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COB 5.10 Corporate finance business issues

Application

COB 5.10.1R

1This section applies to a firm that conducts corporate finance business.

Purpose

COB 5.10.2G

The purpose of this section is to provide guidance on the management of conflicts of interest in particular situations arising in the context of corporate finance business. The FSA expects that in most corporate finance business Principle 1 (Integrity), Principle 2 (Due skill, care and diligence), Principle 5 (High standards of market conduct), Principle 6 (Customers' interests) and Principle 8 (Conflicts of interest), will be particularly relevant. The guidance in this section is not intended to be exhaustive, and is in addition to other provisions which apply to the firm (see COB 1.6 which specifies these). It also supplements other provisions in the Handbook (see, in particular, COB 2.2 (Inducements and soft commission), COB 7.1 (Conflict of interest and material interest) and COB 7.16 (Investment research)).12

Securities offerings

COB 5.10.3G

The Principles referred to in COB 5.10.2 G are highly relevant to the management of an offering of a security by a firm. They require a firm to manage conflicts of interest which may arise in a way which ensures that all its clients are treated fairly and which ensures that the firm is conducting its business with integrity and according to proper standards of business.1

COB 5.10.4G

1The overriding responsibility of the firm is to have in place systems, controls and procedures to ensure that the duties which the firm owes to its clients are identified effectively and discharged appropriately. In particular, the firm's processes and procedures will need to take account of the following:

  1. (1)

    when carrying out a mandate to manage an offering of securities, the firm's duty for that business is to its corporate finance client (in many cases, the corporate issuer or seller of the relevant securities);

  2. (2)

    a firm's responsibilities to provide services to the firm's investment clients (that is, those on the investment client side of the Chinese wall (see COB 5.10.5 G)) are unchanged, even if they have an interest in acquiring securities in the offering. The firm will need to ensure that it complies with the relevant regulatory obligations to its investment clients, such as COB 5.3 (Suitability).

COB 5.10.5G

1Firms will need to have in place systems, controls and procedures, appropriate to its structure and business, and to the sorts of offerings in which they are involved, for identifying and managing conflicts of interest (and see SYSC 3 (Systems and controls)). Examples which the FSA considers that a firm should consider (not every example will be relevant or appropriate to every situation or firm) include:

  1. (1)

    at an early stage, for example before it accepts a mandate to manage the offering, discussing or agreeing with its corporate finance client relevant aspects of the offering process, such as:

    1. (a)

      the process the firm proposes to follow in order to determine what recommendations it will make about allocations for the offering;

    2. (b)

      details of how the target investor group, to whom it is planned to offer the securities, will be identified;

    3. (c)

      the process through which recommendations on allocation and pricing are prepared, and by whom; and

    4. (d)

      (if relevant) that it may recommend placing securities with an investment client of the firm for whom the firm provides other services, with the firm's own proprietary book, or with an associate, and that this represents a potential conflict of interest;

  2. (2)

    having internal arrangements designed to ensure that the firm will give unbiased and full advice to the corporate finance client about the valuation and pricing for an offering (the FSA accepts that valuation is a complex process and great precision may not always be possible in a security offering);

  3. (3)

    having internal arrangements under which individuals or business units in the firm, whose responsibilities are ordinarily to provide services to the firm's investment clients (that is, those on the investment client side of the Chinese wall), are not involved directly in decisions about recommendations to a corporate finance client on pricing (although they might, for example, be permitted to provide information about likely investor interest to those advising the corporate finance client);

  4. (4)

    ensuring that its systems, controls and procedures to identify and manage conflicts of interest also cover the allocation process for an offering of securities; for example:

    1. (a)

      having internal arrangements under which the allocation process and the development of recommendations on allocation (names and amounts proposed to be allocated) are made to the corporate finance client only by staff who do not have any responsibilities for servicing investment clients;

    2. (b)

      inviting the corporate finance client to participate actively in the allocation process so that its proper interests can be taken into account effectively, including making available to the corporate finance client appropriate information to support the proposed recommendations on allocation;

    3. (c)

      basing recommendations about allocation and pricing on objectives agreed with the corporate finance client;

    4. (d)

      making the initial recommendation for allocation to private customers of the firm as a single block and not on a named basis;

    5. (e)

      having internal arrangements under which senior personnel in the department (or equivalent business unit), who are responsible for providing services to private customers, make the individual allocation recommendations for allocation to private customers of the firm; and

    6. (f)

      disclosing to the issuer, after completion of the transaction, details of the allocations which were actually made; and

  5. (5)

    having internal arrangements under which allocation recommendations are not determined by the level of business which a firm does or hopes to do with any other client (see also COB 2.2 (Inducements and soft commission)); for example:

    1. (a)

      any allocation to a private customer of the firm should be justifiable in terms of the process for developing allocation recommendations which was disclosed to the corporate finance client at the outset (as well as in terms of any other obligations which the firm may have - for example under COB 5.3 (Suitability) or COB 7.7 (Aggregation and allocation)); and

    2. (b)

      any recommendation for allocation to the proprietary trading desk of the firm or to an associate or affiliate of the firm should be justifiable in terms of the objectives of the allocation policy and should be consistent with the process for developing allocation recommendations disclosed by the firm at the outset.

COB 5.10.6G

1One control which a firm might use is a review by the compliance function after the event of how well the firm's conflicts of interest management processes worked in relation to an issue. This might be of particular use if there are significant differences between the recommendation on price and subsequent market behaviour. The review might examine how the recommendations of the firm on pricing were reflected in market dealings after the issue. If significant differences are observed, it may be appropriate to identify why, and what that discloses about the way in which the firm's systems and controls operated in relation to that offering. The frequency of any review is a matter for the firm, in the light of its business and structure.

Securities offerings: behaviour in breach of the Principles

COB 5.10.7G
  1. (1)

    1For the avoidance of doubt, the FSA considers that the following would each be a breach of the Principles referred to in COB 5.10.2 G, and a breach of COB 2.2.3 R:

    1. (a)

      an allocation made as an inducement for the payment of excessive compensation in respect of unrelated services provided by the firm; for example, very high rates of commissions paid to the firm by an investment client, or an investment client providing very high volumes of business at normal levels of commission (which may also be a breach of COB 7.2 (Churning and switching));

    2. (b)

      an allocation made to a senior executive or a corporate officer of an existing or potential corporate finance client, or of a listed company, in consideration for the future or past award of corporate finance business; and

    3. (c)

      an allocation which is expressly or implicitly conditional upon the receipt of orders or the purchase of any other service from the firm by the investor, or any body corporate of which the investor is a corporate officer.

  2. (2)

    A firm's systems, controls and procedures should, therefore, be designed to prevent these sorts of behaviour.