WSJ/Page One Feature: CSFB Will Pay $100 Million to Settle Inquiry Into Firm's IPO Distribution
December 11, 2001
By SUSAN PULLIAM, RANDALL SMITH, ANITA RAGHAVAN and GREGORY ZUCKERMAN
Staff Reporters of THE WALL STREET JOURNAL
Few Wall Street players profited more from the technology-stock bubble than Credit Suisse First Boston. During the height of the boom, in 1999 and 2000, the powerful securities unit of Zurich's Credit Suisse Group reaped more than $700 million in fees for helping bring tech upstarts public -- far more than any rival.
Now the big securities firm is paying the price. CSFB has agreed to pay $100 million to resolve a federal investigation into alleged abuses in its distribution of shares of initial public offerings of stock, according to people familiar with the matter.
The proposed settlement marks the biggest regulatory crackdown on the excesses of the dot-com stock boom of the 1990s. And it foreshadows the issuance of new rules that could help level the playing field for small investors.
The pact grows out of an 18-month probe of whether CSFB gave favored investors larger shares of IPO stocks. In exchange, these clients allegedly kicked back part of their quick profits on IPOs to CSFB, in the form of inflated commissions on other stock trades.
The settlement, expected to be officially announced around the end of the year, is likely to include a pledge from CSFB to prevent future improprieties in selling IPOs. Details are being hammered out between the firm and both the Securities and Exchange Commission and the regulatory unit of the National Association of Securities Dealers over what the regulators will formally allege CSFB did. The charges are likely to include the underwriter's improperly sharing in the IPO profits of its customers and various bookkeeping violations. Spokespeople for CSFB, the SEC and the NASD declined to comment.
The payment -- which all sides have agreed to -- would rank as the fifth-largest regulatory settlement by a securities firm, underscoring the seriousness with which regulators viewed the allegations. As is typical in such pacts, CSFB would neither admit nor deny guilt.
"It's a stiff penalty," said Edward Fleischman, a former SEC commissioner and now a senior counsel at Linklaters, a London-based law firm. "That would quite clearly send a very strong message."
In the tech-stock boom, Wall Street securities firms helped nourish companies whose market value once reached $400 billion before melting in the past 20 months. Investors who received extra-large shares of hot IPO stocks had more of an opportunity to rake in big profits before the bubble burst.
The sort of deals CSFB allegedly did with its preferred customers also helped whip up a frenzy over who was getting special access to tech IPOs. Many small investors ended up as losers when they rushed to buy those new stocks just as the favored customers were selling.
0See a timeline of key points in the probe of IPO allocations on Wall Street
***
1At CSFB, Lush Profits From IPOs Found Their Way Back to the Firm (Nov. 30)
2How a Routine Review of CSFB Turned Into a Sweeping Probe (Nov. 30)
3CSFB Won't Face Criminal Charges in Probe of Initial-Offering Abuses (Nov. 29)
4Latest IPO Boom: Number of Suits Alleging Abuses by Underwriters (Nov. 29)
5SEC's IPO Investigation Advances on Two Fronts (Nov. 28)
The CSFB settlement represents an unusual action against alleged abuses in a major Wall Street firm's bread-and-butter business of handling the issuance of securities. Most such disciplinary cases involve small, obscure firms allegedly engaged in "boiler-room" operations to cheat individual investors, regulators have said.
Now, regulators appear set to rewrite the playbook for IPOs, one of Wall Street's most lucrative businesses. Murky regulations and financial-industry secrecy have allowed a backroom culture of IPO side deals with customers to flourish.
Following the announcement of the CSFB settlement, securities regulators are expected to issue new rules on how Wall Street awards shares of IPOs to its customers. The rules are likely to encourage broader distribution of IPOs and limits on deals favoring certain clients, people familiar with the situation said.
Meanwhile, the cost to CSFB could far exceed the settlement. Wall Street firms, including CSFB, face more than 1,000 lawsuits seeking class-action status, brought on behalf of investors in 263 companies that went public during the boom. The suits typically allege that the firms manipulated IPO shares in deals benefiting preferred investors. The potential tab in these cases could be steepest for CSFB, the leader in the tech-securities business. CSFB and the other Wall Street firms have denied the allegations in the suits.
