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Update on 8th March 2021

Perhaps I should have used the word 'scandal' rather than 'trouble' but that would be overstating the recent brouhaha regarding an Anglo Irish Bank bond sale by Davy's for a client back in 2014, in my opinion.

Davy sold the bonds at 20.25 cent each. The client then tried to back out of the deal, on the basis that he was offered a higher price of 32 cent per bond by an investment banker, after he agreed the deal with Davy at 20.25 cent. Unsurprisingly, Davy refused to renegotiate a deal that had already been agreed. Davy had sold the bonds to a group of 16 senior executives at Davy, so as Davy is a partnership, it effectively sold the bonds to itself.

The 16 senior executives are accused of not informing the Davy compliance department of the deal, and the firm as a whole is accused of not having appropriate 'conflict of interest' procedures in place. Furthermore, Davy is accused of not having informed the client that Davy itself was the buyer.

Hereunder is a defence of the 'Davy 16' had the firm not settled with the Central Bank, and the case came before the High Court (rather than the 'Kangaroo Court' known as 'Trial By Media'):-

Firstly, there is nothing remotely irregular or unusual about Davy buying bonds or shares, or any other type of security, for itself. It buys and sells such securities every day of the week that markets are open, in its role as a market-maker. When a deal is agreed, it cannot be cancelled as otherwise the market would not function - that is a fundamental rule of market making.

Secondly, Davy is often referred to in the media as a 'stockbroker'. However, stockbroking is just one of Davy's three businesses. The other two are market making and corporate finance. These are three very different businesses. Stockbroking is the buying and selling of securities for clients. When a stockbroker is buying or selling securities for a client, he/she can deal on an electronic order system and this system matches up the buy orders with sell orders for each security, as much as possible. However, this system can usually handle only the smaller trades, so the larger trades are generally done through market makers.

Market makers quote buy and sell prices for securities such as shares and bonds, and the difference in these prices (which represents the market maker's profit) is known as the 'spread'. If there is very little trading in a particular share or bond, the market makers will widen the spread between the buying and the selling price, to protect themselves from the risk of waiting for a prolonged period to sell on the securities they have bought, or to buy back the securities they have pre-sold ("sold short").

Deals done in the ordinary course of market making, are not reported to the compliance department, but personal account dealings by individuals working at the firm (which would be routed through the stockbroking arm) are.

When the client opened an execution only account with Davy's, he was sent a lengthy terms of business leaflet with his registration form. On the registration form, it was stated he confirms that he has read and understood the accompanying terms and conditions on signing the form. The terms and conditions contain a paragraph stating that J & E Davy may act as agent or principal in dealing for a client. Acting as 'agent' means that Davy is matching your buy (sell) order on the electronic order system with a sell (buy) order from a client of another firm. Acting as 'principal' means that your order has been dealt with a Davy market maker. Therefore, while the client was not informed that the deal was done with Davy itself (as a market maker) - the client was informed in advance that any deal done for him could be done either with another client counterparty, or with a Davy market maker, without specifying which one would occur.

The other business conducted by Davy, is corporate finance which is the raising of funds for companies by initial public offerings, placings and rights issues.

The only other stockbroking & securities firm in Ireland that offers all three of these services is Goodbody. All of the other stockbroking firms that operate here, are engaged in stockbroking only - they have no market making or corporate finance arms, so these conflicts of interest do not arise.

There are significant conflicts of interest between each of these three businesses. For example, the market makers at the firm might find they have bought a load of bonds that they then cannot sell. There is a risk in those circumstances that the clients of the stockbroking arm will be encouraged to buy these bonds, so that the market makers can avoid taking a loss on their position. Another example of a conflict of interest is when the corporate finance department is raising funds for a company and some of the stockbrokers are of the view that the shares in that company are currently overvalued in the market. There is a risk here that those stockbrokers are encouraged to keep their views to themselves until the shares have been placed with buyers in the market.

A famous example of a conflict of interest was when Mr Henry Blodget, an analyst at Goldman Sachs during the dot com boom of 1995 -2000, sent out very bullish reports on technology companies that Goldman was about to bring to the market. He had handwritten "POS" on his research files for many of these. It transpired a few years later, that "POS" stood for Piece Of Shit!

Oh least he knew a POS when he saw one - many other didn't...

These conflicting activities are allowed to take place in a stockbroking firm by regulators, providing that the firm has appropriate procedures in place to guard against abuses arising from such conflicts.

The regulators are, arguably, guilty of incompetence in allowing stockbroking & securities firms to perform these three distinct businesses under the one roof, as conflicts of interests will invariably occur. No procedures to guard against abuses arising from conflicts of interest, can protect a firm from the appearance of an abuse arising, as prices often move sharply up or down after deals are done.

Thirdly, J & E Davy agreed to an early settlement of the Central Bank's allegations of a breach of the EU's Market In Financial Instruments Directive (MIFID) in respect of inappropriate conflict of interest procedures, due to the discount on the fine that was available for doing this, and to avoid the expense in terms of legal fees and management time of appealing to the High Court.

Many firms in the financial services sector prefer to settle early with the regulators, even if the directors believe the firm is not at fault, due to the costs in legal fees and more importantly, in management time, involved in a prolonged legal battle.

