New York, March 11, 2013—Over the last few decades, investment banks fundamentally have changed the way they do business, Visiting Professor Alan Morrison told Columbia Law School students and guests at a recent event sponsored by the Columbia Business and Law Association.
For more than a century, investment banks’ most prized assets were their reputation and their relationships, which they acquired and improved upon as they provided advice to clients, said Morrison, a former banker and professor of law and finance at Saïd Business School at the University of Oxford. But as such banks increasingly have turned to trading as a source of profit, their relationships and reputation have become less significant to many of their customers. What matters instead, Morrison said, is their ability to accurately structure complex deals at arm's length.
The sale of collateralized debt obligations, in which debt is packaged and sold to investors, illustrates this shift, Morrison said. The deals change the dynamic between a bank and its customers. People who thought they had a relationship with the bank that issued their loans may instead have a relationship with a “special purposes vehicle” set up to pass the loans’ profits (or losses) onto investors.
“[As an investment banker] how much do I care about the loan after I’ve sold it?” Morrison asked. “Not much.”
But Morrison said the market seems to have adapted to this shift. In fact, the industry has responded to the changed landscape with new “boutique” banks that specialize in advisory work, in order to avoid conflicts.
He used the example of Abacus 2007-AC1, a collaterized debt obligation that Goldman Sachs structured and marketed to investors in 2007. In the transaction, a hedge fund manager profited from the more than $1 billion in losses by investors who purchased the mortgage-backed securities from Goldman Sachs. In 2010, admitting that its marketing materials were incomplete, the bank paid $550 million to the SEC to settle civil securities fraud charges stemming from the deal.
“In a market where reputation is really important, one big hit like that kills you,” Morrison said. But he noted that Goldman’s share price went up after the deal was announced. “The market clearly in aggregate didn’t think this was a problem because Goldman survived.”
The March 7 event, “Regulating Investment Banking Relationships: The Abacus Transaction and the Duty of Loyalty,” was organized by the Columbia Business and Law Association, a student group that aims to provide a forum for students to pursue scholarship and professional opportunities in business, both within and outside of law.