You may be aware that once there was a problem and this was the problem:
- Investment bankers wanted to win underwriting business.
- They realized that having their research analysts shout “BUY BUY BUY!” about every company they underwrote would help to win this business.
- So they went to their analysts and were all “do that.”
- The analysts, for cost-center and spinelessness reasons, did.
- But in classic passive-aggressive fashion they sent each other emails to the effect of “oh, man, my fingers were totally crossed when I issued that Buy recommendation, that company is dogshit.”1
- It was dogshit, and investors lost money buying those Buys.
This problem was solved via a Global Research Settlement among a bunch of banks, a bunch of state attorneys general, and the SEC. The settlement had various technical provisions around who could talk to whom about what when, but the gist of it was “yo, bankers, stop telling your analysts to talk up shitty stocks.”
You can understand why Morgan Stanley banker Michael Grimes2 would not think that he violated this settlement when he (1) learned that the Facebook underwriting syndicate’s research analysts (including Morgan Stanley’s) had estimates for Facebook’s 2Q2012 revenue were higher than what Facebook expected, (2) told Facebook something to the effect of “hey, it would look really bad if you did an IPO based on misleadingly high revenue estimates, you should guide the analysts lower,” and (3) sat with Facebook’s Treasurer in a hotel room while she did that.
I mean! You can get mad at Grimes, and Facebook, and the research analysts, because that happened.3 There’s a whiff of selective disclosure, of insider trading, of Reg FD violation, of something about it: the analysts seem to have mostly disclosed the revised estimates to favored clients, leaving less favored clients more optimistic and more likely to buy, and that’s mean and unfair and all that stuff.
But the research settlement? The thing that says “bankers, don’t co-opt your research analysts into puffing shitty stocks”? That … what Grimes did was the exact opposite of that. Based on his diligence of Facebook, he was worried that research analysts were being too optimistic about the company, and he told the company that they’d be better off being honest with the market – and here, pre-IPO, “the market” means in good part “research analysts” – about its revenue projections, and so they were.
Anyway though the Massachusetts Securities Division just fined Morgan Stanley $5 million because that happened. There doesn’t seem to be a press release on the MSD web page, just the consent order, presumably because this is all too bonkers to explain. The consent order sets out relevant provisions of the research settlement (bold in original):
1. The firm may not knowingly do indirectly that which it cannot do directly under this [settlement].
2. The firm will adopt and implement policies and procedures designed to ensure that its associated persons (including but not limited to the firm’s investment banking personnel) cannot and do not seek to influence the contents of a research report or the activities of Research personnel for purposes of obtaining or retaining investment banking business.
So did that literally happen? I guess? Grimes indirectly (through the Facebook Treasurer) tried to influence the activities of MS research personnel (their FB revenue estimates) for purposes of … well probably for purposes of not getting FB and MS sued for misleading investors in its IPO, but I guess broadly speaking “doing a decent job of underwriting a deal” is a way to obtain or retain investment banking business so, sure, why not.
But it’s crazy! Investment bankers are companies’ liaisons to the capital markets. One thing that they do – one thing that is their job – is to advise companies on how to deal with research analysts, including their own; I have never heard of anyone concluding that this violates the research settlement.4 And one piece of advice that a banker could give a company is “tell the analysts the truth.” I could just about imagine that a banker telling a company to lie to his own bank’s analysts violates the research settlement – I’d disagree, but whatever – but telling them to tell the truth … ?
If you think that this settlement sets a precedent for the things that it says, then it’s a very weird precedent. Companies, the Mass. Sec. Div. seems to be saying, can’t get any advice from investment bankers on how to talk to research analysts: if they do, the bankers are indirectly violating the research settlement. But of course that’s not the intent here; the settlement doesn’t stand for what it says. Reuters reports that the Massachusetts regulator says “this case illustrates how institutional investors often have an edge over retail investors.” That’s true! It has nothing to do with the research settlement or with what Morgan Stanley was fined for, but, sure, institutional investors do often have an edge over retail investors. That’s … something.
If you’re mad at Facebook’s banks for favoring big investors over retail investors, and if you notice that that favoritism was (1) kinda crappy but (2) probably not actually illegal, then I guess it’s nice that Massachusetts has found creative ways to fine those banks smallish amounts of money for things that have nothing to do with that favoritism. (Citi too, remember.) It’s sort of rough justice. But it’s also very, very strange justice.
Consent Order – In the Matter of Morgan Stanley & Co. [MSD]
Massachusetts fines Morgan Stanley over Facebook research [Reuters]
1. The joke is hoary but good: the analysts said “fuck you” after they hung up the phone. Or in this case they said “fuck this company” after they hit publish on their research reports.
2. Not named in the consent decree but pretty clearly him. (If not, sorry Grimes!) Here’s his LinkedIn; here’s some praise of him; here’s the consent decree:
Senior Investment Banker has been a Managing Director since 1998. Senior Investment Banker has been employed by Morgan Stanley since May 1995 and currently works from Morgan Stanley’s offices located at 2725 Sand Hill Road, Bldg. C., Ste. 200, Menlo Park, California 94025.
3. Or for other reasons! The stock, I am reliably informed, is down since the IPO. Also this happened, per the Mass. Securities Division:
Treasurer began her calls to syndicate research analysts twelve minutes after the S-1 was filed. While Treasurer was making the syndicate research analyst calls, [Grimes] testified that “I was far down the hall so I wouldn’t hear anything; I took extra precaution to do that, and sat on the floor.” [Grimes] emailed [Facebook's] CFO on May 9, 2012 at 9:31 p.m., “[Treasurer] was a champ in the hotel tonight.”
4. The regulators seem particularly enraged that the bankers wrote a script for the treasurer to use in talking to the analysts. So: that happens all the time. The job of a banker is to help a company deal with the markets; when the company is in a situation it’s never been in before – which is pretty much the case throughout an IPO process – the banker holds the company’s hand, including by scripting their calls if necessary. You think a lot of merger conference calls happen where the companies haven’t talked to their bankers about what to say?