders in the aftermarket.
• Allocations should not be made to senior executives and directors of companies the firm is seeking to secure corporate business from.
• Clear processes and responsibilities should be developed on who can provide messaging about the status of a capital raising transaction.

Staff and principal trading

• There should be appropriate blackout periods around capital raising transactions the firm is involved in and appropriate minimum holding periods for staff trading.
• Compliance should monitor staff trading including enforcement of black outs and minimum holding periods.

ASIC Review of Australian equity market cleanliness

ASIC released Report 487: Review of Australian equity market cleanliness following a review into equity "market cleanliness". Market cleanliness refers to the extent to which insider trading and information leakage occurs in the market. The results of this review found that there has been an overall improvement in market cleanliness in the Australian equities market over the past decade.

The report used two types of measures to review equity market cleanliness:

1. Traditional method of measurement: The traditional method measures market cleanliness by measuring significant abnormal pre-announcement price movements ahead of price sensitive announcements. ASIC highlights that this traditional method is somewhat limited due to the fact that abnormal price reactions are not always the result of insider trading, but can also occur due to leaked information or rumours, and insider traders may be able to trade in ways that disguise price impact. As a response to these limitations ASIC developed a new market cleanliness measure.
2. New Measure for Market Cleanliness: ASIC's new measure of market cleanliness uses surveillance data (collected by ASIC's MAI surveillance system) which allows ASIC to identify individual trading accounts. The new method can pinpoint abnormal trades after identification of abnormal pre-announcement price movements before a material, price-sensitive announcement. Using this method, ASIC identified anomalous trading behaviour in individual accounts, measuring abnormalities against historical trades and trades made by the rest of the market. ASIC found that under the new measure results were consistent with the results under the traditional method.

The review found that overall the Australian equity market cleanliness has improved over the past decade. The report found that larger companies were less likely to have abnormal price movements before a material, price-sensitive announcement than smaller companies. ASIC concluded that this is due to the fact that larger companies have greater control over price sensitive information. Further, the report found that there were less abnormal pre-announcement price movements in relation to announcements of M&A transactions than other types of announcements (such as scheduled and unscheduled, positive and negative announcements not relating to M&A transactions).

What this means for you?

This report highlights ASIC 's capabilities to identify abnormal trading in the market and pinpoint specific abnormal trades which occur before material, price-sensitive announcements through the Market Analysis and Intelligence Systems (MAI). Companies should have appropriate policies to address and reduce the possibilities of information leakage and insider trading, which should be front of mind in the lead-up to making a material, price sensitive announcements.