Banks at risk in conflict-of-interest minefield

A scramble for profits has pushed big investment banks in Europe to put fingers in multiple financial pies - throwing up conflicts of interest that can upset, or put the banks in competition with, their own clients.

"Investment banks have got so big and complex that the right hand doesn't know what the left hand is doing," said a senior partner at a financial consultancy.

"The top investment banking firms are trying to play in as many corners of financial services as they can... This leads to a blurring of the lines (and)... increases the chance that investment banks are competing with their clients."

Goldman Sachs, the world's biggest M&A advisor, recently had to stand down from its newly-won role as corporate broker to spirits group Diageo, because of potential conflicts with rival drinks group Allied Domecq.

Goldman had annoyed Allied Domecq Chief Executive Philip Bowman by becoming Diageo's broker when it was already M&A banker to Allied.

Elsewhere the investment bank sector's in-house private equity funds have also got them into hot water with clients, while proprietary trading desks are effectively competing with the banks' clients in the financial markets.

During the dot-com boom, the banks got used to fat fees from M&A and corporate finance. But the drop in mergers and equity deals since then has meant a big drop in fees.

Revenues from institutional equities businesses are also under pressure as commissions are being squeezed by institutional investors. To fill the revenue gap, many of the banks have turned to trading on their own account in equities or fixed income.

"Cash equities trading is a terrible business, so the banks are doing proprietary trading," said another senior banker at a European bank. "The banks are using their analysts' brain power internally to feed their proprietary desks because the institutions won't pay up for it."

But own-account trading can pit the banks against their clients.

"If you are trading on your own account it's very difficult to work out who your client is," said one senior executive at a brokerage firm, who said it would be difficult to run a proprietary trading desk without trading against clients.

In private equity, the conflicts have been so glaring that the banks have had to act.

J.P. Morgan Chase last week revealed plans to spin off its $13 billion private equity fund, joining a long list of banks that have sold or hived off in-house private equity units, including Morgan Stanley, Credit Suisse and UBS AG.

"So many houses have been spinning off private equity because it was creating intolerable consequences," said a senior banker at a corporate finance firm.

Bankers point to the £1.6 billion takeover of British drugs group Warner Chilcott last October, where CSFB and JP Morgan's private equity arms won out in a bidding contest against another consortium that included buyout firms The Blackstone Group and Texas Pacific Group.

The investment banks found themselves on both sides of the deal, financing the private equity bidders at the same time as their own in-house private equity funds were involved in the bidding for Warner Chilcott.

In the uniquely British institution of corporate broking, conflicts were kept at bay by firms keeping broking relationships separate from M&A advisory.

Market leader Cazenove has for years been broker to around half of Britain's top 100 blue chip companies, including both Allied Domecq and Diageo.

But Cazenove is not a big player in M&A, unlike the integrated US investment banks such as Goldman Sachs and Morgan Stanley.

The US firms are vying to win broking mandates, despite potential conflicts, because they see broking as a way to build a close relationship.