The following article presents a high level overview of the use of pre-deal research reports in initial public offerings in selected jurisdictions and is not intended to be fully comprehensive, conclusive or address all legal aspects and regimes that may govern pre-deal research reports in the identified jurisdictions. The following article presents the views and opinions of the author only.
Content
Introduction
The securities market ecosystem involves a number of players with varying roles. At the core of this ecosystem are the corporate issuers, on the one hand, and the universe of investors, on the other hand. The relationship between the corporate issuers and the investors is mediated by a myriad of legal regimes and regulations, all of which aim to ensure that the securities markets in the respective jurisdictions are, among other things, highly functioning, transparent, efficient and fair. While corporate issuers and investors primarily rely on the regulators or entities charged with the oversight of such markets to ensure compliance with applicable legal and regulatory regimes, there are a number of other players within this ecosystem that contribute to the ongoing functioning, transparency, efficiency and integrity of securities markets, including auditors, rating agencies and securities analysts. Indeed, legal scholars have often identified these entities as among the several "gatekeepers" in securities markets that, by pledging their so-called reputational capital to the corporate issuer, the gatekeepers "assure investors as to the quality of the 'signal' sent by a corporate issuer".[1]
As among the "gatekeepers" of securities markets, securities analysts (also known as research analysts, equity analysts or investments analysts) essentially perform financial analysis for external or internal financial clients, largely in the form of research coverage. One of the greatest advantages of ongoing research coverage by securities analysts is, in principle, the "independent" assessment of the issuer's financial performance within the current macro-economic environment as well as how that compares with peers, whether within a specific industry sector or geography. In addition, ongoing coverage by securities analysts providing concise information and analyses on a corporate issuer to the buy-side investment community is among the essential components to increasing the visibility of a corporate issuer's shares and maintaining an active and liquid trading.
A corporate issuer's relationship with securities analysts typically begins (or develops more in earnest) with its initial public offering (IPO).[2] Generally, connected analysts (i.e., those securities analysts from the same financial institutions that are participating as underwriters in the IPO banking syndicate) are introduced to a corporate issuer at so-called analyst presentations or analyst days, which can range from a daylong event to multi-day sessions, during which the company presents its business, strategy and financial performance in recent periods. Oftentimes, these events are accompanied by a tour of the company's headquarters or significant facilities along with live demonstrations of key product offerings or business lines. Securities analysts will then use the information provided and learned at such events as a basis for their own independent assessment, valuation and financial model of the corporate issuer, which typically includes financial forecasts for the next three to five years. In a number of jurisdictions outside the United States, securities analysts will then publish their findings in pre-deal research reports, which (as their name suggests) are published in the weeks leading up to a corporate issuer's launch of its IPO. In addition to the publication of pre-deal research reports, securities analysts may also hold meetings or sessions with clients or potential investors to discuss their views and assessment of a corporate issuer's potential IPO. In many jurisdictions, the publication of pre-deal research reports and/or the accompanying investor meetings are regarded as key elements of investor education as well as a vital source of price discovery (i.e., the potential value of the corporate issuer's shares).[3]
Importantly, depending on the facts and circumstances and in light of the short temporal time period between the publication of pre-deal research reports and the launch of the book-building process in an IPO, the publication of pre-deal research reports raises a number of potential issues. In many jurisdictions the scope of liability around pre-deal research reports is not clearly defined and could potentially give rise to a number of legal claims and causes of action. In the United States, for example, the general anti-fraud provision outlined in Section 10(b) of the U.S. Securities Exchange Act of 1934 and Rule 10b-5 provide broad basis for both civil and criminal liability in connection with securities transactions and extends to "any person" as well as to both oral and written statements, whether or not relating to a disclosure document.[4] In addition to fraud and/or prospectus liability issues, concerns that the research report could be deemed by a court or regulator as an offer to sell securities, potentially running afoul securities laws or regulations relating to timing issues or other technical aspects of the respective regulatory regime, have to be considered.[5] These arguments become further complex for pre-deal research reports published by connected analysts as well as by the active role that companies and advisors take in the preparation of analysts presentations and the subsequent review of pre-deal research reports prior to their publication for factual accuracy. While generally the issuer and other advisors are not permitted to comment on the opinions made by securities analysts nor are they asked to "approve" the pre-deal research reports, if significant factual inaccuracies exist in pre-deal research reports, this could create potential liability issues that may be challenging to navigate.
On top of possible legal and regulatory issues, pre-deal research reports published by connected analysts also raise certain conflict of interest concerns increasing the risk that the content of such pre-deal research reports may be biased. Specifically, the investment banking team participating in the underwriting syndicate owes certain duties to the corporate issuer pursuant to their documented engagement in the IPO process and has a financial interest in the success of the IPO through its commission and fee arrangements.[6] On the other hand, the securities analysts at the same financial institutions responsible for the publication of pre-deal research reports owe certain corresponding duties to the buy-side investors that either purchase such research or are clients of the financial institution. Thus, if sufficient controls and measures are not in place at a financial institution to address such potential conflict of interests, there are heightened risks that connected analysts may not only have access to certain or additional non-public information that will not be included in the offering documents, but (and perhaps most importantly) may also be pressured to publish favorable pre-deal research reports to both secure a position within the IPO underwriting syndicate and drive the share valuation of a corporate issuer. As certain regulators have found, such biased and non-objective analyses could directly influence investors' decisions and compromise the integrity and efficiency of the price discovery process in IPOs.[7]
As a result of these combined factors, the nature of the relationship between corporate issuers and securities analysts, as well as the approach to marketing IPOs by the investment banking teams, has evolved and diverged rather significantly over the last twenty years and across certain of the world's most significant securities markets. To date, international regulators have largely focused on safeguarding securities analysts' independence and objectivity in light of potential conflicts of interest between securities analysts and the corporate finance/investment banking divisions of the same financial institutions and potential biases that could present in pre-deal research reports as a result. Financial regulators have tried to address such issues through specific regulations as well by encouraging market driven measures. Such regulations and measures have led to, among others, the requirement of disclosure statements,[8] limitations on the involvement of securities analysts in investment banking pitches, implementation of Chinese walls and "control rooms" within financial institutions[9] and blackout periods.[10]
In the following sections, this article will explore the regulatory approach to securities analysts and pre-deal research reports in IPOs across the United States, the United Kingdom and Hong Kong and how that compares with the approach used in Switzerland, which is generally representative of the approach used in much of Europe.[11] This survey is followed by a comparative overview and a short commentary on the effectiveness of pre-deal research reports in investor education and efficient...
