IOSCO proposes guidance on conflicts of interest in capital raising

By Lene Powell, J.D.

To address conflicts of interest and associated conduct risks in the equity capital raising process, IOSCO has proposed guidance to help regulators evaluate market practices in their respective jurisdictions and take specific measures to mitigate risks. The guidance focuses on three areas of risk: (1) the role of connected analysts in the capital raising process; (2) the prominent role that connected research plays in investor education and price formation; and (3) allocations of securities. The guidance recommends eight measures for regulators to take.

Public comments on the consultation are due April 4, 2018.

Risks and need for guidance. IOSCO previously issued guidance in 2003 and 2007 on conflicts of interest in the capital raising process. To update and supplement the previous guidance, IOSCO assessed current conflicts of interest and related conduct risks.

The committee found three key risks:

• conflicts of interest and pressures on “connected analysts” (those employed within firms managing the securities offering) while forming their views on an issuer in the pre-offering phase;
• too much prominence on conflicted “connected research” (research produced by connected analysts) during investor education and price formation in equity IPOs; and
• conflicts of interest during the allocation of securities.

In some jurisdictions, the committee also found two additional risks:

• management of underwriting risk by firms managing the offering, resulting in conflicts of interest in securities pricing; and
• conflicts associated with personal transactions by staff employed by firms managing the offering.

In the new guidance, the committee proposes eight measures for regulators to mitigate risk, grouped by the relevant stage in the capital raising process.

Pre-offering phase. To preserve analysts’ independence and the integrity of their research during the pre-offering phase, the committee recommends the following measures:

• Measure 1: Regarding pitches, regulators should consider requiring firms to take steps to prevent their analysts from coming under pressure from the issuer’s representatives to take a favorable view on the securities offering. For example, promises of favorable research coverage should be prohibited, and analysts should be prevented from participating in pitches alongside corporate advisory or investment banking staff within the firm.
• Measure 2: After an underwriting or placing mandate has been awarded, regulators should consider requiring firms to take steps to prevent a connected analyst’s views and research from being improperly influenced and to ensure that the analyst remains independent. For example, firms should not amend the connected research.
• Measure 3: Regulators should consider requiring firms to have appropriate controls to manage conflicts and risks arising from connected analysts performing an internal advisory role in the context of an offering, like organizing meetings with investors for investor education.
• Measure 4: Regulators should consider requiring firms to support the timely provision of a wide range of independent information to investors. This could include referring to the official offering document as the primary source of information in an IPO, and facilitating access for unconnected analysts to necessary information to prepare unconnected research.

Allocation of securities. To ensure that firms manage any conflicts of interest between themselves, issuer clients, and investor clients, the committee recommends the following measures:

• Measure 5: Regulators should consider requiring firms to maintain an allocation policy that sets out their approach for determining allocations and gives the issuer an opportunity to express their preference. Although not all issuers necessarily want to play an active role in the process, giving them the chance to do so promotes transparency and can help to mitigate potential conflicts of interest.
• Measure 6: Regulators should consider requiring firms to maintain records of allocation decisions, including allocation orders received from potential investors and details of the final allocation to each investor. 

Pricing of securities offerings. To ensure that firms manage conflicts of interest related to pricing, the committee recommends the following measure:

• Measure 7: Regulators should consider requiring firms to manage any conflicts of interest relating to pricing, keep the issuer informed of key decisions or actions that might influence pricing outcome, and give the issuer an opportunity to express preference regarding the pricing of an issue. For secondary offerings, regulators should consider requirements to ensure the issuer’s interests are not compromised, including ensuring that the bank manages any conflicts of interest that could arise through hedging strategies and risk management transactions the firm carries out to mitigate its own underwriting risk.

Personal transactions by staff. To ensure that employees do not misuse their position or any confidential information in undertaking personal transactions, the committee recommends the following measure:

• Measure 8: Regulators should consider requiring firms to prevent any employees who have access to confidential information about the issuer from entering into or causing any personal transactions involving misuse or improper disclosure of the confidential information. Here, firms and employees should look to their jurisdiction’s market abuse regulations to determine when it is appropriate for employees to enter into a personal transaction in an offering managed by the firm.

A better capital raising process. IOSCO believes regulators’ adoption of these measures will result in material improvements in the capital raising process, including better information for investors, more transparent allocations, greater efficiency and integrity of the process, increased investor confidence, and greater effectiveness of the capital markets as a route for issuers to raise finance.