Chapter 14 - Investment Banking (v1.2)

Podcast

Play an AI-generated podcast conversation about this lesson

Questions and Answers

What is an essential requirement for a dealer member's due diligence procedures regarding new products?

A mandatory presentation by the product development team

A public feedback form for customer input on proposed products

A standardized process that includes a written proposal (correct)

A verbal discussion among staff members about the new product

Which step must be taken following the approval of a new product?

A one-time training session for sales staff only

Monitoring customer complaints and grievances related to the product (correct)

A comprehensive evaluation of the product's market performance

Immediate marketing launch without further assessments

What is the role of the new product committee in the product evaluation process?

To oversee the financial forecasting of each new product

To publicly announce new products to potential clients

To approve, disapprove, or table the product proposal (correct)

To gather consumer feedback before finalizing the product

What aspect of a proposed new product is NOT required during the preliminary assessment?

The potential sales forecasts for the product Signup and view all the answers

Which of the following is an ongoing requirement for registered individuals regarding client securities recommendations?

Understanding the structure, features, and risks of securities Signup and view all the answers

Which group should be involved in the detailed review of new products or modifications?

A committee composed of members from all relevant sectors Signup and view all the answers

What is the primary responsibility of a compliance department during the underwriting process?

To ensure adherence to the firm's policies and procedures. Signup and view all the answers

How are marketing and research differentiated according to the content?

Research provides a recommendation for securities, whereas marketing promotes the sale of products. Signup and view all the answers

What is a significant conflict of interest in research highlighted in the content?

Analysts may produce biased reports to satisfy investment banking clients. Signup and view all the answers

Which of the following is NOT considered a red flag that underwriters should document?

Positive market forecasts from analysts Signup and view all the answers

What should a dealer member establish concerning their research department according to IDPC Rule 3600, Part B?

A supervision program for the department. Signup and view all the answers

What is one of the key responsibilities of underwriters regarding legal counsel?

Underwriters should supervise legal counsel to ensure effective communication. Signup and view all the answers

What key factor must be considered when creating research policies and procedures?

Which materials are research versus marketing in nature. Signup and view all the answers

Which task is NOT typically included in the legal due diligence process?

Conducting market analysis Signup and view all the answers

In the presence of multiple underwriters, what must counsel ensure during the due diligence process?

To maintain clear communication with all syndicate members. Signup and view all the answers

Why is it important for the compliance function to participate during the underwriting process?

To ensure compliance aligns with the dealer member's business model. Signup and view all the answers

What should be acknowledged when research analysts publish their reports?

They should reveal any personal ties to the companies involved. Signup and view all the answers

Why is it important for underwriters to document red flags?

To guide future transactions and risk assessments. Signup and view all the answers

Who is ultimately liable to purchasers during the due diligence process?

The underwriters themselves Signup and view all the answers

What role does a committee play in the underwriting process as per the content?

It supervises the underwriting process and ensures compliance. Signup and view all the answers

What type of professional is classified as an expert according to the CIRO?

An auditor qualified to assess financial statements Signup and view all the answers

During which significant event were many conflicts of interest in research revealed?

The tech boom and crash of 2000–2001. Signup and view all the answers

What is expected of a dealer member regarding its underwriting due diligence function?

To have a structure that reflects the size and model of the firm. Signup and view all the answers

What indicates that a thorough due diligence process has not been followed by an underwriter?

There are unexplained delays in providing requested information. Signup and view all the answers

Which approach should underwriters take regarding the use of legal counsel during the due diligence process?

Manage legal counsel's tasks appropriately without over-utilizing them. Signup and view all the answers

What is the primary role of a designated derivatives supervisor?

To review client and firm trading activity and ensure compliance. Signup and view all the answers

Which of the following correctly describes structured products?

Investment vehicles combining principal protection with asset exposure. Signup and view all the answers

Which category does commodity futures fall under?

Standardized derivatives traded on exchanges. Signup and view all the answers

What is a significant feature of physical commodity futures?

They must be closed out before expiry if held until that date. Signup and view all the answers

What distinguishes over-the-counter derivatives from exchange-traded derivatives?

