BofA whistleblower complaint focuses the spotlight on India’s block trade playbook

A recent Bank of America (BofA)whistleblower complaint has underscored the complexities involved in navigating a block deal for merchant bankers at a time when such transactions have hit record highs in India.

Bank of America placed two executives in its equity capital markets team in India on administrative leave after a whistleblower complaint alleged an unauthorised leak of information to investors ahead of certain trades, according to a 9 October Wall Street Journal report.

Bank of America declined to comment. Mint has not seen the whistleblower’s complaint.

The development is significant because of the unprecedented growth in block deals over the last 2 years in India, with several private equity and venture capital firms finding exits through such transactions in the public markets. The boom in block trades has also contributed towards record fee levels for merchant banks, Mint reported earlier this month.

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Nearly $15 billion worth of block trades occurred in the Indian markets in the first half of 2024, a 150% rise from that in the same year-earlier period, according to a Bloomberg report in July.

The Bank of America whistleblower alleged that merchant bankers had shared material non-public information (MNPI) with clients ahead of launching certain block deals in the market, prompting the bank to initiate its own investigation, according to the WSJ report.

A high-stakes guessing game

For block trades to go through, investment bankers need to have a measure of the investor appetite and pretty much stitch up the sale book well in advance. However, all this needs to be done without passing on sensitive information.

“It is like threading a fine needle as the playbook is not spelt out," an experienced investment banker said, asking to remain anonymous.

“But there are certain definite ‘don’ts’—you cannot be telling clients the timing, size and the price of the deal before it is launched," he added.

Block trades are usually launched at a small discount after the end of market hours, and the deals are closed before trading begins the next morning.

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One way to do this is for merchant bankers to whet investor appetite for a stock in advance without specifically naming the company.

Conversations with investors revolve around hypotheticals about company or sector performance to gauge investor appetite, a second investment banker said. “The conversation might go like this—if there was a block that was to become available, what kind of interest would there be from investors?" this banker said.

“While it is not explicitly prohibited for investment bankers to identify potential investors before the term sheet is out, they must exercise caution to avoid violating insider trading regulations," said Kunal Sharma, partner, Singhania & Co, a homegrown law firm.

This would include ensuring that internal controls are in place, limiting the number of people with knowledge of the information, and making appropriate disclosures, Sharma said.

Non-deal roadshows

There is a Chinese wall between the origination and the execution teams to avoid information leaks, said a third banker who heads a domestic investment bank.

According to him, banks carry out non-deal road shows to gauge interest before launching a deal. “But they cannot reveal sensitive information," he said.

Investment banks also have large research teams tracking stock trading information—so they already know which funds have been building up their stakes in certain stocks or which investors might be interested in certain segments. “Bankers would then estimate how much they can reliably sell and at what price basis this analysis," one of the people cited above said.

Merchant bankers may send information to interested investors 24-48 hours before a block trade is launched under the terms of a non-disclosure agreement or a “wall-cross"—where investors are prohibited from acting on that information.

Generally institutional investors such as insurance companies, large mutual fund houses, portfolio management services providers and investment firms are the buyers in such deals.

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A senior mutual fund executive said that bankers routinely conduct non-deal road shows on a company or a sector to suss out interest, but are careful to avoid passing on non-published price-sensitive information.

“Even if these are non-deal road shows, with experience and some research on the shareholding data, it is easy for the market to guess whose block is going to become available, but conversations in these meetings are careful," the executive added.

Sometimes, market participants guess that a block will become available or act on their own. These conversations between merchant banks and mutual funds are now recorded, the mutual fund executive said.

“If a merchant banker tried to pass on unpublished information to me, that banker would certainly not figure in my list of executives we would engage with for quite a long time," this executive said, noting that it would spark off a cumbersome compliance problem for the mutual fund, were it to happen. “I would have to immediately report it to the compliance officer, and we would have to stop trading the stock," the executive said, explaining the implications.

In such an instance, a potential investor in the issue or a fellow sales executive may well be within their rights to alert the institution about the breach, the executive said.

Meanwhile, the Securities and Exchange Board of India is overhauling the merchant banking code. Merchant banking regulations were formulated in 1992, and given how the primary markets have deepened since then, Sebi has proposed amendments to the code.