Beyond the lawsuits, other Wall Street firms face more regulatory scrutiny of their IPO practices, as well. In another leg of its civil investigation, the SEC is looking at whether other firms manipulated trading by giving IPO shares to customers willing to buy more of the same stock once it started trading. Such promises of "aftermarket" purchases would help boost the stock price in the weeks and months after the IPO.
That prong of the probe, which is at an earlier stage, focuses on Goldman Sachs Group Inc., Morgan Stanley, J.P. Morgan Chase & Co. and the Robertson Stephens unit of FleetBoston Financial Corp., according to people familiar with the situation. The firms all declined to comment.
For CSFB, the pact will close a difficult chapter. As its executives have grappled with a turbulent period on Wall Street, they have also fretted about limiting the damage from the IPO case.
The settlement is large but won't crush CSFB. The $100 million compares to $717.5 million the firm earned in fees for underwriting tech IPOs in 1999 and 2000, according to Thomson Financial.
As part of the settlement, CSFB is expected to avoid civil securities-fraud charges. Instead, regulators are likely to allege that CSFB committed other violations of securities laws, including a prohibition against Wall Street firms sharing in the IPO profits of its customers. Unlike some other major regulatory cases, none of the $100 million -- which includes civil fines and disgorgement of profits -- will go toward a fund for aggrieved investors. Rather, it will go into the U.S. Treasury and the NASD's coffers.
Investigators began focusing last year on CSFB's alleged practice of awarding shares of hot IPOs to some investors who agreed to pay the firm large commissions on other transactions. As detailed in a series of Wall Street Journal stories beginning in December 2000, some of these commissions came on big batches of trades at hugely inflated rates.
For example, an investor favored in an IPO would pay CSFB as much as $2.75 a share to trade other stocks, compared with the typical five or six cents a share a big institutional client would pay to trade the same stocks. Regulators concluded that the oversize commissions were a way for the investors effectively to pay back to CSFB a portion of their IPO profits at a time when IPOs were soaring in value.
Regulators have found it difficult to bring fraud charges over major Wall Street firms' IPO practices, in part because they must show a clear intention to violate securities law in a fraud case, according to people familiar with the situation. In the CSFB case, regulators have struggled with what law to apply to the firm's practices. In recent weeks, the Manhattan U.S. attorney's office decided not to bring criminal charges against CSFB and closed its own investigation into whether the firm had taken illegal kickbacks.
The relatively quick settlement in the civil case, which began in mid-2000, is partly a reflection of the desire by new SEC Chairman Harvey Pitt to bring enforcement actions swiftly. He has said his goals are to prevent future infractions and help securities firms minimize the harm from lingering investigations.
The Sept. 11 terrorist attacks destroyed the New York office of the SEC, where many of the documents in the IPO investigation were stored. SEC staffers had to scramble to reconstruct their files, with some working at home for several weeks.
CSFB already has taken a number of steps to make a settlement possible. In July, its parent, Credit Suisse Group, ousted CSFB chief executive Allen Wheat. He was replaced by former Morgan Stanley executive John Mack. Mr. Wheat had been criticized for a series of run-ins with regulators in the U.S., Europe and Asia, culminating in the IPO case.
Mr. Wheat declined repeated requests for comment for this article. But in late summer, he told a former company official he believed the regulatory scuffles on his watch had arisen from the firm's fast growth, which led to a "chaotic" atmosphere during the past two years, according to the former official.
CSFB's freewheeling ways "were early warning signals that the aggressiveness of the organization was testing the regulatory limit," said Michael Holland, another former First Boston official, who now runs his own money-management firm. Under Mr. Wheat, he added, "the controls that were part of First Boston's previous culture were lessened in the pursuit of success."
Mr. Mack quickly took steps to pave the way for a settlement, such as hiring former SEC enforcement chief Gary Lynch as the firm's new general counsel.
Another high-profile CSFB official, star technology banker Frank Quattrone, isn't likely to face charges in the case, according to people familiar with the situation. Mr. Quattrone's group received attention after three of its San Francisco brokers were fired in connection with the IPO probe.
Mr. Mack gave Mr. Quattrone his personal endorsement last month, just before federal prosecutors dropped their criminal probe. Messrs. Mack and Quattrone declined to comment.
While Mr. Wheat held the reins at CSFB -- as president from 1993, and later as CEO -- he helped to cultivate a risk-taking culture that emphasized quick profits and market-share gains. Among the side effects, some Wall Street executives have said, was loose oversight of compliance.