Fourthly, the media reporting of this event has sensationalised the story by misrepresenting it as a case of J & E Davy paying only 20.25 cent to a client for his bonds which were worth 32 cent each. One commentator, who should know better, said it was like an auctioneer selling your house for €200,000 to himself, when he had a bid from another client for €300,000. Not a valid comparison, by any stretch of the imagination. Davy's, in its capacity as a market maker, bought the bonds for 20.25 cent each. They sold them three weeks later - we are not told at what price, but one assumes at a profit.

Three weeks is a long time in the financial markets. During that time, the 'Davy 16' were exposed to considerable risk on this holding. It obviously was not easy to sell these 'junk' bonds, because if Davy's could have got rid of them quickly at any sort of decent margin, they would have done so. What if markets had wobbled in that three week period? The 'Davy 16' would almost certainly have incurred substantial losses. They offered the client a price for the bonds, taking into account that it would probably take a few weeks to sell them, so the price they offered reflected that risk.

If they client was not happy with the price offered, all he had to do was say "no". Instead he said "yes" but came back a short while later complaining about the price. This was a client who had his own advisor, and had engaged Davy's in an 'execution-only' role. Therefore Davy's could not give him any advice as that would have been outside their remit.

Of course, no commentator thought it necessary to explain to readers the market making function that Davy provides, in addition to its stockbroking services. That would spoil the 'shock-horror' style headline of J & E Davy being involved in "dodgy dealings".

Also, not one commentator bothered to challenge the client's assertion that he had got an offer for his bonds from an investment banker at 32 cent each. If he indeed did get such an offer, how sure was he that the counterparty would pay up? Perhaps it was one of these phantom bids from a Chinese company - we seem to be seeing a lot of those lately!

Neither did any commentator highlight the fact that it was the client's own advisor (Davy's being in an 'execution-only' role) that initiated legal proceedings - by suing his own client, rather than J & E Davy! The client then sued J & E Davy. A rather peculiar sequence of events that, don't you think? Something to do perhaps with the bizarre deal, apparently agreed, that the client, his advisor and Davy would share the excess of the proceeds over the amount due to the vulture fund. The advisor felt he was cut out of the deal with the sale price being 'too low', and sued his client! The client then was perhaps forced, in a way, to sue Davy's so that if the case against him was settled out of court, he could in turn pursue Davy's for a similar settlement.

If there is any vulnerability in Davy's position, it was in agreeing to this bizarre deal. It is not normal practice to ring up a stockbroker, and say that if you can offload these illiquid 'junk' bonds for more that a certain price, then I'll give you one third of the difference! This indicates that the client is concerned that Davy's won't act for him, as trying to sell these bonds is going to be way too much hassle for them - therefore he feels obliged to give them an extra incentive, in addition to the normal commission they would get if a sale is done.

However, this unusual aspect of the deal is not mentioned by the Central Bank in its reasons for sanctioning Davy's. Instead, there is a vague statement from the CB about not having the appropriate conflict of interest procedures as required by the EU Market In Financial Instruments Directive (MIFID). The CB are not very forthcoming about what exactly these procedures should be - do they want a committee set up that meets monthly, or will every deal need to be signed off with a declaration or whatever.

Stockbroking firms are having great difficulty in trying to comply with MIFID I, which was introduced in 2007 and MIFID II introduced more recently. This is due to the absurdly voluminous nature of these Directives, with MIFID I running to 400 pages and the spectacular monstrosity that is MIFID II which has 1.5 million paragraphs (per the Financial Times) so it must be clocking in at something like 100,000 pages!

So lets imagine for a moment that you are the CEO of J & E Davy. You decide to recruit a new compliance officer and this person will be the MIFID specialist. If he or she can read and understand 20 pages of a Directive every day, it will take them two years to get through it all, providing that they take no holidays and never get sick.

Meanwhile a few officials from the Central Bank waltz into your office, and casually inform you that the firm is being fined €4.1 million for breaching MIFID requirements - you have no choice but to pay it, do you?

However, the truth, especially when it is rather dull, is rarely of any great interest to our wolf pack of journalists as they fearlessly pursue and "hold to account" the "rich and powerful" for their alleged "wrongdoings".

Not content with portraying the entire financial sector as being responsible for the crash of 2008 (thereby absolving its readers of any personal responsibility for their own investment decisions), the Irish media have continued to perpetuate the myth that all financial firms, be they banks, stockbrokers or insurance companies are out to "rip off" their clients by dishonest dealings and subterfuge.

It brings to mind John Houston's classic western film 'The Man Who Shot Liberty Valance' (1962) and the famous quote near the end from one of the news reporters on discovering that a story they had long promulgated, was not actually true. On hearing the real story, the reporter threw away his pen saying he would not print it and when asked why, he said:-

"This is the West, sir. When the legend becomes fact, print the legend!"



I met Brian McKiernan the now former CEO of J & E Davy once or twice back in 2001. He offered me a job at Davy's but I declined, because I received a better offer elsewhere. I was slightly disappointed at his rather low-ball bid for my services but unlike his recent problematical client, I did some 'price discovery' by shopping around.

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