SEC Investigates Wall Street's IPO Money Machine
New York, Dec. 14 (Bloomberg) -- Securities and Exchange
Commission Chairman Arthur Levitt's complaint that some brokers
have charged money managers excessive trading commissions for
access to the most profitable initial public offerings faces an
uphill legal struggle, some lawyers say.
SEC investigators this week ordered the biggest stock
underwriters -- including Goldman Sachs Group Inc., Morgan Stanley
Dean Witter & Co. and Credit Suisse First Boston -- to turn over
records of customers who received shares of the best-performing
IPOs. The SEC also wants records of inflated commissions the
customers paid that may explain why they received the shares.
``They want to apply the magic label of kickback to it,''
said John Coffee, a Columbia University professor who specializes
in the securities industry. ``Then they can characterize it either
as a commercial bribe or extortion by the underwriter.''
Levitt has shown with new regulations he pushed on corporate
disclosure that he is willing to challenge Wall Street practices
he regards as unfair to individual investors. Yet he may have
difficulty proving that high commissions are being charged in
exchange for IPO profits.
``The SEC has a difficult time proving that it's anything
more than a good customer getting well treated,'' said Roger D.
Blanc, a partner at Willkie Farr & Gallagher. ``You'd have to be
able to understand that there was a specific understanding of a
specific quid pro quo and I think that's a high burden for the SEC
to establish. Every business treats its best customers well.''
Routine
Swapping trading for service is how the business works, money
managers and brokerage executives say. Brokerage commissions in
1999 were about $12 billion in the U.S. and have grown about 20
percent annually for the past four years, according to estimates
from Greenwich Associates, a Connecticut-based consulting firm.
Money managers say their system of allocating trades pays for
services they receive from brokerage firms -- such as when Goldman
Sachs sends analysts like Abby Joseph Cohen to meet them -- and
for the research reports firms generate.
Fund managers say they try to use their leverage as customers
to get the best service.
``Wall Street tries to run as if it's an off-the-shelf
business and sometimes it needs customizing,'' said Michael
Weiner, a managing director and fund manager at Bank One
Investment Advisors in Columbus, Ohio, which oversees $130
billion. ``We don't want to make it an entitlement.'
Speaking to a gathering of Wall Street executives in Boca
Raton, Florida, the SEC chief last month set out to break the
cycle. He said securities firms overcharge mutual funds with
brokerage commissions for shares in the hottest IPOs.
Commissions
They will probably focus on subsequent trading commissions in
excess of the traditional nickel a share that would appear to be
``side payments,'' said Coffee.
Fund managers get access to IPOs because of trades they do on
behalf of their investors, although that doesn't mean the IPO
shares always go into the funds, Levitt said.
``Fund managers are paying their expenses with other people's
money,'' Levitt said in the grand ballroom of the Boca Raton
Resort Club at the Securities Industry Association's annual
meeting. ``This plain fact seems to be lost on some advisers
today, particularly where IPO allocations are concerned.''
The average mutual fund company paid $65 million in
commissions last year, 58 percent more than three years ago,
according to Greenwich Associates.
Stamford, Connecticut-based McLagan Partners Inc., a unit of
ASI Solutions Inc. that surveys money managers' trading, provides
one of the only checks securities firms have that their clients
follow through with promised trade allocations. McLagan keeps a
low profile.
``We just don't talk about that study,'' said Brian Dunn,
president of McLagan Partners. ``It's a very, very sensitive
issue. If any of the participants heard we talked to anyone, at
all, they'd pull out.''
While mutual funds said they rarely resort to cutting off a
firm, they will to make a point.
``We put one big firm in the penalty box for a year,'' said
Alan Brown, chief investment officer for State Street Global
Advisors, which manages about $750 billion. ``They immediately
noticed when the spigot was turned off.''
Just as money managers can cut off securities firms they
don't think are providing enough service, they also can get cut
off if firms decided they aren't being paid for their services.
That doesn't happen often.
``Most people in this business are very honorable -- they
remunerate you for your efforts,'' said Michael Benenson, head of
institutional sales at Gerard Klauer Mattison & Co. ``It's sort of
a un-written contract.''
Regardless of the SEC's probe, trades will continue to be the
way Wall Street gets paid.
``If you're going to receive a service that's valuable,
you're going to have to pay for it,'' said Jeff Leerink, chief
executive of Leerink Swann & Co., a Boston-based investment
banking firm dedicated to health care. ``Everyone understands that
the mechanism of payment is trade execution.'' |
