You don’t have to believe all investment bankers are crooks to think that there was something badly wrong with the way the industry worked in the late 1990s.
US prosecutors are investigating how the banks allocated shares in hot initial public offerings during the internet bubble.
A slew of academic studies is questioning the efficiency of the capital-raising process that made the banks so much money.
And investment banks themselves are promising a new code of conduct for their analysts; an implicit mea culpa for the practices of the recent past.
So what, you might think. The big investment banks - the “bulge bracket” firms that have parlayed their dominance of the US market into a central role in global finance during the past decade - will probably survive these pressures unscathed.
All of the criticisms are narrowly focused. Tackling each separately, as the authorities tend to do, throws up allegations that are hard to prove. Detailed investigation of what bankers are up to usually reveals nothing worse than a keen eye for the main chance.
But there is something about the way the big investment banks work that should give their principal interlocutors - companies seeking finance, investors, and regulators - cause for concern. And the internet bubble provides a textbook case of why all of these constituencies should worry.
At the heart of the investment banks’ power lies their control of three crucial areas of modern finance.
Their research departments’ analysts provide the essential intelligence on publicly traded companies.
Their sales forces give them a stranglehold on investors’ attention.
And companies raising capital - in the process making the most important decisions of their managers’ careers - gravitate towards the institutions that can offer an analytical imprimatur and unparalleled access to investors.
Research, distribution, deal flow - these are the three building blocks on which the investment banks’ success is based. And there has been something unhealthy about each of them during the past decade.
Take research, for example. There has always been an implicit conflict of interest in the investment banks’ provision of supposedly impartial judgments as part of the equity sales process. Investors can allow for that. But it is harder to overlook a more recent source of potential conflicts.
Sell-side analysts have become poor relations of their corporate finance colleagues, rewarded less for the judgments they offer to investors than for the deals their research generates.
By acting as cheerleaders of the net bubble, newly famous analysts reinforced their employers’ stranglehold on new issues. Companies issuing the stock were happy to leave “money on the table” - big first-day run-ups in newly issued share prices - from which early investors could profit.
In 1999, says one academic study*, $37bn (£26bn) was left on the table in this way, with another $20bn in the first six months of 2000. Control of deal flow allowed the banks great latitude in allocating stock, and hence first-day profits, to investors, reinforcing the banks’ control over the investor base.
Federal authorities are examining whether the investment banks behaved improperly in funnelling sought-after new issues to their most lucrative broking clients. But you do not need evidence of improprieties to find this unsettling.
It has implications for international financial competition, too. The bulge bracket’s unassailable position, atop the tripod of research, distribution and deal flow, allows them to charge hefty fees for granting access to the US market, the world’s most important source of capital. This stream of profits has allowed them to expand abroad relentlessly.
The US investment banks’ international success owes much to their expertise, enthusiasm and zealously developed relationships with important investors and innovative companies.
But it also owes something to the profits they generate from their dominance of their domestic market - a source of retained earnings that banks from other countries have found it hard to match.
Competition authorities and financial regulators can draw their own conclusions as to whether anything can - or should - be done about this situation.
It would be wrong, though, for private-sector participants to view this as an issue solely for officials. In fact, the most effective curb on the big investment banks’ behaviour is likely to come from their clients and competitors.
Investors can redouble their efforts to build up buy-side analytical expertise, lessening their dependence on the investment banks’ research departments. They can also try to spread their broking commissions around more.
Start-up companies, their advisers and backers can focus harder on the money left on the table, preventing it from accruing to the investment banks’ favoured clients.
Once the banks’ code of conduct for analysts is published, professional bodies can blow the whistle on institutions that abuse its provisions.
Oh, and we journalists can do our bit, too, by lessening our dependence on sell-side analysts and finding other people to quote. Until the next bull market, at least.
* Why don’t issuers get upset about leaving money on the table in their IPOs? by Tim Loughran and Jay Ritter
