Is it wrong that Morgan Stanley upgraded Tesla Motors in advance of underwriting their convertible debt offering?

by Chris on February 27, 2014

Ever since Tesla Motors announced its $1.6 billion convertible debt offering yesterday afternoon, market watchers have been crying foul. Why?  Because Morgan Stanley is one of the underwriters on the deal. Their analyst, Adam Jonas, put out a very bullish report and raised his target price on Tesla just a few days before the deal was announced.  Sounds fishy, eh?

Not so fast.

Sure, I can see how it’s possible for the analyst to have secretly held talks with his banking colleagues and developed a plan to issue a bullish report to win over Tesla’s management such that they’d be included in the deal. This situation, which is only being presented as hypothetical, would be illegal and unethical. I do not believe this is what happened.

Here’s how the business really works.

Analysts are not allowed to communicate with bankers openly. There is a very strict “Chinese Wall” between them. In Canada analysts can at least call their banking colleagues on the phone, provided they stick to the rules about what is and is not allowed to be discussed.  But their phone calls are recorded for regulatory purposes. My understanding is that in the US the rules are even more strict.  Analysts can’t speak to their investment banker colleagues without a compliance officer from their firm present.  The compliance officer’s job is to protect the firm from the dangers of inappropriate behavior by employees.

Analysts also get paid, indirectly, from investment banking revenue that their firm generates.  Analysts who are bullish on stocks obviously want to have their firm included in underwritings of those stocks.

Elon Musk made it crystal clear that a financing was very likely following the company’s Q4 results. The whole Street knew this was coming in order to finance their GigaFactory.  If you were the analyst at Morgan Stanley, and you had a bullish thesis on the stock and believed that the GigaFactory would help Tesla secure a position not only as a leading electric vehicle maker but also in the energy industry, wouldn’t it be your JOB to publish your opinion and tell the world?

Yes. It would.

Provided Adam Jonas believed what he wrote (I imagine he does/did) there is nothing illegal or unethical about Morgan Stanley’s research department publishing a bullish report one follwed by their investmenk banking department underwriting a conertible debt deal a few days later.

Rather than anything sinister happening here … I think it’s more likely that the analyst loves the stock, and the bankers have a good relationship with Tesla’s board of directors.

CanadaGuy March 13, 2014 at 1:00 pm

Chris, in theory I agree with you, but this is Wall Street, and ethics and regulations are sidestepped when bonuses are on the line…remember the mortgage and derivatives issues of 2008?

The real question is not if the report was issued as an obligation of syndicated inclusion, but does the report present 1) a false opinions and 2) sway investors to make a purchase they otherwise would not have.

Both analyst and bankers have an interest in banking fees, thus Maslow’s hierarchy of needs kicks in. Analyst do not live of trading revenues.

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