interactive.wsj.com
December 7, 2000
Heard on the Street
U.S. Investigates Exchange
Of Commissions for IPOs
By RANDALL SMITH and SUSAN PULLIAM
Staff Reporters of THE WALL STREET JOURNAL
Federal authorities have launched an investigation examining whether Wall
Street securities firms have asked some big investors to pay unusually large
trading commissions in exchange for hot initial-public-stock offerings,
people familiar with the matter say.
The Securities and Exchange Commission along with the U.S. attorney's
office in Manhattan are conducting the inquiry, which is at an early stage,
the people say. A federal grand jury has also been called by the U.S.
attorney's office to consider evidence. Both the U.S. attorney's office and
the SEC have issued subpoenas to IPO participants, requesting trading
records and other documents, these people add.
The authorities are scrutinizing ways in which Wall Street dealers may have
sought and obtained larger-than-typical trading commissions in return for
giving coveted allocations of IPOs to certain investors. Some of the
arrangements could have included specific formulas tied to the investors'
profits on the offerings, the people familiar with the probe say. Many of the
offerings doubled or more in their first day of trading during an IPO mania
that began in late 1998.
An early focus of the investigation is the Credit Suisse First Boston unit of
Credit Suisse Group, the people say. In a statement, the firm confirmed the
inquiry. "We have received requests from governmental agencies for
information regarding the allocation of shares to investors in IPOs," CSFB
said.
"Such allocations can be based on a variety of
considerations, such as an investor's interest in
the issue, its demonstrated knowledge of the
issuer and the industry, and the nature and
extent of an investor's brokerage relationship and trading activity," the
statement continued. "We believe that our allocation considerations are
consistent with those employed by others in the industry. We are
cooperating fully with the governmental inquiries."
The joint effort between criminal and civil authorities reflects heightened
efforts by Wall Street regulators and prosecutors to seek to impose
harsher penalties for securities-law crimes. In the past few years, SEC
Chairman Arthur Levitt Jr. has said a top priority is to put
securities-industry offenders behind bars. Mr. Levitt has pushed for greater
coordination between the SEC, which can file only civil cases, and the
Justice Department, so that serious Wall Street offenders can also face
potential criminal prosecution.
Here is how the IPO allocation process typically works: After a
weeks-long period of "roadshows" and other meetings, Wall Street
underwriters line up potential investors, who indicate how many shares
they are willing to buy at various prices. This process always has favored
the biggest investment institutions, including mutual funds and pension
funds, which pay the most stock trading commissions to the Wall Street
firms.
Over the past two years, however, the game has changed, traders say.
With many more deals in big demand, some investors willing to share their
IPO profits, through oversize commission payments, were able to buy their
way into hot deals, traders say. Although individual investors can
sometimes qualify for small amounts of stock through their own brokers,
the practice amounted to a secret set of playing rules that largely shut out
small investors who weren't part of the game, the traders say.
The inquiry is significant because it focuses a spotlight on the inner
workings of one of Wall Street's biggest money machines during a boom in
Internet and technology stocks. Despite a recent slowdown, IPOs have
raised a total of $165.8 billion since mid-1998, according to a tally by
Thomson Financial Securities Data, triggering underwriting fees for Wall
Street firms totaling $8.7 billion.
One of the most unusual features of the boom was the degree to which
such IPOs skyrocketed in price, generating fat profits for investors able to
obtain allocations of the deals. Out of 1,103 IPOs since mid-1998, 363
gained 50% or more in price on their first day of trading, and 199 more
than doubled in price, Thomson Financial said.
In most cases, a majority of IPO shares are allocated to institutional
investors, including fast-trading hedge funds, which cater to wealthy
individuals; these funds are among Wall Street dealers' best customers
because they routinely generate the largest stock-trading commissions. The
probe focuses on whether some investors and dealers took that
arrangement a step further by linking IPO profits to commission levels in
ways that came to resemble kickbacks to the dealers from the investors,
the people say.
In some cases, large commission payments were made by small hedge
funds and wealthy individuals that wouldn't normally have generated
large-enough commissions to receive coveted IPO allocations, traders say.
Indeed, during the height of the IPO boom, a number of hedge funds were
created specifically to play the IPO calendar.
For example, at times dealers asked investors to pay commissions equaling
25% to 40% or more of the investors' IPO profits on those particular
dealers' IPOs, according to traders and people with knowledge of the
probe. In other instances, investors paid big commissions to a dealer the
day after receiving a lucrative IPO allocation, according to one person with
knowledge of the probe.
Sometimes, traders say, the commissions were routed to dealers through a
series of trades, sometimes with offsetting purchases and sales of equal
amounts of the same stock conducted solely to generate commissions.
Commissions sometimes have been paid at well above the prevailing
institutional rate of about five cents a share. At times, traders say, some
investors have paid commissions as high as 50 cents or $1 a share on
jumbo trades of hundreds of thousands of shares in the first few days
immediately after receiving IPO allocations.
In the past few years, regulators have scrutinized other types of IPO
abuses, such as "spinning" IPO shares to the personal brokerage accounts
of executives and venture capitalists in a bid to win business from their
firms. Regulators also have investigated whether Wall Street firms favor
large IPO clients by discouraging quick sales of new issues by individual
investors. But the payment of unusually large commissions to obtain IPO
shares could be easier to prove than activities in the previous investigations,
if there is a paper trail of allocations followed by extra commissions,
according to people familiar with the matter.
As part of the latest probe, the SEC and U.S. attorney's office are
examining whether commission payments linked to IPOs constituted a
violation of securities laws prohibiting undisclosed kickbacks, people
familiar with the matter say. If the violations were willful, the people say,
they could become the basis for criminal charges; violations that weren't
willful could be subject to civil penalties.
On a more technical level, the payments could also violate general
disclosure rules relating to IPOs. Prospectuses, the disclosure documents
provided to IPO investors, include a rundown on commissions and fees
being charged for the offering. The payments could amount to extra
undisclosed underwriting fees.
Credit Suisse First Boston emerged as a leader in underwriting technology
IPOs after tech investment-banking star Frank Quattrone joined the firm in
mid-1998. Other leaders in the IPO boom have been Morgan Stanley
Dean Witter and Goldman Sachs Group. People close to Morgan and
Goldman say neither of those two firms has received requests for
information from government agencies.
Some traders have recounted conversations with Credit Suisse First
Boston sales people, contending that they urged investors to boost their
commissions with the firm's trading desk, citing the investors' profits on
CSFB-led IPOs. Indeed, some traders say such "step-it-up" calls from
Wall Street firms to investors were not uncommon.
Robert Meglio, a trader at the Oracle Partners hedge fund, which
specializes in biotechnology and health-care stocks, said in an August
interview that his CSFB salesman told him: "You've made $2 million in
IPO profits, but you've paid us $500,000 in commissions." Mr. Meglio
added in the interview: "They were saying, 'Listen, can you step it up?'"
Mr. Meglio says he declined.
Responding to the account, CSFB said: "In the normal course of customer
relationships on Wall Street, sales people in any investment bank discuss
levels of business and ask for more business."
Write to Randall Smith at randall.smith@wsj.com and Susan Pulliam at
susan.pulliam@wsj.com
KJC |
