Raising capital, raising standards: managing conflicts of interest in sell-side research and corporate advisory

In brief

Written by Senior Associate Sarah Burgemeister and Law Graduate Jamil Diu

ASIC continues its mission to enhance the regulation of Australia's equity markets with its recent publication of Consultation Paper 290, Sell-side Research, on 30 June 2017. The Consultation Paper intends to supplement Regulatory Guide 79 (RG 79) (Research report providers: Improving the quality of investment research) by seeking feedback on additional guidance regarding management of conflicts of interest with a focus on material non-public information (MNPI) when dealing with sell-side research and corporate advisory.

These proposed amendments will primarily target investment banks and corporate advisors in the IPO and capital raising process.

Feedback from users and providers of sell-side research including investment banks and corporate advisers on this Consultation Paper is due 31 August 2017. ASIC has indicated an interest in the likely compliance costs and effect on competition.

The Regulatory Guide is scheduled for release in December 2017.

• Basis for Consultation Paper
  This Consultation Paper follows an almost two-year review by ASIC of the policies, procedures and practices of Australian Financial Services Licensees engaged in research and corporate advisory. This review was prompted by indications from previous monitoring and surveillance work of poor and inconsistent practices in the handling of MNPI in the course of sell-side research. ASIC was also mindful of recent concerning conduct in other jurisdictions relating to sell-side research and sought to establish whether such conduct was prevalent in Australia.
  
  The outcome of the review was reported in Report 486 (Sell-side research and corporate advisory: Confidential information and conflicts) published on 9 August 2016. While acknowledging most institutions had relevant policies and procedures, the Report identified poor practices and inconsistent practices in applying them. ASIC subsequently consulted with a range of market participants who broadly indicated a desire for detailed guidance on managing conflicts when preparing sell-side research.
  
  ASIC Commissioner Cathie Armour has asserted that 'the integrity of sell-side research directly affects the integrity of financial markets and investor confidence in those markets' and that when MNPI 'is mishandled or conflicts involving research are not managed appropriately, [Licensees] are at risk of breaching financial services laws, including those covering insider trading, market manipulation and deceptive conduct'.
  
  
• Proposed guidelines
  ASIC proposes recommendations for the implementation of processes and procedures for research analysts when dealing with MNPI at certain key stages of a capital raising transaction. There are three key proposals as detailed below.
  
  
• Identification and handling of MNPI
  ASIC has proposed MNPI be the same as 'inside information' defined in section 1042A of the Corporations Act. ASIC's proposed guidelines for implementation include:
  • policies and training to enable staff to identify, verify and manage MNPI in addition to processes for identifying material changes to sell-side research;
  • Licensees should have a process that deals with requests for research functions' financial models;
  • adequate procedures to address wall-crossing and information barriers;
  • review, and approval, of research by compliance prior to distribution, including consideration of whether statements in the research are based on generally available information in the market; and
  • research functions to provide a declaration or certification in the sell-side research which confirms a) no MNPI contained; b) no contact between research function and the subject of the research in the month before publication; c) there has been no attempt by the Licensee to influence the research; and d) the number of shares and options held by the research analyst who prepared the research and the five largest share and option holders at the Licensee.
  These policies and procedures should be continually monitored by Licensees to ensure compliance.
• Management of research conflicts
  The consultation paper proposes to implement recommendations for Licensees and research analysts for four key stages of a capital raising transaction – pre-solicitation, vetting, pitching and the post-mandate period. High-level summary of these proposals include:
  • research analysts, while cognisant of the risks, can attend pre-solicitation discussions and should keep written notes. They should not be present for discussion of MNPI;
  • if research analysts are a party to MNPI discussions, internal protocols to deal with MNPI should be followed;
  • corporate advisory and the research team can interact but should be mindful to keep opinions on key valuation information confidential. Research analysts should not provide feedback of such information;
  • corporate advisory should not pressure research analysts or influence their research;
  • compliance personnel should monitor to ensure adherence to policies and procedures in addition to conducting periodic reviews of the arrangements;
  • research analysts should not interact directly with the issuing company and should be conducted through compliance;
  • research analysts should not communicate with corporate advisory during the pitching stage;
  • corporate advisory should not represent the involvement of research analysts in its pitch or indicate favourable research coverage; and
  • any pitch document should reference policies pertaining to independence of the research function and should include no commitment to the provision of research.
  There are additional guidelines for Licensees that intend to produce an Independent Expert Report (IER). ASIC does not propose to prohibit Licensees working on a capital raising transaction from preparing and distributing IERs. The recommendations are primarily aimed at reducing the risk of the IER containing MNPI and information that may not be subsequently included in the prospectus. A published IER should be withdrawn if there is new information that renders the IER false, misleading or deceptive. If this happens, the Licensee should not issue a further IER.

Structure and funding of research

The proposed recommendations relating to the structure and funding of research aim to promote the independence and objectivity of research analysts within the Licensee. Proposed guidance focuses on:

• the segregation of research from those performing corporate advisory or sales functions;
• remuneration of research staff not linked to corporate advisory performance;
• restriction of research to the relevant individuals until disseminated widely;
• clear documentation of compliance arrangements with relevant training provided;
• relevant policies available on website; and
• guidelines on conflict of interest and certain decision making processes.

Final thoughts

ASIC's recommendations follow other international regulators in their attempts to manage conflicts of interest and research in the capital raising process.

The UK regulator, the Financial Conduct Authority, has identified similar concerns to ASIC and recently completed consultation on whether 'connected' research should be permitted for IPOs. Similarly, the US regulator, the Financial Industry Regulatory Authority, has also sought to improve its equity research rules.

The implementation of these recommendations relating to research in the equity raising process is likely to be seen as an alignment of Australia's position with that of its international peers.