ACCC missing the mark with cartel charges

Back in August 2015, we wrote an incisive article noting that ANZ’s $2.5 billion placement raising had fallen short. Whilst there was no public confirmation at the time by either ANZ or the underwriters, it was our experience in the market that led us to deduce that the investment banks underwriting the deal, Deutsche Bank, Citi and JP Morgan, had been left “holding some of the can”.

In our article, we simply asked who was smarter: the ANZ board who grabbed the money at an attractive price; or the investment banks who had mispriced the deal?

But in the period after we published our article nothing happened. Silence. No journalist, commentator or more importantly – any stockbroking banking analyst – penned a single word on the shortfall.

Was Clime the only group that could see the shortfall play out through the mechanics of the market? Or were we the only group who had nothing to lose by exposing the truth?

Then, a few weeks back, the ACCC shocked the market with its announcement that it was laying criminal cartel charges against ANZ, including its Group Treasurer, Rick Moscati, as well as Deutsche Bank and Citigroup, in relation to the $2.5 billion capital raising.

It seems as if the ACCC has happened upon an interpretation of the competition law as it applies to securities trading that no one knew existed. Therefore, the action by the ACCC will create significant discomfort amongst legal and compliance advisors to the securities market. If the ACCC is successful we would suggest that it will mean that there may have been significant breaches of the competition law in the securities industry for many years.

However, the ACCC action could unintentionally expose an unsavoury undercurrent to the conflicted processes at work in our capital markets. The action may indeed expose a real cover-up. That is the cover-up of information that is known by active participants in the stock market but is held away from the broader market by some covert means.

Normal behaviour?

There is no doubt the ACCC’s cartel action is interesting, but we perceive some issues in terms of the repercussions for securities trading if it happens to succeed.

The ACCC’s criminal charges would appear to relate to ANZ’s alleged knowledge of and Deutsche Bank and Citi’s alleged actions around how they disposed of the shares they were left holding as co-underwriters with JP Morgan. The press has speculated that the ACCC would appear to be alleging that the parties agreed to ‘prevent, restrict, or limit the volume or type of particular service available’.

Our opening observation and question re the action is this. When the investment banks agreed amongst themselves to provide ANZ with an underwritten placement of shares – could that be argued to be cartel type behaviour? Particularly so because together they set an underwritten price for the placement.

If the largest investment banks in Australia act together to approach or respond to ANZ’s desire to raise capital, then is it arguable that they are directing their balance sheet strengths together and therefore are restricting or indeed stopping others from joining them in the underwriting.

The underwriters guaranteed a result for ANZ and they had to reach an agreement to combine their forces and balance sheets. The ACCC is apparently not suggesting that the underwriting was illegal, even though it was clearly an understanding or arrangement to provide a service. Given its sheer size, having offered an underwriting to ANZ, it is very unlikely that a similar offer could have been made at that time by them to another large Australian company.

When the underwriters attempted to place the shares in a 24-hour period they probably acted under an agreed arrangement between themselves. They had to ensure that they would not “over offer” the shares to the market or to market participants. The ACCC is apparently not suggesting that this arrangement was cartel-like behaviour.

However, the ACCC will apparently allege that cartel type behaviour occurred when the investment banks acted together to sell their shortfall through the market. Therefore, it will be interesting to see how the ACCC describes the process by which a consortium of underwriters moves from a non-contravening arrangement (underwriting and offering) to a contravening arrangement in selling a shortfall – for it seems a logical progression of an underwriting arrangement.

Of course, the ACCC may well argue that the whole process was illegal and that the Australian equity market has been acting for decades under a total misconception as to how underwritings and shortfalls are arranged and dealt with – but that would have serious repercussions for the Australian Capital Market.

A difficult and doubtful route

How is the ANZ’s and the investment banks behaviour any different from say a single stockbroking enterprise, with various licensed advisors, taking instructions from numerous clients, to sell their shares in a single entity at the same time? If the advisors decide to not undercut each other, would that not become an arrangement where an intermediary is trying to arrange the selling to ensure that the market is not disturbed by the excessive selling?

Indeed, how are the operations of large entities managing multiple accounts, portfolios and funds any different? A multi funds group decides to sell down a position for multiple accounts and entities. How does it do it if it cannot arrange an in-house meeting to decide on a selling strategy?

Finally, how does the ACCC view affect the operation of “green shoe” arrangements commonly used by underwriters and sanctioned by ASIC to smooth the after-market price of an IPO? This arrangement was most significantly used by the Government to sell down Telstra to the public.

The ACCC actions will seemingly challenge more than the market behaviour of large underwriters. It may also have ramifications for any entity acting on behalf of multiple clients – and that happens every day in the stock market.

In this instance, the ACCC is undertaking a case with no precedence. Therefore, the question as to whether the relevant sections of the Code apply to securities trading generally may well need to be decided by the High Court.

Would it not be better, and less costly, to simply change the law to make it crystal clear when behaviour is illegal? It should not be a matter of legal opinion concerning the meaning or skewed interpretation of words.

