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AWWAL CAPITAL Awwal Capital (AC) is a full-service investment bank and financial services company. It provides corporate finance and strategic advisory services to public and private companies, sales and trading services to institutional and private clients, and securities research. AC has adopted the CFA Institute Code of Ethics and Standards of Professional Conduct as part of its policies and procedures. Sara Khan, CFA, is a managing director at AC who is responsible for overseeing the investment banking, securities research, and sales and trading departments. This morning, Khan is meeting with members of AC's Research Analyst Compensation Committee (RACC), which reviews and approves research analyst compensation. Nateesh Kumar, CFA, is the Director of Investment Banking, Myra Yousuf, CFA, is the Director of Securities Research, and Shoaib Arif, CFA, is the Director of Sales and Trading. Khan: Thanks for meeting with me this morning. As you know, revenues from our broker/dealer subsidiary have declined significantly over the past three years because of intense price competition. This decline means that the revenue we generate from sales and trading as well as investment banking has been and will continue to be an important component of AC s overall profitability. The collaboration between investment bankers and research analysts has benefitted our firm because it has enabled us to assess risks more accurately and make better pricing decisions. I must commend the RACC on the new compensation system that was implemented at the start of this year. Under the previous system, an analyst's compensation included a base salary, a bonus, and a percentage of sales and trading revenue. The new compensation system takes into consideration the analyst's contributions to generating investment banking business. In addition, analysts can now earn bonuses based on their work on investment banking assignments. Kumar: During the past year, my investment banking team has partnered with Yousuf's team of research analysts to promote AC s investment banking services and to solicit investment banking business. As a result of the new compensation system, research analysts are more willing to participate in investment banking presentations. Also, they respond more quickly to our requests to initiate full research coverage on prospective and current corporate finance clients and provide favorable recommendations. Now that you have given me the authority to approve, disapprove, and make changes in research reports and recommendations, it has made the entire process more efficient and effective. Yousuf: At the beginning of the year, Kumar and I met to determine which investment sectors (e.g., consumer discretionary, energy, financials, industrials) the research analysts should focus on based on that sector's potential to generate a significant amount of investment banking business. At that time, Kumar also provided me with a list of companies that he wanted the research analysts to initiate coverage This case was written by Michael G. McMillan, PhD, CFA, CPA, CCEP, former Director of Ethics Education and Professional Standards, CFA Institute. (C) 2022 CFA Institute. All rights reserved. on if those companies agreed to do investment banking with AC. Most of the companies on this list would not have been covered by my analysts and me unless investment banking had requested it. Foodmoji Limited (FML), the department store chain, is a perfect example of this. A few months ago, Kumar asked me to initiate coverage on FML in hopes that it would choose AC to underwrite an upcoming debt offering. So I, along with two of my business school interns, spent weeks researching, analyzing, and writing a detailed research report on the company. We even issued a "Market Outperform" rating on their stock. After all of our work, FML's CFO selected one of our competitors to underwrite their debt offering. Because many companies think that research is free, I emailed FML's chief financial officer (CFO) and said that if the company was not willing to use AC as an underwriter, they could at least pay us a consulting fee for our efforts. Two weeks later, I received a check from their CFO, which I shared with my interns as a bonus for their hard work. Khan: I want to thank all three of you for the fantastic work that you did on the eagerly awaited Abdul Ghafoor Group (AGG) initial public offering (IPO). AGG shares rose by 72% on the first day of trading. As a result of your efforts and the success of the offering, AC generated $25 million in fees, a portion of which we will share with you as a bonus. Because AC was the lead underwriter, I hope you were able to purchase the AGG shares that we set aside for you and your team members. How did you develop such a close relationship with AGG ? Kumar: AGG is one of the largest luxury department store chains in the region. Five years ago, it was the subject of a leveraged buyout (LBO) by two private equity firms. Two months ago, AGG and its private equity owners invited 10 investment banking firms to compete for a role in its IPO. AGG asked the analysts from each of these 10 firms to make separate presentations to their management to ensure that the analysts' views on key issues, such as valuation factors, were in sync with the company's views. Because of Yousuf's outstanding reputation and research abilities, I asked her to make the presentation. I knew it would be a key factor in determining whether AC received a role in underwriting the offering. Yousuf: I