The Harshad Mehta Scam in India (1992)
Harshad Mehta was the son of a peon. He was born in abject poverty and when he migrated to Mumbai, he had a mere Rs 40 i.e. less than $1 in his pocket. However, over the years Harshad Mehta rose meteorically to become one of the most influential and powerful brokers on the Bombay Stock […]
Nominal and Real Value of Money
The previous article was an introduction about the two basic decisions that corporate finance helps a corporation in making. Prima-facie, these two decisions may look pretty simple. After all everyone raises money in their daily lives and puts it to productive use. Simple accounting can tell us whether or not we should make those financing […]
Infrastructure as an Asset Class
As asset class is a group of assets that have similar investment characteristics amongst themselves. At the same time, their investment characteristics are different from other asset classes. For instance, all stocks share certain characteristics amongst themselves, which they do not share with bonds. Similarly, there are certain characteristics that infrastructure also has as an […]
Pension Funds and Income Redistribution
The purpose of pension funds is to ensure that the wealth created by an individual is invested and distributed in such a way that they can afford to maintain their standard of living throughout their lifetime. Pension funds have become a very important tool for retirement planning. An average pensioner plans to survive almost twenty […]
Conservatism Bias
In accounting and in finance, conservatism is generally considered to be a positive quality. However, studies in behavioral finance have shown that this may not be the case. This is because conservatism bias is one of the most profound biases which impact the investment decisions of an average investor. In this article, we will understand […]
Investment banking institutions are engaged in multimillion-dollar transactions. This means that if an investment bank is perceived to be operating in a conflict of interest situation, it could severely damage the reputation of the bank. This lost reputation could end up becoming a financial loss is no time.
There have been several instances where conflict of interest situations have quickly escalated into bad press and even litigation!
The leading investment banks of the world are well aware of this threat. This is the reason why they keep on educating their employees about the perils of conflict of interest and how they must be avoided. In this article, we will have a closer look at the conflict of interest in the investment banking industry as well as steps that can be taken to avoid the same.
A company hires an investment bank to pursue its interests. These interests could be of different types. They could be related to raising capital or scouting for potential merger and acquisition targets. The investment bank is supposed to pursue the interests of their clients.
Hence, if an investment bank takes any actions which are in their own interest but not in the interest of their client, then such an action can be called a “conflict of interest.” In simple words, if the objectives of the client and the investment bank are not aligned, it could lead to a conflict of interest scenario.
It is important to note that it is not necessary for the investment bank to actually act in an unethical manner. Even if the actions of the firm are perceived to be compromised but arent really compromised, it could land up in big trouble.
Conflicts of interest can manifest in multiple ways within the investment banking industry. Here are some of the common ways in which conflicts of interests commonly happen:
Conflict of interest has proved to be a major problem for investment banks such as Goldman Sachs as well. For instance, prior to 2008, Goldman Sachs was deeply involved in the issuance of mortgage-based securities. This meant that Goldman Sachs was extensively advising its clients to buy these securities. The advice issued by Goldman Sachs meant that it was bullish on mortgage-backed securities.
However, later information was revealed which showed that Goldman Sachs had placed several large bets against the housing market on its own account. This meant that as far as its own money was concerned, Goldman Sachs was bearish on the future of these securities.
It finally meant that Goldman Sachs was deliberately giving wrong advice to its clients in order to profit off the same. This meant that Goldman Sachs was not acting in the best interests of their clients, causing an ethical conundrum for the multinational bank.
In the end, the Securities and Exchange Commission filed Goldman Sachs $1 billion for the deliberate wrongdoing. Conflict of interest poses a serious threat. If the mistakes are repeated too often by the bank, it could be broken up into different entities.
It is the duty of the investment bank to disclose any potential conflict of interest they might have. This involved training and educating employees about the importance of identifying conflict of interests as well as reporting them.
The legal department of the investment bank must be kept in the loop in order to get the correct advice on a case to case basis. However, as a thumb rule, it is better for investment banks to avoid certain activities. These activities include:
It is important to know that trust can still be established between the investment bank and the client, even if a conflict of interest exists. However, it is the fiduciary duty of the investment bank to disclose all conflicts and create a transparent environment.
Proactively disclosing any conflicts may go a long way in building rapport and winning over the client for the long term.
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