What really happened with Commonwealth Bank’s bungled share placement: Kohler

Commonwealth Bank’s shambolic share placement raises two questions of substance – did CBA facilitate insider trading in its own shares, and did Merrill Lynch fail to fulfil its contract to mumble the inside information to some of the insiders?

The answer to both questions appears to be yes.

CBA announced an effective profit downgrade at 7.30pm on Monday. I say “effective” because the relevant words in that announcement were “…the full year loan impairment expense to gross loans and acceptances is now expected to be around sixty basis points…”

The previous figure was 40 basis points. The change represents a profit downgrade of roughly 7%.

During that day’s trading session, CBA shares had gone up 4% after JP Morgan upgraded its price target for CBA and downgraded the other banks.

So let’s be charitable and assume that CBA management only discovered the increase in the loan impairment ratio after the close of trading and couldn’t possibly have put out a profit warning in the morning so that those who bought during the day didn’t overpay.

Immediately after the close of trade, CBA’s broker Merrill Lynch started going to the institutions with a placement at $27 a share – $2.15 below the last sale.

Let’s be clear what that means. Some hapless investors paid $29.15 just a few minutes before Merrill Lynch, acting on instructions from CBA management, began inviting institutions to buy at $27 having told them privately that profit would be 7% lower than the market thought it would be. At least they were supposed to tell them that.

In fact, CBA says a draft press release was given to Merrill sales staff to either read out or, preferably, fax or email to the institutions to which they were flogging the stock.

Later that night, after the placement was done at $27 and the press release had been sent out to anyone still in the office at 7.30pm, institutions started ringing CBA chief financial officer, David Craig, complaining that they hadn’t been told by Merrill Lynch about the increase in loan impairment ratio.

At 10pm, Craig called his boss, CEO Ralph Norris, to tell him they had a problem. The relevant folk at Merrill Lynch were then phoned and asked: “Was the press release circulated to the institutions before they signed up for the placement?”

According to CBA, the answer was: “No – we read it out to them.”

David Craig: “OK – can we listen to the tapes?”

Merrill: “Sorry, we didn’t record the conversations.”

It was clear from the barrage of complaints that many, if not all, of the institutions that took up the share issue had not been told. CBA couldn’t prove that without tapes, but decided the placement had to be scrapped.

Next morning UBS’s Matthew Grounds and his team swooped and slurped up the fee, plus an underwriting fee, by issuing the stock at $26 – $1 cheaper.

That, at least, is CBA’s version of events. The broker’s response, both on and off the record, is: “Merrill Lynch does not accept CBA’s characterisation of events.”

I understand from second-hand sources that Merrill doesn’t accept that it was required to carry out CBA’s market disclosure obligations.

CBA admits that it asked Merrill Lynch to supply selected institutions with inside information at around 5pm – two and a half hours before the press release went out.

It’s true that the ASX was closed, but there is always somewhere open in the world where you can trade stock derivatives or the stocks themselves.

I don’t know whether anyone actually did short CBA or any CBA derivatives in London between 5pm and 7.30pm, but they could have. Ralph Norris and David Craig should have issued the press release at 4.30pm – before Merrill Lynch started going to the institutions.

Clearly Merrill’s sales staff did not read out the press release to at least some of the buyers. Perhaps they were uneasy about it. Perhaps, as one senior CBA source suggested to me, they had been at a boozy Christmas lunch and just forgot.

This is a contractual matter. I understand that page four of the agreement between CBA and Merrill states that: “Participating investors will be provided with the draft market announcement.” If that’s correct (and I haven’t actually read the agreement) then Merrill appears to have not fulfilled its side of the contract.

It was on those grounds that CBA cancelled the deal on Tuesday morning and withheld the fee.

Ralph Norris is now deciding whether to sue Merrill Lynch for the $1 a share it missed out on. That’s a bit more than $40 million.

Best not to, I would have thought. It might not look good to sue an investment bank for failing to provide institutions with market sensitive information two and a half hours before a press release.

This article first appeared on Business Spectator