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NASD Proposes New Rules on IPO Allocations

Securities: Brokerage group is seeking to ban some practices by the investment banks that handle stock offerings.

July 29, 2002|From Bloomberg News

NEW YORK — The National Assn. of Securities Dealers approved rules that would ban some of the ways investment banks allot shares of initial public offerings, such as parceling them out in exchange for inflated commissions.

The rules, which require the approval of the Securities and Exchange Commission, would also prohibit firms from distributing IPO shares to a company's executives in return for future investment-banking business, and from penalizing small investors for selling shares in an IPO shortly after its debut while institutional investors aren't penalized for the same actions.

The NASD is putting forward the measures six months after regulators fined Credit Suisse First Boston $100 million for some of its IPO practices in 1999 and 2000. The proposals also come as U.S. stock exchanges and Congress draft new securities, accounting and corporate board regulations in a bid to restore investor confidence after a spate of corporate fraud scandals.

"This is part of the reaction to secure the barn door after the horse is gone," said Roy Smith, professor of investment banking at New York University. "They didn't pick this up yesterday afternoon. We've known about this business of allocating IPOs to potential or favored customers for a long time."

News reports first appeared in 1997 about the practice of "spinning," or allocating shares in an IPO to the personal brokerage account of a corporate or venture-capital executive and selling them the same day or the next day for a quick profit. The practice is an attempt to win future business from the executive's company.

Earlier this month, Level 3 Communications Inc. Chief Executive James Crowe said an investment bank that did business with the fiber-optic network operator bought and sold shares for him in an initial stock offering without his knowledge. Crowe, who didn't name the investment bank, said he voided the transaction as soon as he learned of it.

Crowe's statement came in response to a lawsuit filed by former Salomon Smith Barney Inc. broker David Chacon. The suit alleges that Salomon rewarded top officers of telecommunication investment-banking clients, including Crowe and WorldCom Inc.'s former chief executive, Bernard J. Ebbers, with thousands of shares in IPOs underwritten by the firm.

The NASD's new rules would require investment banks to file information regarding company executives and board directors who receive shares in IPOs. The information would be available to regulators, though not to the public.

The regulations are intended to "signal clearly to the industry what our concerns are," NASD Chairman Robert Glauber told reporters on a conference call Sunday.

"We [already] have on the books the kind of rules we need" to bring a case when IPO practices are abusive, Glauber said, citing the Credit Suisse First Boston charges and "half a dozen" ongoing investigations.

In January, Credit Suisse agreed to pay the fifth-largest penalty ever imposed by U.S. regulators to settle allegations that it charged commissions of as much as $3.15 a share, compared with a typical rate of 6 cents a share, in exchange for giving out shares in skyrocketing IPOs.

One difference the proposed rules would make is in the way individual investors are treated. Previously, the NASD had permitted securities firms to punish brokers whose retail customers sold shares in an IPO shortly after they received it by taking away the commission they earned, while not penalizing brokers with institutional clients who did the same thing.

Now the NASD is saying "as a class the individual investor may not be treated indirectly differently from institutional investors," said Mary Shapiro, who heads the NASD's enforcement division.

The proposals come two years after what Smith called "the hottest IPO market ever, which provoked the abuses." Back then, "you had lunatic conditions that bid these things up three or four times in the first day," he said. "You're not going to see that any time soon."

In 2000, investment banks arranged $99.8 billion of initial stock sales in the U.S., according to Bloomberg data. So far this year they've handled $26.2 billion.

The NASD will require its member firms to adopt procedures ensuring that its new rules are followed.

The NASD's rules follow proposals by the Nasdaq Stock Market and the New York Stock Exchange aimed at reducing conflicts of interest on corporate boards and legislation in Congress increasing penalties for corporate fraud. The legislation comes after accounting irregularities at Enron Corp. and WorldCom led the companies to file for bankruptcy protection.

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Taking Aim at IPO Practices

The National Assn. of Securities Dealers rules, which must be submitted for a period of public comment and approved by the Securities and Exchange Commission before they go into effect, bar:

* Quid pro quo agreements, in which initial public offering shares are allocated in exchange for "excessive compensation relative to the service provided by" the investment bank. That includes commissions.

* Aftermarket agreements, in which investment banks require investors who get an IPO to put in orders for additional shares once the IPO begins trading or otherwise support the IPO once it starts trading.

* Spinning, in which investment banks allocate shares in exchange for future or past business.

* Discriminatory treatment of small investors who "flip," or sell IPOs shortly after they debut for a quick profit.

Bloomberg News

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