This just in, courtesy of the Harvard Law School Corporate Governance Blog: a paper from three European finance professors arguing that investment banks collude with their investment arms by encouraging bidders to buy targets they've already taken stakes in. The paper, evocatively titled "The Dark Role of Investment Banks in the Market for Corporate Control," presents a broad statistical indictment of M&A between 1984 and 2003. The authors argue that advisers are privy to information that they "directly exploit" by investing in target firms. Investment banks advising bidders not only take more positions in target companies before deals are announced than nonadvisers, but profit more from them, they conclude. And they argue that premiums in targets are higher when advisers to bidders have a position in the target.
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This is incendiary stuff. But while the argument is straightforward, the underlying methodology and data is complex, and it's too early to declare their conclusions real or illusory. A cursory read does generate some questions. Given the size of money management at major investment banks, wouldn't it be plausible that there's an overlap between advisers and investors? After all, a few major firms may hold positions in many targets of size, and the largest money managers on Wall Street are also the most successful advisory shops. Should you count a firm that has invested in a target for many years before a bid is made? How do you account for indexed assets, which are essentially passive? And, perhaps most importantly, can you trace the broad statistical pattern back to actual channels of communication between investment bankers on a given deal and investment managers, often in affiliates at some distance from the investment bank? These are, after all, large, complex, global firms, and managing all this, particularly in a boom period with many deals, would be a pretty big job. And hiding a conspiracy of this sort over the last two decades or so is a pretty impressive piece of skullduggery.
Presumably the academic debate over the merits of their thesis will produce some light on the matter. But that'll take awhile. What's more significant is how this paper will play in a media and in a political arena that is already convinced investment bankers are engaged in semicriminal conspiracies and that M&A and inside information are generally synonymous. Make no mistake: This is a frontal attack on both investment banking and money management on Wall Street that makes Spitzerian charges about analysts and bankers look quaint. From the title of the paper, with its "Dark Role," to its conclusions, with their ringing certainty, this paper is destined for publicity, damn the complications and the counterarguments. This could get ugly. - Robert Teitelman
Comments
I'd like to see this report. Unless there is intentional insider trading going on, I would find such a report very difficult to believe. Although it is certain that compliance and other controls do fail, this would be a most certain breach of the Chinese Wall at investment banks and I find it incredibly hard to digest that bankers are doing this on a systematic basis. The risk for something like this is really not noticeable and in order to systematic profit out of this, it would be quite transparent given the required size of stakes to make this profitable consistently. Plus the SEC regularly looks at all meaningful trades before a transaction is actually announced. This would be extremely easy to uncover without going to "myfamilyancestory.com" to see relationships between unusual trades and advisors. Again, unless there is intentional willful misconduct and I don't think the heads of these banks or divisions would jeopardize and put that much at risk.