International Investment banker Morgan Stanley, which presided over the Safaricom IPO, has been heavily criticised in a new government investigation into the manner in which it allocated shares to foreign investors in East Africa’s largest share flotation.

The investigation, conducted by the Office of the Controller and Auditor General, says the government may have lost up to Sh1 billion ($13 million) because of the subjective and opaque methods that Morgan Stanley employed when placing Safaricom IPO shares to the foreign investors.

Under the arrangement, Morgan Stanely was appointed the sole book runner, giving it the exclusive right to sell some two billion Safaricom IPO shares to a selected group of foreign investors according to the formula of its choice — under a method referred to in market jargon as book-building.

In the end, Morgan Stanley came up with an IPO price of Sh5.50 (7.1 US cents) per share for the foreign investors pool.

But the investigation has now discovered that Morgan Stanley actually rejected higher offers for Safaricom IPO shares.

According to the report, a total of 94 investors applied for the shares.

Out of these, 28 offered to pay a price of Sh6 (7.7 US cents) and above — representing an oversubscription of 32 per cent and an effective demand of 2.6 billion shares.

The investigation found that the 28 bidders who offered to buy the shares at Sh6 were capable of taking the entire international pool at an oversubscription of 81.66 per cent.

Says the report, “Due to Morgan Stanley’s use of subjective allotment criteria, the government lost Sh1 billion in the international placement offer at Sh5.50 instead of Sh6.”

The Controller and Auditor General argues that this situation would have been prevented if the book-builder had brought the oversubscription level downwards, accepted the Ksh6 offer as the book-building price for the international pool, and factored in an oversubscription level of 32.5 per cent.

It adds: “Since Morgan Stanley have not given reasons as to why they offered the share price at Sh5.50 instead of Sh6, the loss of Sh1 billion should be recovered from them”.

The investigation found that out of the two billion shares, 814,300,000 were sold to bidders whose accounts are managed by Morgan Stanley.

“This was in pursuit of its own interest of earning management fees in the increased portfolios,” adds the report.

The report recommends that the identity and existence of the firms under the Morgan Stanley nominee accounts be confirmed, as they did not open CDS accounts in their name.

“The basis of allotment to these firms needs to be explained, as some of them did not bear tiering comments in the book,” it adds.

The report by the Controller and Auditor General also says that the book-building process conducted by Morgan Stanley did not achieve its objective of bringing in investors with a long-term approach to investing, who would have been expected to stabilise the Safaricom share price.

Indeed, the prospectus specifically indicated that Morgan Stanley was to “build a book of demand consisting of a mix of investors who are likely to be long-term holders of the securities.”

But the investigation has revealed that the foreign investors who were allotted shares by Morgan Stanley were speculators and short-term investors.

The report adds that it is the speculative behaviour of these investors that has caused the fall in the price of the share — leading to the disappointment and depressed demand that has become a permanent characteristic in the after-trading of the Safaricom share.

It says that the information provided to the investigation by the Nairobi Stock Exchange on trading patterns of foreign investors between January and May 2008 shows that before the Safaricom IPO, foreign investors were net buyers of stocks on the local bourse.

But in June and July 2008, immediately after the listing of the Safaricom shares, the situation changed.

Analysing the trends, the investigation found that between January and May last year, foreign purchases were 66.7 per cent against sales of 33 per cent on total foreign trading, with an average purchase value of Sh1 billion ($13 million) against average sales of Sh500 million ($6.5 million) per month over the same period.

The report says that, going by the trends between January and May, and taking into consideration the total foreign trading in June and July, it follows that trading in the Safaricom share accounted for purchases of approximately Sh1.7 billion ($22 million) in June and Sh2.2 billion ($28.5 million) in July.

This is against sales of Sh6.2 billion ($80.5 million) in June and Sh3.2 billion ($41.5 million) in July.

The Controller and Auditor General has also questioned the manner in which the contract to place shares for foreign investors was awarded, charging that it was single-sourced.

Initially, Morgan Stanley came on the scene as a transaction adviser in partnership with local investment bank Dyer & Blair.

This group won the bid after quoting a paltry Sh100 ($1.30) for the job.

The report says that on July 5, 2007, Dyer & Blair wrote to the Treasury seeking to introduce an amendment to the contract to include a provision saying that a separate agreement would be entered into for international placement.

“The section introduced by Dyer & Blair was exploited to give Morgan Stanley the exclusive right to be the authorised international selling agent, the sole global co-ordinator, and sole book runner for international placement,” says the report.

Signed on May 6, 2007, the contract provided for commissions of 1.5 per cent of the value of the shares placed by Morgan Stanley.

A penalty of 1 per cent per month would accrue for every day in the event that the commission was not paid as soon as practicable with two weeks of presentation of the certificate of clearance.

On December 24, 2007, the acting chief executive of the Capital Markets Authority, Stella Kilonzo, wrote to the Treasury and Dyer & Blair complaining that Morgan Stanley had been given very wide discretion regarding final allotment of the international pool.

Ms Kilonzo sought clarification that controls had been put in place to ensure that the allotment was done equitably, considering that Morgan Stanley was also to receive and process applications as the authorised selling agent.

In a letter dated November 29, the Association of Kenya Stock Brokers wrote to the Treasury questioning the wisdom of giving the responsibility for placing two billion Safaricom IPO shares to one book runner.

The Association had suggested that the issue be opened to other players.

In his report, the Controller and Auditor General notes that he saw no evidence showing that attempts were made to address these legitimate concerns.

“In future, the book runner should be sourced competitively and the management of the book should not be left to one company or individual,” says the report.