Insights

In brief - ASIC's Regulatory Guide 264 addresses conflicts concerns and tightens compliance obligations

The Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry is focussing intently upon disclosure and conflicts in the sector generally. Real questions are being asked as to whether Australian financial services licensees complying with the current regulatory framework can provide services that meet the market's needs and expectations without conflict. 
 
It would not be surprising if the Commissioner were to recommend sweeping prescriptive rules requiring compartmentalisation rather than merely tightening the current disclosure regime.
 
In response to concerns relating to sell-side research in the context of investment firms that also provide other services where conflicts can arise, ASIC has issued Regulatory Guide 264
 
The guide discusses three main issues: inside information, capital raising, and the structure and funding of research. While some aspects of this area may be relevant to sophisticated and wholesale clients, other aspects, in particular relevant to IPOs, will have a much wider impact.
 
The guide is important as it signals how ASIC will approach this issue, and also points out potentially significant structural issues in the industry in the future.
 
In this article we take a closer look at ASIC's guidance on these three issues, and the possible compliance consequences for financial services licensees.

Control and management of inside information 

Research analysts regularly receive information from a range of sources, including companies, third parties and other areas of the licensee. The guide reiterates research analysts' obligation to assess whether this information is inside information and suggests various steps be taken, including:
  • Permanent information barriers, for example where research analysts working on reports which could materially affect prices of bonds or other financial products (RG 264.47).
  • Wall-crossing procedures be managed by compliance or another control function which should be notified whenever a research analyst obtains or is provided inside information (RG.264.49).
  • Wall-crossed research staff be subject to the same trading restrictions imposed on staff on the private side of the licensee's business for the relevant financial products (RG 264.46).
  • Written acknowledgement by wall-crossed research analysts that they have read, understood and will comply with any restrictions imposed on them (RG.264.48).
When research is initiated or there is a change in recommendation, opinion or a material change to a price target in research, licensees should have an appropriate review process in place. The review ought to be undertaken by a supervisory analyst, a senior research team member or by compliance or another control function with appropriate knowledge and experience (RG 264.52).
 
Information that has not yet been disclosed to the market, unpublished research data, research analyst models and draft research should not be made available or provided to any person who is not part of the research team other than under certain conditions:
  • managing requests by compliance or another control function
  • asking for models in relation to a number of companies to minimise the risk of the research analyst becoming aware of the purpose for the request 
  • ensuring the research analyst has not been made aware of the identity of the person or entity that has made a request 
  • ensuring analyst models provided are consistent with the valuation, price target and recommendation in published research
  • redacting any valuation information in research analyst models that is inconsistent with the licensee's published research or generally available to the public (eg, comments or notes)
Types of monitoring to be undertaken by compliance and control functions:
  • attend meetings where both research analysts and corporate advisory are present on a periodic basis, such as internal meetings, to discuss companies or industry sectors and company briefings 
  • undertake regular reviews of communications between research analysts and other parts of the licensee and companies

Managing research conflicts during the capital raising process

Pre-solicitation

ASIC provides pre-solicitation guidelines for research analyst interactions with corporate advisory:
  • For listed companies, discussions between corporate advisory and the research analyst about any potential capital raising transaction or valuation information should only occur if the research analyst has been wall-crossed.
  • Corporate advisory should not place pressure on the research analyst or otherwise seek to influence the research.
  • If the research analyst obtains inside information during the pre-solicitation period, they should following the licensee's internal protocols for the management of inside information. 
  • Compliance or another control function should be aware of and monitor, or undertake periodic reviews to determine, the effectiveness of the licensee's arrangements. 
  • Research analysts and the issuing company may interact if a research analyst is aware of a potential capital raising transaction, provided the licensee has not made a decision to pitch for the capital raising transaction; or seven days before a pitch presentation to the issuing company, whichever is the earlier.
  • Internal protocols for the management of inside information are to be followed if a research analyst obtains inside information during the pre-solicitation process.
  • Research analysts should not volunteer valuation information to the issuing company. 
  • Compliance or another control function should be aware of and monitor, or undertake periodic reviews to determine the effectiveness of the licensee's arrangement.

