The ethical banker who crossed the Street

The case of Michael Grimes and the Facebook float is a sad one for American morality. The investment banker who broke the rule by following the rules has been lambasted from pillar to post.

In an IPO an investment bank takes a fee from a business to place that stock in financial markets. Or, more precisely, they take a fee from a business to sell part of that business.
Their customer is the company doing an IPO and they have a legal and moral obligation to get the highest price for the company they are selling. No more. No less.

However, investment bankers have, as a practical matter, a desire to expand and improve their franchise. Their franchise consists of a huge number of buy-side investors (some retail, some institutional) who will buy from them whatever they sell so long as it comes in a prospectus.

Investment bankers expand that franchise by making sure the things sold in a prospectus have excess demand. If they can sell for $38 they chose to sell for $33 to guarantee a stag. Every time they do so they build their own franchise as an investment bank at a cost to the client to whom they owe a legal and moral duty and who is paying them fees.

The buy-side customers of investment banks have got used to playing in this little game of theft. We – as buy-siders – like to be able to buy IPOs and have instant stag profits. Indeed, in the 1990s the game of giving favours to investment banks in exchange for instant stag profits became the way business was done on Wall Street.

The moral corruption of investment banks not only became accepted but we redefined morality around what investment banks did rather than what they should do. We thought the process of systematically ripping off the sellers of IPOs in order to build the buy-side franchise of the investment bank was right-and-proper.

It is not right-and-proper and it never was right-and-proper.

The investment bank owes a duty to the seller of the IPO and that is all. Whining fools who complain otherwise have allowed their own greed to distort their morality until they have become gebbeths.

But not only have people whose hip-pocket being (justifiably) hit complained about the Facebook IPO their supplicants in the press have been sucked into supporting the buyers same self-interested immorality. The Wall Street Journal (a magazine captured by Wall Street not Silicon Valley) derides Michael Grimes (the Morgan Stanley banker) for not standing up to David Ebersman (Facebook's CFO) and allowing Facebook to sell too many shares at too high a price. This is tits-up-backward. David Ebersman in this context is the client. He paid the fees. Michael Grimes had a duty to act in Ebersman's interest. Ebersman wanted to sell more shares at a higher price. Michael Grimes and Morgan Stanley obliged even at the cost to their own franchise.

And for that he is being pilloried in the press.

What we have here is an investment banker acting ethically. And the whole financial press is a twitter about it.

And the US Securities and Exchange Commission is investigating.

No ethical behaviour goes unpunished in America.

*Footnote: Joe Nocera, of The New York Times, seems one of the few people in the financial press who sees this the right way. My respect for Joe rises every year.

John Hempton is chief investment officer of Bronte Capital Management and blogs atBronte Capital. Reproduced with permission.