were issued and the broker they were issued to. He will also need to review all the recent compliance reports, risk and compliance committee minutes and reports and internal reporting mechanisms and frameworks the company has in place. This will at the same time provide an understanding of the quality of compliance systems in place and if they are operating effectively. Sometimes, the framework or policy exists, but the executives are not responding to the issues raised, meaning it's not operating effectively. Ro recalls the coroners report from the Lehman Brothers collapse and how some systems were in place but no actions were taken by executives when issues were raised. It's why these days risk, legal and compliance staff will report almost directly through to the CEO or Chief Risk Officer (CRO) rather than internal executives. ‘Mental note,’ Ro brainstorms to himself, ‘check the org structure to see the reporting lines.’
After the hour long flight and a thirty minute taxi ride into the city, Ro arrives at the offices of the investment bank Everton Marks at 8am. Sam and Clint are waiting in the foyer.
‘Can't access the books until 830’, Sam says disappointingly. ‘Let’s get a coffee’.
Sam outlines the rules that will be in place. They will be locked in a room with access to the ‘Black Box’. This mysterious sounding term is just a a folder on the Everton Market network which Sam, Clint and Ro will have access to. There will be nothing else on the laptops supplied by the investment bank. They will not be able to copy any contents to any flash drives nor email any content. There is no internet access. They can makes notes in the notepads but that is all. They have two full days to look up the information they need. They can request further information over and above what is in the black box but there is no guarantee they will get it and it will only be available for the term of the due diligence process. Sam proceeds to quiz Ro what he will be looking for. Luckily, Ro has given this some consideration and talks about reviewing the trading book, the capital position and compliance information.
‘Let me know as soon as you can if you find anything and try and identify any requests for additional information early otherwise we won’t have time to look at it.’ Sam explains.
‘Ok’ replies Ro, ‘have we contacted the regulatory authorities about the deal? We might need to let them know’
‘No’ Sam says gruffly, ‘ we’ll worry about that later, ‘let’s head in’.
‘Hi Alfie’, Sam says excitedly with a broad grin, ‘ good to see you.’
‘Thanks for coming’, Alfie says. He’s the lead on this deal for Everton Marks, ‘ let’s meet the team’.
The advisory team introduce themselves to Clint and Ro. Sam has obviously already met them in a previous meeting. Todd, the CFO from Jonathan Forest is also there for any queries.
‘Shall we?’, Alfie motions down the narrow walkway between several meeting rooms. It's time to get to work.
Sam dives straight into validating the data to support the business case for the deal. One of the key items is to understand the profile of the business. How many active customers are there? Jonathan Forest might have 50,000 clients but many of these may be dormant or inactive; meaning they haven’t generated any income for the business in the last twelve months. This may be an issue if these clients hold cash or securities with Jonathan Forest as there will be a risk that these clients choose not to move to Mason Thompson. This will impact the bid price which Sam ultimately decides to put forward. He is desperate to make the economics work so the deal can proceed and he can focus on getting the Mason Thompson brokerage business setup.
Clint begins to focus on the financials. How profitable is the business? What is the cost structure? Would there be room to cut costs? How much has Jonathan Forest invested in the platform and the technology and how much ongoing cost is to maintain the existing platform? One key driver for profitability in any broking business is the margin between the cost per confirmation and the brokerage charged for each confirmation. A confirmation being the contract of record to reflect the details of the trade which has been effected. So if a client bought 10,000 Apple shares the confirmation will show the client’s name, the security name, Apple, how many shares were bought, 10,000, the price paid or sold at, the brokerage charged and when the money is due to be settled. A good technology platform will keep this cost down and maximise the profitability, the difference between the cost and the revenue on the confirmation. Clint knows this information is critical to getting Mason Thompson to agree to the final offer price for the Jonathan Forest business. His heart races.
Chapter 5 Tick Tock
The stale feel of the room starts to grate on Ro. The white walls. The fake-wood panelling on the gallery wall where a sink along with tea and coffee making facilities and three jugs of water sit. The frosted glass lines the glass wall which runs along the hallway. Opposite is a room but not with a view. It faces directly to a 90s building of little appeal. The instant coffee tastes distinctly like pine-o-clean and the water is warm. It's been a long day. The nervous perspiration leaves Ro somewhat clammy under the armpits and the antiperspirant has given up. He starts to smell a little. It's just after four thirty in the afternoon. He only left the room for a thirty minute lunch, a coffee downstairs at three and to go to the toilet. Sam has been in and out of the office constantly all day taking and making phone calls. Clint has been mostly updating his business case, working through business models and changing some revenue and cost estimates.
Ro has been able to identify several compliance policies he needs to review and got his request in before lunch. He checked the history of fines which are published by the regulatory enforcement team and saw nothing in reference to Jonathan Forest Discount Brokers. That was positive.
One of the key changes in the broking industry over the last ten years has been the ability to automate orders placed by clients entering the market directly without needing to be re-keyed by someone at the broker. This is known as Direct Market Access, or DMA for short. This capability removes the need for persons to look at every order sent by a client before it is placed on the market, on the stock exchange. These persons spend months in dedicated training, doing books of theory and then sit two tests. Once they pass these they are authorised by the stock exchange to make amendments to orders, to accept and indeed reject any orders from clients or the internal business known as the principal trading desk. DMA, allows a broker to set business rules or logic in its order management system which filter the orders submitted by clients and either let them through to be automatically placed on the market or to be sent to a designated person to check. The intent is to ensure what is called a ‘fair and orderly market’, preserving the integrity of the stocks listed on the stock exchange. More than 95% of orders are DMA. The business rules or logic must be written in a compliance policy document, submitted to the stock exchange for approval to be used and then implemented by adjusting the filters in the order management system. If any buy order submitted to the broker is say more than 1% above the current buy price it may fail the filter and be sent to the designated person for review. The designated person may either reject the order or notify the person submitting the order that it is too high. There are many filters designed to prevent manipulative trading and other regulatory compliance obligations. The policy document must be maintained, the filters must be tested by both technology and compliance persons and submitted to the stock exchange for each new major version. The Jonathan Forest policy document seems light on. It's only 6 pages long and does not talk in detail about how the order management system is maintained. This information is important for two reasons. Firstly, it should demonstrate detailed knowledge of the system so there is not any reliance on key persons only one or two of whom may know how it works. Secondly, this is a key component of the technology stack. The order management system will need to be integrated with the Mason Thompson banking system. Unfortunately there is no information to this regard.
Sam walks in, still talking on his phone, he gestures to Client and