Pitching and post-pitch stage

There is a risk to the objectivity and independence of research. ASIC considers that:
  • Research analysts should not communicate with or discuss the issuing company or the potential transaction with the licensee’s corporate advisory team during the pitching stage unless the research analyst has been wall-crossed and does not produce research in relation to the issuing company or transaction until the transaction has been completed. The same is advised with dealings with the issuing company or its advisers.
  • Corporate advisory and research analysts should not be made aware of each other’s opinions on valuation information or research analyst models once the pitching phase begins. 
  • Corporate advisory should not place pressure on research analysts or seek to influence research analysts to initiate research coverage or to amend their valuation or price target assessments on issuing companies. 
  • Corporate advisory should not represent to issuing companies or their advisers that their research team or research analysts were involved in the preparation of or endorse the pitch valuation. 
  • Corporate advisory staff should not represent to issuing companies that favourable research coverage will be provided on the issuing company in an attempt to secure a mandate.
  • Corporate advisory mandates should not include any commitment or inducement to provide research.  
  • If research analysts obtain inside information during the pitching process, they should follow their licensee’s internal protocols for the management of inside information. The same is advised with dealings with the issuing company or its advisors.
  • Compliance or another control function should be aware of and monitor, or undertake periodic reviews to determine, the effectiveness of the licensee’s arrangements. 

Investor Education Reports (IERs)

An IER should not be released outside the research team (unless required by law) or circulated for fact checking until the licensee has appointed corporate advisory services on the transaction. Once an advisory team is in place, robust controls are needed to ensure the independence of the research, given that the corporate advisory teams will seek to produce a positive view of the company.
 
Licensees must also take care to ensure that any discretionary fees available to licensees as managers do not place pressure on their research analysts to produce an IER that is consistent with the issuing company's expectation. 
 
ASIC's guidelines are aimed at the separation of research and advisory teams when preparing IERs so that they are unbiased and reflective of research analysts' professional judgment and expertise. Among these recommendations are:
  • Research analysts may attend briefings with the issuing company after the licensee has been appointed to the transaction for the purposes of discussing information about the issuing company’s business and operations.
  • Requests for additional information should be monitored by compliance or another control function. 
  • Licensees should advise the issuing company that they may not ask research analysts questions or seek information or comments from the research analyst about valuation information or express or pass on any views on valuation information to research analysts.
  • Research analysts should not communicate their views on the issuing company, the transaction or any valuation information before it is widely distributed to investors outside the research team except to compliance or another control function and legal counsel which must keep it confidential.
  • A licensee’s corporate advisory staff should not participate in or see any communication between research analysts, the issuing company or its other advisers.
  • A licensee should maintain a record of any meetings between its research analysts, the issuing company or its advisers.
  • Research analysts working for different Joint Lead Managers on the same transaction should not interact (directly or indirectly) on the merits of the issuing company or on valuation information relating to the issuing company or the transaction; nor should they discuss or provide access to each other’s opinions, models or draft research on the issuing company.
  • The integrity of the IER is to be maintained throughout the review process of the IER, with permissible feedback to the research team being confined to factual or legal observations. 

Structure and funding of research 

Structure

ASIC is concerned that the structure and funding of research teams may result in a lack of research independence, as research may be compromised where research funding is linked to corporate advisory revenues or where a research analyst's remuneration is linked to contribution to corporate advisory revenue. They advise that:
  • licensees should segregate research teams from corporate advisory and sales 
  • compliance arrangements should be documented and communicated to staff and reiterated through training on research and independence policies 
  • decisions about research coverage be made by the research team and not be subject to input or influence by other parts of the licensee. It should be clear to users (and prospective users) how a research report provider makes decisions whether to cover or not 
  • corporate advisory mandate agreements should not include an obligation or inducement to the licensee to initiate research coverage following completion
  • "prominent, specific and meaningful information about a licensee's (and its associates') conflicts" must be addressed 

Funding

The quality and independence of research may be compromised where research funding is linked to corporate advisory revenues or where individual research analysts bonuses are linked to the success of the capital raising process.
 
ASIC considers that research budgets and analyst remuneration should not be determined with input from corporate advisory, nor from revenue or results generated by corporate advisory. 

Summary of financial services licensees' obligations and potential consequences for compliance 

A licensee must:
  • control and manage inside information 
  • manage conflicts during the capital raising process, including avoiding, controlling and disclosing these conflicts 
  • manage research teams, including budgeting, research analyst remuneration and coverage details 
As a matter of theory, nothing in the guide should surprise. However, the guide highlights that ASIC will focus on this issue and in a current environment where internal management conduct is being scrutinised further, against a background of tightening returns and concern at the dual role played by licensees, compliance staff will need to review both written procedures and real-life behavioural culture to ensure compliance. 
 
Compliance may involve significant reorganisation and expenditure. The breadth and detail of the suggested steps, in this context, may see some licensed entities start to reconsider whether sell-side research best belongs within an institution, or whether efficiencies suggest that the function be outsourced. 

This article has been published by Colin Biggers & Paisley for information and education purposes only and is a general summary of the topic(s) presented. This article is not specific legal advice. Please seek your own legal advice for any questions you may have. All information contained in this article is subject to change. Colin Biggers & Paisley cannot be held responsible for any liability whatsoever, or for any loss howsoever arising from any reliance upon the contents of this article.​

Related Articles