Over-the-counter derivatives are non-standardized and negotiated individually. Signup and view all the answers

Which of the following best describes credit derivatives?

Financial products primarily used for hedging credit risks. Signup and view all the answers

What are equity and index options primarily traded on?

Various U.S. or international exchanges. Signup and view all the answers

What is the role of designated and proficient staff in the supervision of derivatives?

To monitor and ensure compliance with derivatives transactions. Signup and view all the answers

What financial instruments are included in over-the-counter derivatives?

Interest rate swaps, collateralized debt obligations, and credit default swaps. Signup and view all the answers

What is a key aspect of the compliance program for marketing and research?

It must include regular sampling of the work product. Signup and view all the answers

According to IDPC Rule section 3621, which of the following is prohibited regarding research reports?

The investment banking department approving research reports. Signup and view all the answers

Which of the following is a responsibility of the research supervisor?

Reviewing and approving research reports. Signup and view all the answers

What must the policies and procedures specifically prohibit concerning the investment banking department?

Receiving advance notice of new ratings or changes. Signup and view all the answers

Why is training important for staff in research departments?

To review research products before distribution. Signup and view all the answers

What should a research report always include to avoid misleading investors?

All relevant information known to the analyst. Signup and view all the answers

Which of the following is NOT a responsibility defined in the IDPC Rule for the research department?

Conducting regular training sessions for investors. Signup and view all the answers

What role does the compliance department play in the research process?

Reviewing research products to ensure compliance with regulations. Signup and view all the answers

Which of the following practices is encouraged in order to maintain compliance in research?

Using clippings services to detect unauthorized materials. Signup and view all the answers

What is a critical part of the flow of information between analysts and investment banking staff?

Recording communications to prevent conflicts of interest. Signup and view all the answers

Study Notes

Underwriting Red Flags

Red flags that underwriters should document:
- Inconsistent grants of stock options
- Material sales of securities by insiders
- Recent ratings downgrades
- Identical interview answers from customers and third parties
- Deflection or avoidance of interview questions
- Withholding of requested information
- Undue delay or denial of a site visit

Legal Due Diligence

Legal due diligence is reviewed by the underwriter’s legal counsel
Responsibilities may include:
- Contract review
- Examination of local laws
- Government relations
- Issues related to asset ownership in each jurisdiction
Legal counsel plays an important role in due diligence in foreign and emerging markets
Underwriters should assign appropriate tasks to legal counsel but should avoid overusing them
The underwriter is ultimately liable to purchasers
When multiple underwriters are present, the legal counsel communicates the results of legal due diligence to all syndicate members

Reliance on Experts

An industry expert may be involved in the issuance of a prospectus through a report, opinion, statement, or other disclosure
An expert can be a lawyer, auditor, accountant, engineer, appraiser, or any person or company authorized to provide a statement
The level of expert involvement depends on the specific circumstances surrounding the prospectus
Individuals executing a prospectus on behalf of a dealer member should confirm that the firm’s policies and procedures have been followed and that any red flags have been addressed

Supervision of Underwriting

Supervision of the underwriting process can be done by a committee established by the dealer member
Compliance with underwriting due diligence can be carried out by the compliance department, legal department, or internal audit department
Compliance can occur during the underwriting process with the department or person responsible participating in a committee that oversees the process
The dealer member should put in place a structure that reflects the firm’s size, function, and business model

The Research Department

IDPC Rule 3600, Part B outlines the requirements for establishing a supervision program for a research department
The rule sets out standards for analysts when publishing research reports or making recommendations and addresses conflicts of interest
One of the key issues is defining what material should be covered under research policies and procedures and what is considered marketing material
The key difference is that research makes a recommendation to buy, hold, or sell a security, while marketing material promotes the sale of the firm’s products and services
Research requires additional disclosures to address inherent conflicts of interest that arise when the same dealer provides advisory and trading services to companies they cover with research
The compliance program for marketing and research should review departmental policies and procedures, including a regular sampling of work product
Marketing and research should utilize clipping services and internet searches to identify marketing materials that have not flowed through proper channels