We also suspect that the ACCC has not considered the full ramifications on the established principles governing the behaviour of equity market participants and particularly as it relates to dealing in and around market depth. Success by the ACCC will require a significant carve out of common market circumstances that can be legally undertaken.

In the meantime, as this case wanders through the legal system, how will any major Australian company get an underwriting agreement in place if no single underwriter can take on that risk on? If so that will have serious consequences for the mobility of capital and capital formation in Australia.

A cover-up?

We mentioned earlier that we believe there is an even bigger issue at stake.

The ANZ capital raising happened three years ago. You would think that it had been written about at the time and subsequently complained about. But it wasn’t covered in the press, nor by analysts, yet it would be hard to find a professional market participant who could not discern or did not know about the shortfall.

So why did no one write about it (other than Clime)? How was it covered up and who was protected?

We would suggest that the institutional or sophisticated market for Australian equities knew very quickly after the ANZ placement that there was a shortfall and therefore a possible overhang. The market for ANZ shares immediately traded below the placement price.

Some investors who took the placement would have known that they were in trouble – more so if their bid for the placement was totally filled. Maybe they were even offered more! In hotly contested and attractive placements, fund managers don’t get all the stock they want. So, when the opposite happens the fund manager knows he has overpaid.

The press has reported that JP Morgan confessed to a breach of trading rules when it failed to disclose it was selling (its underwriting position) as principal at some point. The disclosure of principle selling informs a buyer that the broker is not selling as an agent. So how many principal trades in ANZ were disclosed over the months that followed the placement?

Speculating on the ANZ $2.5 billion institutional placement we suspect that there would have been a range of buyers. Index funds, active long-only funds, active long-short funds, international funds and highly geared and hyperactive hedged funds.

It is the hedge funds who often overbid in placements or bookbuilds and attempt to extract excessive returns from small trading spreads on their leveraged capital. We suspect that the hedge funds bid aggressively for the ANZ stock and got caught and that gives us a possible insight into the behaviour of a range of market participants in the months that followed the placement.

The biggest writers of brokerage for stockbrokers, particularly those owned by investment banks are hyperactive hedge funds. They are huge generators of broking commissions because they are big traders and they reward the delivery of good ideas and stock placements. Hyperactive hedge funds are given access to all deals and are well looked after.

Therefore, in the period after the ANZ placement debacle (for the underwriters), why were the major banking analysts so quiet on the obvious shortfall in the ANZ placement? How could any banking analyst who has any understanding of the market, not warn their clients and readers that there was a probable overhang of ANZ stock that will affect its market price until cleared?

It is beyond the realm of possibility that Clime was the only market participant to speculate correctly on the ANZ overhang – admittedly we cannot find anyone else who did. Therefore, it seems to us that the information wasn’t made public because the major market players, commission agents and trading funds needed to protect each other from losses.

The background to this observation is our view that there is possibly way too much money being paid in brokerage by hedge funds, and the fear must be that they may be able to influence market information flows and indeed limit access to information.

The investigation of the ANZ placement is indeed interesting but not for the reasons circulating through the media. It may well blow open a dark side to equities trading that has been under-investigated and unregulated for far too long.

There are many observable instances of broker upgrades and downgrades to stocks, that are preceded by sharp market moves. Or indeed that market prices move instantaneously with the release of research that suggests that research dissemination is controlled and staggered.

If the ANZ capital raising shortfall is shown to have had elements of cover-up, then it will be the clearest and most blatant example of the covert controls that can affect information that flows into the market. It will be blatant because it was obvious to any stock market professional who could read markets.

However, there are more players in equity markets then professionals. There is a swag of advisors and retail investors who – through lack of knowledge and experience – may have had no idea that an overhang existed in the market. Indeed, it was not only the shortfall held by underwriters but the shares held by wrong-footed traders that would depress the ANZ price for months.

Where the real rigging is

Across the world’s capital markets price rigging is a constant. The endless use of quantitative easing by a cartel of central banks to manipulate bond markets creates an interesting environment for the ACCC to argue price cartel behaviour in securities trading in Australia.

Australian regulators seem to have launched a tirade against the banks. Whilst parts are both necessary and long overdue, they must be careful to not overstep and unwittingly create problems for the efficient workings of the Australian financial system.

In passing, we note that this criminal action creates a new front in the debate concerning excessive bank executive salaries. A bank CFO who seemingly does a great job in raising capital for his shareholders may unwittingly become a criminal in doing so. Suddenly pay scales do not seem sufficient to compensate for that risk.

The stock market has been gamed in so many ways, and the ACCC has chosen to focus on a part that is not the real problem. The most blatant rigging is in information flow. Therefore, in the interests of a fair market for all investors we will keep asking: how did the information about the ANZ capital raising shortfall not flow to the broader market? And how did market participants manage to keep it a secret away from the public for so long?

Clime Group owns shares in ANZ.