have been familiar with AGG for many years because my daughter works for the company as a buyer in their Menswear Department. I did not initiate research coverage on the company because I thought it was too heavily laden with debt as a result of its LBO. Despite this, I wanted to secure this deal for AC. During my presentation to AGG s management, I told them that I would initiate full research coverage on the company with a favorable rating. I said that I believed AGG stock was significantly undervalued and that I was very optimistic about its future, based on management's revenue, cash flow, and earnings projections. Because management expected AGG s stock to trade at a higher multiple than its competitors, I asked the CFO for her best estimate of sales per square foot that could be achieved in its stores in an optimal scenario. Based on her response, I said that we would be able to justify the share price AC would be proposing for the IPO. I also promised to send the CFO a copy of my research report before it was disseminated to allow her to review it and correct any factual information. Kumar: Yousuf gave an amazing presentation and wrote such an enthusiastic research report on the company that AGG made AC the lead underwriter in its equity offering. I also used the CFO's sales per square foot estimate as the base case in a sales brochure that I developed for clients and prospective clients. Arif: Regulatory rules prohibit "the publication of research reports regarding a company for which the firm acted as a manager or co-manager of an IPO for 10 calendar days following the date of that offering." As a result, we could not distribute Yousuf's report on AGG to our clients before its IPO. But two days before the IPO, I organized a luncheon for some of our largest clients who had subscribed to the offering and invited Yousuf to be the guest speaker. During the luncheon, I reviewed AC's new Trade Allocation Policy that the clients signed. This policy states: "All allocations are made and documented after the trade has been executed. Therefore, all securities purchased or sold are allocated after the order is filled and the transaction price has been determined. At that point, the allocation to client accounts will be based on the type of account (discretionary versus nondiscretionary), the size of the account, and the amount of fees generated by the account. The allocation process starts with discretionary accounts that generate the highest fees or the largest in terms of assets and then work down from there to non-discretionary accounts, and so on. In cases when accounts are the same size, we allocate securities by portfolio instead of by the client." Yousuf: Because these clients had already subscribed to the IPO, I provided them with details on the methodology I used to value AGG, my recommendation, and my target price for its shares over the next six to nine months. Khan: I didn't know your daughter worked for AGG? Yousuf: Yes, she has worked there for almost seven years. I did not disclose this in my research report because she is not a shareholder of AGG or involved in its financial operations. Khan: Yesterday, I received a call from the CFO of AGG. She was so happy with the research report that you wrote that she invited you to visit the company's headquarters to discuss their expansion plans and to tour their distribution facilities. She even offered to send the company plane to pick you up and to cover your hotel accommodations while you are there. Please visit AGG as soon as possible, and report back to us with what you learn. This case was written by Michael G. McMillan, PhD, CFA, CPA, CCEP, former Director of Ethics Education and Professional Standards, CFA Institute. (c) 2022 CFA Institute. All rights reserved. The day after Yousuf returns from her three-day visit to AGG headquarters (HQ), she meets with Khan, Kumar, and Arif. Below are excerpts from their meeting. Yousuf: My visit to AGG's HQ was very enlightening. Although I declined the CFO's offer to use AGG's plane and to cover my hotel accommodations, the company did cover the cost of my transportation and meals while I was there. During my visit, the CFO and senior management team discussed their plans to expand into Latin America. They have identified three publicly traded department store chains in Latin America that they are interested in acquiring and want to hire AC to help them with the acquisition. AGG has not made any overtures or offers to these companies, and AC has no relationships with them, so I would like your permission to purchase shares in all three companies in my personal account. That way, I can monitor them more closely. I would also like your permission to hire the son of AGG's CFO as an intern in the research department. Her son is a CFA Program candidate preparing for Level II of the CFA exam and will be entering his second year of business school in a few months. Khan: I approve of you purchasing shares in the three Latin American department chains and hiring the CFO's son as a summer intern. And I think it would beneficial for clients and prospective clients if you provided them with a brief "research update" on your visit to AGG and reiterate your "Strong Buy" recommendation. Two days later, Yousuf posts on AC's password-protected client website, a research update on AGG reiterating her "Strong Buy" recommendation on the company. All clients have access to AC's passwordprotected website. The update does not mention AGG's expansion plans or disclose that the CFO's son is an intern in AC s research department