Mr. Wheat embarked on a risky strategy to lure top bankers and traders by paying them more than any other firm and giving them unmatched independence. Trolling the halls at CSFB's plush offices in Manhattan's Flatiron district, he routinely stopped executives to ask: "How much did you make for us today?" according to former employees.
One of Mr. Wheat's more controversial moves was the special deal he cut in 1998 for Mr. Quattrone. The prominent tech banker wanted his own brokerage force, his own press people, oversight of the firm's technology research analysts -- and a cut of his group's banking and trading revenue. Some Credit Suisse executives were wary of Mr. Quattrone's conditions. But Mr. Wheat dismissed these concerns.
Such moves helped increase the firm's prominence in such areas as tech-stock underwriting and helped it rise to No. 4 in overall underwriting fees in 2000, from No. 5 in 1997. But additional profits proved more elusive. CSFB's revenues rose 71%, to $12.2 billion, between 1997 and 2000. Its profits inched up only 17%, to $1.41 billion, during that period.
The IPO investigation traces its roots to a look by the NASD at Wall Street's practice of awarding hot IPO shares to the personal brokerage accounts of executives at potential investment-banking clients. That earlier probe, into what is known as "spinning" IPOs, hasn't resulted in charges, partly because securities law is unclear about the issue, regulators said.
Initially, Mr. Wheat played down the gravity of the IPO inquiry in the U.S. He told colleagues the focus on CSFB reflected the aggressiveness of the NASD's regulatory arm. Once the SEC emerged as the primary investigator, Mr. Wheat said, other securities firms would be under the gun as well.
But by this spring, CSFB remained the focus of regulatory interest in the probe, even after it became clear that the SEC and federal prosecutors were involved.
Mr. Wheat's bosses in Zurich began to pressure him. At a meeting at Credit Suisse's Zurich headquarters, Lukas Muhlemann, chairman of parent Credit Suisse Group, asked Mr. Wheat point-blank if the firm had run afoul of regulations in allocating IPOs. "You have to get your hands around this," Mr. Muhlemann told Mr. Wheat, according to a person at the meeting.
Apart from the IPO probe, CSFB's Swiss owners were getting frustrated over the firm's results. Profits had lagged behind those of other Wall Street firms because of the expensive $13 billion acquisition of Donaldson Lufkin & Jenrette Securities Inc. in November 2000.
Mr. Wheat didn't see the end coming, according to former aides. At a dinner this summer with some of his bond chiefs in Manhattan's tony Danube restaurant, he sounded upbeat, telling them, "We're going to put this behind us."
A few days later, Mr. Muhlemann told him he was fired.
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The Path of an Investigation
Key points in the probe of IPO allocations on Wall Street:
Mid-2000:6 Regulators led by the SEC and the U.S. Attorney's office in Manhattan begin probing whether Wall Street firms sought outsize commissions as kickbacks for distributing shares of sought-after initial public offerings of stock, or IPOs.
December 2000:7 SEC expands IPO probe to include allegations that Wall Street also required some IPO recipients to submit orders for additional stock after trading began, a practice known as "laddering." The probe follows a page-one Wall Street Journal article on this aftermarket practice.
March 2001: Regulatory unit of the NASD notifies Credit Suisse First Boston and six or more of its employees that they may be charged with rule violations for charging big commissions in exchange for shares of hot IPOs.
April 2001:8 CSFB, an early focus of the IPO probes, suspends, then later terminates, three brokers amid evidence they violated firm's policy on IPO allocations.
July 2001:9 Credit Suisse Group sacks Allen Wheat as head of CSFB, replacing him with former Morgan Stanley President John Mack.
August 2001:10 Mr. Mack hires former SEC enforcement chief Gary Lynch in a move that could help firm negotiate a settlement to the IPO case.
November 2001:11 Four major securities emerge as a focus of the "aftermarket" IPO probe; settlement talks heat up between CSFB and regulators on the IPO-kickback probe.
December 2001: CSFB moves to finalize a civil settlement with the SEC in which it will pay a $100 million fine, without admitting or denying charges involving improperly sharing IPO profits with customers and books-and-records violations.
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Write to Susan Pulliam at susan.pulliam@wsj.com12, Randall Smith at randall.smith@wsj.com13, Anita Raghavan at anita.raghavan@wsj.com14 and Gregory Zuckerman at gregory.zuckerman@wsj.com15
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