Viewpoint / Absolute Power

Say your banker has the exclusive right to decide whether or not to sell you a bank deposit. Say he has the power to decide that you can't have a certain kind of deposit, even though you can afford it, because he doesn't like your face. I don't want your money, he sniffs. Why? Because.

Sound ridiculous? Yet that is exactly what the Knesset passed into law Tuesday, with its new Underwriting Law.

The new Underwriting Law says that the lead manager of a company's initial public offering has the right to choose to whom to sell the shares. The underwriter, who is nothing more than a sort of senior bank clerk, can prevent somebody he doesn't like, or want, from buying the shares of a company he's taking public. Why? Because.

Who wouldn't an underwriter want? Small investors from the general public, for instance. The underwriter would feel no obligation to them. If it were up to the underwriters, the public wouldn't be allowed near IPOs at all.

The Israel Securities Authority, which initiated the law, is aware of at least this snag, so it ruled that the right of the general public to participate in IPOs is protected. Shares offered through IPOs will be sold to the general public via tenders, which is the same as the situation under the old underwriting law.

The most substantial change between the new and old underwriting laws is in regard to professional buyers, namely the institutional investors. When it comes to them, the underwriters can get choosy.

Surely confining the right to choose to the institutional investors solves the problem of abuse? After all, the institutionals are enormously powerful and can protect their own interests, so the underwriters wouldn't dare to cross them willfully. But in practice, the convoluted, complex network of relationships in Israel's capital market creates ample room for abuse. For instance, one might figure that if Poalim IBI is handling a very popular offering, it would choose to sell the shares to Bank Hapoalim's provident funds while leaving those of Bank Leumi out in the cold.

There is precedent. In the U.S., three of the biggest investment banks, Morgan Stanley, Bear Stearns and Deutsche Bank, were forced to pay enormous fines for similar sins in the bull years of 1999 and 2000. They were found abusing their status as underwriters of red-hot IPOs to "extort" the Wall Street institutionals. These institutionals, it transpires, only got shares in these popular IPOs by committing to trade in the shares via the banks that underwrote the offerings, in exchange for extravagant fees of $1 to $3 per transaction, rather than the usual fee of 6 cents. Their status and professionalism could not protect even the most powerful American institutionals, which invest the public's money in the stock exchange, against the absolute power of the underwriter to choose buyers.

If that can happen on state-of-the-art Wall Street, what hope is there for Israel's capital market, where white-collar crime earns a tickle on the wrist at best? It may not happen today, or even tomorrow. But when the next boom arrives, you may be sure that the absolute power of the underwriters will lead to absolute corruption.