Finance

Ethical Issues For The Investment Banker The Transgressor Client

Lawyers are guided by ethical codes and rules and significant case regulation (both bankruptcy and non-bankruptcy) when it comes to decisions about how to cope with difficult honest dilemmas. Lawyers also must consider “privilege” issues as they relate to client confidences. Investment bankers, on the other hands, have neither canons of ethics nor privilege responsibilities, and there is certainly little case legislation governing or guiding investment banker ethical behavior.

These distinctions were outlined in an engagement in the past, and it serves as a real-life exemplary case of the ethical dilemmas that investment bankers may face. Certain facts have been changed for privacy reasons. The client was a publicly exchanged producer, with a line of credit guaranteed by “eligible” accounts receivable. Weekly its lender received a certificate from your client that set forth gross accounts receivable for the purpose of the borrowing foundation calculation as well as net (i.e., “eligible”) accounts receivable.

The lender would then progress funds based on an agreed-upon formula. The investment bank or investment company (IVB) were engaged when your client (not in chapter 11) was struggling liquidity problems and functional difficulties, and was in default on interest payments to its bondholders. The IVB’s initial analysis was that your client and the bondholders should form an alliance to restructure the business, on the objections of the lending company perhaps. The IVB believed that the lending company had weaknesses in its documentation and perhaps other vulnerabilities as well.

Several weeks following the engagement commenced and prior to the IVB talked about its proposed restructuring strategy with the company’s key constituencies, the IVB’s homework uncovered that your client was falsifying its borrowing base certificates. This situation, which led to “over-borrowing” from the lending company, have been happening for some time apparently. It was clear that as soon as the lender found out the overborrowing, the company would maintain a material default on its line of credit (among other activities) and out of cash. Without financial assistance and co-operation from the lender, the ongoing company would likely have had to terminate operations and close its doors within days.

What were the IVB’s options in representing this client? After a board meeting, convened at the IVB’s behest to see the plank of the transgressions, company management agreed to a gathering with the lender and the IVB quickly thereafter to go over the overborrowing. After further conversations, company executives also decided to stop further overborrowings in the interim. In short order, the IVB and the company made a presentation to the lender describing the overborrowing and the business’s immediate impending insolvency because of this of correcting the overborrowing, absent assistance from the lending company.

The lender eventually accepted the IVB’s evaluation and supported the business’s suggested game-plan. Through the ensuing financial restructuring, the business’s constituencies achieved recoveries that both surpassed anticipations and were considered to be great results in light of the pre-existing circumstances. And the IVB earned a substantial “success” fee. All’s well that ends well, but imagine if the IVB’s original recommendation to the board had been declined? This was an extremely real possibility, given the “siege” mentality that can conquer a board’s common sense during a problem’s situation. The following are certain issues raised by this example that merit reflection.

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Issue: Did the IVB have the right-or the obligation-to demand that the business stop the overborrowing and disclose the matter to the lending company, with an implicit “if not”? Put another real way, just what was the “if not” at the IVB’s disposal-resignation? Unilaterally advising the lender of the fraud? Response: It obviously was right to demand that the overborrowing cease and desist, which the lending company be apprised at by the company once. Not only was it the ethical move to make, but to do otherwise could have subjected the IVB to legal liability if it continued its engagement without disclosing the overborrowing to the constituencies with which it was dealing.

However, the IVB probably experienced limited flexibility if your client had dropped to “fess up”; resignation may then have been the IVB’s only viable option. Issue: Imagine if the company had ceased the overborrowing but somehow had not been thereafter rendered illiquid? What would the IVB’s responsibilities and duties have been at that juncture, given that no ongoing fraud would be taking place?