Derivatives and Complex Products

Supervision of a dealer member’s derivatives transactions requires designated and proficient staff at both the compliance and departmental levels
Derivatives include a number of separate products that require specific policies and procedures
The rules and requirements vary for exchange-traded options, exchange-traded futures, options on futures, commodities, over-the-counter derivatives, and structured products
Exchange-traded options include equity and index options traded on the Montreal Exchange and on various U.S. or international exchanges
Futures and options on futures cover broad-based product and sector indexes, government debt, short-term treasuries, long-term bonds, and commercial paper
Commodity futures include agriculture futures, oil and gas futures, and metal futures
Commodity futures typically have physical settlement, so care must be taken to ensure that any expiring futures are closed out before expiry
Over-the-counter derivatives include interest rate swaps, equity swaps, collateralized debt obligations, credit default swaps, and any other non-standard derivatives with terms negotiated under an International Swaps and Derivatives Association agreement
Structured products are notes that combine exposure to an underlying asset, such as an equity index, with principal protection

Derivatives and Complex Products Supervision

A designated derivatives supervisor is responsible for approving new derivatives accounts, reviewing client and firm trading activity, and ensuring regulatory, large position reporting is completed on time
Product due diligence procedures should include the following:
- A standardized process that requires a written proposal for new products
- A preliminary assessment of a proposed product or concept by the dealer member, or a department designated in the firm’s policies and procedures, to determine:
  - Whether the product is new or a material modification of an existing product
  - The appropriate level of internal review
- For new products or material modifications to existing products, a detailed review by a committee or working group made up of representatives from all relevant sectors of the firm, including compliance, legal, finance, marketing, sales, and operations
- A formal decision to approve, disapprove, or table the proposal by a new product committee or other decision-making group that includes members of the firm’s senior management
- An assessment of the extent of training in product features and risks necessary to ensure advisors and supervisors can judge the suitability of recommendations and sales to clients, and the development and implementation of the necessary training
- If the product is approved, a determination of the appropriate level of, and process for, post-approval and follow-up, including consideration of the following aspects:
  - Monitoring of customer complaints and grievances related to the product
  - Reassessment of training needs on a continuing basis
  - Monitoring of compliance with restrictions placed on the sale of the product
  - Periodic reassessment of the suitability of the product

Research Supervisor

Most research departments have a director or supervisor responsible for compliance with industry regulations
Appropriately trained staff should review all research products prior to distribution
The research supervisor is responsible for reviewing and approving research reports and ensuring that those reports contain information based on facts, not rumors
A research report should never exclude information relevant to an investor making an investment decision
The supervisor also works with compliance on research that may be about issuers on the grey or restricted lists

Conflicts of Interest

Many conflicts of interest came to light during the tech boom and subsequent crash of 2000–2001
At that time, it was determined that a number of research analysts produced reports that were in conflict with their true opinions, or that were influenced by the desire to please the subject companies so that investment bankers could win more of their business

Preventing Conflict of Interest

IDPC Rule section 3621, Relationship with investment banking, states:
- A Dealer Member’s policies and procedures must specifically address preventing recommendations in research reports from being influenced by the investment banking department or the issuer.
- The policies and procedures must specifically address, at a minimum:
  - Prohibiting the approval of research reports by the investment banking department
  - Limiting the investment banking department’s involvement in the production of research reports solely to the correction of factual errors
  - Prohibiting and preventing the investment banking department from receiving advance notice of new ratings or rating changes on covered issuers
  - Establishing systems to control and record the flow of information between analysts and investment banking department staff regarding issuers that are the subject of current or prospective research reports

Registered Individual Responsibilities

A registered individual must not purchase or sell securities for a client or recommend securities to a client unless the registered individual takes steps to understand the securities, including:
- The securities’ structure
- Features
- Risks
- Initial and ongoing costs
- The impact of those costs

Studying That Suits You

Use AI to generate personalized quizzes and flashcards to suit your learning preferences.

Description

This quiz focuses on essential red flags that underwriters must document during the underwriting process. It also covers the vital role of legal due diligence in ensuring compliance with local laws and effective communication among legal counsel and underwriters. Test your knowledge on these crucial underwriting aspects.