Over the past decade of operating my advisory firm, Euro-Phoenix, I have encountered relatively few instances where a financial advisory firm knowingly breached laws, industry or ethical standards; instances of overt contravention are relatively few and far between.
That does not mean that users of corporate finance advisory services should just assume that the issue of ethics is not important. Ethics are of paramount importance. Allow me to mention some areas where ethical issues can arise:
A.Potential conflicts of interest on due diligence of a buy-side mandate
Several years ago, Euro-Phoenix was working on the buy side of a cable TV mandate in Bulgaria. We uncovered some hidden liabilities on the target company. We did not hesitate for a second to disclose this to our client, knowing full well that we were eliminating the possibility of a success fee, but if you think about it, any advisor on the buy side of a mandate has a similar potential conflict.
B.Setting fees
Fee structures agreed with advisors should be fully aligned with the interests of their clients. For example, if you hire an advisor to buy a company for you, and offer him a success fee based on a percentage of the purchase price, your advisor may have a conflict of interest. The higher the purchase price he negotiates, the higher his success fee will be, which is likely to produce an undesirable result. In my experience, a pre-defined lump sum fee works best in such circumstances.
C.Collecting a fee on the other side of a transaction
Euro-Phoenix was once engaged in selling a major asset for a multinational corporation. We received four offers. Three of those offers came with an explicit bribe from the offering investors: help ensure that a particular investor obtains the asset, and work on driving the price down rather than up - and the investor would be willing to pay us a success fee even larger than that offered by our client. (When we expressed our concern to one particular investor, he hastened to add, "Don't worry - you can collect the success fee from your client as well!") Are you sure that your advisor will resist temptation? Some jurisdictions (eg. the UK) specifically forbid financial advisors from collecting fees on both sides of a transaction.
D.Where a financial advisor is also in the private equity business
Can you be sure that there are strong Chinese walls in place? I am aware of one situation where a private equity firm related to a particular financial advisory firm made an acquisition in the cable TV area. Whereas previously the advisory firm had had a vibrant business in the cable TV sector, to the best of my knowledge it never achieved another mandate in that sector, because the owners or managers of cable TV firms could not be fully confident that their confidential information would not end up in the hands of a competitor.
E.When a financial advisor also provides audit or other services to a client
In a number of Central European jurisdictions (eg. Croatia), it is forbidden by law for a firm that provides audit services to a client to provide financial advisory services or any other services to the same client. (The US, UK, and France, also have restrictive regimes, preventing audit firms from deriving non-audit fees from audit clients). The potential conflicts of interest are numerous. Obtaining a generous success fee on a corporate finance mandate could just provide the right incentive to be more "flexible" with respect to some sticky points in the audit.
I hope that the five illustrations above have at least given you pause for thought. The ethics of your advisors are at least as important as their knowledge and technical skills.
